An investigation into the ability of the reverse yield gap to forecast inflation and economic growth in South Africa

Abstract

Background: Monetary policy in South Africa is carried out by the South African Reserve Bank (SARB) with the aim of keeping inflation within a target range of 3% – 6%. The SARB uses a variety of models to aid them, with the core model being the most significant. Aim: The primary aim of this research is to determine whether the reverse yield gap (RYG) contains information that could be useful to the SARB when making monetary policy decisions. Setting: The authors found no evidence that similar studies on the RYG have previously been done in the South African context. Since the yield curve has been found to be significant in South Africa at forecasting economic growth, yet insignificant in Europe, the results for this research may too be different to the global experience. Methods: The authors tested for linear relationships between the RYG and economic growth and inflation over the period 1960–2014. Results: The results indicate that a slight linear relationship may exist in the case of economic growth, with the RYG based on earnings yields showing better out-of-sample forecasting abilities. Further investigation indicates that the linear relationship is stronger during times of economic upturn. The results for inflation forecasting, however, show no signs of a reasonable linear relationship. Conclusion: There is evidence for the SARB to consider whether the RYG can replace other economic variables in its core model without loss of predictive ability. Interestingly, this study found evidence to suggest that the RYG has an inverse relationship to future economic growth in South Africa, which is not what was expected.