The effect of monetary policy on output using sign restriction VAR: evidence from South Africa and South Korea

This paper estimates and contrasts the effects of contractionary monetary policy shocks on output in South Africa and South Korea, using a sign restriction VAR approach. I use quarterly data spanning 1980Q1 to 2010Q3. I investigate how much output movements are induced by monetary policy shocks. The main findings reveal that contractionary monetary policy shock significantly depresses real output for many quarters in South Africa. However, output declines insignificantly and transitorily in South Korea, indicating monetary neutrality. I attribute this difference to the transitory responses of both the monetary aggregate M2 and the exchange rate to a monetary policy shock in South Korea compared to South Africa. This implies that each country, despite targeting inflation, has a different monetary policy reaction function. Evidence shows that the monetary policy shocks explain a large portion of fluctuations in output in these emerging market economies compared to those reported for advanced countries by Uhlig (J Monet Econ 52(2):381–419, 2005) and Rafiq and Mallick (J Macroecon 30:1756–1791, 2008). Lastly, I examined the reasonableness of the estimated monetary policy shocks. Evidence indicates that the estimated monetary policy disturbances capture certain monetary policy activities based on selected major historical and recent real-time macroeconomic shocks.