South Africa's real business cycles: The cycle is the trend

This paper tests the `cycle is the trend' hypothesis. We investigate how far permanent and transitory productivity shocks can account for the dynamics observed in the South African business cycle over the period 1946--2014. By estimating a standard small open economy real business cycle model and its financial frictions augmented counterpart, we show that permanent productivity shocks are more important than transitory ones in explaining this country's business cycle fluctuations. This finding supports the `cycle is the trend' hypothesis in the South African business cycle. The model with financial frictions successfully mimics the downward-sloping high autocorrelation of trade balance to output ratio observed in the data, whereas the benchmark model produces a flat autocorrelation function. Financial frictions such as country risk premium shocks help to explain the fluctuations in investment and in the trade balance to output ratio.