ABSTRACT
South Africa has a very well-developed financial sector and high reliance on capital flows. The country saw large capital outflows as the Covid-19 crisis developed, accompanied by a large depreciation of the rand and spikes in bold yields. We employ a stock- and flow-consistent model to study the impact of capital flow reversal shocks on the South African economy. The model includes a richer representation of institutional balance sheets than existing models. The financial sectors behaviour in the model draws on the theoretical frameworks, which highlight the relationship between bank capital, the risk-taking behaviour of the financial sector, lending spreads and economic activity. We specify a dynamic adjustment model of household expectations with properties that differ from the way in which expectations are formed in either stock- and flow-consistent or (DSGE) models. Household expectations resemble bounded rationality. The financial accelerator mechanism operates through the balance sheets of all institutions in the economy. We find that a reversal in capital flows can affect the domestic economy through its impact on domestic liquidity, on the risk-taking behaviour of the financial sector, and on the demand for assets.
