Targeting financial stress as opposed to the exchange rate

This paper analyses the role of monetary policy in targeting financial stress as opposed to the exchange rate in South Africa. This is achieved by augmenting the central bank’s monetary policy reaction function with the composite indicator of financial stress and the nominal bilateral exchange rate between the US dollar and the South African rand. The results show that the monetary authority adopts an accommodative monetary policy stance in the face of financially stressful economic conditions. The paper further finds a statistical insignificant as well as negligible reaction of the nominal bilateral foreign exchange rate to the changes in the monetary policy interest rate. The paper concludes that, although evidence exists that the monetary policy interest rate in South Africa has reacted to both the indicator of financial stress and the nominal bilateral foreign exchange rate, the impact of such a reaction seems to be more significant on the indicator financial stress as opposed to the exchange rate.