This paper investigates the effectiveness of monetary policy on house prices in South Africa before and after financial liberalization, with financial liberalization being identified with the recommendations of the De Kock Commission in 1985. Using both impulse response and variance decomposition analyses performed on Structural Vector Autoregressive (SVAR) models, the paper finds that irrespective of house sizes, during the period of financial liberalization, interest rate shocks had relatively stronger effects on house price inflation. However, given that the size of these effects was nearly negligible, the result seems to indicate that house prices are exogenous and, at least, are not driven by monetary policy shocks.

In the last four decades or so, South Africa, like many other industrialized and developing countries, has experienced large changes in house prices. It is generally believed that changes in monetary policy have been an important factor behind the inflation and deflation of house prices. In addition, it is also agreed that financial liberalization may have played a direct role in these fluctuations (International Monetary Fund, 2000; and Iacoviello and Minetti, 2003). But little, if not nothing, seems to be known, especially for South Africa, on the possible (indirect) role that financial liberalization could have had in affecting the sensitivity of house prices to monetary policy decisions. This paper takes a preliminary step in investigating this issue. Note, following Ludi and Ground (2006) and Du Plessis et al. (2007), liberalization of the domestic financial sector in South Africa has been identified with the recommendations of the De Kock Commission in 1985, which suggested the abandoning of quantitative controls in favor of market-based instruments.

The main aim of this analysis is to deduce whether monetary policy plays an important role in affecting house price inflation in South Africa, and whether or not the result is sensitive to deregulations in the financial market. The importance of the analysis lies in determining whether house price inflation is purely exogenous, i.e., explained only by itself, or is determined by monetary policy actions. The question is particularly relevant for South Africa, given its inflation targeting framework, and with housing being an important component of the Consumer Price Index (CPI) (Appendix 1). Moreover, recent studies on housing market, business cycles and monetary policies by Iacoviello (2002) and Iacoviello and Minetti (2008) indicate that the housing market might have an important role to play in the monetary transmission mechanism, especially the bank-lending channel of monetary policy. Hence, our analysis also aims to form the prelude to more elaborate analyses of the credit channel of monetary policy in the South African context by accounting explicitly for the role of housing market and financial liberalization. Note, movements in the housing market are likely to play an important role in the business cycle. This is not only because housing investment is a very volatile component of demand (Bernanke and Gertler, 1995), but also because changes in house prices tend to have important wealth effects on consumption (International Monetary Fund, 2000) and investment (Topel and Rosen, 1988). Hence, if we do find worthwhile impact of monetary policy shocks on house price inflation, it would make a strong case for analyzing the credit channel of monetary policy in South Africa by incorporating variables relating to the housing market.

Monetary Economics Journal, Financial Liberalization, Monetary Policy, Domestic Financial Sector, Financial Market, Consumer Price Index, International Monetary Fund, Monetary Transmission Mechanism, Financial Regulation, Gross Domestic Product, GDP, Emerging Market Economies, Financial Deregulation, Housing Market.