The impact of real exchange rate volatility on unemployment in South Africa : (Garch Model)

Abstract

How macroeconomic models are relevant when pursuing the understanding of exchange rate has been doubted by a large portion of research since the beginning of the 1980 s. This dissertation investigates the impact of the real exchange rate volatility on unemployment in South Africa. Since the two variables are linked with the changes in output and price levels through the production function, this dissertation also covers theories that link the subjects with macroeconomic variables that cannot be ignored when analysing unemployment and exchange rates, such as economic growth, inflation, terms of trade and government expenditure. By so doing the study employs econometric instruments in measuring the relationship between the variables at hand. The Ordinary Least Square (OLS) technique will be used to get the model s numerical estimates. Argumented Dicky-Fuller stationarity test will be adopted for unit root testing and the Johansen Causality test will be used to test for the direction of causality between the variables. The vector error correction model is employed to examine the existence of a relationship amongst the variables. Finally the study incorporates the GARCH model to test volatility between unemployment and real exchange rate as well as the relationship between the variables. This study is intended to contribute to the growing body of research about South Africa s past experience with the problem of exchange rate volatility. The outcome may provide guidelines and lessons for South Africa. The GARCH model test results indicate that unemployment is insignificant, as such non-volatile. It further suggests that there is an inverse relationship between unemployment and Real Exchange Rate. There is a significant positive relationship between GDP and unemployment. The economic theory however does not agree with these findings because an increase in GDP is expected to decrease unemployment. There is however a negative and significant relationship between unemployment and export and this happens to be theoretically correct. The study found a negative and statistically significant relationship between CPI and unemployment. These finding agree with the literature of Philips (1958) which means an increase in the level of export is associated with a fall in unemployment.