Tickle tickle - how monetary policy announcements could go wrong

Interest rate announcements and forward guidance
In this post I look at a potential problem central bankers face. Hint: it has to do with forward guidance - the way a central bank communicates its interest rate decisions to us. I picked the South African Reserve Bank's (SARB) latest (April 2015) Monetary Policy Review (MPR) to highlight these issues. The MPR, I think, tells us that everyone should be aware of a rate tightening cycle. Is it nice of them to "warn" us of an impending rate hike? Does it intend to adjust our expectations? Or can it backfire? Let's start by looking at some of its communication tools:

The fan chart:

Fan charts look pretty cool. Fan charts are sometimes used as a forecasting tool and depicts various paths of a variable with a confidence interval. It looks something like the figure below (source: 2015 MPR, SARB). The dark line is the median of the forecast while the lighter areas represent increasing confidence intervals. An easy way to think of this is by inverting the figure and plot a bell shaped curve where the light areas measure the standard deviation.

Why would a central bank produce such a figure ? 1.) It acknowledges that models are only partial representations of reality and that significant forecast errors exist (inflation is forecast to be anywhere from 3% to about 11% in 2017); 2.) to communicate what it might possibly do with interest rates (only if the central bank targets inflation). The fan chart produced below is a split-normal distribution (i.e. it is not perfectly symmetrical on both sides of the median). In fact all the "risk" to the forecast seems to be on higher inflation. Depending on how seriously the SARB takes these forecasts, it could mean that is pricing in a high probability of an interest rate increase.

Announcements or hints

In the latest MPR from the SARB: "Underlying inflationary pressures are resilient and expectations have converged at the top of the target range. This makes a sustained breach of the inflation target more likely...Given all these factors, monetary policy remains in a tightening cycle". There might be a slight contradiction in this statement - if expectations have converged at the top of the target then why would we have a sustained breach of the target? Converged expectations mean anchored expectations (admittedly at the upper limit of the target). Some models allow for backward indexation in the hybrid Phillips curve (more on this later), which means that past inflation and future inflation affects current inflation.

Sounds like the SARB wants to increase interest rates...

This sounds to me like the SARB is seriously thinking of increasing interest rates. Is this what we call forward guidance? The SARB does not make an explicit statement regarding interest rates. The fact that the fan chart for inflation ranges between 3% and 11% suggests that there is huge monetary policy uncertainty (monetary policy uncertainty is a shock over and above actual changes to interest rates see this).

On the one hand the SARB in their models often target expected inflation as opposed to realised inflation. If they believe inflation in the future (say 18 months from now) is above the target level they might very well increase interest rates. However, if they announce that they are in a tightening cycle and consumers and firms believe them, then economic participants might decrease consumption. Especially when higher expected interest rates affect credit and investment decisions. In this case expected inflation should decrease. Thus, consumer and firm decisions are conditional not only future inflation but also future interest rates.

This makes monetary policy incredibly difficult and somewhat counteracts forward guidance. Since the information set that monetary policy makers face is too big to make useful numerical estimates of inflation, they often revert to simple models. The modelling team at a central bank will usually produce inflation and output forecasts and then the MPC will decide on the interest rate path. It would be interesting to do a study the deviations of the policy advice coming from these models from the final MPC decision.

How do we create such a figure?
With a model that captures economy-wide effects. The smallest of such a model includes an equation for interest rates (Taylor rule), for inflation (Phillips curve equation) and output (IS equation).

• Taylor rule: Interest rates are set according to a rule that weights both inflation and output (usually output deviation from potential output) and a disturbance term (which could capture monetary policy uncertainty depending on how the model is solved). The parameters that fit the equation are of particular interest. In many estimates of the equation, interest rates increase by more than 1% for a 1% increase in inflation. An estimate lower than 1 often yield indeterminate equilibria (not a single path solution for the variables).
• Phillips curve: Inflation is a function of future (and sometimes past) inflation and output. If output is above potential output than inflation increases.
• IS curve: Output is a function of the real interest rate (repo rate minus inflation) and future (sometimes past too) output.

To generate the figure the SARB has to make an assumption of the underlying distribution of the disturbance terms. They may decide that all shocks can be drawn from a multivariate normal distribution and solve the model many times. With an adequate amount of solutions they can plot the distribution of the forecasts for each variable. 

So what?
Here is the tricky part: Inflation has been pretty stable around the 6% mark for a while. This has happened despite many negative shocks hitting the economy. Interest rates have also remained pretty much at a similar level. Is this proof for the Neo-Fisherian school (inflation in the long-run follows the monetary policy rate)? Thus when interest rates go up, there might be a little fall in inflation, but then inflation increases. This could be further substantiated by looking at stationary path of inflation. It seems as though inflation is a mean reverting process, but it takes a long time to revert to its mean following a shock.

Using the equations specified above, I illustrate two features of monetary policy: 1.) what happens to the economy when the SARB increases interest rates temporarily where the shock is unanticipated and 2.) where there is a permanent shock while it is anticipated (people have perfect foresight; or the SARB guides the public's expectations).

Scenario 1 is depicted in Figure 1. The results seem pretty standard: An increase in the repo rate decreases inflation. However, Figure 2 shows that an increase in interest rates lead to an increase in inflation. Hmmm...why? This is the idea of the Fischer identity in most central bank models: r=i-p (where r is the real rate, i is the nominal rate and p is inflation). Once we rearrange this identity and make p the object of interest, an increase in i will increase p and vice versa.

Figure 1

Figure 2

  What does all of this mean for forward guidance?
There are some who claim that the SARB has not been able to anchor expectations (Kabundi and Schaling, 2013) and some who claim that the interest rates do not affect inflation as expected (Bonga-Bonga and Kabundi, 2015). If these claims are right then it should matter little what the SARB communicates to the public. Inflation adjustments will simply be backward looking.

If the SARB is very credible and can influence expectations then it still faces some tough decisions. With a perfect foresight model inflation could simply follow interest rates (assuming that the Fisher identity holds). Or people might see the possible hike as a signal for higher inflation in which case firms adjust prices to higher inflation expectations. But, we see that short run unanticipated shocks reduce inflation. The Fisher effect works only really in the long run. The SARB nudges interest rates to control for various shocks, and as such perfect foresight models are not always ideally suited to reality. Models with bounded rationality or learning might be better suited to analyse the economy where some foresight (i.e. SARB forward guidance exist).

On the other hand forward guidance may lead to a reduction in inflation as the potential hike makes consumers and investors cut back on credit and spending now, thus lowering inflation expectations. If the SARB then does not react to its initial "guidance" then it could hurt its credibility and may not be able to anchor inflation expectations.

Perhaps the SARB is much smarter than we think- it knows how to influence our expectations and thus are perfectly aware of what the effects of policy announcement are. I for one am waiting for a paper on this.

References

Kabundi, A. and Schaling, E.(2013). Inflation and inflation expectations in South Africa: an Attempt at explanation. South African Journal of Economics, 81(3): 346-355.

Bonga-Bonga, L. and Kabundi, A. (2015). Monetary policy instrument and inflation in South Africa: Structural Vector Error Correction Model approach. Munich Personal Repec Archive, MPRA Paper No. 63731.

South Africa's economic time bomb

Ok. So it has been a while since I last posted anything. I needed a break. But I am back and I have been fuming over recent South African events. One cannot help but be affected by the political turmoil at home. A lot of people complain about South Africa's economic woes, but few offer simple viable solutions. This post summarises some policy proposals.

South Africa's policy prescriptions - what should they be? South Africa followed a standard textbook example in responding to the financial crisis in 2008/09. Its demand side policies consisted of: (1) Decreasing the primary balance and run consecutive deficits; (2) Decreasing monetary policy interest rates to historic lows and keeping them there (except for one weird 25 basis points hike that seemed to match what our emerging partners were doing); (3) Allowing the exchange rate to depreciate substantially in the hope of generating foreign demand for locally produced goods.

Apart from following the standard textbook model South Africa also had to cope with new banking regulations put forth by Basel. The government continues to delay much needed electricity supply (bad management is to blame, although it looks a bit ridiculous that the Treasury keeps missing the implementation date of the new power stations). It had to deal with sovereign debt downgrades (explains one part of the weak exchange rate story) up to the point where we are one notch away from being non-investment grade (S&P) and two notches away according to Moody's (admittedly I think the rating agencies have made a mistake on this one - South Africa was not close to any default - but bad ratings increases the likelihood of default - this to me implies that the rating agencies are trying to create a self-fulfilling prophecy). It seems like the Treasury has caved a bit under pressure by increasing tax rates at a time when the economy is hardly growing - in my view a mistake by the Treasury. Inflation at its upper limit of the target range also increased the pressure to raise wages (at a time when government is trying to reduce the deficit). Let's leave aside all the political turmoil for a moment and analyse what, if any, additional measures the government can take to speed up the economy.

Suspend ridiculous wage demands temporarily. One thing is certain; the wage hikes do not match productivity growth - the economy is forecast to grow 2% in real terms while wage demands exceed inflation by anything above 3% (inflation seems to fluctuate around 6%). Perhaps it is government's strategy to reduce income inequality by increasing wages rather than growing the economy, decreasing unemployment, keep inflation stable etc. The consequences of higher wages when economic activity is suppressed = higher unemployment. The demand for labour in standard textbook economics depends on maximizing productivity subject to inputs (wages and labour, capital and rent). Higher wages reduce company profits and reduce expansions. Now take a low growth environment and add business pressure by increasing wage demands...unemployment bam! We are already witnessing lower growth in government employment amidst an increase in the working age population.

South Africa has a low savings rate and consumers are current consumers (i.e. the spend most of what they earn rather than save). When wages are indexed to inflation and consumers do not save we have a situation where inflation increases - which will lead to higher wage demands, which will lead to higher inflation etc. (you get dizzy swirl). We need to note two additional features of the South African economy - despite the very weak exchange rate (historically) the current account deficit has not subsided. Those sneaky economists who wish to invoke the J-curve as an explanation has ran out of time - we have had a persistent depreciation for a long time. Exports have increased - but imports have increased too. Thus add the high wage growth to the weak rand and you would expect higher inflation. Note that inflation is rather high given that potential and actual GDP growth is already low.

      Lower the inflation target. If wage spirals become a serious concern then the SARB should lower the inflation target. There are many reasons for doing this (admittedly many reasons to keep it this high too). A high inflation target is often associated with more volatile inflation (in contrast to keeping inflation stable -wink wink SARB). Yes I know that inflation has been lower and more stable since SA adopted inflation targeting. I am saying that it can be lower and even more stable by simply lowering the target (see http://www.voxeu.org/article/how-are-inflation-targets-set). Anchored inflation expectations at a lower rate also mean that interest rates should be lower. The costs of higher inflation seem to outstrip the benefits substantially (these include the costs of adjusting prices, investment uncertainty, higher debt service costs, discourages savings, higher taxes due to bracket creep etc.). In addition, an inflation rate of 6% implies that R1 will be worth less than 50 cents in twelve years from now (i.e. value of assets are halved every twelve years if there is no interest compensation).

      Make banking more competitive. Banking costs in South Africa constitute a crime in my books. The fact that almost all the banks charge similar interest rates on loans and provide ridiculously low savings rates is a modern day travesty. Millions of household face unreasonably high interest payments on their loans because (1) credit access rules are not stringent enough and (2) because interest rates are super high. The banks don't seem to care that much since households meet their liability obligations even if it leads to debt traps. Now take whatever savings you have and deposit it into a bank account...oh crap after a few years you will have less in real terms since you started depositing funds because inflation is higher than deposit rates...is it then strange that South Africa has such a low household saving rate?

Education - need I say more? Sustainable and high long term growth depends on good education. No, not access to education (South Africa has done a decent job), but quality of education. The economics department of the University of Stellenbosch has done a lot of good research on this topic. Unfortunately there seems to be a widening gap between the academic view and the government. Our children do not compete well against our African neighbours in standardised tests. We don't have enough teachers and we don't have good teachers. South Africa already struggles to absorb labour. A lot of South Africans are simply unemployable (we don't have jobs that match the supply of unskilled labour). We will have to contend with generations of unskilled labour the more we procrastinate on fixing the education system. This too is a crime against children who deserve to have a decent education. I am sorry to say, but the ANC is still messing up and is hardly taken to task.

Implement a rules based fiscal policy. South Africa's budget system is one of the world's most transparent systems. However, as with any forecast it had to adjust its fiscal figures on many occasions. If the government says that debt will be x% next year and debt comes out as x%+5% then it might lead to credibility issues. Uncertainty, whether caused by government or not, does not sit well with institutional investors and rating agencies. To address these uncertain terms government has to offer handsome returns for holding bonds. Debt service costs have become one of the biggest expenditure items which avert resources away from investment spending. To make government more credible it could be more specific about its expenditures and implement a rule that is not too stringent when forecast errors occur (something that is inevitable). Each province and municipality should be held accountable for its expenditures and revenue collection. We see that municipalities do an excellent job at remunerating its workers, but do not spend on service delivery or investment (once again making the argument that wage growth should be tied to productivity as opposed to inflation). This is an increasing trend which begs the question of whether government should become more centralised. What is the use of having a decentralised government if it cannot meet its objectives? The taxpayer foots the salary bill of high paying officials that simply renege on their obligations and responsibilities. Pooh pooh!

Increase the VAT rate dammit. What tax is least distortionary? What tax exempts certain goods from being taxed? What tax has a low rate? What tax base as a percent of GDP is seriously high? What tax could possible nudge people to save more if its rate increased? What tax could cover a lot of silly expenses such as e-tolls without having to burden specific users when the whole country benefits in economic terms from improved traffic flow? What tax could decrease the fiscal pressure to consolidate? Hmmm...oh can it be Value Added Taxes? You bet! But why does the government increase capital gains when it hardly makes a dent in the deficit? And what is up with small increase in income taxes - it sounds like it is more of a signaling thing and not meant to change behaviour. VAT has a single rate that all people face. Certain goods, such as food for sustenance, are VAT exempt or zero rated (there is a difference between the two), which means that the poor are not that adversely affected. Internationally, South Africa has relatively low VAT rate, although it is one of the government's main sources of revenue. This is only because the VAT tax base, consumption, is very high. Increasing VAT is not a panacea for South Africa's current economic woes, but it will lessen the pain somewhat - like morphine for a severely injured patient. I really do not understand why the government hesitates to increase VAT, but quite easily increases taxes that hurt the economy while collecting very little revenue...really!

Obviously policy decisions are more nuanced. The fact remains that other countries are able to implement small changes with huge economic benefits. The Treasury and the SARB have excellent policy makers and academia reminds the government that implementing certain policies is beneficial to all. The ANC for some logic-defying reason resists these proposed changes. Instead it seems that the ANC is intent of focusing on weird redistributive policies such as BBBEE and land ownership. They are weird because the benefits have not been quantified and the majority of the country is still poor. Imagine if the ANC instead focused on simple growth strategies. Redistribution will improve and wealth will increase. I think the ANC do this to their detriment and they will bleed votes because of a lack of policy foresight and additionally slow economic growth for decades to come. Sad really. 

Oil - always in a pickle

Watching oil prices change is very entertaining. Oil prices over the last few months have declined sharply. It almost looks odd when we look at the data. I for one cannot help wonder why oil prices decline so sharply over such a short period of time.

Another interesting aspect is that there are large standard deviations and the mass of the distribution seems to be around $100 (this is only from 2007 and is not the growth in oil prices). 

James Hamilton at Econbrowser argues that a fall in the demand for oil is partly to blame for the lower oil prices. The US Energy information agency also shows that US oil production has increased quite sharply.

Despite various assertions I am still a bit sceptical that oil prices would plummet that quick because a few countries have economic problems. For one, the world economy has not recovered to pre financial crises levels and two we have not discovered a major oil resource in the last three months where production has increased. Sure demand for oil might be weakening due to slower world economic growth - but the major consumers of oil (mainly the Western and Northern hemispheres) are in their winter months. This means that the demand for gas will surely increase. On top of that, US economic growth has improved quite a bit - suggesting that the demand for oil should increase.

I tried to get an update on oil consumption and production, but the latest available (and free) data that I could found was until October. The interesting months were November and December. Another interesting observation is the increased volatility in the NYMEX oil open interest contracts. Now it seems that even traders are trying to profit from these swings (when haven't they?).

Finally, one might be tempted to see a correlation between oil prices and the debt problems in Venezuela and the sanctions against Russia - something for the conspiracy theorists. A Bloomberg and a FT story discuss the debt agreement between Venezuela and the Dominican Republic (has to do with oil). The intermediary is Goldman Sachs (the same guys that once upon a time announced that there was a real likelihood that oil prices will hit $200 per barrel). Basically with the fall in oil prices the debt swap is done at a massive discount (not good for Venezuela). Furthermore, oil is one of Russia's biggest export commodities - the fall in oil prices will surely hit their economy hard. But of course all of this might be simple coincidence...

Sources:

http://blogs.ft.com/beyond-brics/2014/12/03/venezuelas-new-best-friend-goldman-sachs/

http://www.bloomberg.com/news/2014-12-04/venezuela-said-to-discuss-swapping-dominican-oil-debt-for-cash.html

http://econbrowser.com/archives/2014/12/supply-demand-and-the-price-of-oil

https://www.quandl.com/

One the convergence between the Christian equality and the material equality

Kierkegaard in Work of Love (2009 - Harperperenial; p. 82-83) writes that "it [Christianity] allows all distinctions to stand, but it teaches the equality of the eternal. It teaches that everyone shall lift himself above earthly distinctions. Notice carefully how equably it speaks. It does not say that it is the poor who shall lift themselves above earthly distinctions, while the mighty should perhaps come down from their elevation - ah, no, such talk is not equable, and the likeness which is obtained by the mighty climbing down and the poor climbing up is not Christian equality; this is worldly likeness. No, if one stands at the top, even if one is the king, he shall lift himself above the distinction of his high position, and the beggar shall lift himself above the distinction of his poverty. Christianity lets all the distinctions of earthly existence stand, but in the command of love, in loving one's neighbour, this equality of lifting oneself above the distinctions of earthly existence is implicit."

There are many such treasure passages in Works of love. This passage, and a large majority of the book, emphasises love for one's neighbour. In loving one's neighbour you throw away any distinction of class and truly unconditionally care for everyone. One's object of love is not one's choosing (e.g. one's spouse or friends), but it is the obedience to God's command that one shall love one's neighbour. Kierkegaard is clear to point out that our neighbour is everyone.

What does this mean from an economics perspective? While politicians and policy makers might greatly care for people, I wonder whether this care is synonymous to loving one's neighbour. In economics we focus on elevating (at least trying to do so) one group of people (the marginalised, the poor and the needy) and lowering the status of another group (usually the wealthy). This is often the aim of progressive taxation and is definitely at the heart of heavy capitalism vs. communism discussions.

In an ideal world, where people truly loved one's neighbour, all types of economic class distinction would disappear. One can imagine that love would spur the other to do everything in his/her power to ease the suffering of a neighbour. Love, unconditional love, would expect nothing in return and would gladly sacrifice. The wealthy person who lifts himself above his "high" position would not care for that position - he is above that and hence would care little for his wealth.

In this sense there is no convergence between the Christian ideal of equality and the material ideal of equality. The former speaks of everyone lifting themselves above their station in life to equality, while the latter attempts to bring a balance by lowering the status of some and simultaneously raising the status of others. The economic equality needs a definition of distinction while the Christian equality makes no distinction. Furthermore, the economic equality requires a benevolent dictator (or a decent government) to do the job, while the Christian equality requires the individual raise himself. The ideal of economic equality requires constant intervention, while that of Christian equality is once-off. Economic equality requires a select group to achieve equality, while everyone is responsible for the other in Christianity.

The fact that so many people are still starving today, that inequality is growing, that individuals amass more than they need while brothers and sisters have nothing, point to our failure in keeping up with this command. Of course there are a handful of people that have sacrificed everything in keeping this command.

It brings some comfort in the midst of failing policies and selfish individuals that God does not distinguish between income, race and gender. That everyone is invited to participate in something that elevates them above the misery in this world - if they so choose it. It should be the ideal of all people to do away with distinctions. Once we are able to do that then individuals will take responsibility for the lives of others and stop waiting for governments, or those that already work hard in making a difference, to achieve said goals.

Solace in hierarchies...

I found a passage in the Žižek and Gunjević book, God in pain, quite interesting. (I am not putting forth any solutions - it is just a curious passage that I wanted to share).The passage looks at hierarchal structures in society and specifically how to eliminate the "pain" associated with falling in an inferior class structure. I almost paraphrase the entire section (taken from p.66) - most of this is quoted from Jean-Pierre Dupuy in Petite métaphysique des tsunamis.

There are four procedures of hierarchy, whose function is to make the relationship of superiority non-humiliating to subordinates:

1.          Hierarchy itself: Experiencing one's lower status as independent of one's inherent value.

2.       Demystification: The relationship between superiority and inferiority is not based on meritocracy, but are the result of ideological and social struggles. I.e. One's status depends on social processes and not on merits. This helps us to avoid painful conclusions that the other's superiority is a result of merit and achievement.

3.       Contingency: One's position on a social scale depends on a natural and social lottery. I.e. lucky are the ones who were born with better dispositions and into rich families.

4.  Complexity: Superiority or inferiority depends on complex social processes independent of individuals' intentions or merits. E.g. despite me being smarter and working harder, my neighbour's success outweighs mine.

The pillars do not threaten hierarchy, but is supposed to make it palatable. Dupuy  -"what triggers the turmoil of envy is the idea that the other deserves his good luck and not the opposite idea which is the only one that can be openly expressed".

Dupuy further states that it is a mistake to think that a society that thinks it is just and proclaims that it is just will be free of resentment. And in these societies it is the people who occupy inferior positions that will burst out in violent resentment.

Žižek quotes Rousseau's example of perverted self-love: One cares more for the destruction of one's enemies (they serve as an obstacle to one's happiness) as opposed to one's own happiness.

What does this have to do with South Africa?

South Africa proclaims that it is a democracy. It claims that it is just and free. Yet, there seems to be social turmoil every day. There are clear class distinctions and those that fall in the inferior classes are supremely unhappy about it. High income inequality, affirmative action (i.e. exclusive rights for some and isolation for others) and corruption are just a few examples of how unjust the country really is. The consequence is violent uprisings undermining every economic and social activity (strikes, destruction of property, crime are a few examples). South Africans, and many others in the world, then surely make a great mistake (in context of Dupuy) in thinking that South Africa is just and proclaiming it is just.

The ideal of demolishing hierarchy stands in opposition to the idea of making hierarchy palatable. Are we really able to demolish hierarchy? In effect this would imply some form of communism. History is definitely not kind to the examples of communism we have seen - numerous people have lost their lives for this ideal and almost always the ideals were perverted by the leaders who exploited the general population. Is the alternative better? Is it better to accept that things are simply unfair and unequal? That no matter what skills or abilities a person has, that person is subject to factors outside his control, or in the very least try to make something from nothing in what we call capitalist societies (there is no promise that hard work and ability will be rewarded). Unfortunately accepting ones circumstances does nothing to help starving people, and a system that proclaims equality cannot truly promise equality and food portions of the same size for everyone. 

These are deep philosophical questions that touch all of us.

While the South African government has done a great deal to improve the lives of the poor since 1994, it never, or hardly, acknowledges its shortcomings (the opposition parties and newspapers do a reasonable job at highlighting inefficiencies). (We also don't know whether future governments will do any better). Perhaps this is what Dupuy wants - societies should acknowledge its mistakes and maybe people will find solace in that - it is sometimes the government and its policies that constrains me and not my merit or ability and on the other spectrum that this same government that constrains me helps another who might be more in need (not always Pareto optimal, and not always welfare enhancing) It does not make it fair, but it surely helps ease the psychological pain of being unfairly treated.

Is there anything new about South Africa's latest crime stats?

In September 2014 the South African Police Service released its latest crime statistics. In this post we will see whether crime rates have dropped and what provinces remain high crime zones.

I believe that crime breaks communities and unity if left unopposed. The recent South African crime statistics do not deliver any good news. Before looking at some of the numbers, we might try and understand what factors lead to crime. It is also important to distinguish between the types of crimes committed. South Africa seems to be plagued by violent crimes.

Here is what the literature says about the determinants of crime (some might seem intuitive):

·         Poverty causes crime, but also, crime can cause poverty (Anderson, xxx). For South Africa the impact of poverty is not that large, but still statistically significant. Anderson (xxx) finds that a R1000 increase in monthly expenditure increases the probability of a robbery by about 7%,

·         Robberies are higher in wealthier areas. For South Africa this can be up to 25% higher in wealthy areas compared to their not so wealthy neighbours (Demombynes and Ozler, 2005).

·         Crimes in South Africa could be a lot higher than reported (Newham, 2002). I don't think it is too much of a stretch to assume that a large number of crimes go unreported. Police corruption, misplacement of documents or the fear of a victim might explain some of this under-reporting.

·         In some cases it is believed that unemployment causes crime.

·         Cultural deviance or cultural conflict can also explain crime (Eide, 1999).

·         The probability of being caught and the type of punishment are also determinants of crime. Criminals weigh the costs and benefits of committing a crime and then act on those calculations. This assumes that many criminals behave rationally and that crime is not always sporadic but often well planned. Other factors that criminals might take account of in committing a crime include tastes (perhaps the criminals are bloodthirsty, perhaps they have an affinity for stealing only small items such as jewels), ability (this includes intellectual and physical) and punishment (the severity of punishment if caught) (see Eide, 1994).

·         The Law commission in 1997 and 1998 tracked over 15,000 and found that only 6% of serious violent crime tracked followed a conviction over this period.

·         Age is an important variable. In a country like South Africa where a large proportion of the youth are unemployed and uneducated one ought to expect high crime rates.

·         Blackmore (2003) show that a higher income per capita, drug related use, urbanisation and the unemployment rate are all important factors that determine crime in South Africa. I am not necessarily a fan of using per capita income as this could be correlated simply with inequality increases.

Some stats

To make the comparison easy across provinces I indexed the various crimes so that crime per 100000 people in 2005 equals 100. This allows us to compare crime rates in 2014 relative to 2005. Obviously we would want all related crime to be below 100 - i.e. this represents a drop in crime.

As an example the map plot illustrates sexual offences in three periods. In 2005 all the provinces have the same colour (remember that we indexed 2005=100). We can then compare 2009 and 2014 (these are fiscal years, i.e. 2014=2013/14). If a province has a darker colour then it implies that it has less crime compared to the other provinces. It is also important to read the colours from the scale provided. For sexual offences the Western Cape had the lowest crime rate while the Eastern Cape and Limpopo had the highest in 2014

When we look at murder rates we see that Gauteng, Mpumalanga and KZN improved the most. 

The Northern Cape improved the most in terms of reducing aggravated robbery in 2014.

Finally I wonder whether overall crime has dropped significantly. The figures show marginal improvements for some provinces, but also a worsening of crime in other provinces. The national figure hardly shows any improvement.

It would be interesting to do a counter-factual analysis of what crime would have been without the security precautions that some households have (armed response, dogs, electric fencing, etc.) vs. a counter-factual of what crime would have been like when holding police service employment constant at 2005 levels. This would also help us make more informed decisions whether employing more police officials and raising their salaries would make a dent in crime.

Finally, do you feel safer? This mental conflict causes psychological problems and an irrational fear. This is one of the sad side-effects of a country with high crime rates. 

UPDATE 24 October 2014:
I recently saw that StatsSA publishes a survey on crime perceptions. This survey shows that there is indeed under-reporting. People also do not feel safe (no surprises there). Thought this was interesting though. 

References

Anderson, M.D. (). The effect of poverty on crime in South Africa: A GMM and IV approach.

Blackmore, F.L.E. (2003). A panel data analysis of crime in South Africa. South African Journal of Economic Management Science, 6(2003): 439-458.

Demombynes, G and Ozler, B. (2005). Crime and local inequality in South Africa. Journal of development economics, 76: 265-92.

Eide, E. (1994). Economics of crime. Stavanger, Rogaland Mediesenter, 158 p.

Eide, E. (1999). Economics of criminal behaviour.

Newham, G. (2002). Tackling police corruption in South Africa. Centre for the study of violence and reconciliation.

South African Law Commission, Conviction rates and other outcomes of crimes reported in eight South African police areas. Research Paper 18, Project 82 (sentencing)

Just how bad is a country's debt for growth

Yes I know that I have a previous entry on the effects of public debt on economic growth. That, however, only focused on South Africa.

Once again public finances bother me. I can't quite wrap my head around why some countries are able to sustain such large amounts of debt and not be in any danger (according to rating agencies) of default while other countries with comparably smaller debt are at risk of defaulting. The common marcro reasons cited for this are long-term growth rates, low interest on bonds, little debt denominated in foreign currency, the maturity of debt and stable and low inflation. Political factors are also important. These include weeding out corruption, have proper expenditure plans in place and don't have domestic strife (investors seem to hate this).

I wish I had time to do a counter-factual and determine how better or worse a country would have been without increasing its sovereign debt. For now we will have to settle with a (hopefully) interesting figure just to get us interested. The scatterplot illustrates the relationship between debt and economic growth for advanced and emerging economies (five year averages from the IMF). A striking feature of the figure is that there is a negative relationship between economic growth and low debt. There is a positive relationship between debt and economic growth for advanced economies between 25%-50% of debt to GDP. Higher values of debt/GDP >50% seems to have a negative effect on economic growth. For EM countries the positive relationship between debt and GDP occur between 35%-100% of debt/GDP. This is indeed a very big range.

What this figure tells us is that aggregating numbers like this tells us very little about the real effects of debt. To really understand the consequences of accumulating debt one has to look at a lot of micro factors (the reasons for accumulating debt, the maturity of debt, etc.). This would be difficult to accomplish since many countries hardly report these variables necessary to do any useful analysis. There is also no reason to believe that debt thresholds are static. The evolution of fiscal policy and the macroeconomic landscape change frequently. We should expect that these thresholds would also change.