A small macroeconometric model for Lesotho

Abstract

This study aims at developing and estimating a small macroeconometric model for Lesotho, a small open developing economy. The model is developed, estimated and evaluated using the annual time-series data from 1980 to 2013. It is made up of four equations, viz, aggregate demand (IS-Curve), money demand (LM-Curve), aggregate supply (Philips-Curve) and the interest rate equations. The equations are estimated using the ordinary least squares (OLS), two stage least squares (2SLS), three stage least squares (3SLS) and full information maximum Likelihood (FIML) methods after taking into account issues of stationarity and cointegration. The results show among others that, Output is backward looking and is also influenced by real interest rate and the real effective exchange rate; Inflation is positively determined by lagged inflation and negatively influenced by output and real effective exchange rate. Moreover, the forecasting results show that, the predictive power of model is satisfactory. The key monetary policy variables such as interest rate, inflation and exchange rate depend largely on those of the South African economy making it hard for monetary policy to be independent. As a result, the study recommends that fiscal policy be implemented with caution as it is relatively effective in influencing most macroeconomic variables in the country.