On the Real Exchange Rate Effects of Higher Electricity Prices in South Africa



households. In this scenario, we model the extreme case where all industries receive a special deal
from the electricity industry, while only households are targeted to pay more for electricity.

Variation (iii) is a comparison between the ORANI standard short-run closure and the closure
we use in the paper, described above. In ORANI, household consumption expenditure is held
fixed in real terms in the short-run, alongside G and I. Only the trade balance is allowed to vary.
We compare two ways of modelling household behaviour. Do households try to keep their real
consumption levels constant in the short-run, or would they allow nominal consumption expenditure
to vary with nominal wage income? The former means that they keep total real spending on
consumption constant, while the latter means they react to the price increase in electricity by
altering the quantities consumed of all commodities, while also adjusting total expenditure. We
study the effects of the two scenarios and comment on the results below.

A key assumption of many CGE models for the short-run is fixed real wages. In variation (iv)
from the standard closure, we compare the situation where real wages are held fixed with the one
where nominal wages are held fixed. If something bad happens in the economy, such as a new tax,
and real wages are fixed, then firms will be inclined to lay off workers. By keeping nominal wages
fixed in the variation, we assume that firms would rather lower real wages than lay off workers. Firms
cannot continue to pay the same real wages and simultaneously employ the same number of workers
when their costs increase. They must reduce either real wages or employment, or a combination
thereof. By allowing real wages to change, we allow a price effect. If they are kept constant, we
expect to see a quantity (number of workers) effect.

The final “variation” is actually the standard long-run closure. We are interested to know what
the effects of a rise in the electricity price would be in the longer run. In our modelling terms, we
allow the capital stocks of all industries in the economy to vary, while keeping employment constant.
In this way, we are able to compare the effects that labour and capital have on the economy in
general.

5 The Results

5.1 Increase in administered prices versus an increase in taxes

The highest increase in the real exchange rate was found when both the households and firms are
paying more for electricity, and when we hold real household spending and real wages fixed at the
same time. The results of the first variation are presented in Table 6 for thirteen variables, of which
the CPI is the focus of the paper4. However, we are convinced that the influence of electricity prices
extends far beyond relative prices, and therefore also comment on the effects of electricity prices on
other variables. We list the relevant scenarios in the columns, and report on the macroeconomic
outcomes of significant variables in the rows.

In Table 6, zeros appear in the first three rows of all the short-run simulations, which indicates
the initial assumption about domestic absorption on the macroeconomic level. The exceptions are
the scenarios where nominal household spending is a function of wage income. The whole third last
row is also filled with zeros, because import prices (PIMP) are assumed exogenous - South Africa
being a small open economy that cannot influence world prices.

INSERT TABLE 6 HERE

Comparing the simulations that start with “fO” to the “pl’s” (see the notes below Table 6),
provides interesting but intuitive results. Levying a tax of IO per cent on electricity is like shifting
one of the curves in a two dimensional graph of supply and demand: the new equilibrium price of
electricity will be less than IO per cent higher due to the elasticities of demand and supply (it turns
out to be 7 per cent higher). However, with the price-simulations, we force the new equilibrium

4In a CGE model with nominal exchange rate fixed, the CPI is measuring real appreciation, or international trade
competitiveness.



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