Abstract
This article examines the co-movement between a leading first-world economy (Germany) and an emerging market economy (South Africa) by applying a dynamic factor model. These countries have been chosen as proxies to analyse the channels of transmission of positive supply and demand shocks in developed economies and the effects of these on emerging market economies. The study concludes that supply and demand shocks in developed economies do not necessarily have similar effects in emerging market economies. A German supply shock has more of a demand-shock effect on the South African economy, while a German demand shock has more of a monetary policy effect on the South African economy. This implies that the policy response in emerging market economies should not necessarily be the same as in developed economies. In the case of the transmission of a positive supply shock from a developed country to an emerging economy, the demand effect will lead to increase in prices, which will require a more restrictive monetary policy stance. Similarly, a positive demand shock from a developed economy is transmitted as a monetary policy shock in an emerging market economy, requiring the latter group of countries to stimulate demand through expansionary fiscal and/or monetary policy.
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