The negative consequences of financial instability for the world economy during the recent
financial crisis have highlighted the need for a better understanding of financial conditions.
We use a financial conditions index (FCI) for South Africa previously constructed
from 16 financial variables to test whether the South African economy responds in a nonlinear
and asymmetric way to unexpected changes in financial conditions. To this end, we
make use of a nonlinear logistic smooth transition vector autoregressive model (LSTVAR),
which allows for a smooth evolution of the economy, governed by a chosen switching variable
between periods of high and low financial volatility. We find that the South African
economy responds nonlinearly to financial shocks, and that manufacturing output growth
and Treasury Bill rates are more affected by financial shocks during upswings. Inflation
responds significantly more to financial changes during recessions.