Interpretation of exchange rate volatility in the light of economic fundamentals comprises an issue of interest for policymakers when it comes to implementing the monetary policy. Understanding the impact of economic news on the Lek exchange rate against two main hard currencies, Euro and US dollar, would serve to better orient the monetary policy and forex market agents positioning in time. Exchange rates volatility on economic news in short-term is an often discussed phenomenon in the economic literature, but through this material we tend to measure these effects in the Albanian foreign currency market and contribute in the literature interpreting foreign currency markets volatility in developing economies. Very often, domestic foreign exchange movements are attributed to developments in large international markets. In the case of Albanian Lek volatility analysis, we tend to find answers regarding the importance of economic news coming from the two main economies in focus, Eurozone and the US. Furthermore, we investigate the importance of the economic information flow in Albania in determining the Lek exchange rate against Euro and US dollar. For a period in focus from January 2007 until July 2012, we try to understand if the exchange rate volatility has been a result of economic fundamentals or financial markets stress related economic news.

The choice of a foreign exchange regime hinges primarily on whether the real exchange rate acts as a shock absorber or reverberator for macroeconomic fluctuations. This policy choice is considered central especially prior to joining currency areas such as the Eurozone. We investigate whether Albania’s current floating exchange rate regime contributes to macroeconomic stability, or generates volatility. Using three different structural vector autoregression techniques, and an expanded five-variable model, we show that the real exchange rate has played a shock absorbing role, buffering the Albanian economy primarily from real demand shocks. The analysis reveals that monetary shocks and supply-side shocks have modest contributions in real exchange rate volatility. This evidence in favor of the “shock absorbing” view of exchange rates lends support to Albania’s policy choice of a flexible exchange rate system. If in future Albania considers joining a currency area, its monetary authority will need to pay attention to real currency misalignments as well as the availability and flexibility of alternative adjustment mechanisms.

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Albanian economic time series show irregular patterns since the 1990s that may affect economic analyses with linear methods. The purpose of this study is to assess the ability of nonlinear methods in producing forecasts that could improve upon univariate linear models. The latter are represented by the classic autoregressive (AR) technique, which is regularly used as a benchmark in forecasting. The nonlinear family is represented by two methods, i) the logistic smooth transition autoregressive (LSTAR) model as a special form of the time-varying parameter method, and ii) the nonparametric artificial neural networks (ANN) that mimic the brain’s problem solving process. Our analysis focuses on four basic economic indicators – the CPI prices, GDP, the T-bill interest rate and the lek exchange rate – that are commonly used in various macroeconomic models. Comparing the forecast ability of the models in 1, 4 and 8 quarters ahead, we find that nonlinear methods rank on the top for more than 75 percent of the out-of-sample forecasts, led by the feed-forward artificial neural networks. Although the loss differential between linear and nonlinear model forecasts is often found not statistically significant by the Diebold-Mariano test, our results suggest that it can be worth trying various alternatives beyond the linear estimation framework.   Received: 19 June 2021 / Accepted: 25 August 2021 / Published: 5 September 2021