Exchange rate fluctuations and macroeconomic performance

Abstract

Purpose Recent turbulence in global financial markets implies that emerging economies are likely to soon enter a new era with greater pressure for currency depreciation and capital outflows. This will likely bring challenges, including macroeconomic instability and inflationary pressures due to potential rapid depreciation. In this context, certain key questions about emerging economies have become focal points of discussion in political and academic spheres: what are the effects of exchange rate depreciation on economic activity? Does exchange rate depreciation create inflationary pressure? Finding answers to these questions is critical for policymakers and financial market participants. As such, the purpose of this paper is to shed light on these questions and thus provides guidance on mitigating the negative impacts of shocks in four fast-growing emerging economies. Design/methodology/approach The authors use a vector autoregression model with sign restrictions to examine the dynamic effects of exchange rate movements on fundamental macroeconomic indicators for four fast-growing countries, namely, Brazil, Turkey, Russia, and South Africa. Following Berument et al. (2012a), Ncube and Ndou (2013), Bjørnland and Halvorsen (2013), and An et al. (2014), the authors adopt the sign restriction methodology to identify exchange rate shocks alongside other macroeconomic shocks (monetary policy and productivity shocks) leading to exchange rate fluctuations. Findings The results show that exchange rate depreciation typically generates a deep recession and high inflation while improving the trade balance in the four emerging economies. This indicates that depreciation has strong “stagflationary” effects, which are transmitted to the macroeconomy primarily via supply-side channels, especially through the cost of import. Furthermore, the authors find that monetary policy reacts immediately to a domestic currency depreciation in all four emerging countries. Practical implications The results imply that these countries’ monetary policies are not and cannot be neutral to exchange rate shocks. However, in these import-dependent countries, monetary tightening (i.e. rate hikes in response to an exchange rate shock) plays a limited role in mitigating the negative effects of depreciation on inflation and economic activity due to the presence of a dominant supply-side channel. In this framework, policymakers should pay greater attention to structural reforms that aim to reduce import dependency. These reforms may increase the effectiveness of domestic monetary policy in mitigating the negative effects of external shocks. Originality/value This paper provides a useful perspective for policymakers designing economic interventions to mitigate the adverse effects of exchange rate depreciation and to those who borrow or lend in domestic or international financial markets.

A quarter century of inflation targeting & structural change in exchange rate pass-through: Evidence from the first three movers

“…It also implies that the depreciation of Sterling could bring international competitiveness for the UK's economy and its external balance. The findings are in line with the existing evidence on the presence of J-Curve and response of trade balance to exchange rate dynamics, for instance, study on USA and Indonesia by Bahmani-Oskooee and Harvey (2015) and among others, Bahmani-Oskooee and Hegerty (2010) and Bahmani-Oskooee et al, (2013), Yildirim and Ivrendi (2016). However, the results are contrary to the studies which could not find evidence of a significant impact of exchange rate on the trade balance.…”

“…Similarly, Bahmani-Oskooee (1991) analysis on LDCs reported that devaluation often improves the trade balance in the long run, while in their study on the trade balances of the developed countries, Lane et al ( 2002) reported negative effects of exchange rates appreciation 10 . As the ERPT effects the prices of imports (Ali and Anwar 2016), concomitantly, the improvements in the trade balance are also results of expenditure switching and expenditure changing policies by the household and firms (Yildirim and Ivrendi, 2016). Contrarily, some of the studies focusing on the exchange rate and trade balance could not find a significant link (Rose, 1990) or evidence of J-Curve (Rose and Yellen, 1989).…”

“…However, effects of exchange rate dynamics on trade balance are contingent on the imports and exports elasticities and whether they add up to a value greater than unity, a phenomenon often referred as the Marshall-Learner condition (Bahmani-Oskooee and Ratha, 2004). Empirical evidence suggests that depreciation of currency shall harbour significant improvement in the external balance of both developed and developing countries (Bahmani-Oskooee et al, 2013, Bahmani-Oskooee, 2016Yildirim and Ivrendi, 2016). Although there are some studies which reported the absence of such a mechanism, for instance, Rose and Yellen (1989) and Rose (1991) failed to find a significant impact of exchange rate dynamics on the trade balance.…”

Identifying Significant Cost-Influencing Factors for Sustainable Development in Construction Industry Using Structural Equation Modelling

“…Furthermore, natural disasters also present many risks to the operational environment of a project. In this study, the external environment category comprised of influencing factors such as political stability [48][49][50], financial integration and deepening [52][53][54], global economic climate [51], and natural disasters [55,56].…”

Dış ve İç Şoklar, Döviz Kuru, Ülke Risk Primi ve Türkiye’de Makroekonomik Koşullar

“…This process consequently brings new structural problems, namely, liability dollarization and currency mismatch. These problems make the corporations' balance sheets and thereby the default risk more vulnerable to large 6 See Yildirim and Ivrendi (2016) for other theoretical channels through which a currency depreciation influences macroeconomic variables, such as inflation, the money supply, interest rates, investment, and consumption. 7 Anaya and Hasenclever (2018) provide an extensive discussion regarding these two channels.…”