Exchange rate volatility is a stated concern for policymakers in many emerging market economies. This paper investigates whether exchange rate volatility impacts the commitment to inflation targeting monetary policy by analyzing thirteen emerging market economies and nine advanced economies from 2000 to 2016. Using a dynamic panel threshold regression model, the response of the domestic target interest rate to the inflation gap, output gap, and exchange rate condition is tested in scenarios of above‐threshold and below‐threshold exchange rate volatility. Both emerging and advanced economies adhere to their inflation targeting commitments when exchange rate volatility is below 1%, but are unable or unwilling to respond to deviations in the inflation gap when volatility is beyond this threshold value.
Studying the determinants of exchange rates is important for understanding economic development, trade patterns, investment decisions and for recommending economic policies. Trade openness is one of the important factors that affect exchange rates. With increase in globalisation, economies around the world are more integrated through liberalised foreign trade policies
Article History
KeywordsAsymmetric preferences Foreign exchange market Intervention Emerging markets Exchange rate volatility Optimal reaction function GMM.
JEL Classification:E58; E61; F31; G15.Policymakers in emerging market economies intervene in currency markets to counter appreciation or depreciation pressure, while also responding to the degree of exchange rate volatility. This paper investigates whether the asymmetric response in terms of foreign exchange intervention depends on the degree of exchange rate volatility. Specifically, we estimate whether the response by policymakers to currency market conditions differs in above or below threshold levels of volatility. We use dynamic threshold panel analysis presented within an asymmetric policy reaction function to investigate the role of exchange rate volatility in foreign exchange intervention. We estimate the model using Generalized Method of Moments (GMM) with monthly data for 23 emerging market economies from 2000 to 2016. We find that the asymmetric aversion to appreciation only holds under below-threshold volatility scenarios, and that the majority of the time, policymakers are simply leaning against exchange rate movements to ensure stable exchange rate conditions. The results confirm that exchange rate volatility impacts the response of policymakers to exchange rate conditions. Contribution/Originality: This study assesses how exchange rate volatility impacts foreign exchange policy decisions in emerging and developing economies. We provide evidence that prior literature, which did not consider volatility, missed an important policy concern for central banks in these economies when analyzing the existence of asymmetric preference in foreign exchange intervention.
The impact of unconventional monetary policies adopted by advanced economies in the wake of the Global Financial Crisis has had far reaching implications for global economic conditions. Although several transmission channels of quantitative easing to financial market and exchange rate conditions have been identified, there is a lack of empirical investigation on the spillover effects to exports for emerging market economies. The research presented in this paper focuses on assessing the asymmetric transmission of unconventional monetary policy in the US on exports for fifteen emerging market economies. Employing the panel ARDL (Autoregressive Distributed Lag) model, we find that the increase in large-scale asset purchases in the US corresponds to a decline in exports in the emerging market economies. The effect on exports is more sizable in the Fragile Five than in the other 10 emerging markets. Finally, although monetary policy shocks from the US transmit to impact trade in emerging markets, the effect is asymmetric. Specifically, the tapering of the quantitative easing does not have a statistically significant effect on exports.
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