Exchange Rate Volatility and Output Volatility: A Theoretical Approach*

Abstract

This paper makes an attempt to determine the factors influencing exchange rate and exchange rate uncertainty, as well as output and output variability. In the context of a small open economy under flexible exchange rates regime it is found that the level both of exchange rate and output is affected by monetary and inflationary shocks, as well as shocks in government spending, output, and trade balance. Further, the uncertainty of exchange rate and output is associated positively with the uncertainty of all shocks while the contemporaneous occurrence of selected shocks imposes either a positive or negative impact on exchange rate and output volatility. Finally, it is shown that the effect of the determinants either of exchange rate volatility or output volatility is very sensitive to the parameter values

Modelling Exchange Rate Volatility by Macroeconomic Fundamentals in Pakistan

“…It has positive and insignificant effect on volatility in PKR-JPY exchange rates. The insignificance of real output volatility is in line with Morana (2009) and Grydaki and Fountas (2009) and positive effect is in line with Friedman (1953) where output volatility amplifies exchange rate volatility. The foreign reserves volatility has negative and significant effect on volatility in PKR-USD and PKR-GBP exchange rates.…”

“…Hviding et al (2004) has found higher international reserves reduce exchange rate volatility. Grydaki and Fountas (2009) have found that variability in the money supply, inflation and output explains variability in exchange rates. Morana (2009) have found that that exchange rate volatility is affected by the monetary shocks particularly output and inflation volatility.…”

“…Using information in macroeconomic fundamentals to model volatility in foreign exchange markets is not completely new to the literature (see e.g. Calderón, 2004;Grydaki and Fountas, 2009;Cheung and Lai, 2009;Chipili, 2012) but there is no general conclusion on modelling exchange rates volatility by macroeconomic fundamentals due to the divergent theoretical exchange rate determination models are found in economic literature. There are some studies that have emphasized the importance of nominal shocks with transitory effects on exchange rates volatility (Morana, 2009), while others has documented real shocks with large permanent effects as the dominant source of exchange rate volatility (Bayoumi and Eichengreen, 1998;Devereux and Lane, 2003).…”

Effects Of Exchange Rate Volatility On Real Estate Prices In Developing Economies, A Case Of Ghana

“…The seemingly mixed results from empirical studies, while suggesting that the effect of exchange rate volatility on trade might be an empirical issue, may also reflect the emptiness of theoretical results in the general equilibrium models; they allude t o the fact that inconsistency in exchange rates is contingent on the volatility of underlying shocks to policies, preferences, and technology, to the overall policy regime (Clark et al, 2004). Meaning, exchange rate swings may be as a result of simply the changes in the volatility of rudimentary shocks propagated by the Driskill-McCafferty model (Grydaki and Fountas, 2009).…”

Exchange Rate Volatility and Exports: The Nigerian Scenario

“…Even though the switch to floating exchange rate gives autonomy to the monetary authorities in the management of monetary policy thereby allowing changes in the exchange rate to be dictated by fluctuating market conditions, the situation still generates instability in the exchange rate capable of inflicting significant costs on the economy compared to the expected gains (Grydaki & Fountas, 2009;McKenzie, 1998). On the other hand, under the regime of the fixed exchange rate, exchange rates that are misaligned inflicted costs on the economy.…”