Macroeconomic Currency Crisis Early Warning Indicators in Emerging Countries

Abstract

This study investigates the relationships between exchange rate and the main macroeconomic variables as GDP, inflation and unemployment on one hand and the ability of these variables in alerting about coming exchange rate crisis in emerging countries. The three variables have significant coefficients with exchange rate in line with literature signs except unemployment rate. The study uses signal approach, dealing specifically with the main macroeconomic variables, selected by system GMM method in emerging markets. The study develops macroeconomic pressure indices from these selected macroeconomic variables using the market pressure index methodology from Early Warning System literature. Based on the macroeconomic variables, a combined macroeconomic pressure index has been built. The results of the non-parametric early warning system indicate that the individual macroeconomic pressure indexes created are good warning tools of a currency crisis. The macroeconomic pressure indexes are better early warning indicators than market pressure index built from international reserves, in emerging countries for four quarters warning period window. Production pressure index appears more accurate followed by inflation but unemployment pressure index is the most sensitive. However, the number of effective indicators and the accuracy of the indexes are not the same for all the countries, changing from a country to another.