The result further indicates that there is evidence of long run relationship between real exchange rate and two explanatory variables gross. The real interest rate differential enters with a negative sign indicating that an increase in the differential will cause an appreciation of the real exchange rate. This paper presents a model that integrates money, relative prices, and the current account balance as factors explaining movements in nominal effective exchange rates. Jul 22, 2008 the present research tests validity of this hypothesis in association with the exchange rate between the indian rupee and the us dollar. In this dynamic model of the real exchange rate both real and nominal determinants of real exchange rate misalignment are studied, with emphasis on macroeconomic policy and nominal devaluation, along with other explanatory variables suggested by the theory. During periods of excessive fluctuations in exchange rates, foreign trade and investments could be.
Now suppose the price index is a geometric average of traded and. This study note is intended to provide an overview of what interest rates represent, how they. When e increases the foreign country becomes relatively more expensive and we say that the real exchange rate depreciated. The findings are generally consistent with the predictions of the.
The equilibrium real exchange rate depends not only on productivities but also on some other. The real exchange rate as defined by pilbeam 2006 is the nominal exchange rate. The apparent shift in exchange rate policy to boost export performance and promotes surplus. The findings are generally consistent with the predictions of the model. Nominal and real exchange rates of an open economy with formula. Exchange rates play a vital role in a countrys level of trade, which is critical to almost every free market economy in the world. A setback of foreign exchange rate will causes a lot of troubles in a nation. Differences in gdp per capita relative to trading partners is an important component of short term exchange rate adjustment mechanism. Real exchange rates in the transition region have been relatively volatile over the past two decades, with major variation across countries and over time. Macroeconomic determinants of real exchange rates william h. The working paper series is intended to provide the results of research undertaken within the bank to its staff, interested institutions and the general public. The various determinants of exchange rates uk essays. Pdf determinants of real exchange rate movements in.
The determinants of the real exchange rate associate reading. The rate of depreciation is equal to the inflation differential. Theories of exchange rates foreign exchange financial. I developed a monetary model of the real exchange rate in this paper and showed that longrun determinants of the real exchange rate are a function of the real money supply, domestic and foreign interest rate, real gdp, real government expenditure, deficit per gdp, domestic and foreign outstanding debt per gdp, domestic and foreign externally. Although each factor in isolation has limited explanatory power, we find that these three factors in conjunction can successfully explain the medium to long run movements in 14 bilateral u. An ardl approach 37 in this study, an extension of the benchmark model is used where the equilibrium real exchange rate is a path upon which an economy maintains both internal and external balances. This paper therefore, investigates the determinants of real exchange rate volatility in nigeria from 1981 through 2008.
Determinants of venezuelas equilibrium real exchange rate by. Determinants of equilibrium real exchange rate and its. The model was tested on canadian data for the period 19722010. Exchange rate overshooting shortrun response to a change in market fundamentals greater than longrun response helps explain sharp movements tendency of elasticities to be smaller in the short run than in the long run figure 12. In most countries, there was a shift between the preglobal crisis period, when the region saw significant real appreciation of currencies, and. Macroeconomic determinants of real exchange rates nber. It was found that all variables, except real money supply, domestic and foreign interest rate and domestic externally financed debt have a. It was found that the model performs very well in both long and short runs. Now that we have discussed the importance of forex rates, let us move on to major determinants of exchange rates in a floating exchange rate regime. International trade and investment, international finance and macroeconomics this paper presents a model that integrates money, relative prices, and the current account balance as factors explaining movements in nominal effective exchange rates. Real interest rate is used to assess exchange rate movements as it includes interest and inflation rates, both of which affect exchange rates. Fundamental determinants of exchange rates oxford scholarship.
For example, under the purchasing power parity ppp approach, the longrun real exchange rate is assumed to be stationary so that any deviation from this rate reflects misalignment. Under the assumption of rational expectations, the model yields an expres. Determinants of the real exchange rate in a small open. Gdp per capita, oil prices, fiscal expenditures, and openness are fundamemntal determinants of turkish real exchange rates. The large and persistent deviations of nominal exchange rates from their purchasing. In order to manage foreign exchange rate efficiently, macroeconomic factors of foreign exchange rate should be deeply investigated. The determinants of real exchange rate volatility in nigeria. No matter which way currencies zig or zag, it seems there is always an analyst with a quotable, ready explanation. In a fixed exchange rate regime, the rates are decided by its government. This study analyses the main determinants of the real exchange rate and the dynamic adjustment of the real exchange rate following shocks to those determinants using yearly ethiopian time series. The determinants of exchange rate volatility in south africa. Oil prices and other commodity prices are a primary source of fluctuation in the equilibrium real exchange rate. All factors that determine foreign exchange supply and demand cause indirect exchange rate volatility to change. Determinants of the swiss franc real exchange rate tommaso mancini griffoli, christoph meyer, jeanmarc natal and attilio zanetti snb working papers.
Determinants of turkish real effective exchange rates. In surveying theoretical models of exchange rate determination, therefore, it is appropriate to examine the empirical regularities that have been characteris. None of the domestic fiscal variables has any statistically significant impact on the growth of the real exchange rate over the shortrun. Amuedodorantes and pozo 2004 also find that remittances inflows lead to an appreciation of the real exchange rate. Importers, exporters, investors and the monetary authorities are all concerned with the behavior of the exchange rate, as it directly or indirectly affects them. Here we focus on the determination of the real exchange rate, while recognizing that monetary factors are important. Macro determinants of the real exchange rate in a small open. The determinants of the real exchange rate in zambia aerc. We also hypothesize a third factor which may affect real exchange rates shocks to the global financial system, which we proxy by the real price of gold. Hopper r eaders of the financial press are familiar with the gyrations of the currency market. When e increases the foreign country becomes relatively more expensive and. Hyder and mahboob 2005, saadisedik and petri 2006 find similar results for pakistan and jordan.
The naira exchange rate depreciation and volatility is among the vast macroeconomic maladjustments which have unfolded in the nigerian economy in the recent past. Highlights we developed a real exchange rate model for a smallopen economy. Similarly, an american can exchange two dollars to get one pound. The determinants of real exchange rates in transition. The real exchange rate rer refers to the relative price of goods of britain and usa.
In particular, an attempt is made to investigate the impact of bank rate policy of the reserve bank of india rbi and interest yield differentials between the india and the us securities. The natrex approach offers an alternative paradigm to the purchasing power parity for equilibrium real exchange rates. Pdf determinants of real exchange rate movements in south. An empirical model linking the real exchange rate to its theoretical determinants is then specified. Pdf the determinants of the real exchange rate in zambia. He claims that trade integration andrealexchange rate volatility are structurally linked and there is a negative correlation between them. The determinants of real exchange rate crawford school of public. The change in interest rate, the growth of money supply, the commodity price and the us debt per gdp have a negative impact on the growth of the real exchange rate over the short run. Therefore, the relative version of ppp states that there is a link between the expected exchange rate es n and expected inflation rates i in two countries. The determinants of exchange rate volatility in south africa trust mpofu ersa working paper 604 may 2016.
Determinants of real exchange rate in papua new guinea. Aside from factors such as interest rates and inflation, the exchange rate is one of the most important determinants of a countrys relative level of economic health. Now suppose the price index is a geometric average of traded and nontradedgood prices. Here real exchange rate is calculated as nominal exchange rate cpi cpi where cpi is the foreign price and cpi is the domestic. The purpose of this paper is to explain the magnitude of the misalignment of the real exchange rate and its determinants for the mena countries. This research is concerning on the determinants of foreign exchange rate. Thus fluctuations in real exchange rate have strong on the economic activities. According to relative ppp, price changes due to differences in inflation are the cause and exchange rate changes are the. Real exchange rate volatility is an important contributor to risks in the financial world. Box 882, politickych veznu 7, 111 21 praha 1, czech republic. Working paper on the causes and effects of exchange rate volatility on economic growth. Following literature, we identified the potential determinants of real exchange rate as lag of real exchange rate, real interest rate, inflation rate, trade openness and. The determinants of the real exchange rate with diagram.
Section 4 analyses the cointegration approach and section 5 tests for the longrun properties of the real exchange rate movements. Exchange rate is an important macroeconomic policy instrument which effects all macroeconomics variables. The purpose of this paper is to highlight the main determinants of the exchange rate from a monetary perspective. Having obtained the volatility of exchange rate through the garch 1,1 techniques, the ecm was used to examine the various determinants of exchange rate volatility in nigeria, while the cointegration analysis reveals. Let us make an indepth study of the nominal and real exchange rates. Exchange rates play a vital role in a countrys level of trade, which is critical to most every free market economy in the world.
Thus, the determinants of the real exchange rate are the shocks that drive it from the equilibrium. A case study of pakistan mahnaz muhammad ali 1, salma shaheen 2 nosheenshahzadi 3 abstract. When the exchange rate is officially fixed, essentially the same monetary influences that determine the exchange rate affect the level of official settlements corresponding to the balance of payments surplus or deficit. Pdf on jan 15, 2017, kalimullah bhat and others published determinants of real exchange rate movements in south asian countries. Misalignment is defined as the deviation of the real exchange rate from its equilibrium level, unlike volatility which is defined as fluctuations that are very frequent but do not persist. Consequently, exchange rates are among the most watched, analyzed, and manipulated economic measures. Let us make an indepth study of the determinants of the real exchange rate. Nominal and real exchange rates of an open economy with.
Given all other parameters constant, there is a high corelation between differentials in real interest rate and the exchange rate of a currency. The determinants of the real exchange rate in zambia. The real exchange rate is explained by the expected future real exchange rate, the real interest rate differential and the risk premium. We discuss the implications of the long and short run determinants of exchange rate volatility and the volatility growthnexus. Determinants of the equilibrium real exchange rate also include factors that affect the net trading position of the home country in world markets, as well as the underlying propensity of the home country to be a net lender or borrower of capital.
The study examines the determinants of real exchange rate in the recent years in nigeria over the period of 1970 to 2006 using the nigerian time series data. Timevarying transitional dynamics chunming yuan department of economics, university of maryland, baltimore county hilltop circle, baltimore, md 21250, usa abstract in this paper, i consider modeling the effects of the macroeconomic determinants on. The three factors are sectoral total factor productivity differentials, real interest rate differentials, and the real price of gold, representing real. This paper investigates the determinants of real exchange rate volatility in nigeria from 1981 through 2008. Foreign exchange rates, in fact, are one of the most important determinants of a countrys relative level of economic health, ranking just after interest rates and inflation. P in words, the real exchange rate is the relative price of a foreign basket of goods in terms of comparable domestic baskets of goods. Natrex is the acronym for natural real exchange, referring to a medium. Thus money and the current account are the proximate determinants of changes in real effective rates. Major determinants of foreign exchange rates governmentadda. Determinants of venezuelas equilibrium real exchange rate for venezuelas reer, three factors are likely to be important. Investment i depends on both the domestic and the world rate of interest. Determinants of venezuelas equilibrium real exchange rate. Pdf determinants of the real exchange rate in a small open. The study examined the main determinants of real exchange rates fluctuations in ghana using the autoregressive distributed lag ardl approach bound testing approach.
Determinants of the exchange rate in the short run in the short run, movements of currency respond to short run differences in interest rates so that short run rates of return are equalized across borders. The result further indicates that there is evidence of long run relationship between real exchange rate and two explanatory variables gross domestic product growth rate and trade openness. Determinants of real exchange rate in papua new guinea boniface aipi. The present research tests validity of this hypothesis in association with the exchange rate between the indian rupee and the us dollar. Currency weights in zambias real exchange rate 19901996. There are many factors that affect the real exchange rate volatility, even if the effect of each depends on the economic conditions of. The basic model is first analyzed under static expectations. Real exchange rates in the transition region have been relatively volatile over the. This research is concerning on the determinants of foreign exchange rate in malaysia, in other. So exchange rate volatility and its determinants for countries have become a new focus of interest. The main determinants of the exchange rate sciencedirect.
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