EXCHANGE RATE VOLATILITY AND GROWTH IN EMERGING.docx
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EXCHANGERATEVOLATILITYANDGROWTHINEMERGING
EXCHANGERATEVOLATILITYANDGROWTHINEMERGING
EUROPE
CORINAGEORGETABOAR
Abstract.ThispaperanalysestheinfluenceofNEERandREERvolatilityongrowthin
apanelofsixdevelopingEuropeancountries.Twomeasuresofvolatilityareemployed
(standarddeviationandARCH/GARCHmodels)anditsinfluenceongrowthistestedboth
throughaGLSandaGMMestimation.Moreover,giventhepropertiesofthetimeseries
used,bothpanelandindividualcointegrationaretestedusingthePedroniand,respectively,
theJohansenmethodology.
1.Introduction
Theinternationalexperiencehashighlightedtheimportanceoftheexchangeratedynamics
inacountry’seconomicevolution.Theincreaseincapitalcirculation,thereleaseofthederiva-tives,thecostsofmaintainingfixedexchangerateregimesareonlyfewoftheimportantfactors
substantiatingthechoicebetweenafixedexchangerateregimeandafloatingonecombined
withdifferentmonetarypolicystrategies.Thechoiceisevenmorediffcultfortheemerging
economieswhereimports,exportsandcapitalinflowshaveasignificantweight.Hence,signifi-cantfluctuationsoftheexchangerateleadtosignifcantfluctuationsintherealeconomy,causing
emergingeconomiestoallowonlymoderatefluctuationsofthenominalorrealexchangerate,
attitudeknownintheeconomicliteratureasfearoffloating.Accordingtosomeapproaches,
exchangeratevolatilitypromoteseconomicgrowthbymakingmonetarypolicyinstruments
flexibleenoughtosoftenasymmetricshocks(Meade,1951,Friedman,1953).Ontheother
hand,someauthorsargueforthenegativerelationbetweenthesetwo,giventheincertitude
inducedbythevolatilityinthemacroeconomicenvironmentandtheineffcientforeignexchange
marketsindevelopingeconomies(Altaretal.,2006).
Thereby,weintendtoindentifythedirectionandquantifytheinfluenceoftheexchange
ratevolatilityoneconomicgrowthonapanelofsixemergingeconomies:
CzechRepublic,
Latvia,Poland,Romania,TurkeyandHungary.Moreover,wewanttoestablishtheroleof
financialdevelopmentandtotesttheexistenceofarelationshipinthelong-run.Theresults
weobtainedarecongruoustothepartoftheliteraturethatarguesforthenegativeinfluence
thatexchangeratevolatilityhasongrowth.Financialdevelopmentdoesn’thaveasignificant
roleandcointegrationtestsshowtheabsenceofalong-runrelationship.
Therestofthispaperisstructuredasitfollows:
thefirstsectionconsistsofaliterature
reviewfollowedbyashortdescriptionofthedataandmethodologyused.Thefollowingsection
presentsthevolatilityestimationresultsthatareusedinordertotesttheinfluenceofthe
exchangeratevolatilityoneconomicgrowthandtoidentifyalong-runrelationshipbetweenthe
twovariables.Thelastsectionconcludesthemainfindingsoftheresearch.
ReceivedbytheeditorsAugust28,2010.AcceptedbytheeditorsDecember15,2010.
Keywords:
exchangeratevolatility,growth,emergingeconomies,panelestimation,cointegration.
JELClassification:
E42,F31,F43.
CorinaGeorgetaBoarisPhDStudentattheBarcelonaGraduateSchoolofEconomics.
Email:
corina.boar@barcelonagse.eu.Phone:
+34635721797.
Thispaperisinfinalformandnoversionofitwillbesubmittedforpublicationelsewhere.
c°2010TheReviewofFinanceandBanking
103
104CORINAGEORGETABOAR
2.LiteratureReview
Increasedcapitalmobility,increasedcostsofmaintainingafixedexchangerate,currency
crisesinemergingcountriesandtheintroductionoffinancialinnovationsarejustsomeofthe
reasonsthatmademanycountriesintransitiontodropfixedexchangeratearrangementsandto
switchtofreeorcontrolledfloating.Duetolessdevelopedcapitalmarkets,emergingcountries
aremoreexposedtoexchangeratefluctuationsbecausetheylackthetoolstoprotectagainst
currencyrisk.
TheAsianexperiencebetween1997and1998showedthatcountrieshavetochooseeither
aschemethatensurescredibility,namelyafixedexchangerate(suchas"hardpeg")ora
floatingexchangerateregimecombinedwithdifferentmonetarypolicystrategies.In1961,
RobertMundelllaunchedtheoptimumcurrencyareastheory,accordingtowhichexchangerate
regimesaremeasuredintermsofeffciencyinhelpingtoreducethevariabilityofgrossdomestic
product.Theapplicabilityofthistheoryindevelopingcountriesishoweverquestionablesince
fiscal,financialandmonetaryinstitutionsarepoorlydevelopedandcurrencysubstitutionand
thedollarizationoftheeconomyincreasesvulnerabilitytoasuddenstopincapitalinflows.
Fromthisperspective,thekeytothemacroeconomicsuccessofanemergingeconomyisnot
theinitialchoiceoftheexchangerateregime,butratherthe"health"ofthefundamental
institutionsofthestate.Thus,institutionalreformshouldbeconsideredapriorityratherthan
thechoicebetweenafixedandafloatingexchangerateregime.
Theexchangeratehasbeenthefocusofmacroeconomicdiscussionsinemergingcountriesfor
decades.Hereimports,exportsandcapitalinflowshaveasignificantweight,sothatexchange
ratefluctuationscausesubstantialfluctuationsintherealeconomy.Underafloatingexchange
rateregimeinacountrywherebankshaveloansdenominatedinforeigncurrency,adepreciation
ofthedomesticcurrencywouldendangertheentirefinancialsystem.Hencetheoppositionof
mostdevelopingcountriestoallowfullexchangeratefluctuations,attitudeknownasfearof
floating(CalvoandReinhart,2002).
Proponentsoffixedexchangerateregimesarguethatexchangeratestabilitypromotesgrowth
byensuringmacroeconomicstabilityandgreaterexternaltrade(Frankel,Rose,2001).More-over,exchangerateflexibilitysupportershavehighlightedtheneedformacroeconomicflexibility
tocopewithasymmetricshocksandboostaggregatedemand(Meade,1951,Friedman1953).
However,giventhatpeople’sexpectationsarenotstationary,exchangeratedoesnotfunction
asatoolforstabilizingasymmetricshocks,butrathertendstobecomeanindependentsource
ofvolatilitythatcanbeeliminatedthroughearlyintegrationintoamonetaryunion(Mundell,
1973a,1973b).Exchangeratevolatilityisasourceofineffciencybecauseforeignexchangemar-ketsarecharacterizedbythepresenceofspeculativeactions.Thisleadstochangesinexchange
ratedynamicsthatdonotresultfromthefundamentals.
Analyzingtheperformanceoffloatingexchangerateregimescombinedwithinflationtar-getingversusfixedexchangerateregimes,GaliandMonacelli(2004)showedthattheprice
paidbytheadherentsofthefirstcategoryforthesimultaneousstabilizationoftheoutputgap
andinflationwasahigherexchangeratevolatility,bothinnominalandrealterms.Inclose
connectionwiththis,BleaneyandFrancisco(2008)showthatinflationtargetingreducesthe
volatilityofrealexchangerateexpectations,giventhetendencyofassociatingitwithfloating
exchangerateregimes.Takingalookattheissuefromtheoppositeangle,namelytheinflu-enceofexchangeratevolatilityoninflationperformance,thecross-countryresearchconducted
byEdwards(1993)showedthatdevelopingcountriesthathaveadoptedafixedrateregimeob-tainedbetterinflationaryperformancesthancountriesthatpracticeschemescharacterizedby
greaterflexibility.Inflationismuchlowerandlessvolatileinpegregimes.Regardinggrowth,
fewsystematicdifferencesrelatedtoexchangerateregimehavebeenfound(Ghoshetal.,1995).
Anotherseriesofworkingpapersemphasizestheroleofastate’sfinancialdevelopmentin
assessingtheinfluenceofexchangeratevolatilityongrowth.Differencesgivenbythelevelof
developmentoccurprimarilyintheexchangeratevolatilityasanindependentvariable.Ganguly
EXCHANGERATEVOLATILITYANDGROWTH105
andBoucher(2009)arguethatthelatterishigherindevelopingcountriesthaninindustrialized
countriesduetotheactionofnumerousfactorssuchasshocksinterms-of-trade,highvolatility
ofgrossdomesticproductthereforelimitingtheabilitytodealwithfiscalandmonetaryshocks,
nominalshockswithstrongereffectsduetolackofcrediblemonetaryinstitutionsandweakfiscal
positions,exposuretosuddenstopsincapitalflows.Growthvariableenteringtheequation,
thereisanegativerelationshipbetweenproductivitygrowthandexchangeratevolatilityin
lessfinanciallydevelopedcountriesandthereisnolinkbetweenthetwoindevelopedcountries
(Aghionetal.,2006).Incloseconnectiontotheabovementioned,Schnabl(2007a)showsthat
exchangeratestabilityexertsanegativeinfluenceongrowthindevelopingstatesbecauseit
doesn’tallowthemtoreactflexiblytorealshocksandstimulatesspeculativecapitalinflows.
Ontheotherhand,itcarriesapositiveinfluenceoneconomicgrowthasitleadstolower
transactioncostsininternationaltrade,decreasestheuncertaintyofcapitalflowsandstimulates
internationalmacroeconomicstability.
However,theresultsofempiricalanalysisoverwhelminglydependonthetimeframeandthe
sampleofcountrieschosen.Fromthisperspectivetheresultsaresometimescontradictory:
Ghoshetal.(2003)reportedtheexistenceofweaklinksbetweenexchangeratevolatilityand
growth,EdwardsandLevy-Yeyati(2003)arguethatafloatingexchangerateregimeprovidesa
fastereconomicgrowthandEichengrennandLeblang(2003)showthatthereisanegativelink
betweenexchangeratestabilityandgrowth.
3.DataandMethodology
3.1.Descriptionofthedataset.FollowingSchnabl’s(2007)model,westartedfromasample
of17statesfromwhichthosewhohaveadoptedafixedschemehavebeenremoved.Later,
undertheconstraintofdataavailability,the