Exchange Rate Uncertainty and Business Cycle Fluctuations

Hayk Kamalyan and Vahagn Davtyan

MPRA Paper from University Library of Munich, Germany

Abstract: What is the impact of heightened exchange rate uncertainty on business cycle dynamics? This question is particularly important for emerging economies where exchange rate uncertainty is substantially higher and time-varying. Using data from emerging countries, we show that exchange rate uncertainty is essential for business cycle fluctuations. We find that heightened exchange rate uncertainty yields a drop in economic activity, an increase in prices, and an exchange rate depreciation. We rationalize our empirical findings in a small open economy model augmented with time-varying volatility of exchange rate shocks. In the structural model, the main ingredient of the transmission mechanism is the households’ precautionary behavior. We also show that no other shocks, often featured in the literature, can produce the reported co-movement pattern among the macro variables.

Keywords: DSGE; Stochastic Volatility; Nominal Exchange Rate (search for similar items in EconPapers)
JEL-codes: E32 F41 F44 (search for similar items in EconPapers)
Date: 2022-06-17
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:113443

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