Domestic Consumption and Uncertainty of Exchange Rate in a Monetary Union: Evidence From The Euro Area

Samuel N. Okafor () and Juste S. Lokossou

The European Journal of Applied Economics, 2021, vol. 18, issue 1, 151-172

Abstract: The research seeks to uncover how real consumption reacts to real exchange rate uncertainty in the short and long run for the world’s largest monetary union- the euro zone. Twelve euro zone countries were sampled covering the period 1995Q1-2019Q4. Using generalized autoregressive conditional heteroskedasticity (GARCH) and pooled mean group (PMG), the result shows that exchange rate uncertainty significantly dampens long-run consumption while the short-run effect is mixed. In the benchmark model, a negative and significant error correction coefficient was obtained, which allows to argue that i) there is evidence of a return to the long-run equilibrium path for consumption following short run deviations and ii) the speed of adjustment to equilibrium is low, with a coefficient of ~ 4%. This suggests that, in the euro zone, convergence to long-run equilibrium is slow, as the proportion of disequilibrium corrected in one quarter, following a shock, is about 4%, which implies it would take ~17 quarters for one half of the disequilibrium, or deviations from the long-run consumption path to become corrected.

Keywords: Monetary union; euro zone; exchange rate; consumption; uncertainty; GARCH; PMG. (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:sng:ejae01:148

DOI: 10.5937/EJAE18-28714

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