Veiled Expectations: The Heterogeneous Impact of Exchange Rate Shocks at the Sectoral-Level

Jing Lian Suah

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines the sectoral-level impact of nominal exchange rate shocks. I introduce a model where agents face bounded abilities to form expectations, and agents’ foresight depends directly on the state of financial stress. This leads to differential labour market responses to exchange rate movements. When financial stress is low, absent of shocks, exchange rate movements are minimal and pinned down by agents. When financial stress is salient, agents’ foresight is veiled; they fail to form reliable expectations during episodes of sharp depreciation. Workers and firms fail to adjust expected relative wages and future marginal profits respectively, leading to sub-optimal output. Using monthly sectoral data from Malaysia in Simultaneous Equations and Markov-Switching Models, I find heterogeneous labour market responses. In tradable sectors, labour flows were small and concentrated in the manufacturing sector. Likewise, adjustments in non-tradable sectors were small. On the extensive margin, labour market flows diverge between tradable and non-tradable sectors. On the intensive margin, labour market flows in tradable sectors reverse. In contrast, as the model predicts, non-tradable sectors do not react to substantial terms of trade shocks.

Keywords: Exchange Rate; Labour Market Frictions; Financial Stress; Expectations Formation; Regime-Switching; Simultaneous Equations Model (search for similar items in EconPapers)
JEL-codes: D84 E44 F31 J20 (search for similar items in EconPapers)
Date: 2020-11-01
New Economics Papers: this item is included in nep-isf, nep-mac, nep-opm and nep-sea
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