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Unemployment Fluctuations and Currency Returns in the United Kingdom: Evidence from Over One and a Half Century of Data

Deven Bathia (), Riza Demirer (), Rangan Gupta () and Kevin Kotze ()
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Deven Bathia: Queen Mary University of London, School of Business and Management, Mile End Road, London, E1 4NS, United Kingdom
Kevin Kotze: School of Economics, Faculty of Commerce, University of Cape Town, Private Bag, Rondebosch 7701, South Africa

No 202083, Working Papers from University of Pretoria, Department of Economics

Abstract: This paper provides a long-term perspective to the causal linkages between currency dynamics and macroeconomic conditions by utilising a long span data set for the United Kingdom that extends back to 1856 and a time-varying causality testing methodology that accounts for the nonlinearity and structural breaks. Using unemployment fluctuations as a proxy for macroeconomic conditions and wavelet decompositions to obtain the fundamental factor that drives excess returns for the British pound, time varying causality tests based on alternative model specifications yield significant evidence of causal linkages and information spillovers across the labour and currency markets over the majority of the sample. Causal effects seem to strengthen during the Great Depression and later following the collapse of the Bretton Woods system, highlighting the role of economic crises in the predictive linkages between the two markets. While the predictive role of currency market dynamics over unemployment fluctuations reflects the effect of exchange rate volatility on corporate investment decisions, which in turn, drives subsequent labour market dynamics (e.g. Belke & Gros (2001); Belke & Kaas (2004); Feldman (2011); among others), we argue that causality in the direction of exchange rates from unemployment possibly reflects the signals regarding monetary policy actions, which in turn, spills over to financial markets. Overall, the findings indicate significant information spillovers across the labour and currency markets in both directions with significant policy making implications.

Keywords: Time-varying Granger Causality; GARCH; DCC-MGARCH; Unemployment; Exchange rates (search for similar items in EconPapers)
JEL-codes: C10 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2020-09
New Economics Papers: this item is included in nep-his and nep-ifn
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