The Economy Essay

Summary:

          In this article, the authors have studied the policy factors that lead to exchange rate volatility. In other words, authors tried to find out the effectiveness of the role of Government and Central bank in controlling volatility in the Exchange rate. They identified some tools that are available to the Government and Central bank for managing exchange rates; these are regulating the foreign exchange sector, regulating the outflow and inflow of capital, and central bank intervention. In this research article, authors used the GARCH model to analyze the exchange rate volatility. The variables used for GARCH model were monthly and quarterly exchange rate volatility, exchange rate regime, regulatory restrictions on capital flows, expected real interest rate, central bank intervention in the foreign exchange market, the domestic stock market volatility, country’s economic wealth, domestic economy real openness, domestic economy financial openness. The research was carried out to study the volatility of U.S dollars against the currencies of 43 countries for the period 1990 to 2001.

           The main purpose of this article seems to highlight the appropriate role of the Government and Central bank in restraining the exchange rate volatility, because in the past Asian Financial crisis was not the result of lack of Government role but it was due to the wrong role played by the Central bank and Government. Moreover, the importance of studying the exchange rate volatility is increased because of the fact, that it can have adverse affects on the firm’s profitability, price stability and financial stability.

Findings:

         The authors found out that flexible exchange rate regime, intervention by the Central bank, and uncertainity in the economy leads to volatility in the exchange rate while per capita GDP decreases volatility. They also concluded that real interest rate can help restraining the exchange rate volatility. The results of the research show that the direct intervention by the Central bank, in which it acts against any huge excess demand or supply of domestic currency in the foreign exchange market, increases volatility but intervention of the Central Bank through changes in the interest rate decreases the exchange rate volatility. In article the authors have tried to show the direction of the policy variables rather than the magnitude of these variables. (Benita and Lauterbach, 2007)

Reaction:

         I think authors have done a commendable job and came up with substantial work. This area of exchange rate volatility still needs a lot of research since many countries have become the victim of the adverse effects of volatile exchange rate. The authors used a widely acceptable model of econometrics to analyze the data and came up with valid conclusions. I agree with the conclusions drawn by the authors since it has been supported by reliable facts and figures. Authors used the data of past 11 years which in my opinion is sufficient to check the volatility. Moreover, the authors used the data of 43 countries that differ in the political, economic, social and political environment. This means that results of the study can be fairly generalized.

Questions:

            After reading this research article, there were several questions that clicked my mind. First of all, why was the openness of economy not considered as a policy factor? Openness of economy depends upon policies framed by the Government and the Central bank. Increase in the custom duties or increase in the interest rates can hamper the international trading. Secondly, why the authors did not consider the influence of political conditions on the exchange rate volatility? The countries that have been analyzed have undergone many political problems and there might be a possibility that the volatility has been caused by the adverse political conditions. Thirdly, there is a possibility that factors responsible for the exchange rate volatility in 43 different countries might differ in magnitude. For example, in India central bank intervention might be a dominant factor in the exchange rate volatility while in France economic uncertainty might have played a vital role in the volatility of exchange rate. Moreover, the research analysis has not considered the effect of news on the exchange rate volatility. These days news plays a vital role in shaping the sentiments of the investors. Investors in the foreign exchange, market that are trading for speculative purpose can react quickly to any extraordinary news item. Finally, in my opinion the authors should have used the technique of re-sampling to confirm that whether the results hold true only for specific sample of countries or the results are also applicable for a different sample of countries as well.

References:

Benita.G, Lauterbach.B, 2007, Policy Factors and Exchange Rate Volatility: Panel Data versus a Specific Country Analysis: EuroJournals Publishing, Inc.

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