Effects of real effective exchange rate volatility on export earnings in Ethiopia: Symmetric and asymmetric effect analysis

Abstract

The exchange rate is one of the key monetary policy instruments used to dictate the economy. However, the effect of exchange rate volatility on macroeconomic outcomes has been a subject of debate in previous research. Thus, this study examined the effects of real effective exchange rate (REER) volatility on Ethiopia's export earnings using quarterly data covering 2007 to 2021. The GARCH model is employed to estimate the volatility of the real effective exchange rate, and its effect is examined at the aggregate and disaggregate levels. Disaggregation is made at commodity and partner country levels. Besides these, the study also examined the symmetric and asymmetric effects of exchange rate volatility on the three categories of export earnings. To estimate the effects, both the linear autoregressive distributed lag (ARDL) and nonlinear ARDL (NARDL) models are employed. The short-run ARDL result shows that the real effective exchange rate and its volatility affect export earnings only in a few cases. Real effective exchange rate appreciation is significant and reduces total export earnings and export earnings from vegetables, meat, and oilseed-related products. Similarly, exchange rate volatility reduces total export earnings and earnings from coffee, vegetables, and meat-related products. At the aggregate level, the NARDL result shows that exchange rate volatility has an asymmetric effect on total export earnings. Positive volatility reduces total export earnings, while negative volatility is not significant. At the commodity level, volatility also has an asymmetric effect on earnings from coffee and meat exports in the short run. However, in the long run, there is no asymmetric effect of exchange rate volatility on total and commodity-level export earnings. In terms of the country of destination, there is no strong evidence of the effect of real effective exchange rate appreciation and its volatility on export earnings. Thus, policies that stabilize the volatility of the exchange rate are needed in Ethiopia in order to enhance export earnings.