Exchange Rate Volatility and Macroeconomic Performance in Small Island Developing States

Abstract

The purpose of the study is to provide an investigation into the impact of exchange rate volatility on the macroeconomic performance of Small Island Developing States (SIDS). Taking a sample of 15 SIDS, the present study analyses econometrically the impact of exchange rate volatility on major macroeconomic variables, viz economic growth, external trade and foreign direct investment on the SIDS. The paper first constructs the z-score measure, developed by Wolf et al (2003) as a measure of exchange rate volatility and employs data spanning the period 1999 to 2010 to analyse robust estimates in a static framework as well as in a dynamic and longitudinal data framework using the Generalised Method of Moments. It also analyses the impact of exchange rate volatility on macroeconomic performance of the economies. The OLS with robust standard errors results indicate that, exchange rate volatility impacts negatively on current account balance but positively on the growth rate of the economies studied. In a dynamic setting, however, exchange rate volatility does not influence the macroeconomic variables.