Exchange Rate Volatility Determinant in Indonesia and Malaysia

Abstract

In the case of Indonesia and Malaysia, the positive and significant correlation between real effective exchange rate (REER) and capital and financial account explain that when capital inflows augment to domestic, then REER is more volatile. This result enhances IMF study (2006) show that capital inflow on ASEAN countries is dominated by short-term capital than long-term capital. In addition, the positive and significant correlation between REER and exchange rates regime indicates that when exchange rate regime becomes more flexible, then REER becomes volatile. We can analyze in the shifting of fixed exchange rate and managed floating exchange rate then to floating exchange rate. The negative and significant correlation between REER and interest rate on national currency market in Indonesia indicates this result is appropriate with Frenkel (1981) and Blanchard-Cohen (2007) empirical studies. In the case of Malaysia, this relationship is still significantly positive.