Abstract
Capturing changes in foreign reserves and exchange rates through the exchange market pressure, this article investigates whether economic policy uncertainty plays any role in exchange market pressure movements while controlling for the effects of domestic and external factors. A panel of 20 countries was examined from 2003Q1 to 2017Q4 using panel techniques that are consistent in the presence of heterogeneity and cross-sectional dependence. The study finds that a long-run relationship exists between exchange market pressure and economic policy uncertainty. Our estimation results reveal that a rise in economic policy uncertainty, consumer price index, trade openness, and financial openness increases the severity of the exchange market pressure in the long run. However, gross domestic product (GDP) growth, domestic credit, and foreign direct investment inflows can cushion the effect of the pressure. Therefore, irrespective of whether a country operates fixed, flexible, or intermediate exchange rate regime, its foreign exchange market is still significantly affected by economic policy uncertainty.
Highlights
The end of the 20th century and start of the 21st century have been characterized by financial turbulence, with several financial crises witnessed across countries, regions, and even the entire world
The results indicate that higher gross domestic product (GDP) growth, higher domestic credit as share of GDP, and higher Foreign direct investment (FDI) inflows are significantly associated with lower exchange market pressure (EMP)
Our results show that EMP responds negatively to GDP growth, domestic credit and FDI inflow are in line with Aizenman et al (2012) and Aizenman and Binici (2016) but in contrast to Katircioglu and Feridun (2011), who showed that domestic credit tends to increase EMP in Turkey
Summary
The end of the 20th century and start of the 21st century have been characterized by financial turbulence, with several financial crises witnessed across countries (such as the Argentine crisis of 2001-2002, the Greek crisis of 2011, and the Russian crisis of 2014), regions (such as the European Exchange Rate Mechanism [ERM] crisis of 1992-1993 and the Asian crisis of 1997), and even the entire world (the global financial crisis of 2007-2009). The often resulting currency collapses have been attributed to the overwhelming pressure in the foreign exchange markets (García & Malet, 2007). The same time period has been characterized by increased global economic policy uncertainty (EPU). The degree of uncertainty in economic policies has been on the increase due to the rising complexity of economic and market-related processes (Krol, 2014). Some researchers have suggested a link between EPU and the financial markets. It has been suggested that uncertainties about the fiscal, monetary, and regulatory policies of Europe and the United States played a major role in the global financial crisis of 2007-2009 and slow recoveries experienced afterward
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