Abstract
The exchange rate is a key macroeconomic factor that affects international trade and the real economy of each country. The development of international trade creates conditions where volatility comes with the exchange rate. The purpose of this paper is to examine the effect of real effective exchange rate volatility on economic growth in the Central and Eastern European countries. Additionally, the effect, through three channels of influence on economic growth which vary on the measurement of exchange rate volatility, is examined. The study uses annual data for fourteen CEE countries for the period 2002–2018 to examine the nature and extends the impact of such movements on growth. The empirical findings using the fixed effects estimation for panel data reveal that the volatility of the exchange rate has a significant negative effect on real economic growth. The results appear robust with alternative measures of exchange rate volatility such as standard deviation and z-score. This paper suggests that policymakers should adopt different policies to keep the exchange rate stable in order to foster economic growth.
Highlights
After the failure of the Bretton Woods system in 1970, the regime of the exchange rate changed across countries
To check for robustness, the results are reported by measuring volatility in two ways as a standard deviation and as a z-score
Exchange rates are the main indicator that influences the price of products and services that affect the level of transaction on international trade and capital movement between countries
Summary
After the failure of the Bretton Woods system in 1970, the regime of the exchange rate changed across countries. From this time there has been an increase in the usage of floating exchange rates, but rather most countries have adopted flexible intermediate regimes including conventional pegs. In 1973, floating exchange rates in Europe made nominal and real interest rates more volatile, which discourages investment due to the risk that comes with the exchange rate. The economists believed that floating rates may be harmful to the economy because every country uses the currency as an intermediate to purchase products and services in international trade. The risk or the uncertainty regarding the unpredictable changes over time on the exchange rate can be defined as volatility. Shocks are the main source of unpredictable changes that can affect the price of goods, inflation, interest rates, portfolio investment, savings and loans (Clarida and Gali 1994)
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