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Examining the volatility of exchange rate: Does monetary policy matter?

Lim, Shu Yi and Sek, Siok Kun (2014): Examining the volatility of exchange rate: Does monetary policy matter?

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Abstract

We conduct empirical analysis on examining the changes in exchange rate volatility under two monetary policy regimes, i.e. the pre- and post- inflation targeting (IT) regimes. In addition, we also investigate if the monetary decisions can have impacts on the volatility of exchange rate. The study is focused in four Asian countries that experienced drastic in the switch of monetary policy from the rigid exchange rate to flexible exchange rate and inflation targeting after the Asian financial crisis of 1997. The exponential generalized autoregressive conditional heteroskedasticity model is applied and our results show that exchange rate is more persistent and volatile in the pre-IT period as compared to post-IT period. The exchange rate persistency is higher in the long-run but the persistency is low in the short run. We fail to find evidence to show that the adoption of flexible exchange rate and inflation targeting lead to greater volatility in exchange rate. The monetary decisions can have impacts on the volatility of exchange rate but the impacts vary across countries.

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