Nonlinear relationship between exchange rate volatility and economic growth: A South African perspective

Fourie, Justin and Pretorius, Theuns and Harvey, Rhett and Henrico, Van Niekerk and Phiri, Andrew (2016): Nonlinear relationship between exchange rate volatility and economic growth: A South African perspective.

Abstract

In this paper, we challenge the traditional assumption of a linear relationship between exchange rate volatility and economic growth in South Africa. By using data collected from 1970 to 2016 applied to a smooth transition regression (STR) model, we are able to prove that the exchange rate-economic growth correlation is indeed nonlinear within the sampled time period. In particular, we find that regime switching behaviour is facilitated by government size in which exchange rate volatility positively and significantly influences economic growth when growth in government spending is below 6 percent. Above this 6 percent threshold, volatility exerts an insignificant effect on economic growth. In light of the adoption of a free floating exchange rate regime by the Reserve Bank, our results emphasize the importance of the role which fiscal authorities play on the extent to which exchange rate movements affect economic growth.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rates; economic growth, smooth transition regression (STR) model; thresholds; nonlinearity; volatility; South Africa; monetary policy; fiscal policy.
• Subjects: C - Mathematical and Quantitative Methods > C0 - General > C01 - Econometrics; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O40 - General

References

Abdulla S. (2012), “Modelling exchange rate volatility using GARCH models: Empirical evidence from Arab countries”, International Journal of Economics and Finance, 4(3), 216-229.

Adewuyi A. and Akpokodje G. (2013), “Exchange rate volatility and economic activities of Africa’s sub-groups”, The International Trade Journal, 27, 349-384.

Aghion P., Bacchetta P., Ranciere R. and Rogoff K. (2009), “Exchange rate volatility and productivity growth: The role of financial development”, Journal of Monetary Economics, 56(4), 494-513.

Alagidede P. and Ibrahimm M. (2016), “On the cause and effects of exchange rate volatility on economic growth: Evidence from Ghana”, IGC Working Paper, February.

Arize A., Osang T. and Slottje D., (2003), “Exchange rate volatility and foreign trade: Evidence from Thirteen LDC’s”, Journal of Business and Economic Statistics, 18, 10-17.

Aron J., Elbadawi I. and Kahn B. (1997), “Determinants of real exchange rate in South Africa”, CSAE Working Paper Series No. 97-16, April.

Asimakopoulos S. and Karavias Y. (2016), “The impact of government size on economic growth: A threshold analysis”, Economic Letters, 139, 65-68.

Bahmani-Oskooee M. and Kandil M. (2010), “Exchange rate fluctuations and ouptut in oil-producing countries: The case of Iran”, Emerging Markets and Finance, 46(3), 23-45.

Bahmani-Oskooee M., Baek J. and Hegerty S. (2016), “GARCH-based versus traditional measures of exchange rate volatility: Evidence from Korean industry trade”, International Journal of Trade and Global Markets, 9(2), 103-136.

Biza R., Kapingura F. and Tsegaye A. (2015), “Do budget deficits crowd out private investment? An analysis of the South African economy”, International Journal of Economic Policy in Emerging Economies, 8(1), 52-76.

Bleaney M. and Greenaway D. (2001), “The impact of terms of trade and real exchange rate volatility on investment and growth in Sub-Saharan Africa”, Journal of Development Economics, 48, 461-477.

Bollerslev T. (1986), “Generalized autoregressive conditional heteroskedasticity”, Journal of Econometrics, 31(3), 307-327.

Boshoff W. (2008), “Rethinking ASGISA and the Rand exchange rate”, South African Journal of Economic and Management Sciences, 11(1), 113-120.

Buh I. and Amusi H. (2003), “Real exchange rate volatility and foreign trade: Evidence from South Africa’s exports to the United States”, The African Finance Journal, 5(2), 1-20.

Chamunorwa W. and Choga I. (2015), “Exchange rate volatility and export performance in South Africa: 2000-2014”, Asian Economic and Financial Review, 5(10), 1174-1186.

Chowdury A. (1993), “Does exchange rate volatility depress trade flows?”, The Review of Economics and Statistics, 75(4), 700-706.

Chowdury T. (2005), “Exchange rate volatility and the United States exports: Evidence from Canada and Japan”, Journal of Japanese and International Economies, 19, 51-71.

Cottani J., Leiderman L. and Reinhart C. (1990), “Real exchange rate behaviour and economic performance in LDCs”, Economic Development and Cultural Change, 39(1), 61-76.

Cuestas J. and Mourelle E. (2011), “Nonlinearities in real exchange rate determination: Do African exchange rates follow a random walk?”, Applied Economics, 43(2), 243-258.

Danmola R. (2013), “The impact of exchange rate volatility on the macroeconomic variables in Nigeria”, European Scientific Journal, 9(7), 1857-1881.

Dickson O. (2012), “Exchange rate volatility and economic growth in Nigeria”, Mediterranean Journal of Social Sciences, 3(3), 399-407.

Dollar D. (1992), “Outward oriented economies really do grow more rapidly: Evidence from 95 LDC’s, 1976-1985”, Economic Development and Cultural Change, 9(40-43), 523-544.

Elliot G., Rothenberg T. and Stock J. (1996), “Efficient tests for an autoregressive time series with a unit root”, Econometrica, 64, 813-836.

Ekanayake E., Thaver R. and Plante D. (2012), “The effects of exchange rate volatility on South Africa’s trade with the European Union”, The International Journal of Business and Finance Research, 6(3), 13-26.

Ghosh A., Ostry J., Gulde A. and Wolf H. (1997), “Does exchange rate regime matter for inflation and growth?” IMF Economic Issues, 2, 1-19.

Ghura D. and Grennes T. (1993), “The real exchange rate and macroeconomic performance in Sub-Saharan Africa”, Journal of Development Economics, 42, 155-174.

Ishimwe A. and Ngalawa H. (2015), “Exchange rate volatility and manufacturing exports in South Africa”, Banks and Bank Systems, 10(3), 29-38.

Kandil and Mirzaie (2002), “Exchange rate fluctuations and disaggregate economic activity in the US: Theory and evidence”, Journal of International Money and Finance, 21, 1-31.

Katusiime L. Agbola F. and Shamsuddin A. (2016), “Exchange rate volatility-economic growth nexus in Uganda”, Applied Economics, 48(26), 2428-2442.

Kenen P. and Rodrick D. (1986), “Measuring and analysing the effects of short-term volatility in real exchange rates”, The Review of Economics and Statistics, 68(2), 311-315.

Khosa J., Botha I. and Pretorius M. (2015), “The impact of exchange rate volatility on emerging market exports”, Acta Commercii, 15(1), 1-11.

Lastrapes W. and Koray F. (1990), “Exchange rate volatility and U.S. multilateral trade flows”, Journal of Macroeconomics, 12, 341-362.

Laubscher P. (2014), “A new recession-dating algorithm for South Africa”, Stellenbosch Economic Working Paper Series No. WP06/2014.

Levine R. and Renelt D. (1992), “A sensitivity analysis of cross-country growth regressions”, American Economic Review, 82(4), 942-963.

Mahmood I. and Ali S. (2011), “Impact of exchange rate volatility o macroeconomic performance of Pakistan”, International Research Journal of Finance and Economics, 64, 54-65.

Musyoki D., Pokhariyal G. and Pundo M. (2012), “The impact of exchange rate volatility on economic growth: Kenyan evidence”, Business and Economic Horizons, 7(1), 59-75.

Ndambendia H. and Alhayky A. (2011), “Effective exchange rate volatility and economic growth in Sub-Saharan Africa: Evidence from panel unit root and cointegration tests”, The UIP Journal of Applied Finance, 17(1), 85-94.

Nyahokwe O. and Ncwadi R. (2013), “The impact of exchange rate volatility on South African exports”, Mediterranean Journal of Social Sciences, 4(3), 507-513.

Obstfeld M. and Rogoff K. (1995), “Exchange rate dynamics redux”, Journal of Political Economy, 103(3), 624-660.

Panda S. and Mohanty R. (2015), “Effects of exchange rate volatility on exports: Evidence from India”, Economics Bulletin, 35(1), 305-312.

Pelinescu E. (2014), “Volatility analysis of the Romanian exchange rate”, Procedia Economics and Finance, 8, 543-549.

Phiri A. (2016), “Examining asymmetric effects in the South African Philips curve: Evidence from logistic smooth transitions models”, International Journal of Sustainable Economy, 8(1), 18-42.

Phiri A. (2016), “Nonlinearities in Wagner’s law: Further evidence from South Africa”, MPRA Working Paper No. 71702, June.

Pilbeam K. and Langeland K. (2015), “Forecasting exchange rate volatility: GARCH model versus implied volatility forecasts”, International Economics and Economic Policy, 12(1), 127-142.

Rapach D. and Strauss J. (2008), “Structural breaks and GARCH models of exchange rate volatility”, Journal of Applied Econometrics, 23(1), 65-90.

Salai-I-Martin X. (1997), “I just ran two million regressions”, American Economic Review, 87(2), 178-183.

Sanginabadi B. and Heidari H. (2012), “The effects of exchange rate volatility on economic growth in Iran”, Actual Problems of Economics, 132(6), 430-441.

Schnabl G. (2009), “Exchange rate volatility and growth in emerging Europe and East Asia”, Open Economic Review, 20, 565-587.

Sekantsi L. (2011), “The impact of real exchange rate volatility on South African exports to the United States (US): A bounds test approach”, Review of Economic and Business Studies, 8, 119-139.

Serenis D. and Tsounis N. (2015), “Exchange rate volatility and foreign trade: The case for Cyprus and Croatia”, Procedia Economics and Finance, 5, 677-685.

Sibanda K., Ncwadi R. and Mlambo C. (2014), “Investigating the impacts of real exchange rates on economic growth: A case study of South Africa, Mediterranean Journal of Social Sciences, 4(13), 261-274.

Takaendesa P., Tsheole T. and Azaikpono M. (2006), “Real exchange rate volatility and its effect on trade flows: New evidence from South Africa”, Journal for Studies in Economics and Econometrics, 30, 79-97.

Terasvirta T. (1994), “Specification, estimation and evaluation of smooth transition autoregressive models”, Journal of American Statistical Association, 89(425), 208-218.

Vieira F., Holland M., Silva C. and Bottecchia L. (2011), “Growth and exchange rate volatility: A panel data analysis”, Applied Economics, 45(26), 3733-3741.

Zivot, E. and Andrews, K. (1992) ‘Further evidence on the great crash, the oil price shock and the unit root hypothesis’, Journal of Business and Economic Studies, 10(10), 251-270.