Does the exchange rate overshoot in an emerging economy?
Purpose: The sticky-price monetary model of exchange rate states the overshooting hypothesis as, exchange rate depreciation beyond its long-term value in response to an increase in money supply owing to the sticky nature of prices. Because of interest and relevance to policy, there is a huge extant literature on it but with mixed findings that suggest the need for further studies to refine the findings. Pakistan’s rupee exchange rate against the US dollar depreciated 128.44% over the period May 2007–December 2018. Considering this substantial decline in rupee's value, this study aims to examine either the rupee short-run value is over-shot of its long-term value. Design/methodology/approach: This study uses a linear ARDL approach that segregates the short-run and long-run effects thus clarifying the premise of exchange rate overshooting. Furthermore, this study also uses nonlinear ARDL as a robustness check incorporating structural breaks. Findings: Findings based on a linear model show evidence of exchange rate undershooting that means a positive money shock causes the exchange rate to appreciate. A nonlinear analysis also provides support to these findings. However, the increase in relative money supply has more such effect than that of a decrease in the relative money supply. Moreover, the authorities’ inclination to stabilize the exchange rate appreciates its short-run value. Originality/value: This study substantiates the overshooting hypothesis literature by considering the role of asymmetric effects of exchange rate determinants and structural breaks that is a rare attempt in the extant literature.
Year of publication: |
2021
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Authors: | Aftab, Muhammad ; Rafique, Amir ; Lau, Evan |
Published in: |
Journal of Chinese Economic and Foreign Trade Studies. - Emerald, ISSN 1754-4408, ZDB-ID 2421758-X. - Vol. 15.2021, 1 (09.06.), p. 1-15
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Publisher: |
Emerald |
Saved in:
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