Is Exchange Rate Variability Fueling Inflation and Reducing Growth? Evidence from Developing Countries

Abstract

Purpose - The paper examines the asymmetric effects of exchange rate fluctuations on real output and price in developing countries.

Design/methodology/approach - Unanticipated currency fluctuations determine aggregate demand through exports, imports, and the demand for domestic currency and determine aggregate supply through the cost of imported intermediate goods.

Findings - The evidence indicates that the supply channel leads to output contraction and price inflation in the face of unanticipated currency depreciation. In contrast, the reduction in net exports determines output contraction and reduces price inflation in the face of unanticipated currency appreciation.

Implications - Given asymmetry, an increase in price inflation relative to deflation, correlates with an increase in output contraction relative to expansion across countries. Demand expansion in the face of currency depreciation correlates with an increase in price inflation and a reduction in output growth. Demand contraction in the face of currency appreciation correlates with a reduction in output growth and price inflation.

Originality/value - The variability of the exchange rate significantly reduces trend output growth and increases the trend and variability of price inflation across countries.