Exchange rate uncertainty and economic fluctuations in typical emerging economies

Abstract

This paper examines the role of Exchange Rate Uncertainty (ERU) in driving economic fluctuations in emerging economies using a VAR with stochastic volatility in the mean. We use the quarterly data of three typical emerging economies from 1972Q3 to 2009Q4 within a VAR model. We show that ERU plays a vital role in driving the business cycles of emerging economies. First, an ERU can provoke risks in the financial market and the real economy. Second, ERU hurts equity prices and the output growth of emerging economies. Further investigation shows that the adverse effects of ERU on output are more severe under the fixed exchange rate regime than under the flexible exchange rate regime. This finding implies that adopting the flexible exchange rate regime can help emerging economies mitigate the adverse effects of uncertainty shocks.