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Does the exchange rate overshoot in an emerging economy?

Does the exchange rate overshoot in an emerging economy? 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/approachThis 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.FindingsFindings 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/valueThis 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Chinese Economic and Foreign Trade Studies Emerald Publishing

Does the exchange rate overshoot in an emerging economy?

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References (47)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1754-4408
DOI
10.1108/jcefts-12-2020-0075
Publisher site
See Article on Publisher Site

Abstract

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/approachThis 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.FindingsFindings 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/valueThis 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.

Journal

Journal of Chinese Economic and Foreign Trade Studies – Emerald Publishing

Published: Feb 7, 2022

Keywords: Pakistan; Emerging economy; Exchange rate overshooting; Nonlinear ARDL; Sticky-price monetary model

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