A comparative analysis of exchange rate fluctuations and economic activity

Abstract

Purpose The paper aims to examine the effects of exchange rate fluctuations on real output, the price level, and the real value of components of aggregate demand in Egypt and Turkey. Design/methodology/approach Building on a theoretical model that decomposes movements in the exchange rate into anticipated and unanticipated components, the empirical investigation traces the effects through demand and supply channels. Findings In Turkey, anticipated exchange rate appreciation has significant adverse effects, contracting the growth of real output and the demand for investment and exports, while raising price inflation. Random fluctuations in Turkey have asymmetric effects that highlight the importance of unanticipated depreciation in shrinking output growth and the growth of private consumption and investment, despite an increase in export growth. In Egypt, anticipated exchange rate appreciation decreases export growth. Given asymmetry, the net effect of unanticipated exchange rate fluctuations, in Egypt, decreases real output and consumption growth and increases export growth, on average, over time. Research limitations/implications In light of the country‐specific evidence, future research should extend the investigation using panel estimation, incorporating various demand and supply shocks along with exchange rate fluctuations, to establish the relative importance of various shocks on macroeconomic performance across MENA countries. Practical implications While adhering to a flexible exchange rate policy to boost competitiveness, managing fundamentals to reduce excessive volatility impinging on the economic system over time should top the policy agenda. Originality/value Excessive volatility in the real effective exchange rate could be detrimental to real growth, over time, as the evidence for Turkey and Egypt illustrates.

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