RELATIONSHIP OF EXCHANGE RATE WITH VARIOUS MACRO ECONOMIC

RELATIONSHIP OF EXCHANGE RATE WITH VARIOUS MACRO ECONOMIC VARIABLES BY: MUSHTAQ UR REHMAN MOHAMMAD ALI JINNAH UNIVERSITY , ISLAMABAD CAMPUS & SHAFIQ UR REHMAN SCHOOL OF MANAGEMENT UNIVERSITY OF LIVERPOOL, UK

Contents Introduction Literature Review Theoretical Frame Work Methodology Results and Discussions Conclusion References

Introduction How much of one currency is worth in terms of another. History (Barter system, Paper currency, Plastic money).

Intro…. The Breton Woods Agreement in 1944 introduced an exchange rate system that remained in effect till 1971. Exchange rate in Pakistan

Intro…. The foreign exchange market is one of the largest markets in the world. By some estimates, about 3. 2 trillion USD worth of currency changes hands every day. A growing body of literature has recently focused on Exchange rate. It is now widely recognized that Exchange rate are important to economic development

Literature Review Branson (1981) reported that real exchange rates are influenced by real disturbances in the current account and the time series seems to give signal for adjustment. Simon (1997) found that exchange rate and current account have direct and positive relationship with inflation and both exchange rate and current account are the key factors that badly affect the small economies.

Cont…. Kendal (2004) found a substantial relationship between exchange rates fluctuation and current account balance. Jakab and Kovacs (1999) reported that nominal exchange regimes do not play important role in tradable real exchange rate fluctuation. They argued that policy of exchange rate was not the main factor of real exchange fluctuations. Instead supply shocks were the main determinants of exchange rate fluctuation.

Cont…. Dong (2006) on the other hand reported the influence of macro economic variables on exchange rate. They reported that monitory policy shocks, interest rates and output gap significantly explained the variance of exchange rate. Binder (2000) opined that exchange rate forecasting is linked with key macro economic variables such as money, income, prices and interest rate

Cont… Rehman (2008) further concluded that inflation were the strong macro economic variable that cause appreciation and depreciation in exchange of home currency, therefore inflation is the key indicator for exchange rate.

Theoretical Frame Work Interest Rate (X 1) GDP (X 4) Exchange rate (Y) Current account (X 3) Inflation (X 2)

Methodology Data Y= Annually from 1990 to 2002. a + b. Xi + Ei a = (∑Xί 2∑Y) - (∑X∑XίY) n (∑x 2) - (∑x)2 b = n (∑XίY) (∑X∑Y) n (∑Xί) 2 -(∑Xί)2

Results & Discussions

Exchange Rate VS Interest Rate Whenever the interest rate rises return on investment increases to investors both for private and public investors. When interest rate raises the country currency appreciates. The main reason behind this appreciation is that more and more people come inside the county and invest more and more. R=64. 1% R 2=41%

Exchange Rate and Inflation When the inflation rate of a country increases the currency depreciate. Because inflation is inversely related to that of the value of currency. Analysis the regression relation between the exchange rate fluctuation and the inflation is 65. 4%. this relationships very high. It means the inflation is very important to influence the exchange rate fluctuation. The coefficient of determination i. e. , R 2 is 42. 8% that means that 42. 8% of exchange rate fluctuations is caused by changes in

Exchange Rate and Current Account Balance When there is a surplus balance in the current account the home currency appreciates while in case of the deficit in the current account the home currency depreciates. Findings of the research is as under; R=45. 5%. it means the relationship between current account and exchange rate fluctuation is not very high. Coefficient of determination is 11. 9% i. e. only 11. 9% percent of the exchange rate fluctuation is caused by the changes in the current account.

Exchange Rates and Gross Domestic Product When the gross domestic product increases it decrease the home currency depreciation. So the gross domestic product is influencing the exchange rate fluctuation. Findings of the research are as under; R=84. 4%, it means that there are strong relationship between the exchange rate fluctuation and the gross domestic product (GDP). The coefficient of determination i. e. R 2 is 71. 1%. It means that 71. 1% changes in exchange rate fluctuation is caused by the changes in the gross domestic product.

Conclusion The research findings are summarized below; interest rates, inflation rate, current account, real interest rate and gross domestic products have important role in the exchange rate fluctuations. The results in the Pakistan economy context are as under; among all these variables the most important is the gross domestic products which have correlation coefficient of R= 84. 4% and with 71. 1% of coefficient of determination

Cont…. Inflation rate is more influencing the exchange rate fluctuation. The coefficient of correlation R is Regression coefficient 64. 1% i-e. R 2 is 42. 8% while the coefficient of determination. Next the relationship between interest rate and the exchange rate fluctuation is R= 64. 1% while the coefficient of determination i. e. R 2 is 41. 1%.

Cont…. Effects of current account on exchange rate fluctuations is very low as compared to the above four determinants of exchange rate. The coefficient of correlation is i. e R =34. 5% and the coefficient of determination i. e R 2 = 11. 9%. it means that exchange rate fluctuations is caused only by 11. 9 % by changes in current account while the rest of the changes that is 99. 1% changes are caused by some other factor. Thus the effects of GDP over exchange rate fluctuation are high, and the effects of current account are very low.

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