Sources of Real Exchange Rate Fluctuations in East and Southeast Asia

Abstract

This paper investigates empirically and attempts to identify the sources of real exchange rate fluctuations in 7 Asian and Southeast Asian economies using subsets of quarterly data covering time periods from 1980 to 2015. This work uses structural VAR modeling, impulse response function analysis, and forecast error variance decomposition analysis in the spirit of Clarida and Gali (1994), who identify the model’s structural shocks to demand, supply, and money using the Blanchard-Quah (1989) long-run restrictions approach. The paper contributes to the existing literature in the following ways: first, it includes economies that previously have not been studied or that have not been recently examined in this manner, taking advantage of a wider range of data; secondly, it attempts to identify changes in the sources of real exchange rate fluctuations before and after the Asian financial crisis of 1997, which was a critical point for many Asian economies in the evolution of their respective exchange rate regimes. We find that, with a couple notable exceptions, demand shocks explain the majority of the variance in real exchange rate fluctuations in these economies, and that the roles of nominal shocks and supply shocks are fairly limited. Analysis on the effects of the Asian financial crisis and exchange rate regime changes on sources of real exchange rate fluctuations is inconclusive, but builds a foundation for further research. Analysis of the impulse response functions indicates that many of the variable responses to the structural shocks are inconsistent with the underlying Mundell-Fleming-Dornbusch model theory, but where this study overlaps with previous empirical studies, the results are more consistent with the results for those particular economies, suggesting potential limitations of the model.