A Markov-Switching Approach to Measuring Exchange Market Pressure

October 1, 2007

Preview Citation

Format: Chicago

Francis Y Kumah. A Markov-Switching Approach to Measuring Exchange Market Pressure, (USA: International Monetary Fund, 2007) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper characterizes exchange market pressure as a nonlinear Markov-switching phenomenon, and examines its dynamics in response to money growth and inflation over three regimes. The empirical results identify episodes of exchange market pressure in the Kyrgyz Republic and confirm the statistical superiority of the nonlinear regime-switching model over a linear VAR version in understanding exchange market pressure. The nonlinear empirical approach adequately characterizes the data generation process and yields results that are consistent with theoretical predictions, particularly the dampening effect of monetary contraction on depreciation pressure. During periods of appreciation pressure, however, the reverse policy option-monetary expansion-may not be efficient, particularly where PPP rather than UIP drives exchange rates. In addition, monetary expansion in such cases defeats the primary objective of monetary policy-price stability-and may exacerbate the instability.

Subject: Currencies, Currency markets, Depreciation, Exchange rate adjustments, Exchange rates

Keywords: Financial crisis, Foreign exchange market, Interest rate, WP

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/242
Stock No:

WPIEA2007242
ISBN:

9781451868050
ISSN:

1018-5941

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