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Why are some exchange rates more volatile than others? evidence from transition economies

  • Year: 2008
  • Organisation: University of Cape Town and Deloitte Consulting
  • Author(s): Chandana Kularatne; Roy Haveman
  • Countries and Regions: South Africa

To better understand why some currencies are more volatile than others, this paper considers the cross-country determinants of exchange rate volatility for a set of middle-income countries. Overall, the paper finds that higher levels of reserves reduce volatility, and it is estimated that an appropriate level of reserves is approximately 4 1 2 months of imports. Volatility is increased by increased uncertainty and loose fiscal policy. In addition, a volatile terms of trade spills over into a volatile currency. From a policy perspective, whilst it is clear that prudent macroeconomic policy is the best course of action to reduce exchange rate volatility, the influence of external volatility on the exchange rate (over which the authorities have no control) should not be underestimated.