| The relationship between exchange rates and macroeconomic variables is well documented on advanced economies. However, what is the relationship between macroeconomic variables and the exchange rates of a sample of emerging economies? This study investigates which of the variables included in the regression model is affecting movements in the exchange rate for Euro, the United Kingdom, Japan, South Africa, Brazil, and Mexico against the US dollar between January 1999 and December 2012. The variables in question are money supply, gross domestic product, interest rate, and inflation differential. The results show that the variable money supply, interest rate and inflation differential constitute a significant explanatory variable for exchange rate movements in the entire baseline model analyzed. However, the study found that not all the relationships were consistent in the exchange rates of advanced economies and that of emerging currencies. The baseline model was expanded with additional variable of FX reserve, export to US and import from US to test if these additional variables will improve the model fit. Statistically, the inclusion of the three new variables created a better model fit for EUR/USD exchange rate and GBP/USD exchange rate. None of the additional variables had a significant relationship with the exchange rates of the three emerging currencies analyzed. Overall, the expanded models provide a more comprehensive look at how variability in each economic variable impact exchange rate movements. In addition, the study also analyzed a 3-month moving average forecast on the sample of exchange rates analyzed. With the exception of BRL/USD exchange rate, the trends of the fitted values and the actual data points were consistent with the exchange rate of advanced and emerging currencies analyzed. |
