Role of Exchange Rate in Macroeconomic Fluctuations: The Case of Poland and Hungary
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The purpose of this paper is to analyze the role of exchange rate in macroeconomic fluctuations in Poland and Hungary. The two countries are major economies in central and eastern Europe and members of the European Union, but have not joined the euro area yet. In theory, the exchange rate could be either a shock absorber or a source of shocks in an economy. In our empirical model, we use a structural VAR model identified with sign restrictions that are consistent with economic theories. If the real exchange is mainly influenced by real shocks, the exchange rate is considered as a shock absorber. On the contrary, if the nominal shock is the main reason of the real exchange rate variations, then the exchange rate is considered as a source of shocks. We find that the real exchange rate in Poland and Hungary are affected by both the real and nominal shocks. However, the influence of the nominal shock is more substantial in Poland. We also find that the pure exchange rate shock is a more important factor affecting real exchange rate variations among the nominal shock in both countries. Thus, our empirical results indicate that the exchange rate is a source of shocks in both countries, especially in Poland. Since a large part of the exchange rate fluctuations is caused by the nominal shock and the pure exchange rate shock, the cost of macroeconomic destablization from joining the euro area may not be substantial.
Abstract
The purpose of this paper is to analyze the role of exchange rate in macroeconomic fluctuations in Poland and Hungary. The two countries are major economies in central and eastern Europe and members of the European Union, but have not joined the euro area yet. In theory, the exchange rate could be either a shock absorber or a source of shocks in an economy. In our empirical model, we use a structural VAR model identified with sign restrictions that are consistent with economic theories. If the real exchange is mainly influenced by real shocks, the exchange rate is considered as a shock absorber. On the contrary, if the nominal shock is the main reason of the real exchange rate variations, then the exchange rate is considered as a source of shocks. We find that the real exchange rate in Poland and Hungary are affected by both the real and nominal shocks. However, the influence of the nominal shock is more substantial in Poland. We also find that the pure exchange rate shock is a more important factor affecting real exchange rate variations among the nominal shock in both countries. Thus, our empirical results indicate that the exchange rate is a source of shocks in both countries, especially in Poland. Since a large part of the exchange rate fluctuations is caused by the nominal shock and the pure exchange rate shock, the cost of macroeconomic destablization from joining the euro area may not be substantial.
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