Examining the relationship between macroeconomic fundamentals and exchange rates: Evidence from the Common Monetary Area (CMA)
This study investigated the relationship between macroeconomic fundamentals and exchange rates in the Common Monetary Area (CMA) using the Pooled Mean Group (PMG) methodology within a Panel Autoregressive Distributed Lag (PARDL) framework, accounting for structural breaks. Utilising panel data from 1991 to 2022, the study first applied Fisher-type Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests to determine the integration orders of variables, which were found to be a mix of I(0) and I(1). This mixed integration justified the PARDL approach. The findings revealed that the relative money supply significantly affects the exchange rate in both the long and short runs, with increases in money supply leading to currency depreciation. Thus, the overarching relationship between macroeconomic fundamentals and exchange rates in the CMA indicates a complex interaction where monetary supply significantly influences currency values in both the long and short run, albeit with varying magnitudes. The negative impact of increased money supply on the exchange rate necessitates vigilant monetary policy to prevent undue depreciation and associated economic vulnerabilities. However, the study found that interest rates and GDP growth had a neutral impact on exchange rate fluctuations, which suggests that these variables, under current economic conditions, may have a muted direct effect on exchange rate fluctuations, possibly due to integrated economic policies or external economic shocks that overshadow domestic policy impacts. The Granger causality results reveled significant causality from relative money supply and inflation to the nominal exchange rate showed the predictive power of these macroeconomic fundamentals on exchange rate fluctuations. The study recommends that central banks maintain stringent controls over the money supply to mitigate abrupt exchange rate fluctuations. Monetary policies should be carefully calibrated to manage inflation levels that could lead to rapid changes in exchange rates. Additionally, considering the significant short-run impacts of GDP growth, economic policies should also aim to foster stable economic growth that contributes to currency appreciation and macroeconomic stability. Moreover, economists should look at the underlying mechanisms through which GDP growth impacts exchange rates in the short run and explore the potential buffering effects of economic expansion on currency stability
Panel autoregressive distributed lag, Structural breaks, Granger causality, CMA, Namibia, University of Namibia
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