Consequence of Interactive Effect of Exchange Rate Volatility and Trade on GDP Growth

Abstract: Exchange rate volatility has been regarded as a vital macroeconomic concern for the policy makers and its impact on economic growth has gained much attention from the researchers in recent years. Existing studies tried to analyze the impact focusing on financial development. In contrast, we have given effort to examine it taking into account the trade dependence of the country. A panel of seven developing Asian countries has been studied for a total of 29 years (from 1985 to 2013). In order to generate the variable “exchange rate volatility” GARCH (1, 1) model is used with the monthly exchange rate of the countries for the period 1985 to 2013. By using cross sectional dependence test and panel unit root test the variable properties has been diagnosed and Pooled OLS, Panel Least Squares with Single Fixed Effects as well as Both way Fixed Effects and Panel EGLS with Mixed Effects has been used as the estimation technique. The findings suggest that exchange rate volatility has significant negative impact on economic growth and the impact becomes even more negative whenever Trade – GDP ratio is considered. In particular the negative impact of exchange rate volatility becomes more negative the higher the Trade – GDP ratio of the country. The finding is found to be robust against the definition of exchange rate volatility.