The foreign exchange regime in a small open economy: Armenia and beyond
Abstract
Purpose
Offering an example of a small open developing economy, the purpose of this paper is to explore the reasons for relative stability in Armenia’s foreign exchange market. Relying on a single currency and derived cross-currency exchange rates, the paper models short-term effects between exchange market pressure and financial and macroeconomic factors.
Design/methodology/approach
Following a literature review, the paper sets the macroeconomic context with an initial variance comparison of standard currency pairs and derived cross-currency exchange rates. Then, the core analysis is carried out with a vector error correction model, focusing on short-term cross-dynamics in monthly data. The orthogonal impulse response function analyses help solidify and further inform relevant conclusions.
Findings
Three broad factors influence Armenia’s foreign exchange market: external push factors; domestic banking sector competition, and foreign currency risk perceptions; and domestic macroeconomic and dual, cross-pair, exchange rate target priorities. The central bank’s implicit management of the foreign exchange market’s expectations, pull factor, is consistent with trader market power’s contribution to lower volatility. Yet, the risk of financial and real-sector decoupling remains.
Originality/value
The results are relevant for emerging markets attempting to leverage the global liquidity and low interest rates, while being exposed to external pressures in the post-crisis environment, in which international reserves may be scarce while currency stability is an implied priority. This study can be further adapted to a more comprehensive structural short-term analysis of currency determination or similar dynamics in other small open economies.
Keywords
Acknowledgements
Initial work on this paper benefited from cooperation with the Central Bank of Armenia that offered the use of its research facilities in Dilijan, Armenia, for which the author is thankful. The author is also thankful to the anonymous referees and to the participants at the 2015 Armenian Economic Association Annual Conference, held in Yerevan, Armenia, for suggestions on an earlier draft of this paper. All remaining errors are author’s own. Standard disclaimer applies.
Citation
Gevorkyan, A.V. (2017), "The foreign exchange regime in a small open economy: Armenia and beyond", Journal of Economic Studies, Vol. 44 No. 5, pp. 781-800. https://doi.org/10.1108/JES-08-2016-0155
Publisher
:Emerald Publishing Limited
Copyright © 2017, Emerald Publishing Limited