Macroeconomic fundamentals and dynamics of the Indian rupee-dollar exchange rate

Abstract

Purpose

This paper aims to examine the relationship between Indian rupee-US dollar exchange rate and the macroeconomic fundamentals for the post-economic reform period.

Design/methodology/approach

The authors have used an empirical model which includes a range of important macroeconomic variables based on the basic monetary theories of exchange rate determination. At the first stage of the analysis, they have tested structural break in the data. Subsequently, they have employed the fully modified ordinary least square, Wald’s coefficient restriction and impulse response functions (IRF) to estimate the monetary model in the long- and short-run horizons.

Findings

Results of analyses indicate that the macroeconomic fundamentals determine exchange rate in a significant way, but their effect varies sizably across the periods. The IRF illustrate the importance of interest rate in controlling exchange rate volatility.

Practical implications

The analysis of the behavior of inter-relationship among macroeconomic variables will help policymakers in a deep-rooted understanding of this complex and time-varying relationship.

Originality/value

Most of the existing studies have tested the impact of a single or a few macroeconomic fundamentals on exchange rate. But in the present study, we have tested the impact of a range of important variables, i.e. money supply, real income or output, price level and trade balance. Further, considering the importance of structural breaks in data, they authors have employed standard tests of structural break and incorporated the issue in the cointegration analysis.

Citation

Sharma, C. and Setia, R. (2015), "Macroeconomic fundamentals and dynamics of the Indian rupee-dollar exchange rate", Journal of Financial Economic Policy, Vol. 7 No. 4, pp. 301-326. https://doi.org/10.1108/JFEP-11-2014-0069