Iwegbunam, Ifeoma Anthonia2024-09-122024-09-122022Iwegbunam, Ifeoma Anthonia. (2022). Empirical essays on exchange rate dynamics in large emerging market economies [PhD thesis, University of the Witwatersrand, Johannesburg]. WireDSpace.https://hdl.handle.net/10539/40755https://hdl.handle.net/10539/40755Doctoral thesis submitted in fulfillment of the requirements for the award of the degree of Doctor of Philosophy Graduate School of Business Administration, Wits Business School University of the Witwatersrand, Johannesburg 2022This study investigates the impact of exchange rate volatility on international trade flows using disaggregated industrial trade data, the effects of nominal exchange rate changes on the validity of real interest rate parity conditions, and the effects of monetary policy responses on real effective exchange rate volatility in large emerging market economies (LEMEs) were also examined. As part of countries with convertible currencies, the exchange rate plays a vital role in LEMEs’ economic activities, including engagement in the global markets. The countries’ participation in international trade and financial markets has improved since the liberalisation of global markets at the end of the Bretton Woods era. However, just as they have enjoyed and recorded tremendous successes through economic openness, lack of suitable monetary policy makes LEMEs susceptible to external global contagion shocks ranging from financial crises to interest rate hikes or monetary policy changes in foreign countries. As commodity-dependent countries with increased exchange rate volatility, LEMEs have not benefited profitably from participating in international trade compared to their comparative advantages, such as abundant natural resources, human capacity, skills and production capacity. Moreover, the economies also suffer from internal policy instabilities and other systemic challenges that weaken the institutions and worsen the external challenges faced by LEMEs. All these problems are believed to result from increased exchange rate volatility prevalent in LEMEs. As such, problems related to exchange rate volatility and its impacts on international trade flows in LEMEs have lingered on for years as economic and financial instabilities widened. These challenges can be viewed from increased levels of current account deficits, the rising balance of payment disequilibrium, market imperfections such as asymmetric information, uncertainties leading to increased risk aversion, and systemic imbalances faced by LEMEs. This implies that growth recorded from economic openness have not shielded LEMEs from exchange rate volatility, monetary policy instabilities and economic sustainability challenges. Therefore, whether LEMEs should adopt unconventional monetary policies that suit the characteristics of the economies or the fixed exchange rate regime to mitigate exchange rate volatility and the associated negative effects remains conflicted. The way forward can only be determined by examining the impacts of exchange rate volatility on international trade flows in LEMEs. These unanswered questions have also left the economies hanging as the ripple effects result in real interest rate parity deviations. This reflects the assumption that when financial flows are restricted in economies, the chances of deviation in real interest rate parity increase. Additionally, recorded financial crises since financial market liberalisation also affect exchange rates in countries with convertible currencies. LEMEs are undoubtedly vulnerable to external contagion effects due to the poor-quality financial systems in the economies. Furthermore, research has shown that countries with underdeveloped financial systems remain trapped in vicious cycles affecting their global market performance. However, achieving real interest rate parity conditions is essential and requires standards for adequate capital mobility and efficient market integration. Since achieving real interest rate parity conditions seems implausible due to challenges faced by LEMEs, it would be insightful to explore the possibility of such parity conditions holding amid monetary policy reforms that result in nominal exchange rate regime changes in LEMEs. The problems related to the impacts of exchange rate volatility on international trade flows and achieving real interest rate parity conditions in LEMEs beg for an answer on how monetary policy should be strengthened to suit LEMEs’ financial stability agenda. Over the years, the attempt to restructure LEMEs’ financial systems through monetary policy reform has constituted a significant discussion. Considering that LEMEs suffer institutional setbacks caused by increasing price variability, a poor policy framework, underdeveloped financial systems, and institutional imbalances through exchange rate volatility. Adjusting how monetary policy responds to real effective exchange rate volatility vis-a-vis the inflation targeting (IT) framework guided by the Taylor policy rule does not seem to be the answer. Arguments have been presented regarding the practicability of the Taylor rule in LEMEs, considering the developmental level of policies in these economies. Moreover, there are concerns that the Taylor rule is limited, lacks some macroeconomic instruments that cater to the disadvantages associated with LEMEs, and might not adequately capture the relevant factors needed to restructure monetary policyen© 2022 University of the Witwatersrand, Johannesburg. All rights reserved. The copyright in this work vests in the University of the Witwatersrand, Johannesburg. No part of this work may be reproduced or transmitted in any form or by any means, without the prior written permission of University of the Witwatersrand, Johannesburg.Exchange rate volatilityInterest rate differentialsInternational tradeExchange rate regimeMonetary policyInflation targetingOutput gapsCentral BankLarge emerging market economiesUCTDSDG-8: Decent work and economic growthThesisUniversity of the Witwatersrand, Johannesburg