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The Sources of Real Exchange Rate Fluctuations in India

  • Tomoe Moore

    (Department of Economics, Finance and Accounting, Coventry University, Coventry, CV1 5FB, England)

  • Eric J. Pentecost

    (Department of Economics, Loughborough University, Loughborough, Leicestershire, LE11 3TU, England.)

This paper examines the contributions of real (permanent) and nominal (temporary) shocks on the nominal and real exchange rates of the Indian Rupee against the US dollar in the period since 1993, using the long-run structural VAR technique. If nominal shocks account for most of the movement in the real exchange rate then the authorities can use monetary policy to influence the competitiveness of the economy. On the other hand, if real shocks account for most of the variation in the real exchange rate the Purchasing Power Parity (PPP) hypothesis is invalid and monetary policy ineffective as a tool of exchange rate management. The paper finds that the real exchange rate of the Rupee against the US dollar is non-stationary and that real shocks have permanent effects on the exchange rate, thus making exchange rate management at best futile and possibly harmful to the economy.

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Article provided by Department of Economics, Delhi School of Economics in its journal Indian Economic Review.

Volume (Year): 41 (2006)
Issue (Month): 1 (July)
Pages: 9-23

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Handle: RePEc:dse:indecr:v:41:y:2006:i:1:p:9-23
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