Impact of renewable energy on exchange rates in a system of open economies

The energy transition involves a proportional increase in the production and consumption of renewable energy. However, renewable energy can cause fluctuations in financial markets. We explore the impact of renewable energy on exchange rates in a system of 35 countries connected through trade and financial variables, using a GVAR model from 2000M1–2022M12. Our findings indicate that a renewable energy production (supply) shock leads to the depreciation of domestic currencies against the U.S. dollar, a decrease in stock markets, and an increase in interest rates. This shock also signals rising financial uncertainty. Conversely, a renewable energy consumption (demand) shock is associated with economic expansion, resulting in rising share prices and oil prices. Variance decomposition demonstrates that renewable energy demand is more relevant in explaining exchange rate fluctuations than renewable energy supply. We propose a renewable energy shock identification framework using world renewable supply, world renewable demand, and global energy prices. This shock identification reinforces our findings, showing the sensitivity of domestic currencies to energy price shocks. Our study highlights that renewable energy can drive financial market fluctuations, and governments could mitigate negative effects through the management of international reserves and income transfer programs, in addition to allowing domestic currencies to adjust to shocks.