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This paper provides a long-term perspective to the causal linkages between currency dynamics and macroeconomic conditions by utilising a long span data set for the United Kingdom that extends back to 1856 and a time-varying causality testing methodology that accounts for the nonlinearity and structural breaks. Using unemployment fluctuations as a proxy for macroeconomic conditions and wavelet decompositions to obtain the fundamental factor that drives excess returns for the British pound, time varying causality tests based on alternative model specifications yield significant evidence of causal linkages and information spillovers across the labour and currency markets over the majority of the sample. Causal effects seem to strengthen during the Great Depression and later following the collapse of the Bretton Woods system, highlighting the role of economic crises in the predictive linkages between the two markets. While the predictive role of currency market dynamics over unemployment fluctuations reflects the effect of exchange rate volatility on corporate investment decisions, which in turn, drives subsequent labour market dynamics (e.g. Belke & Gross (2001); Belke & Kaas (2004); Feldman (2011); among others), we argue that causality in the direction of exchange rates from unemployment possibly reflects the signals regarding monetary policy actions, which in turn, spills over to financial markets. Overall, the findings indicate significant information spillovers across the labour and currency markets in both directions with significant policy making implications

Author

Listed:
  • Deven Bathia

    (School of Business and Management, Queen Mary University of London)

  • Riza Demirer

    (Department of Economics & Finance, Southern Illinois University Edwardsville)

  • Rangan Gupta

    (Department of Economics, University of Pretoria)

  • Kevin Kotze

    (School of Economics, University of Cape Town)

Abstract

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Suggested Citation

  • Deven Bathia & Riza Demirer & Rangan Gupta & Kevin Kotze, 2020. "This paper provides a long-term perspective to the causal linkages between currency dynamics and macroeconomic conditions by utilising a long span data set for the United Kingdom that extends back to ," School of Economics Macroeconomic Discussion Paper Series 2020-01, School of Economics, University of Cape Town.
  • Handle: RePEc:ctn:dpaper:2020-01
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    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General

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