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Balance of Payments Pressures on the Nominal Exchange Rate: A Fresh Look at Old Ideas

Author

Listed:
  • Anna Drahozalova

    (Institute of Economic Studies, Charles University, Prague, Czech Republic)

Abstract

This paper contributes to the existing literature on exchange rate modelling by developing a new proxy for foreign exchange market imbalances. By utilizing the monetary presentation of the Balance of Payments we create a measure of net external flows and study its impact on the exchange rate. Focusing on the case of the Czech Republic, we account for the coexistence of fixed and floating exchange rate regimes by relying on the exchange market pressure (EMP) index. A vector autoregression model provides evidence of a causal relationship from net external flows to the EMP index. We find that a positive orthogonal shock to net external flows causes the Exchange rate to appreciate already in the short term with the effect peaking three months after the initial shock.

Suggested Citation

  • Anna Drahozalova, 2025. "Balance of Payments Pressures on the Nominal Exchange Rate: A Fresh Look at Old Ideas," Working Papers IES 2025/13, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jul 2025.
    • Handle: RePEc:fau:wpaper:wp2025_13
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    File URL: https://ies.fsv.cuni.cz/en/balance-payments-pressures-nominal-exchange-rate-fresh-look-old-ideas
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    More about this item

    Keywords

    Foreign Exchange; Exchange Rates; Capital Flows;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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