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Exchange rates in India: current account monetarism in a nonlinear context

Author

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  • Chaubal Aditi

    (Department of Humanities and Social Sciences, Indian Institute of Technology Bombay (IITB), YP Road, Near VMCC, Powai, Mumbai, 400076, India)

Abstract

The Indian exchange rate system has evolved from a pegged system to the current managed float. The study examines the presence of a long-run equilibrium in the monthly Indian exchange rate (Rs/USD) using a current account monetary model (or flexible price monetary model) while accounting for different nonlinearities over the period January 1993 to January 2014 (pre-inflation targeting period). The nonlinear adjustment to disequilibria is modelled using a nonlinear error correction model (NLECM). The nonlinear current account monetarism (CAM) model includes nonlinear transformations of long-run dynamics in the ECM to account for different nonlinearities: multiple equilibria (cubic polynomial function), nonlinear mean reversion (rational polynomial function), and smooth and gradual regime switches (exponential smooth transition autoregressive (ESTAR) function). The NLECM-ESTAR model outperforms other alternatives based on model and forecast performance measures, implying the existence of nonlinear mean reversion and smooth transition across different periods of overvaluation and undervaluation of the exchange rate. This implies the presence of asymmetric adjustment to the movements from the long-run equilibrium, but the nature of such transitions is smooth and not abrupt. The paper also establishes the uniqueness of the long-run equilibrium. A comparison to the sticky price monetary model could not be made due to stationary exchange rate disequilibrium.

Suggested Citation

  • Chaubal Aditi, 2020. "Exchange rates in India: current account monetarism in a nonlinear context," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 24(5), pages 1-27, December.
    • Handle: RePEc:bpj:sndecm:v:24:y:2020:i:5:p:27:n:3
    DOI: 10.1515/snde-2019-0072
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    More about this item

    Keywords

    capital account monetarism; current account monetarism; exchange rate; India; nonlinear error correction model;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C34 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Truncated and Censored Models; Switching Regression Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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