Currencies in Turbulence: Exploring the Impact of Natural Disasters on Exchange Rates
Introduction
The paper investigates the effects of natural disasters on exchange rate dynamics across different country groups—emerging markets and developing economies (EMDEs) and advanced economies (AEs)—using a panel local projection model with high-frequency monthly data from 177 countries over the period 1970M1-2019M12.
Key Findings
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Impact Sensitivity: Exchange rate movements are found to be more sensitive to natural disasters in EMDEs compared to AEs.
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Exchange Rate Regime Dependence: The impact varies based on the adopted exchange rate regime by EMDEs, with both nominal and real exchange rates potentially depreciating by up to 6% within two years post-disaster in non-pegged regimes.
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Recovery Dynamics: EMDEs with flexible exchange rate regimes are observed to recover faster through nominal and real depreciations, albeit with considerations for potential policy implications related to large exchange rate fluctuations caused by natural disaster shocks.
Methodology & Data
- Methodology: A panel local projection model is employed for analysis.
- Data: High-frequency monthly data covering 177 countries from 1970 to 2019 is utilized.
Empirical Results
- All Disasters: Analysis reveals distinct impacts of natural disasters on exchange rates across different country groups.
- Disaster Types: The specific type of disaster influences the nature and extent of exchange rate responses.
- Country Characteristics: Economic indicators and structural features of countries affect the degree of exchange rate sensitivity to natural disasters.
- Larger vs. Smaller Disasters: The size of the disaster significantly impacts the magnitude of exchange rate movements.
Robustness Checks
- The findings are validated through additional analyses ensuring the robustness of the initial conclusions.
Concluding Remarks
The paper underscores the importance of understanding the relationship between natural disasters and exchange rates for policymakers and investors. It highlights the need for tailored policies to manage economic and trading stability, especially in disaster-prone regions, considering the potential for exchange rate volatility following natural disasters.
Recommendations
- Policymakers should consider implementing appropriate monetary and fiscal policies to support economic recovery and stabilize exchange rates post-disasters.
- Investors and market participants should effectively navigate and manage exchange rate volatility, informed by insights into natural disaster impacts.
- The expenditure switching effect offers a potential stabilizing channel, mitigating the impact of natural disasters on economies through adjusting consumption patterns in response to exchange rate fluctuations.