Impact of exchange rate volatility on unemployment in South Africa

Abstract

Real exchange rate volatility have important effects on production, employment and trade, so it is crucial to understand its impact on unemployment especially on a country like South Africa.This article analyses the impact of the real exchange rate volatility on unemployment and the dynamic adjustment of unemployment rate following shocks to its determinants using quarterly South African data covering the period 2000 to 2010. This article augments the cointegration and vector autoregression (VAR) and the GARCH model including analysis with impulse response and variance decomposition analyses to provide robust long run effects and short run dynamic effects on the unemployment rate. The empirical analysis using a variety of specifications, estimation techniques, and robustness tests suggests that exchange rate volatility has a statistically and economically significant impact on employment. The variables that have been found to have a long run relationship with unemployment rate include the real exchange rate, exports, real interest rate and the gross domestic product.The impulse response functions broadly corroborate the theoretical predictions, but only real interest rate and exports have a significant impact on unemployment in the short run. Results from the variance decompositions are largely similar to those from the impulse response analysis. The real exchange rate and exports are the only variables found to significantly explain the variation in the unemployment. The most interesting result that emerged from this analysis and is supported by previous research is that among other determinants, the real exchange rate explain the largest proportion of the variation in unemployment rate. On balance, the evidence therefore suggests that unemployment rate fluctuations are predominantly equilibrium responses to real exchange rate shocks in comparison with interest rates, economic growth and exports.