The role of domestic and foreign economic uncertainties in determining the foreign exchange rates: an extended monetary approach

Abstract

This study extends the monetary model of the exchange rate by incorporating news-based domestic and US economic policy uncertainties (EPUs). We consider 12 developed and developing economies and use monthly data covering 2000:M1 to 2017:M2. The extended monetary model is estimated by the panel quantile regression of Machado and Santos Silva (2019) and Pesaran (2006) common correlated effects within linear and nonlinear panel ARDL frameworks. The estimates illustrate the significant effects of EPUs on developed and developing economies. The ARDL models show that the impact of EPUs is mostly a long-run phenomenon. The Wald test statistics confirm asymmetric effects of EPUs at different quantiles. Moreover, the Wald statistics also support the asymmetric effects of increasing and decreasing EPUs. Overall, domestic, and foreign economic uncertainties significantly affect developed and developing economies’ exchange rates, at least in the long run. Therefore, economic uncertainty should be considered in determining the exchange rate. This extended model might be more appropriate in the post-Covid-19 era.