Document Type : Research Paper
Author
Ph.D. in Monetary Economics, Tabriz University, Tabriz, Iran
Abstract
This study examines how real commodity prices affect foreign exchange market pressure (EMP) in resource-exporting countries using a Panel Smooth Transition Regression (PSTR) approach. Exchange market pressure, characterized by excess demand or supply of domestic currency, often requires monetary policy intervention to stabilize currency values. This research specifically investigates the relationship between EMP and real prices of four commodity categories: food, metals, energy, and raw materials.
Using data from 1990-2022, we first calculated the EMP index using an independent model method. Our findings reveal the non-linear nature of exchange market pressure, with studied countries experiencing continuous fluctuations between appreciation and depreciation pressures throughout the period, never reaching a pressure-free equilibrium.
The PSTR model results demonstrate that real commodity prices have a significant indirect effect on exchange market pressure across the studied countries. The real price index shows a strengthening effect on market pressure in both regimes for all exporting countries, with food-exporting nations particularly exhibiting positive and significant pressure effects across both regimes. Our findings indicate that monetary authority intervention is necessary across all four country groups to achieve target exchange rates and mitigate exchange market pressure.
These results have important implications for monetary policy in resource-exporting countries, suggesting the need for active management of exchange market pressure in response to commodity price fluctuations.
Introduction
The collapse of the Bretton Woods fixed exchange rate system marked a fundamental shift in international financial architecture, leading to the emergence of floating, fixed, and intermediate exchange rate systems (Jalal, 2019). Fixed exchange rates encompass currency unions, where one country adopts another's currency or joins a broader monetary union. Floating exchange rates can be either free or managed, with central banks intervening to moderate adverse fluctuations without committing to specific exchange rate levels. Intermediate systems include fixed rates, crawling pegs, currency devaluation, and various hybrid arrangements - all involving central bank intervention to mitigate pressure on domestic currency. Fisher (2001) documents this evolution, noting that countries employing intermediate exchange rates decreased from 98 in 1992 to 63 in 1999, though a significant number maintained these systems.
Exchange rates serve as crucial predictive variables for commodity market movements, offering insights that simple time series models cannot capture and necessitating analysis through comprehensive, mixed-data approaches (Ferraro et al., 2015). As a fundamental indicator of international competitiveness, exchange rates significantly influence national trade and economic performance. Exchange rate fluctuations both reflect and perpetuate economic instability, potentially undermining overall economic performance. Research in developing economies suggests that unmanaged structural changes, combined with inconsistent monetary and fiscal policies, create disparities between actual and equilibrium exchange rates.
While existing literature has predominantly focused on oil price fluctuations' impact on exchange rates in oil-exporting nations, this study addresses a critical research gap by examining how real commodity price index fluctuations affect foreign exchange market pressure. The need to understand exchange rate dynamics and currency market pressure remains crucial for economic policymaking and market stability. Previous domestic studies have largely employed linear models to evaluate factors affecting currency market pressure. However, given the inherently non-linear nature of currency market pressure, non-linear analytical approaches are necessary for more accurate assessment.
This study aims to examine the non-linear relationship between real commodity prices and foreign exchange market pressure across major commodity-exporting countries, categorized into four groups: energy, metals, food, and raw materials exporters. Using a panel smooth transition regression approach for the period 1990-2022, this research extends beyond traditional variables like oil, trade, and GDP to investigate the understudied impact of real commodity price fluctuations on exchange market dynamics.
Methods and Material
The Panel Smooth Transition Regression (PSTR) model is an extension of the standard panel data framework, characterized by two limiting regimes and a transition function. The basic model is defined by equation (1):
Results and Discussion
The first step in estimating a soft transition regression model involves testing the null hypothesis of model linearity against the alternative hypothesis that the model includes at least one transition variable. The results of Wald's Lagrange Multiplier (LMw), Fisher's Lagrange Multiplier (LMf), and the Likelihood Ratio (LR) tests confirm, at the 5% significance level, the presence of a soft transition regression model (PSTR) with at least one regime. These findings strongly support the non-linear relationship between the variables under study.
Subsequently, the residuals were examined to verify the non-linear structure and determine the number of transition functions (𝑟r). This process involves testing the null hypothesis of a single soft transition function against the alternative hypothesis of at least two transition functions. If the null hypothesis is rejected, additional hypotheses are tested sequentially (e.g., two functions vs. three functions) until the null hypothesis is accepted. Ultimately, a soft transition regression model with one transition function, corresponding to a two-regime structure, was selected for the analysis.
For food and raw material-exporting countries, the estimated parameters of the two-regime PSTR model reveal the following:
(a)Food-Exporting Countries:
Slope Parameter: 3.594 (indicating the speed of transition between regimes).
Threshold Value: 6.765 for the real food price index.
When the food price index equals 6.765, the relationship between the food price index and currency market pressure changes. If the index exceeds 6.765, the model transitions to the second regime at a transition speed of 3.594. Conversely, if the index falls below this threshold, the first regime applies.
(b) Raw Material-Exporting Countries:
Slope Parameter: 0.876.
Threshold Value: 8.302 for the real raw material price index.
For these countries, when the raw material price index reaches 8.302, a regime change occurs. If the index exceeds this threshold, the model transitions to the second regime at a speed of 0.876. If it remains below the threshold, the first regime applies.
The results highlight the non-linear dynamics of the relationship between real price indices and currency market pressure. The coefficients of variables vary with the transition variable's value (price index) and slope parameters, differing across countries and over time. These findings underscore the need for country-specific and time-sensitive policy interventions to manage currency market pressures effectively.
Conclusion
This study analyzed the impact of real prices for food, raw materials, metals, and energy on foreign exchange market pressure (EMP) in exporting countries during the period 1990–2022, using the soft transition regression (PSTR) approach. The findings reveal significant and varied effects across different export categories and regimes, highlighting the non-linear nature of these relationships:
Metal-Exporting Countries:
The real price index of metals negatively impacts currency market pressure in both regimes.
However, the trade balance level exerts a positive influence on EMP in both the linear and non-linear regimes.
Energy-Exporting Countries:
The real price index of energy strengthens EMP in both regimes, indicating heightened sensitivity of currency markets to energy price fluctuations.
The trade balance level exerts a negative effect on EMP, demonstrating its stabilizing role in both linear and non-linear contexts.
Food-Exporting Countries:
The real food price index has a positive and significant effect on EMP in both regimes, reflecting increased market pressure with rising food prices.
Net foreign assets also contribute positively and significantly to EMP in both linear and non-linear regimes.
In contrast, the trade balance equilibrium level mitigates EMP in both regimes.
The Balassa-Samuelson effect is found to significantly influence EMP, underscoring the role of productivity differentials in currency market pressures.
Raw Material-Exporting Countries:
Price indices and the trade balance level negatively and significantly affect EMP in both regimes, suggesting that higher raw material prices and stronger trade balances alleviate market pressures.
Net foreign assets exhibit a dual effect: positively impacting EMP in the first regime but negatively and significantly affecting it in the second regime.
The real price index of goods and the Balassa-Samuelson effect exert positive and significant influences on EMP in both linear and non-linear regimes.
The findings emphasize the importance of tailored monetary and fiscal policies in addressing foreign exchange market pressures. For instance:
-Policymakers in metal-exporting countries should focus on trade balance optimization to counter EMP despite price fluctuations.
-In energy-exporting countries, stabilizing energy prices and enhancing the trade balance are critical to managing EMP effectively.
-For food-exporting countries, mitigating the adverse effects of rising food prices and leveraging net foreign assets can stabilize currency markets.
-Raw material-exporting countries should consider balancing price dynamics and trade balances while accounting for the dual role of net foreign assets in EMP.
Keywords
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