THE MODEL OF THE IMPACT OF CHANGES IN THE ......Halyna Nakonechna, Igor Ruzhytskyi and Tetiana Koliada, The Model of the Impact of Changes in the National Currency on Key Macroeconomic

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International Journal of Management (IJM)

Volume 11, Issue 5, May 2020, pp. 908-919, Article ID: IJM_11_05_083

Available online at http://www.iaeme.com/ijm/issues.asp?JType=IJM&VType=11&IType=5

Journal Impact Factor (2020): 10.1471 (Calculated by GISI) www.jifactor.com

ISSN Print: 0976-6502 and ISSN Online: 0976-6510

DOI: 10.34218/IJM.11.5.2020.083

© IAEME Publication Scopus Indexed

THE MODEL OF THE IMPACT OF CHANGES IN

THE NATIONAL CURRENCY ON KEY

MACROECONOMIC INDICATORS IN THE

FACE OF UNCERTAINTY

Maryna Slatvinska

Department of Finance, Odessa National Economic University, Odessa, Ukraine

Yanina Belinska

Department of International Economics, University of the State Fiscal Service of Ukraine,

Irpin, Ukraine

Oksana Vodolazska

Department of Finance, Banking and Insurance, Oles Honchar Dnipro National University,

Dnipro, Ukraine

Halyna Nakonechna

Department of Civil-Legal Disciplines, Lesia Ukrainka Eastern European National University,

Lutsk, Ukraine

Igor Ruzhytskyi

Department of Accounting, Auditing and Taxation, Chernihiv National University of

Technology, Chernihiv, Ukraine

Tetiana Koliada

Department of Finance, University of State Fiscal Service of Ukraine, Irpin, Ukraine

ABSTRACT

The article is devoted to the study of general provisions that form the

methodological basis for the impact of changes in the national currency rate on key

macroeconomic indicators in the face of uncertainty. The authors examined

macroeconomic indicators, the dynamics of the main ones on a global scale, observed

the change in the national currency of Ukraine to the main foreign ones (Dollar,

Euro). They proposed methodological recommendations for using Hansen’s model of

the impact of changes in the national currency exchange rate on the dynamics of real

macroeconomic variables and comparing long-term effectiveness.

The Model of the Impact of Changes in the National Currency on Key Macroeconomic Indicators in

the Face of Uncertainty


Key words: GDP, GNP, NNP, Macroeconomic Indicators, National Currency,

Uncertainty

Cite this Article: Maryna Slatvinska, Yanina Belinska, Oksana Vodolazska,

Halyna Nakonechna, Igor Ruzhytskyi and Tetiana Koliada, The Model of the Impact

of Changes in the National Currency on Key Macroeconomic Indicators in the Face of

Uncertainty. International Journal of Management, 11 (5), 2020, pp. 908-919.

http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=11&IType=5

1. INTRODUCTION

States seek to reduce the uncertainty of their policies, and if the uncertainty arises from the

outside, smooth out its impact on business activity. The latter is impossible without a clear

understanding of the channels of influence of uncertainty on the economy, and research

continues to identify such channels of influence. Currently, the two main target options in the

world are the exchange rate and inflation. The use of a fixed exchange rate has been and

remains the most popular model, however, the number of countries that use it is gradually

decreasing. Inflation targeting, in turn, is the second most frequent policy option with a clear

nominal anchor, and the popularity of this regime among countries around the world is

growing steadily.

Decisions made by the national bank in the field of exchange rate regulation have an

impact on many key economic parameters. Therefore, an urgent theoretical task is to

understand the direction and mechanisms of the relationship between the exchange rate and

the level of aggregate output of the national economy.

There is still no consensus among economists about how changes in the national currency

affect long-term economic growth. From the traditional view of monetary policy, in the long

run, money is neutral; therefore, monetary policy cannot modify the long-term values of real

variables.

On the other hand, modern studies reveal a series of empirical evidence that refutes the

hypothesis of money neutrality and confirms the effect of inflation of the national currency on

the long-term dynamics of output (Alesina, 1993; Berger, 2000; Bernanke, 2000; Khan, 2001;

Kholod, 2015; Carare, 2002; De Grauwe, 2004; Dubas, 2005; Batini, 2006; Fabayo, 2006;

Fountas, 2010; Antoniuk, 2015; Ibarra, 2016; Thornton, 2016; Muminova, 2020 and others).

And although each of these works individually can be criticized, such a significant body of

research as a whole suggests that the change in the national currency exchange rate

significantly affects key macroeconomic indicators, especially in the face of uncertainty:

under certain conditions, monetary policy contributes to the accumulation of capital, increased

productivity and, ultimately, accelerated economic growth, and the erroneous actions of the

monetary authorities can restrain this growth.

Meanwhile, economic and mathematical models that fully disclose the mechanism of

operation of all channels of the impact of inflation on the long-term dynamics of output are

absent.

2. THEORETICAL ASPECT

The mechanism of the relationship between the real exchange rate and output is quite

complicated. On the one hand, it is generally accepted that an actual weakening of the

currency leads to an increase in the value of imported goods relative to goods produced

domestically, which, in turn, causes import substitution and an increase in domestic output.

On the other hand, several empirical and theoretical works show (Berger,

Maryna Slatvinska, Yanina Belinska, Oksana Vodolazska, Halyna Nakonechna, Igor Ruzhytskyi and

Tetiana Koliada


2000; Anca, 2011; Eggoh, 2014; Grekou, 2018; Boiko V., 2019; Boubellouta, 2019; Dzwigoł,

2019; Prokopenko, 2019) that both real and nominal devaluations of the national currency can

harm the dynamics of national output. This may occur as a result of the following factors: an

increase in the cost of imported intermediate products; reduction in real consumer income due

to higher import prices; increase the value of liabilities denominated in foreign currency;

increasing uncertainty in the foreign exchange market and the international trade sector.

Besides, exchange rate fluctuations in any direction give rise to costs associated with the

possible need to review contracts denominated in national currency. Thus, in the economies of

different countries, the relationship between the exchange rate and key macroeconomic

indicators, depending on various factors, can be both positive and negative.

2.1. Key Macroeconomic Indicators

Market movement is necessarily associated with the release of new data, so the market

movement is quite realistic to predict if you track a clear relationship between macroeconomic

indicators of the economy and other information.

To correctly and clearly plan a deal in the markets, you need to know and understand the

current state of the global economy, based on the above indicators, as well as any of the

specific macroeconomic indicators that can affect the future course of events.

Values of macroeconomic indicators:

Predicted Value (FRC). The value is based on the opinion of analysts and is also a guideline

for the market, and as the output of real data approaches, it is systematically adjusted.

Actual value (ACT). The official published amount.

Corrected value (PRV). This is the adjusted value of the indicator for the previous period.

Market participants, having the values of the predicted indicators, can already plan the

further movement of the market, and after the release of official data, they immediately

compare the values and take action by analyzing the situation.

Macroeconomic indicators are summary indicators of volumes of consumption,

production, expenses, incomes, the welfare of the population, exports, imports, economic

growth, etc.

Key macroeconomic indicators:

1. Gross National Product (GNP)

2. Net National Product (NNP).

3. Gross Domestic Product (GDP).

4. Unemployment rate

5. Inflation rate.

6. The state budget.

7. The rate of economic growth.

The most "indicative" of them are the first three. The main macroeconomic indicator for

studying the production and consumption of a national product is a gross domestic product.

GDP – the value of all final goods and services produced in a country for a certain period

(usually a year), production factors owned by citizens and foreigners. There are three methods

for calculating GDP:

the Income Method, calculated by the formula:




(1)

where TNI – Total National Income; T – Sales Taxes; D – Depreciation; F – Net Foreign

Factor Income.

the Expenditure Method, calculated by the formula:

(2)

where C – Household spending on goods and services; I – Capital Investment spending; G

– Government spending; X – Exports of Goods and Services; M – Imports of Goods and

Services.

by Output (Value Added), calculated by the formula:

– (3)

where VOGS – the gross value of output resulting from domestic economic activity; IC –

intermediate consumption.

It is the most direct but also the least efficient method as it measures the output of all

economic sectors.

Nominal GDP – is a gross domestic product, calculated in real (current) prices of a certain

period.

The nominal GDP is greatly influenced by the inflationary process: it rises with rising

prices. To get rid of inflationary effects real GDP (gross domestic product at constant prices)

is calculated, i.e. in base-year prices.

Real GDP can be obtained by dividing the nominal by the price index (deflator). When the

price index is less than one, the upward adjustment of GDP is called inflation. With a price

index of more than one, a downward adjustment is called deflation. The ratio of nominal GDP

to real is called a deflator. It characterizes the change in the general price level and shows

how much GDP has increased solely due to price increases.

(4)

Consider a numeric example: if nominal GDP is 50,000 UAH, and real GDP is 15,000

UAH, then the GDP deflator will be 333 (GDP deflator = 50,000 UAH 15,000 UAH * 100 =

333.33).


Tetiana Koliada


The World Bank annually calculates the rating of World GDP (nominal) per capita (Fig. 1).

Figure 1 World nominal GDP per capita in 2019 (using data [1])

Ukraine and Suriname are the leaders in the change in the rating of World GDP (nominal)

per capita, increasing its rank by seven positions (in 2019) (Fig. 2).

Figure 2 Change in nominal world GDP per capita in 2019 against 2018 (using data [1])

List of countries by a nominal value of the gross domestic product in dollar terms,

calculated using the market exchange rate or established by the authorities. This indicator is

actual and does not take into account the difference in prices for similar goods and services in

different countries. Since prices in developed countries are higher than in developing




countries, the nominal GDP of developed countries is somewhat overstated, and the nominal

GDP of developing countries is somewhat underestimated. A more objective indicator is GDP

at purchasing power parity (PPP), which takes into account the difference in cost of living in

different countries. PPP GDP more accurately determines the quality of life for citizens within

their countries, without actual (nominal) comparisons based on a single indicator.

Due to the shortcomings indicated above, the IMF in 2020 refused to calculate the

nominal GDP of countries [2].

2.2. The Change in the National Currency against Foreign Currencies (USD,

EUR)

The dynamics of the value of currencies of developed countries in recent years indicates an

increase in volatility (sensitivity) of exchange rates. At the same time, the more critical the

role of the currency in the world economy, the more noticeable fluctuations in its exchange

rate. The most significant change in value is observed among the currencies of leading

developed countries. The study of the Ukrainian hryvnia exchange rate against the main

foreign ones (dollar, euro) shows a tendency to its constant devaluation (Fig. 3). A study of

the Ukrainian hryvnia exchange rate against the main foreign ones (dollar, euro) shows a

tendency to its constant devaluation (Fig. 1), and this happens spasmodically – a paid

decrease, then a sharp drop, again a smooth decrease and back a sharp decline. First of all, this

is due to global and domestic economic crises. So after the COVID 19 pandemic, again, the

hryvnia will face a decline in foreign currencies, but not in such a sharp jump, because

pandemic has more impact on the EU and the USA.

Figure 3 UAH to USD and EUR exchange rate from 2013 to 2019

The forecast shows a further fall in UAH to USD more intensive, to EUR less; this

confirms March 2020 – 0.036 (USD), 0.034 (EUR).

y = 0.0003x2 - 0.0154x + 0.2347

R² = 0.8962

y = 0.0003x2 - 0.0147x + 0.1908

R² = 0.9261

0

0.05

0.1

0.15

0.2

0.25

UAH to dollar UAH to euro

Polynominal (UAH to USD) Polynominal (UAH to EUR)


Tetiana Koliada


Depending on the nature of the action, there are three groups of factors that affect the

exchange rate (Fig. 4).

Figure 4 Groups of factors influencing the exchange rate

The exchange rate affects international economic relations (Table 1). First, it allows

producers in the country to compare the cost of production of goods with world market prices.

Thus, it is one of the benchmarks in the implementation of foreign economic relations, allows

you to predict the financial results of economic activity. Secondly, the level of the exchange

rate directly affects the economic condition of the country, which is manifested in particular

in the state of its balance of payments. Finally, thirdly, the exchange rate affects the

redistribution of world gross domestic product between countries.

Table 1 Dependence of prices on changes in exchange rates

Impact of exchange rate changes on Falling national

currency

Growing national

currency

prices of national goods in the world market reduces increases

trade in national goods in the world market increases export /

reduces import

reduces export /

increases import

prices of national securities and assets decreases increases

the inflow of capital from abroad increases capital

inflows

reduces capital

inflows

the outflow of capital abroad reduces capital

outflows

increases capital

outflows

The impact of exchange rate changes on the value and volume of export-import

operations, capital migration, is quite significant. In the short run, exports and imports are

weak in response to the changing exchange rate. The change in import volumes will depend

on the price elasticity of demand for imports as a whole, on the share of imports of products

FACTORS INFLUENCING THE EXCHANGE RATE

long-term factors of

influence

medium-term

factors of influence

short-term factors of

influence

include indicators of economic growth, the volume

of money in circulation, the solvency of the

country and confidence in the national currency in

domestic and foreign markets, the amount of

domestic and foreign debt, and so on.

the difference in inflation rates in countries, the

state of the balance of payments, the state budget

deficit, etc.

speculative currency transactions, the formation of

inflation expectations, frequent changes of

government, lobbying in the highest echelons of

power of the interests of certain political and

economic structures, the level of development of

other sectors of the financial market, and others.




in total consumption and on the price elasticity of supply formed by domestic producers. As

for the impact of the exchange rate on exports, the following factors should be identified.

First, the cost and physical volumes of commodities will be affected by the elasticity of

demand on the world market for these products. Secondly, the level of monopoly power that

the national exporter has in the world market, which directly affects the elasticity of supply to

the world market of these products. Third, the share of domestic consumption, i.e. the

dependence of the local market on sales in foreign markets and, finally, the price elasticity of

supply of products for export.

The change in the exchange rate affects the public finance system, primarily the state

budget. Thus, as a result of changes in the exchange rate, the volumes of foreign trade

turnover will change, and, accordingly, the volumes of required payments (taxes and fees)

that fall into the state budget. First of all, this applies to the amount of customs duty, proceeds

from the sale of export and import licenses. Relevant changes will take place in the system of

public expenditures, as the cost of public procurement of imported goods, the cost of

servicing the country's external debt, etc. may change. All this forces the country's central

bank to carry out appropriate interventions in the foreign exchange market, take measures to

regulate the convertible national currency, and so on.

3. METHODOLOGY

The methodology for estimating the relationship between inflation and macroeconomic

indicators is based on the approach used by Hansen (Hansen, 2000) – a general method for

estimating threshold regressions. Threshold regression refers to a model that assumes that

there are two (or more) ways for regressors to act on a dependent variable. The threshold level

is also unknown and is estimated during econometric modeling. The model looks like this:

(5)

where – the explained variable; – the vector of explanatory variables, the effect of

which on the explained variable depends on the mode; – threshold variable responsible for

the current mode; – threshold level; – indicator function equal to unity if the inequality

indicated in brackets is true and equal to zero otherwise; – the vector of control variables,

the effect of which does not depend on the current mode.

For the calculation, we will use the annual data for the period from 1980 to 2018 for 170

countries taken from the International Monetary Fund database (World Economic Outlook

dataset) [3].

The adjusted GDP growth rate will be accounted for as a dependent variable and

calculated on a five-year moving average. The smoothing was carried out to neutralize short-

term cyclical fluctuations in GDP and to analyze the long-term effects of inflation on

indicators. Let’s evaluated the model parameters.

–

(6)

where – the vector of control variables. As control variables, the share of investments in

GDP and the population growth rate were used.


Tetiana Koliada


– random model errors;

– country effects;

– the inflation rate in annual terms, smoothed over a five-year moving average;

– a variable characterizing the excess of the inflation threshold: = 1 for > π*

and = 0 for ≤ π*;

π* – the threshold inflation rate. It is assumed that when inflation exceeds the threshold

level, there is an impact of structural changes due to the impact of inflation on output. The

parameter π* will also be evaluated during simulation.

Thus, the model becomes nonlinear and will be estimated using the nonlinear least squares

method, namely: the values of π * will be sequentially sorted in increments of one percent.

For each value in the model with fixed effects, equation (5) and the corresponding sum of the

residual squares was calculated. The model for which the value of the sum of squares of

deductions was the minimum is considered the best. To take into account the specifics of each

country for each of the objects in the sample and to avoid bias in the estimates of the

coefficients due to ignoring these features in the simulation, the use of a model with fixed

effects is the best option. Fixed effects allow us to take into account those features of

countries that do not change or change very slowly over time: cultural variables, the quality of

institutions, education and quality of knowledge, the initial level of welfare, and so on. The

inclusion of fixed effects eliminates the need to take into account in the vector of control

variables those factors that do not change over time, such as a macroeconomic indicator such

as GDP per capita in the initial period of time.

Using this equation specification, the coefficient characterizes the effect of low (below

the threshold level) inflation on growth, and the coefficient characterizes the effect of high

inflation.

4. RESULTS AND DISCUSSION

The results of estimating the regression equation using a model with fixed effects, models

with random effects, and simple complete regression without taking into account the effects

of the country (pooled Ordinary Least Squares) by the described method are presented in

Table 2. We did not take into account reliable standard errors in parentheses coefficients, as

we show the effect of the model for estimating the flow of inflation on macroeconomic

indicators on one parameter.

The control variables included in the model are statistically significant and have signs

corresponding to economic theory: an increase in population growth rates and the share of

investments in gross domestic product positively affects the rate of economic growth.

The first way to test the stability of the results was to evaluate the same equation using

other methods: simple pooled regression and models with random effects. The evaluation

results are also presented in the table. It is easy to see that the estimates of the coefficients

practically do not change, regardless of the specification used.




Table 2 The results of evaluating models of the impact of inflation on economic growth (dependent

Variable: Smoother Real GDP Growth)

Regressor Model 1 Model 2 Model 3

Assessment method Fixed

Effects

Random

Effects

Ordinary

Least

Squares

Inflation below threshold 0,04 0,04 0,05

Inflation above threshold – 0,02 – 0,014 – 0,009

Share of investment in GDP 0,13 0,13 0,11

Population growth rate 0,43 0,45 0,48

Constant – 0,01 – 0,01 – 0,005

Country effects Yes Yes No

Inflation threshold 8% 8% 8%

R2 0,37 — 0,18

R2-within 0,11 — —

P-value of the test for the absence of

individual effects 0,00 0,00 —

P-value of the Houseman test — 0,00 —

Number of observations 5228 5228 5228

The results of the test for the absence of special effects in the model indicate the

justification for using models that take into account country effects. And the results of the

Houseman test for comparing models with random and fixed effects speak in favour of the

latter. Therefore, although the inflation rate below the threshold value is significant at five per

cent or ten per cent significance levels in models with random effects and the usual full

regression, it should be concluded that it still does not affect the long-term dynamics of

output, since in the model with fixed effects it remains insignificant.

5. CONCLUSION

A marked increase in economic uncertainty as a result of the effects of the crisis in recent

years has a significant impact on the development of the economy. Different stages of

development of society are accompanied by a different level of economic uncertainty, which

decreases during periods of economic growth and increases sharply during recessions. As the

modern economy develops, there is a need to reexamine the problems of its forecasting and

the impact of various factors on it.

Currently, due to the intensification of globalization processes, there is doubt about the

legality of using data from prior periods in substantiating current decisions and forecasting the

economies of individual countries and regions, and methods that make it possible to build

forecasts of macroeconomic development based on the conditions of the current state begin to

play a significant role. A modern approach to forecasting macroeconomic development,

taking into account uncertainty and risk factors, is to use stochastic models of economic

growth, involving the modelling of random variables. As part of the analysis of the proposed

model of the effects of changes in the national currency exchange rate on the leading

macroeconomic indicators (using the example of GDP), it is shown that an alternative

mechanism for influencing economic growth is its effect on exchange rate fluctuations. The

direct impact of the weakening of the national currency can cause both an increase in output

and its decrease.


Tetiana Koliada


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Documents

THE MODEL OF THE IMPACT OF CHANGES IN THE ......Halyna Nakonechna, Igor Ruzhytskyi and Tetiana Koliada, The Model of the Impact of Changes in the National Currency on Key Macroeconomic