THE RELATIONSHIP BETWEEN EXCHANGE RATE AND INFLATION: THE CASE OF WESTERN BALKANS COUNTRIES

Abstract

The paper investigates empirically the relationships between exchange rates and inflation in Western Balkan countries. The literature on the transition countries has recently focused on exchange rate as a shock absorber and downplayed its costs to macroeconomic stabilization.  However, the decision to apply a different exchange rate regime depends on the costs and benefits in giving up an exchange rate instrument.  With this in mind, the objective of this study is to determine whether fixed exchange rates play a significant role in inflationary performance or whether flexible exchange rates perform as a better shock-absorbing instrument in the Western Balkans. The result reveals that an exchange rate is still the main source of inflationary pressures in Western Balkan countries. Thus policy makers must weigh the relative costs and benefits associated with introducing a flexible exchange rate in small open economies because such regime is likely to incur more costs than benefits. 

Keywords

• Transition economies,Western Ballkan Countries,exchange rate,inflation

References

1. Adler, G. and Tovar, C. E. 2012, "Riding Global Financial Waves: The Economic Impact of Global Financial Shocks on Emerging Market Economies", IMF Working Paper WP/12/188.
2. Artis, M., and Ehrmann, M. 2006, "The exchange rate _ A shock-absorber or source of shocks? A study of four open economies", Journal of International Money and Finance 25, 874-893.
3. Blanchard, O. 2010 "Institutions, Markets, and Poland's Economic Performance", Argumenta Oeconomica Cracoviensia 6, 7-11.
4. Bailliu J, Fujii E, 2005 :"Exchange Rate Pass-Through and the Inflation Environment in Industrialized Countries " Working Paper 2004-21, ISSN 1192-5434.
5. Baltagi, B. 2009 : "Econometric Analysis of Panel Data", Fourth Edition, London: John Wiley & Sons Ltd.Bank of New Zealand, (2003), pp. 1-28
6. Borghijs, A., and Kuijs, L. 2004, "Exchange Rates in Central Europe: A Blessing or a Curse?", IMF Working Paper WP/04/2, 1-28.
7. Calvo, G., and Reinhart, M.,K., 2002, "Fear of Floting," Quarterly Journal of Economics.
8. Coricelli, F., Bostjan, J., Masten, I., 2005: "Exchange rate pass-through in EMU acceding countries: Empirical analysis and policy implication," Journal of banking anf finance, 2005.

9. Canzoneri, M. B., Vallés Liberal, J.,and Viñals, J. 1996, "Do Exchange Rates Move to Address International Macroeconomic Imbalances?," Banco de España - Servicio de Estudios, Documento de Trabajo 9626.
10. Dabrowski, M. A., and Wróblewska, J. 2014, "Financial shocks as a cause of real exchange rate fluctuations in Poland-evidence from the Bayesian structural VAR models", in: Proceedings of the 8th Professor Aleksander Zelias International Conference on Modeling and Forecasting of Socio-Economic Phenomena, Foundation of the Cracow University of Economics, Cracow, 37-46.
11. Edwards , S., 2006: "The relationships between exchange rates and inflation targeting revisited", NBER, Working Paper 12163, Cambridge, 1-33.
12. Fetai, B 2013: "Exchange rates pass-through in transition economies", Transition Studies Review, vol. 20, 309-324.
13. Funke, M., 2000: "Macroeconomic shocks in Euroland vs the UK: supply, demand or nominal?" University of Hamburg, Mimeo.
14. Ganev G, Molnar K, Rybinski K, Wozniak P 2002:" Transmission mechanisms of monetary policy in central and eastern Europe", central for social and economic research, Case Reports No. 0052, Warsaw, pp 1–28.
15. Kuijs L., 2002. "Monetary Policy Transmission Mechanisms and Inflation in the Slovak Republic". IMF Working Paper, 80.
16. Stażka-Gawrisyak, A., 2009: "The Shock-Absorbing capacity of the flexible exchange rate in Poland", Focus on Economic Integartion, 4, 5470.
17. Shevchuk 2014, Tsangarides, C. G. 2012, "Crisis and recovery: role of the exchange rate regime in emerging market countries". Journal of Macroeconomics 34, 470-488.
18. Tsangarides, C. G. 2012, "Crisis and recovery: role of the exchange rate regime in emerging market countries". Journal of Macroeconomics 34, 470-488.
19. Thomas, A., 1997: "The monetray transmission mechanism in Sweeden", IMF working paper, WP/97/176.