Consumption and exchange rate uncertainty: Evidence from selected Asian countries

• Published date: 01 September 2020
• Author: Bernard Njindan Iyke,Sin‐Yu Ho
• DOI: http://doi.org/10.1111/twec.12900
• Date: 01 September 2020

World Econ. 2020;43:2437–2462. wileyonlinelibrary.com/journal/twec

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2437

© 2019 John Wiley & Sons Ltd

Received: 24 July 2017

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Revised: 6 July 2019

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Accepted: 2 November 2019

DOI: 10.1111/twec.12900

ORIGINAL ARTICLE

Consumption and exchange rate uncertainty:

Evidence from selected Asian countries

Bernard NjindanIyke1

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Sin-YuHo2

1Department of Finance, Deakin Business School, Centre for Financial Econometrics, Deakin University, Melbourne, Vic.,

Australia

2Department of Economics, University of South Africa, UNISA, Pretoria, South Africa

KEYWORDS

Asian countries, exchange rate uncertainty, real consumption

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INTRODUCTION

We assess the effects of exchange rate uncertainty on real consumption in selected Asian countries.

Consumption and saving decisions are critical components of short- and long-run economic analysis

owing to several factors but the following two stand out. First, because consumption affects business

cycles, it influences short-run monetary policy decisions. Second, saving decisions affect the level of

capital stock, wages, interest rates and the standard of living in the long run and therefore affect fiscal

and monetary policies (Carroll, 2006; Iyke & Ho, 2018a). Since consumption and saving decisions are

critical factors shaping both fiscal and monetary policies, a large number of studies have focused on

the factors influencing consumption and saving. From the consumption literature, real income and in-

terest rates regularly appear as fundamental determinants of consumption (Bahmani-Oskooee, Kutan,

& Xi, 2015). Exchange rates are also gaining prominence as a determinant of consumption in recent

studies because countries are becoming more open (Iyke & Ho, 2018a). Alexander (1952) was one

of the earliest to connect exchange rates to consumption. He contended that exchange rates influence

consumption by their pass-through effects on inflation. That is, exchange rate uncertainty is associated

with inflation uncertainty, thereby affecting consumption decisions (Alexander, 1952).

Providing support for this contention, Carroll (1997), while investigating the optimal behaviour

of consumers with standard attitudes towards risk andfacing income uncertainty, found that it could

be optimal for average household consumption behaviour to mimic the average household income

for most part of the life cycle, conditional on the household's income and its degree of impatience.

Moreover, Obstfeld and Rogoff (1998) noted that exchange rate uncertainty impedes real consump-

tion through direct and indirect channels. In terms of the direct channel, they explained that firms

and households react adversely to uncertainty generally, which in turn influences their consumption

decisions. Equally, uncertainty impedes production, income and trade and consequently affects con-

sumption. In terms of the indirect channel, they argued that firms could attempt to hedge the risks

related with exchange rate uncertainty by pushing up prices of their goods and services, which may in

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IYKE and HO

turn hurt real consumption. On the empirical front, few studies have examined the effects of exchange

rate uncertainty on domestic consumption. Bahmani-Oskooee and Hajilee (2010), for example, found

currency depreciation to be associated with low unskilled labour wages in some countries and to boost

skilled labour wages in others. Similarly, Bahmani-Oskooee et al. (2015) found that while exchange

rate uncertainty has short-run effects on consumption in all countries in their sample, the short-run

effects translate to long-run effects only in six countries.

A contribution of our study is that we re-examine the effects of exchange rate uncertainty on con-

sumption using a selected sample of Asian countries. Specifically, we combined the traditional Asian

Tigers: South Korea, Taiwan, Hong Kong and Singapore, the new Asian Tigers: Thailand, Indonesia,

Malaysia and China, and the first industrialised Asian country, Japan, to achieve this objective.

Previous studies have mainly focused on advanced countries elsewhere in the world (see Bahmani-

Oskooee & Xi, 2012). Recent attempts to extend the analysis to other economies have only considered

a few Asian countries in their samples. Bahmani-Oskooee and Xi (2011) included only Japan, South

Korea and Singapore in their sample, while Bahmani-Oskooee et al. (2015) considered Malaysia and

the Philippines. Hence, to date, the empirical evidence on the effect of exchange rate uncertainty on

consumption is skewed towards a few Asian economies. Our study offers a broader examination of the

relationship by including several countries. Unlike these studies, we analysed the impact of various

forms of exchange rate uncertainty—asymmetric, temporary and permanent uncertainties—on con-

sumption. These countries merit attention because they have undergone unique periods of exchange

rate uncertainty. For instance, these countries experienced the Asian financial crisis in 1997. The

crisis originated from currency crisis in Thailand and later spread to other Asian countries via finan-

cial and real channels (see Julian, 2000). Amidst the crisis were geopolitical tensions, which further

heightened the level of uncertainty in these countries. Hong Kong, for instance, was handed over to

the Mainland China in 1997 by the British, and there was an increasing tension between North and

South Korea during 2010s, a break down in the Indonesian monetary system in 1997/98, and political

instability in Thailand (via military coup in 2006).1 And very recently, these countries have experi-

enced the adverse impact of the Global Finance Crisis. Evidence suggests that consumption has expe-

rienced volatility during these uncertain periods (see Brunschwig, Carrasco, Hayashi, & Mukhopadhyay,

2011; Kato, 2009). The only notable exception is China whose consumption growth has been steady

with limited volatility (see Kato, 2009). By contrast, the consumption in Japan has stagnated with

volatile movement due to various factors, the notable being weak economic growth, pessimistic ex-

pectations and ageing population (Vihriälä, 2017).

Another contribution is that we extend the literature by estimating both short- and long-run effects

of exchange rate uncertainty on consumption. Existing studies mainly focus on estimating long-run

effects. The short-run transitional dynamics are usually ignored. There are few exceptions. Bahmani-

Oskooee and Xi (2011) and Bahmani-Oskooee et al. (2015) examined both the short- and long-run

effects in their studies. As mentioned above, both studies considered few Asian countries and used

time-series estimators, which are less efficient in small samples. We address these concerns by includ-

ing a broader sample of countries and using a distributed lag approach developed by Pesaran, Shin, and

Smith (1999). This approach entails pooling countries together and verifying whether cross-equation

restriction of a common equilibrium relationship exists among variables by applying the pooled mean

group (PMG) estimator. In the current context, our aim is to establish whether cross-equation restriction

of a common equilibrium relationship exists between uncertainty and consumption. The approach is

particularly desirable because it allows the policymaker to capture persistence in consumption decisions

by way of imposing specific lag structure, model policy changes, accommodate imperfections in the

1 See Sherlock (1998), Tsang (2004), Teanravisitsagool (2009), and The Straits Times (2018), for more details.