What Makes a Currency Procyclical? An Empirical Investigation

32 Pages Posted: 20 Apr 2016

See all articles by Tito Cordella

Tito Cordella

Johns Hopkins University - Bologna Center

Poonam Gupta

World Bank

Date Written: November 1, 2014

Abstract

This paper looks at the correlation between the cyclical components of gross domestic product and the exchange rate and classifies countries' currencies as procyclical if they appreciate in good times, countercyclical if they appreciate in bad times, and acyclical otherwise. With this classification, the paper shows that: (i) the countries that are commodity exporters and experience procyclical capital flows tend to have procyclical currencies; (ii) countries with procyclical currencies tend to restrict their capital accounts, perhaps as an attempt to reduce the degree of procyclicality; (iii) countries with procyclical currencies pursue procyclical monetary policy; (iv) however, in the last decade, there is a disconnect between the cyclicality of currency and monetary policy; and (v) the disconnect may reflect a decline in the fear of floating, which can be partially attributed to an improvement in countries' net foreign asset positions.

Keywords: Macroeconomic Management, Currencies and Exchange Rates

Suggested Citation

Cordella, Tito and Gupta, Poonam, What Makes a Currency Procyclical? An Empirical Investigation (November 1, 2014). World Bank Policy Research Working Paper No. 7113, Available at SSRN: https://ssrn.com/abstract=2526570

Tito Cordella (Contact Author)

Johns Hopkins University - Bologna Center ( email )

Via Belmeloro 11
40126 Bologna
Italy

Poonam Gupta

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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