Results from Granger Causality Test

Since there is cointegration between exchange rates and macroeconomic variable, this study moves on to test the direction of causalities. As was mentioned earlier in Section 4.2.2, the variables Y1,t , Y2,t , Y3,t …Yk,t are assumed to be stationary for the Granger Causality test. Both the Ng-Perron and Phillips-Perron unit root tests are applied for all cointegrated variables. The unit root tests results for advanced, emerging and frontier markets are shown in Appendix 15, 16 and 17 respectively. The unit root tests show that all of the cointegrated variables are non-stationary in levels. Only when the variables are differentiated once do, they became stationary. Therefore, all of the cointegrated variables are integrated of order one i.e I(1). In order to examine the Granger Causality, four lags were selected as the maximum lag following Pesaran and Pesaran’s (2009) recommendation17. The block Ganger Causality test between the exchange rates and macroeconomic variables (and vice versa) was performed where there were more than one independent variable. In this case, the result of the LR (χ2) test was obtained via the Microfit 4.1 software package. Conversely, when there was only one independent variable, the pairwise Granger Causality test was performed. In this case, an F statistic was generated by the EViews 7 software package. The test results are sectionalised into advanced, emerging and frontier markets.

4.5.1 Advanced Markets

The Granger Causality tests for all advanced countries are presented at Appendix 18. The result of the LR (χ2

) test is reported in Appendix 18A. The results suggest that in the long- run, macroeconomic variables do Granger cause exchange rate in all the cases. The null of block Granger Causality is rejected since the LR (χ2) is statistically significant (p < 0.05). This means that the country specific macroeconomic variables do jointly Granger cause exchange rates. The results of Granger Causality test can be explained as follows. For example, in the case of Australia, the null of block Granger Causality is rejected when the exchange rate (LNER) acts as a dependent variable. This indicates that long run interest rate (IRLAUS), inflation rates (INFRAUS), trade balances (TBAUS) and trade openness (TOAUS) do jointly Granger cause the exchange rate of Australian dollar/ USA dollar. By

interchanging the dependent variable, the block Granger Causality test was used to examine the direction of causality among other variables. The results suggest that exchange rates (LNER), long run interest rates (IRLAUS), trade balances (TBAUS) and trade openness (TOAUS) do jointly Granger cause of inflation rate of Australia (INFRAUS). Moreover, exchange rate (LNER), long run interest rate (IRLAUS), inflation rate (INFRAUS) and trade balance (TBAUS) do jointly Granger causes the trade openness of Australia (TOAUS). However, we failed to reject the null of block Granger Causality (p > 0.05) when long run interest rate of Australia (IRLAUS) is used as a dependent variable. This indicates that the exchange rate (LNER), inflation rate (INFRAUS), trade balance (TBAUS) and trade openness (TOAUS) do not jointly Ganger cause the long run interest rate of Australia (IRLAUS). Similar results also found in the case of trade balance of Australia (TBAUS). The unidirectional causality i.e from macroeconomic variables to exchange rate is found in all cases. Moreover, unidirectional causality i.e from exchange rate to macroeconomic variables is found in the majority cases. The results of the block Ganger Causality for rest of the advanced countries can be explained in an analogous way

As was mentioned earlier in Section 4.5, when there was only one independent variable, the pairwise Granger Causality test was performed. The F statistics for the pairwise Granger Causality test for Singapore, Switzerland and UK are reported in Appendix 18B. The null hypothesis is rejected in every cases (p < 0.05) indicating that country specific macroeconomic variables do Granger cause exchange rates. The unidirectional causality from macroeconomic variables to exchange rate is found in the case of Singapore and Switzerland. The bilateral causality i.e macroeconomic variable to exchange rate and vice versa is evident in the case of UK. The null of pairwise Granger Causality is rejected in the case of UK since the F is statistically significant (p < 0.05) when the exchange rate (LNER) and trade openness (TOUK) act as dependent variable. This indicates that the bilateral causality from exchange rate (LNER) to trade openness (TOUK) of UK and vice versa. The results of pairwise Ganger Causality for rest of the Singapore and Switzerland can be explained in an analogous way.

4.5.2 Emerging Markets

The results of Granger Causality tests for all emerging countries are reported at Appendix 19. The result of the LR (χ2) test is reported in Appendix 19A. The results suggest that in the long-run, macroeconomic variables do Granger cause exchange rate in all the cases. The null of block Granger Causality is rejected since the LR (χ2) is statistically significant (p < 0.05). This means that the country specific macroeconomic variables do jointly Granger cause exchange rates. The null of Granger block Causality for Brazil, for example, is rejected since the LR (χ2

) is statistically significant (p < 0.05) when the dependent variables are exchange rates (LNER) and interest rates (IRSBZ). This indicates that the macroeconomic variables i.e. interest rates (IRSBZ), trade balances (TBBZ) and trade openness (TOBZ) do Granger cause exchange rate of Brazil and USA. Result also showed that exchange rate (LNER) along with two other macroeconomic variables i.e. TBBZ and TOBZ jointly Granger cause the interest rate of Brazil. In contrast, the null of Granger block causality cannot be rejected (p > 0.05) when the dependent variables are trade balance (TBBZ) and trade openness (TOBZ) of Brazil.

The null of block Granger Causality is rejected in the cases of Chile, Colombia and India since the LR (χ2

) is statistically significant (p < 0.05) in all dependent variables cases. For example, in the case of Chile, the macroeconomic variables such as trade balance (TBC), interest rate (IRSC), money supply (MSC) and current account (CAC) jointly Granger causes the exchange rates (LNER) of Chile and USA. The null also rejected when dependent variable is changed to TBC, IRSC, MSC and CAC. This indicates the bidirectional causality from exchange rate to macroeconomic variables and vice versa. Overall, the results suggested that the unidirectional causality i.e from macroeconomic variables to exchange rates is found in the cases of Brazil, Czech Republic, Indonesia, Peru and South Africa. Moreover, the unidirectional causality i.e exchange rate to from macroeconomic variables in all the cases except Czech Republic. Nevertheless, bidirectional causality is observed in the cases of Chile, Colombia and India.

The F statistic for the pairwise Granger Causality test for China, Hungary, Malaysia, Mexico, Philippines, Poland, Russia, South Korea, Taiwan, Thailand, Turkey are reported in Appendix 19B. The null hypothesis i.e ‘macroeconomic variable does not Granger cause exchange rate’ is rejected (p < 0.05) in the cases of Hungary, Malaysia, Russia and Taiwan. This indicates that country specific macroeconomic variable do Granger cause

exchange rates of these countries against the U.S. dollar. The unidirectional causality i.e from exchange rate to macroeconomic variables is found in the case of Mexico, Philippines, Poland and South Korea. Bidirectional causality i.e macroeconomic variable to exchange rate and vice versa is observed in Russia. In contrast, no causality is showed in the cases of China and Turkey. The null of pairwise Granger Causality cannot reject since the F is statistically insignificant (p > 0.05). Therefore, one concludes that there is no causal impact from exchange rate (LNER) to trade balance (TBCHI) and vice versa in the case of China. Similar results also found in the case of Turkey. The results of Ganger Causality for rest of the emerging countries can be explained in a similar way.

4.5.3 Frontier Markets

The Granger Causality tests for all frontier countries are presented at Appendix 20. The result of the LR (χ2

) test is reported in Appendix 20A. These results are generally consistent with the results of advanced and emerging countries. For example, there is a one-way effect running from country specific macroeconomic variables to exchange rate in all cases except Pakistan and Sri Lanka. For instance, the null of block Granger Causality is rejected for Craotia since the LR (χ2) is statistically significant (p < 0.05). This indicates that the macroeconomic variables such as interest rates (IRSC), inflation rates (INFRC), and trade balance (TBC) jointly Granger cause the exchange rate (LNER). The null is also rejected when the dependent variable is changed to IRSC and INFRC. However, we failed to reject the null of bloack Granger Causality (p > 0.05) when trade balance of Croatia (TBC) is used as dependent variable. Similar results are also found for all the countries except Bangladesh and Kazakhstan.

The Causality test also shows a bilateral effect running from macroeconomic variables to exchange rates and vice versa in the cases of Bangladesh and Kazakhstan. The null of block Granger Causality is rejected in those two countries since the LR (χ2) is statistically significant (p < 0.05) for all dependent variables. For example, in the case of Bangladesh, the macroeconomic variables such as GDP (GDPBD), interest rate (IRSBD) and trade balance (TBBD) do jointly Granger cause the exchange rate (LNER) of Bangladeshi taka and USA dollar. The null was also rejected when the dependent variable is changed to GDPBD, IRSBD and TBBD. This indicates bidirectional causality from exchange rate to

macroeconomic variables and vice versa. Similar results also found in the case of Kazakhstan.

The F statistic for the pairwise Granger Causality test for Bhutan, Botswana, Estonia, Jamaica, Kenya, Lao PDR, Myanmar and Vietnam are reported in Appendix 20B. The null hypothesis i.e ‘macroeconomic variable does not Granger cause exchange rate’ is rejected (p < 0.05) in all cases except Jamaica and Kenya. This indicates that country specific macroeconomic variable does Granger cause exchange rates of these countries against the U.S. dollar. The unidirectional causality i.e from macroeconomic variables to exchange rate is found in all cases except Jamaica and Kenya. The unidirectional causality i.e from exchange rate to macroeconomic variables is found in the case of Jamaica and Kenya. No bidirectional causality is observed in any of the frontier market cases. The results of Ganger Causality for remainder of the frontier countries can be explained in a similar way. The next Section compares the forecast performance of ARDL-cointegration model with time series models (discussed in Chapter 3).

4.6 A Comparison of Forecast Performance between Time Series and ARDL-