Exchange rate volatility and domestic consumption: a multicountry analysis

Inflation uncertainty, measured by the volatility of inflation, is said to have a negative effect on domestic consumption by making the public more cautious about their spending. Since exchange rate volatility contributes to inflation volatility, we conjecture that it could have a direct effect on domestic consumption. We demonstrate our conjecture by specifying a consumption function that includes a measure of exchange rate volatility, in addition to its usual determinants. The model is estimated for each of the 17 countries in the sample using the boundstesting approach to cointegration and error-correction modeling. The results reveal that in 12 of the countries, exchange rate volatility has short-run effects on consumption. Long-run effects are observed in only 9 countries.