Exchange Rate Volatility and Macroeconomic Performance: the Case of Liberia

Abstract

The collapse of the Bretton Woods system is widely recognized as a key catalyst for the volatile exchange rate in many economies. The dynamics in the ER have been extensively documented in numerous studies as significant impediments to macroeconomy growth and stability. This study used quarterly data to examine the impact of ERV on Liberia's macroeconomy from 2000 to 2022. The analysis focused on key macroeconomic factors such as GDP, FDI inflow, and inflation, which are crucial indicators of Liberia's macroeconomic performance. The study employed a VEC model for the GDP and FDI inflow equations due to the identification of cointegration, while a VAR model was used for the inflation equation, given the absence of cointegration. The volatility of the ER was measured using the GARCH model. The findings indicated that, in the short run, ER dynamics significantly impact FDI inflows and inflation but not economic growth. However, in the long term, ERV has an inverse impact on economic growth and FDI inflows. The research clinched that the impact of ERV on the macroeconomy is factor-specific, varying depending on the specific macroeconomic indicator under consideration.