HOW DOES FINANCIAL MARKET STRESS RESPOND TO SHOCKS IN GLOBAL ECONOMIC ACTIVITY AND EXCHANGE RATE STABILITY? A STRUCTURAL VAR APPROACH
HOW DOES FINANCIAL MARKET STRESS RESPOND TO SHOCKS IN GLOBAL ECONOMIC ACTIVITY AND EXCHANGE RATE STABILITY? A STRUCTURAL VAR APPROACH

Summary/Abstract: The study examined the response financial market stress to innovations in global economic activity and the exchange rate in emerging economies and advanced economies during the period 2006Q1 and 2020Q4. This was achieved by means of time series econometric analysis. The impulse response function estimated through structural factorisation indicated that financial market stress responds positively towards its own innovations and innovations in global economic activity. In contrast, financial market stress responds negatively to a one standard deviation in the exchange rate at least in the long run albeit the response is neutral in the short run. The findings from the variance decomposition showed that in advanced market economies, a larger fraction of the discrepancies in financial market stress are explained by its own innovations followed by innovations in global economic activity whereas in emerging market economies, a larger proportion of the discrepancies in financial market stress are explained by its own innovations followed by innovations in the broad exchange rate. Given the findings, the study recommends strong coordination between monetary policy and fiscal policy to ensure that overall economic activity is optimized and maintained in the long run.

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