Threshold effects of openness on real and nominal effective exchange rates in emerging and developing economies

In this paper, we assess the direct and indirect effects of the degree of openness in emerging and developing economies on exchange rate movements. Using threshold regression analysis for twenty-five economies for the period of 2000-2017, we find that changes in inflation, interest rate differentials and government debt have a more sizable and significant effect on real effective exchange rates in less open economies, which is not detected in countries with openness above the threshold value. In more open economies, nominal effective exchange rate movements are driven by interest rate differentials and real GDP growth. However, the exchange rate response is still smaller than in less open economies. Lastly, the measure of openness matters. Evidence of threshold effects is most significant when considering overall openness with the KOF Globalisation Index, rather than the traditional measure of trade openness alone.