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 bounds-testing 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.