Exchange Rate Volatility, Inflation and Economic Growth in Developing Countries: Panel Data Approach for SADC

Abstract

In the Southern African Development Community, the relationships between exchange rate instability, inflation and economic growth remain at the forefront of economic debate because of the historical antecedent and economic clustering of member countries. Nonetheless, much is not known regarding the complexity, complementarity or substitutability of exchange rate instability and inflation on economic growth for SADC countries. This article examined the influence of exchange rate instability on the inflation–growth nexus of the region for the period of 2000 to 2018. Three major techniques of analyses, Pooled Mean Group (PMG), Generalised Moments (GM) and Dynamic Fixed Effect (DFE), were employed in achieving the goal of the study, but the Pooled Mean Group estimator of the Panel Autoregressive Distributed Lag was favoured by the Hausman test as the main instrument. The GARCH (1, 1) was also employed to generate exchange rate instability. The findings of the study showed that exchange rate instability and inflation have a negative relationship with economic growth of the region. Results further show evidence that economic growth of the region is adversely influenced by the consequential effect of exchange rate instability on inflation: the higher the level of instability in exchange rate, the worse the inflationary-growth relationship of the region. This confirms the menu cost theory of price setting: the higher the rate of inflation, the quicker the exchange rate pass-through effect. It is therefore recommended that policies to ensure appreciation of local currencies should be the priority of member nations.