Rudi Gunawan, Uswatun Khasanah, Amani Shayo

An empirical analysis of the effects of macroeconomic variables on exchange rate: A time series analysis using ECM

Introduction

An empirical analysis of the effects of macroeconomic variables on exchange rate: a time series analysis using ecm. Empirical analysis using ECM examines macroeconomic variables' impact on Rupiah exchange rate. Finds exports, money supply, and interest rates crucial for Indonesia's economic policy.

Abstract

There are increasing on debate about how the macroeconomic variables causes exchange rate. There are evidence that macroeconomic variables has a little evidence on exchange rate volatility and vice versa. This study aims to analyze the impact of macroeconomic variables, namely exports, imports, inflation, money supply, and interest rates, on the Rupiah exchange rate using the Error Correction Model approach. Using monthly data from 2010 to 2023 obtained from the Central Bureau of Statistics and Bank Indonesia. The finding shows in the long run, exports have a negative effect on the exchange rate, while money supply and interest rates have a positive effect and indicates that an increase in these variables will strengthen the exchange rate. In the long run, imports and inflation do not show a significant effect in the long run. In the short run, only money supply and interest rates significantly affect the exchange rate, while exports, imports, and inflation do not. This study highlights the importance of understanding these macroeconomic dynamics for more effective economic policy making in Indonesia. The dominant role of monetary policy over trade and price variables in stabilizing the exchange rate. Policymakers should focus on managing money supply and interest rates while promoting exports to maintain Rupiah stability amid global uncertainty.

Review

This study presents a timely empirical analysis into the intricate relationship between key macroeconomic variables and the Rupiah exchange rate in Indonesia. Employing the Error Correction Model (ECM) on monthly data from 2010 to 2023, the research effectively distinguishes between short-run and long-run dynamics. The findings offer valuable insights, revealing that exports, money supply, and interest rates significantly influence the exchange rate in the long run, with only money supply and interest rates maintaining significance in the short run. This distinction between short and long-term effects, coupled with the use of an appropriate econometric methodology for time-series data, strengthens the study's contribution to understanding exchange rate determination in an emerging economy context. While the study provides clear empirical results, certain aspects of the abstract warrant further clarification and critical review. The initial motivation, stating "increasing on debate about how the macroeconomic variables causes exchange rate" and "little evidence on exchange rate volatility and vice versa," is somewhat vague and could benefit from a more precise framing of the literature gap. More importantly, the abstract indicates a "positive effect" of money supply and interest rates in the long run, which "indicates that an increase in these variables will strengthen the exchange rate." This statement presents a potential contradiction, as a positive correlation typically means an increase in the independent variable leads to an increase in the dependent variable. If the exchange rate is defined as local currency per unit of foreign currency (e.g., IDR/USD), an increase in this rate signifies a *weakening* of the local currency. This ambiguity in the interpretation of "strengthening" versus the sign of the effect needs to be clarified, as it fundamentally impacts the understanding of the findings. Additionally, the abstract does not explicitly mention the theoretical framework guiding the selection of variables or any robustness checks performed, which would enhance the credibility of the results. Despite these points, the study offers significant policy implications for Indonesia. It effectively highlights the dominant role of monetary policy (money supply and interest rates) over trade and price variables in stabilizing the Rupiah. The recommendation for policymakers to focus on managing money supply and interest rates while promoting exports is a clear and actionable takeaway from the research. For future work, it would be beneficial to explicitly define the exchange rate (e.g., IDR/USD or USD/IDR) to remove any ambiguity in the interpretation of "strengthening" or "weakening." Expanding the analysis to include global economic shocks, capital flows, or investor sentiment could also provide a more holistic understanding of Rupiah dynamics, further enhancing the study's practical and theoretical contributions.

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