Exchange Rate Fluctuations

Applied Econometrics and International Development.

AEID.Vol. 6-1 (2006)

DETERMINANTS OF EXCHANGE RATE FLUCTUATIONS FOR
VENEZUELA: APPLICATION OF AN EXTENDED
MUNDELL-FLEMING MODEL
HSING, Yu*
Abstract
Applying and extending the Mundell-Fleming model, this study attempts to examine the behavior of short-term real exchange rates for Venezuela. It finds that the real effective exchange rate is positively associated with real government deficit spending and negatively influenced by real M2, the world interest rate, county risk, and the expected inflation rate. Hence, the authoritie s need to exercise fiscal discipline so that deficit spending would not be too large to cause real appreciation and hurt exports. When country risk rises due to the financial, economic or political factors, real exchange rates would depreciate.
JEL Classification: F31, F41, O54
Key words: Real Effective Exchange Rate, Country Risk, World Interest Rate, Monetary
Policy, Fiscal Policy
1. Introduction
The Venezuelan government adopted different exchange rate regimes over the last several decades. During 1973.M2 – 1984.M1, the exchange rate was pegged at 4.29 or
4.30 bolivars per U.S. dollar. During 1984.M2 – 1986.M11, it was fixed at 7.50, and between 1986.M12 and 1989.M2 it was pegged to the dollar at 14.50. During 1983-1988, the monetary authorities adopted a complicated four-tier exchange rate regime that offered subsidized exchange rates to selected priority activities. By 1989.M3, the authorities pursued a floating exchange rate system based on the supply of and demand for the bolivar.
As a result, the exchange rate settled at 36.89 in 1989.M3. Large devaluations occurred in 1994.M5, 1996.M4, 2002.M2, 2002.M6, and 2003.M2 due to the decline in crude oil prices, inflation, budget deficits, political events, capital outflows, financial crises, or other developments. The IMF provided an assistance package in April 1996 and required
Venezuela to raise taxes

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