Consumption and exchange rate uncertainty: Evidence from selected Asian countries

Abstract We set out to assess the effects of exchange rate uncertainty on real consumption in selected Asian countries. Consumption influences business cycles, which in turn shape short‐run monetary policy decisions. Hence, understanding factors driving consumption is appealing to policymakers. To date, few studies have analysed the effects of uncertainty on consumption. The available ones generally focus on the long‐run effects, in spite of the fact that the short‐run persistence and adjustments to equilibrium are equally relevant. Our study takes these limitations seriously by distinguishing the short‐ and long‐run effects of exchange rate uncertainty on consumption. Using a flexible dynamic panel data technique that allows long‐run effects to be homogeneous and the short‐run effects to be heterogeneous, we find that uncertainty impedes consumption in the long run. In the short run, however, the effects are immaterial. This evidence remains robust to the measure of uncertainty, asymmetric uncertainty, inflation and the global financial crisis of 2008. By decomposing uncertainty into its temporary and permanent components, we find that the latter have a stronger effect on consumption in the long run than the former. Although both components demand policy attention, the evidence suggests that policymakers should be more concerned with permanent uncertainty.