Impact of Exchange Rate Volatility on the GDP: An Econometric Analysis Dr. Payal*, Dr. Makkar Suman** *Assistant Professor, MCM DAV College for Women, Chandigarh, India **Associate Professor, DES, P U, Chandigarh, India Online published on 11 June, 2014. Abstract In both theory and practice, there is a close relationship between movements in the exchange rate and the rate of inflation. The Purchasing Power Parity theory of exchange rate determination, which is based on the law of one price, expresses the change in the exchange rate as a function of the difference between the (appropriately weighted) change in "world" prices and the change in domestic prices. The monetary theory of the balance of payments, which relates movements in international reserves (if exchange rates are fixed) or the exchange rate (if it is floating) to shifts in the relative demand for and supply of money, suggests a similar functional relationship. The nominal exchange rate is a sensitive policy indicator. Yet, for purposes of growth analysis, economic managers need to focus on trends in the real exchange rate, i.e. the ratio of the price of tradable and the price of non-tradable goods. An overvalued real exchange rate represents a persistent misalignment of prices between a particular country and the rest of the world. Such misalignment has an impact on the pattern and level of production, the allocation and level of expenditure; the distribution and level of factor payments; the composition and size of trade flows; the levels of foreign reserves and external debt; and (in more extreme cases) the emergence of parallel foreign exchange markets, currency substitution and capital flight. Persistent real overvaluation also seriously erodes business and consumer confidence, thereby lowering the rate of savings and investment. The outcome is a decline in growth. This research paper is an attempt to analyze econometrically the relationship between exchange rate volatility and GDP in India. The scheme of the paper has been delineated as follows. The section 1 examines the relationship of exchange rate with GDP. Section 2 will investigate empirically the relationship between exchange rate and GDP. Section 3 contains conclusion of the preceding sections. Top |