The impact of oil shocks on exchange rates: A Markov-switching approach

- Markov-switching models to investigate the impact of oil shocks on real exchange rates
- Exchange rate appreciation in oil exporting economies after oil demand shocks
- Limited evidence that oil supply shocks affect exchange rates
- Global economic demand shocks affect exchange rates.

This paper uses Markov-switching models to investigate the impact of oil shocks on real exchange rates for a sample of oil exporting and oil importing countries. This is an important topic to study because an oil shock can affect a country's terms of trade which can affect its competitiveness. We detect significant exchange rate appreciation pressures in oil exporting economies after oil demand shocks. We find limited evidence that oil supply shocks affect exchange rates. Global economic demand shocks affect exchange rates in both oil exporting and importing countries, though there is no systematic pattern of appreciating and depreciating real exchange rates. The results lend support to the presence of regime switching for the effects of oil shocks on real exchange rates.