The causal relationship between inflation and exchange rate: Evidence from fragile five

This study examines the causal relationship between exchange rate and inflation for Brazil, Indonesia, South Africa, India and Turkey categorized as "Fragile Five" country group. These countries are categorized as Fragile Five by Morgan Stanley (2013) since their domestic currencies depreciated most against US dollar after that Federal Reserve (FED) announced their plan of reduction in asset purchase program on 22 May 2013. As for econometric methodology, Toda – Yamamoto (1995) approach is utilized to detect the long-run causalities between exchange rate and inflation by Granger analysis and the short-run link between them by generalized impulse and response analysis of Peseran and Shin (1998). The empirical findings offer that there exist bidirectional long-run causal relationships between exchange rate and inflation in Brazil and Indonesia, whereas there exists no evidence for long-run causal relationship between these two variables for South Africa, India and Turkey. Key Words: Inflation, Exchange rate, Toda – Yamamoto, Causality, Fragile five