Does exchange rate management affect the causality between exchange rates and oil prices? Evidence from oil-exporting countries

The bi-directional causality between exchange rates and oil prices of oil-exporting countries has been widely investigated since the oil crisis in the 1970s. The classical theoretical framework assumes that countries adopt free-floating exchange rate arrangements, and empirical studies seldom consider exchange rate restrictions when investigating oil exporters that always manage exchange rates. To address these limitations, this study designs a comparative analysis for three groups of oil-exporting economies that adopt different foreign exchange rate policies. The analysis aims to examine whether and how intervention behavior may distort the causal relationship between exchange rates and oil prices. We first show the non-linear causality relationships for countries with “free-floating exchange rate arrangements” in both long and short terms. Then, we establish how the managed floating policy can eliminate the impact of oil prices on exchange rates in bull markets but fail to prevent exchange rate depreciation in bear markets. In bear markets, a negative non-linear feedback from exchange rates to oil prices prevails in these countries. However, contrary to common wisdom, the strict “soft-pegged exchange rate arrangement” cannot remove all the linkages between exchange rates and oil prices. A small but significant response of exchange rates toward oil prices is detected for Kuwait and Saudi Arabia. A similar effect for Kazakhstan is only found in bear markets. In addition, this study re-investigates the relationship between exchange rate and the domestic currency price of oil. The conclusions are similar, except that the relationship is weakened in free-floating countries but strengthened in managed floating countries during the bear market periods.