Exchange Rate Movements and Economic Activity: The Role of Trade and Financial Channels

The paper analyzes the impact of exchange rate movements on economic activity for a panel of countries from 2002 to 2021. By introducing a novel approach of considering the asset side of banks balance sheets in addition to their liabilities, the paper analyzes the importance of considering banks net financial position to determine the significance of the financial channel through which exchange rate fluctuations impact output. The results confirm the importance of both - trade and financial channels - in driving the impact of exchange rate movements in the economic activity, yet the direction and magnitude of the financial channel is contingent upon banks net financial position, corroborating the noteworthiness of analyzing both sides of banks balance sheets.