Non-linear Causality Between Exchange Rates, Inflation, Interest rate Differential and Terms of Trade in Tunisia

Abstract

The purpose of this paper is to investigate the dynamic relationship between inflation, interest rate differential, the exchange trade and exchange rate parities, i.e. (USD/TND, EUR/TND and JPY/TND). Given the existing non-linear form between the different time series in this study, the empirical analysis is based on the using of non-parametric method such as the artificial neural networks. In order to detect the causality relationship between the variables, the authors use an NARX model. Mixed results were found; there is a bidirectional relationship between inflation and exchange rate among others. Results also show that there is a strong correlation between the terms of trade and inflation, which says that trade openness increases the demand for imported goods and, therefore, causes more inflation for Tunisia. After these results, it is important for policymakers to know which factors influence exchange rate stability, especially in developing countries like...