Exchange rate volatility not only impacts exchange rates but also has important implications for export policy. This study investigates these issues as they relate to Indonesia's relationship with its five main trading partners - the United States, Japan, Hong Kong, Singapore, and Malaysia. This is achieved by: (i) measuring exchange rate volatility for each destination country; (ii) analysing whether exchange rate volatility has an impact on the export flows of Indonesia's five main trading partners; and (iii) exploring some of the policy implications. It uses three measures of exchange rate volatility: the standard deviation, the moving average standard deviation (MASD), and the autoregressive conditional heteroscedasticity (ARCH) model. Moreover, to analyse the impact of exchange rate volatility on exports, the study applies Johansen cointegration techniques and an error correction model to Indonesian quarterly data over the period from 1990 to 2008.
According to the AIC (Akaike Information Criterion), the results indicate that the ARCH model is the optimal measure of volatility of exchange rate. Furthermore, long-run relationships exist showing that real exchange rate volatility has negative effects on real export demand for the US, Hong Kong, and Malaysia, in both the long- and short-runs. On the other hand, although real exchange rate volatility has negative effects for Japan and Singapore in the long-run, its effects are insignificant in the short-run. These findings suggest that policy-makers should consider both the level and degree of volatility of exchange rates and take notice of the likely impact of exchange rate volatility when implementing trade policies for each trading partner.