Fixed or floating exchange rate regime is one of dilemmas that arise between economic scholars and policymakers. Republic of Macedonia as a small opened economy has adopted the fixed exchange regime, but there are studies’ conclusions that the country pays considerable costs in maintaining the fixed exchange regime. Therefore the purpose of this research paper is to answer the question by an empirical analysis if Macedonia needs to maintain the fixed exchange regime or should change the regime to floating. To examine this, we analyze the effects of a range of macroeconomic variables such as real GDP, government fiscal balance, retail price index, trade openness, current account balance and monetary aggregates on the real effective exchange rate. In order to allow interaction between above variables a co-integration test has been done for ascertaining the short and long run relationship. Also the Granger Causality test has been applied to determine if causal relationship exists between variables. Based on vector error correction method (VECM) results, real GDP, trade openness, current account and monetary aggregates do not have significant effect on the real effective exchange rate in the long run. Regarding the retail price index and government balance are significant determinants in the short as well as long run dynamics. Thus, the empirical results reveal some relevant arguments that support the fix exchange regime.
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