Exchange Rate Stability in a Dollarized Economy: Analyzing Monetary Policy and Macroeconomic Drivers Fresh Insight from Laos

Abstract

This study analyses the short-run and long-run effects of monetary policy and other critical macroeconomic determinants on Lao's exchange rate, namely money supply, international reserves, real output growth, and domestic inflation, adding to the understanding of currency stabilization in a developing, dollarized, and import-dependent economy. Through the Autoregressive Distributed Lag (ARDL) approach, this study examines secondary sources of data from the World Development Indicators (WDI) and the Asian Development Bank (ADB) from 2000 to 2023. Unit root and bounds testing indicate the presence of cointegration, thus confirming the ARDL method. The diagnostic testing (CUSUM, CUSUMSQ) ensures stability and robustness of the model. The findings revealed that money supply (M2) depreciates the exchange rate while international reserve stabilizes and appreciates the exchange rate. GDP growth and inflation depreciate the exchange rate in the long run. The ECT reveals rapid short-run re   turns to equilibrium, reflecting the efficient responsiveness of policy. This paper does so in the context of our regional focus on the Lao economy, using a dynamic analysis to identify key but hitherto under-researched determinants of exchange rate dynamics in developing countries. It adds to the monetary policy literature by emphasizing structural challenges such as dollarization and import dependence. Policymakers must regulate money supply growth, build up foreign reserves, and use inflation targeting to stabilize the exchange rate. It is also suggested that sustainable GDP growth strategies and export diversification be pursued to ensure the currency's stability.