Behavior Of Real Exchange Rate Research Articles

Understanding Korea's Long-run Real Exchange Rate Behavior

Understanding Korea's Long-run Real Exchange Rate Behavior

Understanding Korea's Long-Run Real Exchange Rate Behavior

Understanding Korea's Long-Run Real Exchange Rate Behavior

Dynamic linkages between real exchange rates and real unit labour costs: evidence from 18 economies

ABSTRACT The article examines the long-run behaviour of real exchange rates based on the premises of classical political economy. Specifically, it investigates the dynamics between real exchange rates and real unit labour costs of tradable commodities for 18 developed and developing economies. The analysis is carried out by applying recent methods of panel data, while the short- and long-run dynamics are estimated based on the cross-sectional autoregressive distributed lag model. Our findings confirm the presence of short- and long-run effects of real unit labour costs on real exchange rates. Consequently, new and more effective foreign exchange rate policies may be designed.

Exchange Rate Determinants of the US Dollar and Chinese RMB: a Classical Political Economics Approach

This paper contributes to the literature on determining the real exchange rates by developing a model that is based on key propositions of the classical political economy within which the real competition governs domestic and international trade, the labor theory of value is underneath domestic and international prices and, under these conditions, the principle of absolute cost advantage shapes international trade. The econometric analysis shows that the relative real unit labor cost is a key regulator of the long-run behavior of real exchange rates in both, China and the USA, for the period 1982-2018.

The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential

This study applies a Markov switching error correction model to describe the single most important real exchange rate (Deutsche mark versus US dollar) over the flexible exchange rates period from 1973 to 2004. We show an alternative way of modelling non-linear adjustment to the purchasing power parity (PPP) besides standard threshold models. The model merges the two possible sources of non-linearity by additionally allowing the probability of a mean-reverting regime to increase with the distance from PPP. The interest rate differential as an additional determinant of real exchange rate behaviour in a Markov switching framework is introduced in the model. The study finds that the real dollar exchange rate during the post-Bretton Woods era is well described by a Markov switching error correction model with (PPP) as long-run equilibrium. There is one mean reversion regime where PPP and the interest parity condition are valid. Contrary, the second regime is characterised by persistent mean aversion, where a regime switch does not become more likely with increasing distance from PPP. The unconditional half-life of shocks is about 1.5 years.

Real exchange rate misalignment and economic growth in East African least developed countries

The behavior of real exchange rate remained an important policy concern for small open economies as its poor management adversely affects their economy with substantial welfare losses. This study examined the main drivers of real effective exchange rate (REER) misalignment and its effect on the economic growth of East African least developed countries (LDCs). The study applied Pooled Mean Group (PMG) and dynamic OLS estimators for panel and ARDL Bound testing for time series data over the period 1980–2019. The panel results revealed that the REER of LDCs were significantly misaligned for the study period. The REER appreciates for an improved terms of trade and net foreign asset position, while it depreciates for an increased trade openness and broad money supply in the long-run. The panel results also confirmed that the GDP per capita would improve for an increase in real investment and human capital, while it decline for an increase in openness, net foreign aid inflows and REER misalignment in the long-run. The ARDL bound testing results generally support the panel estimation results. In the short-run, the REER misalignment would impede growth of Ethiopia while it promotes growth of Kenya. Thus, the central banks and policy makers of East African LDCs should initiate a consistent macroeconomic policies and regulatory frameworks focusing on the main drivers of equilibrium REER to correct currency misalignment and to support their promising economic growth.

Price levels in the European Monetary Union: Even tradables follow independent random walks

This study analyzes the time series behavior of real exchange rates between member states of the European Monetary Union. The analysis is based on the Harmonized Index of Consumer Prices and eight sub-components for tradable and non-tradable goods and services. Stationarity of the real exchange rates is a necessary condition for long-term convergence of price levels. The results of pairwise tests show that the real exchange rates, resulting from these price levels are typically random walks and their components are generally not cointegrated. There is no evidence of the existence of country-specific convergence clusters. A systematic difference in the results for tradable and non-tradable goods cannot be detected.

Nonlinearities and asymmetric adjustment to PPP in an exchange rate model with inflation expectations

PurposeThis paper aims to explain real exchange rate fluctuations by means of a model including both standard fundamentals and two alternative measures of inflation expectations for five inflation targeting countries (the UK, Canada, Australia, New Zealand and Sweden) over the period January 1993–July 2019.Design/methodology/approachBoth a benchmark linear autoregressive distributed lag (ARDL) model and a nonlinear autoregressive distributed lag (NARDL) specification are considered.FindingsThe results suggest that the nonlinear framework is more appropriate to capture the behaviour of real exchange rates given the presence of asymmetries both in the long and short run. In particular, the speed of adjustment towards the purchasing power parity (PPP) implied long-run equilibrium is three times faster in a nonlinear framework, which provides much stronger evidence in support of PPP. Moreover, inflation expectations play an important role, with survey-based ones having a more sizable effect than market-based ones.Originality/valueThe focus on linearities and the estimation of a NARDL model, which is shown to outperform the linear ARDL model both within sample and out of sample, is an important contribution to the existing literature which has rarely applied this type of framework; the choice of an appropriate econometric method also makes the policy implications of the analysis more reliable; in particular, monetary authorities should aim to achieve a high degree of credibility to manage them and thus currency fluctuations effectively; the inflation targeting framework might be especially appropriate for this purpose.

Nonlinearities and Asymmetric Adjustment to PPP in an Exchange Rate Model with Inflation Expectations

This paper estimates a model of the real exchange rate including standard fundamentals as well as two alternative measures of inflation expectations for five inflation targeting countries (UK, Canada, Australia, New Zealand, Sweden) over the period January 1993-July 2019. Both a benchmark linear ARDL model and a nonlinear ARDL (NARDL) specification are considered. The results suggest that the nonlinear framework is more appropriate to capture the behaviour of real exchange rates given the presence of asymmetries both in the long- and short-run. In particular, the speed of adjustment towards the PPP-implied long-run equilibrium is three times faster in a nonlinear framework, which provides much stronger evidence in support of PPP. Moreover, inflation expectations play an important role, with survey-based ones having a more sizable effect than market-based ones. Monetary authorities should aim to achieve a high degree of credibility to manage them and thus currency fluctuations effectively. The inflation targeting framework might be especially appropriate for this purpose.

REER Imbalances and Macroeconomic Adjustments: Evidence from the CEMAC Zone

The European Monetary Union (EMU) crisis holds special lessons for existing monetary unions. We assess the behaviour of real effective exchange rates (REERs) of members of the Central African Economic and Monetary Community zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate model is estimated for associated misalignments. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in the event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. There is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths. JEL: F31, F33, F42, F61, O55

Real Exchange Rate Dynamics Beyond Business Cycles

We examine how medium-term movements in real exchange rates and GDP vary with international financial conditions. For this purpose, we study the international transmission of productivity shocks across a variety of IRBC models that incorporate different assumptions about the persistence of productivity shocks, the degree of international risk sharing and access to international asset markets. Using a new global solution method, we demonstrate that the transmission of productivity shocks depends critically on the proximity of a national economy to its international borrowing limit. We then show that this implication of the IRBC model is consistent with the behavior of the US-UK real exchange rate and GDP over the past 200 years. The model also produces a negative correlation between relative consumption growth and real depreciation rate consistent with more recent data, and hence offers a resolution of the Backus-Smith puzzle.

INTERNATIONAL BUSINESS CYCLES IN EMERGING MARKETS

AbstractI document cyclical behavior of real exchange rates (RERs) in emerging and developed economies: stronger RER procyclicality coincides with larger relative volatility of consumption and more countercyclical trade balance. I then reevaluate the sources of fluctuations in emerging economies using an international business cycle model estimated to match the behavior of the RERs. Interest rate shocks, without any frictions, account for most of output fluctuations. This result is driven by imperfect substitution between domestic and foreign goods, which dampens the impact of trend shocks and accentuates the impact of interest rate shocks on output and consumption.

An empirical study of the behaviour of real exchange rates in the UAE

The recent expansion in global interdependence among countries has increased the relevance of research in the behaviour of the real exchange rate. The real exchange rate as a relative price of home and foreign goods serves as a measure of competitiveness of the domestic economy. The real exchange rate also moves to maintain internal balance where the output gap is kept at zero and external balance where the current account is financed by sustainable capital flows. This paper uses data for the United Arab Emirates from 1980 to 2016 to estimate the relationship between the real exchange rate and selected fundamental determinants such as oil prices, terms of trade, and productivity differentials. We employ time series models and report results and the statistical procedure for estimation and inference. The paper further, considers factors specific to the UAE that might help explain the observed behaviour of the real exchange rate.

An empirical study of the behaviour of real exchange rates in the UAE

The recent expansion in global interdependence among countries has increased the relevance of research in the behaviour of the real exchange rate. The real exchange rate as a relative price of home and foreign goods serves as a measure of competitiveness of the domestic economy. The real exchange rate also moves to maintain internal balance where the output gap is kept at zero and external balance where the current account is financed by sustainable capital flows. This paper uses data for the United Arab Emirates from 1980 to 2016 to estimate the relationship between the real exchange rate and selected fundamental determinants such as oil prices, terms of trade, and productivity differentials. We employ time series models and report results and the statistical procedure for estimation and inference. The paper further, considers factors specific to the UAE that might help explain the observed behaviour of the real exchange rate.

Real exchange rates and primary commodity prices

In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supply of commodities. We calibrate the model so as to reproduce, among other things, the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as they are in the data. The model rationalizes an empirical strategy to identify the fraction of the variance in real exchange rates that can be accounted for by the underlying shocks, even if those shocks are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.

Intermediate Goods and Exchange Rate Disconnect

This paper introduces intermediate goods trade into a two-country real business cycle model and examines its implications for real exchange rate behavior. Intermediate goods trade is shown to reduce “exchange rate disconnect” by increasing the volatility of the real exchange rate relative to output and weakening the link between the real exchange rate and output. Intermediate goods trade also reduces the volatility of the terms of trade relative to the real exchange rate while increasing international output correlations and reducing the correlation between the trade balance and output.

Determinants of the Real Equilibrium Exchange Rate in Albania: An Estimation Based on the Co-Integration Approach

Problem/Relevance: Investigation of exchange rate behaviour has been an important topic in international monetary economics because of the impact of exchange rates on economies. One strand of the literature has focused on explaining the observed movement of the nominal or real exchange rate in terms of macroeconomic variables. Another strand of the literature has evaluated the behaviour of the real exchange rates in relation to the equilibrium exchange rate, which is the real exchange rate that is consistent with macroeconomic balances. Albania implements a free floating exchange rate regime; therefore, evaluating whether the actual real exchange rate is too strong or too weak compared with the real equilibrium exchanges rate has great relevance for the Albanian economy. Research Objective/Questions: Generally, the real exchange rate is defined as the nominal exchange rate adjusted for the relative price differential between domestic and foreign goods and services. So, an appreciation of the nominal exchange rate or higher inflation at home relative to other countries may lead to an appreciation of the real exchange rate. Such appreciation weakens the competitiveness of a country, widens the current account deficit and increases vulnerability to financial crises. The opposite holds true when the real exchange rate depreciates. The aim of this paper is, first, to estimate the equilibrium real exchange rate for the Albanian currency against the euro and, second, to assess the total exchange rate misalignment during the period of 2001Q1-2017Q1. Thus, the equilibrium real exchange rate is used as a benchmark for evaluating the misalignment of the actual real exchange rate. Methodology: This paper explores the determinants of the real exchange rate for Albania, during the period of 2001Q1-2017Q1, based on the stock-flow approach, the so called Behavioural Equilibrium Exchange Rate (BEER), which effectively employs reduced-form modelling of the exchange rate based on standard co-integration techniques. The stock of net foreign assets and productivity changes has been considered fundamental for the real exchange rate. We have used the Johansen co integration technique to test the existence of long-run relationships between our main variables and to evaluate the path of the equilibrium real exchange rate based on vector error correction model (VECM) results. Then the analysis is completed by calculating the degree of misalignment as the difference between the actual real exchange rate and the equilibrium real exchange rate. Major Findings: Based on the Johansen co-integration approach, we find one long-run relationship between the real exchange rate of the Albanian lek against the euro, relative productivity and net foreign assets during the period of 2001Q1 to 2017Q1. The model implies that the real exchange rate is affected, as we expected, by relative productivity and net foreign assets, confirming that an increase in both variables leads to an appreciation of the real exchange rate in the long run. Our results show that the behaviour of the actual real exchange rate is similar to the path of the equilibrium exchange rate and that the degree of misalignment throughout the period is estimated to be moderate. Implications: Our empirical results confirm that the degree of misalignment is reasonable, suggesting a consistency between macroeconomic (especially monetary) policies and the free floating exchange rate regime. Assessing real exchange rate misalignment is a very important issue for policy makers because of the severe welfare and efficiency costs that such misalignment can have for an economy.

REER Imbalances and Macroeconomic Adjustments: Evidence From the CEMAC Zone

The EMU crisis holds special lessons for existing monetary unions. We assess the behavior of real effective exchange rates (REERs) of members of the Central African Economic and Monetary Community (CEMAC) zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate (FEER) model is estimated and associated misalignments. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. There is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths.

Information frictions and real exchange rate dynamics

Real exchange rates are highly volatile and persistent. I provide a novel structural explanation for these facts using a model with dispersed information among firms. When producers face strategic complementarities in price-setting, uncertainty about competitors' beliefs results in sluggish price adjustment that can generate large and long-lived real exchange rate movements. I estimate the model using data from the US and Euro Area, and show that it successfully explains the unconditional volatility and persistence of the real exchange rate. The model also accounts for the persistent and hump-shaped real exchange rate behavior conditional on nominal disturbances documented by a structural VAR. About 50% of this persistence is due to the inertial dynamics of higher-order beliefs.

Distortions in Macroeconomics

Distortions in Macroeconomics