Real Exchange Rate Dynamics Research Articles

Financial development, international reserves, and real exchange rate dynamics: Insights from the Europe and Central Asia region

This study examines the impact of international reserves on real exchange rate (RER) stability in the Europe and Central Asia (ECS) region, focusing on how financial development levels affect this relationship. Using panel threshold regression, the analysis reveals that international reserves significantly stabilize RER when reserves exceed 17.28 % of GDP, especially in countries with underdeveloped financial systems. The findings suggest that reserves play a more critical role in less developed financial markets, providing insights for policymakers on optimal reserve management and financial development strategies in emerging economies.

Are exchange rates absorbers of global oil shocks? A generalized structural analysis

This paper studies the impact of global oil market shocks on the level, volatility, and correlation dynamics of real effective exchange rates over time. We find that the USD and the EURO act as shock absorbers, as shocks to the global oil market explain substantial proportions of the volatility and correlation dynamics of each exchange rate – compared to the small or even negligible contributions of exogenous interest rate and effective exchange rate shocks. Further we find an interesting “puzzle” that the Euro Area unexpectedly behaves as if it were an oil exporting country - the EURO appreciates in response to a flow demand shock that increases oil price. Our findings are garnered from a generalized time-varying SVAR model with stochastic volatility that allows for correlated disturbances between observation and transition equations and among transition equations themselves. This approach of enriching dynamics between the first and second moments of endogenous variables is particularly suitable for capturing the transmission of structural level oil shocks to the volatility of exchange rates and their correlation with the global oil market.

Bounded rational expectation: How it can affect the effectiveness of monetary rules in the open economy

Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.

Real exchange rate dynamics in the New-Keynesian model

Real exchange rate dynamics in the New-Keynesian model

The Macroeconomic Effects of Positive Trend Inflation in a Small Open Economy

ABSTRACT The existing New Keynesian open economy literature tends to make the simplifying assumption that there is no trend inflation. In this paper, we reformulate the standard open economy model to account for positive trend inflation. We then employ the model to understand the effects of macroeconomic shocks in a small open economy when trend inflation is positive. Our main finding is that allowing for trend inflation significantly affects the dynamics of the model through real exchange rate dynamics rather than the slope of the New Keynesian Philips Curve. Specifically, higher trend inflation induces modestly more persistent real exchange rates’ responses to the shocks. Further incorporation of trend inflation in an open economy enables us to discuss the Purchasing Power Parity and Delayed Overshooting Puzzles.

A Dependent Economy Model of Employment, Real Exchange Rate and Debt Dynamics: Towards an Understanding of Pandemic Crisis

Given the unforeseen and uncertain circumstances during the pandemic, the role of government expenditure becomes extremely relevant in sustaining lives and livelihoods of the masses. This brings forth public sector deficit as a key issue of macroeconomic policy debate. This article aims at investigating the effects of an unanticipated adverse shock like COVID-19, on the real value of public debt, in a small open economy, consisting of traded and non-traded sectors, along with proposed management of such crisis with fiscal and monetary expansion. The results of policy-induced and exogenous shocks depend on the difference in the speeds of adjustments in real exchange rate, interest rate and real value of debt, and the associated multitudes of cross effects. While an unanticipated adverse shock like COVID-19 causes contraction of both traded and non-traded sectors and reduces consumption expenditure, investment expenditure and level of employment and real value of aggregate income in the short run, fiscal expansion causes higher real value of debt and lower real exchange rate. JEL Codes: E12, E62, H63

Real Exchange Rate Dynamics and Non-Tradable Goods in a Small Open Economy

Purpose - This paper investigates the relationship between productivity and real exchange rate, the Balassa-Samuelson effect of tradable sector technology shocks on the real exchange rate using a DSGE model. Design/Methodology/Approach - To do this, I have set up a two sector-tradable and nontradable sectors-and a small open economy model with price rigidity. After constructing the model, the structural parameters were calibrated and estimated using historical data and the Bayesian method. The impulse response function was analyzed to determine whether there exists a relationship between productivity and real exchange rate. Findings - As a result of the simulation, after the technology shock hit in the tradable sector, the impulse response function dynamics show the decreasing real exchange rate dynamics that correspond to the theoretical expectation. This implies that there exists a relationship between productivity and the real exchange rate in the Korean economy. Second, analysis of the nontradable sector technology shock suggests that when the consumer piece level inflation decreases, the output increases while the real exchange rate increases. The model’s robustness is verified by the stable dynamics in terms of monetary shock. Research Implications - The results suggest that the New Keynesian model can help to generate the plausible dynamics in a sense that the volatility and persistence of real exchange rate are close to the that of data.

Real Exchange Rate Dynamics and Non-Tradable Goods in a Small Open Economy

Real Exchange Rate Dynamics and Non-Tradable Goods in a Small Open Economy

Real Exchange Rate Dynamics in Model with Habit Formation

Real Exchange Rate Dynamics in Model with Habit Formation

An Analysis of Real Exchange Rate Dynamics in a Small Open Economy

An Analysis of Real Exchange Rate Dynamics in a Small Open Economy

Real Exchange Rate Dynamics under Alternative Approaches to Expectations

Real Exchange Rate Dynamics under Alternative Approaches to Expectations

Dynamics of Crude Oil and Real Exchange Rate in India

This scholarly work is an effort to capture the effects of oil prices on the actual exchange rate between dollar and rupee. This is done with reference to the U.S. dollar as oil prices are marked in USD (U.S. Dollar) in the international market, and India is among the top five importers of oil. Using monthly data from January 2001 to May 2020. The study used the real GDP, money supply, short-term interest rate difference between two countries, and inflation apart from the crude oil prices per barrel as the factors that help define the exchange rate. The analysis, through cointegration and vector error correction method (VECM), suggests long and short-run causality amid prices of oil and the rate of exchange fluctuations. Oil prices are found to be negatively related to the exchange rate in the long term but positively related in the short term. The result of the Wald test also indicates the short-run causation from the short-term interest rate and the prices of crude oil towards the exchange rate. The present study shows that oil prices are evidence of the existence of short-term and long-term driving associations with short-term interest rates and exchange rates.

Factors of the Russian ruble exchange rate dynamics in the 2000s and 2010s

The article discusses the key factors of the ruble exchange rate dynamics, analyzes the features of Russian currency market in the context of inflation targeting and the application of the budget rule. The basic theoretical approaches to modeling the dynamics of real and nominal exchange rates are presented, including behavioral models of the exchange rate, the monetary model of the exchange rate, and the hypothesis of uncovered interest parity. The most important factors of long-term and short-term dynamics of the exchange rate are revealed. The results of an econometric evaluation of the models of the real and nominal ruble exchange rates using dynamic least squares method (DOLS) are presented. It is shown that the key factors shaping the dynamics of the nominal ruble exchange rate are the terms of trade, the interest rate spread, the VIX volatility index, and the operations of the Russian Ministry of Finance under the budget rule. The long-term trajectory of the real exchange rate is formed by the terms of trade conditions, the Balassa—Samuelson effect, the dynamics of net foreign assets of the private sector.

Commodity terms of trade shocks and real effective exchange rate dynamics in Africa's commodity-exporting countries

Motivated by the absence of conclusive guidance from the current literature, this study revisits the effects of terms of trade shocks on real effective exchange rates (RER) across twenty-three primary commodity-exporting countries in Africa. To address the heterogeneity across primary commodities that may have plagued earlier studies, we employed a nonlinear panel ARDL approach to capture both the cross-section and time variations across primary commodities. Our analysis offers three main finding patterns. Firstly, we highlighted that the response of the RER to terms of trade shocks is asymmetric: the real appreciation is more pronounced for positive than negative shocks in terms of trade in the long-run while negative shocks in terms of trade cause the RER to depreciate in the short-run. Secondly, we found that the asymmetric responses of RER differ across commodity subgroups and seem to matter more for energy-exporting countries. Finally, we showed that energy and metal commodity-exporting subgroups are the most subject to real appreciation in the long run in comparison to countries exporting soft commodities such as agricultural and, food and beverage commodities. A fundamental policy corollary follows that there is a need to remediate the loss of the external competitiveness associated with real appreciation by coordinating monetary and fiscal policies to effectively absorb the huge additional foreign reserves and ensure an exchange rate equilibrium level, which will bring macroeconomic stability in primary commodity-exporting countries.

Модель реального обменного курса рубля с марковскими переключениями режимов (Model of the Real Exchange Rate of the Ruble With Markov Mode Switches)

Russian Abstract: В работе анализируется взаимосвязь реального обменного курса рубля и реальных цен на нефть на основе модели коррекции ошибок с марковскими переключениями режимов, позволяющей учесть изменения политики курсообразования. Показано, что в период 1999-2018 гг. хорошо разделяются два режима динамики реального курса: с быстрым и медленным приспособлением к долгосрочному равновесию в ответ на шоки цены нефти. При этом не отвергается гипотеза о том, что долгосрочная взаимосвязь между реальным обменным курсом и ценой на нефть инвариантна к изменению режима. Также показано, что, несмотря на переход к плавающему обменному курсу, в последние годы периодически идентифицируется режим негибкого курсообразования, что может быть связано с новым бюджетным правилом, согласно которому с февраля 2017 г. Минфин России ежемесячно покупал иностранную валюту в объеме превышения фактических поступлений нефтегазовых доходов над уровнем нефтегазовых доходов федерального бюджета, сформированного при цене на нефть марки “Юралс” 40 долларов США за баррель. English Abstract: The paper analyzes the relationship between the real Russian ruble exchange rate and real oil prices using the error correction model with Markov regime switching, which allows for changes in exchange rate policy. It is found that during the period 1999-2018 real exchange rate dynamics was characterized by two clearly distinguishable regimes, one with fast and the other with slow adjustment to long-term equilibrium in response to oil price shocks. Further model testing shows that long-term relationship between real exchange rate and oil price is invariant to regime change. It is also found that, despite adoption of a floating exchange rate policy in 2014, inflexible real exchange rate regime has been periodically identified in recent years. This could be due to the new budget rule, according to which Russian Ministry of Finance in February 2017 started purchasing foreign currencies in amount of excess oil and gas earnings of the federal budget.

US trade deficit, a reality check: New evidence incorporating asymmetric and non‐linear effects of exchange rate dynamics

AbstractIn the context of the debate on the global imbalances, this study investigates the determinants of US trade balance in a non‐linear ARDL framework, which accounts for the asymmetric and non‐linear effects of real effective exchange rate dynamics. Drawing on the data from 1994Q1 to 2018Q1, our key empirical findings suggest significant evidence of short‐ and long‐run asymmetries in the relationship between the real effective exchange rate, US trade balance and its determinants. An asymmetric cumulative dynamic multiplier analysis shows evidence of an asymmetric J‐curve. Furthermore, we find that the price stability, productivity, domestic savings and fiscal deficit/discipline are crucial for the US trade balance in the short to long term. Empirical findings of this study contribute to the contemporary debate on the US trade deficit and have profound policy implications for the competitiveness of the US economy and its external balance.

Structural changes and the real exchange rate dynamics

Since China joined the WTO in 2001, the Chinese economy has grown very rapidly, especially, the tradable goods sector. However, the Chinese real exchange rate did not exhibit a persistent and stable appreciation until 2005. This is a puzzling fact that is inconsistent with theories. This paper documents several stylized facts during the economic transition and argues that two features of Chinese economy may help explain the puzzling real exchange rate pattern for Chinese economy: (i) the faster total factor productivity (TFP) growth in export sector compared with the import sector; (ii) excess supply of unskilled labor. Our hypotheses are supported by cross-country evidence. Furthermore, we construct a small open economy model with an H-O trade structure and show that, due to heterogeneous skilled labor intensity in export and import sectors, the faster TFP growth in the export sector over that in the import sector will lead to the decline of return to capital and the rise of skilled wage. Therefore, the decrease of return to capital and the low unskilled wage, which is caused by the excess supply of unskilled labor, inhibit the rise in the relative price of non-tradable goods to tradable goods as well as the appreciation of real exchange rate. Finally, we show that a dynamic small open economy model with multiple tradable goods sectors does fairly well in explaining the Chinese real exchange rate and other stylized facts in the economic transition.

Real effective exchange rate dynamics in Morocco: Exploring Balassa-Samuelson effect under capital account liberalization

Real effective exchange rate dynamics in Morocco: Exploring Balassa-Samuelson effect under capital account liberalization

Dynamics of Crude Oil and Real Exchange Rate in India

Dynamics of Crude Oil and Real Exchange Rate in India

The changing nature of the real exchange rate: The role of central bank preferences

We investigate the sources of real exchange rate fluctuations. We do so, first, in the context of a DSGE model that explicitly considers the central bank's preferences. Then we estimate SVAR models, where shocks are identified by sign restrictions derived from the DSGE model. We perform this exercise for twelve countries, nine of which have adopted inflation targeting during the period analyzed. In sharp contrast to the previous evidence in the literature, we find that exchange rate (country risk premium) shocks have become the main drivers of real exchange rate dynamics, while real shocks play a less important role. Evidence from the DSGE model reveals that, as the central bank becomes more averse to inflation movements, and cares less about nominal exchange rate fluctuations, the impact of nominal shocks on the real exchange rate tends to increase, while the impact of real shocks decreases. Our results suggest that the adoption of inflation targeting, along with a floating exchange rate, contributes to a shift in the relative importance of demand and country risk premium shocks in determining the RER.