Equilibrium Real Exchange Rate Research Articles

Analyzing Exchange Rate Effects on Trade: Empirical Evidence

In this study, we aimed to find a fair exchange rate for Egypt, exploring how exchange rate policies affect the country’s economic growth and food security. We also sought to answer an important question for Egyptian policymakers: “Do current exchange rate policies help reduce Egypt’s trade deficit?”. We used two methods in our research: First, we applied the purchasing power parity (PPP) method to determine the equilibrium real exchange rate (ERER). Then, we combined the computable general equilibrium model (CGE) with the ERER value from the PPP method to observe how different sectors interact with the overall economy and understand how household incomes and poverty levels are related. Our findings showed that the fair exchange rate is EGP 38.5 per US dollar, according to the PPP method. This new exchange rate may significantly impact the Egyptian economy. Some impacts are positive, such as better real GDP, more exports, and fewer imports; however, these are minor and not significant. On the downside, it may lead to higher inflation, increased prices for goods, and reduced consumption. Moreover, this study highlights the importance of having balanced exchange rate policies that consider Egypt’s unique economic situations, and challenges and align with other economic policies. Experience and reality have shown that exchange rates alone are not the only solution.

Does the equilibrium real exchange rate improve cocoa export performance?

Does the equilibrium real exchange rate improve cocoa export performance?

An Estimation of the Mexican Peso´s Overvaluation for 2023

We estimate the overvaluation of the Mexican peso for the second quarter and June 2023. The equilibrium real exchange rate is approximated by reestimating a cointegration equation where the variable of interest depends on Mexico's GDP, the US Industrial Production Index, the sum of private consumption, the government consumption and exports of Mexico, and US private fixed investment. We use these variables to approximate the relative supply and demand of the two countries. Under certain assumptions, we estimate that the Mexican peso is overvalued by 13.7% and 15.3% in the second quarter and in June 2023, respectively, with information available as of mid-July of the same year. We provide an estimate of the nominal exchange rate compatible with the elimination of the exchange rate misalignment, if this variable were the only one that adjusts.

Assessment of Fiji’s exchange rate

This paper empirically estimates Fiji’s bilateral equilibrium real exchange rate with two of its key trading partners, the US and Australia. Applying the Behavioural Equilibrium Exchange Rate (BEER) approach, we estimate the equilibrium exchange rate by considering the productivity differential, real interest rate differential, net foreign assets, money supply, and terms of trade. Using monthly data from March 2011 to September 2022 and a system approach to cointegration, a strong relationship between the real exchange rate and its fundamentals is found, but importance of factors differed by trading partner. Our findings show that the Fijian Dollar has been undervalued against both US Dollar and Australian Dollar in recent years, but to varying degrees. Our analysis underlines the importance of assessing bilateral exchange rate misalignments in basket pegs when devising exchange rate policy.

Estimating the real exchange rate misalignment of the Algerian dinar during the period (1980-2019) : an empirical study (Arabic)

The aim of this study is to estimate the long-run Equilibrium Real Exchange Rate (ERER) and to assess the degree of misalignment of the Algerian Dinar for the period (1980-2019) using ARDL approach. Considering that the equilibrium exchange rate of the Algerian dinar is determined by a set of fundamentals of the national economy, the study reached the following main results: In the long run, there are positive relationships between the real effective exchange rate and the differential productivity, real oil price and net capital flows. Whereas, there are inverse relationships between the dependent variable and each of the trade openness, General government final consumption expenditure (% of GDP). The second result is that the REER registered a number of deviations from its equilibrium level, that vary between overvaluation and undervaluation. The third result is that the exchange rate cannot be the only adjustment variable, given the extent of macroeconomic imbalances (internal and external). Parallel efforts at fiscal consolidation and deep structural reforms to diversify the economy and accelerate growth are also essential.

O impacto dos desalinhamentos cambiais sobre o investimento industrial no Brasil

ABSTRACT We analyze the hypothesis that variations on manufacturing investment are influenced by the difference between the real effective and industrial equilibrium exchange rates and by the difference between the current account and industrial equilibrium exchange rates (a proxy for the Dutch disease). The current account equilibrium exchange rate is defined as the rate that guarantees that the current account of a country is balanced intertemporally, and the industrial equilibrium exchange rate corresponds to the rate that makes competitive those companies producing internationally tradable non-commodities goods and services in the so-called state-of-art. First, the concepts and methodologies for estimating the current account and industrial equilibrium exchange rate are explained. Then, to test our hypothesis, a database for 24 Brazilian manufacturing sectors was built from 2007 to 2017. A dynamic panel data model was adopted to estimate the relationship between these currency misalignments and the manufacturing investment. The results suggest that the magnitude of those differences influences investment decisions, potentially contributing to economic growth and development.

Real Exchange Rate Misalignments in Tanzania

The study uses a real exchange rate equilibrium (REER) technique to examine real exchange rate misalignments in Tanzania, through the cointegration technique. The empirical findings reveal that the real exchange rate misalignment has decreased significantly over recent years, and the real effective exchange rate has been evolving close to the long-term equilibrium. The findings strongly suggest that the underlying monetary and exchange rate policies were crucial in bringing the real exchange rate back to equilibrium in line with medium-term fundamentals recently. As a result, it is suggested that the existing monetary and exchange rate policies be maintained. While the monetary policy will contribute to real exchange rate stability through low inflation, flexible exchange rate policy will contribute to real exchange rate stability through nominal exchange rate adjustment.

Economic Transformation and Security Analysis of RMB Integration Based on CNN.

Due to the productivity shocks, there exist inherently systemic biases when using purchasing power parity as the equilibrium real exchange rate measure standard. In this paper, based on the characteristic of Chinese economic transformation, considering demographic and weakened Balassa–Samuelson effect, we reestimate the equilibrium level of the real exchange rate of RMB with the quarterly frequency data since 1994 and measure the misalignment of the RMB real exchange rate. The empirical results show that the improved convolutional neural network (CNN) model is a reasonable analytical framework for the RMB equilibrium real exchange rate, and in the sample period, the real exchange rate of RMB is robust, and demographic is an important variable affecting the RMB equilibrium exchange rate. The real exchange rate of RMB is closely related to China's economic development strategy.

How Equilibrium Exchange Rate Misalignments Influence on Economic Growth? Evidence for European Countries

Abstract The determination of the equilibrium real exchange rate is one of the most important issues in open economy since the policymakers are concerned about predicting and monitoring misalignments and they are usually associated with current account problems and currency crises. To the best of my knowledge, this is the first time a study provides empirical evidence on the impact of deviations from the long-run sustainable real exchange rate equilibrium on real economic growth rate applying panel ARDL model (pooled mean group, mean group and dynamic fixed effect estimators) for the 27 European countries during the 2000–2016 period. This study applies the EQCHANGE database developed by Couharde et al. (2017) to obtain the real effective exchange rate (REER) misalignments according to the behavioral equilibrium exchange rate approach for each country. One of the main objectives is to determine the relationship between REER misalignments and economic growth trying to differentiate between short- and long-run effects. To this purpose, a neoclassical growth model is considered controlling for several economic variables such as gross capital formation, degree of openness, human capital, inflation rate, and population rate.

What Does Oil in Triple Digits Mean for India?

The Russia-Ukraine conflict is expected to impact India’s economy through several channels but we posit first order impacts will emanate from higher crude prices. If crude prices were to average $100/barrel in 2022, they will constitute a discernible adverse terms of trade shock for India’s economy that could shave a percentage point off India’s growth, pressure inflation further and widen the current account deficit towards 3% of GDP. How should policy respond? A negative terms of trade shock would argue for a more depreciated equilibrium real effective exchange rate. Policymakers should let this adjustment gradually take place to enable the corresponding “expenditure switching” needed to bring external imbalances back to sustainable levels. A sustained supply shock will make the trade-off for monetary policy more acute, with downside risks to growth accompanied by upside risks to inflation expectations. While the 2022-23 Budget created buffers to protect against shocks, fiscal policy will face its own set of trade-offs in simultaneously attempting to accommodate the shock, support growth and preserve macroeconomic stability. Beyond the near term, policymakers must consider systematically hedging crude price imports in global markets to protect the economy from periods of outsized volatility, apart from the medium-term objective of reducing dependence on imported crude.

Modelling the Equilibrium Real Exchange Rate: Evidence from Oil-Exporting Country

This study aims to specify the best model to estimate the real equilibrium exchange rate of the Libyan dinner during the period 1985-2020 utilizing ARDL model. The results of this study indicate that the best model explains the determinants of the actual exchange rate (ARE) and predicts the equilibrium real exchange rate (ERER) is the one that consists of oil revenues (OR), terms of trade (TOT), ration of bored money supply to gross domestic product (M2/GDP), ratio of domestic inflation to forging inflation (DINF/FINF) and DUMMY. They also point out that OR is the domino force as it drives the exchange rate of the Libyan dollar against the US dollar. The results also reveal that the misalignment between the AER and the ERER had notably increased since the 2002 devaluation. This study provides valuable information for monetary policy makers by establishing a benchmark for the ERER. This information would assist them to reasonably set the exchange rate for future economic purposes.

Decomposition of the Sources of Real Exchange Rate Misalignment in Egypt: Evidence from the ARDL Model


 
 
 This paper examines the behavior of the real exchange rate in Egypt over the period 1965–2018 by attempting to pursue three interrelated purposes. The first is to investigate the extent of deviations between the actual exchange rate and its equilibrium level and illustrate the magnitude of any currency misalignments. The second is to search for the different phases of over- and undervaluation of the local currency and explain the accompanying economic policies and/or factors leading to them. The third and ultimate purpose is to explore the role of transitory and permanent factors in deviating the actual real exchange rate from its equilibrium level. Understanding these factors should help in the design of economic policies directed to address the misalignment of the local currency. An autoregressive distributed lag (ARDL) bound test approach is used and conducted for both the bilateral and effective real exchange rates to achieve these three purposes during the selected period. To derive the equilibrium exchange rate estimate, the behavioral equilibrium exchange rate (BEER) approach is adopted. The findings reveal that the Egyptian pound was misaligned from its equilibrium value during most of the examined period. The results confirm the relative importance of the terms of trade and degree of openness variables in determining the equilibrium real exchange rate in Egypt followed by investment ratio and government consumption variables. The local currency witnessed a recent phase of overvaluation, which began in 2009, until the free float of the local currency in November 2016, after which, the Egyptian pound was found to have experienced a new phase of undervaluation till the end of the period examined. The findings show a considerable relative impact of fundamental-based factors over a prolonged period spanning from 1986 to 2003 and at the end of the period examined as well. Moreover, the documented results lend general support to the fact that both permanent or fundamental-based factors and short-run shocks prove to be important influential factors impacting currency misalignment in Egypt.
 
 

Are exchange rates less important for trade in a more globalized world? Evidence for the new EU members

We evaluate the effect of exchange rate misalignments on the balance of trade and the role that global value chain participation plays in this effect for 11 new European Union member states. Using heterogeneous panel cointegration methods, we first estimate the real equilibrium exchange rate and detect episodes of currency misalignment. We find asymmetric effects of real currency misalignments: overvaluation has a negative effect, but undervaluation has no effect on the trade balance. Additionally, we find that global value chain participation weakens the effect of currency misalignments on the balance of trade. Therefore, our results suggest that globalization reduces the role of exchange rates in stimulating the domestic economy.

The relationship between exchange rate and structural change: an approach based on income elasticities of trade

Abstract We analyse the hypothesis that variations in the income elasticities of the demand for exports and imports are influenced by the difference between the actual and industrial equilibrium levels of real effective exchange rates. The industrial equilibrium is defined as the exchange rate level that equalises real unit labour costs between local producers of manufactured goods and their trading partners. To test our hypothesis, based on data between 1995 and 2014 from the World Input-Output Database (WIOD), a sample of 43 countries was built. First, the actual and the industrial equilibrium real effective exchange rates were calculated; then, the income elasticities were estimated for each country during this period. A dynamic panel data model was adopted to estimate the relationship between these elasticities and the differences between those exchange rates. The results suggest that the magnitude of these differences modifies the income elasticities of trade, potentially contributing to structural change.

Equilibrium Exchange Rate and Competitiveness in Morocco: Estimation by the ARDL Cointegration Model

This study estimated the real equilibrium exchange rate and its misalignment by adopting the Natural Real Exchange Rate (NATREX) approach and ARDL cointegration model. The aim is to interpret the impact of the determinants used to estimate the equilibrium exchange rate and assess the importance of the exchange rate in the Moroccan economy through the evolution and the reaction of the trade balance vis-à-vis the misalignment. The results showed that the rise in terms of trade can have an impact on the appreciation of the exchange rate and constrain Moroccan exports. This evidence confirms indeed the importance of the exchange rate as an instrument of price competitiveness. The study also identified a competitiveness problem linked to the structure of the Moroccan economy showing an absence of the Blassa-Samuelson effect. The impact of public spending on the exchange rate shows a problem of the nature of this spending which is more oriented towards tradable goods contributing to higher imports and hence to the deterioration of the trade balance.

Equilibrium Real Exchange Rate and Misalignment: The Sierra Leone Perspective

This paper estimates the equilibrium real effective exchange rate and determine the level of exchange rate misalignment in Sierra Leone, for the period 1980 to 2018. The paper utilizes the behavioral equilibrium exchange rate methodology within the Johansen maximum likelihood framework to estimate the long run equilibrium real effective exchange rate. The unit root test result shows that all the variables are integrated of order one, whilst the cointegration test establishes the existence of one cointegrating vector as evidenced by both the Trace and Maximum Eigen Statistics. The normalized long run results reveal that openness, government expenditure and money supply were the most significant determinants of the real effective exchange rate in the long run. Furthermore, the findings reveal that the real effective exchange rate experienced sustained deviation from the long run equilibrium real effective exchange rate during the study period, with episodes of overvaluation and undervaluation. Specifically, the real effective exchange rate was overvalued by 3.69 percent during the period between 1980-1985; undervalued by 1.8 percent between 1986-1997, and overvalued by 0.9 percent between 1998-2004, Thus, the paper reveals episodes of misalignment of the real effective exchange rate. Based on these findings, the study recommends that, the monetary authorities should ensure stability of the exchange rate and maintain price stability, through sterilization of capital flows as well as contain money growth within the statutory limit.

Behavioural​ equilibrium real exchange rates and misalignments: Evidence from large emerging markets

In order to contribute to the debate on whether exchange rate under-valuation was a major factor in global trade imbalances that culminated in the 2008 Global Financial Crisis (GFC), we estimate long-run equilibrium real exchange rates (ERER) for a panel of eight large emerging market economies (EMEs) over 1995–2017 based on structural factors. These include EME-AE (advanced economy) differentials in productivity, dependency and financial development, along with factors like trade openness, sectoral relative price and fiscal procyclicality. Amongst the dominant factors, we find that rising relative productivity appreciates ERER, but is offset by an almost equal depreciation from financial development. Estimated misalignments show both EME under- and over-valuation before the GFC, with under-valuation more prominent in Russia and Turkey. China, India, Indonesia and Mexico were experiencing a correction towards equilibrium from over-valued rates a year or two before the GFC. Post-GFC appreciation in EME ERERs compared to pre-GFC years indicates convergence in EME-AE prices, but misalignments were more in the zone of under-valuation during the period. The absence of substantial under-valuation in pre-GFC years indicates that EME RER misalignments were not a major cause of the GFC. Impulse responses show the limited impact of misalignments on current account imbalances, suggesting that the incentive to devalue was low.

One Size Does Not Fit All: Structural Problems of Countervailing Currency Manipulation

The USDOC's new methodology of calculating the amount of benefit as a result of a currency undervaluation raises both theoretical and structural questions. Not only that the econometric model used to calculate the extent of an undervaluation is subject to huge uncertainties, but also it is structurally impossible to calculate a precise amount of duty to offset promotion effect of a subsidy accrued from an undervaluation for individual companies. This paper examines the recent U.S. final rule on countervailing currency manipulation, highlighting the methodological problems of estimating equilibrium real effective exchange rate. For the foreseeable future, however, it would be legally feasible for the USDOC to discretionarily conduct a currency subsidy investigation. If the USDOC makes an affirmative final determination in the first currency countervailing duty investigation against Vietnam, it may open a pandora's box for US industry petitioners.

Nexus between real effective exchange rate misalignment and rubber export in Nigeria

Purpose - This study examines the nexus between the real effective exchange rate misalignment (REERM) and rubber exports in Nigeria. The effects of equilibrium real exchange rate (ERER) and some economic fundamentals on rubber exports are also investigated. Methods - Johansen cointegration, vector error correction model and Granger causality test are employed as methods of data analysis. Findings - The results show that a long-run relationship exists between REERM and rubber export. REERM influenced rubber export negatively while ERER had a positive effect on rubber export. The past values of REERM can be used to predict the present volume of rubber export, and the past values of ERER and rubber export can be used to forecast the present values of each other. Trade openness positively influences rubber export while the term of trade has a negative effect on rubber export. Implication - REERM worsens the performance of rubber export in Nigeria while ERER improves its performance. Thus, rubber export can be enhanced through measures such as trade openness, improved term of trade and monitoring of exchange rate to reduce the REERM and maintain a stabilized equilibrium exchange rate system. Originality - This study focuses on the effect of deviation of the exchange rate from equilibrium, ERER and economic fundamentals on rubber export which has not been previously investigated.

The real equilibrium exchange rate in a commodity­exporting economy: the experience of Azerbaijan

The case of Azerbaijan serves to study the adequacy of exchange-rate policy in a resource-rich economy. This paper analyses the behavior of Azerbaijan’s external accounts over the past twenty years. Declining oil prices made an existing exchange-rate peg unsustainable and led to a large devaluation in 2015. Since then, the current account balance has improved, but by less than expected. We use the EBA-Lite method to derive regression-based estimates of the equilibrium real exchange rate, and relate misalignments to measures of “policy gaps”. Our findings suggest that only a few years after the devaluation, Azerbaijan’s currency has once more become overvalued. Moreover, the equilibrium real exchange rate is volatile and hardly compatible with a long-run exchange rate peg. Exchange rate policy should try to accommodate shifts in the fundamental determinants such as relative productivity and real oil prices.