Exchange Rate Misalignment Research Articles

Real Exchange Rate Misalignment and Economic Growth: The Case of Trinidad and Tobago

Empirical studies outline developing countries’ experience economic growth through an undervalued exchange rate and that exchange rate overvaluations have negative long term effects on economic growth. This paper examined the impact of exchange rate movements as well as exchange rate misalignments on economic growth for the Trinidad and Tobago economy over the period 1960 to 2016. We find statistically significant evidence that both exchange rate appreciation and misalignments impact negatively on economic growth in the T&T economy. Drilling deeper, we find interestingly that there exist no non-linear effects of exchange rate misalignments on growth. Specifically, we find statistically significant evidence that both overvaluations and under valuations hamper economic growth in the Trinidad and Tobago economy. We attribute this to T&T’s small and underdeveloped manufacturing sector that tends to be overlooked on account of its energy resources, in addition to the fact that its manufacturing sector is highly import oriented. A major policy recommendation would be for the critical reassessment of the rules governing the Heritage and Stabilization Fund (HSF), as government expenditure was allowed to follow energy revenues due to its current limitations.

External influence on exchange rates: An empirical investigation of US pressure and the Chinese RMB

Trade imbalances have often led to accusations of ‘currency manipulation’ and efforts to remedy the purported effects of exchange rate misalignment. This paper investigates the impact of US pressure on China to revalue the RMB. Using vector autoregression (VAR) to analyze an original dataset of US statements and actions between 2005 and 2012, we examine the over-time dynamics between US pressure and the nominal RMB/USD exchange rate. A case study of mounting US pressure in advance of the 2010 midterm election illustrates China’s responsiveness in timing adjustments in the RMB to defuse the risk of an international confrontation. Our findings indicate that external political pressures can influence national exchange rate policies under certain conditions.

Much Ado about the Egyptian Pound: Exchange Rate Misalignment and the Path Towards Equilibrium

Abstract This paper estimates Egypt's equilibrium real exchange rate and exchange rate misalignment based on economic fundamentals over the period 2001Q3–2017Q3. Focusing on the more recent period, we find that the Egyptian pound was undervalued by about 22.3% in 2017Q1 due to overshooting its equilibrium value after floating the currency in 2016Q4. The currency undervaluation then declined to 18.5% in 2017Q3 driven by an increase in the real effective exchange rate due to a surge in domestic inflation. With regard to the determinants of the equilibrium real exchange rate, we find the productivity differential (vis-à-vis Egypt's trade partners) and trade openness to be the most significant factors. We also provide projections for the equilibrium real exchange rate and exchange rate misalignment until 2020Q4, which reveal that the exchange rate undervaluation will be dissipating fast due to high inflation. If the nominal exchange rate stabilizes at its level in 2017Q3 (17.73 pounds per US dollar), the currency will be overvalued by 13.1% in 2020Q4. Given the uncertainty surrounding the projections, a forecast combination approach is also presented. Finally, the paper highlights the implications of the empirical findings for the conduct of monetary policy in Egypt.

Dealing with the consequences of exchange rate misalignments for macroeconomic adjustments in the EMU

AbstractThe euro crisis sheds light on the nature of alternative adjustment mechanisms in the EMU. This article examines the exchange rate misalignments within the euro zone, using a FEER approach. To explore the consequences of these misalignments, we use an open economy SFC model with endogenous interest rates and Eurobonds. Facing a competitiveness loss in southern countries due to misalignments, three sets of alternative economic policy are investigated: a policy‐mix based on tax rebates to improve competitiveness; an increase in intra‐European financing by banks of northern countries; and an issuance of Eurobonds to pool European sovereign debt.

From nominal devaluations to real depreciations

In this article, we assess the factors that enable a nominal devaluation to lead to a real depreciation. To this end, we rely on panel data techniques in order to estimate the contribution over time of the key factors influencing devaluations' effectiveness —as well as their mutual interactions, for a sample of 57 devaluation episodes. The results of our econometric analysis suggest that several prerequisites —namely in terms of exchange rate misalignments and accompanying macroeconomic policies— must be met to ensure that devaluations will have the expected effect in terms of real depreciations. Furthermore, due to its inflationary impact, devaluation exerts a nonlinear effect on the dynamics of the real exchange rate, thus emphasizing the importance played by the size of the nominal adjustment.

External Influence on Exchange Rates: An Empirical Investigation of US Pressure and the Chinese RMB

Trade imbalances have often led to accusations of “currency manipulation” and efforts to remedy the purported effects of exchange rate misalignment. This paper investigates the impact of US pressure on China to revalue the RMB. Using vector autoregression (VAR) to analyze an original dataset of US statements and actions between 2005 and 2012, we examine the over-time dynamics between US pressure and the nominal RMB/USD exchange rate. A case study of mounting US pressure in advance of the 2010 midterm election illustrates China’s responsiveness in timing adjustments in the RMB to defuse the risk of an international confrontation. Our findings indicate that external political pressures can influence national exchange rate policies under certain conditions.

A U.S. Perspective on China's External Economic Disputes in the Past 40 Years and in the Coming 40 Years

On the disputes over China’s trade imbalance, (1) they were marked by analytical confusion over the meaning of the term “equilibrium exchange rate”; (2) China’s trade imbalance reflects the economic conditions in both China and abroad, and that the efficient and fair solution of the problem requires policy changes not only by China but also by the US; (3) the dispute on exchange rate misalignment has been a diversion away from (a) addressing the underlying structural factors causing the trade imbalance, and (b) improving the inadequacy of US job transition programs that has exacerbated US unhappiness with trade imbalance. On the industrial policy dispute, (1) the issue of forced technology transfer is largely a dispute about a large economy using its market power to benefit itself at the expense of its trade partners; (2) this use of market power is normally temporary because of the almost inevitable retaliation by other large countries; (3) notion of national security that is commonly adopted in the US trade policy debate is overly broad and short-sighted, and, unless these two aspects are corrected, they will hurt the US economy and weaken US national security in the long-run; (4) the US must reform the CFIUS (Committee on Foreign Investment in the United States) process of reviewing foreign acquisition of US technology by (a) making the process more comprehensive (e.g. setting up foreign-owned R&D centers in US) and (b) making the process more operational by a defining a list of technologies for CFIUS to cover, a list that is constantly updated. On China’s Belt Road Initiative (BRI), (1) as the number of BRI project grows and as the number of partner countries increases, the number of economic disputes that China will be involved in will grow; (2) China should ensure that the BRI projects in a country are beneficial to the general population of that country and not just politically-biased toward the government in power at that time because, unlike in China, most governments in other countries come and go more frequently; and (3) economic disputes are a systemic feature of the present uncoordinated multi-polar world. Our principal policy suggestion to China is that, because China’s economy in 2018 is very different from that in 1978, there should be more reciprocity in China’s trade and investment relations with the advanced economies. China should not only give national treatment in the near future to foreign firms but should also set up a mechanism to start easing up on foreign acquisition of Chinese firms in a manner that is consistent with China’s national security concerns. Our principal policy suggestion to the US is to stop equating strategic competition with economic competition. Strategic competition is normally a zero-sum game while economic competition is usually a zero-sum game in the short-run, but generally creates a win-win outcome in the long-run. National economic dynamism and economic resilience emerge from international economic competition and not from sheltering domestic high-tech firms permanently.

Internal Devaluations and Equilibrium Exchange Rates: new evidences and perspectives for the EMU

ABSTRACTFrom the onset of the euro crisis to the Brexit vote, we have witnessed impressive reductions of current account imbalances in peripheral countries of the euro area. These reductions can be the result of either a compression of internal demand or an improvement in external competitiveness. In this paper, we compute exchange rate misalignments within the euro area to assess whether peripheral countries have managed to improve their external competitiveness. After controlling for the reduction of business cycle synchronization within the EMU, we find that peripheral countries have managed to reduce their exchange rate misalignments thanks to internal devaluations. To some extent, these favourable evolutions reflect improvements in external competitiveness. Nevertheless, these gains could only be temporary if peripheral countries do not improve their non-price competitiveness, their trade structures and their international specializations in the long run.Abbreviations: EMU, European Monetary Union; FEER, Fundamental Equilibrium Exchange Rate; SMIM, Symmetric Matrix Inversion Method; BEER, Behavioural Equilibrium Exchange Rate; PPP, Purchasing Parity Power; OCI, Own Country Included; IMF, International Monetary Fund; OECD, Organisation for Economic Co-operation and Development; NIESR, National Institute of Economic and Social Research.

Current account and real effective exchange rate misalignments in Central Eastern EU countries: An update using the macroeconomic balance approach

We make an assessment of the current account and price competitiveness of the Central Eastern European countries that joined the EU, using data up to 2016. Foreign capital flows, fiscal balance and relative output growth seem to play a crucial role in explaining the current account balance. The real effective exchange rate gaps behave in accord with the current account misalignments, which clearly display cyclical behaviour. When foreign direct investments are introduced as a determinant, the misalignments are larger in boom periods (positive misalignments), whereas the negative misalignments are smaller in magnitude. Overall, the countries have moved closer to their equilibria since 2010.

Real exchange rate appreciation after the financial crisis of 2008–2009: Misalignment or fundamental correction?

AbstractIn the aftermath of the 2008–2009 financial crisis, several emerging economies experienced substantial real exchange rate appreciations. From the point of view of policy makers, understanding the sources of these appreciations is crucial for designing efficient policy responses. The objective of this paper is twofold. First, we determine the extent to which appreciation episodes were determined by changes in fundamentals or if they constitute exchange rate misalignments. Second, we assess the impact that non‐fundamental variables have on the real exchange rate dynamics. Based on a reduced form model, we conclude that appreciation episodes, in the aftermath of the 2009 financial crisis, can be explained by two elements: (i) an improvement in fundamentals and (ii) a correction of past misalignments. Hence, the real appreciation observed since 2010 was driven, mostly, by fundamental elements. In terms of policy implications, our results suggest that appreciations in that period should have been tolerated by policy makers.

Private Enforcement of International Monetary Law: Arbitration of Investment Treaty Claims Relating to Foreign Exchange Restrictions

International economic activity depends on the cross-border flows that characterize economic globalization—principally of goods, services, capital and labour. These flows all have in common that they involve some element of transnational transfers of funds. The international regulation of trade, investments and other economic activities is therefore inextricably linked to the regulation on the international plane of the transfer and currency conversion such funds, i.e. on international monetary law. A closer look at the political reality of international monetary affairs offers scant reason to presume that the existing liberal paradigm of free capital mobility and market-responsive exchange rate flexibility is beyond challenge or a potential reversal. Yet, rules exist on the international plane to ensure that exchange rates and capital flows remain free from restrictions, manipulation and distortion. In the Post-War international economic order and global institutional set-up, the task of enforcing the rules of international monetary law fell upon the International Monetary Fund. This role was enshrined in GATT 1947 and remains essentially intact. Nonetheless, in recent years, the efforts of the Fund to enforce such rules has not been sufficient to quell allegations against States of exchange-rate misalignment and currency manipulation. This paper, which builds on the author’s ongoing PhD research, looks at private enforcement of international monetary law and asks whether investment arbitration of exchange-rate disputes may offer an alternative enforcement mechanism that might result in positive externalities, benefitting all investors, traders and other non-disputing third parties, and thereby may help restoring trust in trade and investment. The paper seeks to confirm the availability, practicality and functionality of arbitral process to resolve disputes relating to currency convertibility. The paper first explores whether investment disputes relating to exchange rate restrictions are arbitrable for reasons of public policy and the political sensitivity of the interests concerned and, if so, whether and under what conditions any resulting arbitral awards nonetheless may be refused recognition and enforcement. In a second step, the enquiry interprets the scope of application and manner of application of substantive international investment law to determine whether such disputes fall within the scope of investment treaty protections and whether such protections should be restrictively applied to such disputes.

The study of exchange rates behavior in Malaysia by using NATREX model

This paper aims to estimate equilibrium exchange rates and identify the determinants of macroeconomics fundamentals affecting exchange rates in Malaysia. By using Natural Real Exchange Rates (NATREX) model, this study adopts the Autoregressive Distributed Lag (ARDL) model to examine the long run relationships (or cointegration) among variables and the dynamic effect within variables in the short run for the period 1970 to 2012. The results suggest that the terms of trade, dependency ratio of the young, and foreign direct investment play an important role in influencing the exchange rates movement in Malaysia. The result also reveals that the misalignment of exchange rates is quite small and stable in Malaysia during 1983 to 2012, except in 1995.

Assessing interdependence among countries' fundamentals and its implications for exchange rate misalignment estimates: An empirical exercise based on GVAR

Abstract Exchange rates are important macroeconomic prices and changes in these rates affect economic activity, prices, interest rates, and trade flows. Methodologies have been developed in empirical exchange rate misalignment studies to evaluate whether a real effective exchange is overvalued or undervalued. There is a vast body of literature on the determinants of long-term real exchange rates and on empirical strategies to implement the equilibrium norms obtained from theoretical models. This study seeks to contribute to this literature by showing that the global vector autoregressions model (GVAR) proposed by Pesaran and co-authors can add relevant information to the literature on measuring exchange rate misalignment. Our empirical exercise suggests that the estimative exchange rate misalignment obtained from GVAR can be quite different to that using the traditional cointegrated time series techniques, which treat countries as detached entities. The differences between the two approaches are more pronounced for small and developing countries. Our results also suggest a strong interdependence among eurozone countries, as expected.

Real Exchange Rate Misalignments in the Euro Area

Building upon a behavioural equilibrium exchange rate (BEER) model, estimated at a quarterly frequency since 1999 on a broad sample of 57 countries, this paper assesses whether both the size and persistence of real effective exchange rate misalignments from the levels implied by economic fundamentals have been affected by the adoption of a single currency. A comparison of real misalignments across different country groupings (euro area, non-euro area, advanced and emerging economies), shows they are smaller in the euro area than in its main trading partners. However, in the euro area real disequilibria are also more persistent, although after the global financial crisis the reactivity of real exchange rates to past misalignments increased, and therefore the persistence decreased. In the absence of the nominal adjustment channel, an improvement in the quality of regulation and institutions is found to reduce the persistence of real exchange rate misalignments, plausibly by removing real rigidities.

Exchange rate misalignment and economic growth: On the possible transmission channels for emerging economies

Despite the large body of work that exists on the impact of exchange rate undervaluation on economic growth, only a mere literature focuses on the potential transmission mechanisms. There are autho...

Interest rate autonomy in the presence of exchange rate stability: evidence from 13 selected Asia Pacific countries

ABSTRACTA notable feature of the empirical research on the interest rate autonomy is that very few studies seek to determine whether the use of interest rate policy to fine-tune the exchange rate misalignments has been undermined by sterilised foreign exchange intervention. To overcome this deficiency, this study uses the open-economy Taylor rule as a policy reaction function in a standard macroeconomic model to specify the measures of independent interest rate policy reacts to the exchange rate and examines the empirical validity based on a sample of 13 selected Asia Pacific countries. Using the generalised method of moments, the findings provide some policy implications; the interest rate instrument can serve as a coordinating function to fine-tune the exchange rate misalignments for improving the macroeconomic stability and serve as an external shock absorber to avoid or mitigate impact of instability in the foreign capital market.

Estimating Equilibrium Real Exchange Rate And Misalignment In An Oil Exporting Country: Libya's Experience

Exchange rate misalignments has attract a significant attention especially in developing economies; Libyan economy has witnessed a major economic and political changes. Libyan exchange rate has been changed specifically after 2000, and political instability after 2011. This paper aims to shed a light on the equilibrium real exchange path to obtain the misalignments level (over and undervaluation) periods for the Libyan economy. This problem have not received an adequate intention from the policy makers in Libya. Cashin (2004) model is used to determine the main fundamentals that affect the equilibrium path. After applying time series analysis for a period (1975-2015). This paper utilized annual data covering the period (1975-2015); and the data extracted from Central Bank of Libya (CBL), International Financial Statistics (IFS), Organization for Economic Cooperation Development (OECD, Arab monetary Fund (AMF) and World Bank (WB). After testing stationarity of time series using ADF and P.P, this study applies co-integration technique to investigate long relationship between exchange arte and its fundamentals. Then, it performs the vector error correction model (VECM) to compare between long run and short relationships, supported by impulse response functions. The main findings of this study as follows. First, real oil prices and real relative productivity are found to play a significant role in the real exchange rate. For Libyan case, this study includes the degree of openness to this model because the Libyan authorities applied intensive restrictions to restrict external trade for a long time. Second, the results of VECM technique reveal that the speed of adjustment is 4.5 years for half-life to return to the actual level of exchange rate to the equilibrium path. In addition, the results from the impulse response functions (IRFs) found that the real exchange rate responds positively to the shocks in (rop) and (rrp), whereas responds negatively to the shocks in (open). Finally, the real exchange rate for the Libyan economy is recently overvaluation by more than 40%. This study provides some important policy implications for Policy maker specifically monetary authorities (Central Bank of Libya) should consider misalignments of Libyan exchange rate, and implement a proper policy to keep the exchange rate reasonably close to what fundamentals suggest. Policy makers should reduce money supply and increase exchange rate. A managed floating exchange rate policy could be a choice.

Exchange rate misalignment and economic growth: evidence from nonlinear panel cointegration and granger causality tests

AbstractWe analyse the impact of exchange rate misalignment on economic growth for a sample of emerging economies from 1970 to 2014 using a panel smooth transition regression vector error correction model. Besides, we provide a granger causality test conducted in a non-linear framework. We find that a rise in misalignment increases significantly the output in the short-run when currencies are close to equilibrium. When they are highly misaligned, the impact on growth is reduced. However, no significant impact of output on misalignment was found in the short-run. We provide evidence that misalignment granger causes the output at any given level of misalignment both in the short and long-run. Weaker granger causality was found between output and misalignment. This raises some important policy implications. Although emerging economies can use undervaluation as a growth strategy, the benefits are smaller when currencies are highly undervalued. There is, therefore, an incentive to keep exchange rates closer to their equilibrium.

The Political Economy of Real Exchange Rate Behavior: Theory and Empirical Evidence for Developed and Developing Countries, 1960–2010

ABSTRACTEmpirical results of testing the PPP hypothesis have constantly shown that relative prices do not converge to the same level, either in the short or the long run. Therefore, the PPP explanation of the real exchange rate does not provide a reasonable measure of competitiveness at the international level. This article puts forth a different approach based on the works of Ricardo, Marx, Harrod and Shaikh. It argues that the real relative unit labor cost is the main factor explaining the long-run behavior of the real exchange rate. The second section of the article explains the theoretical underpinnings of our approach. The third section analyzes the role of the real interest rate differential in explaining real exchange rate misalignments. In the fourth section, we present a graphical analysis of the interrelation among the real effective exchange rate, the real unit labor cost ratio, the short-run real interest rate differential and the trade balance for 16 OECD countries, Taiwan and three developing countries for the period 1960–2010. The fifth section investigates the long-run relationship between the latter three indexes through co-integrating and error correction models using the ARDL–ECM framework. The last section provides our conclusions.

Exchange rate misalignment and economic growth in India

PurposeThe purpose of the paper is to examine the impact of exchange rate misalignment on economic growth in India using annual data from 1980 to 2014.Design/methodology/approachFirst, misalignment is measured, which is defined as the deviations of the actual real exchange rate (RER) from its equilibrium level. The equilibrium real exchange rate (ERER) is estimated using the auto-regressive distributed lag (ARDL) model by considering key macroeconomic fundamentals of the determinants of RER. Zivot and Andrews’ unit root with structural break is used to test the stationarity property of data. The impact of exchange rate misalignment on economic growth has been examined using ARDL and variance decomposition techniques.FindingsOur results find an overvaluation of the exchange rate till 2000, and thereafter, an undervaluation of the exchange rate prevails in India. Further, the result indicates that an increase in exchange rate misalignment leads to a decrease in economic growth and vice versa. Moreover, a positive misalignment (overvaluation) hurts the economic growth and a negative misalignment (undervaluation) promotes the economic growth.Research limitations/implicationsFrom the policy perspective, the results highlight that India needs to maintain an appropriate exchange rate which can reduce the RER misalignment. It is better for the Reserve Bank of India (RBI)’s intervention to smoothen the fluctuations of the exchange rate to avoid the inefficiency in the allocation of resources. However, to minimize the RER misalignment, the intervention should be conducted only in the short run.Originality/valueThe study contributes to the existing literature by estimating the exchange rate misalignment for India and its impact on economic growth.