Exchange Rate Misalignment Research Articles

THE ASYMMETRIC IMPACT OF RER-MISALIGNMENT ON ECONOMIC GROWTH: AN APPLICATION OF HODRICK–PRESCOTT FILTER TECHNIQUE

Previous studies that examined the impact of exchange rate misalignment on economic growth were based on the symmetric approach where both overvalued and undervalued exchange rates were supposed to affect the economic growth in a similar way. However, in recent years, a number of studies have established that exchange rate changes affect the trade flows in an asymmetric way. Hence, this study investigates the asymmetric effect of exchange rate misalignment on the economic growth of Pakistan. The findings of the study indicate that in the case of the symmetric approach, exchange rate misalignment has a negative impact on economic growth. However, after applying the nonlinear ARDL approach, the study finds significant evidence in favor of the asymmetric effect of exchange rate misalignment on economic growth. Interestingly, the results indicate that undervaluation spurs while over-valuation hampers the economic growth in Pakistan. The study recommends that though under-valued exchange rate may have temporary relief for the economy, yet in the long run, a market-based equilibrium exchanger rate is imperative for a developing economy like Pakistan.

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.

Asymmetric Dynamics of Industrial Response to Exchange Rate Variation in Nigeria

Exchange rate policies are germane to industrial subsector development and the country at large. In this regard; the study examines the asymmetric pass through of official exchange rate policy on Nigerian industrial Subsector from 1970Q1 to 2019Q4. Non-linear ARDL method of estimation was adopted to ascertain the long run and short run asymmetric relation between official exchange rate and industrial output subsector. The results confirmed the presence of both long run and short run asymmetries between manufacturing output and official exchange rate. In the long run, increase in official exchange rate (appreciation) portends a corresponding increase in manufacturing output, while decrease in official exchange rate (depreciation) is negatively related to manufacturing output. On the other hand, the short run dynamics revealed that positive changes in official exchange rate choked off industrial output though statistically insignificance while negative change (depreciation) crowded in industrial output in Nigeria in the period under review against a priori expectation. The result also indicated that the crowding out impact of official exchange rate depreciation is more enduring (long lasting) compared to the positive variations. The presence of asymmetry is novel and instructive for policy pundits, executors, theorists, monetary authorities and allied agents to take decisive steps in order to stem the debilitating effects of exchange rate misalignment to encourage domestic investors, attract foreign investors and thus, stimulate the industrial subsector.

Broken Promises: Regime Announcements and Exchange Rates around Elections

We study exchange rate dynamics around government changes conditional on the exchange rate regime, which we identify by combining the IMF de jure and the Reinhart and Rogoff de facto exchange rate regime classifications. This allows distinguishing whether the official exchange rate regime announcements match actual policy or are inconsistent with it. Using monthly data from Latin American democracies, we do not find significant exchange rate depreciations before the change of government in any of the regimes we identify. However, we do detect a gradual real exchange rate overvaluation when the de jure regime is fixed but the de facto policy is flexible, which is abruptly corrected after the change of government; this pattern of real exchange rate misalignments when the announcement does not match actual behavior is linked to incumbents that postpone devaluations until the successor steps in. This pattern of broken promises is typical until 1999, but it becomes exceptional thereafter.

How frequent a BEER? Assessing the impact of data frequency on real exchange rate misalignment estimation

AbstractThis article explores the robustness of Behavioural Equilibrium Exchange Rate models, employed to estimate real effective exchange rate misalignments, to the frequency of the underlying data. It compares misalignments stemming from an annual model, estimated since 1980, and a comparable quarterly model, estimated since 1999. The two sets of estimates are similar. Moreover, the in‐sample power of quarterly REER misalignments in explaining subsequent REER developments is higher than that of the annual estimates. This article therefore suggests that the “optimal” frequency of a BEER model depends on whether its resulting estimates are employed for research purposes or for policy‐making activities.

Exchange rate misalignment, state fragility, and economic growth in sub-Saharan Africa

The sluggish and sometimes negative growth in sub-Saharan Africa has defined the objectives of most studies seeking to explain the sources of its slow growth. I contribute to this inquiry by estima...

The Diversified Business Group and the Margins of Labor Market Adjustment to Real Exchange Rate Misalignment

The Diversified Business Group and the Margins of Labor Market Adjustment to Real Exchange Rate Misalignment

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 effect of real exchange rate misalignment on economic growth: Evidence from emerging markets

Purpose – This study’s main purpose is to investigate the effect of real exchange rate misalignment on economic growth performance for 21 emerging markets from 1980 through 2016. Methods – The study individually measures the real exchange rate misalignment series for 21 emerging markets by using the single-equation approach and then estimates the effect of real exchange rate misalignment, undervaluation, and overvaluation on economic growth performance through dynamic panel system generalized method of moments approach. Findings – The study finds that the real exchange rate of emerging markets is significantly misaligned. The study also argues that any deviation of the real exchange rate from its equilibrium value impairs economic growth. The view that overvaluation erodes growth is customarily accepted, while a real undervaluation is found to be a growth deteriorating fact. Implication - From the policy perspective, policymakers should be cautious enough in setting exchange rate policies to check its sustained misalignments over time so that it can enrich the ability of concerned authorities to attain the growth target by using it as a policy instrument. Originality – The study is in response to the need felt for a common analytical framework for examining misalignment in the real exchange rate to make a more inclusive decision relating to its effects on the growth performance of emerging markets.

Monetary spillovers and real exchange rate misalignments in emerging markets

PurposeAfter the adoption of unconventional monetary policies (UMPs) in advanced economies (AEs) there were many studies of monetary spillovers to asset prices in emerging market economies (EMEs) but the extent of contribution of EMEs and AEs, respectively, in real exchange rate (RER) misalignments has not been addressed. This paper addresses the gap in a cross-country panel set-up with country specific controls.Design/methodology/approachFixed effects, pooled mean group (Pesaran et al., 1999) and common correlated effects (Pesaran, 2006) estimations are used to examine the relationship. Multiway clustering is taken into account to ensure robust statistical inferences.FindingsRobust evidence is found for significant monetary spillovers over 1998–2017 in the form of RER overvaluation of EMEs against AEs, especially through the portfolio rebalancing channel. EME RER against the US saw significantly more overvaluation in UMP years indicating greater role of the US in monetary spillovers. However, in the long-run monetary neutrality holds. EMEs did pursue mercantilist and precautionary policies that undervalued their RERs. Precautionary undervaluation is more evident with bilateral EME US RER.Research limitations/implicationsIt may be useful for large EMEs to monitor the impact of foreign portfolio flows on short-run deviations in RER. Export diversification reduces EME mercantilist motives against the US. That AE monetary policy significantly appreciates EME RER has implications for future policy cooperation between EMEs and AEs.Originality/valueTo the best of the author's knowledge such a comparative analysis between AE and EME policy variables on RER misalignment has not been done previously.

Economic growth and real exchange rate misalignments in the European Union

AbstractWe investigate the relationship between economic growth and real exchange rate (RER) misalignments within the European Union (EU) during the period of 1995–2016. In addition to the relative price level of GDP, we quantify an alternative indicator for the RER: the internal relative price of services to goods. We interpret RER misalignments as deviations from the levels consistent with the levels of economic development among the EU countries. Using pooled OLS and dynamic panel techniques, we find that within the EU over- (under-) valuations are associated with lower (higher) growth. This is mainly due to developments in the countries operating under the fixed exchange rate regimes. Our results indicate that the level of development does not influence the strength of the growth-misalignment relationship within the EU. Regarding the price level of GDP, we find that the positive relationship between undervaluation and growth diminishes with the degree of undervaluation. We find that overvaluation has a statistically significant negative effect on export market shares and private investments, indicating that both the competitiveness and the investment channels play a role in the relationship between growth and RER misalignments. As an extension, we show that the effects of “wage misalignments” from levels consistent with productivity are also negatively related to economic growth. The policy implications of the analysis point to the importance of a growth strategy avoiding overvaluation on the one hand, and to the futility of aiming at excessive undervaluation, on the other.

Real Exchange Rate Misalignment and Currency Crises

This article calculates the real exchange rate misalignment (RERM) of the rupiah to examine the role of misalignment in exchange rate crises in Indonesia. The article does this by employing an autoregressive regime-switching model and behavioural equilibrium exchange rate (BEER) approach. The findings are as follows. First, net foreign assets and the relative productivity differential between sectors significantly influence the equilibrium exchange rate, indicating that external and internal balance determine the behaviour of the rupiah in the long run. Second, the BEER approach can properly predict misalignment of the rupiah, especially through explaining the overvaluation periods of the rupiah before the Asian financial crisis. The regime switching model performs well in identifying episodes of stability and volatility in the rupiah. Third, of the 17 crisis episodes experienced in Indonesia in 1981–2012, 10 were preceded by high RERM.

Real Exchange Rate Misalignments in the Euro Area

Building upon a Behavioural Equilibrium Exchange Rate model, estimated at a quarterly frequency since 1999 on a broad sample of 57 countries, this paper assesses both the size and the persistence of real effective exchange rate misalignments of countries that have adopted the euro and of those outside the euro area. The euro area is indeed a poignant example of a currency union in which the nominal exchange rate is irrevocably fixed; the non-euro area economies considered include countries with either flexible or pegged currencies. While misalignments are found to be smaller in the euro area than in the rest of the world, they are also more persistent; however, the persistence in the euro area has decreased after the global financial crisis. Finally, it is found that improvements in the quality of institutions – observed in particular after 2009 within the euro area – reduce the persistence of misalignments.

Exchange Rate Misalignment and Economic Growth in Pakistan: The Role of Financial Development

This study endeavours to examine empirically how real exchange rate (RER) misalignment affects economic growth in Pakistan. In this regard, we have not only estimated the direct impact but also the indirect impact of misalignment on economic growth by using the financial development channel. We have used time series data ranging from 1980 to 2016 to carry out the empirical analysis. After testing the time series properties of the selected variables, we computed long run equilibrium RER later used to calculate RER misalignment. Finally, we estimated the impact of misalignment on per capita economic growth, both direct and indirect. Our results reveal an adverse impact of RER misalignment on economic growth. However, we report that financial development helps in minimising the adverse impact of RER misalignment, though not fully eliminating it. Based on the empirical findings, the study suggests that exchange rate policies need to be managed more cautiously. Moreover, the financial sector development needs to be strengthened which may help in fully alleviating the adverse impact of RER misalignment on economic growth. JEL Classification: F31, GOO, O47 Keywords: Real Exchange Rate Misalignment, Financial Development, Economic Growth, FMOLS

On the neutrality of the exchange rate regime regarding real misalignments: Evidence from sub‐Saharan Africa

AbstractThis article provides further insights into the issue of real misalignments’ effects of exchange rate regimes. Our approach aims at comparing real exchange rate misalignments between countries with fixed regimes and those practicing alternative arrangements in sub‐Saharan Africa. To this end, we assess the equilibrium exchange rates based on two models of the equilibrium exchange rate, while using competing estimators and both De Jure and De Facto classifications. Our results confirm the exchange rate regime neutrality regarding exchange rate misalignment, implying that the fixed regime is not prone to more misalignment within the sub‐region.

FX Intervention to Stabilize or Manipulate the Exchange Rate? Inference from Profitability

We analyze the profitability of FX swaps used by the central bank of Brazil to shed light on the rationale for FX intervention. We find that swaps are profitable in expectation, suggesting that FX intervention is used to stabilize the exchange rate in the face of temporary excessive movements rather than to manipulate it away from fundamental values. In line with this interpretation, we find that the scale of FX intervention responds to the degree of exchange rate misalignment relative to UIP conditions. We also document that intervention is more aggressive when there is less uncertainty about the medium-term level of the exchange rate and when the exchange rate is overvalued rather than undervalued.

Real exchange rate misalignments in developing countries: The role of exchange rate flexibility and capital account openness

This paper examines the association between real exchange rate (RER) misalignments, exchange rate flexibility, and capital account openness using a panel dataset for 60 developing countries over the period 1980–2014. The analysis is based on an alternative measure of RER that is more consistent with the theoretical concept of RER than the commonly used index, and misalignment estimates that account for country-specific underlying factors. The results suggest that the exchange rate regime and capital account policy are significantly related to the degree of persistence and the magnitude of RER misalignments.

The forward‐looking ability of the real exchange rate and its misalignment to forecast the economic performance and the stock market return

AbstractThis paper aims to examine whether exchange rates can predict future changes in the stock market return and in the economic performance of a country. On the basis of a revision that incorporates relative stock price and rational expectation in Dornbusch's dynamic Mundell–Fleming model, I present a model that can be used for analysing the forward‐looking ability of the real exchange rate. The model builds on the works of Campbell and Shiller (Journal of Political Economy, 95, 1987 and 1062), MacDonald and Taylor (IMF Staff Papers, 40, 1993 and 89) and Engel (American Economic Review, 106, 2016 and 436) which can also be converted into a forward‐looking version of real exchange rate misalignment model to investigate whether the deviation of the real exchange rate from its fundamental value would contain an economically significant predictable component on forecasting the future stock price movement and the real output.

Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response?

How should monetary policy respond to capital inflows that appreciate the currency, widen the current account deficit and cause domestic overheating? Using the workhorse open-macro monetary model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, solve for the optimal targeting rules under cooperation and characterize the constrained-optimal allocation. The answer is sharp: the optimal monetary stance is contractionary if the exchange rate pass-through (ERPT) on import prices is incomplete, expansionary if ERPT is complete–implying that misalignment and exchange rate volatility are higher in economies where incomplete pass through contains the effects of exchange rates on price competitiveness.

Exchange rates, local currency pricing and international tax policies

Empirical evidence suggests that for many countries, retail prices of traded goods are sticky in national currencies. Movements in exchange rates then cause deviations from the law of one price, and exchange rate misalignment, which cannot be corrected by monetary policy alone. This paper shows that a state contingent international tax policy can be combined with monetary policy to eliminate exchange rate misalignment and sustain a fully efficient welfare outcome. But this monetary-fiscal mix cannot be decentralized with non-cooperative determination of monetary and fiscal policy. Non-cooperative use of taxes and subsidies introduces strategic spillovers which opens up a fundamental conflict between the goals of output gap and inflation stabilization and those of terms of trade manipulation in an open economy. The implementation of an efficient monetary-fiscal mix requires effective cooperation in fiscal policy, while leaving monetary policy to be determined non-cooperatively. In addition, while an efficient outcome requires state contingent taxes and subsidies to eliminate exchange rate misalignment, it is still necessary to have flexible exchange rates and independent monetary policy.