Exchange Rate Misalignment Research Articles

Responsiveness of United States – China bilateral commodity trade to real exchange rate misalignment: Does the complexity of traded products matter?

This paper assesses the impact of real exchange rate (RER) misalignment on the trade balance between the United States and China, accounting for the complexity of traded products. We employ two recent econometric techniques: the panel autoregressive distributed lag (ARDL) model to estimate both long – and short-run dynamics, and the dynamic panel threshold model of Seo, M. H., and Y. Shin (2016. “Dynamic Panels with Threshold Effect and Endogeneity.” Journal of Econometrics 195 (2): 169–186) to uncover potential non-linearities and identify critical thresholds that could lead to a regime shift. Using highly disaggregated trade data at the HS 06-digit level, encompassing 913 products from 2004 to 2020, our findings reveal a negative impact of RER misalignment on the United States’ trade balance with China. However, this detrimental effect is significant only in industries dealing with less complex products. In contrast, industries handling highly complex products show a notably positive impact. Furthermore, our results suggest that industries can benefit from an undervalued exchange rate only when they have a relatively high level of product complexity. Additionally, heightened product complexity can mitigate any adverse effects overvaluation might have on the trade balance.

Manufacturing and the real exchange rate: natural resource rents matter when measuring misalignments

ABSTRACT We analyse the relationship between the share of manufacturing in GDP and real exchange rate misalignments based on the purchasing power parity criterion (PPP) and a sample of 102 developing and transition economies (2003–2019). In a departure from usual practice, we subtract natural resource rents from GDP in order to correct misalignments for the productivity bias. A dynamic threshold panel model is used and we separate out the impact of undervaluation and overvaluation components in the same regression. Overvaluation has a negative linear effect, while undervaluation stimulates the manufacturing sector in a non-linear way. Above an 18% threshold, the marginal effect of undervaluation diminishes.

Do real exchange rate misalignments have threshold effects on economic growth? Asymmetric evidence from Pakistan

Do real exchange rate misalignments have threshold effects on economic growth? Asymmetric evidence from Pakistan

Real exchange rate misalignment and economic growth: threshold effect of trade structure

ABSTRACT The growth effect of real exchange rate (RER) misalignment has been an unsolved issue for decades. Rodrik Hypothesis and opposing empirical evidence indicate potential non-linear nexus. This article introduces trade structure into the growth mechanism of RER misalignment and obtains robust empirical evidence employing threshold panel data method and a cross-economy panel dataset covering 67 economies and 40 years from 1980 to 2019. The findings suggest heterogenous growth effect of RER misalignment depending on trade structure: 1) for economies deeply depending on imported consumption goods, overvalued RER can enhance domestic economic development. 2) For economies focusing on exporting manufactures, RER undervaluation may boost domestic economic growth. And 3) for other economies, developed ones will benefit from overvaluation while developing ones benefit from undervaluation. The findings suggest that economies should take different exchange rate arrangements depending on their trade structure.

Beyond symmetry: investigating the asymmetric impact of exchange rate misalignment on economic growth dynamics in Bangladesh

ABSTRACT This study examines the influences of asymmetry in exchange rate misalignment on economic growth of Bangladesh using utilizing time series data over the period from 1980 to 2020. The outcomes of the study symmetrically show that exchange rate misalignment has a significant impact on economic growth. In contrast, the adoption of NARDL technique gives substantial evidence for asymmetric effects, revealing that undervaluation supports economic growth while overvaluation hampers it. This analysis supports implementing a market-based equilibrium exchange rate system. It informs the regulators, policy makers, and market specialists that the customized exchange rate policies support sustained long-term economic growth.

The West African Monetary Zone: is inflation convergence sufficient for a currency union?

The West African Monetary Zone is a proposed monetary union among the nations of The Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone. A key characteristic for a well-functioning common currency is convergence in inflation rates among constituent members. A failure to achieve convergent inflation rates leads to real exchange rate misalignment, balance-of-payments problems, possible debt crises and economic stagnation as (often sticky) prices are all that can adjust when there is no possibility of nominal depreciation. Nigeria is by far the largest of the economies in the proposed union, and will likely dominate in terms of monetary policy. Using a pairwise approach, along with other methods, we find evidence that all other potential members exhibit inflation differentials vis-à-vis Nigeria that are, at a minimum very slow to converge to zero. There is also often slow convergence in inflation differentials among the other five nations. These findings strongly suggest much caution prior to the formal creation of this proposed common currency.

The Effect of Money Supply on Exchange Rate in ASEAN-5: Empirical Test of Dornbusch Overshooting Model

The primary purpose of this study is to analyze the effects of the money supply on exchange rates in ASEAN-5 and whether there is an exchange rate overshooting phenomenon with the application of the Dornbusch Overshooting Model. This study uses the Autoregressive Distributed-Lag (ARDL) method to analyze the short and long-term effects and uses time series data from 1980 to 2021 in ASEAN-5. The results of this study are still ambiguous in finding the overshooting phenomenon in ASEAN-5. In the short term, the research results support overshooting in two countries, Malaysia and Thailand. However, in the long term, no positive and significant influence was found between the money supply gap and exchange rate misalignment in ASEAN-5. Besides that, the inflation gap, interest rate gap, and output gap also greatly influence changes in exchange rate misalignment and have different significant effects in the short and long term.

Correction: Effect of exchange rate misalignments on foreign direct investment in Sub-saharan Africa

Correction: Effect of exchange rate misalignments on foreign direct investment in Sub-saharan Africa

Effects of foreign direct investment on industrial development in Sub-Saharan Africa: the role of exchange rate misalignment

Effects of foreign direct investment on industrial development in Sub-Saharan Africa: the role of exchange rate misalignment

Exchange rate misalignments, growth, and institutions

Exchange rate misalignments, growth, and institutions

Effect of exchange rate misalignments on foreign direct investment in Sub-saharan Africa

Effect of exchange rate misalignments on foreign direct investment in Sub-saharan Africa

Assessing the Impact of Real Exchange Rate Misalignments on Economic Growth in Arab Countries

Assessing the Impact of Real Exchange Rate Misalignments on Economic Growth in Arab Countries

Impact of Real Exchange Rate Misalignment on Economic Growth in Nigeria

Impact of Real Exchange Rate Misalignment on Economic Growth in Nigeria

Exchange rate misalignment and financial development in Africa

AbstractWe examine the effect of misaligned exchange rates on financial development in Africa. Results from quantile regression techniques and the IV Lewbel estimator reveal that exchange rate misalignment significantly hampers financial development on that continent. This result is robust across financial institutions and financial markets. We also show that while the effects of misaligned exchange rates are negative on financial institutions and positive on financial markets in African franc‐zone countries, the effects are consistently negative across all financial sectors in the non‐franc‐zone countries there. When robustness assessment is done using quantile regression, the results show that the negative effect of misalignment on financial development is only feasible from the 75th percentile and higher in Africa in general and for the non‐franc‐zone countries in particular.

Inflation targeting, exchange rate and output gap in Central and Eastern European countries

This paper aims at empirical assessment of monetary policy relationships in Central and Eastern European countries (Czechia, Hungary, Poland, Romania), which practise the monetary regime of inflation targeting. Using quarterly data for the period of 2004-2019, the authors examined the relationship between the output gap, nominal and real exchange rate misalignment, consumer price inflation and the central bank policy rate, using the panel vector autoregression (PVAR) model. According to estimates, the central banks of the CEE-4 countries react with an increase of their policy rate to the output gap and inflation, as implied by the Taylor rule. At the same time, a monetary reaction to nominal (real) exchange rate misalignment is lost in the estimates for the post-crisis period of 2010-2019. An increase of the central bank rates does not seem to have unfavourable output effects, while the nominal exchange rate is likely to depreciate with three to five quarter lags. However, there is evidence of the price puzzle when monetary tightening is followed by a counterintuitive increase in the inflation rate. In full accordance with the New Keynesian framework, inflation depends on the output gap, while being expansionary in the real sector. Evidence of the exchange rate pass-through (ERPT) to inflation is mixed. This article provides insights into the average monetary policy reaction function and its macroeconomic effects in the CEE-4 countries, with the value added in that following the Taylor rule does not guarantee effectiveness in tackling inflation in the presence of the price puzzle. Based on the estimated exchange rate effects on the output gap and inflation, deliberate currency appreciation resulting from the central bank foreign exchange interventions and/or fiscal austerity measures can be helpful for such a disinflation that minimises output losses.

Does exchange rate misalignments lead changes in macroeconomic fundamentals?

This article aimed at verifying the reliability of equilibrium exchange rate (EER) concepts by exploring if exchange rate misalignments are leading to changes in macroeconomic fundamentals. The authors focused on G10 currencies and the three most popular EER models which the IMF regularly uses within the External Balance Assessment: Purchasing Power Parity, Behavioural EER and Fundamental EER. In methodological terms, the study applied the cross-sectional predictability approach developed by Sarno and Schmeling (2014), which ranks countries on the basis of the scale of EER misalignment to check if this ranking helps to predict key macro variables. The results indicate that EER misalignment contains cross-sectional predictive power and allows forecasting real effective exchange rates, short-term interest rates and current account balance differences across countries.

Exchange rate misalignment and revenue mobilisation: a global comparative evidence of trade openness thresholds

Exchange rate misalignment and revenue mobilisation: a global comparative evidence of trade openness thresholds

Civil Conflicts and Exchange Rate Misalignment: Evidence from MENA and Arab League Members

Abstract For more than a decade, civil conflicts intensity has been high in the Middle East and North Africa, yet the monetary and financial impacts of such episodes have received relatively little attention. Using macroeconomic and conflict panel data for Arab League members, Iran and Turkey during the period 1970–2018, this paper constructs a country-specific real exchange rate misalignment index and adopts an instrumental variable approach to show that civil conflicts lead to real exchange rate overvaluations in the region: a 1 unit increase in civil conflict intensity leads to a 0.24 unit increase in the RER misalignment index. The results suggest that upward pressures on the real exchange rate, such as inflation resulting from physical capital and output loss, dominate. Economic policy during post-conflict transitions should mitigate this effect by incorporating a strategy to realign the currency.

The asymmetric impact of real exchange rate misalignment on growth dynamics in Turkey

Earlier empirical studies examining the impact of exchange rate misalignment on economic growth were based on a symmetric approach, assuming that undervaluation and overvaluation affect economic growth symmetrically. However, recent empirical studies have shown that exchange rate misalignments asymmetrically affect economic growth. This study, therefore, examines the asymmetric effects of real exchange rate misalignments on economic growth in Turkey. The asymmetric effects of the non-linear autoregressive distributed lag model show that both overvaluation and undervaluation impede economic growth in Turkey. The study recommends that Turkey should maintain a market-based exchange rate policy to reduce currency misalignment. The study also recommends that the central bank of Turkey should intervene in the foreign exchange market for a short-term to mitigate the excessive distortions in exchange rates and avoid inefficiencies in resource allocation.

Exploring the relationship between exchange rate misalignment uncertainty and economic growth in South Africa

Exploring the relationship between exchange rate misalignment uncertainty and economic growth in South Africa