Overvalued Exchange Rate Research Articles

An evaluation of the forecast performance of DSGE and VAR Models: The case of a developing country

This paper estimates a DSGE model and three versions of VAR models (VARX, BVARX and BVAR) to analyze forecasting performance of these models in context of Pakistan. VAR models and a medium-scale DSGE model are estimated using quarterly data (1980Q4-2017Q2). Expanding window recursive out-of-sample forecasts for GDP growth, call money rate, CPI inflation and percent change in exchange rate are generated and compared over the period 2009Q1-2017Q2. Forecasting performance is analyzed by the comparison of bias and root mean squared errors (RMSE). Analysis of forecasting performance over 1-8 quarters forecast horizon reveals that BVAR model provides relatively better forecast in case of GDP growth, interest rate and inflation while BVARX provides more accurate forecast in case of exchange rate. In case of GDP growth, inflation and exchange rate, forecasting performance of DSGE model considerably improves as forecasting horizon expands. For longer forecast horizons, divergence between DSGE and Bayesian VAR forecasts tends to disappear. This implies that DSGE model is more relevant for medium term forecasting rather than short term forecasting. Structural interpretation of DSGE forecast errors reveals that there has been unutilized growth potential in economic activity. This slack in economic activity might be attributable to unnecessarily high interest rate and overvalued exchange rate.

How Does Export Diversification Impact Economic Growth?

The paper uses a mixed method approach to conduct a literature review of existing econometric studies to determine the key drivers of export diversification and economic growth, and to examine whether export diversification propels or hinders economic growth. The paper differs fundamentally from previous studies, as it focuses on identifying the key variables used, the frequency with which they are used and their degree of significance based on econometric studies that focused on measuring export diversification, economic growth and the linkage between diversification and growth in developed and developing countries, while highlighting a key gap in this literature, namely a lack of empirical studies focused on small island states. The paper finds that eight variables were used across all studies at a frequency of 10% or greater – namely, real GDP per capita, education, population, domestic investment, market distance, openness to trade, export concentration and rule of law. Based on the literature review, the key factors which support export diversification are human capital accumulation inclusive of higher education, domestic investment, population, quality of institutions, quality of infrastructure and market access. Conversely the factors that retard export diversification or increase export concentration are economic distance (remoteness from major markets), openness to trade, and declining terms of trade, foreign direct investment, exchange rate volatility and exchange rate overvaluation. Similarly, with regards to economic growth, the literature review suggests that the key factors which promote economic growth are rule of law, investment ratio, favorable movements in the terms of trade, technology, higher education and increased international openness while the factors that inhibit economic growth are fertility rate, the ratio of government consumption to GDP, and the inflation rate. In terms of the key variables used to link export diversification to economic growth, based on the literature, the six main categories of trade integration variables include export composition, trade orientation, export structure, geographic structure and trade strategy. After having reviewed the extant literature on export diversification and its relationship to economic growth, one of the overlooked areas of research is a lack of studies examining export diversification in small island developing states, and how export diversification may or may not contribute to economic growth in those particular contexts.

Predicting Currency Crises: A Novel Approach Combining Random Forests and Wavelet Transform

We propose a novel approach that combines random forests and the wavelet transform to model the prediction of currency crises. Our classification model of random forests, built using both standard predictors and wavelet predictors, and obtained from the wavelet transform, achieves a demonstrably high level of predictive accuracy. We also use variable importance measures to find that wavelet predictors are key predictors of crises. In particular, we find that real exchange rate appreciation and overvaluation, which are measured over a horizon of 16–32 months, are the most important.

Taxa de câmbio de equilíbrio e desalinhamento cambial: evidências para o Brasil (1994-2011)

O trabalho estima a taxa de câmbio real efetiva de equilíbrio e o desalinhamento cambial para o Brasil no período de 1994T3 a 2011T4. O trabalho contribui em três aspectos: i) constrói a série de taxa de câmbio real efetiva considerando os 20 principais parceiros comerciais; ii) os determinantes da taxa de câmbio real efetiva são calculados em relação àqueles dos 20 principais parceiros comerciais; iii) calcula uma medida de desalinhamento corrente e uma de desalinhamento total. As evidências indicam: sobrevalorização no período de câmbio rígido (1994T3 a 1998T4); subvalorização no período de câmbio flexível (1999T1 a 2011T4); subvalorização no período pós-crise do subprime (2008T3 a 2011T4); e uma sobrevalorização em 2011.

The Effects Of Remittance Inflows On Exchange Rates In Nigeria

The positive impact of remittances on development indicators of recipient countries is well documented in literature. Remittances have been a major source of economic support for dependents of migrant workers in their home countries. Nigeria receives the largest amount of remittances in Africa and the third among developing economies; receiving 21 Billion US Dollars in 2015. Large remittance inflows could however hurt the recipient economy when the flows are significant relative to the size of the recipient economy. With increasing remittance inflows relative to other capital inflows into Nigeria, remittances could have undesired outcomes, with the possibility of the exchange rates appreciation and a loss of competitiveness in the tradable sector. Using the Dynamic Ordinary Least Squares (DOLS) and data covering 1981 to 2014, this paper explores the empirical evidence regarding the impact of remittances on the real exchange rate in Nigeria. DOLS improves on OLS by coping with small sample and dynamic sources of bias to determine the long-run effect/coefficients of remittances and other variables on economic development. The DOLS also deals with the potential endogeneity problem of explanatory variables. Specifically, studying the nature of the variables, there is a possibility of reverse -causality running between the exchange rate and remittance, foreign direct investment. This situation therefore can raise the possibility of endogeneity. The potential of simultaneity bias, small sample bias and endogeneity among the regressors is dealt with by the inclusion of lagged and lead value of first differences of the regressors. In this design, the dynamic OLS estimator performed well relative to other asymptotically efficient estimators Our findings suggest that remittance inflows have been associated with a rise in the real exchange rate in Nigeria. The coefficient on remittances (REMI) is positive and statistically significant. Thus, high remittance inflows have been associated with a rise in the real exchange rate in Nigeria. This implies that high remittance inflows have exerted depreciating pressure on the country's currency. Thus, contrary to the Dutch disease proposition, high remittance inflows into Nigeria have not resulted in an overvalued exchange rate but a low-valued exchange rate.

Output Costs of Currency Crisis and Banking Crisis: Shocks, Policies and Cycles

This paper studies output declines during currency crises based on the theoretical currency crisis model, highlighting the role of shocks that trigger crises. Using panel data on 49 developing countries, we find that both productivity shocks in the real sector and shocks to the country’s risk premium in financial markets affect the output costs of currency crises, which are 4% of GDP on average and 8% for severe crises. Output costs of banking crises are 6–7% of GDP. During severe currency crises in Asian and Latin-American countries, both productivity shocks and exchange rate overvaluation were found to be important factors in explaining large output losses.

Papua New Guinea: 2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Papua New Guinea

The Papua New Guinea (PNG) economy has grown sluggishly in recent years, reflecting a combination of domestic and external factors. External factors have included adverse terms of trade movements, a drought, and, in 2018, a large earthquake. Domestic factors have included a difficult fiscal consolidation and a shortage of foreign exchange, sustained by an overvalued exchange rate, leading to import compression and weak investment in the non-resource sector. The main macroeconomic challenges for the government are to finish putting in place policies that will help promote economic stability, and to strengthen its long-term development framework. In 2017-18, the new government made important progress in narrowing the fiscal deficit, and adopted a medium-term revenue strategy. But progress on fiscal consolidation has stalled, and the debt-to-GDP ratio is well above the medium-term target. Monetary authorities have begun to facilitate exchange rate adjustment and strengthening of the monetary framework. Stronger economic policies, involving more ambitious fiscal consolidation coupled with faster exchange rate adjustment would yield favorable results.

The ambiguous stance of Brazil as a regional power: piloting a course between commodity-based surpluses and national development

ABSTRACTThis article argues that economic growth relying on commodity-based exports – combined with domestic market expansion for consumption, an overvalued exchange rate and high interest rates – constrained national development as much as it did Brazil’s status as a regional power, particularly in the 2000s. The Brazilian ‘neo-developmentalist model’ – pursuing export surplus in the balance of trade and foreign investment – was based excessively on government incentives for the export of natural resources. With regard to agrarian issues, Brazil again played an uncertain role as a regional power during the governments of both Lula (2003–2010) and Rousseff (2011–2016), despite important differences between the two administrations. On the one hand, the country encouraged the transfer of family farming policies to other Latin American countries. On the other hand, the government’s ‘national champions policies’ were also paramount in forging the expansion of agribusinesses and other multinationals across the continent. The very nature of this ambiguity rests on the contradictions between the narrative of a national development project and the reality of deindustrialization and commodity-based economic surplus. By drawing on aggregate data and secondary sources, this article explores the limits and contradictions of the Brazilian development path in becoming a more influential regional power in the 2000s.

Exchange Rate Management and Economic Growth: A Brewing Crisis in Pakistan

In this article it is argued that Pakistan has had a consistently overvalued exchange rate and the policy with regards to management of the exchange rate has undergone a significant change in recent years. We show that prior to March 2013, the policy target of the exchange management was stability of the real effective exchange rate. However, during the tenure of the current government, the policy target for exchange rate management seems to have been stability of the nominal exchange rate against the US dollar. As the currencies of Pakistan’s major trading partners (UK, Europe and China) have depreciated against the dollar during this period, the real effective exchange rate has appreciated by over 20 percent since the time that the current policy makers took office. Overvaluation in general and the recent reversal in the exchange rate management policy in particular have had an adverse impact on exports and the manufacturing sector. This not only has serious negative consequences for the long term, growth of the economy, but has greatly increased the short-term risk of a balance of payments crisis.

Macroeconomic policy regimes, real exchange rate overvaluation, and performance of the Brazilian economy (2003–2015)

ABSTRACTThe objective of this article is to present a review of the workings of the macroeconomic policy regimes in Brazil since 2003 in order to show that both the macroeconomic policy tripod and the new macroeconomic matrix were not capable of ensuring macroeconomic stability in the medium- to long term due to their incapacity to avoid a persistent overvaluation of the real exchange rate or to stop the increasing trend in primary expenditures/gross domestic product, which produced a major fiscal crisis in 2015.

Banking and Currency Crises: Differential Diagnostics for Developed Countries

AbstractWe identify a set of ‘rules of thumb’ that characterize economic, financial and structural conditions preceding the onset of banking and currency crises in 36 advanced economies over 1970–2010. We use the classification and regression tree methodology and its random forest extension, which permits the detection of key variables driving binary crisis outcomes, allows for interactions among key variables and determines critical tipping points. We distinguish between basic country conditions, country structural characteristics and international developments. We find that crises are more varied than they are similar. For banking crises, we find that low net interest rate spreads in the banking sector and a shallow, or inverted, yield curve is their most important forerunners in the short term. In the longer term, it is high house price inflation. For currency crises, high domestic short‐term rates coupled with overvalued exchange rates are the most powerful short‐term predictors. We find that both country structural characteristics and international developments are relevant banking‐crisis predictors. Currency crises, however, seem to be driven more by country idiosyncratic, short‐term developments. We find that some variables, such as the domestic credit gap, provide important unconditional signals, but it is difficult to use them as conditional signals and, more importantly, to find relevant threshold values. Copyright © 2016 John Wiley & Sons, Ltd.

SOVEREIGN DEFAULT IN A CURRENCY AREA: A MONETARY GENERAL EQUILIBRIUM MODEL

Real exchange rate overvaluation can induce default. In a currency area formed by two countries, we prove that if prices differ even slightly then inflations will diverge persistently and monetary policy will be unable to suit all currency area members. In fact, it will affect area members inversely. We show that risk premia are time-varying and determined by real exchange rate overvaluation. Finally, we find a transmission mechanism from the overvaluation of the real exchange rate of a currency area member to his default.

Are the Central and Eastern European Transition Countries Still Vulnerable to a Financial Crisis? Results from the Signals Approach

The aim of paper is to analyse the vulnerability of the Central and Eastern European accession countries to the EU as well as that of Turkey and Russia to a financial crisis. Our methodology is an extension of the signals approach. We develop a composite indicator to measure the evolutin of of the risk potential in each country. Our findings show that crises in Central and Eastern Europe are caused by much the usual suspects s in others emerging markets. In particular an overvalued exchange rate. Weak exports and dwindling currency reserves have good precictive power for assessing crisis vulnerabilities. Keywords: F31, F47, financial crises, vulnerability indicator, Central and Eastern Europe

The Cuban Monetary and Financial Jigsaw Puzzle

The Cuban economy currently operates with two local currencies –the Cuban peso and the convertible peso, both with convertibility problems and multiple and overvalued exchange rates– and has been subject to a banking crisis since 2009. It is a veritable monetary and financial jigsaw puzzle. In order to do away with the dual currency and overcome financial imbalances, monetary policy must devalue the two domestic currencies. Cuba’s banks are facing a systemic liquidity crisis with no lender of last resort to help them out of it. The country cannot access a last-resort loan from the IMF, the World Bank or the IDB since it is not a member of these institutions. The government has been applying a tough adjustment policy which has led to the reduction in the fiscal deficit and to a surplus in the balance of payments, which has served to pay off debt and gradually unfreeze bank accounts, although the matter is far from being fully settled.

The Balance of Payments Constrained Growth Model: An Application to the Turkish Economy

Overvalued exchange rate policy applied during the capital liberalization process starting in 1989 in Turkish economy decreased the price of import goods in terms of national currency and increased the import volume of the intermediate goods or investment goods accordingly. This change caused the foreign source dependence growth in economy and import demand function and income elasticity of import gained importance in terms of the effectiveness of economy policies to be used in order to lessen the structure of the foreign dependence. The aim of this study is to test the validity of the Thirlwall Law, which is also called the balance of payments constrained growth model in the literature of economics. It includes the period between 1989 and 2013. Thirlwall Law is not valid in that period according to the performed analysis.

Real Exchange Rate Overvaluation and WTO Dispute Initiation in Developing Countries

AbstractWhy and when do developing countries file trade disputes at the World Trade Organization (WTO)? Although financial conditions have long been considered an important driver of trade policy, they have been largely absent from the literature on trade disputes. We argue that developing country governments bring more trade dispute to the WTO when overvalued real exchange rates put exporters at a competitive disadvantage. This dynamic is most prevalent in countries where large foreign currency debt burdens discourage nominal currency devaluations that would otherwise serve exporters’ interests. Our findings provide an explanation for differences in dispute participation rates among developing countries, and also suggest a new link between exchange rate regimes and trade policy.

O câmbio como ferramenta de política econômica e os efeitos sobre a indústria brasileira: uma análise histórica

http://dx.doi.org/10.5007/2175-8085.2015v18n2p41O objetivo deste estudo foi analisar o papel da política cambial brasileira e a sua influência sobre o setor industrial. Pode-se constatar que ocorre no Brasil uma desindustrialização como perda de participação do setor industrial no PIB brasileiro. A liberalização comercial e financeira abrupta nos anos 90, combinada a uma política cambial sobrevalorizada nos anos 2000, em decorrência do fenômeno Doença Holandesa no Brasil, podem estar afetando negativamente o setor industrial. Mesmo que os governos Lula e Dilma tenham criado políticas industriais para fomentar o setor e mesmo que tenha sido válida, contudo não foi suficiente, diante de um ambiente macroeconômico desfavorável, principalmente em função do câmbio apreciado e de juros altos que inibem os investimentos necessários para o crescimento da indústria. Em decorrência disso, a indústria brasileira perdeu participação nas exportações brasileiras e o setor industrial apresentou baixo dinamismo tanto externo quanto interno, uma vez que houve uma crescente importação de produtos industriais.

Colombian Monetary and Exchange Rate Policy Over the Past Decade

This paper analyzes the performance of Colombia’s monetary and exchange rate policies over the past decade. It concludes that compared with other medium and large-sized Latin American economies using inflation targeting-cum-managed floating, Colombia has been the most effective in meeting its inflation target. The Colombian central bank has also shown an earlier and greater determination than its partners in pursuing a counter-cyclical monetary policy. But it clearly failed in the objective of avoiding exchange rate overvaluation, particularly in the aftermath of the North-Atlantic financial crisis. This has generated effects on the structure of domestic production and exports that have long-term implications.

Institutional obstacles to Brazil’s economic growth and development

This article tries to discover some of the roots behind Brazil’s slow economic growth. These include the generally low investment/GDP ratio, the country’s incapacity to implement timely infrastructure investments, the long-term overvalued exchange rate, the poverty of human capital, the incapacity to do state-of-the-arts research and development, and the weak educational system.

Empirical Analysis of the Impact of Foreign Exchange Reserves to Economic Growth in Emerging Economics

In this paper we analyzed the effect of the accumulation of foreign exchange reserves to economic growth in emerging countries. In order to empirical estimates of the impact of foreign exchange reserves to economic growth in emerging countries, were collected annual data on real GDP per capita, share of investment in GDP and population from the database of the International Monetary Fund (IMF WEO) in October 2013, while data from the level of foreign exchange reserves statistics collected from the relevant central banks. For a balanced panel data for Brazil, China and Russia, for the period from 1993 to 2012, estimated the relationship between economic growth and changes in foreign exchange reserves by applying the method includes the ONK with fixed individual effects. The empirical results in this paper suggest that the increase in foreign exchange reserves causes the growth of GDP, while in the opposite direction causality has not been proven. Exchange rate depreciation that occurs as a result of the accumulation of foreign exchange reserves is not inflationary because it is a one-time, non-persistent shock, unlike the sudden depreciation of the exchange rate that occurs as a result of maintaining an overvalued exchange rate in the long term and leads to currency crisis. The accumulation of foreign exchange reserves does not lead to inflation if the rate of accumulation of foreign exchange reserves does not exceed the rate of economic growth. Slightly higher inflation is not necessarily harmful, particularly for developing economics and emerging economics.