Real Exchange Rate Depreciation Research Articles

External currency pricing and the East Asian crisis

This paper provides a quantitative investigation of the East Asian crisis of 1997–1999. We stress two essential features of the crisis. First, the crisis was a regional phenomenon; the depth and severity of the crisis were exacerbated by a large decline in regional demand. Second, the predominance of the US dollar in the pricing of export goods in Asia (which we document empirically) led to a powerful internal propagation effect of the crisis within the region, contributing greatly to the decline in regional trade flows. We construct a multi-country macroeconomic model which contains these two features and show that it can do a good job in accounting for the response of the main macroeconomic aggregates in Korea, Malaysia and Thailand during the crisis. A key advantage of our model is that it can explain the very slow response of exports to the large real exchange rate depreciations that took place during the crisis. Without the regional dimension and dollar pricing of exports, we find that the model fails to account for the depth and severity of the crisis.

Current account adjustment in industrial countries

This paper examines the dynamics of current account adjustment among industrial countries. The purpose is to evaluate whether there is a threshold level of a current account deficit at which it becomes unsustainable and whether it is possible to characterize episodes of adjustment. We identify 25 episodes in which there was a sustained improvement in the current account following a large deficit between 1980 and 1997. We find that a typical current account reversal begins when the current account deficit is about 5% of GDP. However, we also find considerable cross-country variation in the reversal threshold, consistent with a stock-adjustment model of current account sustainability. Reversals are associated with slowing income growth and a 10–20% real exchange rate depreciation. Real export growth, declining investment, and an eventual leveling off in the budget deficit–GDP ratio are also likely to be part of the adjustment. These results imply that current account reversals in industrialized countries are related to the business cycle.

Current Account Adjustment in Industrial Countries

Abstract This paper examines the dynamics of current account adjustment among industrial countries. The purpose is to evaluate whether there is a threshold level of a current account deficit at which it becomes unsustainable and whether it is possible to characterize episodes of adjustment. We identify 25 episodes in which there was a sustained improvement in the current account following a large deficit between 1980 and 1997. We find that a typical current account reversal begins when the current account deficit is about 5% of GDP. However, we also find considerable cross-country variation in the reversal threshold, consistent with a stock-adjustment model of current account sustainability. Reversals are associated with slowing income growth and a 10–20% real exchange rate depreciation. Real export growth, declining investment, and an eventual leveling off in the budget deficit–GDP ratio are also likely to be part of the adjustment. These results imply that current account reversals in industrialized countries are related to the business cycle.

The effects of Japanese economic performance on Indonesia

This paper assesses how Japanese economic performance affects the Indonesian economy for the 1988 to 2004 period. The empirical evidence provided here suggests that Japanese growth appreciates the local currency in real terms, decreases the inflation and increases growth. As a side issue, we also documented that real exchange rate depreciation accelerates inflation and decreases growth in Indonesia.

ELECTIONS AND EXCHANGE RATE POLICY CYCLES

This paper presents a theoretical model based on the distributive effects of real exchange rate (RER) changes that generates RER electoral cycles of the type identified in Latin American countries: more appreciated RER before elections and more depreciated after elections. Typically, a RER depreciation favors exporters and import-competing domestic industries, to the detriment of consumers. These RER cycles are generated by imperfect information on policy-makers' preferences, which are concealed from voters with the help of an unstable macroeconomic environment. Exchange rate cycles result from the interplay between the electoral power of the non-tradable sector and the tradable sector's ability to lobby the government.

Trade Reform and Poverty in the Philippines: A Computable General Equilibrium Microsimulation Analysis

The paper employs an integrated CGE-microsimulation approach to analyze the poverty effects of tariff reduction. The results indicate that tariff reduction between 1994 and 2000 is generally poverty-reducing. However, the reduction is much higher in the National Capital Region (NCR), where the incidence of poverty is already lowest, than in other areas, where poverty is much more widespread. Poverty gains are achieved primarily through a reduction in consumer prices, although household incomes also increase. Tariff cuts also lower the cost of local production and bring about a real exchange rate depreciation. Since the non-food manufacturing sector is the most export-oriented sector in the Philippines, it emerges as the biggest beneficiary of trade liberalization. On the other hand, the agricultural sector contracts. As the poor derive most of their income from the agricultural sector, income inequality worsens as a result of trade liberalization.

Exporting goods or exporting labor?: long-term implications for the palestinian economy

During the past four and a half years, the number of Palestinian workers in the Israeli labor market how significantly contracted primarily as a result of restrictions on the movement of Palestinia...

Firm dynamics, investment and debt portfolio: balance sheet effects of the Mexican crisis of 1994

We build a partial equilibrium model of firm dynamics under exchange rate uncertainty. Firms face idiosyncratic productivity shocks and observe the current level of the real exchange rate each period. Given their current level of capital stock, firms make their export decisions and choose how much to invest. Investment is financed through one period loans from foreign lenders. The interest rate charged by each lender is set to satisfy an expected zero-profit condition. The model delivers a distribution of firms over productivity, capital stocks and debt portfolios, as well as an exit rule. We calibrate the model using data from a panel of Mexican firms, from 1989 to 2000, and analyze the effect of the 1994 crisis on these variables. As a result of the real exchange rate depreciation, the model predicts: (i) an increase in the debt burden, (ii) an increase in exports and (iii) a large decline in investment. These real effects are consistent with the evidence for the Mexican crisis.

Macroeconomic Adjustment and the Poor: Analytical Issues and Cross‐Country Evidence

Abstract. This paper studies the links between macroeconomic adjustment and poverty. The first part summarizes some of the recent evidence on poverty in the developing world. The second reviews the various channels through which macroeconomic policies affect the poor, whereas the third is devoted to the specific role of the labor market. It presents an analytical framework that captures some of the main features of the urban labor market in developing countries and studies the effects of fiscal adjustment on wages, employment, and poverty. The fourth part presents cross‐country regressions linking various macroeconomic and structural variables to poverty. Higher levels and growth rates of per capita income, higher rates of real exchange rate depreciation, better health conditions, and a greater degree of commercial openness lower poverty, whereas inflation, greater income inequality, and macroeconomic volatility tend to increase it. Moreover, the impact of growth on poverty appears to be asymmetric; it seems to result from a significant relationship between episodes of increasing poverty and negative growth rates.

The Real Exchange Rate Process and Its Real Effects: The Cases of Mexico and the USA

Exchange rate management is a salient macroeconomic issue, especially in developing countries. In this paper, we study political economy factors that may affect the real exchange rate (RER) process and the real economic effects of the RER. We review recent literature on the effects of elections on the exchange rate, and adapt Ball's (1992) model to show that uncertainty about the future course of policy may make more appreciated RER's less predictable. We also review the literature on the real effect of RER appreciations and of RER uncertainty. We then construct a simultaneous GARCH-M model of the joint determination of the RER and output capable of testing our hypotheses simultaneously in a single model. We estimate the model using data first from Mexico, a developing country, and the US. In Mexico we find that elections significantly affect the evolution of the RER, that more appreciated RERs are less predictable, that RER depreciations lower output growth and that RER uncertainty lowers output growth, even when controlling for its well-studied effect on trade. By contrast, none of these effects are found in the US data.

Trade Finance and Trade Flows: Panel Data Evidence From 10 Crises

This paper assesses the effect of constrained trade finance on trade flows in countries undergoing financial and balance of payments crises. Most of the countries that had a major crisis had a significant trade contraction, while trade-related finance declined sharply. However, trade may also be affected by other variables such as world demand, domestic demand, banking crises, changes in export and import prices, and real exchange rate depreciation. To estimate the effect of constrained trade finance on trade flows, we estimate import and export volume equations including explicitly trade financing as an explanatory variable in addition to the usual variables such as relative prices and income. We conclude that constrained trade finance is a factor in explaining both export and import volumes in the short-run. A fall in external trade finance explains a relatively small part of the trade loss during crises, while a fall in trade financing in connection with domestic banking crisis can lead to a substantial loss of trade.

Trade Finance and Trade Flows: Panel Data Evidence from 10 Crises

This paper assesses the effect of constrained trade finance on trade flows in countries undergoing financial and balance of payments crises. Most of the countries that had a major crisis had a significant trade contraction, while trade-related finance declined sharply. However, trade may also be affected by other variables such as world demand, domestic demand, banking crises, changes in export and import prices, and real exchange rate depreciation. To estimate the effect of constrained trade finance on trade flows, we estimate import and export volume equations including explicitly trade financing as an explanatory variable in addition to the usual variables such as relative prices and income. We conclude that constrained trade finance is a factor in explaining both export and import volumes in the short-run. A fall in external trade finance explains a relatively small part of the trade loss during crises, while a fall in trade financing in connection with domestic banking crisis can lead to a substantial loss of trade.

EFFECTS OF THE REAL EXCHANGE RATE ON OUTPUT AND INFLATION: EVIDENCE FROM TURKEY

This paper assesses the effects of real depreciation on the economic performance of Turkey by considering quarterly data from 1987:I to 2001:III. The empirical evidence suggests that, contrary to classical wisdom, the real depreciations are contractionary, even when external factors like world interest rates, international trade, and capital flows are controlled. Moreover, the results obtained from the analyses indicate that real exchange rate depreciations are inflationary.

Exchange rate volatility and economic performance in Peru: a firm level analysis

This paper analyzes the impact of the exchange rate volatility on the performance of the Peruvian economy using financial information from 163 non-financial listed firms. We find evidence that, for firms holding dollar-denominated debt, investment decisions are negatively affected by real exchange rate depreciation. The reasons behind this result are: (i) the high degree of liability dollarization and currency mismatch that create the conditions for a balance sheet effect and a financial stress in the aftermath of a currency depreciation; (ii) the strong bank-lending channel that follows and reinforces the balance sheet effect; (iii) the domestic demand shrinkage that affects severely firms’ sales; and (iv) the relatively small and poorly diversified export sector.

Employment determination at Mexican maquiladoras: Does location matter?

This paper develops a microeconomic model of employment at Mexican maquiladoras using panel data from border and non‐border states. Employment estimates for industry output are always positive, while wage increases depress employment only for the border panel. External factors, such as positive changes in U.S. output, contribute to maquiladora employment, while real effective exchange rate depreciations reduce employment, notably for border firms. Real exchange rate appreciations make imported inputs cheaper and create an output effect: exports fall, real wages fall, and employment increases. The NAFTA dummy variable carries a dual effect: employment rises in border firms and falls in interior firms.

The Effects of Trade on Research and Development

This paper examines how U.S. manufacturing firms' research budgets respond to international trade. Using a simple dynamic model of R&D investment and dynamic heterogeneous panel estimation techniques developed by Peseran, Shin, and Smith (1999), firm-level data reveal that increased import competition tends to reduce the research efforts of purely domestic U.S. manufacturing firms. Firms with foreign sales, however, respond very weakly to import competition, and increase research efforts in response to real exchange rate depreciation.

Exporting Labor or Goods? Long-term Implications for the Palestinian Economy

The restricted access of the Israeli labor market to Palestinian workers is a major negative shock for the Palestinian economy, and naturally raises the question of whether an alternative strategy to exporting labor is feasible and presents at least similar growth opportunities. In this paper, we develop a dynamic general equilibrium model to assess the impact of restricted access to the Israeli labor market on the Palestinian export performance, and in turn, on GDP growth. The results suggest first that exporting large flows of Palestinian workers in Israel tends to reduce the capacity of the Palestinian industry to export goods. Second, that - even under optimistic assumptions on the export-led growth potential of the Palestinian economy - the induced depreciation of the real exchange rate after the closure will not have sufficient growth effects to avoid large per capita income losses. Third, that the adoption of appropriate trade and fiscal policies in this context could significantly magnify the potential growth impact of a real exchange rate depreciation. Fourth, that external assistance is likely to have then a larger developmental impact, than in the case of a re-opening of the Israeli labor market to Palestinian workers.

The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation

This paper studies a quantitative dynamic-optimizing business cycle model of a small open economy with staggered price and wage setting. The model exhibits exchange rate overshooting in response to money supply shocks. The predicted variability of the nominal and, especially, of the real exchange rate is noticeably higher than in standard Real Business Cycle models with flexible prices and wages. A positive domestic money supply shock is predicted to lower the domestic interest rate, raise GDP, and trigger a depreciation of both the nominal and real exchange rate. Increases in domestic productivity and in the world interest rate are also predicted to induce a nominal and real exchange rate depreciation.

Learning by doing and the Dutch disease

This paper develops a model of learning by doing and the Dutch disease that extends the earlier literature in two ways. First, it is assumed that both the traded and the non-traded sector can contribute to learning. Second, it is assumed that there are learning spillovers between the sectors. It is shown that within such a model a foreign exchange gift results in a real exchange rate depreciation in the long run, due to a shift in the steady-state relative productivity between the traded and the non-traded sector. In contrast to standard models of the Dutch disease, production and productivity in both sectors may go up or down. The conditions for the different cases are worked out.

Capital Controls and Financial Crises

The purpose of this paper is to explain the reluctance of developing countries to open up their capital market to foreigners, and the conditions inducing an emerging market economy to switch its policies. We consider an economy characterized initially by a one-sided openness to the capital market domestic agents can borrow internationally, but foreign agents cannot hold domestic equity. We identify conditions under which the emerging market's capitalists would oppose financial reform. This would be the case if 'green field' investment by multinationals would bid up real wages, reducing thereby the rents of domestic capitalists. A financial crisis that raises the domestic interest rate and causes a real exchange rate depreciation may induce the emerging market's capitalists to support opening up the economy to FDI. This attitude switch is more likely to occur the greater the debt overhang, the lower the borrowing constraint, and the weaker the market power of foreign entrepreneurs. Even in these circumstances, the emerging market's capitalists would prefer a partial reform to a comprehensive one -- they would prefer to maintain the restrictions on 'green field' FDI.