Real Exchange Rate Movements Research Articles

Exchange Rate Regimes and the Real Exchange Rate

It is well established now that the (nominal) exchange rate regime has important implications for the behavior of real exchange rates. Two key stylized facts in this regard are that real exchange rate variability is greater under flexible exchange rates than under fixed exchange rates and that real and nominal exchange rate movements are positively related under flexible exchange rates. One class of models that are consistent with these observations are sticky price models. This paper constructs an equilibrium model of real and nominal exchange rate determination that is capable of explaining these observed facts without resorting to differences in other policies across regimes. The paper thus shows that there is an inherent tendency, due solely to the difference in monetary adjustment mechanisms across alternative exchange rate regimes, for real exchange rates to exhibit greater variability under flexible exchange rates and this tendency turns out to be compatible with the observed positive correlation between real and nominal exchange rates. The model relies on the inflation tax mechanism and the impact of temporary, country-specific shocks to generate these results.

Real Exchange Rate Movements in High Inflation Countries

We empirically assess the sources of fluctuations in the real exchange rates of four high inflation countries, for which monetary shocks are generally believed to be predominant. In a benchmark model we identify fiscal, monetary, and output shocks based on a general-equilibrium optimizing model. We then estimate two alternative extensions. In the first, we decompose the output shock into supply and demand disturbances; in the second, the monetary shock is further decomposed into money supply and nominal exchange rate disturbances. Monetary shocks are found to be generally significant. Real shocks, especially those associated with government policy restrictions on the flow of currency, income from foreign investments, capital, and/or goods, are uniformly more influential however. The paper suggests that analyses of real exchange rates in high inflation economies using models emphasizing monetary shocks and sticky prices could be improved by not negtecting real shocks.

A reappraisal of parity reversion for UK real exchange rates

We apply a new approach to test the long-run purchasing power parity theory of real exchange rate movements for the UK. The question of whether real exchange rates have a unit root or are mean reverting is set in the more general framework of fractionally differenced time-series models. Our results suggest that in the current period of floating rates, UK real exchange rates return to parity in the long run.

Government spending And Movements Of Real Exchange Rates: An Empirical Investigation

This paper investigates whether a stylized two-country real model can explain movements of real exchange rates during the recent floating exchange rate period. It is found that, under reasonable calibration, the stylized model does well in terms of matching moments and autocorrelation coefficients of changes in real exchange rates. [F31]

Real Exchange Rate Misalignment and Agricultural Export Performance in Developing Countries

The influence of fluctuating currency values on agricultural trade has been acknowledged, especially since the demise of the Bretton Woods system of fixed exchange rates. Following G. E. Schuh's pioneering articles linking exchange rates to country performance in the global agricultural market, several attempts were made to quantify the effects of nominal and real exchange rate movements on agricultural trade.' Recently, another body of literature emerged aimed at quantifying the effects of exchange rate risk on trade.2 Despite these studies, inadequate attention has been directed toward analyses of underlying policies that directly influence real exchange rates and that indirectly affect trade performance. Specifically, the issue of incorrect real exchange rate alignment has been ignored. Real exchange rate misalignment occurs in markets in which actual exchange rates are not allowed to adjust to changes in economic fundamentals. Unsustainable monetary, fiscal, and various trade and exchange control policies are its principal cause. Calculation of misaligned exchange rates is dependent on the ability to disentangle equilibrium from disequilibrium disturbances affecting movements in actual real exchange rates. Quantification represents a major challenge. Purchasing power parity (PPP) provides the simplest way to estimate misalignment. However, real exchange rate deviations from PPP often do not indicate incorrect alignment of the real exchange rate because the actual rate ought to vary in response to external or internal shocks that modify the equilibrium rate. Ideally, misalignments are measured using real exchange rates that are permitted to vary in response to changed economic conditions. The changing path of real equilibrium exchange rates is somewhat elusive and can be identified using a structural model.

Fiscal announcements and real exchange rate dynamics

This paper examines the dynamic impact of anticipated government spending on real exchange rates in a general-equilibrium framework. I show that an increase in government spending causes persistent movements in real exchange rates, and that the time profile of real exchange rates differs with patterns of government spending. Hence, one of the explanations for the misalignment and excess volatility of real exchange rates during the flexible exchange rate system may be volatile changes in government spending.

Asian–Pacific real exchange rates

Real exchange rate behaviour is investigated for 11 Asian–Pacific countries between 1976 and 1990 using a modified version of principal components analysis. The standard principal component analysis is changed such that the results are independent of the numeraire currency. For the full-sample period the dominant Asian exchange rate movements are relative to Indonesia, Japan and the United States. Significant changes in the convariance structure have taken place since 1986. It appears that Asian—Pacific real exchange rate movements since September 1986 are dominated by Australia, Korea, New Zealand and Japan. This contradicts the popular notion of an emerging yen-block in the Asian—Pacific region

Changing determinants of Japanese foreign investment in the United States

Japan's changing share of new foreign investments in the United States is analyzed in a panel data set (1975–1986) to obtain the following conclusions: (1) Japanese R&D spending exerts an increasingly positive effect on the country's foreign investment; (2) in the 1980s Japan's share became positively related to advertising intensity; (3) foreign investment follows upon Japan's export successes and is increased by U.S. trade restrictions; and (4) foreign investment behaves as arbitrage in response to movements in real effective exchange rates.

Speculation, incomplete currency market participation, and nonfundamental movements in nominal and real exchange rates

This paper studies possible nonfundamental movements in nominal and real exchange rates arising from a world economy with speculation, incomplete participation in international currency markets and nontraded goods. The model is capable of generating equilibria which display comovements in nominal and real exchange rates not unlike those observed in actual economies.

Ex ante purchasing power parity: An empirical note

In the paper, the EAPPP theory was discussed and three different tests with increasingly statistic power were proposed and implemented. The results are mixed, since the theory passed the randomness and orthogonality tests, but not the direct regression test. The impression is that EAPPP seems to hold in a weak sense, since the evidence confirms random movements of real exchange rates and an efficient use of information by agents but not the constraints on (14) postulated by EAPPP. In general, the results of the present study are in accordance with those of Cumby and Obstfeld [1984], Mishkin [1984], MacDonald [1985] and Gaab et al. [1986] who found only weak support to the EAPPP theory. Furthermore, in the case of the dollar-lira exchange rate, our findings are different from those of Tronzano [1987] according to which “although PPP holds very badly in its traditional (absolute or relative formulation), ex ante PPP (both in “weak” and in “strong” version) [is] highly supported by data”. In fact, in our case both the second orthogonality test and the regression test are unfavourable to the EAPPP.

An empirical inquiry into the nature of the forward exchange rate bias

This paper tests whether anticipated real exchange rate movements fully account for the systematic, time-varying discrepancies between forward and future spot exchange rates. The data do not reject this hypothesis. The results demonstrate that (1) real exchange rate changes are predictable; (2) anticipated real exchange rate changes are reflected in the forward bias; and (3) information available at the signing of the forward contract is useless in forecasting differences between forward and future spot prices beyond the information's ability to predict real exchange rate changes. The results emphasize the importance of real exchange rates in international asset pricing.

Real and Monetary Causes of Real Exchange Rate Movements in the Pacific Rim

Modem models of exchange rate determination suggest that real shocks can induce changes in the real exchange rate; a real shock which is permanent can induce a permanent deviation from Purchasing Power Parity (PPP). Nominal shocks, on the other hand, can induce temporary but not permanent deviations from PPP. Even if money is not neutral in the short-run, long-run money neutrality guarantees that monetary shocks of any variety have no permanent effects on the long-run value of the real exchange rate. For example, in the well-known Dornbusch [4] overshooting-model, an increase in the money supply initially causes real and nominal exchange rate depreciation. Over time, the real rate converges to its original level and the proportional change in the nominal rate approaches the percentage change in the money supply. To date, the vast majority of tests concerning PPP have been conducted for the U.S., European, and Japanese economies; most of these tests are not supportive of the hypothesis. For example, Corbae and Ouliaris [1] and Enders [5] use unit-root and co-integration tests to reject PPP for this group of nations. However, as shown by Mussa [9] and Enders [6], PPP works quite well for nations experiencing very different rates of inflation. These findings are consistent with the theoretical models of the exchange rate if the industrialized nations experience permanent real shocks while the high inflation nations experience substantial monetary growth. In this light, it is interesting to consider behavior of the real exchange rate for the Pacific Rim nations. These nations-particularly Japan and Korea-represent rapidly growing nations with strong trading ties to the United States and Europe. Comparing of the behavior of the real exchange rate between Japan and Korea (two rapidly growing nations) might provide an interesting contrast to that of Korea versus other Pacific Rim nations and Korea versus the United States.

A New Way to Analyze International Equity Market Performance

Under a new framework for comparing international equity market returns, local returns are split into two real components. One component reflects changes in earnings and one reflects changes in the price paid for earnings. Real exchange rate movements and dividend income are then incorporated into the analysis. The resulting common-currency returns allow one to separate changes in underlying characteristics from changes in the markets' valuation of these characteristics. Historical analysis shows that underlying corporate performance in real terms has been similar from country to country. The observed out and under-performances of various countries can be attributed to the markets' revaluation of earnings and currency. These observations have implications for market-valuation models.

Real and Nominal Exchange Rates in the Long Run

This paper decomposes longer-run movements in (major) dollar real exchange rates into components associated with changes in nominal exchange rates and price levels, and their comovements. Though the decompositions suggest some permanent movements, they imply that there are large transitory components in real exchange rates. These transitory components in real exchange rates are found to be closely associated with those in nominal exchange rates. A stochastic version of Dornbusch’s overshooting model—configured with representative parameter values for the United States and subjected to permanent nominal shocks—can rationalize these transitory comovements of nominal and real exchange rates as well as several other features of the decompositions.

Real and Nominal Exchange Rates in the Long Run

This paper decomposes longer-run movements in (major) dollar real exchange rates into components associated with changes in nominal exchange rates and price levels, and their comovements. Though the decompositions suggest some permanent movements, they imply that there are large transitory components in real exchange rates. These transitory components in real exchange rates are found to be closely associated with those in nominal exchange rates. A stochastic version of Dornbusch`s overshooting model--configured with representative parameter values for the United States and subjected to permanent nominal shocks--can rationalize these transitory comovements of nominal and real exchange rates as well as several other features of the decompositions.

Systematic movements in real exchange rates in the G-5: Evidence on the integration of internal and external markets

Many recent studies have documented the random behavior of real exchange rates. This paper shows that real exchange rates defined for different sectors of an economy move closely together with one another even though each of the sectoral real exchange rates taken alone has a large random component. The sectoral real exchange rates are tied together by internal price links due to factor mobility within each national economy. Any differences between real exchange rates which develop, moreover, can be explained almost entirely by productivity differentials, at least in the long run. This paper contrasts the strong ties which bind together prices from different sectors internally with ties that bind the prices of goods from the same sector internationally. Prices are shown to be much more highly correlated internally than externally because flexible exchange rates disrupt normal pricing relationships between goods from different countries.

Real exchange rate variability and Japanese industrial employment

This paper studies the effects on employment of real exchange rate movements in Japan during the period 1973–1986 and compares them with similar effects for the United States. As expected, employment reacts to exchange rate fluctuations more sluggishly in Japan than in the United States in most of the industrial sectors considered. The rate of unemployment consistent with Williamson's fundamental exchange rates is only marginally higher than the observed rate and can be set close to 3% if there are no changes in policy rules.

Dominant real exchange rate movements

Principal component analysis is used to investigate two types of questions about the behavior of real exchange rates. First, what group of currencies display the same empirical regularities? Can we attribute dominant movements in real exchange rates to a specific country ( e.g., the United States) or a group of countries? Second, does the prevailing nominal exchange rate regime affect the long-run properties of real exchange rates? In the empirical analysis we use real exchange rates between 15 industrial countries for the sample period 1957 to 1986. The standard principal component analysis is modified such that results are independent of the numeraire currency.

Misalignment of Exchange Rates: Effects on Trade and Industry

Economists writing on flexible exchange rates in the 1960s foresaw neither the magnitude nor the persistence of the changes in real exchange rates that have occurred in the last fifteen years. Unexpectedly large movements in relative prices have lead to sharp changes in exports and imports, disrupting normal trading relations and causing shifts in employment and output. Many of the largest changes are not equilibrium adjustments to real disturbances but represent instead sustained departures from long-run equilibrium levels, with real exchange rates remaining misaligned for years at a time. Contributors to Misalignment of Exchange Rates address a series of questions about misalignment. Several papers investigate the causes of misalignment and the extent to which observed movements in real exchange rates can be attributed to misalignment. These studies are conducted both empirically, through the experiences of the United States, Great Britain, Japan, and the countries of the European Monetary System, and theoretically, through models of imperfect competition. Attention is then turned to the effects of misalignment, especially on employment and production, and to detailed estimates of the effects of changes in exchange rates on several industries, including the U.S. auto industry. In response to the contention that there is significant hysteresis in the adjustment of employment and production to changes in exchange rates, contributors also attempt to determine whether the effects of misalignment can be reversed once exchange rates return to earlier levels. Finally, the issue of how to avoid or at least control misalignment through macroeconomic policy is confronted.

The pricing of forward exchange rates

This paper tests the hypotheses that (1) risk premia fully account for the observed systematic discrepancies between forward and future spot exchange rates; and (2) ‘efficient markets versions’ of PPP holds. A simple theoretical framework is used to derive testable restrictions on the parameters of a multivariate regression model. The data reject the restrictions and each hypothesis. In contract to past investigations, the empirical analysis strongly suggest that forward exchange rates incorporate anticipated real exchange rate movements.