Real Exchange Rate Overvaluation Research Articles

Ecological transition and structural change: A new-developmentalist analysis

The article aims to analyze the ecological transition and the structural change by considering the role of Medium-Income Trap (MIT) with respect to exchange rate overvaluation and (re)industrialization, according to the structuralist-New Developmentalist Approach. The ecological challenges can be faced by an ecological transition based on Ecological Technological Progress and Ecological Structural Change (ESC). The ESC can be represented by the increase of the share of green activities in output for increasing the environmental efficiency of the economy. The theoretical core of the new developmentalism is the tendency of overvaluation of real exchange rate for middle income countries whose sources are the Dutch disease (and the growth with external saving strategy). This fact generates the MIT concerning the negative impact of overvaluation real exchange rate on the industrial development. Thus, we analyze how the ESC interact with the drivers of overvaluation exchange rate by carrying out a post-Keynesian model based the Structuralist-New Developmentalist features. In this perspective, we integrate the issue of the achievement of the environmental targets as indicated by the Climate International Conferences and by the UN initiative of the Sustainable Developments Goals, to the structural change necessary for the economic catching-up of the middle income (and/or developing) countries.

Political economy of real exchange rate levels

Voluminous theoretical and empirical research shows that real exchange rate (RER) undervaluation could be conducive to economic development. Why do countries then often avoid the pursuit of policies that facilitate undervaluation or even intentionally pursue RER overvaluation? We address this question by investigating economic, institutional, and policy factors that help explain the within-country variation in RER undervaluation in a baseline panel of 68 developing and 39 developed countries between 1989–2013 using OLS and GMM estimators. Our results indicate that increases in the share of non-tradable sector output, imported input intensity of exports, and capital account openness is systematically associated with less undervalued RERs. We also provide evidence that independent central banks and democratic institutions are linked to RER overvaluation. Our key findings are robust to using alternative specifications, measures, estimation techniques, samples, and additional control variables. A preliminary comparison of Latin America and East Asia suggests interesting support for our key findings.

Capital Account Liberalisation and Crises: A Meta-Analysis

The present study is a critical survey of the literature on the impact of capital account liberalisation on both banking and currency crises. The objective of the study is to identify the publication bias and explore heterogeneity in the extant studies. For measuring the effect size of capital account liberalisation on banking and currency crises, an identification of relevant studies is done. Partial correlation coefficient is used for measuring standardised effect size. Funnel asymmetry test (FAT) and precision effect test (PET–PEE) are used for identifying publication selection bias. Meta-regression analysis (MRA) is done for exploring the heterogeneity in literature. I did meta-analysis on 121 t stats reported in 14 empirical papers. The results of the FAT–PET–PEE test indicate that publication bias does not exist in the literature. The study explains the heterogeneity of results reported in earlier studies. De facto measure, size of economy, inflation, real interest rate differential, real effective exchange rate overvaluation, current account balance to GDP and reserve money to GDP are the major impacting variables of both banking and currency crises. The probit approach is seen to be more appropriate in capturing the above relationship. JEL Codes: C1, F6, G01

The Asymmetric Effects of the Determinants of Real Exchange Rate in Jordan: The Role of Price Index Selection

This study examines the asymmetric effect of real exchange rate (RER) determinants on RER. Workers' remittances (REM), foreign reserves (RES), government expenditures (EXP) and terms of trade (TOT) were chosen as determinants of the RER, which was measured with four different price indices; (CPIU.S/CPIJOR, GDP Def. rU.S/GDP Def.JOR, IPIU.S/GDP Def. JOR , PPIU.S/GDP Def. JOR). Quarterly data were applied from Jordan for the period of (2004-2017) using nonlinear autoregressive distributed lag (NARDL) model. The results indicate that the choice of the price index affect significantly the symmetry/asymmetry patterns of the RER determinants, thus, the choice of the price index should be directly linked to the purpose of the study to gain accurate results. Moreover, expansive fiscal policy may increase TOT by causing a country’s currency to depreciate. However, TOT was the only determinant that resulted in symmetrical behavior regardless of the price index chosen as a basis for measuring a currency’s RER. Contrary to the study’s hypothesis, fluctuations in Jordanian imports and exports do not fluctuate with RER. With respect to the short-run symmetry, foreign reserves (RES), governmental expenditures (EXP) and TOT may influence RER asymmetrically leading to possibility to peg RER in the short-run. The expansionary economic policy may have a greater impact on RER than the contractionary policy, which may in turn increase TOT. Hence, overvaluation of RER may hamper economic growth. This may be particularly true for emerging economies, such as Jordan’s, this may be particularly true for emerging [or emerging-market] economies, such as Jordan’s, which are overseen by weak institutions and plagued by market failure.

A meta de inflação é desestabilizadora? Lições da América Latina

ABSTRACT This paper argues that several aspects of the productive structure and the macroeconomic policies of Latin American countries, when combined with a Taylor Rule, may produce too much output volatility and a bias towards real exchange rate overvaluation. Relaying on a simple Aggregate Demand - Aggregate Supply model, we show that this is a likely outcome when: a) the real interest rate elasticity of demand is low; b) depreciations have strong contractionary effects; and c) the exchange rate pass-through is relatively large. These conditions imply that depreciations are contractionary and a have a strong effect on inflation.

Effects of the business cycle on real exchange rate misalignments with respect to exchange rate regimes

This paper explores the relationship between real exchange rate (RER) misalignments and economic fundamentals with respect to the exchange rate regime choice. In a first step, using the technical inefficiency model, we measure RER misalignments and, more specifically, RER overvaluation. In a second step, we assess the effects of the main economic indicators and the choice of a country's exchange rate regime on RER overvaluation. Our empirical findings, based on nonlinear specifications and impulse response functions of Panel Vector Auto Regression (PVAR) estimations, reveal that for developing countries, and during the expansion and peak phases of the business cycle, the floating exchange rate regime may be used as a policy tool to contain the pressure in the exchange rate, and so limit overvaluation. Our findings also reveal that in the context of fixed and intermediate exchange rate regimes, an expansionary monetary policy is an effective tool to stabilize exchange rate fluctuations and mitigate overvaluation.

Real Exchange Rate Misalignment and Economic Growth Nexus: Evidence from Southern African countries

This paper investigates the link between real exchange rate misalignment and Southern African countries' economic growth. The study used panel data for 16 Southern African countries over 17 years. Generalized methods of moments (GMM) was applied to analyze the panel growth equation. The estimated results have suggested that the real exchange rate, real exchange rate misalignment, terms of trade, and foreign direct investment explains variation in income growth of southern African countries. The real exchange rate appreciation over the study period has adversely affected growth, whereas real exchange rate undervaluation suggests a positive impact on annual income growth. Unfavourable terms of trade were found to hurt growth, whereas foreign direct investment upsurge stimulates growth. Thus, policymakers in their respective African countries ought to diligently monitor real exchange rate misalignment in the foreign exchange market. An increase in real exchange rate overvaluation may adversely affect the trade and current account balances, which might ultimately hurt growth.

Deindustrialization, economic complexity and exchange rate overvaluation: the case of Brazil (1998-2017)

We analyze the determinants of the deindustrialization of the Brazilian economy in the period between 1998 and 2017. This is a typical example of ‘premature deindustrialization’ in the sense that the major reason for the fall in the manufacturing share has not been the increase in per-capita income but rather real exchange rate overvaluation. In the Brazilian case, real exchange rate overvaluation results both from an appreciation of the real effective exchange rate, and an increase in the equilibrium value of the real exchange rate, the “industrial equilibrium exchange rate” of the new developmentalist literature. The elimination of the real exchange rate overvaluation requires not only the adoption of a macroeconomic policy regime in which some kind of real exchange rate targeting is adopted, but also industrial policies designed for increasing the economic complexity of the Brazilian economy and, hence, to reduce the equilibrium value of the real exchange rate. JEL codes : O11, O14, O24

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.

New Developmentalism: beyond competitive exchange rate

ABSTRACT The aim of this article is to show that the achievement of a competitive level for real exchange rate is a necessary, although not sufficient condition for the catching-up of middle-income countries to developed countries. It is also required a change in the long-term expectations of real exchange rate by entrepreneurs which requires the elimination of the underlying causes of the tendency of overvaluation of real exchange rate, that encompass the Dutch Disease and capital account liberalization. Due to the existence of technological gap, industrial equilibrium exchange rate in middle-income countries may be higher enough to compensate domestic firms for their technological backwardness relative to firms of developed countries. This means that there is a space for Industrial and Science and Technology Policies in the New-Developmentalist theoretical framework.

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.

Trade competitiveness of Pakistan: evidence from the revealed comparative advantage approach

PurposePakistan’s natural endowment of labour and land is suitable for labour-intensive agriculture and manufacturing sector. This study aims to investigate international trade competitiveness of Pakistan in 14 major industries of agriculture and manufacturing sector, accounting more than 85 per cent of total export receipts.Design/methodology/approachThe competitiveness of Pakistan in selected industries of agriculture and manufacturing sectors from 2003 to 2014 is investigated using the revealed comparative advantage (RCA) index, introduced by Balassa (1965) on HS data collected from the United Nations Commodity Trade database. The obtained indices in this study are then subjected to panel regression analysis to investigate the effect of domestic productivity growth and real exchange rate on international trade competitiveness of major industries.FindingsThe results show that the agriculture sector of Pakistan has higher comparative advantage in raw cotton, cereals, raw leather and fruits. The raw cotton shows the highest competitiveness of 54.46 which is followed by cereals (17.13), leather (9.83) and fruits (1.97). The RCA of the manufacturing sector shows that textile (54.85), carpets (10.72), sports goods (2.18) and beverages (1.47) have higher competitiveness. The RCA, in relatively capital-intensive industries, shows a high disadvantage. The trend analysis shows distorted competitiveness in labour-intensive, textile, carpet and footwear industries. The results of panel regression analysis show that the domestic productivity growth and real exchange rate depreciation have a significant positive impact on the international competitiveness of selected industries. The study urges Pakistan to make its macroeconomic environment investment-friendly and encourage investment in deteriorating labour-intensive industries.Practical implicationsGlobalisation has significantly increased international competition, and Pakistan is losing its competitiveness in labour-intensive industries owing to lack of domestic value addition and development efforts. The major problem with the productivity of these industries is the lack of proper infrastructure, acute energy crisis, lack of domestic and foreign investment and overvaluation of real exchange rate. The domestic investors are shifting their capital either to other domestic sectors and/or other investment-friendly countries. Policymakers in Pakistan should address the problems of these important labour-intensive industries. The government needs to understand macroeconomic uncertainties and make investment-friendly policies to encourage domestic and foreign investment. The future studies should perform in-depth research to identify both microeconomic and macroeconomic variables responsible for deterioration in competitiveness of major labour-intensive industries in the agriculture and manufacturing sectors of Pakistan.Originality/valueThis study is a comprehensive examination into the nature and pattern of international competitiveness of Pakistan in 14 important industries of the agriculture and manufacturing sector which has seldom been investigated empirically. The obtained indices in this study are also subjected to panel regression analysis to explore the effect of domestic productivity growth and real exchange rate depreciation on the international competitiveness of Pakistan.

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.

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.

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.

Making explosive cocktails: Recipes and costs of 20 Argentine crises from 1865 to 2004

The objective of this paper is twofold. Firstly, we investigate what were the “recipes” of the 20 Argentine currency crises from 1865 to 2004 using regression tree analysis, which is a non-parametric data classification technique. Secondly, we evaluate the costs of Argentina's crises in terms of output losses and recovery time.We obtained three “recipes” that constitute an early warning system. The most costly and frequent mix has two “ingredients”: high Public Expenditures (% of GDP) and Current Account Deficit (% of GDP). The less frequent and less costly mix consists of moderate Public Expenditures, Real Exchange Rate Overvaluation, and high International Interest Rates. Finally, the mix with intermediate costs and medium frequency is made up of five ingredients: moderate Public Expenditures, Real Exchange Rate Overvaluation, moderate International Interest Rates, strong decline in Bank Deposits, and high ratio of Monetary Aggregate M2 to International Reserves.

Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries

This paper empirically analyzes how exchange rate policy affects the issuance and pricing of international bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher sovereign bond spreads and are less likely to issue bonds. Quantitatively, changing a free-floating regime to a fixed regime decreases the likelihood of bond issuance by 4.6% and increases the bond spread by 1.3% on average. Furthermore, countries with real exchange rate overvaluation have higher bond spreads and higher bond issuance probabilities. Moreover, such positive effects of real exchange rate overvaluation tend to be magnified for countries with fixed exchange rate regimes. Our results suggest that choosing a less flexible exchange rate regime in general leads to higher borrowing costs for developing countries, especially when their currencies are overvalued.

Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries

This paper analyzes how exchange rate policy affects the issuance and pricing of sovereign bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher spreads and are less likely to issue bonds. Changing a free‐floating regime to a fixed regime decreases the likelihood of bond issuance by 5.5% and increases the spread by 88 basis points on average. Countries with real overvaluation have higher spreads and higher bond issuance probabilities. The effects of real overvaluation on sovereign bonds tend to be magnified for countries with fixed exchange rate regimes.

Government Spending and Real Exchange Rate Case of Albania

Various studies have found that governmentspending can lead to overestimation orunderestimation of the real exchange rate, depending on the composition of theseexpenditures. The purpose of this paper is toassess the impact of government spendingon real exchange rate in Albania. In this paper is used a log liner model with quarterlydata. Other explanatory variables in this model are: foreign direct investment, remittances,real GDP per capita, openness. Variables are tested for unit root and cointegration. Theresults indicate that government spendingis associated with overvaluation of realexchange rate in Albania.JEL Classification: E62; F31Various studies have found that governmentspending can lead to overestimation orunderestimation of the real exchange rate, depending on the composition of theseexpenditures. The purpose of this paper is toassess the impact of government spendingon real exchange rate in Albania. In this paper is used a log liner model with quarterlydata. Other explanatory variables in this model are: foreign direct investment, remittances,real GDP per capita, openness. Variables are tested for unit root and cointegration. Theresults indicate that government spendingis associated with overvaluation of realexchange rate in Albania.

IMPLICATIONS OF REAL EXCHANGE RATE MISALIGNMENT IN DEVELOPING COUNTRIES: THEORY, EMPIRICAL EVIDENCE AND APPLICATION TO GROWTH PERFORMANCE IN ZIMBABWE

AbstractThe influence of exchange rate signals in an economy is very powerful and often pervasive. Moreover, sustained real exchange rate overvaluation will, by distorting resource allocation away from productive activities, eventually lead to drastic adjustments of relative prices and reduction of aggregate economic growth. However, the direct theoretical and empirical link between exchange rate misalignment and macroeconomic indicators still remains to be fully understood. Nonetheless, empirical studies continue to make attempts to understand this relationship by exploring relationships that incorporate different measures of exchange rate misalignment in traditional growth regression models. Based on a behavioural equilibrium exchange rate derived measure exchange rate misalignment, this paper presents an empirical analysis of the relationship between real gross domestic product growth and real exchange rate misalignment for Zimbabwe. After controlling for other structural and policy variables, the main findings demonstrate that exchange rate misalignment exerts a negative and highly statistically significant impact on growth. Overall, the results lend support to the hypothesis that chronic real exchange rate overvaluation was a key fundamental behind the post‐2000 economic growth contraction in Zimbabwe.