Real Exchange Rate Policy Research Articles

The real consequences of policy‐driven exchange rate cycles: A stylized comparison of East Asia and Latin America

AbstractI develop the implications for capital accumulation, the trade balance, and real exchange rate cycles of different policy preferences, focusing in particular on broad stylized features of major Latin American and East Asian economies. Recent development literature has renewed interest in real exchange rate policy and the desirability of avoiding overvaluations. Political science literature, on the other hand, has emphasized the role of factors such as the influence of the manufacturing sector and the nature of the work force in shaping exchange rate policy. I formalize and relate some of these insights in a simple, dynamic, developing country framework with policy makers who intertemporally optimize and voters/audiences that are myopic. Given the choice between assigning greater weight to: (1) raising immediate worker purchasing power or (2) generating wage increases and manufacturing employment over time, I show that developing countries where policy makers choose the former are more likely to experience cycles with overvaluation, trade deficits, and abrupt (postponed) devaluations. Moreover, these cyclical differences may help explain differences in structural evolution over longer periods of time.

Walking the tightrope of real exchange rate policy for development: the roles of targets, instruments, and saving rates

Real exchange rate policy can potentially be utilized to target the trade balance and/or development through capital accumulation. However, the presence of distributional conflict and the tradeoff between current and future trade imbalances complicates matters. For example, steps that address development/external account issues may influence income distribution in socially unacceptable ways. Comparative studies of the East Asian and Latin American development experiences serve to highlight this issue. I show that policy assignment matters for dynamic stability, that is, the simultaneous achievability of multiple targets. Moreover, the relative saving behavior of different functional income groups influences dynamic behavior. The analysis sheds light on why real exchange rate policy may often be infeasible, even if desirable from a developmental perspective.

A FORECASTING APPROACH TO REAL EFFECTIVE EXCHANGE RATE-OIL PRICE NEXUS IN CHINA

Motivated by the theoretical link between real exchange rates and oil prices, we utilize a univariate moving average (MA) and an augmented MA (A-MA) model to generate multi-period forecasts of China’s real effective exchange rate for 2008–2018. The MA model utilizes past information in real exchange rates, and the A-MA model utilizes past information in both real exchange rates and oil prices. We show that the A-MA forecasts are unbiased and embody useful predictive information beyond that contained in the MA forecasts. In addition, the A-MA forecasts are directionally accurate under asymmetric loss. Such accurate forecasts are useful as inputs for policymakers to design an optimal real exchange rate policy to promote trade and attract foreign investment, and for foreign entities that regard China as an attractive environment for investing in various sectors.

Real exchange rate policies for economic development

Abstract This paper analyzes the role of real exchange rate (RER) policies in promoting economic development. Markets provide a suboptimal amount of investment in sectors characterized by learning spillovers. We show that a stable and competitive RER policy may correct for this externality and other related market failures. The resulting development of these sectors leads to overall faster economic growth. A system of effectively multiple exchange rates is required when spillovers across different tradable sectors differ. The impact of RER policies is increased when they are complemented by traditional industrial policies that increase the elasticity of the aggregate supply to the RER. Among the instruments required to implement a stable and competitive RER are interventions in the foreign exchange market and regulation of capital flows. We also discuss the trade-offs associated with alternative stable and competitive RER policies and the relationship between the use of exchange rate policies for macro-stability and for development.

REAL EXCHANGE RATE AND ECONOMIC GROWTH IN EAST ASIAN COUNTRIES: THE ROLE OF FINANCIAL INTEGRATION

This study examines the role of financial integration in determining the relationship between the real exchange rate (RER) and economic growth in East Asian countries. It hypothesizes that a competitive RER could play a greater role in promoting economic growth in countries with a low degree of financial integration. A growth model was specified using a RER misalignment index and its interaction terms with financial integration as explanatory variables. Different proxies for financial integration were employed to verify the interaction. The empirical results demonstrate the significance of the interaction terms and largely validate the hypothesis. This result demonstrates that a competitive RER policy is not a general solution for economic growth and its effectiveness could largely depend on a country’s degree of financial integration.

Optimal capital controls and real exchange rate policies: A pecuniary externality perspective

A new literature studies the use of capital controls to prevent financial crises. Within this new framework, we show that when exchange rate policy is costless, there is no need for capital controls. However, if exchange rate policy entails efficiency costs, capital controls become part of the optimal policy mix. When exchange rate policy is costly, the optimal mix combines prudential capital controls in tranquil times with policies that limit exchange rate depreciation in crisis times. The optimal mix yields more borrowing, fewer and less severe financial crises, and much higher welfare than with capital controls alone.

The Political Economy of Exchange Rate Policy in Brazil: 1964-1997

This paper analyzes political economy determinants of exchange rate policy in Brazil over the past thirty years. Two complementary methodologies are used. The first consists of investigating the exchange rate policy historical context over this period. Thus, part of the paper is dedicated to an historical account of the political economy of the exchange rate policy in Brazil from 1964 to 1997. The driving force affecting exchange rate policy was the tradeoff between the positive effect of a depreciated exchange rate on the balance of payments and its negative effect on inflation. The exchange rate policy resulting from this tradeoff depended on the political environment. An analytical framework is sketched to interpret the real exchange rate policy history, and then it is extended to encompass short-run election cycles. The second methodology is statistical. A Markov Switching Model is used to characterize statistically the exchange rate regimes, defined as valued or devalued real exchange rates, and the influence of political economy variables on regime changes. The results support the interpretation pursued in the analytical part. We found statistical evidence that the probability of an appreciated exchange rate is higher under democracy than under dictatorship. Furthermore, according to our statistical results there is also an election cycle: the probability of having an appreciated exchange rate is higher in the months preceding elections while the probability of having a depreciated exchange rate is higher in the months succeeding elections.

Exchange rates and the competitiveness of the United States timber sector in a global economy

This article examines the competitiveness of the US timber industry under different exchange rate policies using a dynamic optimization model of global timber markets. Recent exchange rate adjustments by economies that compete with the United States in the timber sector suggest that it is important to consider how future trends in exchange rates may affect roundwood producers in the US that are already facing competitive pressures from abroad due to differences in capital and labor costs, environmental restrictions, and other factors. We assume that exchange rates affect the cost structure of harvesting and managing forests and simulate the model for baseline conditions and six additional real exchange rate policies. Two policies consider a strengthening United States dollar (US $) scenario, two policies examine weak South American currencies, and two scenarios assume a persistently weak US $. The results indicate that US competitiveness in the forestry sector is sensitive both to strong US $ policies and to the weak currency policies pursued by South American governments, as well as a weak dollar policy that is intended to improve the United States' competitiveness in the global timber market and reduce the large trade gap and account deficit. A 20% increase in value of the US $ compared to all other currencies can reduce harvests by 4–7% in the United States over the next 50 years, while a similar reduction in currency values in South America can reduce U.S. production less than 1%. A 20% devaluation of the US $ can increase annual domestic timber harvests by 2–3% and net present value of producer surplus by 3–10%.

Real exchange rate and openness in emerging economies: Argentina in the long run

Argentina's economic policies since the beginning of the century, give an interesting background to the study of Real Exchange Rate (RER) management in emerging countries. In this article, four types of RER overvaluation are identified. In the 1920s, Argentina provides a short example of overvaluation in a context of a fixed exchange rate policy. Moreover, the estimations show that import substitution regimes can lead to a misalignment of RER. Argentina illustrates also the difficult management of RER in a volatile environment. The results allow, in addition, to better understand the failure of the trade liberalization attempts of the country and remind that successfully integrating the world economy asks for an appropriate RER policy.

Real exchange rate and openness in emerging economies: Argentina in the long run

Argentina's economic policies since the beginning of the century, provide an interesting background to the study of real exchange rate (RER) management in emerging countries. In this article, four types of RER overvaluation are identified. In the 1920s, Argentina provides a short example of overvaluation in the context of a fixed exchange rate policy. Moreover, estimations show that import substitution regimes can lead to a misalignment of RER. Argentina illustrates also the difficult management of RER in a volatile environment. Results allow, in addition, a better understanding of the failure of the trade liberalization attempts of the country and reminds one that successfully integrating the world economy requires an appropriate RER policy.

Taux de change réel et croissance : Perspectives pour une zone euro en Méditerranée

Real Exchange Rates and Growth, Some Prospects for a Euro Zone in the Mediterranean Area The coming of the euro will force South Mediterranean Countries (SMCs) to define their exchange rate policy with respect to the new currency. This paper examines their real exchange rate policy vis-à-vis the euro. The theoretical framework allows for an underdevelopment trap, that can be overcome thanks to a temporary variation in the real exchange rate. The long run growth rate can therefore be modified through a temporary exchange rate movement. The empirical analysis shows that, given their level of development, SMCs could use their real exchange rate to grow more rapidly. This would not necessarily adversely affect their European partners. Hence, SMCs should, above all, prevent any real overvaluation of their currencies.

Real exchange rate targeting and inflation in Turkey: An empirical analysis with policy credibility

In this paper we make an empirical investigation into the conflict among objectives under a real exchange rate policy i.e. between the trade balance and domestic inflation. This occurs when the nominal exchange rate is managed to achieve a certain level of the real exchange rate in order to main external competitiveness. Our empirical analysis draws on the Turkish case, whereby the exchange rate has been the key policy instrument since the 1980s. The results from the simulation experiments with a well-defined macromodel, where the devaluation expectations are explicitly considered, indicate moderate inflationary consequences of a real exchange rate policy based on the relative purchasing power parity (PPP) rule in Turkey. Moreover, a real exchange rate appreciation is found to be contractionary. These are common characteristics of the demand-determined output case. Another major conclusion is that the exchange rate policy can provide an anchor for price stability only if it is credible.

La théorie de la parité des pouvoirs d'achat : un nouveau réexamen

Rejecting Cassel's Purchasing Power Parity , Balassa's JPE article affirmed that interna¬ tional price level relations were a function of relative real per capita incomes. This depended on four postulates. Tradeable prices tend to be equal across countries. Wage structures are the same across sectors within each country. Wages are determined by relative productivity in tradeables. In non-tradeables (i.e. services) prices are determined by wages, and by productivity levels that differ little across countries. International price comparisons and the evolution of real exchange rates confirmed Balassa's theory at first, but not in recent years. The postulates were never fully valid. They have been further weakened by technical progress that increased international productivity differences in services. Above all, many developing countries accelerated their growth through low real exchange rate policies. Balassa, the outstanding advocate of such policies, has contributed to weakening the price-income relationship he had earlier established.