Presentation on theme: "1 ACADEMY OF ECONOMIC STUDIES DOCTORAL SCHOOL OF FINANCE AND BANKING Dissertation Paper The Equilibrium Real Exchange Rate (An Empirical Analysis on the."— Presentation transcript:
1 ACADEMY OF ECONOMIC STUDIES DOCTORAL SCHOOL OF FINANCE AND BANKING Dissertation Paper The Equilibrium Real Exchange Rate (An Empirical Analysis on the USD/ROL exchange rate) Student: Cristina Maria Iacob Supervisor: Professor Moisă Altăr
2 CONTENTS Literature review The concept of Equilibrium Real Exchange Rate (ERER) and its importance The model The data Estimating the ERER and the degree of misalignment Concluding remarks
3 LITERATURE REVIEW The FEER approach Williamson (1985, 1994): the ERER is calibrated at a level consistent with both internal and external balance. The BEER approach P.Clark and R.MacDonald (1997,1998,2001) J.Baffes, I.A.Elbadawi, S.A.O’Connell (1997) T.Feyzioglu (1997) L.Halpern and C.Wyplosz (1996,1998,2001) B.Egert (2001), B.Y. Kim and I.Korhonen (2002) a two-step procedure: a simple behavioral ERER relationship is estimated and then this is used to determine the misalignment.
4 THE CONCEPT OF ERER The PPP Theory The PPP Theory: the exchange rate should be driven only by the level and movement of the prices in the two countries ; - the wrong rule to follow by transition economies (lack of historical data; non-conventional factors ). The Equilibrium Real Exchange RateThe Equilibrium Real Exchange Rate is the level of the real exchange rate when internal (equilibrium in the non- tradable market) and external (sustainability of long-term capital flows) balances are achieved.
5 THE IMPORTANCE OF ERER External competitiveness External competitiveness: overvalued currency: high export prices, loss of competitiveness; in transition economies (reduced output and high unemployment) e xport-led growth argues in favor of slightly undervalued exchange rates. Joining the EU and adopting the Euro Joining the EU and adopting the Euro: ERM2: an undervalued currency is susceptible to experience inflationary pressure in the process of real appreciation (fail to meet the Maastricht convergence criterion on inflation).
6 THE ROMANIAN ECONOMY The NBR’s objective: to assure currency stability in order to maintain price stability. Managed float exchange rate regime. 19971997: foreign exchange market liberalization; the last stage of price liberalization high jump in inflation and nominal depreciation. 19991999: peak of the due payment of external debt balance of payment crisis (the country didn’t enter payment incapacity). High liberalization of the capital account.
7 THE REAL EXCHANGE RATE USD/ROL (1995-2002) The beginning of transition: real depreciation. This is followed by real appreciation driven not by increases in productivity, but by a “natural recovery” process. 1997: nominal depreciation and higher inflation real appreciation. 1999: nominal and real depreciation. 2001: real appreciation followed by nominal appreciation
8 THE MODEL ( S.Edwards (1989) and Montiel (1996) ) A small, open economy based on two sectors. Maximizing utility households:. The dynamic budgetary constraint: The public sector: Internal balance: External balance:
9 THE DATA Internal balance: CREDIT (non-governmental), DEP (difference between foreign currency and ROL deposits); External balance: NFA (net foreign assets to GDP), OPEN (exports plus imports to GDP); GDP proxied by the index of industrial output Real indeces (CPI deflated), fixed base January 1995=100; Monthly data Source: NBR Annual Reports
10 THE GOAL To estimate the equilibrium real exchange rate as: Cointegration technique (Johansen, Engle-Granger) - + +/- +
11 DECOMPOSING REAL AND NOMINAL EXCHANGE RATE MOVEMENTS VAR analysis (Blanchard and Quah decomposition) on the log of the real and nominal exchange rate (I(1)). The restriction:nominal shocks have no long-run effect on the RER Variance Decomposition The importance of nominal shocks (due to NBR’s interventions)
12 ESTIMATING THE ERER Unit root tests Variable ADF PP RER C I(1) C I(1) NFA TC I(1) TC I(1) OPEN C I(1) C I(1) CREDITC I(1) C I(1) DEP C I(1) C I(1) 1% significance level; the unit root tests are biased towards accepting the null of a unit root in the presence of structural breaks.
13 ESTIMATING THE ERER VAR analysis Variables in levels, 2 lags; Impulse response functions: + - + + +
14 ESTIMATING THE ERER Johansen cointegration test
16 ESTIMATING THE ERER Engle-Granger cointegrating relation: RER=0.356169-0.053560*NFA+0.131087*OPEN+0.193242*DEP+ (0.048655) (0.005841) (0.031664) (0.015865) +0.320477*CREDIT (0.022323) The cointegrating relation (stationary residuals:ADF and PP)
17 ESTIMATING THE ERER The estimated ERER Fitted ERER on the Johansen equilibrium relationship Fitted ERER on the Engle-Granger equilibrium relationship The estimated ERER will allow us to determine the misalignment of the exchange rate.
18 SHORT-RUN DYNAMICS VEC representation: D(RER) = - 0.32354355*( RER(-1) - 0.5384287381*OPEN(-1) + +0.06886480321*NFA(-1) - 0.03830424481*DEP(-1) - 0.2985004165*CREDIT(-1) - 0.02129682639 ) - 0.06856552318*D(RER(-1)) - 0.107401684*D(OPEN(-1)) - 0.004766388211*D(NFA(-1)) + 0.06294160197*D(DEP(-1)) + +0.09737686503*D(CREDIT(-1)) + 0.0008867915601 The time required to dissipate x% of a shock in the RER: α = the absolute value of the speed of adjustment 0.0257559.272 the time it takes for the RER to come to equilibrium after a 1% shock, is 0.025755 years or 9.272 days.
19 WEAK-EXOGENEITY TESTS The NFA and the proxi for the demand of foreign currency (DEP) are weakly exogenous. OPEN and CREDIT accomodate to RER disequilibrium.
20 STABILITY TESTS The CUSUM test on the VEC representation of the Johansen equilibrium relationship The CUSUm test on the Engle- Granger estimated equilibrium relationship Only the Johansen estimated equilibrium relationship has stable coefficients over the whole sample. The second relation is not stable.
21 EXCHANGE RATE ACTUAL MISALIGNMENT Model 1: On average, the national currency was undervalued Model 2: On average, the national currency was overvalued
22 EXCHANGE RATE TOTAL MISALIGNMENT Estimated ERER based on the long-run value of the fundamentals vs. the actual RER Total misalignment for Johansen equilibrium relation Total misalignment for Engle- Granger equilibrium relation Total misalignment includes the departure from equilibrium of the fundamentals, too. Model 1 undervaluation of the national currency. Model 2 overvaluation of the national currency.
23 THE MODEL’S FORECAST ABILITY The VEC representation of the first model the one step ahead forecast of the real exchange rate: The model yields a reasonable approximation of the real exchange rate for the period 1995:01-2002:12 It reveals an overvaluation of the national currency during the second half of 2002
24 CONCLUSIONS Nominal factors (monetary policy) play an important role in exchange rate determination. The undervaluation of the national currency improves the external competitiveness and favorizes export-led growth. Further analysis should determine the EUR/ROL ERER. The managed float regime is more suitable than a fixed regime. The results are determined by the choice of fundamentals.
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