Examining measures of the equilibrium Real Exchange Rate: Macroeconomic Balance and the Natural Real Exchange Rate Approaches

Wright, Nicholas Anthony (2013): Examining measures of the equilibrium Real Exchange Rate: Macroeconomic Balance and the Natural Real Exchange Rate Approaches.

Abstract

This paper examines two measures of the equilibrium real exchange rate using the Macroeconomic Balance (MB) and the Natural Real Exchange Rate (NATREX) approaches. Unlike previous studies, this study controls for business cycle effects and the debt sustainability position of countries on the current account, while providing a more comprehensive measure of relative productivity. A longitudinal panel econometric technique is utilized on a set of countries from the Western Hemisphere. These countries operate a managed float exchange rate system; have similar output per capita and equivalent levels of openness. The findings suggest that there were several intervals of exchange rate misalignment for each country, including Jamaica, over the 1990-2010 study period. The exchange rate misalignment series was found to be stationary which is an indication that there is a long-run equilibrium mean and a constant variance for exchange rate misalignment. This long-run misalignment mean is assumed to be zero by economic theory. The Autoregressive Distributive Lag (ARDL) error correction model suggests that disequilibrium in the exchange rate is adjusted by 46.2 per cent each year and the half-life deviation formula suggests that a half of the deviation in the exchange rate is corrected after 1.1 years for each country in the panel.

• Item Type: MPRA Paper
• Language: English
• Keywords: Macro-balance approach, NATREX, Current Account Misalignment, Real Effective Exchange Rates, Exchange Rate Misalignment, Trade.
• Subjects: F - International Economics > F1 - Trade > F14 - Empirical Studies of Trade; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation: Models and Applications; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Cashin, P. et al. (2009). Assessing exchange rate competitiveness in the eastern Caribbean currency union. Washington, D.C.: International Monetary Fund.

Coudert, V. & Couharde, C.. (2005). Real equilibrium exchange rate in China. Paris: CEPII.

Driver, R. L., Westaway, P., & Bank of England. (2004). Concepts of equilibrium exchange rates. London: Bank of England.

Dunaway, S. V., Li, X., & International Monetary Fund. (2005). Estimating China's "equilibrium" real exchange rate. Washington, D.C.: International Monetary Fund, Asia and Pacific Dept. and Policy Development and Review Dept.

Eckstein, Z & Friedman, A. (2011). The equilibrium real exchange rate for Israel. Bank of Israel: Papers No 57.

Edwards, S. (1989). Real exchange rates devaluation and adjustment. London: MIT Press.

Egert, B. Halpern, L. (2005). Equilibrium exchange rates in Central and Eastern Europe. London: Centre for Economic Policy Research.

Egert, B., Halpern, L., MacDonald, R., Oesterreichische Nationalbank. (2005). Equilibrium exchange rates in transition economies: Taking stock of the issues. Vienna: Oesterreichische Nationalbank.

Fida, B et al. 2012. 'Estimating Equilibrium Real Exchange Rate through NATREX Approach: A case of Pakistan. Journal of Basic and Applied Scientific Research 2(4) p. 3642-3645.

Graham, J and Steekamp, D. (2012). Extending the Reserve Bank's macroeconomic balance model of the exchange rate. Retrieved from http://www.rbnz.govt.nz/research_and_publications/analytical_notes/2012/an2012_08.pdf on July 20, 2013.

Henry and Longmore. (2003). Current Account Dynamics and the Real Effective Exchange Rate. Research and Economic Planning Division: Bank of Jamaica.

Hojman, D. (July 01, 1989). Fundamental Equilibrium Exchange Rates under Contractionary Devaluation: A Peruvian Model. Journal of Economic Studies, 16, 3.)

Husted, S. L., & Melvin, M. (1990). International economics. New York: Harper & Row.

IMF. (April 2013). World Economic Outlook Database. Retrieved from http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/weoselgr.aspx on June 11, 2013.

IMF. (2008). De Facto Classification of Exchange Rate Regimes and Monetary Policy Frameworks. Retrieved from https://www.imf.org/external/np/mfd/er/2008/eng/0408.htm on June 13, 2013.

Isard, P et al. (2001). Methodology for current account and exchange rate assessments. Washington, DC: International Monetary Fund.

Karadi, Peter. (2003). Structural and Single Equation Estimation of the NATREX Equilibrium Real Exchange Rate, Central Bank of Hungary, Working Paper.

Lee, J et al. (2006). Methodologies for CGER exchange rates assessment. Washington, DC: International Monetary Fund.

Levin, A., C.-F. Lin, and C.-S. J. Chu. 2002. Unit root tests in panel data: Asymptotic and finite-sample properties. Journal of Econometrics 108: 1–24.

MacDonald, R., and L. Ricci. (2003). Estimation of the Equilibrium Real Exchange Rate for South Africa. IMF Working Paper 03/44 (Washington: International Monetary Fund).

Maddala, G. S., & Wu, S. (January 01, 1999). A Comparative Study of Unit Root Tests with Panel Data and a New Simple Test. Oxford Bulletin of Economics and Statistics, 61, 631.

Montiel, P., & United Nations. (2007). Equilibrium real exchange rates, misalignment and competitiveness in the Southern Cone. Santiago Chile: Naciones Unidas, CEPAL, Economic Development Division.

Narayan, P.K., (2005), “The saving and investment nexus for China: Evidence from cointegration tests”. Applied Economics, 37: 1979–1990.

Nowak-Lehmann D., Felicitas, Herzer, Dierk, Vollmer, Sebastian, Mart nez-Zarzoso, Inmaculada. (2011). Modelling the Dynamics of Market Shares in a Pooled Data Setting.

Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds Testing Approaches to the Analysis of level Relationships. Dae Working Papers, 7.

Robinson, J. (2010). Determining the Equilibrium Exchange Rate for Jamaica: A fundamentalist approach. Research and Economic Planning Division: Bank of Jamaica.

Siregar, R. Y., & South-East Asian Central Banks. (2011). The concepts of equilibrium exchange rate: A survey of literature. Kuala Lumpur: South East Asian Central Banks (SEACEN) Research and Training Centre.

Siregar, R., Rajan, R., & University of Adelaide. (2006). Models of equilibrium real exchange rates revisited: A selective review of the literature. Adelaide: School of Economics, University of Adelaide.

STATA. (2011). LONGITUDINALDATA/PANEL DATA REFERENCE MANUAL. STATA Press: Texas.

Stein, J. L. (2005). The transition economies: A NATREX evaluation of research. M nchen: CESifo.

Stein, J. L. (2001). The equilibrium value of the Euro, $ US exchange rate: An evaluation of research. Munich: Univ., Center for Economic Studies.

Stein, J.L. (1994). “The Natural Real Exchange Rate of the US Dollar and Determinants of Capital Flows” in J. Williamson (ed.), Estimating Equilibrium Exchange Rates, Washington, D.C.: Institute for International Economics. United Nations Statistics Division. (2013). UNDATA. Retrieved from http://data.un.org/Default.aspx on June 13, 2013.

Williams, P. (June 2008). Estimating Jamaica’s Real Equilibrium Exchange Rate. Bank of Jamaica Working paper retrieved from http://www.boj.org.jm/publications/research_papers.php on June 11, 2013.

Williamson, J. (1994), “Estimates of FEERs,” in J. Williamson (ed.), Estimating Equilibrium Exchange Rates, Washington, D.C.: Institute for International Economics.

Zalduendo, J., & International Monetary Fund. (2006). Determinants of Venezuela's equilibrium real exchange rate. Washington, D.C.: International Monetary Fund, Western Hemisphere Dept.