The real exchange rate and the black market exchange rate in developing countries

This article tests for the validity of the Purchasing power parity (PPP) theory using both the black market and the official exchange rates for panels with cross sectional dependency. The test is conducted using a newly developed, nonlinear IV panel unit root test that properly handles cross-sectional dependency for thirty-seven developing countries. We find that the null of joint unit root hypothesis is rejected for the whole panel, using the black market exchange rate, and for sub-panels of African and high inflation countries, using either exchange rate. The black market-based real exchange rates are, therefore, shown to provide stronger evidence for the purchasing power parity theory than do the official rates. This finding is consistent with the observation that black market exchange rates better represent market forces and thus are more relevant when testing for the validity of the PPP theory in developing countries.     

Capital flows,real exchange rate,and growth constraints in Mexico

Besides its well‐known problem of slow economic growth, Mexico’s recent evolution features both a sharp rise in the import‐intensity of economic activity – which may have tightened an external constraint on growth – and a persistent real appreciation of the peso – which may have created a profitability constraint. Adopting the approach of gap models and growth diagnostics, the paper contrasts the relevance of the external and the profitability constraints in Mexico after trade liberalization in the mid‐1980s. Although the trade deficit was pro‐cyclical, the three recent episodes of GDP growth acceleration were not accompanied by pressures in the foreign exchange market. Moreover, error correction models show that investment was highly responsive to the real exchange rate but largely unresponsive to foreign capital flows. The evidence supports the conclusion that investment was deterred by the low profitability of an uncompetitive real exchange rate, rather than by the external constraint.     

China's economic growth and its real exchange rate

The shocks that underlie China's comparatively rapid growth include gains in productivity, factor accumulation and policy reforms that increase allocative efficiency. The well-known Balassa–Samuelson hypothesis links productivity growth in tradable industries with real appreciations. Yet it relies heavily on the law of one price applying for tradable goods, against which there is now considerable evidence. In its absence, other growth shocks also affect the real exchange rate by influencing relative supply or demand for home product varieties. This paper investigates the pre-conditions for the Balassa–Samuelson hypothesis to predict a real appreciation in the Chinese case. It then quantifies the links between all growth shocks and the Chinese real exchange rate using a dynamic model of the global economy with open capital accounts and full demographic underpinnings to labor supply. The results suggest that financial capital inflows most affect the real exchange rate in the short term, while differential productivity is strong in the medium term. Contrary to expectation, in the long term demographic forces prove to be weak relative to changes in the skill composition of the labor force, which enhances services sector performance and depreciates the real exchange rate.     

Large real exchange rate movements, firm dynamics, and productivity growth

Abstract.  This paper examines the influence of large real exchange rate movements on firm turnover and production scale, and the contribution of these decisions to productivity growth. Our theoretical model predicts that home currency appreciations cause firm closure and reduce surviving firms' exports while boosting domestic sales. The net effect on sales and productivity therefore depends on changes in domestic sales and exports. Taiwanese firm-level data are used to test these predictions. The results show that real currency appreciations lead to scale expansion of surviving firms which in turn raises productivity. Our findings suggest the existence of a significant scale effect.     

Explaining forecasting bias: The case of real exchange rate variance

Recent tests of the rational expections hypothesis (REH), based on the assumption that agents are risk-neutral, have yielded conflicting results when applied to foreign exchange markets. Here a two-stage procedure which does not assumej risk-neutrality is derived from a model of a utility-maximizing importer who incurs an adjustment cost if he changes his import order. Although a short-run test (based on aggregate imports) leads to rejection of the REH in the majortity of cases, a longer-ren test (based on manchinery imports) is more favourable to the null huypthesis. The observed shot-run tendency to, in effect, ignore low levels of real exchange rate variation is found to be more likely when bilateral rates have remained relatively stable, when the importingj economy is relatively closed, or when governments have announced policies of intervention to stabilize bilateral rates.     

Real exchange rate volatility,financial crises and exchange rate regimes

This article examines real exchange rate (RER) volatility in 80 countries around the world, during the period 1970 to 2011. Two main questions are raised: are structural breaks in RER volatility related to changes in exchange rate regimes or financial crises? And do these two events affect the permanent and transitory components of RER volatility? To answer these, we employ two complementary procedures that consist in detecting structural breaks in the RER series and decomposing volatility into its permanent and transitory components. Our results suggest that structural breaks in RER volatility coincidence with financial crises and certain changes in nominal exchange rate regimes. Moreover, our findings confirm that RER volatility does increase with the global financial crises and detect that the more flexible the exchange rate regime, the higher the volatility of the RER using a de facto exchange rate classification.     

Causality between inflation and real growth

The paper investigates inflation-growth causality over 1947–2005 with VARMA-ML-Asymmetric-VGARCH. The results imply that one uncertainty affects positively its level and much less negatively the other level whereas one level influences positively both uncertainties. Friedman's hypothesis was not strongly rejected.     

Exchange rate exposure of the key financial institutions in the foreign exchange market

Exchange rate exposure is assessed for key individual financial institutions, country-specific portfolios, and global portfolios. The results show that the majority of the key individual institutions are significantly exposed. U.K., Swiss, and Japanese portfolios are found to be significantly exposed, whereas U.S. portfolios are not exposed. There is also some evidence that exchange rate exposure does not exist on a global level. To the extent that the vast majority of currency trading is conducted among the financial institutions included in the portfolio, exposure is expected to be insignificant as gains accrued by one institution would be offset by losses incurred by another institution.     

Limited asset market participation and the consumption‐real exchange rate anomaly

Abstract Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country's aggregate consumption rises relative to foreign consumption, when the country's real exchange rate depreciates. Yet empirically, relative consumption and the real exchange rate are essentially uncorrelated. This paper shows that this ‘consumption‐real exchange rate anomaly’ can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand‐to‐mouth (HTM) lives. HTM behaviour also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.     

Fertility and the real exchange rate

Abstract .  We use a quinquennial data set covering 87 countries between 1975 and 2005 to investigate empirically the relationship between fertility and the real effective exchange rate. Theoretically, a country experiencing a decline in its fertility rate can be expected to experience a real depreciation. We test and confirm this hypothesis, controlling for a number of other potential determinants. We find a statistically significant and robust link between fertility and the exchange rate. Our point-estimate is that a decline in the fertility rate of one child per woman is associated with a depreciation of approximately 15% in the real effective exchange rate.     

Deforestation and the real exchange rate

Deforestation is a phenomenon that has largely been concentrated in the developing world. We construct a theoretical model of deforestation that focuses on the factors affecting the incentives to transform forested land into agricultural land. We show that: (i) lower discount rates and stronger institutions decrease deforestation; (ii) a depreciation in the real exchange rate increases deforestation in developing countries whereas the opposite obtains in developed countries; (iii) paradoxically, better institutions may exacerbate the deleterious impact of a depreciation in developing countries. These hypotheses are tested on an annual sample of 101 countries over the 1961–1988 period, and are not rejected by the data. Our results suggest that short-term macroeconomic policy, institutional factors, and the interaction between the two, are potentially important determinants of environmental outcomes.     

The information content of money in forecasting euro area inflation

This article contributes to the debate on the role of money in monetary policy by analysing the information content of money in forecasting euro-area inflation. We compare the predictive performance within and among various classes of structural and empirical models in a consistent framework using Bayesian and other estimation techniques. We find that money contains relevant information for inflation in some model classes. Money-based New Keynesian Dynamic Stochastic General Equilibrium (DSGE) models and Vector Autoregressions (VARs) incorporating money perform better than their cashless counterparts. But there are also indications that the contribution of money has its limits. The marginal contribution of money to forecasting accuracy is often small, money adds little to dynamic factor models, and it worsens forecasting accuracy of partial equilibrium models. Finally, nonmonetary models dominate monetary models in an all-out horserace.     

Impact of oil price shocks on output,inflation and the real exchange rate: evidence from selected ASEAN countries

This article analyses the impact of oil price shocks on real output, inflation and the real exchange rate in Thailand, Malaysia, Singapore, the Philippines and Indonesia (ASEAN-5) using a Structural VAR model. The cointegration tests indicate that the macroeconomic variables of these countries are cointegrated and share common trends in the long run. The impulse response functions reveal that oil price fluctuations do not impact the ASEAN-5 economies in the long run and much of its effect is absorbed within five to six quarters. The variance decomposition results further assert that with a few exceptions oil price shocks do not explain a significant variation in any of the variables under consideration. We also identify a very unique pattern of response to oil price fluctuations between Malaysia and Singapore and between the Philippines and Thailand. The pairs exhibit a high degree of similarity in their responses; they do not share any commonalities across the group.     

Capital accumulation and real exchange rate behavior in a small open economy with credit market frictions

Summary. We consider the nature of the relationship between the real exchange rate and capital formation. We present a model of a small open economy that produces and consumes two goods, one tradable and one not. Domestic residents can borrow and lend abroad, and costly state verification (CSV) is a source of frictions in domestic credit markets. The real exchange rate matters for capital accumulation because it affects the␣potential for investors to provide internal finance, which mitigates the CSV problem. We demonstrate that the real exchange rate must monotonically approach its steady state level. However, capital accumulation need not be monotonic and real exchange rate appreciation can be associated with either a rising or a falling capital stock. The relationship between world financial market conditions and the real exchange rate is also investigated. Received: October 3, 1997; revised version: October 23, 1997     

Rational expectations,market shocks,and the exchange rate

The world economy has been subjected to numerous real shocks in recent years. In addition, purchasing-power parity seems to have collapsed. Critics of the monetary approach to the exchange rate have been quick to draw attention to these facts. This paper extends the basic framework of the monetary approach so that it provides a useful tool for explaining the impact of real shocks on the exchange rate and so that it is compatible with the existence of significant deviations from purchasing-power parity. The real shocks that are discussed include changes in commercial policy, the terms of trade, and productivity. It is demonstrated that real shocks influence the exchange rate through two distinct channels—a real-income channel and a deviations from purchasing-power-parity channel.     

The effects of exchange rate regimes on real exchange rate misalignment

The literature on exchange rate regimes has paid little attention to the effects of exchange rate policies on real exchange rate misalignments. This paper contributes to filling that gap by exploring such relation empirically. Because the underlying model is probably not linear and the treated individuals differ from non-treated individuals, we rely on Matching models rather than on standard regressions. Our main finding is that pegs are associated with more overvaluation. The results are robust to different exchange rate regime classifications, misalignment indexes, and matching estimators. The evidence presented suggests that policy-makers concerned with overvaluation should avoid sticking with rigid arrangements for too long.     

Remittances and the real effective exchange rate

We examine the long-run relationship between remittances and the real exchange rate for less-developed countries. In a key departure from the literature, we employ a panel cointegration approach using an innovative method for the measurement of the multilateral real effective exchange rate and we focus on high-remittance economies. We find a small inelastic, but significant, long-run relationship which confirms a Dutch disease type effect. The short-run relationship is explored using a panel vector error correction model which confirms that short-run causality is unidirectional running from remittances to the exchange rate. Potential asymmetries in this relationship are identified using quantile regression analysis.     

Sudden stops,sectoral reallocations,and the real exchange rate

A sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994–95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.