The Yen Real Exchange Rate may be Stationary after all: Evidence from Non‐linear Unit‐root Tests*

The empirical literature that tests for purchasing power parity (PPP) by focusing on the stationarity of real exchange rates has so far provided, at best, mixed results. The behaviour of the yen real exchange rate has most stubbornly challenged the PPP hypothesis and deepened this puzzle. This paper contributes to this discussion by providing new evidence on the stationarity of bilateral yen real exchange rates. We employ a non‐linear version of the augmented Dickey–Fuller test, based on an exponentially smooth‐transition autoregressive model (ESTAR) that enhances the power of the tests against mean‐reverting non‐linear alternative hypotheses. Our results suggest that the bilateral yen real exchange rates against the other G7 and Asian currencies were mean reverting during the post‐Bretton Woods era. Thus, the real yen behaviour may not be so different after all but simply perceived to be so because of the use of a restrictive alternative hypothesis in previous tests.     

Further Evidence on PPP Adjustment Speeds: the Case of Effective Real Exchange Rates and the EMS*

Two different approaches intend to resolve the ‘puzzling’ slow convergence to purchasing power parity (PPP) reported in the literature [see Rogoff (1996) , Journal of Economic Literature, Vol. 34.] On the one hand, there are models that consider a non‐linear adjustment of real exchange rate to PPP induced by transaction costs. Such costs imply the presence of a certain transaction band where adjustment is too costly to be undertaken. On the other hand, there are models that relax the ‘classical’ PPP assumption of constant equilibrium real exchange rates. A prominent theory put together by Balassa (1964, Journal of Political Economy, Vol. 72) and Samuelson (1964 Review of Economics and Statistics, Vol. 46) , the BS effect, suggests that a non‐constant real exchange rate equilibrium is induced by different productivity growth rates between countries. This paper reconciles those two approaches by considering an exponential smooth transition‐in‐deviation non‐linear adjustment mechanism towards non‐constant equilibrium real exchange rates within the EMS (European Monetary System) and effective rates. The equilibrium is proxied, in a theoretically appealing manner, using deterministic trends and the relative price of non‐tradables to proxy for BS effects. The empirical results provide further support for the hypothesis that real exchange rates are well described by symmetric, nonlinear processes. Furthermore, the half‐life of shocks in such models is found to be dramatically shorter than that obtained in linear models.     

The exchange value of the dollar and the U.S. trade balance: An empirical investigation based on cointegradon and Granger causality tests

This article performs tests of Granger causality in the relationships between the nominal ad real exchange rates of the dollar and the U.S. trade balance as well as its price and quantity components over the period 1973:IIQ–1989:IIIQ. Our results suggest: (i) weak statistical evidence of unidirectional causality running from the nominal exchange rate to import prices and nominal trade balance (ii) no statistical support for the proposition that the real exchange rate simply “accommodates” changes in the real trade balance, and (iii) strong (no) causal links between the nominal and real exchange rates and export (import) volume. We tentatively conclude that movements in the exchange rate have a rather limited effect on the trade balance and that this effect is more likely to materialize on the export side of the trade balance.     

An assessment of another decade of capital controls in Colombia: 1998–2008

We explore the effectiveness of capital controls in Colombia. We analyze the impact of administrative restrictions to capital flows on aggregate capital flows, the composition of capital flows, the real exchange rate, and economic activity using restricted versions of vector error correction models (VEC) that control for exogenous global financial conditions. The models are estimated using monthly data ranging from August of 1998 to May of 2008. In addition we estimate GARCH models to identify if capital controls have had relevant impacts on the volatility of the nominal exchange rate and of other relevant asset prices. These models are estimated using weekly data covering the same time period. Results suggest that the capital controls used since 1998 have been ineffective in reducing capital flows and the trend of the Colombian peso to appreciate. In addition there is no evidence suggesting a change in the composition of capital flows induced by capital controls. We find some evidence in favor of capital controls reducing nominal exchange rate volatility at high frequencies.     

Real exchange rate,stationarity, and economic fundamentals

Using monthly data for the US/UK real exchange rate over the period 1921–2002, we find evidence that the mean reverting tendency of the real exchange rate is stochastic, and regime-dependent. There is one regime over which PPP holds as a long-run equilibrium relation, i.e. a stationary PPP regime, and another regime over which PPP does not hold, i.e. a non-stationary PPP regime. The transition from the non-stationary to the stationary regime is found to be affected by the real interest rate differential, and by the volatility of the nominal exchange rate. The real output differential does not appear to affect the transition probability.     

U.S. interest rates and the exchange value of the dollar: A test of causality

This study examines the causal relationship between interset rates and the exchange value of the dollar using Granger causality tests. Cointegration tests show that error correction models are not necessary in this case. The results suggest that the combination of short- and long-term U.S. interest rates, in nominal or real terms, Granger cause the exchange value of the dollar, and that the difference between nominal domestic and foreign rates does not Granger cause the exchange value of the dollar. This result supports the proposition that budget deficits contribute to trade deficits.     

The exchange rate pass-through in the new EU member states

This paper aims to complete our understanding of the relationship between changes in nominal effective exchange rates and prices in the new EU member states. I investigate the exchange rate pass-through to import, producer and consumer prices for ten Central and Eastern European countries with quarterly data from January 1996 to December 2011. In a first step, the pass-through estimates are derived from a dynamic panel data model through the generalized method of moments. A statistically significant exchange rate pass-through to consumer, producer and import prices is found, both in the short and long run. In a second step, I proceed to an individual analysis, country by country, and find support for an increased heterogeneity in the exchange rate pass-through estimates. In a third step, I assess the drivers of the estimated exchange rate pass-through coefficients and find support for a significant impact of exchange rate volatility, inflation volatility, import dependence, and the output gap, as well as the global outlook.     

Mixed random forest,cointegration, and forecasting gasoline prices

One of the most successful forecasting machine learning (ML) procedures is random forest (RF). In this paper, we propose a new mixed RF approach for modeling departures from linearity that helps identify (i) explanatory variables with nonlinear impacts, (ii) threshold values, and (iii) the closest parametric approximation. The methodology is applied to weekly forecasts of gasoline prices, cointegrated with international oil prices and exchange rates. Recent specifications for nonlinear error correction (NEC) models include threshold autoregressive models (TAR) and double-threshold smooth transition autoregressive (STAR) models. We propose a new mixed RF model specification strategy and apply it to the determinants of weekly prices of the Spanish gasoline market from 2010 to 2019. In particular, the mixed RF is able to identify nonlinearities in both the error correction term and the rate of change of oil prices. It provides the best weekly gasoline price forecasting performance and supports the logistic error correction model (ECM) approximation.     

Investigating properties of commodity price responses to real and nominal shocks

This paper studies dynamic adjustments of 49 world commodity prices in response to innovations in the nominal exchange rate and the world real GDP. After we estimate the dynamic elasticity of the prices with respect to these shocks, we obtain the kernel density of our estimates to establish stylized facts on the adjustment process of the commodity price toward a new equilibrium path. Our empirical findings imply, on average, that the law of one price holds in the long-run, whereas the substantial degree of short-run price rigidity was observed in response to the nominal exchange rate shock. The real GDP shock tends to generate substantial price fluctuations in the short-run because adjustments of the supply can be limited, but have much weaker effects in the long-run as the supply eventually counterbalances the increase in the demand. Overall, we report persistent long-lasting effects of the nominal exchange rate shock on commodity prices relative to those of the real GDP shock.     

Oil prices and exchange rates in oil-exporting countries: evidence from TAR and M-TAR models

The paper studies the long-run relation and short-run dynamics between real oil prices and real exchange rates in a sample of 13 oil-exporting countries. The purpose of the study is to examine the possibility of Dutch disease in these countries. Tests of cointegration using threshold and momentum-threshold autoregressive (TAR and M-TAR) models suggest the possibility of the disease in 3-out-of 13 countries??Bolivia, Mexico and Norway. For these countries, we also find that (a) oil prices have a long-run effect on the exchange rates; and (b) exchange rates adjust faster to positive deviations from the equilibrium; and (c) there is no evidence of short-run causality between real exchange rates and real oil prices in either direction. Over all, these findings suggest a weak link between oil prices and real exchange rates and thus limited evidence in favor of the Dutch disease.     

Real exchange rate persistence and the excess return puzzle: The case of Switzerland versus the US

The PPP puzzle refers to the wide swings of nominal exchange rates around their long‐run equilibrium values whereas the excess return puzzle represents the persistent deviation of the domestic‐foreign interest rate differential from the expected change in the nominal exchange rate. Using the I(2) cointegrated VAR model, much of the excess return puzzle disappears when an uncertainty premium in the foreign exchange market, proxied by the persistent PPP gap, is introduced. Self‐reinforcing feedback mechanisms seem to cause the persistence in the Swiss‐US parity conditions. These results support imperfect knowledge based expectations rather than so‐called “rational expectations”.     

Nonlinear dynamics of interest rate and inflation

According to several empirical studies US inflation and nominal interest rates as well as the real interest rate can be described as unit root processes. These results imply that nominal interest rates and expected inflation do not move one‐for‐one in the long run, which is incongruent with theoretical models. In this paper we introduce a new nonlinear bivariate mixture autoregressive model that seems to fit quarterly US data (1953 : II–2004 : IV) reasonably well. It is found that the three‐month Treasury bill rate and inflation share a common nonlinear component that explains a large part of their persistence. The real interest rate is devoid of this component, indicating one‐for‐one movement of the nominal interest rate and inflation in the long run and, hence, stationarity of the real interest rate. Copyright © 2006 John Wiley & Sons, Ltd.     

Testing the purchasing power parity through I(2) cointegration techniques

This paper contributes to the empirical literature on the purchasing power parity (PPP) over the post‐Bretton Woods period by providing a time‐series based interpretation of the controversial evidence characterizing the dynamics of real exchange rates. It is shown that the persistence of deviations from the PPP between a set of European countries and the United States may be empirically attributed to the presence of I(2) stochastic trends in prices using Consumer Price Indices. Interestingly, the slow adjustment towards the equilibrium can be modelled through ‘integral‐proportional’ equilibrium correction models and this evidence can be partly reconciled with theories where the inflation rate reduces the markup of profit‐maximizing firms acting on imperfectly competitive markets. Copyright © 2005 John Wiley & Sons, Ltd.     

Regime switching as a test for exchange rate bubbles

This paper develops a new test for speculative bubbles, which is applied to data for the Japanese yen, the German mark and the Canadian dollar exchange rates from 1977 to 1991. The test assumes that bubbles display a particular kind of regime-switching behaviour, which is shown to imply coefficient restrictions on a simple switching-regression model of exchange rate innovations. Test results are sensitive to the specification of exchange rate fundamentals and other factors. Evidence most consistent with the bubble hypothesis is found using an overshooting model of the Canadian dollar and a PPP model of the Japanese yen.     

PPP may hold better than you think: Smooth breaks and non-linear mean reversion in real effective exchange rates

This paper revisits some key topics in the literature on purchasing power parity (PPP). The study applies a set of newly developed unit root tests, which account for both nonlinearity and multiple smooth temporary breaks in series, to the real effective exchange rates (REERs) of 23 developed countries. The results suggest that PPP generally holds for various currency-based real rates. There is evidence in favor of linear stationarity in REERs for highly integrated economies. The REERs of most other countries tend to have nonlinear adjustment toward large long-swing type mean changes around constant equilibrium values.     

人民币升值的探讨

根据汇率决定的基本因素,中国国际收支持续顺差,持续高经济增长率,投资收益高,人民币应该升值;根据名义汇率与实际汇率的关系,由于中国物价持续上涨,人民币实际汇率升值;根据当前国内外经济环境,美国经济衰退,中国经济仍被看好,人民币存在升值的压力;根据日元升值的历史背景,人民币会升值。     

Real exchange rate behaviour: evidence from black markets

The behaviour of real exchange rates (relative to the US dollar) is examined using monthly data obtained from the black markets for foreign exchange of eight Asian developing countries. The data span is 31 years. The black market real exchange rates do not show excess volatility during the recent float which is in sharp contrast to the results reported elsewhere. Unit root tests in heterogeneous panels and variance ratio tests confirm their stationarity. Thus, we find support for PPP but not for the ‘survivorship’ bias (Froot and Rogoff, 1995 ). There is little evidence of segmented trends. Issues raised by Rogoff ( 1996 )—of whether PPP would hold across countries with differing growth experience—and Lothian and Taylor ( 1996 )—of whether the degree of relative price volatility may bias results in favour of mean reverting real exchange rates—are addressed. Copyright © 2000 John Wiley & Sons, Ltd.     

Cross-border restaurant price and exchange rate interactions

Purchasing power parity suggests that international price ratios for identical goods should approximate nominal exchange rates for the currencies in which the prices are denominated. Deviations of the price ratios from exchange rates can occur for a number of reasons and mixed evidence has been recorded for how long those deviations last. Empirical evidence for international restaurant prices in El Paso, Texas and Ciudad Juarez, Mexico confirms that menu item price ratios are strongly correlated with the peso/dollar exchange rate. An earlier exploratory study of eight individual products also indicated that half-life deviations in this market are very short. This study utilizes additional data from a larger and more extensive sample to examine if the prior results are confirmed.     

What determines the long-term correlation between oil prices and exchange rates?

In this study, we obtain the long-term correlation between oil prices and exchange rates by employing the dynamic conditional correlation-mixed data sampling (DCC-MIDAS) model. We then identify the factors that influence the long-term correlation using panel data analysis. We find that the long-run correlations between oil prices and exchange rates are negative for all oil-exchange rate markets except Japan. We also find that both inflation and term spread have negative effects, while the risk-free interest rate has a positive effect on the long-term correlation between oil prices and exchange rates. Importantly, the empirical results show that an increase in inflation will significantly damage the real value of the currency itself.     

Is PPP sensitive to time-varying trade weights in constructing real effective exchange rates?

While the use of real effective exchange rates in stationarity tests of purchasing power parity (PPP) avoids the problems created using bilateral rates, these rates are often constructed using trade shares that are fixed at a single base year. This method fails to take into account the fact that trade shares can change drastically in parts of the world that are undergoing dramatic transformations. In this study, we apply linear as well as nonlinear stationarity tests to 52 currencies’ real effective rates, which were constructed using time-varying weights. Incorporating a time trend, we are also able to assess whether breakdowns in PPP are due to productivity differentials. We find that while nonlinear tests provide more evidence of “productivity bias” than do linear tests, they do not provide much more evidence of PPP. A comparison to a previous study that used fixed-weight data shows that there is somewhat more evidence of productivity bias using the new dataset, especially in Eastern Europe and Asia. We can conclude that PPP and a key cause of its breakdown are somewhat sensitive to the use of time-varying weights in these stationarity tests.