Nonlinearities in the real exchange rates: new evidence from developed and developing countries

This paper investigates nonlinearities in the dynamics of real exchange rates. We use Monte Carlo simulations to establish the size properties of the Teräsvirta-Anderson test, when the dynamics of the real exchange rate is influenced by an exogenous process. In addition, we show that a modified nonlinearity test, which includes additional right-hand-side variables, performs much better than the original in both Monte Carlo exercises and in the actual data on 1431 bilateral real exchange rate series. Finally, we investigate the dynamics of the real exchange rate for both developed and developing countries using the modified test for the recent floating period. In general, the results find a greater incidence of nonlinear dynamics for developing country real exchange rates.     

Real exchange rates,economic performance,and trade balances in the central european free trade association

The relationships between real exchange rates dynamics, domestic economic growth, and external economic positions are examined for four East European countries: Poland, Hungary, Slovakia, and the Czech Republic. Results show that in Poland the dynamic of the trade balance is independent of both the real exchange rate and industrial production. In both Hungary and Slovakia, trade balances appear to have strong autonomous components, albeit in circumstances where the influence of real exchange rates and industrial production dynamics cannot be entirely denied. The Czech Republic's situation is, however, substantially different from its Central European Free Trade Assocation partners. The growing trade balance deficit appears to be determined by both the continuing real appreciation of the Czech currency and a mildly accelerating industrial production growth. Both are the consequence of accelerating capital inflow.     

Real and nominal effective exchange rates for developing countries: 1973:1-1997:3

The International Monetary Fund construct and publish real and nominal effective exchange rate data, mostly for developed countries. In this paper real and nominal effective rate data for developing countries are constructed. Application of the KPSS test to real effective rate data reveals that PPP holds in most countries.     

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.     

Long-run versus short-run behaviour of the real exchange rates

This paper discusses the mean stationarity of real exchange rates by using new time series methods and new tests. The question whether the real exchange rates have a unit root or are level reverting is set in the general and flexible framework of fractionally integrated processes. The estimations and tests sustain the claim that real exchange rates may be nonstationary and not revert to any short-run parity. However, estimations also suggest that real exchange rates behave differently on the short and on the long run and that they may revert to parity in a century-long period.     

World Bank trade loans and export performance of recipient countries

Since 1980 several developing countries have received World Bank structural loans, aimed at opening their economy to international trade. By estimating a gravity equation on a panel of 180 countries, observed from 1962 to 2010, we investigate whether the Bank’s programs have affected the export performance of beneficiaries in the subsequent years. According to our results, trade loans have been ineffective in the shorter run while, in the longer, they appear to have hindered the export performance of recipient countries. The Bank’s new trade policy approach, however, seems to have some potential for inverting the negative influence that we have detected.     

Home bias, distribution services and determinants of real exchange rates

This paper examines empirically how exogenous changes in the terms of trade affect the real exchange rate through the relative price of traded goods with Canada–US data. The relative price of traded goods is constructed using prices at the dock and retail prices. The first measure emphasizes the importance of home bias in consumption of traded goods. The second measure highlights the importance of distribution services required for consumption of traded goods. It is found that terms of trade shocks affect the relative price of traded goods using both measures. A possible interpretation of empirical findings is that home bias and distribution services are important for understanding the relative price of traded goods.     

Terms of trade and the exchange rates of New Zealand and Australia

Effects of the terms of trade on the bilateral exchange rate of New Zealand and Australia and of each of these countries with the USA are evaluated. There is strong evidence of cointegration of the exchange rates and a ration of the respective national price levels when the relative terms of trade of the countries are included in dynamic models. While evidence that the long-run equilibrium relationships satisfy purchasing power parity is mixed, relative improvement of a country's terms of trade results in real appreciation of its currency in all cases. The terms of trade are also found to be exogenous for the parameters of the long-run New Zealand–Australia exchange-rate equilibrium.     

Understanding forecast failure of ESTAR models of real exchange rates

The forecast performance of the empirical ESTAR model of Taylor et al. (2001) is examined for 4 bilateral real exchange rate series over an out-of-sample evaluation period of nearly 12?years. Point as well as density forecasts are constructed, considering forecast horizons of 1 to 22 steps head. The study finds that no forecast gains over a simple AR(1) specification exist at any of the forecast horizons that are considered, regardless of whether point or density forecasts are utilised in the evaluation. Non-parametric methods are used in conjunction with simulation techniques to learn about the models and their forecasts. It is shown graphically that the nonlinearity in the conditional means (or point forecasts) of the ESTAR model decreases as the forecast horizon increases. The non-parametric methods show also that the multiple steps ahead forecast densities are normal looking with no signs of bi-modality, skewness or kurtosis.     

External wealth, the trade balance, and the real exchange rate

We examine the link between the net foreign asset position, the trade balance and the real exchange rate. In particular, we decompose the impact of a country's net foreign asset position (‘external wealth’) on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, a negative relation between the trade balance and the real exchange rate. We also provide additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.     

A simple unit root test against asymmetric STAR nonlinearity with an application to real exchange rates in Nordic countries

Existing tests of the unit root hypothesis against the alternative hypothesis of exponential smooth transition autoregressive (ESTAR) nonlinearity implicitly assume symmetry under the alternative. This paper proposes a simple unit root test against the alternative of symmetric or asymmetric ESTAR nonlinearity. In the event that the unit root hypothesis is rejected, a simple test of symmetric versus asymmetric ESTAR nonlinearity is also proposed. The asymptotic distributions of the test statistics are straightforward to establish and finite-sample performance is studied with Monte Carlo simulations. An empirical application involving the real exchange rates of four Nordic countries against the U.S. dollar illustrates the usefulness of the new tests.     

Nominal and real volatility as determinants of FDI

This article examines the role of country-specific sources of output and interest rate or exchange rate volatility in driving Foreign Direct Investment (FDI) activities. Building on a dataset with bilateral FDI flows among 24 Organization for Economic Co-operation and Development (OECD) economies over the period 1985–2007, we find that nominal and real volatility strongly deter foreign investments. Output and exchange rate volatility matter in particular for the decision whether to invest in a foreign country in the first place. Interest rate volatility mainly influences the amount of foreign investments.     

Inflation targeting and real exchange rates: A bias correction approach

This paper examines whether inflation targeting (IT) influences purchasing power parity (PPP) by a bias correction approach under cross-sectional dependence. The recursive mean adjustment (RMA) method proposed by So and Shin (1999) and Shin and So (2001) is employed to correct a downward bias in half-life estimates of real exchange rates. More importantly, the empirical results show that IT lowers variability of real exchange rates and plays an important role in providing favorable evidence for long-run PPP.     

Catching up: The role of demand, supply and regulated price effects on the real exchange rates of four accession countries

The main aim of this paper is to examine the exchange rate behaviour of a group of four transitional, EU accession countries, with a view to making policy recommendations regarding their full accession to the European Monetary Union. We employ a dynamic OLS panel estimator to investigate the relative importance of demand and supply influences on the exchange rates of these countries. Our analysis shows that both supply‐ and demand‐side effects are important for the accession countries, although their overall effect on inflation differentials and competitiveness seems to be small. An additional focus of the paper is the examination of the role that administrated, or regulated, prices and the productivity of the distribution sector play in the real exchange rate dynamics. Using a unique database we show that administrative prices have been a powerful force behind price and real exchange developments for our group of accession countries. The distribution sector is shown to have an independent effect on the internal price ratio over and above that generated by the Balassa–Samuelson effect.     

Smooth structural breaks and the stationarity of the yen real exchange rates

This article examines and solves an interesting paradox in the literature that the tests for purchasing power parity (PPP) based on the yen real exchange rates (RERs) refute the PPP hypothesis more often than those with other major currency-based RERs, and the evidence is sensitive to the sample period used. Using a new empirical methodology accounting for both nonlinearity and multiple smooth temporary breaks in the data, we show that the puzzling finding is due to the failure to take into account the long but temporary large rise and fall in the yen RERs. The results illustrate that the yen RERs in the post-Bretton Woods period are likely mean reverting with linear or nonlinear adjustment toward large, long swing type of infrequent smooth temporary changes around constant equilibrium values, supporting the validity of PPP and resolving the paradox.     

Non-parametric tests of real exchange rates in the post-Bretton Woods era

This paper examines the mean-reverting property of real exchange rates. Earlier studies have generally not been able to reject the null hypothesis of a unit-root in real exchange rates, especially for the post-Bretton Woods floating period. The results imply that long-run purchasing power parity does not hold. More recent studies, especially those using panel unit-root tests or nonlinear time series models, have found more favorable results, however. But the results from these recent studies are far from conclusive. Consistent individual country time series evidence that supports long-run purchasing power parity continues to be scarce. In this paper, we test for long memory using (Lo’s in Econometrica 59:1279–1313, 1991) the modified rescaled range test, and the rescaled variance test of Giraitis et al. (J Econ 112:265–294, 2003a). Our testing procedure provides a non-parametric alternative to the parametric tests commonly used in this literature. Our data set consists of monthly observations from April 1973 to April 2001 of the G-6 countries (excluding the US) in the OECD. Using the modified rescaled range test, we find only 2 cases out of 15 where the null hypothesis of a unit-root with short-term dependence could be rejected in favor of the alternative hypothesis of long-term dependence and none using the rescaled variance test. Our results therefore do not provide strong empirical support for the stationarity of real exchange rates.