estimates of the fundamental equilibrium exchange rate of kuna katja gattin turkalj croatian...
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Estimates of the Fundamental Equilibrium Exchange Rate of
Kuna
Katja Gattin TurkaljCroatian National Bank
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Introduction
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Real Equilibrium Exchange Rates
• A “fair” value of a currency
• Getting the rate “right” is of great importance as the exchange rate influences competitiveness, price trends and other key macroeconomic variables.
• Various concepts of EER, depending on the definition of internal and external balance
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FEER
• Fundamental equilibrium exchange rate
• FEER is the real effective er that secures internal and external balance for a country (or for a number of countries) simultaneously.
• Internal balance: NAIRU
• External balance: "sustainable" BoP position
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FEER
• Advantages: does not require to much data, easily computed, and tested in the literature many times
• Drawbacks: normative elements, ad hoc definition of sustainable CA position, difficult to model trade, but…
• “Possibly the most popular of the underlying balance models” (Driver and Westaway, 2001)
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Trade, capital flows and ER
in Croatia
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Index of Real Exchange Rate
92
96
100
104
108
112
116
94 95 96 97 98 99 00 01 02 03 04
IREET ppi 97 eop
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Nominal ER of Euro and USD
6.6
6.8
7.0
7.2
7.4
7.6
7.8
4
5
6
7
8
9
10
94 95 96 97 98 99 00 01 02 03 04
HRK_EUR HRK_USD
kuna
/eur
o
kuna/USD
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PPI for Croatia, EU, and relative PPI
92
96
100
104
108
112
116
120
124
94 95 96 97 98 99 00 01 02 03 04
PPI97EUR PPI97HRV PPI97REL
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Construction on IREER
ECU/EUR USD GBP CHF SIT
WEIGHTS 70,6 27,2 1,0 1,0 0,2
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Export of goods and services
8
12
16
20
24
28
32
93 94 95 96 97 98 99 00 01 02 03 04
SHARE_EXPG_CP SHARE_EXPS_CP
in %
of G
DP
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Imports of goods and services
-52
-48
-44
-40
-36
-11
-10
-9
-8
-7
93 94 95 96 97 98 99 00 01 02 03 04
SHARE_IMPG_CP SHARE_IMPS_CP
in %
of G
DP (go
ods)
in % of G
DP (services)
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Destination of exports
in % of total exports 2004 cum 2004
TOTAL 100 eu15 51 eu25 65 65 of which -Austria 9 -Italy 23 -Germany 11 -Slovenia 7 Bosnia and Herzegovina 14 79 YU;Srbija and Montenegro 4 83 Russia 1 84 USA 3 87
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Changes in trade patterns
• WTO 2000
• Bilateral agreements (first signed in 1996, by the end of 2004 25 agreements)
• EFTA 2001
• SAA 2001
• CEFTA 2003
• Return of export markets of former YU
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Liberalization of capital flows
• New FX law in 2003
• Liberalization especially for firms
• Very few restrictions remain (some short-term flows, outflow of capital for residents, real estate, …) to be lifted by the end of SAA (2007)
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Estimating FEER
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Concepts of equilibrium ER
• market equilibrium: balances supply and demand of currency (Williamson)
• current equilibrium: consistent with the given or current fundamentals
• medium term equilibrium: consistent with the fundamentals at their equilibrium level
• long term equilibrium: in the long run, the capital stock and foreign debt are also endogenous and will be related, along with the real exchange rate, to long run fundamentals
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Estimates of the EER
• PPP, HBS and NATREX are long-term concepts,
• On the short end, there are purely statistical approaches SVAR, BEER and CHEER
• FEER, DEER and PEER, refer to modeling the medium term equilibrium.
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Estimating FEER
• Internal eq: potential GDP growth associated with low and "non-accelerating" inflation rate
• 1) Output gap
• 2) HP filter or BN decomposition
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Estimating FEER
• External eq:
• 1) Macroeconomic balance approach (IMF)
• S(X)-I(Y)=CA (rer, Ybar)
• X and Y are arrays of explanatory variables (fiscal position, openness, population growth...)
• 2) "sustainable" current account position...
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Estimate Trade balance
• and elasticities of imports and exports relative to the exogenous variables
• + +• + -
1131211 )ln(*)*ln()ln( RERorMYX
2232221 )ln()ln()ln( RERYM
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Solve for FEER
• CA= X-M• FEER is the solution for RER in
• when CA, Y and Y* are replaced with their long term values
Y
eeCA
Y
CA RERYRERY
Y
)ln(*)ln()ln()ln(
%
131211232221
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Estimate X and M equations…
DLOG(X) = -5.25 + 1.10*LOG(RER) + 3.44*DLOG(M*(-1)) + 4.58*DLOG(M) (-2.18) (2.12) (5.01) (12.16) R2=0.79 F-stat=53.9
DLOG(M) = 0.47 + 1.09*DLOG(Y) - 0.10*LOG(RER) (0.30) (4.18) (-0.29) R2=0.27 F-stat=8.54
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Actual REER and FEER
95
97
99
101
103
105
107
109
111
113
115
2/95
.
4/95
.
2/96
.
4/96
.
2/97
.
4/97
.
2/98
.
4/98
.
2/99
.
4/99
.
2/00
.
4/00
.
2/01
.
4/01
.
2/02
.
4/02
.
2/03
.
4/03
.
2/04
.
4/04
.
reer
feer hpTB
feer TB 0%
feer TB -6,5%
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Conclusion
• The drawback inherent in the FEER method, cannot be resolved within the framework of FEER
• Often, another method is used along with FEER to verify its findings (BEER)