Download Equilibrium exchange rate and Misalignment in Morocco

Equilibrium exchange rate and
Misalignment in
Morocco
1-Motivation and outline
The exchange rate policy is amidst the most important macroeconomic decision and
dominates the public policy debate today. The recent reforms adopted in MENA countries
particularly in Morocco during the period (2000-2011) aiming at opening up its economy to
trade and capital flows and allowing much more weight to market mechanisms raise the need
to re-examine the current exchange rate management. In particular, to assess whether an
exchange rate is undervalued or overvalued with respect to its equilibrium value during this
period. A large number of working paper dealt with this issue, but they treat the
misalignment’s evolution till 2002 which is insufficient, as Morocco has implemented a vast
program of economic reforms after 2002.
The purpose of this paper is to estimate the effects of the trade liberalization and of
the international financial integration on the long-term behaviour of Real
Exchange Rate (RER) for Morocco currency in the spirit of Equilibrium Real Exchange Rate
2
(ERER) first put forward by Edwards (1994), and Elbadawi (1994) who put forward the
need to capture the economic factors in estimating equilibrium real exchange rate. Edwards
uses co-integration techniques to estimate ERER for three countries (Chile, Ghana and India)
over the period 1965-1990.
2-Methodology and analysis
The main research question
The scope of this paper is to estimate the equilibrium real exchange rate and to assess the
degree of misalignment of the real exchange rate of the Dirham over the period 1965-2011
The Hypothesis to be tested
What are the effects of capital account liberalization to the fundamentals on
thebehaviour of the real exchange rate based on regression coefficient?

 Is the real exchange rate undervalued or overvalued with respect to its equilibrium
value ? 
 How much can a devaluation help in achieving equilibrium? 
The analytical technique
A multivariate regression model computed on standard OLS formula as well as the bound
testing approach to cointegration within an autoregressive distributed lag (ARDL) (Pesaran
3
and shin) framework will be used to estimate the relationship between the real exchange rate
and economic fundamentals for the period 1965-2011.
So far we have estimated this long-run equation, to assess the size of misalignment of real
exchange rate, the aim of the next step is to determine the equilibrium value of real exchange
rate (ERER), using the long-run parameter estimates and sustainable values of the
fundamentals.
To compute the long run sustainable values of the fundamentals, we will use the moving
average procedure. Then, The degree of misalignment is estimated as the difference between
the actual real exchange rate and its estimated equilibrium value.
a-Data :
The dependent variable : the real effectif exchange rate.
The independent variables : terms of trade, the national economy’s specialisation, the
productivity gap between Morocco and its trading partner, the trading partner’s production
weighted by their trade share, and foreign direct investment.
2 J. BAFFES I. A. ELBADAWI S. A. O'CONNELL ‘’Single-Equation Estimation of the Equilibrium Real Exchange Rate
Working paper’’pp 2-13
3 H.Pesaran R.J.Smith et Y.Shin (1999) ‘’Bounds testing appraaches to the analysis of the long run relationships’’
Journal of econometrics . p 20-41
Data are available in different reports of the monetary authorities, the world bank and the
IMF.
b-The time span :
We consider the annual data for the economic variables over the period 1965 - 2011.
c-The rationale for using the selected methodology :
The application of the unit root tests to the six variable yields mixed results with strong
evidences in favour of the unit root hypothesis only in the case of the real exchange rate and
the productivity gap. This doesn’t necessarily mean that the other variables are not likely to
have any long-run impacts on real exchange rate. Following the methodology developed by
Pesaran and Shin it is possible to test the existence of a long-run equation involving all the
variables irrespective of whether they are I(0) ou I(1).This methodology is therefore
particularly suitable.
3-Policy implications
Preliminary results
It is expected that the real exchange rate of the Dirham would be overvaluated.
Policy implications
Results let us deduce that the real exchange rate of the Dirham exhibits some level of
overvaluation during the last years consequently, policy-makers would need to react either
through a nominal devaluation or by adapting exchange rate policy to the new international
economic and financial context.