Download (I) Relative PPP

Approaches to Assessing
Currency Misalignment
Menzie D. Chinn
UW-Madison & NBER
http://www.ssc.wisc.edu/~mchinn
Presentation at
Office of International Affairs
Department of the Treasury
October 26, 2006
Outline
•
•
•
•
•
Caveats
Methodologies
Example: China
New Approaches
Conclusion
Key Point:
There Are Many Equilibrium Exch. Rates
• There is no way to get the equilibrium rate
and hence misalignment
• The appropriate measure depends upon the
conditions of the economy you’re
examining
• Different models will be relevant
• And different models will be consistent with
different time horizons.
Methodologies
•
•
•
•
•
Relative PPP
Absolute PPP/Deviations from Absolute PPP
Productivity based models
BEERs/Fair Value Models
Macroeconomic Balance/FEERs/External or
Basic Balance
Relative PPP
• Assumes that relative price levels
(measured by deflators, CPIs, or PPIs)
adjusted by nominal exchange rates must be
revert to some average level.
• Other deflators possible -- ULCs
• More flexible interpretations allow for
reversion to trends.
• A long run – goods arbitrage perspective
Example: US Dollar (in real terms)
Source: DB, Exchange Rate Perspectives, October 2006.
Example: US Dollar (nom. terms)
Example: Korean Won (nom. terms)
Source: Chinn, EMR (2000)
Problems
• The relative PPP level must occur in the
sample period.
• Only if the real exchange rate is stationary
is the conditional mean invariant with
respect to the sample.
• Related to the issue of whether the real rate
is I(0), or price indices and the exchange
rate are cointegrated with (1 -1 1)
coefficients.
Absolute PPP
• Absolute PPP requires the prices of bundles
of goods are equalized in common currency
terms.
• MacParity is a special case of absolute PPP.
• But Absolute PPP doesn’t hold across
countries of dissimilar incomes
-4
-2
0
2
The Failure of Absolute PPP
6
7
8
9
10
11
lrypc_ppp00
lpppcvr
Fitted values
Note: Log “price level” & log income/capita in 2000$. Source: Cheung, et al. (2006); WDI.
“Penn Effect” and MacParity
Source: Pakko and Pollard, FRB SL Review (2003).
Productivity Based Models
• Balassa-Samuelson is the most prominent
• Higher productivity levels in tradable sector
induces a stronger currency in real terms.
• Assumes PPP for traded goods.
• Perfect factor mobility w/in countries.
• Isn’t the only relevant model; in two good
models, higher productivity may lead to a
weaker real currency.
• Also a long run/long horizon model.
Example: China
1.9
Real Bilat.
Exchange Rate
(RMB/USD)
1.8
1.7
1.6
1.5
1.4
Est'd
Prod'y
Szirmai
Mfg. prod'y
1.3
88
90
92
94
96
98
00
02
Source: Cheung, et al., FRB SF conference paper (2005).
04
BEER/DEER or “Kitchen Sink”
• Combination of Balassa-Samuelson, real interest
differential (UIP with sticky prices),
nontradables, and portfolio balance motivations
(see Cheung, et al. (2005)).
Source: F. Yilmaz and S. Jen, Morgan Stanley (2001).
• Where does NFA come from? CA equals inverse
of negative returns times NFA. See Lane and
Milesi-Ferretti (2002).
Macro Balance and Related Approaches
• Determine a “normal” level of current
account balance or “basic balance”
• “Basic balance” is current account plus
financial account (sometimes FDI flows).
• Using price elasticities, back out the
equilibrium exchange rate.
• If an econometric approach is used to
determine “normal” level of CA, then IMF’s
“Macroeconomic Balance” approach.
In-Sample Fit for CA “norms”: Korea &
Emerging Asia
Korea
-.1
-.08 -.06 -.04 -.02
0
-.08 -.06 -.04 -.02
0
.02 .04 .06 .08
.02 .04 .06 .08
Emerging Asia excluding China
1971-1975 1976-1980 1981-1985 1986-1990 1991-1995 1996-2000 2001-2004
period
Current Account % of GDP
lower limit
Fitted values
upper limit
Source: Chinn and Ito (2006)
1971-1975 1976-1980 1981-1985 1986-1990 1991-1995 1996-2000 2001-2004
period
ea_current_m5
lower limit
yhat_ea_w
upper limit
In-Sample Fit: China
-.04
-.02
0
.02
.04
.06
China
1971-1975 1976-1980 1981-1985 1986-1990 1991-1995 1996-2000 2001-2004
period
Current Account % of GDP
lower limit
Source: Chinn and Ito (2006)
Fitted values
upper limit
Complications
• Large prediction intervals for CA norms.
• What are the relevant trade elasticities?
• What are the conditioning variables (e.g.,
does one take budget deficits as given?)
• Details? See Isard, Faruqee, Kincaid,
Fetherston (2001).
• FEER uses a normative assessment of
equilibrium current account/basic balance.
• Looking at reserve accumulation is a
variation on this approach.
Many Equil’m Rates: China
GAO (August 2005)
Relative PPP (I)
-2.2
Official real
exchange rate
(USD/CNY)
-2.3
-2.4
-2.5
-2.6
Trend
\
-2.7
/
Official trend
-2.8
-2.9
-3.0
"Adjusted" real
exchange rate
-3.1
88
90
92
94
96
98
00
02
04
Relative PPP (II)
6.0
5.6
Trade Weighted
Value of RMB
5.2
4.8
Trend
4.4
4.0
80 82 84 86 88 90 92 94 96 98 00 02 04 06
Absolute PPP and Uncertainty
Relative price level
1.5
1
0.5
China 1975
0
-0.5
-1
-1.5
China 2004
-2
-2.5
-3
-3.5
-5
-4
-3
-2
-1
0
1
2
Relative per capita income in PPP terms
Source: Cheung et al. (2006)
Recent Developments
• The role of net foreign assets, gross assets
• Measurement of the effective exchange rate
Assets and Adjustment:
Gourinchas-Rey
• Propose a framework for NFA-ex rate
movements
• Builds upon reversion to trend in NFA
• And an intertemporal budget constraint
• So a deficit can be closed by either the
traditional trade channel (net exports), or
• Closed by revaluation effects
• NB: depreciation works in same direction
Normalized net exports/net assets
• Nxa is normalized so export weight is unity
• This means it’s measured in same units as
exports.
• Interpretation: nxa is (approx.) the %age
increase in exports necessary to restore ext.
balance
Econometrics
First part: component that f’casts future ret.
Second: component that f’casts nx growth
Estimate using VAR
Exchange Rate Adjustment
Gourinchas and Rey, “International Financial Adjustment” (2005)
Approximating G-R
(in-sample)
5.0
4.9
Log nominal Fed
dollar index
(major currencies)
4.8
4.7
4.6
4.5
4.4
Fitted
2 yr ahead
4.3
1970 1975 1980 1985 1990 1995 2000 2005
Source: author’s calculations
Measurement: Divisia vs. geometric?
Source: Thomas and Marquez (2006)
References
Cheung, Yin-Wong, Menzie Chinn and Eiji Fujii, 2006, “The
Overvaluation of Renminbi Undervaluation,” paper presented at the
conference on “Financial and Commercial Integration,” SCCIE-JIMF
conference, Santa Cruz (Sept.).
http://sccie.ucsc.edu/webpages/conf/Cheung-Chinn.pdf
Cheung, Yin-Wong, Menzie Chinn and Antonio Garcia Pascual, 2005
“Empirical Exchange Rate Models of the Nineties: Are Any Fit to
Survive?” Journal of International Money and Finance 24: 1150-1175.
http://www.ssc.wisc.edu/~mchinn/FXForecast.pdf
Chinn, Menzie, 2000, “Before the Fall: Were East Asian Currencies
Overvalued?” Emerging Markets Review 1(2) (August 2000): 101-126.
http://www.ssc.wisc.edu/~mchinn/BeforetheFall_EMR.pdf
GAO, 2005, “International Trade: Treasury Assessments Have Not Found
Currency Manipulation, but Concerns about Exchange Rates
Continue,” Report GAO-05-351 (April).
Gourinchas, Pierre-Olivier and Helene Rey, 2005, “International Financial
Adjustment.” NBER Working Paper No. 11155 (February).
http://www.nber.org/w11155/
Isard, Peter , Hamid Faruqee, G. Russell Kincaid, Martin Fetherston,
2001, Methodology for Current Account and Exchange Rate
Assessments, IMF Occasional Paper No. 209.
Lane, Philip and Gian Maria Milesi-Ferretti, 2002, “External Wealth, the
Trade Balance, and the Real Exchange Rate,” European Economic
Review 46: 1049-71.
Pakko, Michael R. and Patricia S. Pollard, 2003, “Burgernomics: A Big
Mac™ Guide to Purchasing Power Parity,” Review 85(6) Nov.: 9-28.
http://research.stlouisfed.org/publications/review/03/11/pakko.pdf