Download Estimates of the Fundamental Equilibrium Exchange Rate of Kuna

Estimates of the Fundamental
Equilibrium Exchange Rate of
Kuna
Katja Gattin Turkalj
Croatian National Bank
Introduction
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
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
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)
Trade, capital flows and ER
in Croatia
Index of Real Exchange Rate
116
112
108
104
100
96
92
94
95
96
97
98
99
00
01
IREET ppi 97 eop
02
03
04
7.8
10
7.6
9
7.4
8
7.2
7
7.0
6
6.8
5
6.6
4
94
95
96
97
HRK_EUR
98
99
00
HRK_USD
01
02
03
04
kuna/USD
kuna/euro
Nominal ER of Euro and USD
PPI for Croatia, EU, and relative PPI
124
120
116
112
108
104
100
96
92
94
95
96
97
PPI97EUR
98
99
00
01
PPI97HRV
02
03
04
PPI97REL
Construction on IREER
WEIGHTS
ECU/EUR
USD
GBP
CHF
SIT
70,6
27,2
1,0
1,0
0,2
Export of goods and services
32
in % of GDP
28
24
20
16
12
8
93
94
95
96
97
98
SHARE_EXPG_CP
99
00
01
02
03
04
SHARE_EXPS_CP
Imports of goods and services
-8
-9
-10
in % of GDP (goods)
-36
-11
-40
-44
-48
-52
93
94
95
96
97
98
SHARE_IMPG_CP
99
00
01
02
03
04
SHARE_IMPS_CP
in % of GDP (services)
-7
Destination of exports
in % of total exports
TOTAL
eu15
eu25
of which
-Austria
-Italy
-Germany
-Slovenia
Bosnia and Herzegovina
YU;Srbija and Montenegro
Russia
USA
2004
100
51
65
9
23
11
7
14
4
1
3
cum
2004
65
79
83
84
87
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
Liberalization of capital flows
• New FX law in 2003
• Liberalization especially for firms
• Very few restrictions remain (some shortterm flows, outflow of capital for residents,
real estate, …) to be lifted by the end of
SAA (2007)
Estimating FEER
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
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.
Estimating FEER
• Internal eq: potential GDP growth
associated with low and "non-accelerating"
inflation rate
• 1) Output gap
• 2) HP filter or BN decomposition
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...
Estimate Trade balance
• and elasticities of imports and exports relative to
the exogenous variables
ln( X )  11  12 ln( Y * orM *)  13 ln( RER )  1
ln( M )   21   22 ln( Y )   23 ln( RER )   2
•
•
+
+
+
-
Solve for FEER
• CA= X-M
• FEER is the solution for RER in
 21 22 ln(Y ) 23 ln(RER) 
1112 ln(Y *)13 ln(RER) 
CA
e
e
 CA%Y 
Y
Y
• when CA, Y and Y* are replaced with their
long term values
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
4/04.
2/04.
4/03.
2/03.
4/02.
2/02.
4/01.
2/01.
4/00.
2/00.
4/99.
2/99.
4/98.
2/98.
4/97.
109
2/97.
111
4/96.
113
2/96.
4/95.
2/95.
Actual REER and FEER
115
reer
feer hpTB
feer TB 0%
feer TB -6,5%
107
105
103
101
99
97
95
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)