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Conference
“Competitiveness of the South Eastern European Countries and
Challenges on the Road to EU “
REAL EXCHANGE RATE DYNAMICS IN
REPUBLIC OF MACEDONIA: OLD WISDOMS
AND NEW INSIGHTS
Sultanija Bojceva Terzijan, MSc.
National Bank of the Republic of Macedonia
30.05.2008, Skopje
Outline:
Republic of Macedonia road to EU


Real convergence
Nominal convergence
Competitiveness and real exchange rate dynamics in
RM

Estimation of the equilibrium real exchange rate (REER)
for Macedonian Denar
Republic of Macedonia road to EU






Stabilization and Association Agreement with EU, April 2001
Interim Agreement on Trade and Trade Issues -into force from
June 1st 2001
Submission of the membership application , March 2004
Submitted Questionnaire to the Government of RM, October 1st
2004
Positive opinion from European Commission for RM candidacy,
November 2005
RM was granted candidate status, December 17th 2005
Real Convergence

GDP per capita PPP - EU15
Slow real convergence
Absence of FDI, new
technology and know-how
 Negative external and
domestic shocks

Intensified in 2007

Real GDP growth rate of
5,1%
2007
47
50
45
37
40
31
35
30
25
15
12
24
21
19
20

1997
26
13
10
5
0
Albania
Bosnia and
Herzegovina
Croatia
Macedonia
Serbia
Real Convergence – continues
Contribution of the production factors to GDP growth

Total factor productivity dominates as in all SEE countries
Contribution to GDP growth
(average 1996-2006)
Sectoral productivity growth
(average 2002-2007)
2
2
10
5.2
1.5
5
5.7
4.2
3.4
2.9
0.4
1
0.5
9.1
0
0.4
0.1
-5
0
capital
labor
Source: IMF Article IV, 2005
TFP
-3.8
Nominal Convergence



Stylized fact: the absolute price level of less developed countries
is bellow the euro area average
Macedonia fits this pattern as well
Lower absolute levels of price parities towards Germany, Italy,
Slovenia
PP level (Goods)
120
100
80
61
68
63
68
104 104
75 78
60
40
20
0
Germany
Italy
Slovenia
Serbia
140
120
100
80
60
40
20
0
PP level (Services)
127
111
Nov.05
66 62
41 45
Germany
47 46
Italy
Oct.06
Slovenia
Serbia
Nominal Convergence - continues
Price level convergence (EU 27=100)
100
90
80
70
60
50
40
2003
30
2006
20
10
0
Potential sources of upward inflation
pressures

Balassa-Samuelson effect from the supply side

Adjustment in regulated prices

Cost-push factors from non-tradable intermediates
(distribution sector, business services sector, rents)

Higher quality and reputation of domestically produced
goods
Real exchange rate dynamics in RM
Analysis based on a paper “Real exchange rate dynamics in
Macedonia: Old wisdoms and new insights”
Motivation:
 Explain reason for
depreciation of MK
REER
Inflation and REER developments
1.3
1.2
1.1
1.0
Try to link it to
productivity
developments –
the B-S effect
CPI
0.8
0.7
0.6
1997Q1
1997Q3
1998Q1
1998Q3
1999Q1
1999Q3
2000Q1
2000Q3
2001Q1
2001Q3
2002Q1
2002Q3
2003Q1
2003Q3
2004Q1
2004Q3
2005Q1
2005Q3
2006Q1
2006Q3
2007Q1
2007Q3

REER
0.9
Balassa-Samuelson effect in Macedonia
Domestic productivity

Starting point:
productivity
differential bears a
link to the relative
prices – domestic
concept
1.4
prod1
1.3
1.2
prod2
1.1
prod3
1.0
0.9
prod4
0.8

2007q03
2006q04
2006q01
2005q02
2004q03
2003q04
2003q01
2002q02
2001q03
2000q04
2000q01
1999q02
1998q03
prices since 2000
0.6
1997q04
 change in administrative
prod5
0.7
1997q01
Prices increased due
to other factors than
the B-S effect
Rel
B-S effect in Macedonia – continues
45

If potentially there is a
link from productivity
to relative prices the
share of non-tradables
in the CPI basket is
crucial (Engel’s law)
40
35
30
25
Weights of selected categories in CPI, 2007 (%)
Food including
alcohol and
tobacco
Energy
20
15
10
5
0
Services
B-S effect in Macedonia – continues


Fairly limited contribution
to total CPI
The steady rise of services
from 2000 have negligible
influence on the CPI
Tradable, non-tradable and overall price
inflation in Macedonia
140
130
120
CPI1
TI
NTI
110
100
QI.07
QI.06
QI.05
QI.04
QI.03
QI.02
QI.01
QI.00
QI.99
90
QI.98
The CPI index has strong
co-movement with goods
price inflation
QI.97

B-S effect in Macedonia – continues
Balassa-Samuelson effect bleeds from two wounds:

Rises in service prices were not connected to developments in the
productivity differential in Macedonia from 1997 to 2005

Service price inflation has potentially little impact on headline
inflation - modest weight of services in final household expenditures

Empirical evidence indicates non existence of domestic B-S effect
Real exchange rate dynamics in RM

“Composition
puzzle” solved and
new REER series
were constructed
Low goods price
inflation and high
service price inflation
in foreign benchmark
overestimates the
depreciation of
REER
1.09
1.06
1.03
1.00
0.97
0.94
0.91
0.88
0.85
0.82
0.79
0.76
0.73
0.70
Different CPI based REER
REER
REER1_EU5
REER2_EU5
1997Q1
1997Q3
1998Q1
1998Q3
1999Q1
1999Q3
2000Q1
2000Q3
2001Q1
2001Q3
2002Q1
2002Q3
2003Q1
2003Q3
2004Q1
2004Q3
2005Q1
2005Q3
2006Q1
2006Q3
2007Q1
2007Q3

REER - official series; REER1_EU5 - with MK CPI weights,
REER2_EU5 - with average EU 5 CPI weights
Real exchange rate dynamics in RM
0.9
proddiff1
0.8
proddiff2
proddiff3
0.7
proddiff4
0.6
2007q01
2006q01
2005q01
2004q01
2003q01
2002q01
2001q01
2000q01
0.5
1999q01
Slow catching-up
process, contrary to
the most transition
countries – increase
of productivity gap
relative to abroad
1.0
1998q01

Continual decline of
the MK productivity
relative to the foreign
trade partners
1997q01

Domestic vs foreign productivity – prod. differentials
1.1
Real exchange rate dynamics in RM

Co-movement of the new
REER series and the
productivity differentials
Co-movement of REER and
prod.differentials
1.09
1.03
0.97
0.91
Possible explanations:
0.85
0.79
0.73
REER1_EU5
0.67
proddiff3
0.61
2007Q3
2007Q1
2006Q1
2006Q3
2005Q3
2005Q1
2004Q3
2004Q1
2003Q3
2003Q1
2002Q3
2002Q1
2001Q3
2001Q1
2000Q3
1999Q1
1998Q3
1998Q1
1997Q1
Non-tradable component
of tradable prices
0.55
1997Q3

REER
2000Q1
The (inverse) quality effect
1999Q3

Estimation of a behavioral equilibrium exchange rate
The productivity variable has
a positive sign


Increases in public
expenditures lead to real
appreciation through the
relative price of tradable
goods.

Rise/fall in openness is
reflected in real exchange rate
appreciation /depreciation
(a surprising finding)

Method:
OLS, E-G
Model 1 Model 2 Model 3 Model 1
-0.5** -0.47** -0.47** -0.23**
-4.86** -6.48** -7.29** -4.24**
4.70**
-0.43**
0.37
-3.06**
ARDL
Model 2
-0.30**
-4.21**
5.59**
-0.15**
DOLS
Model 3 Model 4 Model 5
-0.30** -0.46** -0.46**
-4.31** -5.44** -5.45**
5.89**
-1.96**
0.02
-0.01
0.12**
0.14**
ECT
UR
F-test
Const
proddiff1
proddiff2 0.18**
0.41**
proddiff3
0.19
0.63**
proddiff4
0.09*
0.25**
gcon_diff
0.06** 0.14** 0.07* 0.12** 0.25** 0.09**
open
0.04
-0.04 0.29**
0.18**
nfa
-0.02**
0.04**
rel.prices
0.14**
0.13**
Notes: * and ** indicate statistical significance at the 10% and 5% levels, respectively
Productivity, government consumption and the openness variables - fairly
robust both in terms of sign and size
Misalignment of Macedonian REER
0.2
Missalignment, Model 1
0.15
Missalignment, Model 2
Missalignment, Model 3
0.1
2007Q4
2007Q1
2006Q2
2005Q3
2004Q4
2004Q1
2003Q2
2002Q3
2001Q4
2001Q1
2000Q2
1999Q3
1998Q4
-0.05
1998Q1
0
1997Q2
0.05
-0.1
According to the three models, there is not significant
misalignment of MK Denar
Conclusion





Macedonia in process of catching up growth
Real convergence might induce risk for meeting nominal
criteria
B-S effect has a very limited role in the Macedonian case
The (inverse) quality effect, or the non-tradable
component of tradable prices - two possible explanations
REER in line with its fundamentals, absence of significant
misalignment of MK Denar
Thank you for your
attention
References
1. Bogoev, J., Bojceva, T. S., Egert, B. and Petrovska M. (2007), "Real exchange rate dynamics in Macedonia: Old
wisdoms and new insights, The Open-Access, Open-Assesment E-Journal, Vol. 2, 2008-12.
2. DeBroeck, M. and T. Slok (2006), "Interpreting real exchange rate movements in transition economies", Journal of
International Economics, 68(2), pp. 368-383.
3. Égert, B. and K. Lommatzsch (2004), " Equilibrium Exchange Rates in the Transition: The Tradable Price-Based Real
Appreciation and Estimation Uncertainty", William Davidson Institute Working Paper No. 676.
4. Égert, B., Halpern, L. and R. MacDonald (2006) Equilibrium exchange rates in transition economies: Taking stock of
the issues, Journal of Economic Surveys, 20(2), 253-324.
5. Gutierrez, E. (2006), "Export Performance and External Competitiveness in the Former Yugoslav Republic of
Macedonia", IMF Working Paper No. 261.
6. Loko, B. and A. Tuladhar (2005), "Labor Productivity and Real Exchange Rate: The Balassa-Samuelson Disconnect in
the Former Yugoslav Republic of Macedonia", IMF Working Paper No. 113.
7. Mihaljek, D. and M. Klau (2004), "The Balassa-Samuelson Effect in Central Europe: A Disaggregated Analysis",
Comparative Economic Studies, 46(1), 63-94.