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ACADEMY OF ECONOMIC STUDIES DOFIN 2009 Coord. Prof. Moisa Altar, Ph.D stud. Ana-Maria Castravete Balaita Introduction 1. 2. The importance of studying the types of shocks that affect the real exchange rate is twofold: Regarding monetary and governmental policies; e.g. justifying or not a controlled nominal exchange rate; Regarding the economic theoretical models that include this variable; e.g. invalidation of the PPP or of the uncovered interest parity hypothesis; Overview of economic literature Identifying permanent and temporary shocks of the real exchange rate has followed two main directions suring the last two decades: 1. Identifying one permanent and one temporary shock, with the approximation that the former includes real shocks and the latter monetary shocks. Lastrapes (1992), Evans&Lothian (1993), Enders&Lee (1997), Dibooglu and Kutan (2001), Narayan (2008) analyze the shocks on the real rate of the USD with the main trading partners, including in the Blanchard Quah decomposition the time series of nominal exchange rate or inflation in the home and foreign countries; Overview of economic literature(cont.) 2. Identifying different types of monetary and real shocks that influence the real exchange rate by including in the analysis variables such as government consumption, GDP, monetary aggregates, prices: Clarida &Gali (1994), Rogers (1999), Alexius (2005); Unlike the previous approach, this allows the identification of various type of real and monetary shocks, which are possibly acting in opposite ways. Overview of economic literature(cont.) The theoretical models used in the literature follow two main models: 1. The Dornbusch “overshooting” model (1976), according to which the fluctuations of the real exchange rate in the short run are due to monetary shocks; 2.The Stockman model (1980), according to which the fluctuations in the real exchage rate are caused by real shocks both on the short and long-time horizon. Identification of the model: types of shocks and variables The shocks on the real exchange rate are: Fiscal shocks – increases of government taxes. Influences the variable “Share of government consumption in GDP”; Productivity shocks. Influences the “Real GDP” variable; Preference shocks – changes in preferences of the population towards or away traded goods. Influences the variable “Real exchange rate “; Monetary shocks. Influences the variable “Consumer Price Index “. Solving the model: restrictions The long-run restrictions are as follows: The productivity, preference and monetary shocks do not affect the share of government consumption in GDP; The preference and monetary shocks do not affect real GDP; The monetary shock does not affect the real variables (share of government consumption, real GDP and consumer preferences) Solving the model: data • Save for the real RON/EUR exchange rate, the series are • • • • • • calculated as log differential between the value of the variable in Romania and the value in the Euro zone (Source: Eurostat). Frequency: quarterly, over 1998:3 – 2000:3 The differential of government consumption share of GDP; The real GDP differential; Log of real exchange rate; CPI differential, base July 2000. Real GDP series and the series of government consumption share of GDP are deseasonalized (using Tramo/Seats); Unit root tests Series ADF test Level Philips Perron test First difference -4.582835 -10.27251 Level Conclusion First difference -4.555969 -11.93934 DLGOV I(0) (0.0007) 1.148434 (0.0000) (0.0007) -2.787268 (0.0000) 0.196695 -6.620463 DLGDP I(1) (0.9971) -0.319777 (0.0704) -4.733657 (0.9690) -0.635424 (0.0000) 4.733657 LRER I(1) (0.9129) -6.979194 (0.0004) -0.759765 (0.8511) -6.812498 (0.0000) -5.389427 DLCPI I(0) (0.0000) (0.9599) (0.0000) (0.0004) VAR estimation Stationarity condition: Roots of Characteristic Polynomial Endogenous variables: DLGOV DIFDLGDP DIFLRER DLCPI Exogenous variables: C Lag specification: 1 2 Date: 07/01/09 Time: 22:36 Root 0.918099 -0.062073 - 0.573863i -0.062073 + 0.573863i -0.494308 0.403856 - 0.205666i 0.403856 + 0.205666i -0.237974 0.009307 No root lies outside the unit circle. VAR satisfies the stability condition. Modulus 0.918099 0.577210 0.577210 0.494308 0.453209 0.453209 0.237974 0.009307 VAR estimation Normality of the residuals: VAR Residual Normality Tests Orthogonalization: Cholesky (Lutkepohl) H0: residuals are multivariate normal Date: 07/01/09 Time: 22:41 Sample: 1998Q4 2008Q3 Included observations: 38 Component Jarque-Bera df Prob. 1 2 3 4 1.619460 4.199317 3.754361 2.789446 2 2 2 2 0.4450 0.1225 0.1530 0.2479 Joint 12.36258 8 0.1357 VAR estimation White's test: VAR Residual Heteroskedasticity Tests: No Cross Terms (only levels and squares) Date: 07/01/09 Time: 22:50 Sample: 1998Q4 2008Q3 Included observations: 38 Joint test: Chi-sq df Prob. 132.4330 160 0.9454 Individual components: Dependent R-squared F(16,21) Prob. Chi-sq(16) Prob. res1*res1 res2*res2 res3*res3 res4*res4 res2*res1 res3*res1 res3*res2 res4*res1 res4*res2 res4*res3 0.323730 0.528570 0.267238 0.273078 0.238095 0.259710 0.333114 0.368407 0.290824 0.356862 0.628294 1.471584 0.478669 0.493059 0.410157 0.460454 0.655604 0.765580 0.538238 0.728276 0.8268 0.2010 0.9315 0.9234 0.9632 0.9410 0.8037 0.7040 0.8950 0.7387 12.30175 20.08567 10.15506 10.37698 9.047624 9.868983 12.65835 13.99948 11.05129 13.56076 0.7230 0.2164 0.8584 0.8462 0.9114 0.8734 0.6976 0.5988 0.8063 0.6314 Long-run restrictions The restrictions are imposed according to the equation: Yt = Impulse Response Functions of the real exchange rate The response of the change in the real exchange rate to shocks The relative fiscal shock generates an initial appreciation of the real exchange rate, indicating that an increase of taxation encourages consumption of non-tradable goods; The productivity shock generates an appreciation of the real exchange rate which is persistent in the logrun. The response of the change in the real exchange rate to shocks (cont.) • As expected, the preferences shock generates a depreciation of the real exchange rate that remains permanent above the level of the initial shock. We notice that the supply shock (previous table) and the demand shock (current table) have contrasting influences over the real exchange rate, thus justifying our approach of using several “real” variables in order to identify various real structural shocks. The monetary shock generates an initial appreciation of the real exchange rate, indicating price stickiness, which is absorbed within approximately a year. Variance decomposition Horizon fiscal productivity preference monetary 1 16.6 58.5 16.5 0.9 2.0,48.0 34.5,77.0 6.9,30.4 0.1, 3.5 14.2 62.5 16.4 0.5 2.7,42.0 40.4,79.1 6.8,29.4 0.1, 1.5 12.9 63.0 16.8 0.4 3.3,40.3 41.2,78.7 7.2,30.5 0.1, 1.0 13.0 62.6 17.0 0.3 3.4,39.1 42.4,78.5 7.4,30.4 0.1, 0.8 13.8 62.3 16.6 0.2 3.3,40.5 41.5,79.1 6.9,30.0 0.0, 0.4 14.1 62.4 16.4 0.1 3.1,43.0 39.7,79.1 6.6,29.8 0.0, 0.3 14.1 62.6 16.2 0.1 2.3,44.7 38.5,79.4 6.4,29.7 0.0, 0.2 2 3 4 8 12 24 Variance decomposition (cont.) The largest part of the forecast error variance is due to the productivity shock, followed by the preference and the fiscal shock; The monetary shock has an extremely small influence; The majority of studies of structural shocks affecting the real exchange rate find over 50% of the forecast error variance explained by real (or “permanent”) shocks, although the percentage due to monetary shocks is much larger. Historical decomposition – fiscal shock Historical decomposition – productivity shock Historical decomposition – preference shock Historical decomposition – monetary shock Historical decomposition (cont.) the fiscal and preference shocks act in opposite directions in influencing the RER; during the two main swings of the real path: the preference shock influences towards the depreciation of the RER and the fiscal shock towards appreciation. Conclusions • The shocks affecting the RON/EUR real exchange rate are over 95% real in nature; • The real shock with the most important weight is the productivity shock; the historical decomposition shows that the main changes in the RER are due to this shock; • The real shocks have contradictory signs, which justifies the inclusion of more than one "real" variable in our model; Conclusions (cont.) • The results regarding the shocks that influence the EUR/RON real exchange rate are in line with the findings for the developed countries and also with the results obtained by Dibooglu&Kutan (2001) for Hungary; • These findings confirm the predictions of the "equilibrium" models over those of the "disequilibrium" models; References • Alexius, A. (2005). Productivity shocks and real exchange rates. Journal of Monetary Economics, 52, 555−566. • Blanchard, O. J., & Quah, D. (1989). The dynamic effects of aggregate demand and supply disturbances. 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