Real Exchange Rate

12 Key excerpts on "Real Exchange Rate"

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  eBook - ePub

  Exchange Rate Regimes in East Asia

  • Masahiro Kawai, Gordon de Brouwer(Authors)
  • 2004(Publication Date)
  • Routledge

    (Publisher)

  Equation 4 can take on non-zero values. In either of these cases, a large number of variables could influence each relative price. And, of course, there is nothing to rule out both relative price channels being operative. In popular discussion, all three definitions of the ‘Real Exchange Rate’ are used, sometimes leading to considerable confusion.

  Which Real Exchange Rate?

  Most models of the Real Exchange Rate can be categorised according to which specific relative price serves as the object of focus. If the relative price of non-tradables is key, the resulting models have been termed ‘dependent economy’ or ‘Scandinavian’.1 The home economy is small relative to the world economy, so the tradable price is pinned down by the rest-of-the-world supply of traded goods. Hence, the ‘Real Exchange Rate’ in this case is (

  Jf-p7

  ), set to achieve internal balance – that is, the equilibrium in the supply and demand of non-traded and traded goods (see Hinkle and Nsengiyumva 1999). More generally, the relative price of non-tradables moves to achieve internal balance in both countries:2

  As Engel (1999) has pointed out, it is typically not appropriate to assume that traded goods prices are equalised, especially at short horizons, but perhaps even at long horizons. For many countries, the variation in the relative price on non-tradables may be fairly small. In that case, the relevant exchange rate might well be adequately represented by.

  This definition is most appropriate when considering the relative price that achieves external balance in trade in goods and services. This variable is also what macroeconomic policymakers allude to as price competitiveness: a weaker domestic currency (in real terms) means that it is easier to sell domestic goods abroad. Of course, it is also true that a higher

  qT

  is equivalent to a worse trade-off in terms of the number of domestic units required to obtain a single foreign unit.

  A related concept is cost competitiveness (Marsh and Tokarick 1996). To see how this variable is related to the preceding one, consider a mark-up model of pricing:

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  Exchange Rate Movements and Their Impact on Trade and Investment in the APEC Region

  • Takatoshi Ito, Tamim Bayoumi, Peter Isard, and Steven Symansky(Authors)
  • 1996(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  III. International Trade and Real Exchange Rates

  Tamim Bayoumi

  The Real Exchange Rate is one of the key relative prices in an economy, defining the rate of exchange between domestic goods and their foreign counterparts. As a result, changes in the exchange rate have economy-wide implications that are communicated largely through international trade. The effects of exchange rate changes on the economy are particularly important for the APEC region because the exchange rates of its two largest members, the United States and Japan, have experienced large deviations from trend over the past twenty years. The appreciation and subsequent depreciation of the U.S. dollar over the mid-1980s had a significant impact on regional trade linkages, as has the appreciation of the yen since 1993.

  In looking at the relationship between Real Exchange Rates (defined as the relative price of goods in different countries) and trade, it is useful to distinguish between the effects of day-to-day exchange rate volatility and more persistent movements in the exchange rate. The breakup of the Bretton Woods fixed exchange rate system in the early 1970s led to the general adoption of floating exchange rates. One consequence of this shift was a marked increase in the level of exchange rate volatility, with day-to-day and month-to-month movements in the exchange rate becoming much larger. For example, the standard deviation of monthly changes in the exchange rate between the yen and the dollar after 1973 has been over triple the value between 1962 and 1972 (Mussa and others, 1994 , Table 2). In addition to this short-term volatility, there have also been more persistent deviations of Real Exchange Rates from long-term trends. The most obvious cases are those mentioned earlier: the appreciation and depreciation of the dollar in the mid-1980s and the more recent appreciation of the yen.

  This section assesses the impact of both types of exchange rate behavior on trade within the APEC region. The focus will be largely on the impact of medium-term changes in the exchange rate. There is strong evidence that such movements have significant effects on trade; empirical trade equations consistently have found that the Real Exchange Rate is one of the key determinants of both exports and imports. In addition to reviewing the relevant literature, some new estimates of the impact of such exchange rate changes on trade volumes will be presented.

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  Economic Adjustment and Exchange Rates in Developing Countries

  • Sebastian Edwards, Liaquat Ahamed, Sebastian Edwards, Liaquat Ahamed(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  7.4 Concluding Remarks With increasing regularity, the exchange rate is being singled out as one of the most important economic variables in developing countries. In fact, it is almost impossible these days to discuss macroeconomic policy problems in the less developed countries without addressing exchange rate issues. From a policy perspective one of the most im- portant problems is determining whether the Real Exchange Rate in a particular country is out of line with respect to its equilibrium value.21 To the extent that the Real Exchange Rate is misaligned, policy actions designed to reestablish equilibrium will be called for.22From a policy viewpoint, then, a crucial aspect of any analysis of Real Exchange Rates is to distinguish between equilibrium and disequilibrium movements of these rates. Only in this way will it be possible to develop appropriate policy measures. In spite of the obvious policy importance of analyzing the mecha- nism through which Real Exchange Rate movements take place, very few empirical studies have tackled this problem. In this paper the more specific problem of the effect of commodity export price changes on the Real Exchange Rate has been investigated empirically. The third section of the paper developed and estimated a model of the effects of coffee price changes on money creation, inflation, and the rate of devaluation in Colombia. A virtue of this model is that it highlights two of the channels that have been traditionally mentioned in casual discussions of the effect of commodity price changes on the Real Exchange Rate: money creation and inflation, and the rate of adjustment of the nominal exchange rate (the rate of devaluation of the crawling peg). The model showed that commodity export booms will generally lead to short-run increases in money creation and inflation and to a real 255 Commodity Export Prices and the Real Exchange Rate appreciation.

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  Resources Booms and Macroeconomic Adjustments in Developing Countries

  • Mamta Banu Chowdhury(Author)
  • 2017(Publication Date)
  • Taylor & Francis

    (Publisher)

  The Real Exchange Rate (RER) can be defined as the ratio of relative price of tradables (PT) with respect to nontradables (PNT). This ratio, which is also known as the ‘Salter ratio’, can be written symbolically as follows:

  PER   =   Price   of Tradables Price   of Nontradables   =   P T P NT

  It is clear from the above definition that Real Exchange Rate is a concept that measures the relative price of two goods as opposed to the nominal exchange rate, which is a measure of two monies (Edwards, 1988b). International competitiveness is usually measured in terms of Real Exchange Rate movements. The definition of RER focuses on the rate at which tradables are exchanged for nontradables, or the cost of domestically produced tradables (Edwards, 1988b). A fall in this ratio represents an appreciation of RER, induced by an increase in the price of nontradable goods, and/or by a reduction in the relative price of tradables to nontradables. Real Exchange Rate appreciation is synonymous with a deterioration in a country’s international competitiveness, as it increases the profitability of the nontraded sector and attracts resources from other traded sectors, as well as increasing the domestic cost of producing tradable goods. By contrast, an increase in this ratio represents a real depreciation, or an improvement in the international competitiveness of tradable production.

  It is important to recognise a fundamental notion about the concept of RER. RER is not unique for every sector of an economy. Within the tradable sectors, different Real Exchange Rates can be observed for import substitutes and for exportables. For example, an exporter’s Real Exchange Rate can be significantly different from the Real Exchange Rate for an importer, due to costs and productivity differences in these sectors. For these reasons different RER indices are used separately to identify the changes in the competitiveness of importable and exportable sectors of an economy.

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  International Macroeconomics

  • Harms, Philipp(Authors)
  • 2016(Publication Date)
  • Mohr Siebeck

    (Publisher)

  Taken together, most of the arguments that explain the high correlation between the time series in Figure 7.9 vindicate the use of the CPI-based Real Exchange Rate as a measure of price competitiveness. Figure 7.9: Real effective exchange rates of the Euro vis-à-vis 19 trading part-ners, based on consumer price indices (CPI), GDP deflators, and unit labor costs in the total economy (ULC). Source: Deutsche Bundesbank. Note that the orig-inal time series (base period 1999.Q1) have been inverted in order to be com-patible with the price notation for exchange rates that we use in this book. VII.6 The Equilibrium Real Exchange Rate VII.6.1 Motivation Figure 7.1 and Figure 7.4 have shown that Real Exchange Rates vary considerably over time. The theory of purchasing power parity interprets these fluctuations as symptoms of temporary “overvaluations” and “undervaluation”, which will be corrected in the medium run through an adjustment of nominal exchange 80 85 90 95 100 105 110 115 120 125 1993-01 1994-01 1995-01 1996-01 1997-01 1998-01 1999-01 2000-01 2001-01 2002-01 2003-01 2004-01 2005-01 2006-01 2007-01 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 Real effective exchange rate of the Euro (based on CPI) Real effective exchange rate of the Euro (based on GDP deflators) Real effective exchange rate of the Euro (based on ULC) VII.6 The Equilibrium Real Exchange Rate 301 rates and/or national price levels. This diagnosis, however, is based on the no-tion that the equilibrium Real Exchange Rate is constant – an idea that is un-likely to be supported by reality. In fact, the presentation in Section VII.4 has demonstrated that a variation in economic fundamentals – a change of market structure, preferences, or productivity – may result in a variation of relative prices which, in turn, gives rise to a movement of the Real Exchange Rate. Such movements should not be interpreted as over- or undervaluations, but as the outcome of market equilibria.

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  International Financial Markets And Agricultural Trade

  • Thomas Grennes(Author)
  • 2019(Publication Date)
  • CRC Press

    (Publisher)

  By partially delinking the current from the capital account, all the dual rates system can hope to do is delay the eventual crisis. A system that is particularly relevant for the developing countries consists of the coexistence of a fixed rate for commercial transactions with a floating parallel (either black or grey) market rate governing the financial transactions. 9 3. MEASURING Real Exchange RateS From an empirical point of view, the first question that should be addressed is: How should the Real Exchange Rate be measured? From equation (9), which defines the Real Exchange Rate as the relative price of tradables and nontradables, it is apparent that the main measurement problems are those related to the selection of the real-world counterparts of P; and P N In reality, it is extremely difficult, if not impossible, to define which goods are actually tradables and which are nontradables. A second measurement problem is related to the definition of E. Should the nominal exchange rate with respect to the U.S. dollar be considered? Or is the exchange rate with respect to the DM the most appropriate? Or should an average of both rates be used? These and other problems related to the measurement of the Real Exchange Rate will be discussed in this section. The analysis will be restricted to the actual measurement of the RER without entering into the important and difficult question of the empirical definition of the equilibrium level of the Real Exchange Rate. The analysis presented in this section will first discuss briefly the arguments traditionally given favoring alternative measures of the Real Exchange Rate. The discussion will be quite general and will provide a broad cover of the literature. That is, the presentation will also deal, even though briefly, with the PPP Real Exchange Rate. Section 4, on the other hand, deals with the actual behavior of different RER indexes in the developing countries.

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  Exchange Rate Regimes

  Fixed, Flexible or Something in Between?

  • I. Moosa(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  When the Real Exchange Rate makes the economy highly P P = α + βEP ∗ P ∗ Figure 2.3 The effect of domestic currency appreciation and rising foreign prices on domestic prices The Role of the Exchange Rate in the Economy 31 competitive, resources are drawn into the traded goods sector, which is mirrored in the factor market by a new allocation of resources. The economy becomes trade-oriented, with rising employment of capital and labour in the export- and import-competing sectors. The distribu- tion of income is also affected. If the country has a traditional export sector (for example, agriculture or mining), then a very competitive exchange rate will make traditional exports profitable. There are also implications for the asset markets. When domestic returns are below foreign returns, capital flight will occur, leaving a smaller amount of resources available for domestic investment. Moreover, those who indulge in capital flight (for example, those who can fake trade invoices) often do so at the expense of those who do not (perhaps because they cannot). Exchange rate policies/regimes affect the external balance and the internal balance through their effects on total spending (via the demand for money) and on the competitiveness of traded goods. According to Collier and Joshi (1989), the external balance should be interpreted as the achievement of a sustainable current account deficit (a deficit that is consistent with a realistic medium-run projection of foreign capital inflow). The internal balance is a more complex target as it has Inflow i – i ∗ Outflow Inflow Inflow Outflow Outflow E e + ρ ⋅ Figure 2.4 Interest and exchange rate configurations and capital flows 32 Exchange Rate Regimes employment (or output) and inflation as its components. Policy-makers would like to have high employment and output and low inflation, but complications are introduced by the fact that there may be a trade-off between these sub-targets (as implied by the Phillips curve).

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  Macroeconomics and Development

  • Mario Damill, Martín Rapetti, Guillermo Rozenwurcel(Authors)
  • 2016(Publication Date)
  • Columbia University Press

    (Publisher)

  In this regard, much could be learned from the detailed study of specific episodes of growth acceleration triggered by stable and competitive RER strategies. N O T E S I thank Jaime Ros, Ricardo Ffrench-Davis, Roxana Maurizio, and Emiliano Libman for their helpful comments. 1. I follow the definition of nominal exchange rate as the domestic price of a foreign currency. Consequently, a higher RER implies a more competitive or depreci-ated domestic currency in real terms. 2. Other strategies, such as case and episode studies or historical narratives, have also been used. For studies of growth episodes, see Hausmann et al. (2005) and Freund and Pierola (2012). For historical analyses of specific cases in Latin America, see Frenkel and Rapetti (2008, 2012). 3. For a critical assessment of the notion of exchange rate equilibrium, see Taylor (2004). 4. This would be defining the nominal exchange rate as the units of foreign cur-rency exchanged for one unit of domestic currency. 5. A slightly different classification of the mechanisms is presented in Skott et al. (2012). 6. Frenkel (1983) pioneered the analysis and formalization of this kind of dynam-ics. See also Frenkel and Rapetti (2009). 7. See chapter 10, this volume: “Balance-of-Payments Dominance: Its Implications for Macroeconomic Policy” by José Antonio Ocampo. 8. Porcile and Lima (2010) and Razmi et al. (2012) are recent examples. 266 THE Real Exchange Rate, BALANCE OF PAYMENTS, AND ECONOMIC DEVELOPMENT 9. It could even be argued that tradable production also operates under some broad form of increasing returns in the external-constrained growth story. The expan-sion of tradable activities generates a positive externality by raising the net supply of foreign exchange and thus providing the rest of the economic sectors foreign exchange at a relatively lower cost. Given that exporters do not internalize the posi-tive external effect of supplying additional units of foreign exchange, an undervalued RER is required.

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  Global Imbalances, Exchange Rates and Stabilization Policy

  • A. Makin(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  As in the previous chapter we use the inverse of the capital-output ratio, once central to investment and growth theory. In initial equi- librium the economy is assumed to be at its potential level of output with unemployment at the ‘natural rate’. If the economy operates below potential capacity, this is reflected in a rise in unemployment above the natural rate. Central to what follows is a distinction between full employment national output (or output consistent with the natural rate of unem- ployment) and total expenditure on that output which varies with Real Exchange Rate fluctuations. The Real Exchange Rate, or competi- tiveness, is defined as R eP P * (9.2) where e is the nominal effective exchange rate, defined as the price of foreign exchange; P* is the exogenous world price level; and P is the domestic price level. If in initial equilibrium the Real Exchange Rate is normalized at unity, R eP P * 1 (9.3) This implies that deviations from the unity value of the Real Exchange Rate also measure deviations from PPP. Nominal exchange rate 146 Global Imbalances, Exchange Rates and Policy movements primarily drive Real Exchange Rates since national price levels are sticky in the short run. A real depreciation due to nominal depreciation (R > 1) therefore instantly improves competitiveness. This raises domestic demand for domestic product and net exports, thereby raising aggregate demand AD, above normal full employ- ment output in the short run, whereas a real appreciation due to nominal appreciation (R < 1) worsens competitiveness and lowers AD below normal. This notion of aggregate expenditure by resident and non-resident entities accords with the traditional textbook inter- pretation of AD. However, in earlier chapters we defined aggregate expenditure as absorption in the Alexander (1952) sense and used the acronym AE to denote it. To avoid confusion it is important to note the changed use of terms at this juncture.

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  Exchange Rate Theory and Practice

  • John F. Bilson, Richard C. Marston, John F. Bilson, Richard C. Marston(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  Thus, if we define the Real Exchange Rate as the relative price of traded goods and the terms of trade as the relative price of exportables (that is, the inverse of Ph and P,, respectively), it follows that trade-biased growth in the foreign country causes the home country’s real exchange to depreciate and its terms of trade to improve. 4. A push for higher real wages in either country has, as one would expect, ambiguous effects on the relative price of goods. The outcome will depend once again on the relative size of the supply and demand elasticities. 5. The results from the transfer experiment are interesting in light of the Ohlin-Keynes insights and can be studied in conjunction with the ds exper- iment. If the home country’s money supply is increased by the same amount as the reduction in the money supply of the trading partner, home saving 289 Real Exchange Rates in the 1970s falls. As in the case of a reduction in the marginal propensity to save, the ensuing change in Ph depends on the marginal propensities to consume the home and exportable commodities. If mh is sufficiently larger than m,, then Ph unambiguously increases. The effects on P, are harder to ascertain, A reduction in saving unambiguously reduces P, as consumption of both the nontraded good and the exportable rises in the home country. However, the effects of a transfer which increases M in the home country depend not only on the home country’s reaction but also on the foreign country. Hence, as is shown in Appendix 3, the relative size of both the home and foreign marginal propensities to consume is important. The ambiguities that characterize the flow equilibrium solutions reappear in the stock equilibrium version, which is characterized by a balanced cur- rent account and an endogenous money supply. In stock equilibrium the system consists of four equations in four unknowns and can be solved re- cursively, as is shown in Appendix 4.

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  International Macroeconomics

  A Modern Approach

  • Stephanie Schmitt-Grohé, Martín Uribe, Michael Woodford(Authors)
  • 2022(Publication Date)
  • Princeton University Press

    (Publisher)

  The Real Exchange Rate, e = E P ∗ /P, can then be written as e = E P ∗ P = E φ(P ∗ X , P ∗ M ) φ(P X , P M ) = φ(E P ∗ X , E P ∗ M ) φ(P X , P M ) = φ(P X , P M ) φ(P X , P M ) = 1, where the third equality uses the fact that φ is homogeneous of degree one and the fourth equality uses the fact that the law of one price holds for both goods. This 216 Chapter 9 expression says that if all goods are internationally tradable and no trade barriers are in place, the two countries are equally expensive. Consider next the consequences of imposing a tariff τ > 0 on imports in the home country. Now an importer of goods pays E P ∗ M to the foreign producer and τ E P ∗ M in tariffs to the local government. Consequently, the domestic price of the importable good increases by a factor of 1 + τ ; that is, P M = (1 + τ)E P ∗ M . Then the Real Exchange Rate becomes e = E φ(P ∗ X , P ∗ M ) φ(P X , P M ) = φ(E P ∗ X , E P ∗ M ) φ(E P ∗ X , (1 + τ)E P ∗ M ) < 1, where the inequality follows from the fact that φ(·, ·) is increasing in both argu- ments and that 1 + τ > 1. This expression shows that the imposition of import tariffs leads to an appreciation of the Real Exchange Rate; that is, it makes the domes- tic consumption basket more expensive relative to the foreign consumption basket. Exercise 9.7 asks you to analyze how the imposition of an export subsidy affects the Real Exchange Rate. We have established that trade barriers can cause persistent deviations from PPP. According to this analysis, one should expect that protectionist trade policies, like the import tariffs imposed by the Trump administration in 2019, will cause an appreciation of the Real Exchange Rate (a fall in e), making the United States more expensive relative to the rest of the world. 9.8 Home Bias and the Real Exchange Rate Thus far we have seen that PPP may fail because not all goods are tradable or because of the presence of tariffs.

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  The Economics of Exchange Rates

  • Lucio Sarno, Mark P. Taylor(Authors)
  • 2003(Publication Date)
  • Cambridge University Press

    (Publisher)

  In fact, a close correlation is often found between these two variables. For example, Obstfeld and Rogoff (1995) find a large correlation coefficient between trade-weighted Real Exchange Rate changes and changes in net foreign asset positions for fifteen countries during the 1980s. Correlation between these two endogenous variables does not necessarily imply, however, that there is causation. For example, Bayoumi, Clark, Symansky and Taylor (1994) use the International Monetary Fund’s MULTIMOD and provide evidence that the correlation between current account deficits and the Real Exchange Rate is in fact very sensitive to whether the driving factor is fiscal or monetary policy. More generally, current account deficits may be rationalised on the basis of many different driving factors. Purchasing power parity and the Real Exchange Rate 83 originally developed by Blanchard and Quah (1989). 59 In this section we provide a brief review of this literature. Lastrapes (1992) applies the Blanchard and Quah (1989) decomposition to real and nominal US dollar exchange rates of five industrialised countries (Germany, UK, Japan, Italy and Canada) over the sample period from 1973 to 1989. Lastrapes finds that real shocks cause a permanent real and nominal appreciation, while nominal shocks are found to cause a permanent nominal depreciation. Evans and Lothian (1993) also examine real dollar exchange rates of four major industrial countries under the recent float and report that transitory shocks play a relatively small role in explaining Real Exchange Rate movements. Their findings, however, also suggest that there are instances when temporary shocks make a more substantial contribution, so that the role of temporary and permanent shocks in driving exchange rate movements may be varying over time.

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