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Revised Version External Wealth, the Trade Balance, and the Real Exchange Rate
Abstract
We examine the link between the net foreign asset position, the trade balance and the real exchange rate. In particular, we decompose the impact of a country’s net foreign asset position (‘external wealth’) on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, a negative relation between the trade balance and the real exchange rate. We also provide additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate. JEL Classification: F21, F31, F41.
... Following Kosteletou and Liargovas (2000), we also examine the relevance of the FDI as a RER determinant. 12 If capital inflows are used for a spending finance purpose, traded and non-traded goods' demand rises pushing up the RER. 13 In line with the work from Lane and Milesi-Ferretti (2002), our set of potential control 12 It is worth noting that in our empirical analysis, we only consider the most straightforward RER determinants. One can also consider, for example, global financial variables such as the VIX as done in Phillips et al. (2014). ...
... We also control for the government investment as it can influence the relative price of non-traded to traded goods depending on which sectoral productivity (tradable or non-tradable) is the most affected by higher government investment (Galstyan and Lane, 2009). Moreover, we also examine the relevance of the trade balance which is expected to influence negatively the relative price of non-tradable (Lane and Milesi-Ferretti, 2002). Finally, the level of GDP PC of a country is expected to influence the relative price of non-traded goods through the Penn-effect, i.e. the positive association between per capita income and price level. ...
... Finally, the level of GDP PC of a country is expected to influence the relative price of non-traded goods through the Penn-effect, i.e. the positive association between per capita income and price level. Evidence in favor of this hypothesis is provided by Lane and Milesi-Ferretti (2002) showing a positive effect of relative income on the relative price of non-tradable. The impact is expected to be positive as it occurs through a positive wealth effect which increases demand for non-traded goods. ...
This paper investigates the robustness of the Balassa-Samuelson (BS) effect to alternative proxies and to different sectoral classifications between tradable and non-tradable sectors for a panel of 38 developing and emerging economies over the period 1980-2016. We examine the internal and external versions of the BS hypothesis using five different measures. We show that the internal version of the BS hypothesis holds only if the labor productivity differential between the tradable and non-tradable sectors is used rather than the Gross Domestic Product Per worker. Using the mostly conventional sectoral classification between tradable and non-tradable sectors, we also find evidence of a positive effect of the relative price of the non-traded to traded goods on the real exchange rate. Finally, we also show that the previous result is sensitive to the sectoral classification implemented.
... Como ponto de partida, considera-se a equação de equilíbrio intertemporal do Balanço de Pagamentos de uma economia aberta utilizada por Lane & Milesi-Ferretti (2002): ...
... Supõe-se que a taxa de crescimento real do PIB seja igual a zero no equilíbrio de longo prazo na equação (1). Seguindo Marçal et al. (2017), e em conformidade com a ideia apresentada por Lane & Milesi-Ferretti (2002), pode-se incluir a taxa de crescimento real do PIB (g) diferente de zero nesta equação. Dessa maneira, obtém-se uma nova equação para descrever o equilíbrio do Balanço de Pagamentos no longo prazo: ...
Este trabalho analisa o comportamento das contas externas dos Estados Unidos e do Brasil no período entre 1970 e 2017 com o objetivo de entender se a trajetória da conta corrente é sustentável no longo prazo. Há evidência de existência de comportamento explosivo por parte dos ativos e passivos externos dos EUA. Se os ativos do país no exterior continuarem com uma taxa de retorno maior do que a taxa com a qual o país remunera seus passivos externos, o país conseguirá prosseguir com uma Balança Comercial deficitária sem deixar de ser solvente. No caso do Brasil, a evidência é de solvência externa, mas sem diferença entre as taxas de retorno dos ativos e dos passivos externos.
... Meanwhile, Rasbin, Ikhsan, Gitaharie, & Affandi(2021)found that when the Indonesia rupiah was undervalued (almost all periods) the trade was relatively in a surplus and when it was ideal (aligned) in 1993-1996, the trade was relatively balanced. Various other empirical research results also found more or less the same evidence(Lane & Milesi-Ferretti, 2002;Kharroubi, 2011;Tandon, 2014;Dogru, Isik, & Sirakaya-Turk, 2019;Neumann & Tabrizy, 2021). ...
This paper proposes a shared international monetary system (IMS) that can be self-balancing, self-stabilizing, and self-sufficient. We call it an “organic system”. The organic system issues a cross-border means of payment called “organic currency”. Organic currency is only for international transactions between member countries. Domestic transactions continue to use their respective national currencies. Non-member countries cannot use organic currency. Organic and national currencies are interchangeable using an “auto-balancing” exchange rate that follows the fundamentals and neutrality of the foreign balance sheet of each member country. We utilize a 3-dimensional simulation of trade and investment involving 5 countries, 20 products, and a 12-month (5x20x12 model) to test the workability of the system. The results show that this model could provide international liquidity to all (member) countries in the world sustainably and efficiently, make the IMS naturally self-balancing and self-stabilizing, and make the current accounts, balance sheets, and FX reserves of all member countries tend to be self-sufficient. We implant a digital and decentralized system in the very core of the system, which works semi-automatically. This system is flexible; it can start from anywhere in the world and any country may join.
... A debtor country will need a depreciated exchange rate to generate the trade surpluses necessary to service its external liabilities. Conversely, a country with a large and positive NFA position can afford a more appreciated exchange rate, and the associated trade deficit remains solvent (Lane and Milesi-Ferretti 2002). Thus, α 1 is expected to be positive. ...
This study explores the possible existence of threshold kink
effects in the impact of the real dollar-renminbi exchange rate
misalignment on the bilateral trade flows between the United
States and China. Empirical results show a significant threshold
effect, with differential effects of undervaluation and overvaluation. Specifically, our findings suggest that while an overvaluation of the Chinese currency over 2.83% will attenuate the United States’ trade deficit with China, an undervaluation
greater than 4.04% will deepen it. This suggests that a revaluation of the renminbi against the dollar would be helpful in improving the United States trade balance with China.
... This means that when the US Dollar exchange rate rises, the price of Indonesian export goods is more expensive when compared to imported goods which will encourage people to export. Rising exports can improve the trade balance (Lane & Milesi-Ferretti, 2002;Arize et al., 2017). ...
This study aims to determine the direct and indirect effects between the variables that are the object of research, namely the US Dollar exchange rate, foreign direct investment, and the trade balance in Indonesia. The data used is secondary data for the period 2000-2019. The data analysis technique used is path analysis with the help of the SPSS 27.00 program. Based on the results of the analysis of the variable US dollar exchange rate which has a negative effect on foreign direct investment, the US dollar exchange rate has a positive effect on the trade balance and foreign direct investment does not affect the trade balance. The US Dollar exchange rate has no indirect effect on the trade balance through foreign direct investment in Indonesia from 2000-2019.
... The fertility rate is considered as control variable as Rose et al. (2009) find a positive effect for this determinant as the young's consumption is biased towards non-traded goods. Considering the intertemporal budget constraint (Lane and Milesi-Ferretti, 2002), the Net Foreign Asset position constitutes a RER determinant. A country running a current account deficit should experience a more depreciated exchange rate in order to restore exeternal equilibrium. ...
This paper investigates the nonlinear relationship between infrastructures and the Real Effective Exchange Rate (REER). Applying a Panel Smooth Transition Regression (PSTR) model to a sample of 31 countries over the period 1973-2014, we find strong evidence of a nonlinear impact of electricity generating capacity (EGC) and telecommunications on the REER dynamics. When the network is not completed or the stock of infrastructures is low, an increase in EGC and telecommunications depreciates the REER, while the additional depreciation is lower or inexistent once the network is established. Finally, turning to power grid quality, we show that higher electric power losses are associated with a REER depreciation that is particularly marked when the former are high. JEL codes: F31, F41
... The trade balance, also known as the net export or commercial credit, is the monetary difference between imports and exports during a specific period. A trade deficit occurs when imports exceed exports; a trade surplus occurs when exports surpass imports (Lane & Milesi-Ferretti, 2002, Alessandria & Choi, 2021. It was observed from the different papers that the balance of trade has a significant impact on the GDP of India and so many Asian countries, which are developing nations (Prabhakar & Rentala, 2019). ...
... According to Benigno and Thoenissen (2005), in the case of incomplete financial markets, real ER and consumption may have a negative correlation. More importantly, the economic literature emphasises that increases in the real ER may increase imports and reduce exports, leading to imbalances in trade balance (Kim and Roubini, 2008;Lane and Milesi-Ferretti, 2002). Trade deficits are a negative factor for the overall economy, and may cause a loss in national wealth to foreign investors through external debt (Dornbusch, 1983). ...
Institutional frameworks are important for individuals’ attitudes and behaviours, and thus they are important for travel decisions. This study endeavours to examine the influence of various formal and informal institutional factors on tourism spending for a global sample of 120 countries from 2002 to 2019. Applying the two-step system generalised method of moments estimate, the results are robust and consistent. First, informal institutions, that is, colonial history, socialist history, origin of the legal system, religion and language, are important explanatory factors for differences in tourism spending between countries. Second, improvements in formal institutions appear to increase domestic tourism spending while they decrease outbound tourism spending. The results have important policy implications.
JEL code: E02, Z30, Z32.
... The ensuing rise in domestic demand for and the reduction in the foreign supply of non-tradables increases domestic non-tradable prices and therefore leads to a RER appreciation (Neary, 1988). If there is a home bias in the tradables consumption basket, this will reinforce the real appreciation following a rise in the terms of trade (Lane & Milesi-Ferretti, 2002). ...
This article explores the robustness of Behavioural Equilibrium Exchange Rate models, employed to estimate real effective exchange rate misalignments, to the frequency of the underlying data. It compares misalignments stemming from an annual model, estimated since 1980, and a comparable quarterly model, estimated since 1999. The two sets of estimates are similar. Moreover, the in-sample power of quarterly REER misalignments in explaining subsequent REER developments is higher than that of the annual estimates. This article therefore suggests that the "optimal" frequency of a BEER model depends on whether its resulting estimates are employed for research purposes or for policy-making activities. K E Y W O R D S real effective exchange rate, equilibrium exchange rate, BEER model, data frequency J E L C L A S S I F I C A T I O N F00; F31
... Valuation Effects was first discussed by Lane and Milesi-Ferretti [1,2], who assessed the external wealth of 67 countries and regions from 1970 to 1998 using the Balance of Payments (BOP) and the International Investment Position (IIP) data. Inconsistent with the traditional theories of the intertemporal approach to the current account [3], they found significant gaps between changes in net foreign assets and current account balances in various countries and argued that it is the changes in the market value of net foreign assets caused by exchange rate and asset price fluctuations, namely Valuation Effects, which is not captured in the BOP statistics, that leads to the discrepancies. ...
... However, asynchronous current account trends between the North and South of the Euro Area were accompanied by significant appreciations in the real exchange rate in the periphery economies, originating in the strong shifts in consumer prices and unit labour costs in these countries relative to the countries of the Euro Area core (Holinski, Kool and Muysken, 2012). As a result, the issue is whether the real exchange rate is a significant driver of persisting current account imbalances in the Euro Area (Lane and Milesi-Ferretti, 2002). ...
Current account imbalances and their sustainability in the EU member countries has been examined in the recent empirical literature since the establishment of the Euro Area. Deeper trade integration within the EU is generally beneficial. However, international fragmentation of production resulting from emergence of global value chains deepens external imbalances due to persisting differences in macroeconomic performance among member countries. The main objective of the paper is to examine effects of price and non-price determinants of exports and imports in 21 EU member countries. We have estimated the determinants of export and import demand functions in the 21 EU member countries. Our results indicate the high role of imports in aggregate export functions, while aggregate functions indicated a high contribution of domestic demand to the imports dynamics. Dis-aggregated analysis revealed the importance of intermediates in the external trade within and outside the EU from territorial and commodity aspects.
... This is in line with the result in Hamid Faruquee (1995), Ronald MacDonald (1999), Philip, Gian (2002), and Jorge, Romain (2008), who found that net foreign assets have a positive impact on local currency. ...
The exchange rate policy considered as one of the most important macroeconomic policy instruments, for it constitutes along with other policies an effective mechanism to protect the local economy from internal and external shocks. As a result, the importance of looking for the optimal model, which ensures internal and external balance, appeared and exchange rate is squeamish economic variable, especially in front of the great effect of the international trade on the economic development, and the international capital markets development. This paper is aimed to investigate the drivers of the Foreign Exchange Rate Fluctuations through giving international proof on 7 Asian developing countries, which are China, Korea, India, Pakistan, Philippines, Singapore, and Sri Lanka, and test the variables that can affect the exchange rate in this group of countries during 21 years from 1995 till 2015. The researcher use multiple linear regression analysis by GMM techniques that is a suitable estimator for not normally distributed samples. The model tested the impact of the independent variables, which are inflation rate, interest rate, GDP per capita, International reserve, public budget deficit, current account balance, government debt, FDI net inflow, and net foreign assets on the dependent variable, which is the exchange rate.
... Given the policy relevance of current account imbalances, a number of explanations have been provided, including fiscal policy (Chinn and Prasad, 2003), exchange rate regimes (Lane and Milesi-Ferretti, 2002), financial crises (Gruber and Kamin, 2007), financial openness (Reinhardt et al., 2013), the development of financial markets (Mendoza et al., 2009;Sandri, 2014), expropriation risk (Aguiar and Amador, 2011;Benhima, 2013), assets prices , real estate valuation (Aizenman and Jinjarak, 2009), productivity shocks (Bussiere et al., 2010), firms' credit constraints (Song et al., 2011;Bacchetta and Benhima, 2015), households' credit constraints (Coeurdacier et al., 2015), households' saving constraints (Caballero et al., 2008;Gourinchas and Jeanne, 2013) or demographics (Chinn and Ito, 2007;Gerigk et al., 2018). 3 Yet, as Fratzscher et al. (2010) write, 'the debate on the causes of global current account imbalances is still wide open' (p. ...
Explaining cross-country differences in current accounts is difficult. While pay-as-you-go pensions reduce the need to save for retirement, contributions to capital-funded pensions are saved for future consumption. An overlapping-generations analysis shows that capital-funded pensions increase net foreign assets holdings. With a multi-pillar system whose capital-funded part accounts for 18% of pensions, the Austrian current account balance would be 1 percentage point of gross domestic product (GDP) higher than with pure pay-as-you-go pensions in 20 years. By comparison, the Austrian current account surplus averages 1.8% of GDP. Empirically, I find that the current account of high-income countries increases with the coverage and replacement rates of capital-funded pensions.
... The ensuing rise in domestic demand for and the reduction in the foreign supply of non-tradables increases domestic non-tradable prices and therefore leads to a RER appreciation (Neary, 1988). If there is a home bias in the tradables consumption basket, this will reinforce the real appreciation following a rise in the terms of trade (Lane and Milesi-Ferretti, 2002). ...
This paper explores the robustness of Behavioural Equilibrium Exchange Rate (BEER)
models – employed to estimate real effective exchange rate (REER) deviations from
“equilibrium” values consistent with macroeconomic fundamentals – to the frequency (annual
vs. quarterly) of the underlying data. Indeed, data frequency influences both the length of the
sample period (which is typically shorter in a quarterly model) and the set of relevant
fundamentals to be included in the specification, and can affect the plausibility of some of the
BEER modelling assumptions, which are especially restrictive at the quarterly frequency. The
paper compares REER misalignment estimates stemming from a carefully specified annual
model, estimated since 1980 for 55 countries, and a comparable quarterly model, estimated
since 1999, which is a variant of that currently in use at the Bank of Italy (Giordano, 2018). In
the overlapping period the annualised quarterly-model misalignments are quite similar to
those based on the annual model. Moreover, the in-sample power of quarterly REER
misalignments in explaining subsequent, actual REER developments is found to be higher
than that of the annual estimates, signalling their greater usefulness in assessing a country’s
external economic outlook. This paper therefore confirms the robustness of the quarterly
BEER model currently employed at the Bank of Italy; moreover, it suggests that the
“optimal” frequency of a BEER model depends on the use (research vs. monitoring and
policy-making) one makes of the resulting measures.
... The foreign exchange (FX) market is the most liquid and largest financial market [1][2][3]. It identifies the exchange rates of global trade and also determines the relative wealth of a country [4][5][6]. The volatility of the FX market is affected by many factors, and its occurrence, formation and evolution show the typical feature of complex system [7][8][9]. ...
The foreign exchange (FX) market, one of the important components of the financial market, is a typical complex system. In this paper, by resorting to the complex network method, we use the daily closing prices of 41 FX markets to build the dynamical networks and their minimum spanning tree (MST) maps by virtue of a moving window correlation coefficient. The properties of FX networks are characterized by the normalized tree length, node degree distributions, centrality measures and edge survival ratios. Empirical results show that: (i) the normalized tree length plays a role in identifying crises and is negatively correlated with the market return and volatility; (ii) 83% of FX networks follow power-law node degree distribution, which means that the FX market is a typical heterogeneous market, and a few hub nodes play key roles in the market; (iii) the highest centrality measures reveal that the USD, EUR and CNY are the three most powerful currencies in FX markets; and (iv) the edge survival ratio analysis implies that the FX structure is relatively stable.
This study aims to compare the performances in intra-period forecast values of the exchange rate, which is one of the classic linear time series models, ARIMA model, and one of machine learning methods, artificial neural network models. This study uses monthly data for the USD/TRY exchange rates for Turkey over the period from January 2010 to October 2024. Exchange rates are sensitive to unexpected events and political uncertainties in the economy. It is, therefore, highly considerable that the estimation of the future values of exchange rates is important to central banks and companies concerning risk management. ARIMA is a linear univariate time series model that makes in-sample and/or out-of-sample value estimates based on the AR and MA components in the relevant time series data. ARIMA models are models based on a linear component of past data that makes estimates and can yield statistically reliable results. However, all these models are based on the assumption of data having a linear structure and do not give successful results in estimates against nonlinear series. In the literature, it was indicated that the ANN model is more successful than ARIMA models in capturing and predicting the nonlinear structure of the data structure. Since the USD/TRY exchange rate might have a nonlinear structure due to this fact, the use of the ANN model, methods were preferred in this study. According to the empirical findings in the study, the intra-period forecast values obtained with the ANN model on the USD/TRY exchange rate were determined to be more successful than the ARIMA model according to the forecast performance criteria.
This paper proposes a symmetrical international monetary system (IMS) that can be self-balancing, self-stabilizing, and self-sufficient, called an “organic system”. The organic system issues a cross-border means of payment called “organic currency”. Organic currency is only for international transactions between member countries. Domestic transactions continue to use their respective national currencies. Non-member countries cannot use organic currency. The system can provide international liquidity for all member countries in the world efficiently and sustainably. Our simulation shows that this system could eliminate global imbalances to the roots and make the IMS naturally stable. While the current accounts, foreign balance sheets, and FX reserves of all member countries tend to be self-sufficient. The organic system could potentially eliminate the two main problems of current IMS, namely global imbalances and instability so that it could eliminate the potential for currency crises at their roots. The organic system could also make international trade relatively balanced, eliminating the potential for trade exploitation (beggar-thy-neighbor), international trade disputes, and trade wars. We implanted a digital and decentralized system, which works semi-automatically. This system is flexible; it can start from anywhere in the world and any country may join.
This paper investigates the determinants of external imbalances for a group of 26 developed and emerging countries over the period 1972–2021. In addition to traditional factors, the model incorporates the impact of external imbalances in third countries. The empirical evidence highlights the importance of accounting for parameter instabilities in modeling external imbalances, with countries exhibiting heterogeneous behavior in terms of the estimated break dates. The results underscore the critical role of external drivers, such as oil shocks, and the growing influence of third-country imbalances in an increasingly globalized world. Additionally, demographic trends emerge as a significant long-run internal driver. Finally, the paper calculates regime-specific short-run multipliers.
We construct currency portfolios based on the premise that exchange rates gradually converge toward their equilibrium levels, yielding three key findings. First, this convergence can be leveraged to build profitable portfolios. Second, the slow rate of convergence over shorter horizons aligns with the sustained profitability of carry trade strategies, where investors borrow in low-yield currencies and invest in high-yield ones. Third, incorporating the predictive insights of equilibrium exchange rates can boost the performance of carry trade strategies.
The paper studies the long‐term stability of the purchasing‐power‐parity (PPP) relation using data for the Netherlands and Great Britain (earlier the Dutch Republic and England) from 1590 until 2020. We begin by investigating the behavior of the real exchange rate in rate‐of‐growth form finding strong evidence supporting long‐run relative PPP. Turning to price levels, we find evidence of mean‐reverting behavior over the whole period with one long‐lived shift in mean between 1788 and 1931. The myriad other factors that varied over this long period that might have affected the stability of the PPP relation do not appear to have mattered.
In this study, we expanded upon the current benchmark model of external adjustment and dissected the concept of international financial adjustment into two distinct components: valuation effect and investment income. Our enhanced model, which we refer to as “tri‐channel model,” incorporates three key elements: trade balance, valuation effect, and investment income. Using a consolidated quarterly dataset that encompassed China's balance of payments and international investment positions from 1998 to 2020, we estimated the relative importance of the three newly introduced adjustment channels to China's cyclical external imbalance. We found that the trade balance channel played a major role, accounting for approximately 76 percent of cyclical external adjustment. The contribution of the investment income channel to cyclical external adjustment (21 percent) was much greater than that of the valuation effect channel (3 percent). These findings imply that policy responses to the cyclical external imbalance in China should focus more on the trade balance and investment incomes channels rather than exploiting the valuation effects.
Despite global efforts to harmonize international trade statistics, our understanding of digital trade and its implications remains limited. Here, we introduce a method to estimate bilateral exports and imports for dozens of sectors starting from the corporate revenue data of large digital firms. This method allows us to provide estimates for digitally ordered and delivered trade involving digital goods (e.g. video games), productized services (e.g. digital advertising), and digital intermediation fees (e.g. hotel rental), which together we call digital products. We use these estimates to study five key aspects of digital trade. We find that, compared to trade in physical goods, digital product exports are more spatially concentrated, have been growing faster, and can offset trade balance estimates, like the United States trade deficit on physical goods. We also find that countries that have decoupled economic growth from greenhouse gas emissions tend to have larger digital exports and that digital exports contribute positively to the complexity of economies. This method, dataset, and findings provide a new lens to understand the impact of international trade in digital products.
There is surprisingly little empirical research on whether Balassa-Samuelson effects can explain the long-run behavior of real exchange rates in developing countries. This paper presents new evidence on this issue based on a panel-data sample of 16 developing countries. The paper finds that the traded-nontraded productivity differential is a significant determinant of the relative price of nontraded goods, and the relative price in turn exerts a significant effect on the real exchange rate. The terms of trade also influence the real exchange rate. These results provide strong verification of Balassa-Samuelson effects for developing countries
This paper investigates the extent to which domestic and foreign money balances in emerging European countries are influenced by foreign exchange considerations. A well‐specified and stable relationship between real money demand and the exchange rate can be perceived as an important part of a successful monetary policy. This study examines the long‐run determinants of real exchange rates (RERs)associated with the behavioral equilibrium exchange rate (BEER) approach and identifies currency misalignments in these countries. The misalignment is later used to test the nonlinear behavior of the demand for money. The results indicate that the RER misalignments have a significant impact on domestic money demand. When the currencies are overvalued, there is a reduction in domestic money demand, and when they are undervalued, there is an increase in domestic money demand. Furthermore, it can be concluded that overvaluation causes an increase in foreign money demand indicating a shift of preference from domestic to foreign currency.
The progression of financial globalization increases the importance of valuation changes of foreign assets and liabilities, similar to that of current account in explaining the recent net foreign asset position of countries around the world. This study analyzes the long‐term determinants of valuation effects by using panel regression with 10‐year data span of 188 countries. The main findings are as follows. First, the size of foreign assets and relative portion of risky assets are positively associated with valuation effects, which suggests that general principles for long‐term individual investors also hold for an entire country. Second, current account is negatively associated with valuation effects, which suggests that these two mechanisms stabilize each other in overall international adjustment process. Third, exchange rate changes are often positively associated with valuation effects, which at times depend on foreign asset and liability positions. Fourth, per capita GDP are negatively associated with valuation effects. Fifth, current account is mainly associated with valuation effects due to asset price changes, but exchange rate changes and foreign asset and liability positions are mainly associated with valuation effects due to exchange rate changes. The relative proportion of risky assets is associated with both types of valuation effects.
Long-and short-run current account balance (CAB) determinants of the nineteen Eurozone (EZ) member states visa -vis the United States (US) are examined. Particularly, the competitiveness of the EZ vs the US, the relationship between the current account deficit and the budget deficit (twin deficit), and other factors determining the current account balance are studied. Quarterly data was used in a sample of the nineteen EZ member states with the US as a trading partner over the period 2008-2018. It is found that the CAB in the long run has a positive relationship with the real interest rate, real exchange rate, Gross Domestic Product (GDP) per capita, and exchange rate volatility, but a negative relationship with the fiscal balance. In the short run, it is notable that only the real exchange rate affects the current account balance. Finally, policy implications are discussed regarding the determinants of the current account.
This paper evaluates the reliability of alternative equilibrium exchange rate assessments. The literature has predominantly relied on the behavioral equilibrium exchange rate (BEER) model, which attempts to establish a long-term link between the real exchange rate and economic fundamentals. We challenge the recent tendency among BEER modelers to increase the number of regressors. The wisdom of this choice is evaluated with the criterion that equilibrium exchange rates should help predict the future trajectory of real exchange rates. Using panel data for 30 countries during the period 1991–2018, we show that it is hard to outperform both a parsimonious BEER model (with only three fundamentals) and the relative PPP model (which excludes a role for fundamentals in the long run). This finding calls for caution in the ability of economists to closely map the evolution of equilibrium exchange rates and economic fundamentals.
Purpose
This paper aims to examine the effects of the real exchange rate on trade balance in Algeria and investigates whether it represents a viable tool to sustain and improve trade performance using the nonlinear autoregressive distributed lag (NARDL) estimation technique and data from Algeria over the period 1980–2018. This study also highlights the role of trading partners with large income endowments in enhancing the trade balance.
Design/methodology/approach
The NARDL model is used to unveil potential short and long run nonlinear responses of the trade balance to shocks in real exchange rates and detect whether these responses are different in terms of sign and magnitude. The paper also provides a dynamic multiplier analysis that tests the existence of a J-Curve pattern in Algeria with several policy recommendations.
Findings
The findings confirm the existence of a J-curve pattern in Algeria where domestic currency depreciation will worsen the trade balance in the short run and improve it in the long run. The authors also find that the asymmetrical effect of real exchange rate on trade balance is different in sign and magnitude. Finally, the results indicate that an increase in trade partners' income increases the trade balance in Algeria. The findings are of utmost importance with several policy implications.
Originality/value
While some works investigated the nonlinear response of trade balance to real exchange rate movements, their results remain inconclusive and seem to depend on the characteristics of the country/region of study. Moreover, the role of trade partners and their potential impact on trade balance has been relatively overlooked in the literature. The authors fill this gap by examining the asymmetric impacts of real exchange rate and the effect of trade partners' income on trade balance in Algeria.
We document a new international stylized fact on the relationship between external wealth, capital controls, and the real exchange rate. We first re-confirm that the real exchange rate appreciates when external asset holdings increase, all else equal, a central mechanism in international economics. However, we find that increases in publicly held external assets (reserves) are associated with depreciation, especially if combined with high capital controls. Reserve accumulation is also associated with a larger trade surplus, and higher GDP and TFP growth, in countries with high capital controls. The results hold using an instrumental variable for reserves based on commodity export surrender requirements. A simple rationale is presented to account for the new fact: combined reserves and capital controls can affect trade balances via undervaluation (mercantilist motive), while reserve increases without controls can insure against crises (precautionary motive) independently of real exchange rates.
Why are price levels in Germany lower than in Switzerland despite comparable productivity levels and the possibility of goods arbitrage in this region? Standard theories in macroeconomics have severe difficulties in explaining this theoretically important outlier. We construct a dataset of 73 developed and developing countries to highlight the tight connection between price levels, product quality and household wealth. We find that wealth per capita has a 20 percentage points higher explanatory power than income per capita — the key variable implied by standard theories. Analyzing more than 4000 product import categories, we find that Swiss unit values are more than twice as high as German unit values in the median product category. We then provide a theory linking these three forces. Wealth induces consumption shifts toward more expensive goods. As official price statistics may to underestimate quality improvements, they may overstate prices. In turn, higher product quality that comes with higher wealth inflates prices and thus contributes toward explaining price level differences across countries.
This paper proposes a decomposition for the total trade deficit of a country by using implications of a dynamic trade model. It is shown that the total trade deficit of a country can be decomposed into changes due to its effective terms of trade, its relative trade costs, and its macroeconomic developments with respect to its export partners. The implications for bilateral trade are estimated using both imports and exports data for 188 countries, and the decomposition of total trade deficit is achieved for each country. Empirical results show evidence for heterogeneity across countries regarding the decomposition of trade deficits, suggesting alternative policy tools to rebalance trade at the country level. A cross-country investigation further suggests that relative trade costs, followed by relative macroeconomic developments, have contributed the most to the heterogeneity of trade imbalances.
We study low-frequency correlations between real exchange rates (RERs) and fundamentals using historical data starting in 1870. Increases in real GDP per capita – a proxy for the Balassa-Samuelson effect – and terms of trade improvements in the United States relative to advanced economies are associated with stronger US dollar RERs, as predicted by economic theory. For several other fundamentals considered in the literature, we find no evidence of robust low-frequency correlations with RERs.
This paper investigates the effects of the renminbi (RMB) exchange rate on trade prices and volumes in selected Belt and Road Initiative (BRI) countries in comparison with the effects of the US dollar. The stylized facts show that the RMB is underused in bilateral trade with selected BRI countries where intermediate goods dominate. By estimating the level of exchange rate pass‐through and trade volume elasticity, we find that the RMB is significantly correlated with the volume of imports in the sample countries, predicted by the producer currency pricing (PCP) paradigm. We also regroup intermediate and final goods between China and the BRI countries. The evidence shows that dollar fluctuation affects export volumes, reflecting the role of the US as a final goods destination, whereas the RMB exerts a significant impact on the volume of intermediate goods imported from China to the sample countries due to China's important position in global value chains.
This paper conducts an in-depth empirical investigation on the impact of the exchange rate regime (ERR) on real currency misalignments in a panel of 17 Latin American countries over the 1970-2016 period. We consider explicitly the two dimensions of misalignments, size and persistence, and evaluate four different ERR classifications. We also pay attention to cross-sectional dependencies across countries that appear to be important in Latin America, and provide several robustness checks. Our main findings show that, although fixed ERR perform well in limiting the size of misalignments—and in reducing inflation and fiscal deficit—the disequilibria are more persistent. On the contrary, allowing for more flexibility reduces persistence but increases the size of misalignments. Overall, we show that Latin American countries face a crucial trade-off when they have to choose their ERR. JEL Codes: F31, C23, E42.
This study analyses the implications of Inflation Targeting (I.T.) for the Exchange Rate Pass-Through (ERPT) to inflation and trade balance by focusing on the first three movers i.e. New Zealand, UK and Canada. Drawing on the monthly data from October 1976 to September 2017, we employ a TVSVAR framework. Our key findings suggest that there is significant evidence of time-variation in the ERPT to inflation and trade balance in all three countries. Contrary to the notion that the ERPT to inflation has decreased under inflation targeting, in fact, there is strong evidence that if there is anything, it is the other way round. The ADF unit root test with a structural break suggests that the oscillations in coefficients for inflation show a decrease and timing corresponds with the start of I.T. However, this coincident cannot lead to infer that the ERPT has lost its significance. There is also a considerable amount of heterogeneity in the ERPT in the under-analysis countries. Specifically, in response to the positive Real Effective Exchange Rate (REER) shock, the inflation fell in the UK and New Zealand whereas, in Canada, it had the opposite effect. On the ERPT to the trade balance, the results on the UK showed clear evidence of J-curve whereas in Canada, the impact was rather instantaneous, and the trade balance quickly deteriorated. In New Zealand, the trade balance also showed deterioration in response to the REER shocks, although comparatively there was milder response than Canada and the UK. Our findings have profound implications for monetary policy formulation under I.T. regimes and the influence of ERPT on price stability and external balance.
This paper examines the determinants of real effective exchange rate (REER) for a panel of 13 countries covering post Bretton Woods period. The fundamental determinants of the equilibrium real exchange rate are terms of trade, trade openness, government expenditure, technology and capital controls. Im, Pesaran, and Shin (1997) unit root test confirms the non-stationarity of all the series. Pedroni (1997) co-integration test confirms stable long run relationship between REER and real variables. REER appreciates in response to changes in terms of trade, productivity and capital flows, and depreciates in the presence of open trade regime. Our results are robust to different measures of REER and trade openness.
This paper investigates the impact of the distribution sector on the real exchange rate, controlling for the Balassa-Samuelson effect, as well as other macro variables. Long-run coefficients are estimated using a panel dynamic OLS estimator. The main result is that an increase in the productivity and competitiveness of the distribution sector with respect to foreign countries leads to an appreciation of the real exchange rate, similarly to what a relative increase in the domestic productivity of tradables does. This contrasts with the result that one would expect by considering the distribution sector as belonging to the non-tradable sector. One explanation may lie in the use of the services from the distribution sector in the tradable sector. Our results also contribute to explaining the so-called PPP puzzle.
In this chapter we study the asymptotic distributions for ordinary least squares (OLS), fully modified OLS (FMOLS), and dynamic OLS (DOLS) estimators in cointegrated regression models in panel data. We show that the OLS: FMOLS, and DOLS estimators are all asymptotically normally distributed. However; the asymptotic distribution of the OLS estimator is shown to have a non-zero mean. Monte Carlo results illustrate the sampling behavior of the proposed estimators and show that (I) the OLS estimator has a non-negligible bias in finite samples, (2) the FMOLS estimator does not improve over the OLS estimator in general, and (3) the DOLS outperforms both the OLS and FMOLS estimators.
The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs but more broadly, tariffs, nontariff barriers and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home bias in trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity home bias puzzle, and the Backus-Kehoe-Kydland consumption correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad arrange of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing power parity puzzle emphasized by Rogoff, and what we term "the exchange rate disconnect puzzle." The latter category of riddles includes both the Meese-Rogoff exchange rate forecasting puzzle and the Baxter-Stockman neutrality of exchange rate regime puzzle. Here, although many elements need to be added to our extremely simple model, trade costs still play an essential role.
Using 1970–1985 sectoral data for the OECD we find that inflation in nontradable goods exceeds inflation in tradables. We identify a demand shift towards nontradables and faster growth of total factor productivity in the tradable goods sector as the prime causes of the differential inflation. In addition, disinflation attempts and the exchange rate regime appear to have exerted significant influence on the relative inflation rate.
The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs but more broadly, tariffs, nontariff barriers and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home bias in trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity home bias puzzle, and the Backus-Kehoe-Kydland consumption correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad arrange of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing power parity puzzle emphasized by Rogoff, and what we term "the exchange rate disconnect puzzle." The latter category of riddles includes both the Meese-Rogoff exchange rate forecasting puzzle and the Baxter-Stockman neutrality of exchange rate regime puzzle. Here, although many elements need to be added to our extremely simple model, trade costs still play an essential role.
This paper examines whether electoral motives and government ideology influence short-term economic performance. I employ data on annual GDP growth in 21 OECD countries over the 1951-2006 period and provide a battery of empirical tests. In countries with two-party systems GDP growth is boosted before elections and, under leftwing governments, in the first two years of a legislative period. These findings indicate that political cycles are more prevalent in two-party systems because voters can clearly punish or reward political parties for governmental performance. My findings imply that we need more elaborate theories of how government ideology and electoral motives influence short-term economic performance.
This paper provides an empirical investigation of the medium-term determinants of current accounts for a large sample of industrial and developing countries. The analysis is based on a structural approach that highlights the roles of the fundamental macroeconomic determinants of saving and investment. Cross-section and panel regression techniques are used to characterize the properties of current account variation across countries and over time. We find that current account balances are positively correlated with government budget balances and initial stocks of net foreign assets. Among developing countries, measures of financial deepening are positively associated with current account balances while indicators of openness to international trade are negatively correlated with current account balances.
The Balassa-Samuelson model, which explains real exchange rate movements in terms of sectoral productivities, rests on two components. First, for a class of technologies including Cobb-Douglas, the model implies that the relative price of nontraded goods in each country should reflect the relative productivity of labor in the traded and nontraded goods sectors. Second, the model assumes that purchasing power parity holds for traded goods in the long-run. We test each of these implications using data from a panel of OECD countries. Our results suggest that the first of these two fits the data quite well. In the long run, relative prices generally reflect relative labor productivities. The evidence on purchasing power parity in traded goods is considerably less favorable. When we look at US dollar exchange rates, PPP does not appear to hold for traded goods, even in the long run. On the other hand, when we look at DM exchange rates purchasing power parity appears to be a somewhat better characterization of traded goods prices.
We study a panel version of the dynamic OLS estimator of a cointegration vector. The estimator is asymptotically normally distributed, can be made fully parametric, is computationally simple, and can achieve substantial improvements in precision over the single equation estimator. In a series of Monte Carlo experiments, we find that the asymptotic distribution theory provides a reasonably close approximation to the exact finite sample distribution. As an empirical application, we use panel dynamic OLS to estimate coe#cients of the long-run money demand function in a panel data set of 19 countries with annual observations from 1957 to 1996. We estimate the income elasticity to be 1.08 (asymptotic s.e.=0.17) and the interest rate semi-elasticity to be-0.02 (asymptotic s.e.=0.003). Keywords:Nonstationary Panel Data, Cointegration Vector Estimation, Money Demand 1 Department of Economics, The Ohio State University. We thank Paul Evans, Masao Ogaki, and seminar participants at Georgetown ...
International financial integration allows countries to become net creditors or net debtors with respect to the rest of the world. In this paper, we show that a small set of fundamentals-shifts in relative output levels, the stock of public debt, and demographic factors-can do much to explain the evolution of net foreign-asset positions. In addition, we highlight that "external wealth" plays a critical role in determining the behavior of the trade balance, both through shifts in the desired net foreign-asset position and through the investment returns generated on the outstanding stock of net foreign assets. Finally, we provide some evidence that a portfolio balance effect exists: real interest-rate differentials are inversely related to net foreign-asset positions.
This chapter discusses portfolio balance models with postulated asset demands, asset demands broadly consistent with but not directly implied by microeconomic theory. The demand for the sum of assets denominated in each currency is homogeneous of degree one in nominal wealth, and the demand for money in each country depends on the return on the security denominated in that country's currency but not on the return on securities denominated in other currencies. However, under these same assumptions the demand for money depends on real wealth. Because the conclusions of macroeconomic analysis often depend crucially on the form of asset demand functions, it is important to continue to explore the implications of the microeconomic theory and other microeconomic approaches. The chapter discusses that the consumer arrives at his or her asset demands by maximizing his or her utility given interest rates and the parameters of the distributions of prices and exchange rates. The distributions of prices and exchange rates are not invariant to changes in the distributions of policy variables and stochastic components of tastes and technology. It has been recognized that a very important item on the research agenda is imbedding consumer's asset demands based on utility maximization in a general equilibrium model in which the distributions of prices and exchange rates are determined endogenously.
This paper presents a methodology for calculating bilateral equilibrium exchange rates for a panel of currencies in a way that guarantees global consistency. The methodology has three parts: a theoretical model that encompasses the balance of payments and the Balassa-Samuelson approaches to real exchange rate determination; an unobserved components decomposition in a cointegration framework that identifies a time-varying equilibrium real exchange rate; and an algebraic transformation that extracts bilateral equilibrium nominal rates. The results uncover that, by the start of Stage III of the European Economic and Monetary Union (EMU), the euro was significantly undervalued against the dollar and the pound, but overvalued against the yen. The paper also shows that the four major EMU currencies locked their parities with the euro at a rate close to equilibrium.
This paper examines the long-run determinants of the real exchange rate from a stock-flow perspective. The empirical analysis estimates a long-run relationship between the real exchange rate, net foreign assets and other factors affecting trade flows. Using postwar data for the United States and Japan, cointegration analysis supports the finding that the structural factors underlying each country's net trade and net foreign asset positions determine the long-run path for the real value of the dollar and the yen. The empirical analysis also provides estimates for the underlying stochastic trend in each real exchange rate series.
Asymptotic distributions and critical values are computed for several residual-based tests of the null of no cointegration in panels for the case of multiple regressors, including regressions with individual-specific fixed effects and time trends. The associated cointegrating vectors and the dynamics of the underlying error processes are permitted considerable heterogeneity across individual members of the panel.
This paper describes the methodology and the data used to compute nominal and real effective exchange rate indices in the International Monetary Fund`s Information Notice System (INS). In particular, it highlights improvements to the INS implemented over 1994-96, including modifications to the computational methodology, use of updated data, and extension of the INS to recent Fund members.
Foundations of International Macroeconomics is an innovative text that offers the first integrative modern treatment of the core issues in open economy macroeconomics and finance. With its clear and accessible style, it is suitable for first-year graduate macroeconomics courses as well as graduate courses in international macroeconomics and finance. Each chapter incorporates an extensive and eclectic array of empirical evidence. For the beginning student, these examples provide motivation and aid in understanding the practical value of the economic models developed. For advanced researchers, they highlight key insights and conundrums in the field. Topic coverage includes intertemporal consumption and investment theory, government spending and budget deficits, finance theory and asset pricing, the implications of (and problems inherent in) international capital market integration, growth, inflation and seignorage, policy credibility, real and nominal exchange rate determination, and many interesting special topics such as speculative attacks, target exchange rate zones, and parallels between immigration and capital mobility. Most main results are derived both for the small country and world economy cases. The first seven chapters cover models of the real economy, while the final three chapters incorporate the economy's monetary side, including an innovative approach to bridging the usual chasm between real and monetary models.
Since the 1995 publication of Obsteld and Rogoff’s Redux model, there has been an outpouring of research on open-economy dynamic general equilibrium models that incorporate imperfect competition and nominal rigidities. This paper offers an interim survey of this recent literature.
Although capital flows are closely monitored, surprisingly little is known about the accumulated stocks of foreign assets and liabilities held by various countries, especially in the developing world. This paper constructs estimates of foreign assets and liabilities and their equity and debt subcomponents for a sample of 67 industrial and developing countries. It characterizes the stylized facts of international balance sheets and asks whether there are trends in net foreign asset positions and shifts in debt–equity ratios over time. Finally, it explores the sensitivity of estimated stock positions to the treatment of valuation effects not captured in balance of payments data.
This paper presents and applies some results on the interpretation of cointegrating regressions. The key concept is the irreducible cointegrating (IC) relation, one from which no variable can be omitted without loss of the cointegration property. Extending earlier results, it is shown that under certain circumstances, IC relations are identified structural forms. It is possible, at least in principle, to learn about the structure of simultaneous long-run relations directly from cointegration analyses, in contrast with the well-known fact that no such knowledge can be obtained from the correlations between stationary variables. IC relations can also be estimated by asymptotically mixed Gaussian and median unbiased estimators, permitting standard inference. MINIMAL, an algorithm for extracting the IC subsets of a data set, is applied to variety of artificial and actual data.
Abstract : The US current account deficit has been persistently large and has brought the country's ratio of foreign debt to GDP to 20%, a figure that is high by historical standards. This paper argues that while US solvency is not a near-term constraint on ongoing deficits, the sheer size of the US economy makes it likely that its current account will have to approach balance in the next five to ten years, if not sooner. The paper surveys a wide body of evidence suggesting that the US economy remains surprisingly closed to external trade in products and capital, and suggests that costs of international trade in goods can explain the evidence. Given the trade costs, a substantial real depreciation of the dollar will be needed to close the US current account gap. If current-account adjustment is gradual, then the medium-term depreciation of the dollar would be on the order of 12%. If the current account deficit is eliminated in a precipitous and disorderly fashion, and the Fed attempts to maintain full employment, the depreciation could be much bigger, even on the order of 40% to 50%.
This paper develops an equilibrium model of the determination of exchange rates and prices of goods. Changes in relative prices of goods, due to supply or demand shifts, induce changes in exchange rates and deviations from purchasing power parity. These changes may create a correlation between the exchange rate and the terms of trade, but this correlation cannot be exploited by the government to affect the terms of trade by foreign exchange market operations.
In this paper, we study the asymptotic distributions for least-squares (OLS), fully modified (FM), and dynamic OLS\ (DOLS) estimators in cointegrated regression models in panel data. We show that the OLS, FM, and DOLS estimators are all asymptotically normally distributed. However, the asymptotic distribution of the OLS estimator is shown to have a non-zero mean. Monte Carlo results examine the sampling behavior of the proposed estimators and show that (1) the OLS estimator has a non-negligible bias in finite samples, (2) the FM estimator does not improve over the OLS estimator in general, and (3) the DOLS out-performs both the OLS and FM estimators.
We examine the impact of natural disasters on annual output growth in Vietnam. Using provincial data for primary and secondary industries, we employ the Blundell-Bond General Method of Moments procedure to estimate the impact of disasters on the macroeconomy. We show that more lethal disasters result in lower output growth but that disasters that destroy more property and capital actually appear to boost the economy in the short-run. This is consistent with the [`]investment-producing destruction' hypothesis that we outline. However, we find that disasters have a different macroeconomic impact in different geographical regions; these differences are potentially related to the ability to generate transfers from the Vietnamese central government.
An MLE of the unknown parameters of co integrating vectors is presented for systems in which some variables exhibit higher orders of integration, in which there might be deterministic components, and in which the co integrating vector itself might involve variables of differing orders of integration. The estimator is simple to compute: it can be calculated by running GLS for standard regression equations with serially correlated errors. Alternatively, an asymptotically equivalent estimator can be computed using OLS. Usual Wald test statistics based on these MLE's (constructed using an autocorrelation robust covariance matrix in the case of the OLS estimator) have asymptotic x2 distributions.
We collect data from 29 separate papers estimating the equilibrium level and possible undervaluation of the Chinese currency, the renminbi. These papers yield a total of 97 individual observations on misalignment, which we analyse with the help of meta-analysis. We find that the vast majority of observations point to renminbi undervaluation in recent years and that the undervaluation is more pronounced when the US dollar exchange rate is used instead of the real effective exchange rate. We find several characteristics of papers and authors that clearly seem to influence the reported misalignments. For example, when the author is affiliated with an investment bank, the reported misalignment is smaller. Using time-series techniques also results in lower estimates of undervaluation. On the other hand, refereed journals seemingly are inclined to publish papers that report larger misalignments. Results caution against trusting too much in any one study concerning renminbi undervaluation.
The US current account deficit has been persistently large and has brought the country's ratio of foreign debt to GDP to 20%, a figure that is high by historical standards. This paper argues that while US solvency is not a near-term constraint on ongoing deficits, the sheer size of the US economy makes it likely that its current account will have to approach balance in the next five to ten years, if not sooner. The paper surveys a wide body of evidence suggesting that the US economy remains surprisingly closed to external trade in products and capital, and suggests that costs of international trade in goods can explain the evidence. Given the trade costs, a substantial real depreciation of the dollar will be needed to close the US current account gap. If current-account adjustment is gradual, then the medium-term depreciation of the dollar would be on the order of 12%. If the current account deficit is eliminated in a precipitous and disorderly fashion, and the Fed attempts to maintain full employment, the depreciation could be much bigger, even on the order of 40% to 50%.
This paper explains what is meant by the concept of equilibrium exchange rates. It argues that a variety of equilibrium exchange rates can be defined and their behaviour will vary according to different definitions of the exchange rate, and over short, medium and long-term horizons. It emphasises that the relevance of each type will depend on the question at hand.
The behaviour of different measures of the equilibrium exchange rate is explained with reference to a range of theoretical models. The paper explicitly addresses the circumstances under which purchasing power parity, a commonly adopted benchmark for long-run exchange rate movements, is appropriate.
The most important purpose of the paper is to provide a taxonomy of the different empirical measures of equilibrium exchange rates that have been derived in the literature. It offers a comprehensive guide to the bewildering array of related acronyms that has sprung up and explains the different contexts in which different equilibrium measures might prove informative.
Asymptotic distributions and critical values are computed for several residual-based tests of the null of no cointegration in panels for the case of multiple regressors, including regressions with individual-specific fixed effects and time trends. The associated cointegrating vectors and the dynamics of the underlying error processes are permitted considerable heterogeneity across individual members of the panel. Copyright 1999 by Blackwell Publishing Ltd
This paper proposes a residual-based Lagrange multiplier (LM) test for a null that the individual observed series are stationary around a deterministic level or around a deterministic trend against the alternative of a unit root in panel data. The tests which are asymptotically similar under the null, belong to the locally best invariant (LBI) test statistics. The asymptotic distributions of the statistics are derived under the null and are shown to be normally distributed. Finite sample sizes and powers are considered in a Monte Carlo experiment. The empirical sizes of the tests are close to the true size even in small samples. The testing procedure is easy to apply, including, to panel data models with fixed effects, individual deterministic trends and heterogeneous errors across cross-sections. It is also shown how to apply the tests to the more general case of serially correlated disturbance terms.
Efficient estimators of cointegrating vectors are presented for systems involving deterministic components and variables of differing, higher orders of integration. The estimators are computed using GLS or OLS, and Wald statistics constructed from these estimators have asymptotic x [superscript] 2 distributions. These and previously proposed estimators of cointegrating vectors are used to study long-run U.S. money (M1) demand. M1 demand is found to be stable over 1900-1989; the 95 percent confidence intervals for the income elasticity and interest rate semielasticity are (0.88, 1.06) and (-0.13, -0.08), respectively. Estimates based on the postwar data alone, however, are unstable, with variances which indicate substantial sampling uncertainty. Copyright 1993 by The Econometric Society.
We derive two key propositions of the Balassa‐Samuelson model as long‐run balanced growth implications of a neoclassical general equilibrium model. the propositions are that productivity differentials determine international differences in nontradable relative prices and deviations from PPP reflect differences in nontradable prices. Closed‐form solutions are obtained and tested using panel methods applied to long‐run components of OECD sectoral data computed using the Hodrick‐Prescott filter. the results indicate that labor productivity differentials help explain international low‐frequency differences in relative prices. However, predicted nontradable relative prices are less successful in explaining long‐run deviations from PPP.
Unless very sophisticated indeed, PPP is a misleadingly pretentious doctrine, promising us what is rare in economics, detailed numerical predictions. (Paul A. Samuelson, 1964, p. 153)
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