Estimating equilibrium exchange rate - FEER vs BEER -

Estimating equilibrium Estimating equilibrium exchange rateexchange rate

- FEER vs BEER -- FEER vs BEER -

MCs student: Ana Simona ManuSupervisor Professor: Moisă Altăr

July, 2010

Academy of Economics Studies

Doctoral School of Finance and Banking

Dissertation paper outlineDissertation paper outline

The importance of the equilibrium real The importance of the equilibrium real exchange rateexchange rate

The aims of the paperThe aims of the paper Literature reviewLiterature review Economic foundation: FEER and BEEREconomic foundation: FEER and BEER Empirical evidenceEmpirical evidence Concluding remarksConcluding remarks

The importance of the The importance of the equilibrium real exchange rateequilibrium real exchange rate

The stability of the exchange rate is an imperative condition for a country that aims to join the European Monetary Union while the competitiveness of an economy is a measure of the real convergence process.

The fulfillment of Maastricht criterion regarding the exchange rate stability depends on the optimal setting of the central parity consistent with the economic fundamentals

One important indicator of the price competitiveness of a country is represented by the real exchange rate misalignment towards its equilibrium values

The aims of the paperThe aims of the paper

Assessing the equilibrium exchange rate for the Romanian Assessing the equilibrium exchange rate for the Romanian economy using two alternative approaches, respectively economy using two alternative approaches, respectively Fundamental Equilibrium Exchange RateFundamental Equilibrium Exchange Rate (FEER)(FEER) andand Behavioral Equilibrium Exchange Rate (BEER)Behavioral Equilibrium Exchange Rate (BEER)

Evaluating the price competitiveness through real effective Evaluating the price competitiveness through real effective exchange rate (REER) misalignment using the two modelsexchange rate (REER) misalignment using the two models

Calculating the nominal equilibrium exchange rate using Calculating the nominal equilibrium exchange rate using bilateral EUR/RON exchange rate in an attempt to find an bilateral EUR/RON exchange rate in an attempt to find an optimal central parity by applying the two methodologiesoptimal central parity by applying the two methodologies

Comparing FEERs vs. BEERs resultsComparing FEERs vs. BEERs results

Literature reviewLiterature review The first attempts to model equilibrium exchange rate are based The first attempts to model equilibrium exchange rate are based

on on Purchasing Power ParityPurchasing Power Parity first developed by first developed by Gustav Gustav Cassel (1922)Cassel (1922), however the empirical evidence hardly validates however the empirical evidence hardly validates this theory and only over the long term horizon. this theory and only over the long term horizon.

In this context it became necessary to develop alternative In this context it became necessary to develop alternative approaches for modeling equilibrium exchange rate: approaches for modeling equilibrium exchange rate:

FEER: introduced by Williamson (1994)FEER: introduced by Williamson (1994) the equilibrium value is defined the equilibrium value is defined as that level of the exchange rate that assures simultaneous achievement as that level of the exchange rate that assures simultaneous achievement of the internal and external balanceof the internal and external balance

IMF macroeconomic balance approachIMF macroeconomic balance approach used as a variant of FEER, which used as a variant of FEER, which is based on a direct estimation of the sustainable level of the current is based on a direct estimation of the sustainable level of the current account deficit considering the investment – savings relation account deficit considering the investment – savings relation

BEER: first introduced by Clark and MacDonald (1998),BEER: first introduced by Clark and MacDonald (1998), aims to asses aims to asses the equilibrium exchange rate by using a more empirical approach based the equilibrium exchange rate by using a more empirical approach based on fundamental variables affecting the evolution of the exchange rate on on fundamental variables affecting the evolution of the exchange rate on short and medium term. short and medium term.

for CEEC countries the most employed models are FEER and BEERfor CEEC countries the most employed models are FEER and BEER adjusted to the particularities of transition countriesadjusted to the particularities of transition countries ( note ( note Egert Egert and and Lahrèche-Révil (2003), Lahrèche-Révil (2003), Bulir and Smidkova (2005), Michael Rubaszek Bulir and Smidkova (2005), Michael Rubaszek studies on FEER)studies on FEER)

Economic foundation of the models

A. The FEER model

Determines the ERER consistent with Determines the ERER consistent with both both internal and external equilibriuminternal and external equilibrium

Internal equilibriumInternal equilibrium is usualy defined as that is usualy defined as that level of output consistent with full employmentlevel of output consistent with full employment

External equilibriumExternal equilibrium is achieved when is achieved when structural current account adjust to its structural current account adjust to its norm/target levelnorm/target level

Structural current accountStructural current account

It is defined as the level of the current account It is defined as the level of the current account which is not affected by cyclical fluctuation of the which is not affected by cyclical fluctuation of the explanatory variablesexplanatory variables

It is based on describing the external sector It is based on describing the external sector activity, respectively, the estimation of the activity, respectively, the estimation of the exports/imports equationsexports/imports equations

It is computed by imposing internal equilibrium It is computed by imposing internal equilibrium condition and accounting for exchange rate condition and accounting for exchange rate variationsvariations

2

1

/

ff

x YNERP

PX

2

1

YP

PM m

The current account could be expressed based on the following The current account could be expressed based on the following equations:equations:

)1()/( NERPPP fx

)1()/( NERPPP fm

(1)

(2)

(3)

(4)

mx PMPXTB (5)

YP

trendINCtrendTRMPXPstructuralCA

Y

mx

__)(

_ (6)

Current account normCurrent account norm

For estimating the current account norm it was employed For estimating the current account norm it was employed the methodology proposed by IMF researchers (Faruqee the methodology proposed by IMF researchers (Faruqee şi Debelle (1998), Masson (1998)), the key element of şi Debelle (1998), Masson (1998)), the key element of this approach consisting in defining the current account this approach consisting in defining the current account norm as the difference between saving and investment norm as the difference between saving and investment long term values. long term values. Fiscal balanceFiscal balance - positive relation, higher public spending - positive relation, higher public spending

triggering a lower level of national savings.triggering a lower level of national savings. Demographic factorsDemographic factors – negative relation, a higher level of – negative relation, a higher level of

population dependency ratio reduces savings and the current population dependency ratio reduces savings and the current account balance.,account balance.,

Net foreign assetsNet foreign assets. – ambiguous effect, economies with high . – ambiguous effect, economies with high NFA can support higher level of current account deficits NFA can support higher level of current account deficits without having negative implication in terms of solvability, without having negative implication in terms of solvability, while a solid investment position triggers higher revenues from while a solid investment position triggers higher revenues from abroad improving the current account balanceabroad improving the current account balance

The balance of fuel productsThe balance of fuel products - this variable is introduce in - this variable is introduce in order to account for terms of trade shocks associated with oil order to account for terms of trade shocks associated with oil prices. prices.

The relative income per capitaThe relative income per capita.. It is expected that countries It is expected that countries with lower level of capital to recall to external resources in with lower level of capital to recall to external resources in order to finance the internal investments, triggering the order to finance the internal investments, triggering the deterioration of the current account. deterioration of the current account.

Economic growth.Economic growth. A higher level of this indicator generates A higher level of this indicator generates a higher current account deficit if the economic growth is a higher current account deficit if the economic growth is fuelled by foreign investments or if it is perceived as being fuelled by foreign investments or if it is perceived as being permanent, with a negative potential on saving ratio.permanent, with a negative potential on saving ratio.

Foreign direct investmentsForeign direct investments. The growth of foreign direct . The growth of foreign direct investments is associated with higher imports, having a investments is associated with higher imports, having a negative impact on CC.negative impact on CC.

Fundamental equilibrium exchange rateFundamental equilibrium exchange rate The exchange rate is expressed as units of The exchange rate is expressed as units of

foreign currency per unit of domestic foreign currency per unit of domestic currency, an increase of the indicator being currency, an increase of the indicator being equivalent with an appreciation equivalent with an appreciation

For a given level of output , the relation For a given level of output , the relation between the exchange rate and the current between the exchange rate and the current account is indirect, a depreciation leading account is indirect, a depreciation leading to a deterioration of the current accountto a deterioration of the current account

If the domestic output increases above the If the domestic output increases above the potential value, the curve will translate potential value, the curve will translate towards the left side, as we will have a towards the left side, as we will have a permanent deterioration of the current permanent deterioration of the current account given the increase of importsaccount given the increase of imports

The equilibrium exchange rate is that level The equilibrium exchange rate is that level consistent with simultaneous achievement consistent with simultaneous achievement of internal and external equilibrium, both of internal and external equilibrium, both being impose exogenously.being impose exogenously.

This model gives us a trajectory of the This model gives us a trajectory of the ERER on medium term trough the ERER on medium term trough the adjustment of the current account trend to adjustment of the current account trend to its norm value but it doesn’t capture the its norm value but it doesn’t capture the short term adjustment towards equilibrium short term adjustment towards equilibrium value value

Stylized figure

Economic foundation of the modelsB. The BEER model

The observed level of the real exchange rate can be expressed as a The observed level of the real exchange rate can be expressed as a function of its expected value and the real interest rate function of its expected value and the real interest rate differential: differential:

is an unobserved variable will be determined solely by a is an unobserved variable will be determined solely by a vector of fundamental economic variables which act on the vector of fundamental economic variables which act on the medium and long term:medium and long term:

The empirical analysis considered testing the relation between the The empirical analysis considered testing the relation between the real exchange rate and variables like the productivity differential real exchange rate and variables like the productivity differential between the tradable and non-tradable sector of the economy, between the tradable and non-tradable sector of the economy, private and government consumption, the openness of an economy, private and government consumption, the openness of an economy, net foreign assets, terms of trade:net foreign assets, terms of trade:

Considering this framework, we can define the total misalignment Considering this framework, we can define the total misalignment as:as:

)( 1tt qE

)()( *1 ttttt rrqEq

)( 1tt qE

))(,( *ttt

BEERt rrZfq

tZ

),,,,()( 1 totnfaopenessconsproddiffqE tt

ttt Zqtm

Empirical evidenceEmpirical evidence1.The data1.The data

Quarterly data extracted from Eurostat, Bank of International Quarterly data extracted from Eurostat, Bank of International Settlements, National Bank of Romania databases for the Settlements, National Bank of Romania databases for the period 2000Q1- 2009Q4 (40 observations). First, all series period 2000Q1- 2009Q4 (40 observations). First, all series were seasonally adjusted using were seasonally adjusted using Demetra software, Demetra software, developed by Eurostat. developed by Eurostat.

It was used both effective and bilateral EUR/RON real It was used both effective and bilateral EUR/RON real exchange rate. The REER was extracted from the BIS exchange rate. The REER was extracted from the BIS database and is computed by using HICP as a deflator. The database and is computed by using HICP as a deflator. The same method is applied in the case of bilateral EUR/RON real same method is applied in the case of bilateral EUR/RON real exchange rate. exchange rate.

all the variables are in constant prices (2000=100).all the variables are in constant prices (2000=100).

For determining For determining current account norm current account norm it was it was employed a employed a panel data analysispanel data analysis, the data sample comprising data from , the data sample comprising data from 5 countries (Romania, Hungary, Poland, Czech Republic and 5 countries (Romania, Hungary, Poland, Czech Republic and Bulgaria) for the period 2001Q1-2009Q4. The decision Bulgaria) for the period 2001Q1-2009Q4. The decision regarding the countries included in the analysis was regarding the countries included in the analysis was motivated by the relatively similar characteristics of the motivated by the relatively similar characteristics of the countries given the geographic position and the development countries given the geographic position and the development stage, while the choice of the period was conditioned by the stage, while the choice of the period was conditioned by the data availability. The source of data is Eurostat database.data availability. The source of data is Eurostat database.

FEER empirical approachFEER empirical approach This step consist in modelling the trade sector of This step consist in modelling the trade sector of

Romanian economy by identifying long term relation Romanian economy by identifying long term relation for the considered variables. For this purpose I’ve for the considered variables. For this purpose I’ve employ a employ a Engle Granger methodologyEngle Granger methodology

For estimating the For estimating the cointegration equation we used cointegration equation we used the FMOLS estimatorthe FMOLS estimator, as an alternative to static , as an alternative to static OLS, considering the significant errors that could OLS, considering the significant errors that could appear given the reduce sample of dataappear given the reduce sample of data

The ADF and PP testThe ADF and PP test are presented in are presented in Appendix 1Appendix 1 indicate that indicate that all the variables are I(1)all the variables are I(1). All the . All the estimated relations are cointegrated ones according to estimated relations are cointegrated ones according to Engle-Granger tests (Engle-Granger tests (see Appendix 2see Appendix 2))

Volume of import and export equations

Import price and export price equations

GDP deflator equation

18,000

20,000

22,000

24,000

26,000

28,000

30,000

32,000

34,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

GDP_HP GDP_RO

Chart 1 : The evolution of potential GDP

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

DD_HP DD_RO

Chart 2: The evolution of domestic demand trend

0.9

1.0

1.1

1.2

1.3

1.4

1.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

W_IND W_IND_HP

Chart 3: The evolution the labor productivity trend

Internal equilibrium

Structural current account

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

TRANSFERURI TRANSFERURI_HP

Chart 4:The trend of the transfer

-7,000

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

VENITURI VENITURI_HP

Chart 5: The trend of income balance

-16

-14

-12

-10

-8

-6

-4

-2

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Current account_Current account_structural_ _

Chart 6: Actual current account vs structural current account

Current account norm

I’ve considered the fundamental variables presented in the theoretical part, the empirical evidence indicating the following statistical significant variables fiscal balance, GDP growth per capita, fiscal balance, GDP growth per capita, population growth, fuel products balance and direct foreign investmentpopulation growth, fuel products balance and direct foreign investment.

Before running the regression all the variable were tested for unit root process, resulting that all variables are stationary (Appendix 3)(Appendix 3)

-11

-10

-9

-8

-7

-6

-5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

CC_STRUCTURAL CC_NORM

Chart 7: Structural current account vs current account norm

The results indicates a current account norm between -8,5 percent of GDP at the beginning of the period and -7,45 percent at the end of 2009.

*__)(

CAYP

trendINCtrendTRMPXP

Y

mx

Structural CC

External equilibrium

CC norm

In the period 2001Q1-2009Q4 the misalignment of the REER from the equilibrium In the period 2001Q1-2009Q4 the misalignment of the REER from the equilibrium value varied between – 16,11 percent and 10,69 percent. value varied between – 16,11 percent and 10,69 percent.

in 2001-2004 the REER was undervalued in average by 10 percent given that the in 2001-2004 the REER was undervalued in average by 10 percent given that the structural current account deficit was lower then the current account deficit norm.structural current account deficit was lower then the current account deficit norm.

Starting 2005, once with the deterioration of the structural current account deficit, Starting 2005, once with the deterioration of the structural current account deficit, REER becomes overvalued, in order to restore the equilibrium being necessary a REER becomes overvalued, in order to restore the equilibrium being necessary a depreciation of REER between 1 and 10,7 percent. depreciation of REER between 1 and 10,7 percent.

This trajectory reversed at the end of the analyzed period, the excessive correction This trajectory reversed at the end of the analyzed period, the excessive correction of the external position leading in 2009 to a level of REER slightly undervalued of the external position leading in 2009 to a level of REER slightly undervalued (-1,46 percent). (-1,46 percent).

80

90

100

110

120

130

140

150

2

00

1Q

1

2

00

1Q

4

2

00

2Q

3

2

00

3Q

2

2

00

4Q

1

2

00

4Q

4

2

00

5Q

3

2

00

6Q

2

2

00

7Q

1

2

00

7Q

4

2

00

8Q

3

2

00

9Q

2

FEER (REER) REER

Sursa: BIS, own calculation

-20

-15

-10

-5

0

5

10

15

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

REER misalignment

Chart 8: The evolution of the FEER equilibrium exchange rate and REER misalignment

index, 2000=100 percent

In the period 2001Q1-2009Q4 the misalignment of the RER_EUR from the In the period 2001Q1-2009Q4 the misalignment of the RER_EUR from the equilibrium value varied between – 21,16 percent and 11,54 percent. equilibrium value varied between – 21,16 percent and 11,54 percent.

In 2001-2004 the degree of the RER_EUR undervaluation was in average with 2,45 In 2001-2004 the degree of the RER_EUR undervaluation was in average with 2,45 percentage points lower then that associated with REERpercentage points lower then that associated with REER

In 2005-2008 the overvaluation of RER_EUR was in average with 0,9 percentage In 2005-2008 the overvaluation of RER_EUR was in average with 0,9 percentage points higher than in the case REER.points higher than in the case REER.

80

90

100

110

120

130

140

150

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

FEER (RER_EUR)

RER_EUR

source: own calculation

-25

-20

-15

-10

-5

0

5

10

15

200

1Q

1

200

2Q

1

200

3Q

1

200

4Q

1

200

5Q

1

200

6Q

1

200

7Q

1

200

8Q

1

200

9Q

1

REER misalignment

RER_EUR misalignment

Chart 9: FEER (RER_EUR) evolution and the RER_EUR vs REER misalignment


there are no important changes in the periods of under/over valuation of the real there are no important changes in the periods of under/over valuation of the real

exchange rate, but the magnitude of misalignment is significantly higherexchange rate, but the magnitude of misalignment is significantly higher In the case of REER the misalignment of the current values from the equilibrium In the case of REER the misalignment of the current values from the equilibrium

increases in average with around 6 percentage points, while the RER_EUR increases in average with around 6 percentage points, while the RER_EUR misalignment is even more sensitive to this hypotheses, growing in average by 7,7 misalignment is even more sensitive to this hypotheses, growing in average by 7,7 percentage pointspercentage points

towards the end of 2009 the sensitivity analysis indicate an equilibrium value towards the end of 2009 the sensitivity analysis indicate an equilibrium value around the actual value, and not an undervalued onearound the actual value, and not an undervalued one

80

90

100

110

120

130

140

150

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

FEER (RER_EUR)

RER_EUR

source: own calculation

-25

-20

-15

-10

-5

0

5

10

15

200

1Q

1

200

2Q

1

200

3Q

1

200

4Q

1

200

5Q

1

200

6Q

1

200

7Q

1

200

8Q

1

200

9Q

1

REER misalignment


Chart 9: FEER (RER_EUR) evolution and the RER_EUR vs REER misalignment


-30

-20

-10

0

10

20

30

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

REER misalignment

REER_SEZ misalignment

Source: own calculation

-30

-20

-10

0

10

20

30

2001Q

1

2002Q

1

2003Q

1

2004Q

1

2005Q

1

2006Q

1

2007Q

1

2008Q

1

2009Q

1

RER_EUR_SEZ misalignment


Chart11: The impact of 1 pp. lower current account norm on REER/RER_EUR misalignment

percent percent

For period 2001q1-2009q4, the increase of elasticises by 10% implies a higher misalignment of For period 2001q1-2009q4, the increase of elasticises by 10% implies a higher misalignment of REER in average with 1,5 pp. compared with the initial situation. REER in average with 1,5 pp. compared with the initial situation. in 2001q1-2004q4 the level of undervaluation was lower with around 1pp. (of-9,15%)in 2001q1-2004q4 the level of undervaluation was lower with around 1pp. (of-9,15%) 2005q1-2008q4 the level of overvaluation was higher in average with around 2 pp.(8,85 %)2005q1-2008q4 the level of overvaluation was higher in average with around 2 pp.(8,85 %)

The decrease of the elasticises by 10% triggered for the entirely analyzed period a lower level of The decrease of the elasticises by 10% triggered for the entirely analyzed period a lower level of REER misalignment in average with 1,8 pp. REER misalignment in average with 1,8 pp. for 2001q1-2004q4 the undervaluation is higher with 1,2 pp. (of -11, 3%), for 2001q1-2004q4 the undervaluation is higher with 1,2 pp. (of -11, 3%), for 2005q1-2008q4 it can be seen a lower level of the overvaluation with 2,3 pp.(4,62 %). for 2005q1-2008q4 it can be seen a lower level of the overvaluation with 2,3 pp.(4,62 %).

For the end of 2009 the sensitivity analysis indicates that the REER undervaluation is For the end of 2009 the sensitivity analysis indicates that the REER undervaluation is between 3 and 8 percent.between 3 and 8 percent.

-30

-25

-20

-15

-10

-5

0

5

10

15

20 2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

REER misalignment

REER_SEZ1 misalignment

REER_SEZ2 misalignment


-30

-25

-20

-15

-10

-5

0

5

10

15

20

2

001

Q1

2

002

Q1

2

003

Q1

2

004

Q1

2

005

Q1

2

006

Q1

2

007

Q1

2

008

Q1

2

009

Q1

RER_EUR_SEZ1 misalignment


RER_EUR_SEZ2 misalignment

Chart 12: The impact of elasticities variation on REER/RER_EUR misalignment

percent percent

BEER empirical approachBEER empirical approach is based on the estimation of a long term equilibrium relation between the real exchange rate and the is based on the estimation of a long term equilibrium relation between the real exchange rate and the

fundamental variables: fundamental variables: REER, net foreign liabilities, relative price of non-tradables versus REER, net foreign liabilities, relative price of non-tradables versus tradables, terms of tradetradables, terms of trade

It were performed ADF and PP tests (It were performed ADF and PP tests (Appendix 5)Appendix 5) showing that all the variables have a unit root. showing that all the variables have a unit root. The first step in implementing Johansen 's test consists in the estimation of a VAR model with a The first step in implementing Johansen 's test consists in the estimation of a VAR model with a

number of lags determined by the information criteria.. The quality test of VAR are presented in number of lags determined by the information criteria.. The quality test of VAR are presented in Appendix 6.Appendix 6.

The cointegrating relationship is given by:The cointegrating relationship is given by:

log(REER)= -0,1623*log(NFL) +0,8803*log(TNT) +1,9739*log(TOT) log(REER)= -0,1623*log(NFL) +0,8803*log(TNT) +1,9739*log(TOT) + 0.507370 + 0.507370 (0.0493)(0.0493) (0.1234)(0.1234) (0.029) (0.029) [3.2939] [-7.1334[3.2939] [-7.1334] ] [14.8208] [14.8208] The equilibrium exchange rate was obtained by filtering the explicative variables The equilibrium exchange rate was obtained by filtering the explicative variables

80

90

100

110

120

130

140

150

2

00

0Q

1

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

BEER (REER) REER

Source: BIS, own calculation

-15

-10

-5

0

5

10

15

20

2

00

0Q

1

2

00

1Q

1

2

00

2Q

1

2

00

3Q

1

2

00

4Q

1

2

00

5Q

1

2

00

6Q

1

2

00

7Q

1

2

00

8Q

1

2

00

9Q

1

REER misalignment

Chart 13: The evolution of the BEER and REER misalignment


REER misalignment REER misalignment in in the 2001Q1-2009Q4 period varies between -9,9 per cent and 13,9 per cent. the 2001Q1-2009Q4 period varies between -9,9 per cent and 13,9 per cent. at the beginning of the analyzed period, REER was around its equilibrium valueat the beginning of the analyzed period, REER was around its equilibrium value starting with 2002, REER becomes clearly undervalued with a maximum misalignment in 2004Q2. starting with 2002, REER becomes clearly undervalued with a maximum misalignment in 2004Q2. In the 2005Q1-2008Q4 period , the overvaluation of REER was on average 5,9 per cent In the 2005Q1-2008Q4 period , the overvaluation of REER was on average 5,9 per cent IIn 2009Q4 we can observe an undervaluation of 1,51 per cent.n 2009Q4 we can observe an undervaluation of 1,51 per cent.

Important differences between the two approaches appear only at the beginning of the analyzed period Important differences between the two approaches appear only at the beginning of the analyzed period The The FEER model indicates an equilibrium real exchange rate more appreciated by an average of 15 FEER model indicates an equilibrium real exchange rate more appreciated by an average of 15 pp. pp.

2001Q1-2002Q4.2001Q1-2002Q4. This is mainly due to significantly lower This is mainly due to significantly lower CACA deficit than the one supported by the deficit than the one supported by the normnorm level as indicated by fundamental values of savings and investments (structural level as indicated by fundamental values of savings and investments (structural CACA was on average was on average -5,72-5,72% of GDP % of GDP compared to a 8,4compared to a 8,4%% deficit supported by the deficit supported by the CA normCA norm))

The modified hypothesis of a lower sustainable current account deficit by a single percentage point (to -The modified hypothesis of a lower sustainable current account deficit by a single percentage point (to -7,47,4%%) leads to significantly lower gaps between the misalignments predicted by FEER and BEER.) leads to significantly lower gaps between the misalignments predicted by FEER and BEER.

Starting with 2003, given the rise of the structural deficit, the undervaluation for REER indicated by Starting with 2003, given the rise of the structural deficit, the undervaluation for REER indicated by FEER was reduced, with an average gap over the level indicated by BEER of 5,82 per cent on average FEER was reduced, with an average gap over the level indicated by BEER of 5,82 per cent on average (2003Q1-2004Q4). (2003Q1-2004Q4).

FEER and BEER indicate for the 2005-2008 period an overvaluation for the real exchange rate, with an FEER and BEER indicate for the 2005-2008 period an overvaluation for the real exchange rate, with an average misalignment of 6,92average misalignment of 6,92% % for the fundamental approach and one of 5,94for the fundamental approach and one of 5,94% % for the behavioral for the behavioral oneone. . The maximum misalignment was 10,7 per cent as indicated by FEER and 13,9The maximum misalignment was 10,7 per cent as indicated by FEER and 13,9%% as pointed by BEER as pointed by BEER

In 2009, it can be observed an undervaluation for REER with a misalignment of 1,46In 2009, it can be observed an undervaluation for REER with a misalignment of 1,46% % (FEER) or 2,56(FEER) or 2,56% % (BEER(BEER))

80

90

100

110

120

130

140

1502

00

1Q

1

20

02

Q1

20

03

Q1

20

04

Q1

20

05

Q1

20

06

Q1

20

07

Q1

20

08

Q1

20

09

Q1

BEER

REER

FEER


-20

-15

-10

-5

0

5

10

15

20

20

01

Q1

20

02

Q1

20

03

Q1

20

04

Q1

20

05

Q1

20

06

Q1

20

07

Q1

20

08

Q1

20

09

Q1

-20

-15

-10

-5

0

5

10

15

20

FEER-BEER

FEER misalignment

BEER misalignment

Chart 15:The comparative presentation of the results obtain for equilibrium REERFEER vs BEER


BEERBEER vs FEER vs FEER

80

90

100

110

120

130

140

150

20

01

Q0

1

20

02

Q0

1

20

03

Q0

1

20

04

Q0

1

20

05

Q0

1

20

06

Q0

1

20

07

Q0

1

20

08

Q0

1

20

09

Q0

1

BEER

RER_EUR

FEER


-30

-20

-10

0

10

20

30

20

01

Q0

1

20

02

Q0

1

20

03

Q0

1

20

04

Q0

1

20

05

Q0

1

20

06

Q0

1

20

07

Q0

1

20

08

Q0

1

20

09

Q0

1

-30

-20

-10

0

10

20

30

FEER-BEER

BEER misalignment

FEER misalignment

Chart 16: The comparative presentation of the results obtain for equilibrium RER_EURFEER vs BEER


Chart 17: The nominal RON/EUR exchange rate vs the level implied by BEER and FEER

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

NER_EUR BEER FEER


According to FEER, in Q4 2009 the EUR/RON equilibrium value was around 4,02 RON/EUR while BEER indicates 4,17 RON/EUR

Concluding remarksConcluding remarks The equilibrium real exchange rate, a fundamental indicator when judging the The equilibrium real exchange rate, a fundamental indicator when judging the

competitiveness of an economy and its ability to match the nominal competitiveness of an economy and its ability to match the nominal convergence criteria was assessed using the method of fundamental convergence criteria was assessed using the method of fundamental equilibrium exchange rate (FEER) and of behavioural equilibrium real equilibrium exchange rate (FEER) and of behavioural equilibrium real exchange rate (BEER) exchange rate (BEER)

Both FEER and BEER models revealed the same three periods in the Both FEER and BEER models revealed the same three periods in the evolution of the real exchange rate misalignment towards equilibriumevolution of the real exchange rate misalignment towards equilibrium

The sensitivity analysis performed on the FEER model revealed that the The sensitivity analysis performed on the FEER model revealed that the results are more sensitive to the hypothesis of the structural current account results are more sensitive to the hypothesis of the structural current account than the one related to export/import elasticises. than the one related to export/import elasticises.

The assessment of the equilibrium real exchange rate is also useful in the The assessment of the equilibrium real exchange rate is also useful in the determination of the nominal equilibrium exchange rate. According to FEER determination of the nominal equilibrium exchange rate. According to FEER method the in last quarter of 2009 the nominal equilibrium exchange rate was method the in last quarter of 2009 the nominal equilibrium exchange rate was 4,02 while BEER suggests an equilibrium value of 4, 17. 4,02 while BEER suggests an equilibrium value of 4, 17.

In this context, for transition countries, BEER and FEER should be used as In this context, for transition countries, BEER and FEER should be used as complementary methodologies rather then substitutablecomplementary methodologies rather then substitutable

Estimating equilibrium exchange rate - FEER vs BEER -

Documents

Transcript of Estimating equilibrium exchange rate - FEER vs BEER -