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LIBERALIZATION, PRODUCTIVITY AND AGGREGATE EXPENDITURE: FUNDAMENTAL DETERMINANTS
OF REAL EQUILIBRIUM EXCHANGE RATE
Juan Benítez
Gabriela Mordecki
XI Arnoldshain, Antwerp June 2013
Presentation Outline
Objectives and justification
Theoretical framework
RER Fundamentals
Methodology
Main results
Final remarks
Objectives and justification
Uruguay is a small open economy
Between 2004 and 2010 the economy experienced a process of strong economic growth and appreciation of domestic currency
6% GDP annual growth
5.4% annual Global Real Exchange Rate (RER) appreciation
2.3% RER annual appreciation defined as TP/NTP
8.9% appreciation of extra-regional RER 4
• In the period there has been a strong increase in commodity prices, particularly of food and oil
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Commodities Oil Food
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Is the appreciation a long-term trend or short-term phenomenon?
• Changes in fundamentals:
– Productivity
– Weight of extra-regional trade– Aggregate expenditure
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Theoretical framework
Purchasing Power ParityBalassa-Samuelson Hypothesis
• RER: relative price of tradables, which prices are determined on the international market compared to non-tradables, which prices are determined by supply and demand in the domestic economy:
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RER = TP/NTP
RER Fundamentals:
• Productivity differentials (-)
• Terms of trade (-)
• Capital inflow (-)
• Total consumption expenditure (-)
• Interest rate differential (-)
• Exports increase (-)
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Methodology Cointegration analysis through Johansen
method Variables included in the model:• logtcr: RER Log, estimated as the coefficient of TP and
NTP • logpreleeuu: Log of the labor productivity gap between
Uruguay and USA.• logxx: Log of the share of extra-regional good exports
over total good exports• loggtot: Log of total expenditure
All variables have a unit root
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Main resultsLong run relationship:
• Interest rates and terms of trade were not significant in the relationship
• The increase in productivity with respect to trading partners contributing to RER appreciation: Balassa-Samuelson effect
• Coherent with Aboal (2002) and Gianelli & Mednik (2006)
gtotxxpreleeuutcr log76,0log88,0log26,186,17log
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The increase of extra-regional export flow appreciates domestic currencyThe increase in disposable income, with given world prices: demand shock in the non-tradable sector
According to Granger Test:The extra-regional insertion precedes the appreciation
The external integration intensifies in those goods that the economy has comparative advantages: primary products of agricultural origin, which causes a fall in relative prices and consequently in the price competitiveness of the economy.
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Productivity ratios and extra-regional exports are not significantly different from unity, so productivity increases completely impact on equilibrium RER appreciating currency
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In the short-term relationship, after one quarter RER adjusted 5.6%, productivity by 15.9% and 32.1% extra-regional exports.
Adjustment coefficients of the variables to imbalances
Δlogtcr Δlogpreleeuu Δlogxx
Error Correction Term -0.055258 -0.159192 -0.320460
T statistic [-2.20323] [-3.45526] [-3.85957]
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The RER is set to its equilibrium value after 10 quarters, confirming that the RER, or its components of the tradable and non-tradable prices misalignment corrected more slowly than productivity and much less speed and extra-regional exports aggregate consumption
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Impulse responsesRER response to an impulse in Productivity
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RER response to an impulse in extra-regional exports
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RER response to an impulse in total consumption
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Evolution of the trend and observed RER (Index, 1988.I = 100)
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1988Q1
1989Q1
1990Q1
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Observed RER
Equilibrium RER
Final Remarks
RER misalignments between observed and its equilibrium level in the period of analysis are more minor than what could be feared. The variations observed in the RER in the analysis period are due primarily to movements in fundamentals
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The evolution of the fundamentals during the analysis support the expectation that the phenomenon of domestic appreciation continue
It is likely that the prices of exported goods continue to increase, intensifying the displacement from non-tradable sector resources towards the competitive sector
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RER fluctuations are less intense at the end of the analysis period, when the monetary authority ceased to have the exchange rate as a nominal anchor
The RER imbalances regarding its fundamentals have strong links with other relevant variables for the economy as the nominal exchange rate, the output gap and inflation
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