What does it tell us about the Czech Republic and other EU countries?

Transcription

1 The Real Exchange Rate Phenomenon What does it tell us about the Czech Republic and other EU countries? Luboš Komárek Research Seminar, VSB-Technical University Ostrava 15 th November 2017

2 OUTLINE I. The Real Exchange Rate Bilateral dimension Effective dimension and deindustrialisation II. The Equilibrium Real Exchange Rate BEER: Behavioural Equilibrium Exchange Rate FEER: Fundamental Equilibrium Exchange Rate NATREX: Natural Real Exchange Rate The views expressed in this article are those of the author and do not necessarily reflect the official position of the Czech National Bank. The author wishes to thank his co-authors, i.e. Jan Frait, Martin Melecký and Martin Motl for many valuable discussions and efforts in this field.

3 I. The Real Exchange Rate

4 The Real Exchange Rate Real appreciation variants R=E.P /P Note: R real exchange rate, E nominal exchange rate, P home price level, P* foreign price level Real exchange rate calculation methods

5 The Real Exchange Rate appreciation variants Based on the evolution of the real bilateral exchange rates and their components, it can be concluded that Slovakia was converging the fastest to the euro area core countries in the period under review. Slovakia was followed by Bulgaria and, just behind it, the Czech Republic.

6 The Real Exchange Rate Group I: Countries with significant real appreciation supported by nominal appreciation. This group contains Slovakia, the Czech Republic and Lithuania, with Slovakia having shown the largest real appreciation of its currency of all the EU countries in Group II: Countries with real appreciation reduced by nominal depreciation. This group contains Hungary, Latvia and Poland and also, albeit with much lower rates of real appreciation, Slovenia, Greece, Malta and Cyprus. Group III: Countries with real appreciation achieved solely through the relative price channel. This group contains countries with fixed exchange rate systems (Bulgaria and Estonia) and also, for example, one of the most advanced euro area countries, Luxembourg. =============================================== Group IV: Countries with visible real depreciation. This group consists of advanced EU countries such as Denmark, France, Germany, Sweden and the UK, whose currency showed the largest real depreciation due mainly to events following the victory of the leave campaign in the Brexit referendum. ===============================================

7 The Real Exchange Rate Decomposition of the real bilateral exchange rate in EU countries Source: EIU RER The real bilateral exchange rate and convergence of the economy

8 The Real Exchange Rate Decomposition of the real effective exchange rate in EU countries Source: EIU REER The real effective exchange rate and the competitiveness of the economy

9 Comparison of price growth using CPI and ULC For the competitiveness debate it may be useful to compare relative prices in the home and foreign economies using CPI and ULC Their movements differed markedly, particularly in Bulgaria, Estonia and Latvia (where ULC-based relative prices rose more sharply than CPIbased ones in ). Source: IMF

10 The Real Exchange Rate and Deindustrialisation The highest share of industry (2016) in real terms in GDP: Ireland, Czech Republic, Slovakia. The evolution of the real exchange rate and the competitiveness of an economy may be linked with the process of deindustrialisation. This process has been going on for decades (maybe since the peak of the industrial revolution), particularly in advanced market economies which first went through industrialisation (e.g. the UK) or which experienced rapid industrialisation and achieved a high level of national income (e.g. the USA). The deindustrialisation process is also relevant to catching-up economies, as their traditional industries may disappear or be streamlined and their services sectors may develop. Source: EIU

11 The Real Exchange Rate and Deindustrialisation DEINDUSTRALIZATION Source: EIU Graph shows that the largest drops in the industry-to-gdp ratio (between 1999 and outlook for 2021) are generally recorded by the most advanced countries, with the exception of Cyprus and Malta, where the situation is again specific. However, it is also interesting that the Czech Republic, Slovakia and Romania have not been affected through deindustrialisation and are not expected to in the years ahead either. In some of these countries, the share of industry in GDP has even increased. This is related to per capita car production, which is the highest in the world in Slovakia and the Czech Republic in that order. Source: EIU

12 II. The Equilibrium Real Exchange Rate

13 ERER: Reasons to calculate The equilibrium exchange rate plays an important role in modern macroeconomics. Estimating it is a challenge both for academicians and for central bankers. Estimates of the ERER are useful for various closely related reasons: o (i) One of the primary issues in this case is what level to set the exchange rate (central parity) at prior to entering the ERM II. To ensure a stable economic environment, this parity should be set close to the equilibrium exchange rate. o (ii) it is useful to understand whether the current exchange rate is different from its equilibrium value, as this provides information on the likely future development of the exchange rate. o (iii) if the authorities want to peg the value of the currency (as in the case of ERM II entry), it is useful to know the equilibrium exchange rate ECB (2003): the central rate should reflect the best possible assessment of the equilibrium exchange rate at the time of entry into the mechanism. This assessment should be based on a broad range of economic indicators and developments while also taking account for the market rate. 18 th December 2003 Real exchange rate, monetary union and reaction to asymmetric shocks.

14 BUBBLE Volatility, misalignment, bubble Asset price PEAK Creation of bubble Burst of bubble Misalignment Market price V OLATILITY Fundamental value of asset t 1 t 2 Time

15 Central parity and Conversion rate

16 ERER the view of economics Equilibrium Real Exchange Rate BEER Behavioral Equilibrium ER MMAER Multifactorial Model of Autarkic ER Approaches with internal and external equilibrium PEER Permanent and Transitory Decomp. of Real ER ITMEER Intermediate Term Model-Based Equilibrium ER CHEER Capital Enhanced Equilibrium ER MB Macroeconomic balance approach DEER Desirable Equilibrium ER FEER Fundamental Equilibrium ER SRER Sustainable real ER NATREX Natural Equilibrium ER but for example Driver and Westaway (2004) distinguishes up to 14 approaches Positive approaches: using current values of variables and current policies. Normative approaches: using not only current variables, but also desirable model relationships and trajectories, which we would like to reach

17 ERER the view of econometrics Equilibrium Real Exchange Rate Per Partes Estimations (country by country) Cross section analysis GARCH models Panel Data Estimations Cointegration - Johansen - ARDL - DOLS - Engel-Granger - etc. SVAR models Simultaneous systems of equations Out of sample In sample

18 BEER R = f(fundamental variables) For example: Productivity differential Foreign direct investment Terms of trade Openness Net foreign assets Real interest rate differential Government spending

19 Some economics behind ERER [1] Productivity Productivity and productivity differential (dprod; -) = GDP_R/E via price channel: dprod higher domestic (p ) r [r= e + (p*-p)]; (this channel is associated with the well-known Balassa-Samuelson effect) via exchange rate channel: dprod higher economic growth higher demand for the domestic currency relative to the foreign currency e r An increase in productivity should result in an appreciation of the RER.

20 Some economics behind ERER [2] Foreign direct investment Foreign direct investment (fdi; -) = FDI/ GDP N transition variable: proxy for many channels and effects via financial account: fdi higher supply for foreign currency e and r via productivity and price channel: fdi higher productivity r An increase in fdi should result in an appreciation of the RER, but could be different at the longer time horizon (profit outflows).

21 Some economics behind ERER [3] Terms of trade Terms of trade (tot; -) = P ex /P im endogenous improvement: tot P ex rise due to quality improvement domestic prices (p) r exogenous improvement: tot because of a positive shock to TOT (decrease in prices of raw materials substitution effect (firms produce more exportable and fewer non-tradable goods) AS w T w NT P NT domestic prices (p) CA (improves) r (if country mainly imports raw materials) An increase in tot should result in an appreciation of the RER.

22 Some economics behind ERER [4] Openness Openness (open; ambiguous) = (Ex+Im)/GDP N open as liberalisation phenomenon: higher trade restrictions (tightening of trade policy) p T domestic prices (p) r open as country risk phenomenon: more open economy smaller country risk NMS: higher openness of NMS (especially due to trade liberalisation lower country risk) should lead to an appreciation of the RER. However, the transformation aspect is gradually decreasing. Overall effect is ambiguous.

23 Some economics behind ERER [5] Net foreign assets Net foreign assets (nfa; -) = NFA/GDP N NFA domestic income larger expenditure on domestic goods p NT domestic prices (p) r An increase in nfa should result in an appreciation of the RER.

24 Some economics behind ERER [6] Real interest rates differential Real interest rate differential (drir; -) = real LR-real LR* Standard view drir higher demand for domestic assets r (currently), but also indicates - according to UIP condition - depreciation expectations in the future. More complex view: absorption (relative to savings) upward pressure on the RIR (if capital mobility is imperfect) demand for T and NT rer An increase in drid should result in an appreciation of the RER.

25 Some economics behind ERER [7] Government spending Government spending (gs;+, ambiguous) = GS/GDP N in the short run GS public consumption (due to a higher share of NT goods in public consumption relative to private consumption) demand for NT goods PNT domestic prices (P) r in the long run (medium run) GS growing budget deficit possible destabilisation of the economy (if current GS > then sustainable GS Maastricht criterion) r An increase in gs should result in an appreciation of the RER.

26 FEER CA EB CA EQ CA GAP NX Y Y GAP Y EQ sustainable balance of the balance of payments sustainable level of CA/HDP deviation of the CA from external equilibrium net real export real GDP growth deviation of the GDP form internal balance potential GDP (Cobb-Douglas production function)

27 NATREX The NATREX is a model of the equilibrium real exchange rate, which is where the real exchange rate is heading. Intuition: (I-S)+CA=0 Interconnection between savings, investments and current account of balance of payments (extended Mundell-Fleming model); The NATREX model has two components: the long-run equilibrium real exchange rate and the dynamics of adjustment of the medium-run equilibrium to the long-run equilibrium. In the medium-run equilibrium, the ratio of the external debt/gdp is predetermined, and the real exchange rate is associated with both internal and external balance. The real exchange rate and debt ratio are endogenous variables. In full stock-flow equilibrium, the long run equilibrium real exchange rate and external debt ratio depend upon the vector of time varying fundamentals, which are productivity and thrift in the country relative to the rest of the world. Structure: (i) equilibrium equation, (ii) current account equation, (iii) investment equation, (iv) savings equation, (vi) equation of capital flows, (vi) equilibrium of portfolio flows.

28 ERER of the CZK/EUR close to equilibrium overvaluation Equilibrium real band CZK/EUR mid Real CZK/EUR 65 undervaluation

29 ENER of the CZK/EUR close to equilibrium overvaluation Equilibrium nominal band CZK/EUR mid Nominal CZK/EUR 23 undervaluation

30 Thank you for your attention! Luboš Komárek Monetary Department External Economic Relations Division Director

31 References Frait, J. and Komárek, L. (2001). On the Way to European Union: Nominal and Real Convergence in Transition Countries. Finance a úvěr (Czech Journal of Economics and Finance), 6, pp Frait, J. and Komárek, L. (2002). Theoretical and empirical analysis of the debt adjusted real exchange rate in selected transition economies during Warwick Economic Research Papers No. 646, Department of Economics, The University of Warwick. Frait, J. and Komárek, L. (2003). Exchange rate and monetary developments in accession countries. In: Polouček, S. et al.: Reforming the financial sector in Central European countries. Palgrave Macmillan Publishers Ltd. (Studies in Economic Transition), Houndmills, etc, UK; December 2003, pp Horváth, R. and Komárek, L. (2007). Equilibrium exchange rates in the EU new members: Methodology, estimation and applicability to ERM II. Prague Economic Papers, 1, pp Jackson Hole (1999). New challenges for monetary policy. Economic Policy Symposium Proceedings. Komárek, L., Koprnická, K. and Král, P. (2010).: A Long-Term Real Appreciation as the Phenomenon of Economic Convergence. Politická ekonomie, LVIII(1), pp Komárek, L. and Melecký, M. (2008). Transitional appreciation of equilibrium exchange rates and the ERM II, Transition Studies Review, 15(1), pp Komárek, L. and Motl, M. (2012). Behavioral and Fundamental Real Equilibrium Exchange Rate. Politická ekonomie, 2, pp Rowthorn, R. and Ramaswamy, R. (1998). Growth, trade, and deindustrialization. IMF Working Paper WP/98/60, April Skořepa, M. and Komárek, L. (2015). Sources of asymmetric shocks: The exchange rate or other culprits? Economic Systems 6. Tatom, J. (1992). Currency appreciation and deindustrialization: A European perspective. Federal Reserve Bank of St. Louis, Working Paper, August 1992, no A.

32 Asymmetric shock textbook solutions R Czech Republic (affected) Without Monetary Union S CR R Germany (unaffected) S G 1 A A B D CR D CR D G 0 OG 0 OG Note: R real exchange rate; OG output gap Sticky prices and the adverse shock affects only the Czech Republic (which is not a part of monetary union) D CR D CR depreciation of R=E.P*/P moving from equilibrium A to B P R (if no change in E) or E R (if no change in P) Germany has no reason to change its nominal (E) and real (R) exchange rates, which remain at equilibrium in position A.

33 Asymmetric shock textbook solutions R Czech Republic (affected) With Monetary Union S CR R Germany (unaffected) S G 1 A A A 1 B B 1 B 2 D CR D CR D G 0 OG 0 Sticky prices and the adverse shock affects only the Czech Republic, which is (hypothetically) a part of monetary union D CR D CR A) ECB cares about the Czech Republic change of R=E.P*/P (good for the Czech Republic, bad for Germany) inflationary excess demand in Germany (the size is between B 1 and B 2 ) B) ECB cares about Germany no change of R=E.P*/P (good for Germany, bad for the CR) excess supply for the Czech Republic (the size is between A and A 1 ) Floating of the union s exchange rate depreciation because of the Czech Republic (reaction to the adverse shock to the Czech part of the hypothetical monetary union) but because of the simultaneous reaction to excess demand in Germany the depreciation is lower than in the situation without monetary union red line represents the new level of R (no optimal solution) OG