Transcript POSIBILITAŢI DE PERFECŢIONARE A ACTIVITAŢII DE …
Trade-off between the exchange rate and inflation
Supervisor: Professor Moisa Altar MSc Student: Razvan Pascalau
Abstract
Focus:
the dynamics of the convergence of both the exchange rate and inflation to the optimum pre-accession requirements revealing the trade-off existing between those two macroeconomic variables both in the short and the long term.
On the short-run:
analysis of the instruments to fight-off inflationary pressures in an Inflation Targeting framework
On the long run:
PPP hypothesis vs. Balassa-Samuelson effect
Contents:
1.Introduction………………………………………………..…………..4
2.Technical aspects of IT in Romania…..…………………..…………...5
3.Econometric estimation (I)………………...…………………………..6
3.1. VAR methodology…………………………………….…..6
3.2. Data……………………………………………………..…6 3.3. Estimation and specification issues……………………..…8 4.Interpreting the effects of Monetary Policy from the data……………..8
5.Purchasing Power Parity versus the Balassa-Samuelson hypothesis.13
6.Econometric estimation (II)………………………………………...…15 6.1. Methodology……………………………………………...15
6.2. Data……………………………………………………….15
6.3. Unit Roots and Co-Integration……………...…………….15
6.4. Error Correction equations…………………………..……17 7.Conclusion………………………………………………………...…..17
8.Bibliography…………………………………………………………..33
Appendix:
Appendix 1…………………………………………………………………..18
1.1. Unit Root tests…………………………………………………18 1.1. Johansen Co-Integration test…………………………………..22
1.1. Error terms analysis…………………………………………..26
1.4. Stability coefficient tests………………………………………28 1.5. Granger causality tests……………………………………..…30 Appendix 2..…………………………………………………………………30 2.1. Johansen Co-Integration test (I)…...……………………….….30
2.2. Pairwise Granger causality/Block exogeneity Wald test……...31
2.3.ECM………...……...………………………………………….31
2.4. Engle-Granger stationarity test………………...……………...32
2.5. Johansen Co-Integration test (II).……………………………...32
1. Introduction
Three-step
approach to the European monetary integration
Adoption in the near future of the IT policy regime
Romania faces the integration challenge as
Specify and estimate several vector-autoregressive models:
interest rate policy shocks and interventions on the foreign exchange market lead to puzzling effects ( trade-off between the exchange rate and inflation)
Balassa-Samuelson effect:
Romania’s case
Co-Integration analysis under PPP theory:
the real appreciation of ROL can be explained as the correction of an undervalued currency, with no evidence of an appreciation in the equilibrium exchange rate so far as the forecast of year 2000
2. Technical aspects of IT in Romania
“The economic program of pre-accession” (2001)
- the Romanian government stated IT as the first option of the NBR for years 2003 2004
The literature on IT can be separated in two categories
The analysis of IT
in emerging economies should consider the higher pass through from the exchange rate into inflation pressure
The transactions of the NBR
on the foreign exchange market frequent, exceeding what we can normally see as specific to a managed float regime
The interest rate policy instrument
so far played an insignificant role due to the monetary and non-monetary adverse conditions: fiscal dominance, position of net-debtor of the NBR towards the banking system, thin Treasury bonds market etc.
3. Econometric estimation (I)
3.1.VAR Methodology
VAR models
under study focus on the analysis of the “innovations” on the variables • y t • z t = b 10 = b 20 - b 12 * z t + 11 *y t-1 – b 21 * y t + 21 *y t-1 + 12 *z t-1 + 22 *z t-1 + yt + zt Using matrix algebra we have: • Bx t = 0 + 1 x t-1 + t where (3.1) (3.2)
B
b
1 21
b
12 1
x t
z y t t
0
b
10
b
20 1 11 21 12 22
t
yt
zt
• Premultiplication by B x t = A 0 + A 1 x t-1 + e -1 t allows us to obtain the VAR in standard form (3.3) where A 0 = B -1 0 , A 1 = B -1 1 , e t = B -1 t • Using the new notation the following system of equations results: • y t • z t = a 10 = a 20 + a + a 11 21 *y *y t-1 t-1 + a + a 12 22 *z *z t-1 t-1 + e + e 1t 2t (3.4) (3.5)
3. Econometric estimation (I)
3.2.Data
-
lniprodi_sa
as the logarithm of the industrial production index (Y) -
lnpretprodi
as the logarithm of the industrial price index (PPI) -
lncpi
as the logarithm of the consumers price index (CPI) -
m2nom_sa
as the logarithm of the monetary aggregate, seasonally adjusted (M2) -
dobref
reference interest rate used by the NBR -
dobdep
as the percentage of the sterilization (“deposit taking”) interest rate (D2) -
lncursnom
ROL (Exc) as the nominal exchange rate between the US dollar and -
expnet_sa
as the net export calculated as the difference between export (fob) and import (fob) (Exp) -
ygrowth
as the output growth, approximated through the growth of the industrial production index (Ygr)
3. Econometric estimation (I)
3.2.Data
Two dummy variables are included in each VAR
:
dumm97.
dumf97
and The first dummy picks up the rapid nominal depreciation at the start of 1997 following the ending of foreign currency rationing. The second dummy is required for the inflationary effect of heavy capital inflows following the resumption of the stabilization program at the start of 1997.
Altogether there are five models I have estimated
, as follows: M(1) : CPI, PPI, Exc M(2) : CPI, Ygr, Exp, Exc M(3) : CPI, M2, Exc M(4) : Y, CPI, D1, M2, Exc M(5): Y, CPI, D2, M2, Exc
• • •
3. Econometric estimation (I)
3.2.Estimation and Specification Issues
Testing the order of integration:
All variables are I(1) integrated. (see Appendix 1.1)
The choice for the optimum lag length
: 1 lag for models M(1) and M(2), 3 lags for M(3) and 3 for M(4) and M(5).
Johansen Cointegration test:
rejects the existence of cointegration at both 5% and 1% significance levels for the first three models (see Appendix 1.2.). However for the last ones the VAR will not fulfill the stability condition anymore. Therefore I will estimate the models in first differences • • •
The test for the VAR stability:
proves successful for all models.
Error terms analysis:
error terms are white-noise processes. That means they are normally distributed, have constant variance (i.e. homoskedasticity property) and have no autocorrelation. Without the display of a first lag autocorrelation, the above mentioned conditions look satisfactorily for all models. (see Appendix 1.3).
The test for the stability of the coefficients:
was conducted in order to identify any regime changes in the period under study (see Appendix 1.4).
Specification for the structural VAR
Table 1. M(1) – Direct Pass-Through Table 2. M(2) – Indirect Pass-Through CPI PPI EXC CPI 1 0 0 Table 3. M(3) PPI 0 1 0 EXC 1 1 1 CPI CPI 1 Ygr 0 Ygr 0 1 EXP 0 0 EXC 0 0 Table 4. M(4), M(5) EXP 0 0 1 0 EXC 1 0 1 1 CPI M2 EXC CPI 1 0 0 M2 0 1 0 EXC 1 1 1 Y CPI D M2 EXC Y 1 0 0 1 0 CPI 1 1 0 0 0 D 0 0 1 0 0 M2 0 0 1 1 0 EXC 0 1 1 1 1
Likelihood Ratio Test (LR)
M(1): Log likelihood LR test for over-identification: Chi-s quare(1) Table 5.
M(2): Log likelihood LR test for over-identification: Chi-s quare(4) Table 6.
M(3): Log likelihood LR test for over-identification: Chi-s quare(1) Table 7.
Log likelihood LR test for over-identification: Chi-s quare(4) Table 8 695.3686
0.399370
-70.92055
0.743159
627.4656
0.986480
537.3339
2.396429
Probability 0.5274
Probability 0.9459
Probability 0.3206
Probability 0.6633
4. Interpreting the Effects of the Monetary Policy from the Data
Direct Pass-Through effect
is measured through the impulse response of tradable good prices and inflation to shocks on exchange rate.
Figure 1. Impulse response to exchange rate shock M(1): Exchange rate shock
Tradable good price
Inflation rate
.020
.015
.010
.005
.000
-.005
-.010
R e s p o n s e t o C h o l e s k y O n e S . D . I n n o v a t i o n s ± 2 S . E .
R e s p o n s e o f D ( L N C P I) t o D ( L N C U R S N O M ) R e s p o n s e o f D ( L N P R E T P R O D I) t o D ( L N C U R S N O M ) .003
5 10 .002
.001
.000
-.001
15 -.002
20 25 5 10 R e s p o n s e o f D ( L N C U R S N O M ) t o D ( L N C U R S N O M ) .04
.03
.02
.01
.00
-.01
-.02
5 10 15 20 25 15 20 25
4. Interpreting the Effects of the Monetary Policy from the Data
Indirect pass-through effect.
The analysis on indirect pass-through effect is done through impulse response of net export, output growth and inflation rate to shocks on exchange rate (Figure 2). The findings show that indirect pass-through effect also worked well during the period.
Figure 2. Impulse response to exchange rate shock M(2): Exchange rate shock
Net export
Output growth
Inflation rate
.020
.015
.010
.005
.000
-.005
-.010
R e s p o n s e t o C h o l e s k y O n e S . D . I n n o v a t i o n s ± 2 S . E .
R e s p o n s e o f D ( L N C P I) t o D ( L N C U R S N O M ) .3
R e s p o n s e o f D ( Y G R O W T H ) t o D ( L N C U R S N O M ) .2
.1
.0
-.1
-.2
2 4 6 8 10 12 14 16 18 20 22 24 2 4 6 8 10 12 14 16 18 20 22 24 R e s p o n s e o f D ( E X P N E T _ S A ) t o D ( L N C U R S N O M ) 4 0 -4 -8 -12 2 4 6 8 10 12 14 16 18 20 22 24 R e s p o n s e o f D ( L N C U R S N O M ) t o D ( L N C U R S N O M ) .04
.03
.02
.01
.00
-.01
-.02
2 4 6 8 10 12 14 16 18 20 22 24
4. Interpreting the Effects of the Monetary Policy from the Data
For the
direct-pass through effect
one can notice the stronger impact of a shock in the exchange rate.( Figure 3) .02 5 .02 0 .01 5 .01 0 .00 5 .00 0 - .00 5 - .01 0
Figure 3. Impulse response to exchange rate shock M(1): Exchange rate shock
Tradable good price
Inflation rate
R e s p o n s e t o S t r u c t u r a l O n e S . D . I n n o v a t i o n s ± 2 S . E .
R e s p o n s e o f D ( L N C P I ) t o S h o c k 3 R e s p o n s e o f D ( L N P R E T P R O D I ) t o S h o c k 3 .00 4 .00 3 .00 2 .00 1 .00 0 - .00 1 - .00 2 5 1 0 1 5 2 0 2 5 5 1 0 1 5 2 0 2 5 R e s p o n s e o f D ( L N C U R S N O M ) t o S h o c k 3 .05
.04
.03
.02
.01
.00
- .01
- .02
- .03
5 1 0 1 5 2 0 2 5
4. Interpreting the Effects of the Monetary Policy from the Data
Figure 4. Impulse response to exchange rate shock M(2): Exchange rate shock Net export Output growth Inflation rate .005
.000
-.005
-.010
.025
.020
.015
.010
2 4 R e s p o n s e t o S t r u c t u r a l O n e S . D . I n n o v a t i o n s ± 2 S . E .
R e s p o n s e o f D ( L N C P I ) t o S h o c k 4 R e s p o n s e o f D ( Y G R O W T H ) t o S h o c k 4 .4
-.1
-.2
.1
.0
.3
.2
6 8 10 12 14 16 18 20 22 24 2 4 6 8 10 12 14 16 18 20 22 24 R e s p o n s e o f D ( E X P N E T _ S A ) t o S h o c k 4 -12 -16 -4 -8 8 4 0 2 4 6 8 10 12 14 16 18 20 22 24 R e s p o n s e o f D ( L N C U R S N O M ) t o S h o c k 4 .00
-.01
-.02
-.03
.05
.04
.03
.02
.01
2 4 6 8 10 12 14 16 18 20 22 24
4. Interpreting the Effects of the Monetary Policy from the Data
Figure 5. M(3) The impulse response function
R e s p o n s e o f D ( L N C P I ) t o C h o le s k y O n e S . D . I n n o v a t i o n s . 0 1 2 . 0 0 8 . 0 0 4 . 0 0 0 -. 0 0 4 -. 0 0 8 2 4 6 D (M 2 N O M _ S A ) 8 1 0 1 2 D (L N C U R S N O M ) 1 4 1 6
4. Interpreting the Effects of the Monetary Policy from the Data
Figure 6. M(3): The impulse response
R e s p o n s e o f D ( L N C P I ) t o S t r u c t u r a l O n e S . D . I n n o v a t i o n s .016
.012
.008
.004
.000
-.004
2 4 6 Shock2 8 10 Shock3 12 14 16
4. Interpreting the Effects of the Monetary Policy from the Data
Figure 7. The impulse response
.012
.008
.004
.000
-.004
-.008
2 R e s p o n s e t o C h o le s k y O n e S . D . I n n o v a t io n s ± 2 S .
E .
R e s p o n s e o f D ( L N C P I) to D ( D O B R E F ) R e s p o n s e o f D ( D O B R E F ) to D ( D O B R E F ) 5 4 3 0 -1 2 1 -2 -3 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16 .004
.000
-.004
-.008
R e s p o n s e o f D ( M 2 N O M _ S A ) to D ( D O B R E F ) 2 4 6 8 10 12 14 16 .02
R e s p o n s e o f D ( L N C U R S N O M ) to D ( D O B R E F ) .01
.00
-.01
2 4 6 8 10 12 14 16
4. Interpreting the Effects of the Monetary Policy from the Data
Figure 8. The impulse response (M5)
.008
.004
.000
-.004
-.008
-.012
2 R e s p o n s e t o S t r u c t u r a l O n e S . D . I n n o v a t i o n s ± 2 S . E .
R e s p o n s e o f D ( L N C P I) t o S h o c k 3 R e s p o n s e o f D ( D O B D E P ) t o S h o c k 3 16 12 8 4 0 -4 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16 R e s p o n s e o f D ( M 2 N O M _ S A ) t o S h o c k 3 .006
.004
.002
.000
-.002
-.004
-.006
-.008
2 4 6 8 10 12 14 16 .02
.01
.00
-.01
-.02
-.03
R e s p o n s e o f D ( L N C U R S N O M ) t o S h o c k 3 2 4 6 8 10 12 14 16
5.Purchasing Power Parity versus Balassa Samuelson hypothesis
PPP theory:
nominal exchange rates should move in line with price differentials, at least in the long run (stationary real exchange rate)
Balassa (1964) & Samuelson (1964)
show that if productivity gains in the tradable sector exceed those in the non-tradable sector, then the equilibrium real exchange rate should appreciate
Two possible explanations
for the real appreciation of the exchange rate can be put forward: 1.Excessive undervaluation at the beginning of transition 2.Structural changes in demand and production ( Halpern & Wyplosz, 1997, 2001)
6. Econometric estimation (II)
6.1. Methodology
•
Cursscht = C(1) + C(2)*Inflromt - C(3)*Inflsuat + ut, (6.1)
Cursscht
is the logarithm of the exchange rate, the domestic currency price of the dollar; • •
IInflromt
is the logarithm of the industrial price index;
Inflsuat
is the logarithm of the US industrial price index; •
ut
represents deviations from PPP.
For the PPP theory to hold, it is required that C(2)= C(3) = 1
Furthermore
, if the nominal exchange rate and the two price series are non-stationary, then the strong form of the PPP hypothesis requires that the nominal exchange rate and relative prices are co-integrated.
Two sample periods
are used: 1992:01-2000:08 & 1992:01 2003:01
6. Econometric estimation (II)
6.2.Data
4.4
4.0
3.6
3.2
2.8
2.4
2.0
92 93 94 95 96 97 98 99 00 01 02 F i g u r e 9 . L o g o f t h e n o m i n a l e x c h a n g e r a t e a g a i n s t t h e d o l l a r 4.5
4.0
3.5
3.0
2.5
2.0
92 93 94 95 96 97 98 99 00 01 F i g u r e 1 0 . L o g o f t h e i n d u s t r i a l p r i c e i n d e x 02
6. Econometric estimation (II)
6.2.Data
2.10
2.08
2.06
2.04
2.02
2.00
1.98
92 93 94 95 96 97 98 Figure 11. Log of the US i ndustri al pri ce i ndex 99 00 01 02 . 30 . 25 . 20 . 15 . 10 . 05 . 00 92 93 94 95 96 97 98 F igure 12. Log of t he real ex change rat e 99 00 01 02
6. Econometric estimation (II)
6.3.Unit Roots and Co-Integration
1992:01-2000:08
Normalized cointegrating coefficients
(std.err. in parentheses) CURSSCH 1.000000
INFLROM -0.963950
INFLSUA 0.980738
(0.01677) (0.68234) ( 2 = 0.000582, p-value = 0.980747 for restrictions C(2)=1 and C(3)=-1)
1992:08-2003:01
Normalized cointegrating coefficients (std.err. in parentheses) CURSNOM 1.000000
INFLROM -0.976765
(0.02625) [-37.2079] INFLSUA 0.086388
(0.87964) [ 0.09821]
6. Econometric estimation (II)
6.3.Error Correction Equations
According
to the Engle & Granger (1987) representation theorem,a valid error correction model implies co-integration.
I specify
two error correction equations, for which the dependent variables are the nominal depreciation and domestic inflation.
Error Correction
: D(CURSSCH) D(INFLROM) CointEq -0.039486
(0.04405) 0.181091
(0.02959) [-0.89648] [ 6.11977] White Heteroskedasticity Test CHSQ(1):p=0.132248
Breusch-Godfrey Serial Correlation LM Test CHSQ(16):p=0.133201
7. Conclusion
Efficiency
of the monetary policy instruments in the light of a possible change to an inflation targeting framework
Weak performance
concerning appreciation of the real exchange rate through productivity gains
The interventions
on the foreign exchange market often lead to adverse effects (trade-off effect)
The limitation
of the interest rate channel (trade-off effect)
Appreciation
of the real exchange rate mainly due to the initial devaluation
Year 2000
can be seen as a changing point in the evolution of the real appreciation process
Possible trade-off effect
on the long run as Romania accedes the EMU