Transcript Low consumption

The Real Exchange
Rate Always Floats
Thorvaldur Gylfason
Outline
 Make two points about long-run
behavior of real exchange rates
 They float, always

because relative prices at home and
abroad move about
 They fluctuate

because it takes time for the effects of
real exchange rate changes on trade
flows to materialize in full
But First This
The exchange rate is a relative price
But relative price of what?
Domestic and foreign moneys?
Yes, the nominal exchange rate is a
monetary phenomenon, but exchange
rate regimes are not, they are “real”
Exchange rate regimes have real effects
Domestic and foreign GDP?
Yes, the real exchange rate is, of course,
a real phenomenon
Two Definitions
eW
eP
Rw 
Rp 
W*
P*
 Even if prices are not sticky,
wages often are
 Real exchange rate varies
directly with inflation
Inflation and Overvaluation
Real exchange rate
Suppose inflation is
10 percent per year
110
105
100
Average
Time
Inflation and
Overvaluation
Real exchange rate
Suppose inflation rises
to 20 percent per year
120
110
Average
100
Time
Two Types of
Overvaluation
 African type
 Real exchange rates kept artificially
high by government intervention as
well as by high inflation
 Should Africa fix of flex?
 Japanese type
 Real exchange rates kept high
primarily by domestic inefficiency
More on Japan
The yen is overvalued, or at least
high
Brings home
the importance
of looking at
the real as well
as monetary
determinants
of exchange
rates
 How do we see this?

Not by looking at Japan´s monetary
or balance of payments statistics
 No, Japan’s per capita GDP
seems overvalued at the current
exchange rate of the yen

Japan’s PPP-adjusted per capita
GDP is far lower and more accurate
NATREX Model:
Some Results
NATREX is a trajectory, not a
number
Solve etMT from CAt = St – It
Two main results:
 Increased productivity leads to
real appreciation
 Increased expenditure (“social
consumption”) leads to real
depreciation
Classification of
Cases
High
productivity
High
consumption
Low
consumption
Low
productivity
Classification of
Cases
High
productivity
High
consumption
Low
consumption
Low
productivity
Weak currency,
low income:
Africa
Classification of
Cases
High
productivity
High
consumption
Low
consumption
Low
productivity
Weak currency,
low income:
Africa
Strong currency,
high income:
Hong Kong
Classification of
Cases
High
productivity
High
consumption
Low
consumption
Low
productivity
Weak currency,
low income:
Africa
Strong currency, Japan (?)
high income:
Hong Kong
Classification of
Cases
High
productivity
Low
productivity
High
consumption
United States,
European Union
Weak currency,
low income:
Africa
Low
consumption
Strong currency, Japan (?)
high income:
Hong Kong
A Little Trigonometry
dR
B
dt
dB
 R
dt
R = real exchange rate
B = current account balance
B(t )  cos(t )
R (t )  sin( t )
Real effective exchange rates
1990-1999 (1995 = 100)
130
120
110
100
90
80
70
Australia
Japan
Philippines
China
New Zealand
Africa
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
60
From Lags to Swings
X t  a0Y e e
*a1 a2 a3
t
t
t 1
b1 b2 b3
t
t
t 1
M t  b0 Y e e
Bt  X t  et M t  0
 a3  b3 
ln( et )  
 ln( et 1 )  c
 a2  b2  1
From Lags to Swings
a2  b2  1
a2  b2  1  a3  b3
Oscillations
Stability
 a3  b3 
ln( et )  
 ln( et 1 )  c
 a2  b2  1
Empirical Estimates
of Elasticities
a2  b2  1
Export
elasticity
Industrial
countries
Developing
countries
Lagged effects
are smaller than
concurrent effects
Import
elasticity
1.11
0.99
1.1
1.5
a2  b2  1  a3  b3
The paper is on my website:
www.hi.is/~gylfason
In Conclusion
 Real exchange rates float …


The real exchange rate of the Euro is
dominated by movements in the nominal
exchange rate, not in relative prices
More often, real exchange rate
movements are dominated by price
changes, as in Hong Kong
 … and fluctuate as well

due to dynamic interaction between real
exchange rates and trade flows