Equilibrium real exchange rates and misalignments in large emerging markets: A Re-look through panel cointegrating estimation

Krittika Banerjee () and Ashima Goyal
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Krittika Banerjee: Indira Gandhi Institute of Development Research

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: Equilibrium real exchange rates (ERERs) of a set of major emerging market economies (EMEs) are estimated in a panel cointegrating equation framework against trade weighted advanced economy (AE) currencies taking into account structural emerging market issues, and then used to derive misalignments of the RER. Since US as a dominant economy has considerable effect on EME monetary policy, we use weighted AE variables in order to avoid endogeneity when US data alone is used. We find robust support for the Balassa-Samuelson effect, whereby productivity appreciates RER. This is also seen to be a dominant factor, along with financial development. We find that dependency ratio appreciates ERER indicating excess demand possibly from increase in young dependent population, as well as future growth potential for these EMEs. Rise in fiscal expenditure and financial development, on average, have a depreciatory effect indicating improvements in long run supply conditions. Institutions are found to improve competitiveness in all EMEs in our sample, except Thailand. On average, Asian economies have more appreciated ERER indicating better fundamentals. Over 1995-2017 we find that EME RER followed a cyclical pattern closely linked to global events, with periods of appreciation followed by depreciation. Asian economies along with Brazil and Mexico can be grouped together in terms of RER movement. Russia and Turkey have edged on the side of under-valuation and followed a more random path. The absence of substantial prolonged under-valuation before the Global Financial Crisis implies it was not a sole cause of imbalances. Over-valuation indicates EMEs bore large post-crisis adjustment costs.

Keywords: Real exchange rate; fundamentals; emerging markets; misalignments; global imbalances; adjustment costs (search for similar items in EconPapers)
JEL-codes: C21 C22 C23 F31 F41 O5 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2020-01
New Economics Papers: this item is included in nep-cba, nep-cis, nep-opm and nep-sea
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