External shocks and the real exchange rate: a simulation model for Egypt

Khalifa Hassanain

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: In March 1990, the Government of Egypt (GOE) launched a comprehensive economic and social reform program (ERSAP) to strengthen Egypt's ongoing adjustment program. The reform program constituted a major break from the policies pursued in the past, and had the underlying objective of modernizing the country and improving living standards. While the program has scored many successes, many observers of the Egyptian economy believe that the real exchange rate (RE) is currently out of equilibrium;The RE prevailing in a country at any point in time is determined by two main factors: structural (e.g., external capital flows, changes in terms of trade, and commercial policy), and short run factors (macroeconomic policy in general). This study suggests and focuses on three of the structural factors that can affect the RE in Egypt. The first is the increase in the flow of foreign capital both public and private. The second is the commercial policy which is characterized by a high degree of protection for industry and can be traced back to the import substitution policy regime. The final factor is changes in terms of trade, especially for food imports. This study suggests that each of these factors has significantly contributed to the RE overvaluation in Egypt;The study uses a computable general equilibrium model (CGE) to study the impact of changes in structural factors on the RE trade flows, production and consumption in Egypt. The focus is on competitiveness and relative price effects. With their origin in microeconomic theory, CGE models are well prepared to study the impact of change in relative prices. The model is static, and the data base is a social accounting matrix for 1991/92, originally prepared by Lofgren (1995);The results of the simulations suggest that, in general, these structural factors, especially the increase in the flow of foreign capital and the commercial policy, could very well be responsible for the RE overvaluation in Egypt.

Date: 1997-01-01
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