Should the CNB Devaluate the Exchange Rate? 23/06/2010 Dubrovnik Marina Tkalec - Maruška Vizek 16...

23/06/2010Dubrovnik

Marina Tkalec - Maruška Vizek16th Young Economists’ Seminar

Should the CNB Devaluate the Exchange Rate?

Should the Croatian National Bank Devaluate the Exchange

Rate?

Evidence from Purchasing Power Parity

23/06/2010Dubrovnik



Content

• PPP hypothesis

• Review of empirical research

• Data

• Methodology

• Results

• Policy implications

23/06/2010Dubrovnik



PPP hypothesis

• Exchange rate that equates domestic and foreign price levels so that the purchasing power of a unit of one currency would be the same in both economies (Sarno and Taylor, 2001)

• One of the most extensively tested theoretical propositions

• Intuitive and simple

We wanted to test whether ppp holds in Croatia since the debates about the overvaluation of the nominal hrk/eur exchange rate are quitte common

23/06/2010Dubrovnik



Review of empirical research

• Consensus concerning the validity of PPP appears to have shifted several times in the post-war period

• The prevailing view is that long-run PPP does have some validity, although a number of puzzles have yet to be resolved

• For transition countries results seem less conclusive reasons stem from characteristics of transition economies

• Most of transition economies suffered external and internal shocks, high inflation and/or major exchange rate shifts

• Nonlinear tests more succesful in detecting PPP for developing countries when compared to linear tests

• Croatia: till now authors tested only for linear ppp (unit root, cointegration and panel data tests) contradictory results

23/06/2010Dubrovnik



Data

• To test the PPP theory we needed:Monthly average nominal HRK/EUR

exchange rateMonthly Croatian consumer price indexMonthly harmonized index of consumer prices

for EMU

• All data range from January 2000 to December 2009

23/06/2010Dubrovnik



HRK/EUR

0.85

0.86

0.87

0.88

0.89

01/00 01/02 01/04 01/06 01/08

23/06/2010Dubrovnik



Croatian CPI

1.93

1.96

1.99

2.02

2.05

01/00 01/02 01/04 01/06 01/08

23/06/2010Dubrovnik



Eurozone HCPI

1.94

1.97

2.00

2.03

01/00 01/02 01/04 01/06 01/08

23/06/2010Dubrovnik



HRK/EUR in first differences

-0.01

-0.01

0.00

0.01

02/00 02/02 02/04 02/06 02/08

23/06/2010Dubrovnik



Croatian CPI in first differences

-0.003

-0.001

0.002

0.005

0.007

02/00 02/02 02/04 02/06 02/08

23/06/2010Dubrovnik



Eurozone HCPI in first differences

-0.002

-0.001

0.001

0.003

02/00 02/02 02/04 02/06 02/08

23/06/2010Dubrovnik



Methodology

• Two cointegration methods:- Johansen cointegration: symmetry in both the

short and long run

- Threshold cointegration: asymmetry in short and symmetry in the long run Enders and Siklos (2001)

• Vector error correction models

23/06/2010Dubrovnik



Results – Johansen cointegration

• Two cointegrating vectors:1. Absolute PPP condition

2. Long run relationship between domestic and eurozone price level

Rank Eigenvalue Trace test Max test Trace test (T-nm) Max test (T-nm)

0 - 62.42 [0.000]* 42.15 [0.000]* 59.25 [0.000]* 40.01 [0.000]*

1 0.3004 20.27 [0.048]** 18.61 [0.016]** 19.24 [0.068] 17.67 [0.024]**

2 0.1459 1.66 [0.836] 1.66 [0.835] 1.57 [0.850] 1.57 [0.849]

3 0.0139 - - - -

23/06/2010Dubrovnik



Results – Johansen cointegrationRestrictions:

First cointegrating vector:- long run coefficients for the exchange rate should be equal to 1- long run coefficients for EMU prices should be equal to 1- long run coefficient for domestic prices should be equal to -1- in the short run EMU prices are weakly exogenousSecond cointegrating vector:– long run coefficients for the exchange rate should be equal to 0– long run coefficient for domestic prices should be equal to 1

Variables

Long run(1. vector)

Short-run(1. vector)

Long run(2. vector)

Short-run(2. vector)

β coefficients α coefficients β coefficients α coefficients

Exchange rate 1.0 -0.236 - -0.286

Domestic prices

-1.0 0.0235 1.00.0168

EMU prices 1.0 0 -0.871 -0.0076

Constant -0.7717 - -0.340 -

23/06/2010Dubrovnik



Results – VECMs’

Dependant variable Δ Exchange rate Δ Domestic prices Δ EMU prices

Constant9.98252e-5

(0.066)0.00013(0.066)

-8.6e-6(-0.015)

Δ Exchange rate(-1)0.192(1.52)

0.0175(0.32)

-0.029(-1.38)

Δ Domestic prices(-1)-0.055

(-0.251)0.038(0.34)

0.069 (1.43)

Δ EMU prices(-1)-0.884*(-2.205)

0.187(0.74)

0.062 (0.44)

ECT_PPP(-1)-0.236*(-3.84)

0.023(0.68)

0.0004(0.031)

ECT_INFLATIONDIFFERENTIAL(-1)

-0.2853*(-3.70)

0.0189(0.44)

-0.007(-0.36)

23/06/2010Dubrovnik



Results

1. Absolute power parity holds in the long run2. Exchange rate adjusts to deviations from the parity in

the short run3. Price level in Croatia and the eurozone are weakly

exogenous4. Higher inflation in Eurozone leads to appreciation of

nominal HRK/EUR exchange rate in the short run 5. No proof of exchange rate pass-through to domestic

consumer prices6. Adjustments of deviations from the PPP is not

asymmetric

23/06/2010Dubrovnik



Policy implications

1. Devaluation is not an appropriate policy response

2. Nominal rigidity in the economy should be decreased

3. More nominal exchange rate variability when no structural characteristics are taken into account

* Exchange rate is flexible enough to correct discrepancies in prices; performs its basic economic function

23/06/2010Dubrovnik



Results - TAR and M-TAR

TAR M-TAR TAR M-TAR

Threshold = 0 Threshold = 0 Threshold = 0.0131 Threshold = 0.00018

Parameters and tests

valuesParameters

and testsvalues

Parameters and tests

valuesParameters

and testsvalues

ρ1= -0.071 ρ1 = -0.121 ρ1 = -0.086 ρ1 = -0.128

ρ2 = -0.067 ρ2 = -0.018 ρ2 = -0.056 ρ2 = -0.012

Tmax -1.24 Tmax -0.36 Tmax -1.14 Tmax -0.247

Φ(ρ1= ρ2 = 0) 2.10 Φ(ρ1= ρ2 = 0) 3.45 Φ(ρ1= ρ2 = 0) 2.35 Φ(ρ1= ρ2 = 0) 3.78

W(ρ1= ρ2) 0.003(0.96)

W(ρ1= ρ2) 2.31(0.12)

W(ρ1= ρ2) 0.19 (0.66)

W(ρ1= ρ2) 2.95(0.09)

AR test 0.96(0.46)

AR test 0.83(0.56)

AR test 0.85 (0.55)

AR test 0.84(0.55)

Should the CNB Devaluate the Exchange Rate? 23/06/2010 Dubrovnik Marina Tkalec - Maruška Vizek 16...

Documents

Transcript of Should the CNB Devaluate the Exchange Rate? 23/06/2010 Dubrovnik Marina Tkalec - Maruška Vizek 16...