Equilibrium Exchange Rates in Transition Countries: Evidence from Dynamic Heterogeneous Panel Models

Estimating Equilibrium Real Exchange Rates in the Franc Zone

“…Given the determinants of the RER, as described in section 2:1, data considerations require some compromises to be made as follows: investment as a share of GDP (INVSH t ) is used to capture the domestic supply capacity and possibly technological progress (see Kim and Korhonen, 2002); government consumption as a share of GDP (GOVCON t ) to capture the impact of changes in …scal policy; and the terms of trade (TOT t ) is used to capture changes in international economic environment. In addition, resource balance is treated as one of the fundamentals, consistent with an assumption that Franc zone memberstates face an upward-sloping supply curve of external loans, thereby imposing a binding credit ceiling which shuts down the capital account and determes net interest payments.…”

“…The equilibrium RER can then be identi…ed as that unobserved function of the fundamentals towards which the actual RER gravitates over time (Kaminsky, 1988;Elbadawi, 1994; Elbadawi and Soto, 1994, 1997; Kim and Korhonen, 2002). Although time series estimations have been used in many contexts to estimate the equilibrium RER (and misalignment) and to establish a long-run relationship between the RER and its fundamentals, this paper suggests that considering the e¤ects of cross-sectional dependence will improve the results.…”

Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues*

“…It is admittedly difficult to test for cointegration when the time series dimension of the panel is limited. However, this issue can be tackled by running the regression in both levels and in first differences (Krajnyák andZettelmeyer, 1998, andMaurin, 2001) or by applying nonstationary panel techniques: De Broeck and Sløk (2001) and Kim and Korhonen (2005) use PMGE and MGE and take a significant error correction adjustment parameter as evidence for cointegration. Crespo-Cuaresma et al (2005) use a variety of estimation methods and systematically apply cointegration tests proposed by Kao (1999) to the residuals of the long-term relationships.…”

“…While Braumann (1998), Begg, Halpern and Wyplosz (1999), Beguna (2002) and Csajbók (2003) find that an increase in the openness ratio leads to a real appreciation of the exchange rate, estimates in Avallone andLahrèche-Révil (1999), De Broeck andSløk (2001), Bitans (2002), Kim and Korhonen (2005), Vetlov (2002), and show the opposite to be the case. A negative sign (an increase in openness leads to a depreciation of the real exchange rate) reflects the traditional view according to which openness is an indicator of trade liberalization: higher openness is associated with decreasing trade barriers, which raises imports more than exports.…”

“…Hence, constants obtained for the "out-of-sample panel" should be used. 54 Constant terms obtained on the basis of cumulated indices have no cross-sectional meaning (Kim and Korhonen, 2005). This is why MaesoFernandez, Osbat and Schnatz (2004) use data in levels.…”