Long Run Determinants of Real Exchange Rates in Latin America

Abstract

This paper investigates the long run behavior of real exchange rates in nineteen countries of Latin America over the period 1970 -2006. Our data does not support the Purchasing Power Parity (PPP) hypothesis, implying that real shocks tend to have permanent effects on Latin America's real exchange rates. By exploiting the advantage of non stationary panel econometrics, we are able to determinate factors that drive real exchanges rate in the long run : the Balassa-Samuelson effect, government spending, the terms of trade, the openness degree, foreign capital flows and the de facto nominal exchange regime. The latter effect has policy implications since we find that a fixed regime tends to appreciate the real exchange rate. This finding shows the non neutrality of exchange rate regime regarding its effects on real exchange rates. We also run estimations for country subgroups (South America versus Caribbean and Central America). Regional results highlight that several real exchange rates determinants are specific to one geographic zone. Finally, we compute equilibrium real exchange rate estimations. Two main results are derived from the investigation of misalignments, [i] eight real exchange rates are quite close to their equilibrium level in 2006, and [ii] our model shows that a part of currencies crises that arose in Latin America was preceded by a real exchange rate overvaluation.

Long-Run Determinants and Misalignments of the Real Effective Exchange Rate in the EU

“…To our knowledge there is still no comparison available between GM-DOLS and GM-FMOLS. By the way, in Carrera and Restout (2008), the authors claim that GM-DOLS suffers from two main drawbacks: it is too sensitive to the number of leads and lags, for which there is no statistical method to choose them properly, and even with only 1-lead and 1-lag having a limited time span (in our case T=19) the degrees of freedom are too short.…”

“…This event can bring two different effects: an income effect and a substitution one (Carrera and Restout, 2008). The increase in the TOT makes the imports relatively cheaper (positive substitution effect) but brings also a rise in the purchasing power and in the demand for non-traded goods.…”

“…13 We have chosen 1994 as a starting point for our data because this is the first year in which all the former Soviet countries now in the EU have been independent. Pedroni (2000) and used for instance by Carrera and Restout (2008) and Roudet et al (2012), which will be also applied to build the BEER. In addition, we provide an analysis of the long-run determinants by using a dynamic framework: a panel Error Correction Model (see Annex 2).…”

“…The GM-FMOLS estimator can be obtained also through the following cointegrated system as explained by Carrera and Restout (2008) and Pedroni (2000Pedroni ( , 2001:…”

“…This method considers the "equilibrium" value not immutable but it can vary through time. Moreover, it assumes that the actual REER is mean reverting and misalignments are due to inadequate (temporary) macroeconomic policies (Carrera and Restout, 2008).…”