Equilibrium real exchange rates
TL;DR: In this article, the role of the real exchange rate in macroeconomic equilibrium is analyzed and the stabilizing role of monetary policy in adjustment towards the supply-side equilibrium exchange rate is analyzed both before and after entry to the exchange rate mechanism of the European Monetar System.
Abstract: This paper analyzes the role of the real exchange rate in macroeconomic equilibrium. The supply-side equilibrium exchange rate, that level of the real exchange rate at which (relative) inflation is constant, is derived from a simple macro-model and related to the standard "NAIRU" model. The stabilizing role of monetary policy in adjustment towards the supply-side equilibrium exchange rate is analyzed both before and after entry to the exchange rate mechanism of the European Monetar System. Resolution of the conflict between supply-side and external equilibrium produces a stricter definition of the fundamental equilibrium exchange rate of J. Williamson. Copyright 1992 by Blackwell Publishers Ltd and The Victoria University of Manchester
Citations
More filters
Book•
23 Jun 2005
TL;DR: In this paper, the Norwegian main-course model and the New Keynesian Phillips curve are used to model the distribution of wage bargaining and price setting in large scale macromodels.
Abstract: 1. Introduction 2. Methodological issues of large scale macromodels 3. The Norwegian main-course model 4. The Phillips curve 5. Wage bargaining and price setting 6. Wage-price dynamics 7. The New Keynesian Phillips Curve 8. Money and inflation 9. Transmission channels and model properties 10. Evaluation of monetary policy rules 11. Forecasting using econometric models 12. Appendices
166 citations
TL;DR: This article showed that small changes in model specifications, explanatory variable definitions, and time periods used in estimation can lead to very substantial differences in equilibrium real exchange rate estimates, and that such estimates should be treated with great caution.
Abstract: . Assessments of a country's real exchange rate relative to its ‘equilibrium’ value as suggested by ‘fundamental’ determinants have received increasing attention. Using China as an example, the present paper illustrates models commonly used to derive equilibrium real exchange rate estimates. The large variance in the estimates raises serious questions about the robustness of these results. The basic conclusion is that, at least for China, small changes in model specifications, explanatory variable definitions, and time periods used in estimation can lead to very substantial differences in equilibrium real exchange rate estimates. Therefore, such estimates should be treated with great caution.
121 citations
Posted Content•
TL;DR: In this paper, the authors describe how and why the discipline of macro-econometric modelling continues to play a role for economic policymaking by adapting to changing demands, in response to new policy regimes like inflation targeting.
Abstract: Macroeconometric models, in many ways the flagships of the economist's profession in the 1960s, came under increasing attack from both theoretical economist and practitioners in the late 1970s. Critics referred to their lack of microeconomic theoretical foundations, ad hoc models of expectations, lack of identification, neglect of dynamics and non-stationarity, and poor forecasting properties. By the start of the 1990s, the status of macroeconometric models had declined markedly, and had fallen completely out of, and with, academic economics. Nevertheless, unlike the dinosaurs to which they often have been likened, macroeconometric models have never completely disappeared from the scene. This book describes how and why the discipline of macroeconometric modelling continues to play a role for economic policymaking by adapting to changing demands, in response, for instance, to new policy regimes like inflation targeting. Model builders have adopted new insights from economic theory and taken advantage of the methodological and conceptual advances within time series econometrics over the last twenty years. The modelling of wages and prices takes a central part in the book as the authors interpret and evaluate the last forty years of international research experience in the light of the Norwegian 'main course' model of inflation in a small open economy. The preferred model is a dynamic model of incomplete competition, which is evaluated against alternatives as diverse as the Phillips curve, Nickell-Layard wage curves, the New Keynesian Phillips curve, and monetary inflation models on data from the Euro area, the UK, and Norway. The wage price core model is built into a small econometric model for Norway to analyse the transmission mechanism and to evaluate monetary policy rules. The final chapter explores the main sources of forecast failure likely to occur in a practical modelling situation, using the large-scale nodel RIMINI and the inflation models of earlier chapters as case studies.
113 citations
TL;DR: In this paper, the authors present a dynamic model of real wages in the open economy that encapsulates the well-known "competing claims model" or "incomplete competition model" of real wage determination.
Abstract: We present a dynamic model of real wages in the open economy that encapsulates the well‐known “competing claims model” or “incomplete competition model” of real wage determination. In general, the model determines the development of inflation, real wages and the real exchange rate for any given rate of unemployment. Inflation, rather than unemployment, is the “conflict solver” in the unrestricted model. However, a supply side determined equilibrium rate of unemployment is subsumed as a special case. A re‐appraisal of the empirical literature shows that there is little evidence in support of the “natural rate” restrictions.
53 citations
TL;DR: The authors examined the extent to which a number of currencies central to the Asian currency crisis were misaligned at the end of 1996 and concluded that the cause of the Asian crash cannot be attributed to traditional fundamentals.
50 citations
References
More filters
TL;DR: Unemployment in Britain has risen from around 2 per cent in the late 1950s and early 1960s to around 3 per cent today as mentioned in this paper. But what accounts for this astonishing increase?
Abstract: Unemployment in Britain has risen from around 2 per cent in the late 1950s and early 1960s to around 3 per cent today. What accounts for this astonishing increase?
297 citations
TL;DR: The authors evaluate the exchange rate mechanisms embodied in current large-scale models of the UK economy, and develop a new specification that is econometrically preferable to the existing models.
Abstract: In June 1972 sterling's fixed parity against the dollar was abandoned, and macroeconomic modellers could no longer treat the exchange rate as an exogenous variable. A considerable research effort ensued, as modellers sought to integrate exchange rate systems into their econometric models. None of the resulting systems performed well, however, and the exchange rate equations often had to be overridden or subjected to heavy residual adjustment in forecasting and policy analysis exercises. In the first instance these difficulties came as no surprise, given the short series of data available for the 'floating' regime and the uninformative nature of the 'fixed' regime. The difficulties have persisted, however: in an analysis of the historical tracking performance of a recent vintage of the main UK macroeconometric models, Fisher and Wallis (I990) find that no model has a particularly good static simulation record with respect to the exchange rate. Nor are these difficulties purely local ones: in his international survey Isard (i 988) concludes that 'empirical modeling of exchange rates over the past decade has been largely a failure'. This paper evaluates the exchange rate mechanisms embodied in current large-scale models of the UK economy, and develops a new specification that is econometrically preferable. The models considered are those of the London Business School (LBS), National Institute of Economic and Social Research (NIESR), Liverpool University Research Group in Macroeconomics (LPL), Bank of England (BE) and Her Majesty's Treasury (HMT), as deposited with
56 citations
TL;DR: In this paper, the authors look at the problem of inflation both in general terms and in the British context, and consider inflation from a particular point of view, namely that of the labour market, although it would perhaps be more apt to describe the viewpoint as the supply side.
Abstract: Inflation is endemic in Britain. Aside from the odd year, inflation in Britain has been higher than the average of the OECD countries for the last forty years. This is as true for the anti-inflationary 1980s as for the inflationary 1970s and the ‘libertarian’ 1960s. In the light of this fact, we look at the problem of inflation both in general terms and in the British context. Furthermore, we shall consider inflation from a particular point of view, namely that of the labour market, although it would perhaps be more apt to describe the viewpoint as the supply side.
46 citations
TL;DR: This article examined three aspects of the NAIRU in the United Kingdom, all of which have been comparatively neglected in the literature, including the speed at which the NIRU is approached, where demand shocks persist because of contracts or adjustment costs, and the dynamic interrelationship between unemployment and utilisation in the goods market.
Abstract: The concept of the NAIRU or Natural Rate is central to macroeconomics, but our empirical knowledge about it remains hazy. In this paper we examine three aspects of the NAIRU in the United Kingdom, all of which have been comparatively neglected in the literature. The first involves the speed at which the NAIRU is approached, where demand shocks persist because of contracts or adjustment costs. A second, related issue involves the dynamic interrelationship between unemployment and utilisation in the goods market, and the implications of both variables for inflationary pressure. The third aspect we explore is the two way interaction between the NAIRU and the real exchange rate. One of the most influential studies of the U.K. NAIRU is Layard and Nickell (I986). This used a four equation model based on imperfectly competitive goods and labour markets. The model we use here (NIDEM I I.4) has the same theoretical foundations but is considerably more complex. In particular, the current account, the exchange rate and demand are modelled in a more structural manner, and expectations are assumed to be rational. In Section I we show how the wage and price equations in this model combine to give a relationship between unemployment, capacity utilisation, the real exchange rate and changes in inflation. We then examine how movements in the NAIRU are associated with changes in the current account, which in turn generate real exchange rate changes that feedback on to the NAIRU. Section II looks at the issues involving dynamic convergence to the NAIRU, using simulations of the model. Section III outlines the main conclusions.
31 citations
TL;DR: In this article, the authors argue that entry must be consistent with the economy's fundamental equilibrium exchange rate, but that governments can influence the speed of convergence to the fundamental equilibria.
Abstract: The paper discusses how a country should choose the rate at which it enters a fixed or quasi-fixed exchange rate zone. It is argued that entry must be consistent with the economy's fundamental equilibrium exchange rate, but that governments can influence the speed of convergence to the fundamental equilibrium exchange rate. Once entry has occurred, this can either involve using fiscal policy to alter the economy's transitional inflation path or monetary policy to move within the currency band. This framework is applied to U.K. entry into the European Monetary System and suggests that entry was at an unrealistically high rate.
18 citations