Equilibrium exchange rates in the new EU members: external imbalances vs. real convergence
AbstractNew EU members share two very marked features which have conflicting implications for the evolution of their real exchange rates in the long run: accelerated growth and systematic current account imbalances, which would anticipate, respectively an appreciation and a depreciation of their currencies, according to different theories of exchange rate determination. Furthermore, both elements are intertwined, for current account imbalances are the other side of capital inflows which have been central in boosting potential output and productivity convergence in these economies. In this paper, we aim at achieving some insight on the role of persistent and substantial capital inflows and the consequent accumulation of net foreign liabilities in improving competitiveness and in the determination of the exchange rate for the three largest new EU members: Poland, Hungary and the Czech Republic. We adopt a sequential approach that sheds light on the role of capital flows and their interaction with the Balassa-Samuelson hypothesis. We start by noting in a bivariate cointegration analysis that the accumulation of net foreign liabilities, far from depressing the exchange rate in the long-run, has gone hand-in-hand with exchange rate appreciation. We claim that this may be due to the induced effect that capital inflows are expected to have on productivity and competitiveness. After testing that foreign direct investment is cointegrated with productivity trends, we show that a extended empirical model comprising relative productivity and net foreign assets is well-suited in general to capture this indirect, opposite effect of liabilities accumulation on the real exchange rate. Finally, the model makes it possible to estimate for the considered countries equilibrium exchange rates and misalignments and perform some simulations on their expected future path.
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Bibliographic InfoPaper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0708.
Length: 36 pages
Date of creation: Apr 2007
Date of revision:
new EU members; Balassa-Samuelson; FDI; REER; current account; convergence;
Find related papers by JEL classification:
- F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-07-07 (All new papers)
- NEP-CBA-2007-07-07 (Central Banking)
- NEP-TRA-2007-07-07 (Transition Economics)
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