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Real exchange rates: measurement and implications for predicting U.S. external imbalances

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Author Info
Jaime Marquez
Abstract

That international trade flows respond to changes in real exchange rates is beyond question. What is less clear is whether the measurement of real exchange rates matters for characterizing and predicting such responses. To identify the implications of choosing a given measure of the real exchange rate, I examine how the parameter estimates and the forecast performance of a given model vary in response to alternative measures of real exchange rates. I reject a given measure if its use (a) implies estimates inconsistent with economic theory; (b) contradicts the assumptions needed for statistical inference; (c) leads to systematic forecast errors; or (d) entails a loss of information relative to an alternative measure. Although the analysis rejects several measures of real exchange rates, it cannot identify a unique measure suitable for explaining U.S. trade: relative unit labor costs and relative consumer prices are equally suited for modeling and predicting U.S. trade.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 427.

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Date of creation: 1992
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Handle: RePEc:fip:fedgif:427

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Keywords: Foreign exchange rates ; International trade;

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  1. Hendry, David F. & Pagan, Adrian R. & Sargan, J.Denis, 1984. "Dynamic specification," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 18, pages 1023-1100 Elsevier. [Downloadable!] (restricted)
  2. Jaime Marquez, 1992. "The autonomy of trade elasticities: choice and consequences," International Finance Discussion Papers 422, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  3. Leslie Lipschitz & Donogh McDonald, 1991. "Real Exchange Rates and Competitiveness - A Clarification of Concepts, and Some Measurements for Europe," IMF Working Papers 91/25, International Monetary Fund.
  4. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Technical Working Papers 0100, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Chong, Yock Y & Hendry, David F, 1986. "Econometric Evaluation of Linear Macro-Economic Models," Review of Economic Studies, Blackwell Publishing, vol. 53(4), pages 671-90, August. [Downloadable!] (restricted)
  6. Moffett, Michael H., 1989. "The J-curve revisited: an empirical examination for the United States," Journal of International Money and Finance, Elsevier, vol. 8(3), pages 425-444, September. [Downloadable!] (restricted)
  7. Goldstein, Morris & Khan, Mohsin S., 1985. "Income and price effects in foreign trade," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 20, pages 1041-1105 Elsevier. [Downloadable!] (restricted)
  8. Jarque, Carlos M. & Bera, Anil K., 1980. "Efficient tests for normality, homoscedasticity and serial independence of regression residuals," Economics Letters, Elsevier, vol. 6(3), pages 255-259. [Downloadable!] (restricted)
  9. B. Dianne Pauls & William L. Helkie, 1987. "A reassessment of measures of the dollar's effective exchange value," International Finance Discussion Papers 306, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  10. Jaime Marquez & Neil R. Ericsson, 1990. "Evaluating the predictive performance of trade-account models," International Finance Discussion Papers 377, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Robert Z. Lawrence, 1990. "U.S. Current Account Adjustment: An Appraisal," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990-2), pages 343-392. [Downloadable!]
  12. Hakkio, Craig S. & Rush, Mark, 1991. "Cointegration: how short is the long run?," Journal of International Money and Finance, Elsevier, vol. 10(4), pages 571-581, December. [Downloadable!] (restricted)
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  13. Neil R. Ericsson, 1991. "Parameter constancy, mean square forecast errors, and measuring forecast performance: an exposition, extensions, and illustration," International Finance Discussion Papers 412, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  14. Houthakker, Hendrik S & Magee, Stephen P, 1969. "Income and Price Elasticities in World Trade," The Review of Economics and Statistics, MIT Press, vol. 51(2), pages 111-25, May. [Downloadable!] (restricted)
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