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The equilibrium exchange rate according to PPP and UIP

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    Abstract

    This paper uses Purchasing Power Parity (PPP) and Uncovered Interest Rate Parity (UIP) to estimate a time-varying equilibrium for the $NZ/$US nominal exchange rate over the period 1992 to 2003. While PPP is supported, the data does not support the strictest form of UIP. The estimated equilibrium can be considered a Behavioural Equilibrium Exchange Rate (BEER) that is conditional on interest rates and price levels. The large swings in New Zealand's exchange rate during the 1990s were broadly consistent with the estimated conditional equilibrium, while the equally large swings in the exchange rate since 2000 were moves away from the conditional equilibrium. This may be because some factor other than interest rates or price levels has driven the exchange rate away from the conditional equilibrium since 2000. Alternatively, the long-run relationship between interest rates and the exchange rate may have changed since the 1990s.

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    File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2004/dp04_03.pdf
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    Bibliographic Info

    Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP 2004/03.

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    Length: 28p
    Date of creation: Apr 2004
    Date of revision:
    Handle: RePEc:nzb:nzbdps:2004/03

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    1. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
    2. Ronald MacDonald, 1995. "Long-Run Exchange Rate Modeling - A Survey of the Recent Evidence," IMF Working Papers 95/14, International Monetary Fund.
    3. Ronald MacDonald, 2001. "Modelling the long-run real effective exchange rate of the New Zealand Dollar," Reserve Bank of New Zealand Discussion Paper Series DP2002/02, Reserve Bank of New Zealand.
    4. Pesaran, M. H. & Shin, Y. & Smith, R. J., 1997. "Structural Analysis of Vector Error Correction Models with Exogenous I(1) Variables," Cambridge Working Papers in Economics 9706, Faculty of Economics, University of Cambridge.
    5. Ronald MacDonald & Jun Nagayasu, 2000. "The Long-Run Relationship Between Real Exchange Rates and Real Interest Rate Differentials: A Panel Study," IMF Staff Papers, Palgrave Macmillan, vol. 47(1), pages 5.
    6. Diebold, Francis X & Husted, Steven & Rush, Mark, 1991. "Real Exchange Rates under the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1252-71, December.
    7. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    8. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
    9. Guy Meredith & Menzie D. Chinn, 1998. "Long-Horizon Uncovered Interest Rate Parity," NBER Working Papers 6797, National Bureau of Economic Research, Inc.
    10. Pantula, Sastry G., 1989. "Testing for Unit Roots in Time Series Data," Econometric Theory, Cambridge University Press, vol. 5(02), pages 256-271, August.
    11. Anne-Marie Brook & David Hargreaves, 2001. "PPP-based analysis of New Zealand's equilibrium exchange rate," Reserve Bank of New Zealand Discussion Paper Series DP2001/01, Reserve Bank of New Zealand.
    12. Juselius, Katarina, 1995. "Do purchasing power parity and uncovered interest rate parity hold in the long run? An example of likelihood inference in a multivariate time-series model," Journal of Econometrics, Elsevier, vol. 69(1), pages 211-240, September.
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    Cited by:
    1. Beirne, John & Bijsterbosch, Martin, 2011. "Exchange rate pass-through in central and eastern European EU Member States," Journal of Policy Modeling, Elsevier, vol. 33(2), pages 241-254, March.
    2. Dominick Stephens, 2006. "Should monetary policy attempt to reduce exchange rate volatility in New Zealand?," Reserve Bank of New Zealand Discussion Paper Series DP2006/05, Reserve Bank of New Zealand.
    3. Rashid, Abdul & Ling, Jeffrey, 2009. "Fundamentals and Exchange Rates: Evidence from ASEAN-5," MPRA Paper 22451, University Library of Munich, Germany.
    4. Anella Munro, 2005. "UIP, Expectations and the Kiwi," Reserve Bank of New Zealand Discussion Paper Series DP2005/05, Reserve Bank of New Zealand.

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