International investment positions and exchange rate dynamics: a dynamic panel analysis
AbstractIn this paper we revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we develop a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country's international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions, but not outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality. Finally, we adduce evidence that whether deterioration of a country's net foreign asset to GDP position leads to a depreciation of that country's effective exchange rate depends on its rate of inflation relative to the rate of inflation abroad as well as its exposure to global shocks. --
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Bibliographic InfoPaper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2007,23.
Date of creation: 2007
Date of revision:
Exchange Rate Determination; International Financial Integration; Dynamic Panel Data Models;
Find related papers by JEL classification:
- C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
- F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-09-30 (All new papers)
- NEP-CBA-2007-09-30 (Central Banking)
- NEP-IFN-2007-09-30 (International Finance)
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