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International investment positions and exchange rate dynamics: a dynamic panel analysis

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  • Binder, Michael
  • Offermanns, Christian J.
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    Abstract

    In 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 Info

    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2007,23.

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    Date of creation: 2007
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    Handle: RePEc:zbw:bubdp1:6144

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    Related research

    Keywords: Exchange Rate Determination; International Financial Integration; Dynamic Panel Data Models;

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    1. Pesaran, Mohammad Hashem & Pettenuzzo, Davide & Timmermann, Allan, 2006. "Learning, structural instability and present value calculations," Discussion Paper Series 1: Economic Studies 2006,27, Deutsche Bundesbank, Research Centre.
    2. Taylor, Mark P. & Schmidt, Markus & Reitz, Stefan, 2007. "End-user order flow and exchange rate dynamics," Discussion Paper Series 1: Economic Studies 2007,05, Deutsche Bundesbank, Research Centre.
    3. repec:rus:hseeco:318682 is not listed on IDEAS
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    Cited by:
    1. Sascha S. Becker, 2011. "What Drives the Relationship Between Inflation and Price Dispersion? Market Power vs. Price Rigidity," SFB 649 Discussion Papers SFB649DP2011-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    2. Georgiadis, Georgios, 2014. "Towards an explanation of cross-country asymmetries in monetary transmission," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 66-84.
    3. Markus Eberhardt & Francis Teal, . "Aggregation versus Heterogeneity in Cross-Country Growth Empirics," Discussion Papers 11/08, University of Nottingham, CREDIT.

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