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Estimating currency misalignment using the Penn effect: It is not as simple as it looks

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  • Yin†Wong Cheung
  • Menzie Chinn
  • Xin Nong

Abstract

We investigate the robustness of the Penn effect—the finding that the price level is higher in countries with a higher per capita income—over different samples, measures, and specifications. Testing for the Penn effect has been hampered by the imprecision of the price measures, so that use of different versions of the data set can lead to substantially different results. We find that the price level†income elasticity is fairly consistently estimated across data sets. However, there is some evidence that the relationship is non†linear. For developed economies, the quadratic term implies an inverted U†shaped relationship. Developing economies, on the other hand, display a U†shaped relationship. Estimates of misalignment differ, depending on the choice of specification and data sets. It appears that the Renminbi (RMB) was fairly valued by 2011. In contrast, the RMB's value was undervalued in 2005, and overvalued in 2014.

Suggested Citation

  • Yin†Wong Cheung & Menzie Chinn & Xin Nong, 2017. "Estimating currency misalignment using the Penn effect: It is not as simple as it looks," International Finance, Wiley Blackwell, vol. 20(3), pages 222-242, December.
  • Handle: RePEc:bla:intfin:v:20:y:2017:i:3:p:222-242
    DOI: 10.1111/infi.12113
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    Cited by:

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    4. Almås, Ingvild & Grewal, Mandeep & Hvide, Marielle & Ugurlu, Serhat, 2017. "The PPP approach revisited: A study of RMB valuation against the USD," Journal of International Money and Finance, Elsevier, vol. 77(C), pages 18-38.
    5. Yin-Wong Cheung & Wenhao Wang, 2020. "A Jackknife Model Averaging Analysis of RMB Misalignment Estimates," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 11(02), pages 1-45, June.
    6. Grabowski, Wojciech & Welfe, Aleksander, 2020. "The Tobit cointegrated vector autoregressive model: An application to the currency market," Economic Modelling, Elsevier, vol. 89(C), pages 88-100.
    7. Mr. Pau Rabanal & Luciana Juvenal & Gustavo Adler & Ms. Carolina Osorio Buitron & Jair Rodriguez & Ms. Nan Li & Mrs. Swarnali A Hannan & Signe Krogstrup & Mai Chi Dao & Mr. Daniel Garcia-Macia & Callu, 2019. "The External Balance Assessment Methodology: 2018 Update," IMF Working Papers 2019/065, International Monetary Fund.
    8. Ms. Carolina Osorio Buitron & Mr. Mauricio Vargas & Rui Mano & Mr. Luca A Ricci, 2019. "The Level REER model in the External Balance Assessment (EBA) Methodology," IMF Working Papers 2019/192, International Monetary Fund.

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    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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