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Equilibrium Real Effective Exchange Rate and Exchange Rate Misalignment in Pakistan

Author

Listed:
  • Zulfiqar Hyder

    () (State Bank of Pakistan)

  • Adil Mahboob

    () (State Bank of Pakistan)

Abstract

This paper estimates equilibrium real effective exchange rate (EREER) and exchange rate misalignment for Pakistan. Using the annual data from FY78 to FY05, Engle Granger co-integration technique is used to estimate the EREER based on various macroeconomic fundamentals suggested in economic literature by Edwards (1988, 1989, 1994), Elbadawi (1994), and Montiel (1997). The results indicate that EREER is determined by terms of trade, trade openness, net capital inflows, relative productivity differential, government consumption, and workers’ remittances. Trade openness, the increase in government consumption and capital inflows depreciate the REER, while, the increase in workers’ remittances and the improvement in terms of trade and total factor productivity relative to trading partners appreciate REER. The coefficients of the error correction term indicate the gradual convergence of the exchange rate toward long-run equilibrium. The estimated long run EREER and degree of exchange rate misalignment reveal that exchange rate misalignment ranged between -11.1 percent to 20.1 percent with zero reversion mean from FY78 to FY05 reflecting the long-term convergence tendency of actual REER toward EREER in Pakistan. Furthermore, the actual REER of FY05 is slightly depreciated in the range of 1.8-2.4 percent on the basis of two estimated regressions while one equation reflects an appreciation of 2.0 percent relative to EREER. This suggests that the current exchange rate is not too far away from the EREER and more or less reflects the underlying macroeconomic fundamentals. The result also reflects that the exchange rate misalignment and its volatility in REER measured by standard deviation tend to be smaller in the flexible exchange rate regime as compared to others

Suggested Citation

  • Zulfiqar Hyder & Adil Mahboob, 2006. "Equilibrium Real Effective Exchange Rate and Exchange Rate Misalignment in Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 2, pages 237-263..
  • Handle: RePEc:sbp:journl:13
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    References listed on IDEAS

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    Cited by:

    1. Matthew McCartney, 2015. "The Missing Economic Magic: The Failure of Trade Liberalization and Exchange Rate Devaluation in Pakistan, 1980–2012," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 20(Special E), pages 59-86, September.
    2. repec:rjr:romjef:v::y:2018:i:1:p:20-41 is not listed on IDEAS
    3. Adolfo Barajas & Ralph Chami & Dalia Hakura & Peter Montiel, 2011. "Workers’ Remittances and the Equilibrium Real Exchange Rate: Theory and Evidence," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 45-99, January.
    4. Muhammad Omer & Omar Farooq Saqib, 2009. "Monetary Targeting in Pakistan: A Skeptical Note," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 5, pages 53-81.
    5. Farid Makhlouf & Mazhar Mughal, 2013. "Remittances, Dutch Disease, And Competitiveness: A Bayesian Analysis," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(2), pages 67-97, June.
    6. Nadia Tahir, 2013. "Forward-Looking and Backward-Looking Taylor Rules: Evidence from Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 18(2), pages 121-145, July-Dec.
    7. Debowicz, Dario & Saeed, Wajiha, 2014. "Exchange rate misalignment in Pakistan and its general equilibrium distributional implications:," PSSP working papers 16, International Food Policy Research Institute (IFPRI).
    8. Mariem Brahim & Nader Nefzi & Hamed Sambo, 2017. "Remittances and the real effective exchange rates in MENA countries: What is the long run impact?," CEPN Working Papers 2017-15, Centre d'Economie de l'Université de Paris Nord.
    9. Shah Hussain, 2008. "Sources of Real Exchange Rate Misalignment Evidence from Pakistan," SBP Working Paper Series 26, State Bank of Pakistan, Research Department.
    10. repec:lje:journl:v:22:y:2017:i:sp:p:73-110 is not listed on IDEAS
    11. M. Lopreite, 2012. "The endogenous money hypothesis and securitization: the Euro area case (1999-2010)," Economics Department Working Papers 2012-EP02, Department of Economics, Parma University (Italy).
    12. Darío Debowicz & Wajiha Saeed, 2014. "Exchange rate misalignment and economic development: the case of Pakistan," Global Development Institute Working Paper Series 21014, GDI, The University of Manchester.
    13. Mishra, Prachi & Montiel, Peter J & Spilimbergo, Antonio, 2010. "Monetary transmission in low income countries," CEPR Discussion Papers 7951, C.E.P.R. Discussion Papers.
    14. M. Ashraf Janjua, 2007. "Pakistan’s External Trade: Does Exchange Rate Misalignment Matter for Pakistan?," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 12(Special E), pages 126-152, September.
    15. repec:sae:prodev:v:19:y:2019:i:1:p:55-82 is not listed on IDEAS
    16. Hassan, Rubina & Shahzad, Mirza Muhammad, 2011. "A macroeconometric framework for monetary policy evaluation: A case study of Pakistan," Economic Modelling, Elsevier, vol. 28(1-2), pages 118-137, January.
    17. Fizza Malik, 2016. "Modeling Dynamics of Exchange Rates Volatility: A Case of Pakistan from 1980-2010," Bulletin of Business and Economics (BBE), Research Foundation for Humanity (RFH), vol. 5(3), pages 144-161, September.
    18. Mario Holzner, 2006. "Real Exchange Rate Distortion in Southeast Europe," wiiw Balkan Observatory Working Papers 68, The Vienna Institute for International Economic Studies, wiiw.
    19. Jesus Felipe, 2009. "Does Pakistan Need To Adopt Inflation Targeting? Some Questions," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 5, pages 113-162.
    20. Saira Tufail & Sadia Batool, 2013. "An Analysis of the Relationship between Inflation and Gold Prices: Evidence from Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 18(2), pages 1-35, July-Dec.
    21. Mariem Brahim & Nader Nefzi & Hamed Sambo, 2017. "Remittances and the real effective exchange rates in MENA countries: What is the long run impact?," CEPN Working Papers hal-01583564, HAL.
    22. Muhammad ASIF & Kashif RASHID, 2011. "Impact of Devaluation on Trade Balance in Pakistan," Oeconomics of Knowledge, Saphira Publishing House, vol. 3(3), pages 16-25, July.

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