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Equilibrium exchange rates in the new EU members: external imbalances vs. real convergence

  • Enrique Alberola

    ()

    (Banco de España)

  • Daniel Navia

    ()

    (Banco de España)

New EU members share two very marked features which have conflicting implications for the evolution of their real exchange rates in the long run: accelerated growth and systematic current account imbalances, which would anticipate, respectively an appreciation and a depreciation of their currencies, according to different theories of exchange rate determination. Furthermore, both elements are intertwined, for current account imbalances are the other side of capital inflows which have been central in boosting potential output and productivity convergence in these economies. In this paper, we aim at achieving some insight on the role of persistent and substantial capital inflows and the consequent accumulation of net foreign liabilities in improving competitiveness and in the determination of the exchange rate for the three largest new EU members: Poland, Hungary and the Czech Republic. We adopt a sequential approach that sheds light on the role of capital flows and their interaction with the Balassa-Samuelson hypothesis. We start by noting in a bivariate cointegration analysis that the accumulation of net foreign liabilities, far from depressing the exchange rate in the long-run, has gone hand-in-hand with exchange rate appreciation. We claim that this may be due to the induced effect that capital inflows are expected to have on productivity and competitiveness. After testing that foreign direct investment is cointegrated with productivity trends, we show that a extended empirical model comprising relative productivity and net foreign assets is well-suited in general to capture this indirect, opposite effect of liabilities accumulation on the real exchange rate. Finally, the model makes it possible to estimate for the considered countries equilibrium exchange rates and misalignments and perform some simulations on their expected future path.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/07/Fic/dt0708e.pdf
File Function: First version, June 2007
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0708.

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Length: 36 pages
Date of creation: Apr 2007
Date of revision:
Handle: RePEc:bde:wpaper:0708
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  1. Balázs Égert, & László Halpern & Ronald MacDonald, 2005. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues," William Davidson Institute Working Papers Series wp793, William Davidson Institute at the University of Michigan.
  2. Lionel Halpern & Charles Wyplosz, 1996. "Equilibrium Exchange Rates in Transition Economies," IMF Working Papers 96/125, International Monetary Fund.
  3. De Broeck, Mark & Slok, Torsten, 2006. "Interpreting real exchange rate movements in transition countries," Journal of International Economics, Elsevier, vol. 68(2), pages 368-383, March.
  4. Ronald MacDonald & Tamim Bayoumi, 1998. "Deviations of Exchange Rates From Purchasing Power Parity; A Story Featuring Two Monetary Unions," IMF Working Papers 98/69, International Monetary Fund.
  5. Byung-Yeon Kim & Iikka Korhonen, 2002. "Equilibrium Exchange Rates in Transition Countries: Evidence from Dynamic Heterogeneous Panel Models," Macroeconomics 0212014, EconWPA.
  6. Kirsten Lommatzsch & Balazs Egert & Amina Lahreche-Revil, 2005. "The Stock-Flow Approach to the Real Exchange Rate of CEE Transition Economies:," Money Macro and Finance (MMF) Research Group Conference 2005 14, Money Macro and Finance Research Group.
  7. Susana Garcia Cervero & J. Humberto Lopez & Enrique Alberola Ila & Angel J. Ubide, 1999. "Global Equilibrium Exchange Rates; Euro, Dollar, "Ins," "Outs," and Other Major Currencies in a Panel Cointegration Framework," IMF Working Papers 99/175, International Monetary Fund.
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