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Expectations of future income and real exchange rate movements

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  • Hayat, Aziz
  • Ganiev, Bahodir
  • Tang, Xueli

Abstract

We show that changes in expectations of future income driven by exogenous factors (such as the discovery of oil and an increase in global demand for natural resources) can cause movements in the real exchange rate (RER) in excess of, and sometimes even in the opposite direction to, what one would expect given the changes in current income. We provide both a theoretical model and empirical evidence of this. In particular, we show that the signing of numerous production sharing agreements (PSAs) between the government of Azerbaijan and foreign oil companies in 1994–1998 fueled expectations of higher future incomes, resulting in a considerable appreciation of the RER. Some of these PSAs subsequently failed or ran into difficulties, which led to a downward revision of expected future income and a depreciation of the RER in 1999–2003, even though the current income started to rise, due to an increase in the current oil revenue.
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  • Hayat, Aziz & Ganiev, Bahodir & Tang, Xueli, 2012. "Expectations of future income and real exchange rate movements," Working Papers fe_2012_05, Deakin University, Department of Economics.
  • Handle: RePEc:dkn:ecomet:fe_2012_05
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    Keywords

    Expectations of future income; Real exchange rate; Booming sector; Azerbaijan economy;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • P28 - Economic Systems - - Socialist Systems and Transition Economies - - - Natural Resources; Environment
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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