Observatory on exchange rate

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Observatory on Exchange Rate

Emerson Fernandes Marçal

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Talking points

CEMAP:

Forecast Lab:

Time Series Reconstruction: Observatory on Exchange Rate:

Recent Releases: Misalignment Assessment

Why do we have a preferred methodology? Traditional Behavioral Exchange Rate Approach Addressing Important Econometric Issues

Our approach: Joint Modeling (JMA) Why exchange misalignment can differ. Empirical Illustration

Database Description Brazilian Case: Australian Case: Future Challenges

Mapping Real Effective Exchange rate into bilateral real exchange rate

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Projects

• Observatory on Exchange Rate:

• Foster research on Exchange Rate Equilibrium Models and its relationship with trade issues;

• Forecast Lab:

• Joint project with CEQEF;

• Test and develop forecast techniques to Brazilian

Macroeconomic and Financial series;

• Reconstruction and evaluating compatibility of historical data using Econometric techniques:

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Projects

• Forecast Lab:

• Test and develop forecast techniques to Brazilian Macroeconomic and Financial series;

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Projects

• Forecast Lab:

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Projects

• Forecast Lab:

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CEMAP:

Forecast Lab:

Time Series Reconstruction:

Observatory on Exchange Rate:

Recent Releases:

Misalignment Assessment

Why do we have a preferred methodology?

Traditional Behavioral Exchange Rate Approach

Addressing Important Econometric Issues

Our approach: Joint Modeling (JMA)

Why exchange misalignment can differ.

Empirical Illustration

Database Description Brazilian Case: Australian Case:

Future Challenges

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Forecast Lab

• Site - www.cemap.fgv.br;

• Social Medias;

• Our Publications:

• CEMAP Short Notes on economic activity, inflation and

exchange rate (link);

• CEMAP Letters (link);

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Forecast Lab

• Social Medias;

• CEMAP Short Notes on economic activity, inflation and

exchange rate (link);

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Forecast Lab

• Social Medias;

• CEMAP Short Notes on economic activity, inflation and exchange rate (link);

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Forecast Lab

• Social Medias;

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Forecast Lab

• Social Medias;

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Forecast Lab

• Many scholar paper published on peer review journals and conferences:

• Applied Economics; Economic Studies (USP); J. of Forecasting;

• ESEM, IAAE, Oxmetrics User Conference, BCB;

• Mini-courses on the subject;

• Papers on on methodological evaluation of forecast tecniques:

• inflation, credit volume and default rates, GDP, industrial

production;

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Forecast Lab

• inflation, credit volume and default rates, GDP, industrial

production;

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Forecast Lab

• inflation, credit volume and default rates, GDP, industrial production;

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Forecast Lab

• inflation, credit volume and default rates, GDP, industrial production;

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CEMAP:

Forecast Lab:

Recent Releases:

Future Challenges

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Estimate of Historical Unemployment Rate

Unemployment Rate - PNAD

1980 1985 1990 1995 2000 2005 2010 2015 4 5 6 7 8 9 10 11 12 13 14

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Observatory on Exchange Rate: Some Facts

• First Release of Exchange Rate Estimates were 2010 in CEMAP’s Letter number 2;

• In 2013 Observatory on Exchange Rate was officially created;

• Two years grant from IPEA (2013-2014);

• One year grant from BNDES (2014);

• Three years grant from WTO Chair (2015-2017);

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Observatory on Exchange Rate: Some Facts

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Observatory on Exchange Rate: Some Facts

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Observatory on Exchange Rate: Some Facts

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Observatory on Exchange Rate: Some Facts

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Observatory on Exchange Rate: Some Facts

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Observatory in Action:

• Releases Estimates of Exchange Rate Misalignment in a Monthly Basis;

• A Series of Working Papers on the subject;

• Peer Review Papers Published on Economic Journals;

• Papers discussed with Staff of Peterson Institute, IMF, World Bank, BCB and private financial institutions;

• Papers presented and discussed in Conferences such as IAAF,

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Observatory in Action:

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Observatory in Action:

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Observatory in Action:

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Observatory in Action:

• Papers presented and discussed in Conferences such as IAAF, EMG-ECB, LAMES, Oxmetrics Users, Petersen Institute.

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Researchers:

• Emerson Fernandes Marçal (CEMAP);

• Vera Thorstensen (CCGI)

• Beatrice Zimmerman (World Bank);

• Diogo de Prince (CEMAP - UNIFESP);

• Giovanni Merlin (PhD candidate, EESP);

• Rafael Mouallem Rosa (PhD candidate, EESP);

• Ronan Cunha (PhD candidate, EESP);

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CEMAP:

Forecast Lab:

Observatory on Exchange Rate: Recent Releases:

Future Challenges

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Brazilian Case: Average

Real Effective Exchange Rate Fundamentals

1980 1985 1990 1995 2000 2005 2010 2015 60 80 100 Year Index

Average Exchange Rate Misalignment

1980 1985 1990 1995 2000 2005 2010 2015

-20 0 20

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Brazilian Case: Preferred Methodology

Fundamentals: ToT, NFA, BS and TB.

Real Effective Exchange Rate

1980 1985 1990 1995 2000 2005 2010 2015 60 80 100 Year Index

Exchange Rate Misalignment-RER TB NFA BS TOT

1980 1985 1990 1995 2000 2005 2010 2015

-25 0 25

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Brazilian Case: Preferred Methodology

Fundamentals: ToT, NFA, BS and TB.

1980 1985 1990 1995 2000 2005 2010 2015 60 80 100 Year Index

Exchange Rate Misalignment-RER TB NFA BS TOT

1980 1985 1990 1995 2000 2005 2010 2015

-25 0 25

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Misalignment Decomposition:

Fundamentals and Solvency Issues.

Exchange Rate Misalignment-RER NFA TB-NFA Disequilibrium Contribution

Fundamentals Contribution 1980 1985 1990 1995 2000 2005 2010 2015 -40 -30 -20 -10 0 10 20 30 40 50 Year Index

Exchange Rate Misalignment-RER NFA TB-NFA Disequilibrium Contribution

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North American Case:

Fundamentals: NFA, and TB.

1975 1980 1985 1990 1995 2000 2005 2010 2015 100 120 140 Year Index

Exchange Rate Misalignment

1975 1980 1985 1990 1995 2000 2005 2010 2015 -10 0 10 20 30 40

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Australian Case:

Fundamentals: ToT, NFA, BS-PIB and TB.

1975 1980 1985 1990 1995 2000 2005 2010 2015

80

100

Year

Index

Exchange Rate Misalignment

1975 1980 1985 1990 1995 2000 2005 2010 2015 -20

-10 0 10

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Summary:

• Real (R$) compared to its basket has reached its equilibrium;

• Dolar (US$) compared to its basket is strongly overvalued;

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Summary:

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Summary:

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CEMAP:

Forecast Lab:

Recent Releases:

Why do we have a preferred methodology? Traditional Behavioral Exchange Rate Approach Addressing Important Econometric Issues

Future Challenges

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Basic Equilibrium Equation for RER.

• From many intertemporal macroeconomic models it’s possible to obtain the following steady state equations

RER = −φ tb + λ X (1)

• equation (1) shows that if a country can run a trade deficit in equilibrium the RER has to appreciate ;

• The term X accounts for any other factor affecting equilibrium Real Effective Exchange Rate (RER) such as Balassa-Samuelson effect, terms of trade, government consumption, trade and financial openness among others;

tb = −r ∗ NFA (2)

• equation (2) shows that a country can run a trade deficits if revenues from NFA are large enough;

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Basic Equilibrium Equation for RER.

• From many intertemporal macroeconomic models it’s possible to obtain the following steady state equations

RER = −φ tb + λ X (1)

• equation (1) shows that if a country can run a trade deficit in equilibrium the RER has to appreciate ;

• The term X accounts for any other factor affecting equilibrium Real Effective Exchange Rate (RER) such as Balassa-Samuelson effect, terms of trade, government consumption, trade and financial openness among others;

tb = −r ∗ NFA (2)

• equation (2) shows that a country can run a trade deficits if revenues from NFA are large enough;

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A brief description of traditional BEER approach

• Fundamental Real exchange rate is calculated using an econometric model (based on (2)):

Applications: Faruquee (1994, IMF), Clark (1999), Ubide (1999) and Kubota (2009)

• Cointegration techniques based on selected series associated with fundamentals ;

• Econometric Questions:

• Detect long run relationship - cointegration analysis;

• Different set of fundamentals can be tested;

• Perform permanent and transitory decomposition to better understand the adjustment towards equilibrium;

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A brief description of traditional BEER approach

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A brief description of traditional BEER approach

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A brief description of traditional BEER approach

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CEMAP:

Forecast Lab:

Recent Releases:

Addressing Important Econometric Issues Our approach: Joint Modeling (JMA) Why exchange misalignment can differ.

Future Challenges

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Our starting point

• We assume for simplicity that DGP for the variables trade balance, real effective exchange rate and net foreign asset position and fundamentals is given by the following vector autoregressive model:

∆Yt= Γ1∆Yt−1+ ... + Γk−1∆Yt−k+1+α β0Yt−1+µ+εt (3)

• Instead of arbitrarily ignoring trade balance information and

estimate (2), we jointly estimate (2) and (1).

• We use long run restrictions suggested by the theory to validate the

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Our starting point

• Instead of arbitrarily ignoring trade balance information and estimate (2), we jointly estimate (2) and (1).

• We use long run restrictions suggested by the theory to validate the

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Our starting point

• Instead of arbitrarily ignoring trade balance information and estimate (2), we jointly estimate (2) and (1).

• We use long run restrictions suggested by the theory to validate the exchange rate misalignment estimate;

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Transitory and Permanent components

• Using the parameters from (3), it is possible to calculate the transitory (Tit) and permanent (Pit) components from the following equations:

Pt = β⊥(α⊥0β⊥)−1α⊥0Yt (4)

Tt=α(β0α)−1β0Yt (5)

• Assuming that the real exchange rate is in the first position of the vector, and using the value of the error correction mechanism centered on their own means, we can calculate the misalignment using the following equation, then:

mist≡ F1(β10Yt− E ([β10Yt]) + F2(β20Yt− E ([β20Yt]) (6)

where [ V1 V2 ] = (β0α)−1and Vihas dimension 2x1

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Transitory and Permanent components

• Using the parameters from (3), it is possible to calculate the transitory (Tit) and permanent (Pit) components from the following equations:

Pt = β⊥(α⊥0β⊥)−1α⊥0Yt (4)

Tt=α(β0α)−1β0Yt (5)

• Assuming that the real exchange rate is in the first position of the vector, and using the value of the error correction mechanism centered on their own means, we can calculate the misalignment using the following equation, then:

mist≡ F1(β10Yt− E ([β10Yt]) + F2(β20Yt− E ([β20Yt]) (6)

where [ V1 V2 ] = (β0α)−1and Vihas dimension 2x1

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CEMAP:

Forecast Lab:

Recent Releases:

Future Challenges

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Adapting Blinder-Oaxaca decomposition:

• Blinder-Oaxaca decomposition.

mis_{i ,t}JMA− misBEER

i ,t = ( hJMA₁ hBEER 1 − 1)(h₁BEERf_1,tBEER) | {z }

Less weight on what we knew

+

+hJMA₁ (f_1,tJMA− f_1,tBEER) + hJMA₂ f_2,tJMA

| {z }

What we learn from new model

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Adapting Blinder-Oaxaca decomposition:

• If cointegrated relationships are properly identified:

f_1,tJMA− f_1,tBEER→ 0p (8)

• Both models are nested and it is interesting to investigate whether • hJMA1 hBEER 1 = 1 • hJMA₂ = 0.

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Conditions to guarantee h

JMA₂

= 0

• Weight of GG decomposition are given by:

hJMA 1 hJMA2 = α(β 0 α )−1= α11 α21 α12 α22 β₁0α1 β10α2 β₂0α1 β₂0α2 −1 (9)

• If β₁0α2= 0 and α21= 0 then hJMA2 = 0.

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Example when h

JMA₂

= 0

• Assume that: α 0 = α11 ab32 −a α41 α51 0 α21 α31 α41 α51 (10) . β0 = 1 0 b31 b41 b51 0 1 b32 0 0 (11)

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Example when (

h1JMA hBEER 1

− 1) = 0 and h

JMA₂

= 0

• Assume that: α 0 = α11 0 0 0 0 0 0 α31 α41 α51 (12) . β0 = 1 0 b31 b41 b51 0 1 b32 0 0 (13) • Then (h1JMA hBEER 1 − 1) = 0 and h JMA

2 = 0. Note also that hJMA₁ = hBEER₁ = 1

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CEMAP:

Forecast Lab:

Recent Releases:

Empirical Illustration Database Description Brazilian Case: Australian Case:

Future Challenges

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Database description

Variable Source Definition

IMF and BIS

Weighted Average of Real exchange rate based on Consumer price index (RERi ,t).

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Database description

IMF and BIS

Weighted Average of Real exchange rate based on Consumer price index (RERi ,t). Trade balance as

Share of GDP

IMF and WB

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Database description

IMF and BIS

Share of GDP

IMF and WB

Ratio of trade balance and GDP (TBi ,t)

Relative per capita income

WB BSPIBi ,t=

Percapita Indexii ,t ∑Ni =1wiPercapita Indexj,t

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Database description

IMF and BIS

Share of GDP

IMF and WB

Relative per capita income WB BSPIBi ,t= Percapita Indexii ,t ∑Ni =1wiPercapita Indexj,t Relative terms of trade

IMF Toti ,t= ToTi ,t ∑Ni =1wiToTj,t

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Database description

IMF and BIS

Share of GDP

IMF and WB

Net Foreign Asset Position

Milesi e Ferreti and IMF

Ratio of Net Foreign Asset Position and GDP (NFAi ,t)

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Database description

IMF and BIS

Share of GDP

IMF and WB

Net Foreign Asset Position

Milesi e Ferreti and IMF

Ratio of Net Foreign Asset Position and GDP (NFAi ,t)

Relative price ratio IMF BSi ,t= WSPi,t

IPCi ,t

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Are TB and NFA cointegrated?

Countries Rank Eigenvalues Trace p-value

Australia r=0 0.345 18.596 0.3% *** r=1 0.000 0.012 95.1% Austria r=0 0.111 8.011 23.7% r=1 0.062 2.812 10.9% Brazil r=0 0.264 13.729 2.8% ** r=1 0.006 0.258 68.4% China r=0 0.139 9.137 16.2% r=1 0.056 2.539 13.0% Colombia r=0 0.150 7.795 25.5% r=1 0.015 0.649 48.4%

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Are TB and NFA cointegrated?

Denmark r=0 0.207 12.114 5.3% * r=1 0.042 1.906 19.6% Finland r=0 0.288 17.649 0.5% *** r=1 0.060 2.715 11.6% Germany r=0 0.153 8.286 21.7% r=1 0.022 0.991 37.2% Greece r=0 0.174 10.263 10.8% r=1 0.041 1.862 20.2% Ireland r=0 0.129 6.453 38.4% r=1 0.008 0.365 61.7%

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Are TB and NFA cointegrated?

Italy r=0 0.214 10.686 9.2% * r=1 0.002 0.080 84.0% Japan r=0 0.273 17.607 0.5% *** r=1 0.078 3.578 6.8% * Korea r=0 0.303 17.730 0.5% *** r=1 0.050 2.202 16.2% Mexico r=0 0.195 9.527 14.1% r=1 0.000 0.000 99.3% Netherland r=0 0.057 2.682 87.2% r=1 0.003 0.111 80.6% New Zeland r=0 0.244 12.036 5.5% * r=1 0.000 0.014 94.4%

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Are TB and NFA cointegrated?

New Zeland r=0 0.244 12.036 5.5% * r=1 0.000 0.014 94.4% Norway r=0 0.268 13.828 2.7% ** r=1 0.003 0.128 78.9% Portugal r=0 0.125 6.313 40.0% r=1 0.017 0.729 45.4% Singapore r=0 0.255 13.048 3.7% ** r=1 0.003 0.114 80.3% Spain r=0 0.373 20.764 0.1% *** r=1 0.006 0.246 69.2% Sweden r=0 0.218 12.338 4.9% ** r=1 0.034 1.510 25.7%

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Are TB and NFA cointegrated?

Sweden r=0 0.218 12.338 4.9% ** r=1 0.034 1.510 25.7% Switzerland r=0 0.063 2.973 83.9% r=1 0.002 0.109 80.8% Turkey r=0 0.205 10.776 8.9% * r=1 0.015 0.661 47.9% United Kingdom r=0 0.212 11.743 6.2% * r=1 0.029 1.276 30.3% United States r=0 0.074 6.501 37.9% r=1 0.068 3.105 9.1% * Uruguay r=0 0.194 10.280 10.7% r=1 0.018 0.798 43.0%

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Summary of evidence for TB and NFA:

• Evidence of cointegration between TB and NFA for good number of variables.

• The number of rejection taking into account the size of the sample is quite good;

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Summary of evidence for TB and NFA:

• Evidence of cointegration between TB and NFA for good number of variables.

• The number of rejection taking into account the size of the sample is quite good;

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CEMAP:

Forecast Lab:

Recent Releases:

Future Challenges

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CEMAP:

Forecast Lab:

Recent Releases:

Future Challenges

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CEMAP:

Forecast Lab:

Recent Releases:

Future Challenges

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From REER to bilateral real exchange rate:

• After some algebra it is possible to convert RER misalignment estimates into bilateral estimates;

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Bilateral estimates:

AU IT SW AS JP SZ BE KR UK BR ME US CA NE CN NZ DE NO FI PO FR SG GE SP 2005 2010 2015 -40 -30 -20 -10 0 10 20 30 40 50 AU IT SW AS JP SZ BE KR UK BR ME US CA NE CN NZ DE NO FI PO FR SG GE SP

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But nominal variable may matter:

• After some algebra it is possible to convert REER misalignment estimates into bilateral real estimates;

• Under certain statistical conditions it may be possible to model nominal variables as marginal models;

• It would be possible to address how nominal shocks in interest rate and-or inflation affect real exchange rate and

misalignment;

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But nominal variable may matter:

misalignment;

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But nominal variable may matter:

misalignment;

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But nominal variable may matter:

misalignment;

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Dealing with mixed frequency:

• Variables are available in different frequency (daily, monthly, quarterly, etc);

• How to adapt the methodology to deal with fact in an

efficient way;

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Dealing with mixed frequency:

• How to adapt the methodology to deal with fact in an efficient way;

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Dealing with mixed frequency:

• How to adapt the methodology to deal with fact in an efficient way;

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