Working Paper: NBER ID: w2721
Authors: Sebastian Edwards
Abstract: This paper develops a dynamic model of real exchange rate behavior in developing countries. A three goods economy (exportables, importables and nontradables) is considered. Residents of this country hold domestic and foreign assets, and there is a dual exchange rate regime. There is a government that consumes importables and nontradables. A distinction is made between equilibrium and disequilibrium movements of the RER. The determinants of real exchange rate misalignment are studied with emphasis placed on the role of devaluations and balance of payments crisis. The implications of the model are tested using data for 12 developing countries. The results obtained are generally favorable for the model. The issue of RER stationarity is also analyzed.
Keywords: Real Exchange Rate; Developing Countries; Monetary Policy; Macroeconomic Stability
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real exchange rate misalignment (F31) | devaluations (F31) |
| real exchange rate misalignment (F31) | balance of payments crises (F32) |
| devaluations (F31) | real exchange rate misalignment (F31) |
| balance of payments crises (F32) | real exchange rate misalignment (F31) |
| higher import tariffs (F14) | equilibrium real appreciation (F31) |
| increases in government consumption of nontradables (H59) | equilibrium real appreciation (F31) |
| expansive macroeconomic policies (E65) | loss of international reserves (F31) |
| expansive macroeconomic policies (E65) | current account deficit (F32) |
| expansive macroeconomic policies (E65) | increase in the spread between nominal rates (E43) |
| loss of international reserves (F31) | real exchange rate overvaluation (F31) |
| current account deficit (F32) | real exchange rate overvaluation (F31) |
| increase in the spread between nominal rates (E43) | real exchange rate overvaluation (F31) |