An Estimate of the Equlibrium Excgange Rate for Romania A BEER Approach Adrian Codirlasu Research and Publications Department National Bank of Romania London, 18 – 22 July 2005

Models  Purchasing Power Parity – PPP (Gustav Cassel, 1918);  Monetary models (extensions of the PPP), Mundell (1968), Dornbush (1976)  Harrod-Balassa-Samuelson approach (alternative to the PPP), R.Harrod (1933), B.Balassa (1964), P.Samuelson (1964)  Capital Enhanced Equilibrium Exchange Rate – CHEER (combination between PPP and UIP), Juselius (1991, 1995), Johansen and Juselius (1992)  Natural Real Exchange Rate – NATREX, Stein (1994, 1999)  Fundamental Equilibrium Exchange Rate – FEER, Williamson (1994)  Behavioral Equilibrium Exchange Rate – BEER (alternative to FEER), Clark and MacDonald (1999)

BEER  Takes into account both current and capital account items  Estimation based on vector error correction mechanism (VECM), Johansen (1995)  Allows for estimation of both:  Current misalignment (difference between the actual value of the exchange rate and the estimate level of the exchange rate given by the current values of the fundamentals)  Total misalignment (difference between the actual exchange rate and that given by the sustainable or long-run values of the economic fundamentals), by using Hodrick-Prescott (HP) filter or Beveridge-Nelson (1981) decomposition (PEER), Clark and MacDonald (2000)

BEER Model (1) (Clark and MacDonald, 1998) Risk adjusted interest parity condition Risk premium that have a time-varying component Substracting the expected inflation differential

BEER Model (2) Assuming and that the unobservable expectation of exchange rate is determined solely by the long-run economic fundamentals (Z 1 ), long-run equilibrium exchange rate is and Hence,

Data (quarterly, 1998 – 2004)  Real exchange rate (L_EUR_R_SA), I(1);  Liquid foreign assets of the banking system (L_LFABS_ROL_R_SA), I(1);  Net foreign assets of the banking system (L_NFABS_ROL_R_SA), I(1);  3M real interest rate (euribor), euro, (EURIBOR3M_R_SA), I(1);  3M real interest rate, ROL, (BUBOR3M_R_SA), I(1), considered I(0);  Productivity in industry, (L_PROD_RO_SA), I(1), considered I(0);  Relative prices, EU, (L_REL_PR_EU_SA), I(1);  Relative prices, Romania, (L_REL_PR_RO_SA), I(0), considered I(1);  Domestic demand, (L_DD_RO_R_SA), I(1);  Exports, (L_X_RO_R_SA), I(1);  Imports, (L_M_RO_R_SA), I(1));  Euro-area real GDP, (L_GDP_EU12_R_SA), I(1);  Income and transfers from abroad, (L_INC_TRANSF_ROL_R_SA), I(1).

Model 1

Model 2

Model 3

Conclusions  Two periods of misalignment of the real exchange rate in 1998 – 2000 which seem to be consistent with historical data  Real interest rate differential had a small impact on the real exchange rate (capital controls)  Due to the catching-up process, the Balassa- Samuelson effect (identified in the first two models) will lead to a real exchange rate appreciation

Further research  Compute the PEER measure, using Gonzalo-Granger decomposition, from the VEC models  Compute a FEER measure of the equilibrium exchange rate to check the consistency of the total misalignment estimation

References (1)  Balassa, Bela, 1964, “The Purchasing Power Parity Doctrine: A Reapraisal”, Journal of Political Economy 72, p 584 – 596  Clark, Peter B. and Ronald MacDonald, 1998, “Exchange Rates and Economic Fundamentals: A Methodological Comparison of BEERs and FEERs”, IMF Working Paper WP/98/67  Clark, Peter B. şi Ronald MacDonald, 2000, „Filtering the BEER: A Permanent and Transitory Decomposition”, IMF Working Paper WP/00/144  Dornbusch, Rudiger (1976), “Expectations and Exchange Rate Dynamics”, Journal of Political Economy 84,  Juselius, K, 1991, “Long-run relations in a well defined statistical model for the data generation process: Cointegration analysis of the PPP and UIP relations between Denmark and Germany”, in J. Gruber (ed.), “Econometric decision models: New methods of modeling and applications”, Springer Verlag, New York

References (2)  Mundell, R. A., 1968, “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates”, Chapter 18 of International Economics, New York: Macmillan, pp  Rogoff, Kenneth, 1996, “The Purchasing Power Parity Puzzle”, Journal of Economic Literature, Vol. XXXIV  Samuelson, Paul A., 1964, “Theoretical Notes on Trade Problems”, Review of Economics and Statistics 46, p 145 – 154  Stein, J., 1994, “The Natural Real Exchange Rate of the United States Dollar and Determinants of Capital Flows” in J. Williamson (ed), “Estimating Equilibrium Exchange Rates”, Institute for International Economics, Washington DC.  Williamson, John, 1994, “Estimates of FEER’s” in J. Williamson (ed), “Estimating Equilibrium Exchange Rates”, Institute for International Economics, Washington DC.

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