TopicIICEmpiricalAnalysisHowWellDotheParityRelations.pptVIP

 Topic IIC: Empirical Analysis: How Well Do the Parity Relations Hold? OUTLINE Review of Evidence on PPP Alternative Exchange Rate Approaches Forecasting Forward Premium Puzzle I. Recall the Evidence on PPP Deviations from purchasing power parity can be substantial in the short run. Real exchange rates can take several years to return to equilibrium. Real exchange rates are autoregressive that is, they depend on previous levels . The empirical Record of RPPP in the long run Evidence on RPPP Deviations RXRs Over the Very Long Run: 1900-1990 Implementation Issues A few problems/questions arise The choice of a price index choices include CPI, PPI, GDP The choice of a base year/reference level chose an “equilibrium” period ...but I how do we know?, and II what does disequ’m mean? some fundamental structural changes might have occurred Relative prices might have changed hence PPP is not expected to hold PPP: an Exchange Rate Determination Theory Causality is Goods market Currency Market The adjustment mechanism: real$ is weak and domestic prices are low export will rise import will fall a trade surplus will generate a real and nominal $ appreciation We completely ignore the role of financial transactions the forward-looking nature of exchange rates the stickiness of prices Recall the Evidence on the Fisher Relation II. Alternative Approaches to Modeling XR Determination Main challenge is to relate Macro variables: consumption, savings, taxes, investments, export, import, gvt’ deficit supply and demand of FX THE FUNDAMENTALS APPROACH TO XRs DETERMINATION Financial variables: interest rates, asset flows, volatility, risk premiums, stockmarket behavior central bank policy and intervention THE ASSET APPROACH TO XRs DETERMINATION ...and to provide theory ies which explain and reconcile short, medium and long term behavior of XRs and RXRs puzzles The Balance of Payments Approach Current Account: sales and purchases of goods and services CA