Otaviano Canuto Vice-President, PREM Network The World Bank March 2012.
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Transcript of Otaviano Canuto Vice-President, PREM Network The World Bank March 2012.
Otaviano CanutoVice-President, PREM NetworkThe World BankMarch 2012
The Subject of Our Concern
Real exchange rate “under-valuation” as a distortion in the global trading system
If so, would a mechanism for the international “coordination” of exchange-rate policies provide global welfare gains?
Outline
Why would countries want to maintain “under-valued” real exchange rates?
Can “under-valuation” boost exports? What Affects the RER? Policies & other
determinants Can we identify real exchange rate
targeting? Measuring and “correcting”
misalignments Implications for international
coordination mechanism
Under-valuation as Development Policy The argument: Under-valuation stimulates
economic growth through trade (Rodrik, 2008) Export growth spurs investment and technical
change
Particularly true for developing countries Tradables suffer disproportionately from
government and market failures Undervaluation allows a level-playing field
Under-valuation can be effective only if Nominal wages do not increase with rise of
exchange rate It does not lead to macro instability Mainly domestic (not imported) inputs are used
Exchange Rate-Trade Nexus: Some Ambiguity
Effect of change in exchange rate on trade is a priori ambiguous
Impact depends on: Extent to which exporters hedge against
foreign exchange risk (Fabling and Grimes, 2008)
Currency in which they invoice their products (Staiger and Sykes, 2010)
Import content of exports (Evenett, 2010) Extent of price pass-through (Berman,
Martin and Mayer, 2012) Role of FDI (Lederman, 2011)
Might Work for LICs in theShort Run
Source: Haddad and Pancaro (2010).
Impact of 50% (in one measure of) RER Under-valuation
on
1)Exports/GDP
And
2) GDPPC Growth
Might Work on the Intensive but Not on the Extensive
Margin
Source: Taglioni (forthcoming)
% c
hange in e
xport
gro
wth
due t
o a
10
%
decr
ease
in t
he r
eal exch
ange r
ate
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
Intensive margin
Firm entries
Market entries
Product entries
Firm exits Market exits
Product exits
CHL MKD TUR
Intensive margin MKD: 13.4%
Under-valuation Can Be Costly, Unsustainable and
Regressive Over-accumulation of foreign reserves (opportunity costs of capital)
Liquidity growth and inflationary pressures Constraints on monetary policy Tax on tradable consumption; regressive
(Fajnzylber & Lederman, 2012) Difficult to exit Requires issuing sovereign bonds (with fiscal
costs) under sterilization Cannot be used to target exchange rate other
than that dictated by fundamentals in the long run (Eichengreen, 2008)
Policies that Can Affect the RER: Targeted and Untargeted
Targeted monetary and fiscal policy Other policies: distorting private
savings (among others) Subsidized savings (financial repression) Tax consumption Weak social protection systems Restricted access to global financial
markets
Other Determinants ofExchange Rates
Financial underdevelopment Precautionary savings motive, exodus of savings,
exporting firms with better access to credit (Klapper, 2000; Melitz,2003)
Closed economies (trade and capital) tend to have an “under-valued” exchange rate
Commodity prices Natural resource discoveries Demographics (e.g., old age dependency
ratio)
Policies that Affect the Exchange Rate Do Not Equate
to Targeting Policies that affect dependency ratio unintentionally lead to higher domestic savings and a depreciated exchange rate
Financial underdevelopment implies: High household saving because of inability to
properly insure against shocks High corporate saving because of lack of financial
options (deep corporate bond market) and incentive to retain earnings
Macro prudential regulations may require capital controls
Frictions working in the opposite direction: Labor rigidities keeping labor in rural, low
productivity agriculture
Measuring Misalignments Is Difficult
Requires estimates of “equilibrium” exchange rate and current account
This is a challenge! Large number of determinants Complexity of the mechanisms at play
Hence abundance of methods Little consensus as to the best approach
The Experts in the Room: The IMF’s Approaches Thus
Far Three methods used by the IMF: Macroeconomic balance approach (MB) Equilibrium real exchange rate approach (ERER) External sustainability approach (ES)
… and their correlations:
Source: Eden and Nguyen, forthcoming
Dispersion of Country-Specific Estimates of Misalignment Can Be Large: MB and ERER Methods
Source: Eden and Nguyen, forthcoming
Dispersion of Country-Specific Estimates of Misalignment Can Be Large: MB and ES Methods
Source: Eden and Nguyen, forthcoming
Dispersion of Country-Specific Estimates of Misalignment Can Be Large: ERER and ES Methods
Source: Eden and Nguyen, forthcoming
Correcting RER Misalignment: Conceptual
and Practical Issues Distinction between policy-driven misalignment and exogenous RER movements hard to assess, yet crucial for introducing the right policy to eliminate misalignment
If exogenous distortions difficult to eliminate (e.g., underdeveloped financial system), a policy aimed at restoring equilibrium RER may lead to further distortions
Conditions for Success of International Coordination
Mechanisms The extent of exchange-rate misalignment needs to be observable Unlike tariffs, misalignment is not directly observed Hard “estimate” because of endogeneity and reverse
causality Uncertainty about the proper methodology in academia
and in policy (IMF currently re-evaluating its three methodologies)
None directly measures whether a country has unexploited gains from growing the tradable sector
The gains and losses of other countries from the devaluation of one country need to be estimated Unlike tariffs, country gains or losses spread across
industries Potential gains for many, e.g., low global interest rates
Multilateral Disciplining of Currency Practices Is
Difficult Technicalities matter! Difficult to introduce coordination mechanism over a distortion that is not directly observed
Under-valuation might be desirable under certain circumstances (e.g., capital controls during crisis)
Scope for international coordination to achieve Pareto improving outcomes is small
Multilateral Coordination and Peer Pressure Should Rather Focus on Achieving Good Fundamentals
Across Countries
Improving economic structures, running viable fiscal frameworks and achieving macroeconomic stability
Enabling reforms to have efficient and market driven wage and price settings
Enabling reforms to boost productivity and growth
Enabling reforms in financial market and social protection systems
Thank you
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