The Role of Fundamentals on the Persistence of Real Exchange Rate Misalignments in Argentina, Brazil, Chile, Mexico and Venezuela

Viena

Workshop; XV Arnoldshain Seminar ?The EU and Latin America Facing Globalization?; 2017

Universidad de Viena

This research analyses the behaviour of misalignments of the structural real exchange rate (relative tradable to non-tradable prices) and PPP real exchange rate (relative foreign to domestic prices adjusted by the nominal exchange rate) for Argentina, Brazil, Chile, Mexico and Venezuela. Misalignments are measured by the difference between the equilibrium and the observed real exchange rate. Long-run values are estimated by the Hodrick and Prescott filter or the Dynamic OLS cointegration method; the latter considers the effect of fundamentals on real exchange rates. The persistence of real exchange misalignments is determined by the application of autoregressive model of order p, AR(p), and the estimation of their corresponding impulse response function. In the case of the Hodrick and Prescott equilibrium measures, structural and PPP real exchange rate misalignments exhibit an overshooting behaviour (monotonous, but not linear, adjustment), a pattern showing an up and down movement, when a temporary shock hits the economy. In the case of the fundamentals based real exchange rate misalignments, only the structural real exchange rate shows an overshooting behaviour.The months in which real exchange rate misalignment disappears after a shock has hit the economy varies between 10 and 17 (21 to 45) months for Hodrick and Prescott(fundamentals) based real exchange rate misalignments. In any case, 50% of the adjustment after a shock (temporary or permanent) hits the economy occurs between the first six months.