Real Exchange Rate and External Balance: How Important Are Price Deflators?

March 30, 2017

Preview Citation

Format: Chicago

JaeBin Ahn, Rui Mano, and Jing Zhou. Real Exchange Rate and External Balance: How Important Are Price Deflators?, (USA: International Monetary Fund, 2017) accessed December 26, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper contrasts real exchange rate (RER) measures based on different deflators (CPI, GDP deflator, and ULC) and discusses potential implications for the link—or lack thereof—between RER and external balance. We begin by documenting patterns in the evolution of different measures of RERs, and confirm that the choice of deflator plays a significant role in RER movements. A subsequent empirical investigation based on 35 developed and emerging market economies over 1995 to 2014 yields comprehensive and robust evidence that only the RER deflated by ULC exhibits contemporaneous patterns consistent with the expenditure-switching mechanism. We rationalize the empirical findings by introducing a simple model featuring nominal rigidity and trade in intermediate goods as the one in Obstfeld (2001) and Devereux and Engel (2007), which is shown to generate qualitatively identical patterns to empirical findings.

Subject: Consumer price indexes, Consumption, Deflation, Foreign exchange, National accounts, Prices, Real effective exchange rates, Real exchange rates

Keywords: Coefficient estimate, Consumer price indexes, Consumption, Deflation, Deflators, Exchange rate, Expenditure switching, Expenditure-switching mechanism, External balance, GDP deflator, Global, Real effective exchange rates, Real exchange rate, Real exchange rates, REER measure, REER-GDP deflator, Standard error, WP

Publication Details

Pages:

49
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2017/081
Stock No:

WPIEA2017081
ISBN:

9781475590500
ISSN:

1018-5941

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