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Real and nominal determinants of real exchange rates in Latin America: Short-run dynamics and long-run equilibrium

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  • Joseph Joyce
  • Linda Kamas

Abstract

This article analyses the factors that determine the long-run real exchange rate in Argentina, Colombia and Mexico, distinguishing between real and nominal determinants. Cointegration analysis is utilised to establish that the real exchange rate has an equilibrium relationship with real variables (the terms of trade, capital flows, productivity, and government share of GDP) which excludes nominal variables (nominal exchange rate, money) and central bank intervention. Variance decompositions reveal that among the real variables that determine the real exchange rate, the terms of trade and productivity explain much of the variation in the real exchange rates. When nominal variables are included in the model, the nominal exchange rate accounts for most of the variation in the real exchange rates of all three countries. The impulse response functions are broadly consistent with theoretical predictions and shocks to the nominal variables have only transitory effects on the real exchange rate.

Suggested Citation

  • Joseph Joyce & Linda Kamas, 2003. "Real and nominal determinants of real exchange rates in Latin America: Short-run dynamics and long-run equilibrium," Journal of Development Studies, Taylor & Francis Journals, vol. 39(6), pages 155-182.
    • Handle: RePEc:taf:jdevst:v:39:y:2003:i:6:p:155-182
    DOI: 10.1080/00220380312331293617
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    Cited by:

    1. Antonia López Villavicencio & Josep Lluís Raymond Bara, 2006. "The short and long-run determinants of the real exchange rate in Mexico," Working Papers wpdea0606, Department of Applied Economics at Universitat Autonoma of Barcelona.
    2. Ibarra, Carlos A., 2011. "Capital Flows and Real Exchange Rate Appreciation in Mexico," World Development, Elsevier, vol. 39(12), pages 2080-2090.
    3. Astorga, Pablo, 2012. "Mean reversion in long-horizon real exchange rates: Evidence from Latin America," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1529-1550.
    4. Luis Alejandro Lee P & Angélica María Quiroga E., 2010. "Descomposición histórica de choques del tipo de cambio real en Colombia: un enfoque DSGE," Vniversitas Económica, Universidad Javeriana - Bogotá, vol. 0(0), pages 1-41, June.
    5. Antonia LÓPEZ VILLAVICENCIO & Josep Lluís RAYMOND BARA, 2008. "Short‐Run And Long‐Run Determinants Of The Real Exchange Rate In Mexico," The Developing Economies, Institute of Developing Economies, vol. 46(1), pages 52-74, March.
    6. Sawuya Nakijoba, 2018. "Determinants of Nominal Effective Exchange Rate in Uganda (2000-2017): A Vecm Approach," Applied Economics and Finance, Redfame publishing, vol. 5(5), pages 45-58, September.
    7. Wei Sun, 2006. "Why Do Floating Exchange Rates Float? Evidence From Capital Flows in a Structural VAR Model," EcoMod2006 272100092, EcoMod.
    8. Carlos A. Ibarra, 2016. "Investment, asset market, and the relative unit labor cost in Mexico," Economic Change and Restructuring, Springer, vol. 49(4), pages 339-364, November.
    9. Narayan, Paresh Kumar, 2008. "Estimating exchange rate responsiveness to shocks," Review of Financial Economics, Elsevier, vol. 17(4), pages 338-351, December.
    10. Rajagopal, 2006. "Where Did the Trade Liberalization Drive Latin American Economy: A Cross Section Analysis," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(2).
    11. Paresh Kumar Narayan, 2008. "Estimating exchange rate responsiveness to shocks," Review of Financial Economics, John Wiley & Sons, vol. 17(4), pages 338-351, December.
    12. Bahmani-Oskooee, Mohsen & Hegerty, Scott W. & Kutan, Ali M., 2008. "Do nominal devaluations lead to real devaluations? Evidence from 89 countries," International Review of Economics & Finance, Elsevier, vol. 17(4), pages 644-670, October.
    13. Alexius, Annika & Post, Erik, 2006. "Cointegration and the stabilizing role of exchange rates," Working Paper Series 2006:8, Uppsala University, Department of Economics.
    14. Guzin BAYAR & Selman TOKPUNAR, 2013. "Turk Lirasi Reel Kuru Denge Degerinde Mi?," Ege Academic Review, Ege University Faculty of Economics and Administrative Sciences, vol. 13(4), pages 405-426.
    15. Astorga, Pablo, 2012. "Mean reversion in long-horizon real exchange rates: Evidence from Latin America," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1529-1550.
    16. Boubellouta Bilal & Muhammad Shahbaz, 2021. "Comparing the Relationship Between Nominal and Real Effective Exchange Rates During the Last Two Devaluations in Algeria," Global Business Review, International Management Institute, vol. 22(6), pages 1421-1440, December.
    17. Muhammad Kamran Khan & Jian-Zhou Teng & Muhammad Imran Khan, 2019. "Cointegration between macroeconomic factors and the exchange rate USD/CNY," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 5(1), pages 1-15, December.
    18. Xiaojian Su & Cheng Peng & Zhike Lv & Chao Deng, 2022. "Do the Renminbi and Hong Kong dollar bubbles interact?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(1), pages 312-319, January.
    19. Syed Ali Raza & Sahar Afshan, 2017. "Determinants of Exchange Rate in Pakistan: Revisited with Structural Break Testing," Global Business Review, International Management Institute, vol. 18(4), pages 825-848, August.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development

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