Estimation of Nominal Exchange Rate Deviation from Long-Run Equilibrium Path

اقتصاد پولی مالی

Article 5, Volume 22, Issue 9, January 2016, Pages 183-207   

Document Type: پژوهشی

DOI: 10.22067/pm.v22i9.16846

Authors

Sohrab Delangizan^{* 1}; Kiomars Sohaili²; Minoo Mohammadi Tirandazeh²

¹Rrazi University

²Razi University

Abstract

Abstract:
Introduction
Over the past years, Iranian foreign exchange system encountered with many changes. This matter has increased the possibility of deviation of the real exchange rate from its equilibrium path. So, realizing the long run equilibrium path deviations and their impact on macroeconomic variables can provide economic policymakers with suitable solutions. In specialists discussions, the correct exchange rate that meets the needs of all sectors of economy, from producers to the consumers in the best conditions, is among the most important and challenging issues.
Theoretical frame work
According to the extent of government and central bank intervention there are several exchange rate systems are: 1) fixed exchange rate regime, 2) managed floating exchange rate regime and 3) floating exchange regime. According to Nurks, deviation of exchange rate from long-term equilibrium path leads to internal and external balance simultaneously. The Real exchange rate balance can be determined with respect to three perspectives: Purchasing Power Parity method, The Elasticities Approach, and General-Functional Balance method. The nominal exchange rate can be determined according to: 1) PPP model, 2) Fundamental Equilibrium Exchange rate model, 3) Behavioral Equilibrium Exchange rate model, 4) Permanent Equilibrium Exchange rate model, 5) Natural Rate of Exchange .(Siregar& Rahan,2006)
Methodology
This Study attempts to estimate the deviation of nominal exchange rate of Iranian Rial against U.S. dollar from its long-run equilibrium level, using the model of Coudert and Couharde (2007), based on FEER, applying the method of Johansson cointegration (1999).
Results & Discussion
None of the variables is stationary in level (TRGOVER/GDP), CPIIRWHOLS, and CPIIR . We apply the Johansen- Juselius test (1999), for testing the existence of cointegration relationship between time series. Vector Error Correction Model (VECM) related to this model is as follow:
〖∆Y〗_t=β_1 〖∆Y〗_(t-1)+β_2 〖∆Y〗_(t-2)+⋯+β_(ρ-1) 〖∆Y〗_(t-ρ-1)+∏▒Y_(t-ρ) +φD_t+Uu_t
After estimation of import and export function and the their effect on exchange rates deviation, the deviations in official exchange rate according to trade balance in public and private sectors is:
me (=[(tb) ̌-tbgovertarget-tbprovtarget])/(φ+(a/0.698273))
a=φ〖*τ〗_g+ϑ*ε*τ_ρ-ϑ*έ-ϑ

Conclusion & Suggestion
The result shows that the official exchange rate of the Rial against U.S. dollar has been over-valued by about 64.75 percent. Therefore the Iranian rial should be allowed to depreciate by this amount in order to achieve the internal and external equilibrum. The important point that must be considered by policymakers is that iranan country is the importer of many raw and intermediary goods, and with increasing exchange rate, the costs of production of final goods will increase. Therefore this condition leads to inflation, so that by increasing exchange rate, competition capacity of final producs in Iran decreases in comparing with the production of the same goods in other countries.A recommendation for solving this problem is that for importing raw and intermediary goods, subsides should be paid to the producers, so that the competition capacity of domestic producers increase against foreign producers.

Keywords: Exchange Rate Deviation, the Fundamental Equilibrium Exchange Rate, Internal Balance, External Balance, Trade Balance.

JEL: F32, F31

Keywords

Exchange Rate Deviation; the Fundamental Equilibrium Exchange Rate; Internal Balance; External Balance; Trade Balance

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