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Current Account Sustainability in Transition Economies
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Economic literature: papers , articles , software , chapters , books. Current Account Sustainability in Transition Economies.
Registered: Nouriel Roubini Paul Wachtel. This paper presents an analysis of the sustainability of current account deficits in transition economies in Central and Eastern Europe. These countries have experienced large current account imbalances in the transition to a market economy. We consider a wide range of macroeconomic factors that may indicate whether such imbalances are sustainable. We find that capital inflows and the choice of regimes of fixed exchange rates have led to a real exchange rate appreciation in many countries; this in turn has led to a significant loss of competitiveness and a worsening of the current account.
In several countries there are a number of other indicators that point to a fragility of the external balance: weak banking and financial systems, large fiscal imbalances, low foreign reserves, increasing foreign debt and foreign debt-burden ratios.
Some countries, like Russia, have created two funds — for the longer term perspective and for the medium term perspective — that are invested in financial instruments with different risks and returns. Other countries, like Chile, established rules that required repayment of national debt after export prices and fund resources accumulated to a certain threshold.
In any case, in coping with their primary goal — mitigation of external shocks to the balance of payments — stabilisation funds are fairly successful all over the world.europeschool.com.ua/profiles/menuqilo/los-canos-haro.php
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But if there is no sterilisation of the change in FOREX under fixed exchange rates, there is an automatic mechanism at work to correct the disequilibrium in the balance of payments. The reduction of foreign exchange reserves leads to the reduction in the money supply: this will drive domestic prices down and stimulate exports, raise interest rates, and stimulate the inflow of capital, which will finally correct the balance of payments.
Because national prices are less flexible than exchange rates, this type of adjustment, when compared to a nominal exchange rate change, is associated with a greater reduction in output. The empirical evidence from Eastern European countries and other transition economies for the —99 period — an outflow of capital after the Asian crisis and the Russian currency crisis and a slowdown of output growth rates — suggests that the second type of policy response — devaluation — was associated with a smaller loss of output than the first type — monetary contraction. The —09 developments provide additional evidence for this hypothesis Popov, a.
In a sense, the downsides of this type of adjustment match all the disadvantages of fixed exchange rates. In the long term, it cannot maintain inflation rates that differ from its major trading partners. In the short term, it does not have appropriate instruments to react to asymmetric shocks. Like in the previous case, the result is a real devaluation of the national currency, i. This mechanism implies that export and import volumes change in response to changes in the RER, hence the real sector of the economy also responds, as seen in output changes.
Suppose oil prices fall and the national currency of the oil-exporting country is devalued to keep the balance of payments in equilibrium.
For oil producers, the positive impact of devaluation neutralises the negative impact of falling oil prices, but for other producers of tradable goods — machinery, for instance — real devaluation means higher prices and profits, so there is a reallocation of resources — capital and labour — from oil to the machinery sector. The problem is that this reallocation is temporary because after a while, oil prices will rise and resources should flow in the opposite direction. Inasmuch as oil prices fluctuate around the trend, it does not make sense to change the structure of the economy in response to their fluctuations; this is just too costly.
To word it differently, the real exchange rate should be as stable as possible; if it fluctuates a lot, this is a definite sign of bad policy that misleads economic agents. The real exchange rate RER is the nominal exchange rate adjusted for the ratio of prices between two countries. To give an example, the real exchange rate of the US Dollar in terms of the Chinese Yuan is the nominal rate 6 yuan per dollar multiplied by the ratio of US prices to Chinese prices.
When the US price of a particular good is multiplied by the nominal rate of the Dollar in Yuan 6 yuan per dollar , we get the price of American good in Yuan. When we divide this latter value by the price of the same good in the Chinese market, we get the ratio of prices between the two countries. Normally, the RER is computed for a basket of goods — with weights that coincide with the share of these goods in GDP — of one country or another, or the geometric average of weights in two countries.
The ratio of US prices to Chinese prices is about 1. This is usually explained by the Balassa-Samuelson effect, which I discuss later. The RER is very important because it determines competitiveness: if prices in country A, expressed in US dollars, are lower or getting lower than prices in country B, then exports from A to B are likely to increase, whereas imports from B to A are likely to fall. The decline in the RER and the rise in competitiveness may result from devaluation — i. In macroeconomic textbooks, the RER is usually seen as endogenous, i.
For example, if the country devalues its national currency via the nominal exchange rate, there will be an increase in export revenues and a reduction in imports, an inflow of foreign investment and hence an improvement in the balance of payments. If the exchange rate is floating, it will rise back to its initial value before devaluation. If the exchange rate is fixed and there is no sterilisation, the increase in foreign exchange reserves will cause the money supply to expand, which in turn will contribute to higher prices of national goods, i.
If monetary authorities pursue a sterilisation policy — i. A sterilisation policy is hence considered self-defeating under conditions of free movement of capital. However, capital mobility is never perfect; some countries exercise controls over capital movements, and the size of foreign exchange reserves varies greatly across countries, even after controlling for objective determinants such as the size and volatility of foreign trade and the size of foreign debt Polterovich and Popov, This means that many countries pursue policies that influence their RER.
An excess accumulation of FOREX creates additional demand for foreign currency and an additional supply of domestic currency, so that with a sterilisation policy, the RER depreciates, thus deviating from equilibrium value. In practice, an accumulation of FOREX is financed mostly through a government budget surplus and debt accumulation, but not through printing money: regressions show that inflation is not significant as an explanatory variable for reserve accumulation Polterovich and Popov, Most countries that have rapidly accumulated reserves exhibited low budget deficits — or budget surpluses — or increasing government debt, but small increases in money supply and low inflation.
Actual fluctuations of the RER vary from country to country. Clearly, insufficiency of buffers in Latin American commodity exporters in the past, along with pro-cyclical policy responses, have led to strong fluctuations in the RER. Figure 1. To put it differently, it seems like Latin American countries reacted to trade and financial shocks more through changes in the real exchange rate than through changes in reserves and stabilisation funds.
Today, Latin American countries have smaller buffers and hence weaker abilities to manage negative terms-of-trade and financial shocks than East Asian and Middle Eastern and North African countries. The same pattern can be observed for the sovereign wealth funds that are concentrated in East Asian and Middle Eastern and North African countries.
External Deficit, Exchange Rate, and Competitiveness in Croatia: Is There a Problem?
Countries that devalued their currencies in response to outflow of capital during the Asian currency crisis of and the global recession of were able to support output and employment better than countries that kept their nominal rates stable Popov, b. Cespedes and Velasco provide empirical evidence — using commodity price boom and bust episodes — that commodity price shocks have a less significant impact on output and investment dynamics in economies with more flexible exchange rate regimes. The reason for such a pattern of adjustment to external shocks is most often associated with an inadequacy of FOREX reserves and an inability to sterilise, i.
Figure 2. Foreign exchange reserves in months of imports in major regions of the world.
Read Balance Of Payments, Exchange Rates, And Competitiveness In Transition Economies 1999
It is well known that prices in developing countries are mostly lower than in developed countries, i. This is usually explained using the Balassa-Samuelson effect: there is a smaller productivity gap between developing and developed countries for the non-tradable goods sector than for tradables, but equal wages in both sectors, so prices for non-tradable goods turn out to be lower. And in terms of dynamics, if productivity grows faster in sectors producing tradable output — mainly goods — than in sectors producing non-tradable output — mainly services — and if wage rates are equalised across sectors with the result that economy-wide real wage increases lag behind productivity growth, then the real exchange rate RER can appreciate without undermining business profits.
This correlation exists not only for non-tradables, but also — although not as significantly — for tradable goods. But it is difficult to detect the effect of RER appreciation for particular countries even for a period of 25 years, even in fast-growing developing countries the RER generally declined, driven more by a deterioration in the terms of trade than by the Balassa-Samuelson effect Polterovich and Popov, Besides, many developing countries that are rich in resources try to limit appreciation of the RER due to the Dutch disease and many others pursue deliberate low exchange-rate policies of as part of their general export-orientated strategy.
By creating downward pressure on their currencies through a build-up foreign exchange reserves, they are able to limit consumption and imports and to stimulate exports, investment, and growth. Undervaluation of the exchange rate via accumulation of foreign exchange reserves is in fact an industrial policy to promote export-oriented growth. It benefits the producers of tradables and exporters at the expense of the producers of non-tradables and importers. This view is gaining support in the literature Dollar, ; Easterly, ; Polterovich and Popov, ; Rodrik, ; Bhalla, If there are externalities from exports and the production of tradables — such as industrialisation — undervaluation of the exchange rate resulting from the accumulation of reserves provides a subsidy to these activities and this subsidy is automatic, i.
In short, this is a non-selective industrial policy promoting export and the production of tradables that seems to be quite efficient, especially in countries with high levels of corruption and poor quality institutions Polterovich and Popov, ; Rodrik, Exchange rate policy, then, is not simply a tactical matter of getting-prices-right, but may turn out to be a strategic matter of a deliberately undervalued exchange rate, maintained over a period of time, to provide an entry into the world market for differentiated manufactured goods.
Several Asian countries have used such strategic exchange rate policy to promote manufactured exports. The formal model demonstrating how an accumulation of reserves can spur growth, as well as the empirical evidence, is presented by Polterovich and Popov It is shown that an accumulation of reserves leads to exchange-rate disequilibrium, which in turn causes an increase in export-to-GDP and trade-to-GDP ratios, which stimulates growth.
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