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Should the Cr oatian N ational B ank D evaluate the E xchange R ate?

Should the Cr oatian N ational B ank D evaluate the E xchange R ate?. Evidence from P urchasing P ower P arity. Content. PPP hypothesis Review of empirical research Data Methodology Results Policy implications. PPP hypothesis.

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Should the Cr oatian N ational B ank D evaluate the E xchange R ate?

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  1. Should the Croatian National Bank Devaluate the Exchange Rate? Evidence from Purchasing Power Parity Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  2. Content • PPP hypothesis • Review of empirical research • Data • Methodology • Results • Policy implications Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  3. PPP hypothesis • Exchange rate that equates domestic and foreign price levels so that the purchasing power of a unit of one currency would be the same in both economies (Sarno and Taylor, 2001) • One of the most extensively tested theoretical propositions • Intuitive and simple  We wanted to test whether ppp holds in Croatia since the debates about the overvaluation of the nominal hrk/eur exchange rate are quitte common Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  4. Review of empirical research • Consensus concerning the validity of PPP appears to have shifted several times in the post-war period • The prevailing view is that long-run PPP does have some validity, although a number of puzzles have yet to be resolved • For transition countries results seem less conclusive  reasons stem from characteristics of transition economies • Most of transition economies suffered external and internal shocks, high inflation and/or major exchange rate shifts • Nonlinear tests more succesful in detecting PPP for developing countries when compared to linear tests • Croatia: till now authors tested only for linear ppp (unit root, cointegration and panel data tests) contradictory results Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  5. Data • To test the PPP theory we needed: • Monthly average nominal HRK/EUR exchange rate • Monthly Croatian consumer price index • Monthly harmonized index of consumer prices for EMU • All data range from January 2000 to December 2009 Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  6. HRK/EUR Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  7. Croatian CPI Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  8. Eurozone HCPI Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  9. HRK/EUR in first differences Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  10. Croatian CPI in first differences Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  11. Eurozone HCPI in first differences Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  12. Methodology • Two cointegration methods: • Johansen cointegration: symmetry in both the short and long run • Threshold cointegration: asymmetry in short and symmetry in the long run  Enders and Siklos (2001) • Vector error correction models Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  13. Results – Johansen cointegration • Two cointegrating vectors: • Absolute PPP condition • Long run relationship between domestic and eurozone price level Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  14. Results – Johansen cointegration Restrictions: First cointegrating vector: • long run coefficients for the exchange rate should be equal to 1 • long run coefficients for EMU prices should be equal to 1 • long run coefficient for domestic prices should be equal to -1 • in the short runEMU prices are weakly exogenous Second cointegrating vector: • long run coefficients for the exchange rate should be equal to 0 • long run coefficient for domestic prices should be equal to 1 Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  15. Results – VECMs’ Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  16. Results • Absolute power parity holds in the long run • Exchange rate adjusts to deviations from the parity in the short run • Price level in Croatia and the eurozone are weakly exogenous • Higher inflation in Eurozone leads to appreciation of nominal HRK/EUR exchange rate in the short run • No proof of exchange rate pass-through to domestic consumer prices • Adjustments of deviations from the PPP is not asymmetric Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  17. Policy implications • Devaluation is not an appropriate policy response • Nominal rigidity in the economy should be decreased • More nominal exchange rate variability  when no structural characteristics are taken into account * Exchange rate is flexible enough to correct discrepancies in prices; performs its basic economic function Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

  18. Results - TAR and M-TAR Marina Tkalec - Maruška Vizek 16th Young Economists’ Seminar

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