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Real Exchange Rate Misalignment in Turkey, 1987-2003

Real Exchange Rate Misalignment in Turkey, 1987-2003. Aykut Kibritçioğlu Department of Economics Ankara University, Turkey. Dr. sc. pol. Aykut Kibritçioğlu Associate Professor Department of Economics Faculty of Political Sciences Ankara University TR-06590 Cebeci, Ankara, Turkey

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Real Exchange Rate Misalignment in Turkey, 1987-2003

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  1. Real Exchange Rate Misalignment in Turkey, 1987-2003 Aykut Kibritçioğlu Department of Economics Ankara University, Turkey

  2. Dr. sc. pol. Aykut Kibritçioğlu Associate Professor Department of Economics Faculty of Political Sciences Ankara University TR-06590 Cebeci, Ankara, Turkey Tel.: +90-312-3197720, ext. 340 Fax: +90-312-3197736 E-mail: kibritci@politics.ankara.edu.tr Homepage: http://dialup.ankara.edu.tr/~kibritci/wiiw.html

  3. Research Visit to the ÖNB & WIIW (Vienna, Austria, November 1-15, 2004) • “An Analysis of Early Warning Signals of Currency Crises in Turkey, 1986-2004” • “Real Exchange Rate Misalignment in Turkey, 1987-2003” • “An Overview of Macroeconomic Developments in Turkey” (with special reference to the AK-Party Era, 2002-04) http://dialup.ankara.edu.tr/~kibritci/wiiw.html

  4. Real Exchange Rate Misalignment in Turkey, 1987-2003 Abstract: Real exchange rate misalignment measures deviations of actual real exchange rate from its long-run, or equilibrium, level. Policy makers and many researchers are interested in predicting and monitoring misalignment in the foreign exchange market, because, in many cases, it is closely related to possible current account problems or impending currency crises. This study mainly aims to discuss the sensitivity of estimation results to the alternative combinations of actual real exchange rate indices and equilibrium definitions, by using quarterly data from 1987 to 2003 for Turkish lira. The 16 measures of misalignment employed in this study show that the differences between these alternative measures vary between 6.5 and 36.5 percent points, which actually is a very strong indication for high sensitivity of the degree of misalignment to the selected combination of the actual and equilibrium real exchange rate indices. JEL Classification: E31, F31, C22 Key Words: Exchange rate determination; purchasing power parity; real exchange rate; misalignment; time series techniques; Turkish economy

  5. The full-text of the study is downloadable as pdf file (in Turkish): http://econpapers.hhs.se/paper/wpawuwpma/0403006.htm or http://econwpa.wustl.edu/eps/mac/papers/0403/0403006.pdf

  6. Outline of the Presentation • Introduction: Motivation and Aims • Real Exchange Rate: Conceptual Classification • Literature Review • Actual Real Exchange Rate (A) • Long-Run Real Exchange Rate (E) • Real Exchange Rate Misalignment (M) • Currency Crises and Misalignment • Concluding Remarks

  7. Introduction: Motivation & Aims of the Study

  8. Introduction: Motivation & Aims (1) Annual Consumer Price Inflation (%, log scale) • In the late 1990s, Turkey was not able to join the global disinflation process observed explicitly...

  9. Introduction: Motivation & Aims (2) Consumer Price Inflation (%) • Turkey suffered from high and persistent inflation since more than three decades. But , finally, it’s declining now...

  10. Introduction: Motivation & Aims (3) • In Turkey, the black-market for foreign exchange disappeared gradually since early 1980s. Source: CBRT and PCY/WCY; own calculations.

  11. Introduction: Motivation & Aims (4) • Since May 1981, Turkey has a relatively flexible exchange rate system. This gradually removed the black-market for FX in Turkey. • In 2000, the monthly growth rates of nominal exchange rates were pre-determined to gradually disinflate the economy.

  12. Introduction: Motivation & Aims (5) “Currency Substitution” in Turkey FX Deposits to M2 • High inflation and low credibility of government policies in the 1990s created a strong currency substitution. But it’s changing now...

  13. Introduction: Motivation & Aims (6) • Latest monthly data shows that there is a tendency towards “reverse currency substitution” in Turkey, since late 2002.

  14. Introduction: Motivation & Aims (7) • Do the actual nominal exchange rates show “equilibrium” or “long-run” exchange rates, since the “black market” disappeared in Turkey? • If not, why some economic actors sometimes are suggesting that the Turkish lira is “over” or “under”valued against foreign currencies? • What are the reasons for disequilibrium in the FX market, if there is no “black market” for FX? • How can we measure the divergence of actual real exchange rates from long-run levels? Any reliable empirical methodology? • Why do the “black market” exchange rates not necessarily represent the “equilibrium” exchange rates?

  15. Real Exchange Rates: Conceptual Classification E A E3 & E4 A1 & A2 E1 E2

  16. Introduction: Motivation & Aims (8) • How far were real exchange rates diverged from equilibrium levels between 1987 and 2003 in Turkey? • To what extent were the real exchange rates misaligned or appreciated before the 1994 and 2000-2001 currency crises in Turkey? • Is the Turkish lira really overvalued in real terms against foreign currencies as early 2003? If yes, how far? • If there is a remarkable signal of real appreciation, can it cause a new currency crisis in the country? • Which one of the real exchange rate indices that are currently available is more reliable to detect an approaching currency crisis?

  17. Introduction: Motivation & Aims (9) What we will not do in this study are: • Forecasting the future values of the Turkish lira! • Determining any “notional” equilibrium (nominal or real) exchange rates! • Testing whether the PPP rule is valid for the case of Turkey! • Measuring the degree of the nominal real exchange rate misalignment! • Investigating the short-run dynamics of real exchange rates (issues of adjustment speed & symmetry)!

  18. Introduction: Motivation & Aims (10) A: Actual real exchange rate E: Long-run (Equilibrium) Real Exchange Rate M: Degree of Misalignment M = (A – E) / E M > 0 => TL is depreciated in real terms M = 0 => A is a “realistic” exchange rate M < 0 => TL is appreciated in real terms Attention:A is an “observable” variable, while E is a “non-observable” one!

  19. Real Exchange Rates: Conceptual Classification

  20. Real Exchange Rates: Conceptual Classification Internal Real Exchange Rates A1 & A2

  21. Real Exchange Rates: Conceptual Classification External Real Exchange Rates

  22. Literature Review: Equilibrium Exchange Rates and the Case of Turkey

  23. Literature: Estimation Methodologies for E (I) E1 & E2 E3 & E4

  24. Literature: Estimation Methodologies for E (II)

  25. Literature: A, E and M Related Studies on Turkey (I)

  26. Literature: A, E and M Related Studies on Turkey (II)

  27. “Actual” Real Exchange Rates: Internal & External “A” Indices for Turkey

  28. Actual Real Exchange Rates (A): Alternatives 1995=100, 1995.I – 2003.III

  29. Actual Real Exchange Rates (A): Alternatives Correlations Between Different A Indices Note: The correlation coefficients for two CBRT indices are calculated for the 1995.I-2003.III period, while for all other indices the correlation coefficients are calculated for the 1987.I-2003.III period.

  30. Actual Real Exchange Rates (A): Selected A’s 1995=100, 1987.I – 2003.III

  31. Actual Real Exchange Rates (A): Properties A1: Trade-Weighted Real Effective Real Exchange Rate 1995=100; for 8 countries; PTΣaeWPIf , PNCPId ; A1 = PT/PN .Source: SIS, CBRT and IMF’s IFS; authors’ calculations. A2: Internal (TNT) Real Exchange Rate Index 1995=100; derived by using implicit price deflators calculated from GDP accounts: PT (bPx+ g Pm) and PNPy-x+m ; A2 = PT / PN . Source: SIS and CBRT; authors’ calculations; deseasonalized. A3: Reuters’ TRTWIN Index June 1999 = 100; for four countries; trade-weighted. Source: Reuters; the inverse of the original index; base year adjusted as 1995=100. A4: SPO’s Real Effective Real Exchange Rate Index Jan. 1982 = 100; USD: 75% & Euro: 25%; for USA & Euro area PPI and for Turkey WPI. Source: SPO; the inverse of the original index; base year adjusted as 1995=100.

  32. “Equilibrium” or “Long-Run” Real Exchange Rates: Alternative “E” Indices for Turkey

  33. Long-Run Real Exchange Rate (E): Theoretical Overview • Internal balance implies that markets for labor and non-tradable goods are “cleared”. • External balance requires a sustainable current account balance (CAB) in the country. • Accordingly, E is the real exchange rate which guarantees internal and external macroeconomic balances simultaneously, while external (policy) variables are at their sustainable levels. • It is expected that E is influenced by nominal and real variables in the short run, while it is affected only by real variables in the long run.

  34. Long-Run Real Exchange Rate (E): Operational Definitions Definition 1: “Base-Year Approach” Basic PPP approach suggests that E is that real exchange rate which is valid when it is believed that the real value of a national currency is not over- or under-valued at that specific point of time. Example: E is equal to the base-year value of an A index. (Selection of the base-year of A is crucial!) Reference: Ahlers & Hinkle (1999) General Reference: Hinkle & Montiel (1999) E1

  35. Long-Run Real Exchange Rate (E): Operational Definitions Definition 2: “Trend Approach” Changing fundamentals also should change E! Therefore, the improved PPP idea allows for changes in E by defining E as a “time-varying trend value” of an A index. Example: A’s trend value, which is calculated by employing the so-called Hodrick-Prescott filter. Reference: Ahlers & Hinkle (1999) General Reference: Hinkle & Montiel (1999) E2

  36. Long-Run Real Exchange Rate (E): Operational Definitions • Definition 3: • “Fundamentals-Based Reduced Form Approach” • E is that real exchange rate which ensures the internal and external balances in the economy at the same time. • Internal Balance: E guarantees that the labor and non-tradables markets are “cleared”. • External Balance: E guarantees that the CAB is at its sustainable level. • References: Baffes et al. (1999), Montiel (1997), Edwards (1989) • & Rodriguez (1994) • General Reference: Hinkle & Montiel (1999) E3 & E4

  37. Long-Run Real Exchange Rate: Selected Es E1: “Base-Year Value” of A For each A index we have a different E1: E11, E12, E13 & E14. As the base year values of A1, A2, A3 and A4 are already set as 1995 = 100, E1 values are simply given as: E11=E12=E13=E14=100. E2: “Time-Varying Trend” of A For each A index we have a different E2: E21, E22, E23 & E24. The values of E2 are calculated by applying the Hodrick-Prescott filter methodology. E3: “Estimated” Long-Run Value of A For each A index we have a different E3: E31, E32, E33 & E34. Following cointegration analysis, the values of E3 are computed by considering the “actual” values of fundamentals. E4: Long-Run Value of A For each A index we have a different E4: E41, E42, E43 & E44. Following cointegration analysis, the values of E3 are computed by considering the “smoothed”, or long-run, values of fundamentals.

  38. Long-Run Real Exchange Rate: E3 & E4 Methodology Used to Calculate E3 & E4: Time series properties of variables are investigated: Correlograms checked & ADF unit-root tests implemented Integration degrees of series are determined: Nonstationarity in levels, I(1), and stationarity in first differences, I(0). Investigated by using Johansen cointegration analysis whether series have more than one cointegrating vectors: Only one cointegrating vector found.

  39. Long-Run Real Exchange Rate: E3 & E4 The Long-Run relationship between A indices and fundamentals are estimated by employing Engle-Granger approach: ln At = ß ln Ft + ut , F = (GOVGDPS, OPENS, TOT) Tested whether the error terms are stationary: ADF unit-root tests showed that, in all equations, the error terms are stationary. E3: computed by considering the “actual” values of fundamentals E4: computed by considering the “smoothed”, or “long-run”, values of fundamentals. MacDonald and Ricci (2003) are not in favor of the E3-type of definition. They argue that the E3 may only show the “short-run” equilibrium of A because of the effects of transitory shocks caused by fundamentals.

  40. Long-Run Real Exchange Rate: Fundamentals • List of Potential Determinants of E3 and E4: • Terms of trade (TOT) • Productivity difference between tradables and nontradables sectors • International differences between GDP growth rates • Public sector expenditures to GDP (GOVGDP) • Public sector investments to GDP • Net exports to GDP • Openness to international trade in goods (OPEN) • Real world interest rates or international differences between real interest rates • Net foreign direct investments to GDP • Net capital inflows from abroad to GDP • Debt service to exports • Absolute change in monetary base • Public sector balance • Net foreign assets of the central bank • Public debts to GDP

  41. Long-Run Real Exchange Rate: Fundamentals • Fundamentals Used to Explain Changes in E3 & E4: • Public Expenditures / GDP (GOVGDPSL) Sum of the real consumption and investment expenditures of the public sector divided by real GDP Source: SIS; authors’ calculations; log of the deseasonalized series • Openness to Trade in Goods (OPENSL) Total trade volume in current prices divided by nominal GDP Source : SIS; authors’ calculations; log of the deseasonalized series • External Terms-of-Trade (TOTL) Export price index divided by import price index Source : SPO’s MEI, 1994=100; authors’ calculations; log of the TOT

  42. Long-Run Real Exchange Rate: Fundamentals GOVGDPSL OPENSL TOTL

  43. Real Exchange Rate Misalignment: Estimation Results for Turkey, 1987.q1 – 2003.q3

  44. Real Exchange Rate Misalignment (M) 16 Different Measures of Misalignment According to 4 Different Actual Real Exchange Rate Indices and 4 Different Equilibrium Definitions

  45. E1-Type of Long-Run Real Exchange Rates

  46. E2-Type of Long-Run Real Exchange Rates

  47. E3-Type of Long-Run Real Exchange Rates

  48. E4-Type of Long-Run Real Exchange Rates

  49. A1 Index & Alternative Measures of Long-Run Equilibrium

  50. A2 Index & Alternative Measures of Long-Run Equilibrium

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