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Are Real Devaluations Contractionary? Empirical Strategy

Equation shows the open economy IS curve model. In the model q^stands for the real exchange rate, tb31 for the real trade balance and the fr31 for the real foreign exchange reserves. Here, the constraint (q^ = 0) are relaxed for identifying that real exchange rate is present in the model. Like Ball the q-.is included in the model in lag form. However, it is included in the model so that an increase in it stands for the depreciation/devaluation, fr,. is also include in the model with lags. However, tb31 is included contemporaneously.
Finally, for capturing the effects of the two regime switches in the open economy IS output gap model, two dummy variables i.e. DRegm1 and DRegm2 stand for the two regime shifts occurred during the study period, 1973-2008 have also been included in the open economy model. Here, DRegm1 stands for the first regime shift occurred during 1982. Whereas, DRegm2 stands for the second regime shift occurred during 2000. Both the regime shifts are included in the in the model so that DRegm1 takes the value of “1” for the full period from 1982 to 1999 and “0” otherwise. Similarly, DRegm2 takes the value of “1” for the full period from 2000 to 2008. and “0” for the rest of the period.
Equation is the open economy model with the regime shifts. Here, the constraints i.e. D„    = 0 and D„ = 0 have been Regm relaxed for showing that both the regime shifts are considered in the open economy model. The main purpose here is to examine whether exchange rate systems affect the У* in Pakistan or not.
In the above models the symbol “g” has been putted on all the variables which shows that this study is concerning only with the cyclical components of the data which are extracted from the observed series through the application of Hodrick Prescott filter method. The application of the Hodrick Prescott (HP) filter method not only limit the researchers focus on the short run fluctuations of the variables but it also avoid the problem of spurious regression, which can arise if the data is non-stationary and make the regression results non-reliable. payday loans with no bank account

It has been noted that it is difficult to explore the relationship between the real exchange rate and output gap on the priori basis; therefore it seems plausible to make an empirical evaluation of the contractionary hypothesis of real devaluations for Pakistan. For doing so, the results have been divided into three parts on the basis of all the models of the study. First, results have been computed for the closed economy model which is placed in table 1. After that results for the open economy model have been derived. These results are given in table 2. Finally, for examining the role of the regime shifts in the determination of output some more results are computed which are given in table 3. A detail discussion of all the results is given as under. Table 1 show the results for the closed economy IS curve model of the study. The main purpose here is to find out whether output gap for Pakistan can be determined in a closed economy setup or not. Here, only two domestic factors i.e. interest rate (igt) and (ngt) have been incorporated in the model. The igt is included in the model by assuming that the State Bank of Pakistan uses it as a monetary policy instrument by following the Taylor rule.

Table 1 Estimation results for the closed economy IS-curve model

Parameter Estimates Standard Error
lgt 1.333887 0.249445)
ngt-1 0.159575 (0.193852)
ngt-2 -0.410692 (0.157169)
ngt-3 0.261726 (0.140168)
ngt-4 0.338245 (0.064448)
ygt-1 0.269455 (0.130396)
gy t-2 -0.278724 (0.102516)
gy t-3 0.280000 (0.114479)

Table 2 Estimation Results for the Open Economy IS-curve model

Parameter Estimates Standard Error
git -2.160768 (0.555379)
g t-1 1.327435 (0.604548)
gi t-2 1.326249 (0.323743)
gi t-3 -1.249717 (0.292507)
gi t-4 -1.001293 (0.327678)
igt-5 0.916754 (0.368092)
ngt-1 0.472093 (0.376331)
ngt-2 1.020856 (0.262219)
ngt-3 0.829516 (0.302096)
ngt-4 -0.742159 (0.156731)
gq t-1 0.364413 (0.177082)
gq t-2 0.424787 (0.122177)
tbgt -3.47E-05 (1.03E-05)
frgt-1 0.079241 (0.018047)
frgt-2 -0.044001 (0.015958)
frgt-3 -0.124219 (0.013413)
ygt-1 0.209367 (0.141786)
gy t-2 0.890570 (0.172931)
gy t-3 1.081885 (0.311672)

Table 4 : Estimation Results for the Open Economy IS-curve model With Regime Shifts

Parameter Estimates Standard Error
git -1.974180 (0.432543)
gi t-1 1.383463 (0.472624)
gi t-2 1.356247 (0.364560)
gi t-3 -1.068252 (0.182819)
gi t-4 -0.913732 (0.458990)
gi t-5 -0.913732 (0.458990)
gn t-1 0.451527 (0.292995)
gn t-2 1.013660 (0.330259)
gn t-3 0.676829 (0.141861)
gn t-4 -0.697273 (0.110406)
gq t-1 0.268078 (0.112831)
qgt-2 0.334657 (0.091582)
frgt-1 -3.27E-05 (9.88E-06)
frgt-2 -0.0415753 (0.019175)
frgt-3 -0.0118594 (0.010014)
gУ t-1 0.191383 (0.134707)
gУ t-2 -0.225765 (0.112150)
gУ t-з 0.844096 (0.228291)
1.692790 (0.425135)
This post was written by , posted on May 6, 2014 Tuesday at 2:24 pm