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N° 1997 - 18 |
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| December |
| Why the Euro Will Be Strong : an Approach
Based on Equilibrium Exchange Rates |
Michel Aglietta
Camille Baulant
Virginie Coudert |
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| For the last few years macroeconomic analysis
of equilibrium exchange rates has been rejuvenated. Transition and developing
countries have linked their exchange rates more or less loosely to key-currencies
or baskets of currencies. Besides the prospect of EMU entails hopes or fears about
the external value of the Euro Assessing equilibrium real exchange rates is the
way to bring some insight into the matter. The theory of equilibrium real exchange
rate has been spurred by the failure of PPP to provide any guidance as regards
to the proper evolution of exchange rates. In the medium run, structural forces
impinge upon real exchange rates: productivity, innovation, saving behaviour,
net foreign assets. To embodying these factors a range of models have been developed
which are modulations of a basic stock-flow approach. The equilibrium real exchange
rate is the one, which makes internal and external equilibria compatible. Our
study uses a dynamic model and derives the relevant explanatory variables for
the real exchange rates from the saddle-point equilibrium embedded into the dynamics.
Two reduced-form equations have been sorted out of the theoretical model for econometric
testing: a long-run equation between cointegrated variables on one hand, a short-run
error correction model on the other hand. The equilibrium real exchange rates
for the DM, French Franc, Italian Lira against the Dollar have been estimated
first in a simultaneous equation. Econometric results are satisfactory and depict
the paramount influence of two variables on real exchange rate changes: the trend
in wholesale prices relative to retail prices on one hand, the cumulative current
account balances on the other hand. The regression coefficients have been applied
to generate the evolution of the equilibrium real exchange rate between the Dollar
and the Euro. The latter has been proxied as a weighted average of the DM, the
French Franc and the Italian Lira. A significant trend reversal is exhibited.
Between 1979 and 1985 a real appreciation of the equilibrium exchange rate of
the Dollar, though of much less magnitude than that of the market exchange rate,
is chiefly due to the much steeper fall of industrial prices relative to consumer
prices in the US than in Germany. Since the mid-80's a real depreciation of the
dollar is mainly due to the increasing foreign indebtedness in the US against
the rise in net foreign assets in Europe. As much as this tendency is not expected
to be reversed in the near future, there are strong reasons to surmise that the
Euro will be a strong currency from the start. |
Abstract |
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Keywords |
| F31 |
JEL classification |
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