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© 1993 International Bank for Reconstruction and Development / The World Bank
research-article |
A Medium-Term Framework for Analyzing the Real Exchange Rate, with Applications to the Philippines and Tanzania
Kathie L. Krumm is in the Office of the Vice President for the Europe and Central Asia Region of the World Bank. This article is based on work done for the Philippines Country Economic Memorandum and Tanzanian Multisector Rehabilitation Credit in 1986. The author wishes to thank Vittorio Corbo, Issbel Guerrero, Daniel Kaufmann, Enrique Rueda-Sabater, and many Philippine and Tanzanian officials and researchers for helpful discussions. Marinela Dado and Francis Ng provided excellent research assistance.
A competitive official real exchange rate is important to external balance and sustainable medium-term growth in developing countries. This article presents a methodology for estimating the appropriate real rate and provides a basis for evaluating the extent to which the prevailing rate is misaligned. In particular, the medium-term equilibrium real exchange rate is evaluated by estimating the effects of structural factors on the trend observed for a country's real rate compared with the rates of its major trading partners, taking into account the effects of macroeconomic policy. Structural factors include terms of trade, external capital flows, and trade policy, plus other factors relevant to the circumstances of individual countries. The implied change in the medium-term equilibrium real rate is compared with that of a historical reference period. The application of this methodology to two developing countries, the Philippines and Tanzania, illustrates how it can complement and improve upon other analytic approaches, such as those using purchasing power parity and analysis of parallel rates. This approach is complemented by an analysis of the relation between a country's real exchange rate and those of its major competitors.