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European I Department, IMF; and University of Pittsburgh, respectively. The authors would like to thank Timothy Callen, Charles Engel, David Goldsbrough, and Christopher Towe for helpful comments on this and earlier versions of this paper, and Janet Bungay for editorial suggestions. All errors are the responsibility of the authors.
For a review of the long-run external sector performance and other economic developments, see Chopra, et al. (1995).
Following the convention used by the IMF, an increase in the real effective exchange rate (REER) is an appreciation.
In this case, the parallel and official rates are in rupees per dollar and the spread is the difference between them. Therefore, a positive spread reflects a more depreciated parallel rate compared with the official rate.
The lifting of capital controls is typically associated with inflows of capital in developing countries, as foreign investors seek new investment opportunities and as domestic industries resort to borrowing abroad. The reduction of capital controls could also conceivably lead to an outflow of capital, although this would most likely occur in response to a temporary loss of confidence in domestic policies or economic prospects.
Of course, much research has shown that unit root tests of economic variables suffer from lack of power. That is, when a series is stationary, but highly autocorrelated, rejection of the unit root hypothesis requires a considerably longer sample period than the sample typically available. Nonetheless, the consequences of assuming that variables are stationary when they are not include finding spurious relationships. Hence, it is more conservative to assume that the variables are nonstationary even if they are not.
Note that this one cointegrating vector can also be obtained as a linear combination of the estimated multiple cointegrating vectors.
Sensitivity tests indicated that there was no advantage in using the full specification of Model 1 when analyzing the effects of the exogenous variables, since the results were not significantly different from those reported from the parsimonious specification while several degrees of freedom were lost in the process of carrying around the insignificant variables and their lags.
The table shows the results for the most significant lag. The coefficients on other lags have the same sign as the third lag, with one negligible exception.
Since we could not reject the hypothesis of a unit root for the level of political confidence, its first difference was taken in the specification.
The insignificant lags were eliminated.
We report only the equilibrium exchange rate estimated from the baseline ECM (Model 6).
Previous work with the Beveridge-Nelson decomposition has shown that since the method assumes that the permanent component is a random walk, the filtered series tends to closely replicate the actual data; very little smoothing tends to occur.
Except for the exogenous variable, for which there is no forecast model in the ECM method, and the parameters of the full sample model, which rely on the complete data set.