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The author would like to thank Enrica Detragiache, Gabriela Inchauste, Ales Bulir, Emine Boz, Marcello Estevao, Martin Cerisola, Roberto Guimaraes, and Professor Michael Wickens for valuable comments and discussions on the subject.
Export market shares are calculated as the 4-quarter average growth of export volumes divided by the 4-quarter average growth of import volumes in Brazil’s main trading partners according to IMF, World Economic Outlook data.
Installed productive capacity was estimated using the series for the level of production and capacity utilization compiled by the Brazil’s National Confederation of Industries (CNI). Although the national accounts data do not show a significant increase in investment rates, it does show an increase in the share of machinery and equipment in total investment expenditure.
The increase in Brazil’s unit labor costs in 2005 was associated with both an increase in average real wages and a decline in average productivity in the manufacturing sector.
A possible drawback of using this variable as a proxy for relative productivity differentials is in the event of tax-driven relative price changes and the varying composition of price indexes over time and across countries. Despite these potential imperfections, this variable remains widely used to assess competitiveness and exchange rate dynamics. See, for instance, Kakkar and Ogaki (1999) and Chinn (1999).
The country weights used in this section are those in the IMF’s calculation of Brazil’s REER. Some criticism has been made about the inclusion of this variable among the fundamentals explaining REER dynamics on grounds that the NTT would be an equivalent measure of the (price-deflated) real exchange rate. However, the NTT series in our sample has shown a strong, upward trend during the sample period, with the average in the 1990s being about 50 percent higher than the average in the 1970s, whereas the average REER rose by only 16 percent in the same period. The NTT calculated for Brazil therefore seems to be broadly reflecting productivity trends and the country’s productivity “catching up” process as hypothesized by the model.
Notice that FDI inflows may also indirectly stimulate an equilibrium appreciation of the exchange rate by promoting economic efficiency and raising the productivity of tradable goods; in addition, privatization-related inflows or FDI in public utilities may also contribute to reduce the public sector debt, reducing risk and leading to a stronger equilibrium exchange rate.
Fiscal policy could also affect the (equilibrium) exchange rate through its impact on national savings and the composition of aggregate demand. Nonetheless, these effects are accounted for by the net foreign assets position and the relative price of tradables to nontradables, leaving the risk factor as the plausible effect captured by this variable.
MacDonald and Clark (1998) and Maeso-Fernandez, Osbat, and Schnatz (2001) have also reported finding “border line” test statistics for some measures of interest rate differentials but treating the series as I(1).
The wide discrepancies between actual and estimated values observed around 1990 and 1994 should be viewed with caution as they may reflect distortions in the measurement of some of the variables entering the estimation caused by the very high inflation observed in the period as well as the stabilization strategies and currency reforms implemented.
The test statistics reported were adjusted for the small sample size as recommended in Reimers (1992) by multiplying the original values by a factor of (T- nk)/T, where T is the number of observations, n is the number of variables, and k is the number of lags in the system. Notice that, as appropriate, the adjustment factor converges to 1 as the sample size increases for a given model specification with n variables and k lags. The unadjusted test statistics suggested the existence of two cointegrating vectors. However, this second hypothesized cointegrating vector probably corresponded to the real interest differential variable (rintdiff), which was found to be border-line stationary in the tests described above. This possibility was confirmed by estimating the VEC system imposing two cointegrating relations with the second vector constrained to include only the rintdiff variable. The constraints were accepted and the first cointegrating vector yielded coefficient estimates that are very similar to the ones obtained under the hypothesis of a single cointegrating vector.