Appendix I: Tourism and the Real Exchange Rate
Appendix II. Data Sources
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)| false Chudik, A.and J. Mongardini, 2007, “ In Search of Equilibrium: Estimating Equilibrium Real Exchange Rates in Low-Income African Countries,” Assessing Competitiveness and Real Exchange Rate Misalignment in Low-Income Countries,” IMF Working Paper 07/90 ( Washington DC: International Monetary Fund).
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)| false Pesaran, M.H.and Y. Shin, 1999, “ An Autoregressive Distributed Lag Modeling Approach to Cointegration Analysis,” in ( S. Strom, A. Hollyand P. Diamond eds.), Econometrics and Economic Theory in the 20 th Century: The Ragnar Frisch Centennial Symposium( Cambridge: Cambridge University Press).
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The authors are grateful to Sam Ouliaris, Luca Ricci, Ketil Hviding, Said Bakhache, Garfield Riley, Kari Grenade, Stephen Tokarick, and seminar participants at the First Eastern Caribbean Central Bank-IMF Research Seminar (July 2008) and Fortieth Annual Caribbean Monetary Studies Conference (November 2008) for helpful comments on earlier versions of the paper, and Cleary Haines for excellent research assistance.
An additional feature of the ECCU is the generalized acceptance of the U.S. dollar in current transactions. The impact of currency competition on ECCU real exchange rates is beyond the scope of this paper.
These measures have the following weights: (i) Customers: Antigua and Barbuda (Canada, U.K., U.S.); Dominica (France, U.K., U.S.); Grenada (Trinidad and Tobago, U.K., U.S.); St. Kitts and Nevis (Canada, U.K., U.S.); St. Lucia (Canada, U.K., U.S.); St. Vincent and the Grenadines (Trinidad and Tobago, U.K., U.S.); (ii) Competitors: The Bahamas (23.4 percent), Barbados (8.0 percent), Dominican Republic (43.5 percent), Jamaica (19.4 percent), and Trinidad and Tobago (5.7 percent). The weights, in parentheses, are chosen based on the share of tourism arrivals to the Caribbean in 2001.
Darius and Williams (2000) reject the PPP hypothesis for ECCU countries after conducting univariate unit root tests.
When performing this test and correcting for serial correlation of the errors we could not reject the null hypothesis that all series are stationary at a 90 percent level of confidence. This test helps to address difficulties in interpreting the results of the other four tests, since rejection of the null hypothesis of joint non-stationary may occur even if only one of the series is stationary (Sarno and Taylor, 1998).
For an autoregressive process, half life of a misalignment is calculated as –ln(2)/ln(ρ), where ρ is the estimated autoregressive coefficient.
As argued by Cashin and McDermott (2006), since the existing literature on developing countries has centered around high-inflation Latin American countries, these findings suffered from a sample selection bias. Our analysis does not suffer from this bias because inflation in the ECCU countries remained in the low-single digits throughout most of the period.
Different benchmark countries—including Antigua and Barbuda and Barbados—were used with similar results.
Tokarick (2008) points out that an improvement in the terms of trade need not necessarily lead to a rise in the price of nontradables relative to the price of tradable goods—relative price movements will depend on the magnitude of substitution and income effects.
Our finding that the real exchange rate in ECCU countries does not exhibit a unit root rules out the possibility of cointegration, and thus standard panel models used in the literature such as dynamic ordinary least squares (DOLS) cannot be used. This strategy is also consistent with that adopted by Chen and Rogoff (2003), who argue that is plausible to assume that over finite samples real exchange rates are stationary.
The inability to account for this cross-sectional correlation is one of the constant criticisms of most panel data-based real exchange rate estimations.
When comparing the performance of both estimators Jönsson (2005) concludes that the PCSE estimator is preferable to its FGLS counterpart when ½ (N2 + N) ≥ T.
This is complicated by the fact the asymptotic distribution of the associated F-statistic is nonstandard and will depend on whether the regressors are I(0) or I(1). Pesaran, Shin, and Smith (2001) tabulate two sets of critical values. The first assumes that all the variables in the ARDL model are I(1) and the second that they are all I(0). This gives a band of critical values that covers all possible classifications of the variables into I(0), I(1), or even fractionally integrated. If the computed F-statistic falls outside this band, a decision about the existence of a level relationship can be made without knowing whether the underlying variables are I(0) or I(1). The critical values for the Wald version of the bounds test are given by k+1 times the critical values of the F-test, where k is the number of regressors.
In addition, Pesaran and others (2001) show that the small sample performance of the bound testing approach is superior to other cointegration approaches, particularly that of Johansen.
As the model contains 4 regressors, the 95 percent critical value for the bounds F-test is (2.86, 4.01) and for the bounds Wald test is (11.44, 16.04). With a calculated Wald statistic of 53.01 (for model with lag order 1), the null hypothesis that there exists no long-run real exchange rate equation is clearly rejected.
Following Bayoumi and others (2005) we defined as tourism-dependent countries those where tourism exports exceeded a threshold of 20 percent of total export receipts. Bayoumi and others (2005) find 29 tourism-dependent countries, however, given the lack of tourist arrivals time-series for eight of them we were left with the following list of 21 countries: Antigua and Barbuda, The Bahamas, Barbados, Belize, Cyprus, Dominica, Dominican Republic, Egypt, Fiji, Greece, Grenada, Jamaica, Jordan, St. Kitts and Nevis, Malta, St. Lucia, St. Vincent and the Grenadines, Mauritius, Samoa, Seychelles, and Vanuatu. See Appendix II for the derivation of the data.
The ARDL approach of Pesaran and Shin (1999) is applicable, irrespective of whether the regressors are I(0) or I(1).
The three main approaches to CGER-based assessments of real exchange rates include the equilibrium real exchange rate approach; the macroeconomic balance approach; and the external stability approach. The latter is not presented here—it involves calculating the difference between the actual current account balance and the balance that would stabilize the net foreign asset position of the country at some benchmark level (for further details see IMF, 2006; Lee and others, 2008).
Macroeconomic balance-based estimates of the equilibrium current account position are typically subject to uncertainty, given the large variation in current account balances across countries and over time, and the limits of the common specification imposed across a diverse set of countries.
Current account norms for the ECCU and other tourism-dependent countries are much larger than those calculated for other groups of developing countries, with the exception of the Baltic and new European Union member states (see Rahman 2008). See also IMF (2008) for an analysis of the persistence of current account imbalances in Asia and Europe.
In analyzing the capital account of Asian and Latin American countries in the 1990s, De Gregorio (2003) notes that the volatility of more liquid portfolio equity flows and external debt greatly exceed that of FDI.
Calculations by the authors estimate the current account elasticity of FDI flows to be in the range 0.5–0.7, meaning that FDI and current account balances move together.
Current account deficits in the ECCU are rather persistent, and have occurred in the context of the ECCU’s hard peg exchange rate arrangement. See Chinn and Wei (2008) on the absence of a link between the persistence of current account imbalances and the exchange rate regime.
Crucially we assume “tourism services” to be a tradable as tourists will exercise arbitrage in the tourism consumption decision when deciding: whether to visit a country or not, and when deciding how much of the tourism services (e.g. length of the stay, restaurant meals, etc.) they should consume once they are at the destination.