Isard, Peter, Hamid Faruqee, G. Russell Kinkaid, and Martin Fetherston (2001), “Methodology for Current Account and Exchange Rate Assessments,” IMF Occasional Papers, No. 209, International Monetary Fund, Washington.
Senhadji, Abdelhak S. (1998), “Time Series Estimation of Structural Import Demand Equations: A Cross-Country Analysis,” IMF Staff Papers, vol.45 no. 2, International Monetary Fund, Washington.
Senhadji, Abdelhak S., and Claudio E. Montenegro (1999), “Time Series Analysis of Export Demand Equations: A Cross-Country Analysis,” IMF Staff Papers, vol.46 no. 3, International Monetary Fund, Washington.
Prepared by Sanket Mohapatra (AFR).
The current levels of external financing are assumed to persist under the unified exchange regime.
For instance, estimating potential output is fraught with considerable difficulty for an economy that has faced extremely high inflation and large concurrent output shocks, which in addition may have affected the long-run supply of physical and human capital.
This formulation explicitly recognizes that the real exchange rate relevant for export and import demands can differ when there is a constrained foreign exchange market with multiple exchange rates.
The income elasticity of imports ηm is sometimes estimated relative to domestic output net of exports, i.e. total domestic production, rather than real GDP (For instance, see Senhadji (1998)). However, this difference is not consequential for purposes of the short run analysis of this paper.
The financing items for the trade deficit include net official and private inflows, humanitarian aid, worker remittances, trade credit, arrears and other items.
Reflecting the partial equilibrium and short run nature of the model, the response of aggregate GDP to a devaluation (and other second-order effects) are assumed not to be felt immediately but only over the medium run.
Empirical import price elasticities have been estimated for Cameroon (0.80), Malawi (1.63), South Africa (1.04), and Zambia (1.22); and export price elasticities for Cameroon (0.17), Malawi (0.11) and South Africa (0.19) (See Senhadji (1998) and Senhadji and Montenegro (1999)). The assumed export price elasticity of 0.5 is higher than neighboring countries as there may be excess capacity that can be used to expand exports as the country moves from a constrained to an unconstrained system.
For instance, this would preclude situations where the central bank increases the rate of money growth or the fiscal deficit widens further, both of which could put additional pressure on the real exchange rate.