Appendix I.1. Data Sources and Estimation Methodology
The dataset consists of annual observations for ECCU countries and 16 other tourism dependent economies for the period 1979–2006.11 The ECCU average is the GDP-weighted average of the six ECCU countries.
Bayoumi, T., H. Faruqee, and J. Lee, 2005, “A Fair Exchange? Theory and Practice of Calculating Underlying Exchange Rate Trends,” IMF Working Paper 05/229 (Washington, DC: International Monetary Fund).
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Cashin, P., and P. Rodriguez, 2004, “Competitiveness in the ECCU: Measures of the Real Exchange Rate,” Eastern Caribbean Currency Union: Selected Issues, IMF Country Report No. 04/335 (Washington DC: International Monetary Fund), pp. 56–64.
Chen, Y., and K. Rogoff, 2003, “Commodity Currencies and Empirical Exchange Rate Puzzles,” Journal of International Economics, Vol. 60, pp. 133–60.
Chinn, M., and E. Prasad, 2003, “Medium-Term Determinants of Current Accounts in Industrial and Developing Countries: An Empirical Exploration,” Journal of International Economics, Vol. 59, pp. 47–76.
Di Bella, G., M. Lewis, and A. Martin 2007, “Assessing Competitiveness and Real Exchange Rate Misalignment in Low-Income Countries,” IMF Working Paper WP/07/201, (Washington DC: International Monetary Fund:).
Froot, K., and K. Rogoff, 1995, “Perspectives on PPP and Long-Run Real Exchange Rates,” in Handbook of International Economics, Vol. 3, ed. by Gene Grossman and Kenneth Rogoff (Amsterdam: Elsevier), pp. 1647–88.
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Williamson, J., 1994, “Estimates of FEERs”, in Estimating Equilibrium Exchange Rates, ed. by J. Williamson (Washington DC: Institute for International Economics), pp. 177–243.
The ECCU consists of six Fund-member countries (Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines) and two territories of the United Kingdom (Anguilla and Montserrat).
Prepared by Emilio Pineda and Paul Cashin.
The EC dollar has been pegged to the U.S. dollar at a rate of EC$2.7 per US$1 since 1976 in the context of a quasi-currency board arrangement.
According to staff analysis by the Consultative Group on Exchange Rates (CGER) as of July 2007, further real effective dollar depreciation of 10–30 percent would be required to eliminate the misalignment relative to medium-term macroeconomic fundamentals. See United States—Staff Report for the 2007 Article IV Consultation (IMF Country Report No. 07/264).
Since the ECCU economies are dominated by tourism, it is of interest to analyze the evolution of the real exchange rate against some key tourism customers and competitors. These measures are variants of the traditional real effective exchange rate index calculated by the IMF. 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.). 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.
Estimates of the equilibrium REER are sensitive to the methodology used, and are particularly challenging in developing countries where the data are relatively weak (see Di Bella and others, 2007).
Other countries—such as Antigua and Barbuda or Barbados—were used as benchmarks with similar results.
The fundamentals can exhibit a substantial degree of “noise” or fluctuations. To ameliorate the impact of these fluctuations we applied a Hodrick-Prescott filter with a smoothing factor of 10.
As shown in the Appendix, net foreign assets and population growth were statistically insignificant.
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.
Following Bayoumi and others (2005), we defined tourism-dependent countries as those where tourism exports exceeded a threshold of 20 percent of total exports. Bayoumi and others (2005) find 29 tourismdependent countries; however, given the lack of tourist arrivals time-series for seven of them, we were left with the following 22 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, Uganda, and Vanuatu.
Our finding that the real exchange rate in the 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 it is plausible to assume that over finite samples real exchange rates are stationary.