EXCHANGE RATE POLICIES, PRICES AND SUPPLY-SIDE RESPONSE

EXCHANGE RATE POLICIES, PRICES AND SUPPLY-SIDE RESPONSE

Also by Eric J. Pentecost EXCHANGE RATE DYNAMICS THE MACROECONOMICS OF INTERNATIONAL CURRENCIES (with Paul Mizen) REGIONAL ECONOMIC PERFORMANCE WITHIN THE EUROPEAN UNION (with K.J. Button) MACROECONOMICS: An Open Economy Approach

Exchange Rate Policies, Prices and Supply-Side Response A Study of Transitional Economies Edited by Christos Papazoglou and Eric J. Pentecost

* SeLection and editoral matter Christos PapazogLou and Eric J. Pentecost 2001 Softcover reprint of the hardcover 1st edition 2001 978-0-333-79457-9 ALL rights reserved. No reproduction. copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced. copied or transmitted save with written permission or in accordance with the provisions of the Copyright. Designs and Patents Act 1988. or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency. 90 Tottenham Court Road. London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be LiabLe to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright. Designs and Patents Act 1988. Published by PALGRAVE MACMILLAN HoundmilLs. Basingstoke. Hampshire RG21 6XS and 175 Fifth Avenue. New York. N. Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the PaLgrave Macmillan division of St. Martin's Press. LLC and of PaLgrave Macmillan Ltd1 MacmilLan is a registered trademark in the United States. United Kingdon and other countries. PaLgrave is a registered trademark in the European Union and other countries. ISBN 978-1-349-42020-9 ISBN 978-0-230-55453-5 (ebook) DOI 10.1057/9780230554535 This book is printed on paper suitable for recycling and made from fully : managed and sustained forest sources. Logging. pulping and manufacturin@ processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress CataLog Card Number: 2001027368

Contents List oftables List offigures Acknowledgements List ofcontributors vii viii x xi Introduction: Issues, Structure and Policy Recommendations Christos Papazoglou and Eric J. Pentecost Part I The Theoretical Framework 9 2 Output Dynamics in Transition Economies under Alternative Exchange Rate Regimes Christos Papazoglou and Eric J. Pentecost 3 Currency Options and Trade Smoothing under an Exchange Rate Regime Shift Alexis Dervi; 11 24 Part II Comparative Studies 4 Exchange Rate Policy and Output Growth in Transition Economies: The Experience of Bulgaria, the Czech Republic, Poland and Slovenia 57 Christos Papazoglou 5 The Real Exchange Rate and the Output Response in Four Transition Economies: A Panel Data Study 68 Aleda Mitchell and Eric J. Pentecost 6 The Exchange Rate, Prices and the Supply Response under Transition: A Simulation Study 78 Pavlos Karadeloglou with George Chobanov, Ales Delakorda, Wladyslaw Milo and Piotr Wdowinski 55 v

vi Contents Part III Country Studies 7 Price and Output Dynamics under a Currency Board: The Case of Bulgaria George Chobanov and Eric J. Pentecost 8 Exchange Rates and the Supply Response in the Czech Republic: Is PPP a Relevant Rule for Assessing the Equilibrium? 104 Vladimir Benacek 9 Exchange Rate and the Price Response in the Czech Republic 122 Jan Hosek 10 Economic Performance in Poland under Fixed and Flexible Exchange Rate Regimes 140 Piotr Wdowinski and Bas van Aarle 11 Supply and Price Effects of Monetary and Fiscal Policy in Poland under Transition: An Econometric Analysis 157 Wladyslaw Milo, Urszula Ciesluk and Aneta Zglinska-Pietrzak 12 The Determination of the Real Exchange Rate and its Effects on Output and Prices in Slovenia 166 Bastjan Jarbec, Ales Delakorda and Vladimir Lavrac 89 91 References 188 Author Index 196 Subject Index 199

List of Tables 4.1 5.1 5.2 5.3 6.1 6.2 6.3 7.1 7.2 8.1 8.2 10.1 A10.1 11.1 11.2 A11.1 All.2 A11.3 12.1 Empirical results Alternative dynamic models Model selection tests Short-run and long-run coefficients and country fixed effects GDP equation Wage equation Price equation Bulgarian macroeconomic statistics, 1993-99 Macroeconomic correlation coefficients for Bulgaria Selected macroeconomic indicators for the Czech Republic, 1989-99 The exchange rate deviation index and balance of trade of Czechia Parameters of the model The sensitivity analysis of the determinant, trace and eigenvalues (percentage change with respect to the base scenario) Names of variables Unit-root tests for stationarity Prognoses of CPI Prognoses of GNP Prognoses of unemployment Simulation of diagnostic statistics 66 74 75 75 84 85 85 92 93 106 112 146 156 159 160 165 165 165 179 vii

List of Figures 2.1 Model stability 15 2.2 A fall in core inflation 16 2.3 A rise in v: financial liberalization shock 17 2.4 A fall in the money wage (rise in productivity) 18 2.5 Stability with floating rates 19 2.6 A fall in core inflation 20 2.7 A rise in v: financial liberalization shock 21 3.1 The Czech koruna exchange rate with respect to the currency basket 26 3.2 Supply and demand in the market for currency calls 47 3.3 Equilibria in the imported-goods market with and without currency-call utilization 52 4.1 Poland: macroeconomic indicators 60 4.2 The Czech Republic: macroeconomic indicators 61 4.3 Slovenia: macroeconomic indicators 62 4.4 Bulgaria: macroeconomic indicators 63 6.1 The interaction between exchange rate and output 81 6.2 Devaluation by 5%, impact on GDP 86 6.3 Devaluation by 50/0, impact on wages 86 6.4 Devaluation by 5%, impact on prices 87 7.1 The stability of the model 97 7.2 A rise in output (or fall in government spending) 98 7.3 The dynamics of a foreign price rise 98 7.4 The stability in the supply-side model 101 7.5 The effect of a rise in output due to the liberalization of production 102 7.6 A trade balance shock 102 8.1 The stylized facts describing the hypothetical trajectory of the Czech real exchange rate 108 8.2 Balance of trade as a function of ERDI 114 viii

List offigures IX 8.3 Change in the balance of trade as a function of the changes in real exchange rates 116 8.4 Net exports weighted by the turnover of trade taken as a function of ERDI 119 9.1 Simulation time profile 132 10.1 Effects of a decrease in government spending 147 10.2 Effects of an increase of total credit 147 10.3 Effects of a decrease in the ED interest rate 148 10.4 Effects of an increase in the EU price level 148 12.1 Percentage change of industrial production 180 12.2 Percentage change of imports (DIFIM) and exports (DIFIZ) 181 12.3 Percentage point in prices of non-tradable (DIFCPIST), tradables (DIFCPIBL) and (DIFCPI) 181

Acknowledgements The papers in this volume are a selection of the research output from ACE/Phare research project No. P96-6176-R, 'Exchange Rate Policies, Prices and the Supply Response under Transition'. We are grateful to the European Commission for funding this research and for the hospitality provided by the hosts of the four workshop meetings held in Athens, Ljubljana, Rethymno and Prague. The editors also wish to thank Mrs Denise Simpson for secretarial and administrative support. CHRISTOS PAPAZOGLOU ERIC J. PENTECOST x

List of Contributors Vladimir Benacek is Associate Professor, Charles University, Prague, Czech Republic. George Chobanov is Dean of the Faculty of Economics and Business, St Kliment Ohridski University, Sofia, Bulgaria. Urszula Ciesluk is a member of the Department of Econometrics, University of Lodz, Lodz, Poland. Ales Delakorda works at the Bank of Slovenia, Ljubljana, Slovenia. Alexis Derviz works at the Czech National Bank, Prague, Czech Republic. Jan Hosek works for CERGE, Charles University, Prague, Czech Republic. Bostjan Jazbec is a member of the Institute for Economic Research, Ljubljana, Solvenia. Pavlos Karadeloglou works at the European Central Bank, Frankfurt, Germany. Vladimir Lavrac is a member of the Institute for Economic Research, Ljubljana, Solvenia. Wladyslaw Milo is a member of the Department of Econometrics, University of Lodz, Lodz, Poland. Aleda Mitchell was a member of the Department of Economics, Loughborough University, Loughborough, England. Christos Papazoglou is a member of the University of Crete, Rethymno and the Central Bank of Greece, Athens, Greece. Xl

xii List ofcontributors Eric J. Pentecost is a member of the Department of Economics and the Centre for International and Financial Economics Research (CIFER), Loughborough University, Loughborough, England. Bas van Aarle is a member of the Centre for Economic Studies, University of Munich, Munich, Germany. Piotr Wdowinski is a member of the Department of Econometrics, University of Lodz, Lodz, Poland. Aneta Zgtinska-Pietrzak is a member of the Department of Econometrics, University of Lodz, Lodz, Poland.