url
28
Nov
2013

Performance of CHEERs Based Equilibrium Exchange Rate of Pakistan: Data Analysis

Performance of CHEERs Based Equilibrium Exchange Rate of Pakistan: Data Analysis7. Contribution & Policy Implications

This paper built on the CHEERS model for the Exchange Rate which was not tested for Pakistan economy especially considering that it takes time for the people to respond to price and interest rate opportunities using a lag between dependent and independent variable, while proving that the RMSE method to test forecast is not ideal when there is already disequilibrium, a second best strategy was tried that can check the forecast ability.
Although significant long run relationship is present between the capital and goods market, still the slow convergence shows that these markets might not have independent role in shaping the Exchange Rate of the country. The capital markets should be made stronger as compared to the US market in order to have any power to move or control the Exchange Rate between Pakistan and USA.
The results represented that the Prices in the goods market of Pakistan and USA have highly elastic effect on the change (devaluation/evaluation) of the currency in next time period respectively. Hence in order to avoid further depreciation of the currency, the rising speed of the prices in Pakistan should be slowed down as the Inflation in USA is considerably lower hence it is not sensible to expect that to rise and appreciate Exchange Rate of Pakistan.

8. Conclusion

A co-integrated relationship among PPP, UIP and the nominal Exchange Rate of Pakistan/USA found out to be successful in available data range, shows that this PPP and UIP coordinated framework works well as a foundation for any expanded model that can increase the convergence speed of the equilibrium. The results revealed that any increase in the Prices and Interest rate of Pakistan as compared to the Prices and Interest rate of USA translated directly to the increase in the Exchange Rate, hence in response to any arbitrage opportunity the individuals in Goods and Capital market become active to shift their currency in terms of the country where the Good are cheaper or the returns are higher respectively.
The results of rank test and the VECM stability test shows that there was only one equilibrium, which was not very stable and slow converging, suggesting that there is some part of the Exchange Rate pattern that is missing. The non- normality of the variables, also suggested that there might be some non-economic events that altered the course of the relationship.
Several papers corresponding to (Frenkel, J. A. 1976) found that monetary and output differential increases the convergence power of the model, but due the data constraints for the case of Pakistan, this paper only focused on the Performance of CHEERs bases Exchange Rate Model.
The forecasting performance tested against the RW model, may cause misleading results as both set of models include different conditions, it would be better to compare the performance of this CHEERs model with some other similar model

7. Contribution & Policy Implications This paper built on the CHEERS model for the Exchange Rate which was not tested for Pakistan economy especially considering that it takes time for the people to respond to price and interest rate opportunities using a lag between dependent and independent variable, while proving that the RMSE method to test forecast is not ideal when there is already disequilibrium, a second best strategy was tried that can check the forecast ability. Although significant long run relationship is present between the capital and goods market, still the slow convergence shows that these markets might not have independent role in shaping the Exchange Rate of the country. The capital markets should be made stronger as compared

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Kevin J. Brandon

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