url
22
Nov
2013

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

Statistical evidence using Chi-Square in hypothesis 1 and 2 rejects the presence of PPP and UIP in isolation, this statistically rejects Hypothesis two. The failure of hypothesis 3 and 4 specifies that the nominal Exchange Rate of Pakistan is not controlled by economic activities of only one country; it is the interaction between these two countries that determine the pattern formed by the Exchange Rate.

But on the other hand, the combination of PPP and UIP with different flavors in hypothesis 6& 7 like strict PPP & loose UIP and Strict PPP and UIP, were statistically acceptable under 5% criterion. Hence the current equilibrium relationship nests the Strict PPP and Strict UIP in it results similar to conclusion of (Camarero & Tamarit, 1996) and (Juselius & MacDonald, 2004) in explaining Exchnage Rate. The acceptance of these restrictions shows that the PPP-UIP model works well inside a sample with almost unit elastic parameters. Further this PPP-UIP model will be used to estimate the Exchange Rate and compare its pattern with the actual Exchange Rate.

5.10 Equilibrium Exchange Rate and its Alignment
The pattern of the Exchange Rate given by the PPP-UIP model, seem more volatile and responsive to the differential of prices and interest rates between Pakistan and USA. The following graph (Figure 10) shows that the Estimated Exchange Rate is mostly present above the Actual Exchange Rate, and if PPP-UIP model is considered a true representative of the Exchange Rate pattern then the shaded gaps in this graph will represent the degree of misalignment of Exchange Rate.

The graph (Figure 11) of the gap between the Actual and Estimated Exchange Rate suggests that there as a little amount of convergence of the Gap to zero point but beyond the year 2000 the gap tend to deviate around the zero point.
Here the increasingly negative gap up till year 2000 means, the Actual Exchange Rate to be below the Estimated Exchange Rate hence suspecting that the Exchange Rate of Pakistan to be increasingly undervalued, due to of increasing domestic price level in Pakistan. These results are similar to (Qayyum, Khan, & Kair-u-Zaman, 2004) with presistent undervalued Exchange Rate of Pakistan.
After year 2000 this gap seems random around zero, this change may not be surprising when compared what happened around this year in the world. Around year 2000, several events happened like changing of political regime from Democratic to Dictatorship, the 9/11 incident and inclusion of Pakistan as an ally in war against terror.
The Dickey Fuller test of the gap showed that it is not random. Hence the non-stationarity (non-mean-convergence) of this gap statistically proves that the Actual Exchange Rate is not aligned with the Equilibrium Exchange Rate hence rejecting Hypothesis three.

Figure 10

Figure 10. Actual vs Eq. exchange rate

Figure 11

Figure 11. Actual and estimated

Statistical evidence using Chi-Square in hypothesis 1 and 2 rejects the presence of PPP and UIP in isolation, this statistically rejects Hypothesis two. The failure of hypothesis 3 and 4 specifies that the nominal Exchange Rate of Pakistan is not controlled by economic activities of only one country; it is the interaction between these two countries that determine the pattern formed by the Exchange Rate. But on the other hand, the combination of PPP and UIP with different flavors in hypothesis 6& 7 like strict PPP & loose UIP and Strict PPP and UIP, were statistically acceptable under 5% criterion. Hence the current equilibrium relationship nests the Strict PPP and Strict UIP in it results similar to conclusion of (Camarero

About The Author

Kevin J. Brandon

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