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The Real Exchange Rate Process and its Real Effects: The Cases of Mexico and the USA

Journal of Applied Economics, Vol. 7, No. 1, pp. 1-25, May 2004

Posted: 15 Nov 2004  

Kevin B. Grier

University of Oklahoma - Department of Economics

Fausto Hernandez-Trillo

Centro de Investigación y Docencia Económicas (CIDE) - Division of Economics

Abstract

Exchange rate management is a salient macroeconomic issue, especially in developing countries. In this paper, we study political economy factors that may affect the real exchange rate (RER) process and the real economic effects of the RER. We review recent literature on the effects of elections on the exchange rate, and adapt Ball's (1992) model to show that uncertainty about the future course of policy may make more appreciated RER's less predictable. We also review the literature on the real effect of RER appreciations and of RER uncertainty. We then construct a simultaneous GARCH-M model of the joint determination of the RER and output capable of testing our hypotheses simultaneously in a single model. We estimate the model using data first from Mexico, a developing country, and the US. In Mexico we find that elections significantly affect the evolution of the RER, that more appreciated RERs are less predictable, that RER depreciations lower output growth and that RER uncertainty lowers output growth, even when controlling for its wellstudied effect on trade. By contrast, none of these effects are found in the US data.

Keywords: Real exchange rate volatility, economic growth, electoral cycle

JEL Classification: F3, F4, O42

Suggested Citation

Grier, Kevin B. and Hernandez-Trillo, Fausto, The Real Exchange Rate Process and its Real Effects: The Cases of Mexico and the USA. Journal of Applied Economics, Vol. 7, No. 1, pp. 1-25, May 2004. Available at SSRN: https://ssrn.com/abstract=583981

Kevin B. Grier (Contact Author)

University of Oklahoma - Department of Economics ( email )

729 Elm Avenue
329 Hester Hall
Norman, OK 73019-2103
United States
405-325-2861 (Phone)
405-325-5842 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/G/Robin.M.Grier-1/

Fausto Hernandez-Trillo

Centro de Investigación y Docencia Económicas (CIDE) - Division of Economics ( email )

Carretera Mexico Toluca 3655
01210 Mexico, D.F.
Mexico

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