Basis concepts of real exchange rate and trade elasticity

Chapter 2: LITERATURE REVIEW

2.1. BASIS CONCEPT

This subdivision will bespeak footing constructs of existent exchange rate and trade snap ( exports and imports snap ) .

2.1.1. Real exchange rate

Most people are familiar with nominal exchange rate, the monetary value of one state ‘s currency in footings of another’s. It is sometimes non clear from Vietnamese literature precisely how to cipher existent ER. Its informations in assorted literatures are frequently inconsistent with each other. Hence, it is deserving clear uping its definition in the paper.

Theoretically, there are two chief ways to specify existent ER. First, it can be defined in external footings as the nominal ER adjusted for monetary value degree differences between states ( that is, as the ratio of the aggregative foreign monetary value degree to the place country’s aggregative monetary value degree in a common currency ) . Second, it can be defined in internal footings as the ratio of the domestic monetary value of tradable to non-tradable goods within a individual state.

Although defined in different ways, existent Erbium in both external and internal footings can be used to pull illation about a state ‘s fight. However, in pattern the former definition is used more frequently.

Harmonizing to the formal method adopted by the IMF, existent ER is derived in external footings as follows:

In which NER is Nominal ER.

Following this method, Bilateral Real ER between VND ( Vietnamese currency ) and USD is calculated as follows:

( ** )

However, BRER merely captures alterations in monetary value index of the US and Vietnam, but non of all of import trade-partner states of Vietnam, therefore it is unable to reflect the full consequence of ER on trade. To rectify for this defect, Multilateral Real ER ( besides referred as Real Effective ER ) is developed as follows:

( *** )

Where NERi is nominal ER of VND over currency of state I, Wi, Pi are trade-based weight and monetary value index of state I, and P is monetary value index of Vietnam.

MRER is considered the most dependable step of existent ER for ER policy appraisal ( Nguyen Hoai Bao, 2002 ) . Fortunately, we have such informations on quarterly footing ; therefore, we take expression ( *** ) for computation of existent ER. In this expression, we use nominal ER of VND against currency of state I, trade based weight and consumer monetary value index ( CPI ) of 15 most of import trading spouse states of Vietnam since the most of trade public presentation are do with these spouse states and the consumer monetary value index might partially ( non wholly ) reflect motions in the universe monetary value. Therefore, the expression might stand for the motion of existent ER.

2.1.2. Exports and imports snap

Elasticity is a step ofa variable ‘s sensitiveness to a alteration in another variable. In this paper, to look into the magnitude of impact of alterations in existent exchange rate on alterations in exports and imports, we measure the ratio of the per centum alteration of exports and imports to the per centum alteration of existent exchange rate.

Denotes X is exports, IM is imports and E is exchange rate, we have export snap ( denote by B ) and import snap ( denote by b’ ) in response of exchange rate as followers:

Export snap = B =

When difference— – & A ; gt ; 0, B =. Therefore, the theoretical account for export snap can show as: ln ( X ) = a + bln ( E ) +where a andis fixed coefficient and remainders.

Similarly for import snap:

Import snap = b’ =

When difference— – & A ; gt ; 0, b’ =. Therefore, the theoretical account for export snap can show as: ln ( IM ) = a’ + b’ln ( E ) +’ where a’ and’ is fixed coefficient and remainders.

2.2. EMPIRICAL REVIEW

To look into the magnitude of impact of alterations in existent exchange rate on alterations in imports and exports, most international literature uses the term trade snap, or more specifically, export and import snap. For ciphering the snap of explanatory variables, the Error-Correction Mechanism method ( ECM ) is applied widely in international literature, viz. Bayoumi ( 1996 ) , Wren-Lewis et Al ( 1998 ) , Lord ( 2002 ) , etc. The ECM method is a really utile econometric tool for quantifying short-term and long-term effects of explanatory variables on the dependent variables utilizing time-series informations. In peculiar, in the above literature, the method is used to measure the short-term and long-term impacts of existent exchange rate on export and import volumes. The method assumes that the short-term consequence occurs when the economic system is still in “disequilibrium, ” and that the consequence will go the long-term 1 as the economic system moves to “equilibrium” province.

In Vietnam, the comparative surveies of Exchange rate issues appear in early 1990s with the argument of VND devaluation. Among these surveies, some has simply described the ER government in Vietnam with some commentary ( for illustration, SBVN ( 1995-1998 ) , World Bank ( 1997 ) ) . The others which used quantitative method in research can be listed as: Le Viet Duc and Tran Thu Hang ( 1995 ) , Pham Chi Quang and Nguyen Viet Cuong ( 1999 ) who used one-year time-series informations to research the possible impact of devaluation on the trade balance by look intoing the Marshall-Learner status ; Ngo Huy Duc ( 1997 ) and Vo Tri Thanh ( 1996 and 1997 ) accessed the impact of existent ER on industrial end product and rising prices. In 2000, Vo Tri Thanh, Dinh Hien Minh, Do Xuan Truong, Hoang Van Thanh and Pham Chi Quang ( Vo Tri Thanh is principle research worker ) had a general research on ER in Vietnam by which given an overall image of the ER agreement and associate policies every bit good as examined the ER’s interrelatedness with and its impacts on the chief macroeconomic variables in the context of economic reforms in Vietnam during 1990s. For him, the research on impact of ER on exports and imports in the first phase gap of Vietnam has a batch of uncertainties about the relevancy. In this phase, the figure one-year time-series informations point are frequently little so crisp additions in trade can mostly be explained by the gap of the economic system and enlargement of external markets over the reform period. The construction of trade besides impact on trade than the impact of ER. However, he besides agree that existent ER has important impact on trade through many other channels, e.g. factors of production ( capital and labor ) , investings.

Le Viet Duc et Al ( 2002 ) used arrested development theoretical account to gauging the relationship between export and devaluation in Vietnam with the one-year information from 1991 to 2000. His probe shows that devaluations from 1991 to day of the month significantly impacted export within one twelvemonth. Based on these simulation consequences, he argues that if the major spouse states do non accomplish the same growing degree as before the Asiatic crisis in 1997, Vietnam should devalue its currency by 50 % in order to hold export growing of 32 % per twelvemonth for the economic system to turn at 8 % per twelvemonth.

Lord ( 2002 ) besides used ECM to analyse the effects of existent exchange rate alteration on footwear exports of Vietnam. His arrested development consequences indicate that the consequence of existent exchange rate on Vietnam’s footwear export demand is statistically important in planetary market and figure of regional markets. The existent exchange rate snap of demand for exports in the planetary market is equal to -1.8 in the short-term and -2.0 in the long-run. In the short-run, the existent ER snap ranges from -0.1 in the ASEAN-5 market to -0.3 in the US market, while in the long-term it ranges from -0.4 in the US market to -1.9 in the EU market. Lord shows that while existent ER motions in recent old ages would by and large propose a modest impairment in Vietnam ‘s international fight, a more appropriate index of fight is the existent cross-rates of Vietnam with its major trading spouses. Using this index, Lord finds that Vietnam ‘s fight in the last few old ages has improved in the Chinese market and, to a lesser extent, in that of the US, while its fight in the markets of ASEAN, Japan and the European Union has worsened. The loss of fight in the European market is the effect of the grasp of the dollar relation to the Euro and the close association of the dong with the US dollar.

Nguyen Chien Thang ( 2002 ) used ECM to measure the impact of existent exchange rate on Vietnam export public presentation, with the quarterly informations from 1992 to 2001. In his paper, he besides used the Bilateral Real ER ( BRER ) between VND and USD attack on ciphering existent exchange rate in which export monetary value index represented the United State of America’s monetary value index and Vietnam’s consumer monetary value index represented domestic monetary value index. His probe shows that existent exchange rate affected export volumes with snap is 2.07 for short-run and 1.13 for long-run. The statistically significance for the snap were 1 per centum degree and 10 per centum degree severally. Based on these consequences he argued that the devaluation of VND against USD by the province bank in that period was effectual to extent in bettering exports. However, he seems keep cautious position in the devaluation of VND.

Other surveies besides analyzed Vietnam ‘s existent ER impact on trade in general and on exports in peculiar, such as the surveies of Nguyen Thi Thu ( 2000 ) , Vu Hung Cuong ( 1996 ) , Minh Hue ( 1996 ) , Nguyen Thi Hien ( 1995 ) , etc. However, these research workers do non supply a strong quantitative appraisal of the likely impact of existent ER on export public presentation.

Some research theses of of last MDE’s pupils ( category 4, 10 ) that touched this subject such as Dinh Mai Huong –MDE4, Nguyen Do Quyen – MDE10 and Ta Nhu Phong – MDE10. However, these theses merely investigated the impact of exchange rate policy in general Vietnam’s economic sciences exclusion thesis of Nguyen Mai Huong – MDE4. Nguyen Do Quyen – MDE10 used the alterations in foreign exchange direction to measure the openness of the economic system in Vietnam during 1989-2004 ; Ta Nh?° Phong – MDE10 analysis the foreign exchange market and involvement para status in Vietnam. Nguyen Mai Huong – MDE4 used the Microfit Package to look into the relationship of exchange rate with balance trade in period 1989-1998. In her thesis, existent exchange rate was used non merely nominal exchange rate, but besides two other existent exchange rates BRER and MRER. By utilizing additive map and indirectly computation, her probe shows that MRER affected export and import volumes with snap is 1.25 and 0.86 for long-run. She argued that although the amount of snap indexes of exports and imports to MRER is higher than integrity, the Marshall-Lerner status does keep. The consequences are utile in mentioning as a methodological analysis instead the finding of the relationship between exchange rate and balance trade.

Since the survey by Lord ( 2002 ) and Nguyen Chien Thang ( 2002 ) utilizing ECM theoretical account in empirical analysis, no survey on the subject for the instance of Vietnam has used the method. Furthermore, other domestic comparative surveies since to day of the month did non updated the clip series informations and cover specifically with the export side instead than overall trade ( One special survey was “Analysis the impact of exchange rate volatility ( USD and EUR ) to Vietnam’s export performance” – the ministry degree undertaking research survey by Dr. Nguyen Thi Quy ( Vice Chancellor – Vietnam University of Foreign Trade, president of scientific undertaking research survey from 2006-2008 ) . Thus the writer would be interesting to use the method in this paper.