MACRO DETERMINANTS OF THE REAL EXCHANGE RATE IN A SMALL OPEN SMALL ISLAND ECONOMY: EVIDENCE FROM MAURITIUS VIA BMA
Keywords:
Model Uncertainty, Bayesian Model Averaging (BMA), Macro Determinants, Real Exchange Rate, Mauritius.
Abstract
We assess the robust macro determinants of the real exchange rate in Mauritius under model uncertainty by utilizing Bayesian Model Averaging (BMA). We introduce a broader range of potential macro determinants of the real exchange rate in Mauritius. Then we tackle the issue of model uncertainty when identifying these macro determinants of the real exchange rate by exploring the impact of different priors on the model size, and different priors on model coefficients on the posterior estimates. We identify the real money supply, and the real productivity to be the robust macro determinants of the real exchange rate in Mauritius. Their coefficient signs are also theoretically consistent. The real money supply impact on the real exchange rate negatively, whereas the real productivity impact on it positively. Our results remain robust to different priors on the model size, and to different priors on model coefficients.
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References
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of the Real Exchange Rate in South Africa,” in Development Issues in South
Africa, Ed. By Ibrahim Elbadawi, I., and Hartzenberg, T. (London: Macmillan).
Broda, C. (2002). Terms of Trade and Exchange Rate Regimes in Developing
Countries. Federal Reserve Bank of New York.
Brown, P., Vannucci, M., and Fearn, T. (1998). Multivariate Bayesian Variable
Selection and Prediction. Journal of the Royal Statistical Society B, 60:627–641.
Cardenas, M. (1997) La Tasa de Cambio en Colombia (Bogota: Cuadernos
Fedesarallo).
Cashin, P., Cespedes, L., and Sahay, R. (2002). Developing Country Real Exchange
Rates: How Many are Commodity Countries?. IMF Working Paper 02/223
(Washington: International Monetary Fund).
Cassel, G. (1918). Abnormal Deviations in International Exchanges. The Economic
Journal 28(112): 413-415.
Chen, Y-C., and Rogoff, K. (2002). Commodity Currencies and Empirical Exchange
Rate Puzzles. IMF Working Paper 02/27 (Washington: International Monetary
Fund).
Chipman, H. (1996). Bayesian Variable Selection with Related Predictors. Canadian
Journal of Statistics, 24:17–36.
Chipman, H., George, E., and McCulloch, R. (2001). The Practical Implementation
of Bayesian Model Selection. Institute of Mathematical Statistics Lecture Notes
Monograph Series Vol. 38. Beachwood, Ohio.
Ciccone, A., and Jarociński, M. (2010). Determinants of Economic Growth: Will
Data Tell?. American Economic Journal: Macroeconomics, 2(4): 222-246.
Clark, P.B. and R. MacDonald. (1999). “Exchange Rates and Economic Fundamentals:
A Methodological Comparison of BEERs and FEERs” in R. MacDonald and J Stein
(eds) Equilibrium Exchange Rates, Kluwer: Amsterdam. And IMF Working
Paper 98/67 (Washington: International Monetary Fund, March 1998)
Crespo Cuaresma, J., Doppelhofer, G., and Feldkircher, M. (2014). The Determinants
of Economic Growth in European Regions. Regional Studies 48(1): 44-67.
De Gregorio, J., Giovannini, A., and Wolf, H. (1994). International Evidence on
Tradables and Nontradables Inflation. European Economic Review 38:1225-44.
Detken, C., Dieppe, A., Henry, J., Smets, F., and Marin, C. (2002). Determinants
of the Effective Real Exchange Rate of the Synthetic Euro: Alternative
Methodological Approaches. Australian Economic Papers 41(4): 404-436.
Driver, R., and Wren-Lewis, S. (1997). Real Exchange Rates in the Year 200
(Washington: Institute for International Economics).
Drine, I., and Rault, C. (2015). “Learning about the Long-Run Determinants of Real
Exchange Rates for Developing Countries: A Panel Data Investigation” in Panel
Data Econometrics Theoretical Contributions and Empirical Applications 307-
325.
Edwards, S. (1993). Openness, Trade Liberalization, and Growth in Developing
Countries. Journal of Economic Literature 31 (3):1358–1393.
Edwards, S. (1994). “Real Monetary Determinants of Real Exchange Rate Behavior:
Theory and Evidence from Developing Countries,” in Estimating Equilibrium
Exchange Rates, ed. by J. Williamson (Washington: Institute for International
Economics).
Elbadawi, I., and Soto, R. (1994). Capital Flows and Long-Term Equilibrium Real Exchange Rates: Chile (Unpublished, Washington: World Bank).
Eicher, T. S. and Papageorgiou, C., and Raftery, A. E. (2011). Default priors and
predictive performance in Bayesian model averaging, with application to
growth determinants. Journal of Applied Econometrics 26(1): 30-55.
Faruqee, H. (1995). Long-Run Determinants of the Real Exchange Rate: A Stock-
Flow Perspective. IMF Staff Papers, Palgrave Macmillan, 42(1): 80-107.
Feldkircher, M. (2012). Forecast Combination and Bayesian Model Averaging: A
Prior Sensitivity Analysis. Journal of Forecasting, 31(4): 361-376.
Feldkircher, M. and Zeugner, S. (2015). Bayesian Model Averaging Employing
Fixed and Flexible Priors: The BMS Package for R. Journal of Statistical Software
68(4).
Fernández, C., Ley, E., and Steel, M. F. (2001). Benchmark Priors for Bayesian
Model Averaging. Journal of Econometrics, 100:381–427.
Foster, D. P., and George, E. I. (1994). The Risk Inflation Criterion for Multiple
Regression. The Annals of Statistics, 22:1947-1975.
Frankel, J. (1995). Monetary Regime Choice for a Semi-Open Country, in Capital
Controls, Exchange Rates and Monetary Policy in the World Economy, edited
by Sebastian Edwards, (Cambridge, England: Cambridge University Press).
GEM Commodities. (2014). http://data.worldbank.org/data-catalog/commodityprice-
data.
George, E. I. (2010). Dilution Priors: Compensating for Model Space Redundancy.”
In Berger, J. O., Cai, T. T., and Johnstone, I. M. (eds.), Borrowing Strength:
Theory Powering Applications, Festschrift for Lawrence D. Brown, Volume
6 of Collections, pp. 158-165. Institute of Mathematical Statistics, Beachwood,
Ohio, USA.
George, E. I., and Foster, D. P. (2000). Calibration and Empirical Bayes Variable
Selection. Biometrika, 87(4), 731-747.
Ghei, N., and Pritchett, L. (1999). “The Three Pessimisms: Real Exchange Rates
and Trade Flows in Developing Countries,” in Exchange Rate Misalignment:
Concepts and Measurement for Developing Countries, ed. by L. Hinkle and P.
Montiel (New York: Oxford University Press for the World Bank).
Goldfajn, I., and Valdes, R. (1999). The Aftermath of Appreciations. Quarterly
Journal of Economics. Vol. 114 (February), Pp. 229–62.
Hansen, M. H., and Yu, B. (2001). Model Selection and the Principle of Minimum
Description Length. Journal of the American Statistical Association, 96(454): 746-
774.
Hinkle, L., and Montiel, P. J. (1999). Estimating Equilibrium Real Exchange Rates
in Developing Countries (New York: Oxford University Press for the World
Bank).
Hoeting, J. A., Madigan, D., Raftery, A. E., and Volinsky, C. T. (1999). Bayesian
Model Averaging: A Tutorial. Statistical Science, 14, No. 4:382–417.
Imam, P. and Minoiu, C. (2011). The Equilibrium Exchange Rate of Mauritius:
Evidence from Two Structural Models. Emerging Markets Finance & Trade /
November–December 2011, Vol. 47, No. 6, pp. 134–147.
IMF. (2008). Mauritius: Selected Issues. IMF Country Report No. 08/237, The
International Monetary Fund. Washington DC.
Kass, R. and Raftery, A. (1995). Bayes Factors. Journal of the American Statistical
Association, 90:773–795.
Khan, M. S., and Ostry, J. D. (1991). Response of the Equilibrium Real Exchange
Rate to Real Disturbances in Developing Countries. IMF Working Papers 91/3
International Monetary Fund.
Kia, A. (2013). Determinants of the Real Exchange Rate in a Small Open Economy:
Evidence from Canada. Journal of International Financial Markets, Institutions &
Money 23(1): 163-178.
Lane, P. R., and Milesi-Ferretti, G. M. (2000). Long-Term Capital Movements. NBER
Working Paper No. 8366 (Cambridge, MA: National Bureau of Economic
Research).
Lee, J., G. M. Milesi-Ferretti, J. Ostry, A. Prati, and Ricci, L. A. (2008). Exchange
Rate Assessments: CGER Methodologies. IMF Occasional Paper No. 261
(Washington: International Monetary Fund).
LeSage, J. P. and Parent, O. (2007). Bayesian Model Averaging for Spatial
Econometric Models. Geographical Analysis, 39:3:241–267.
Ley, E. and Steel, M. F. (2009). On the Effect of Prior Assumptions in Bayesian
Model Averaging with Applications to Growth Regressions. Journal of Applied
Econometrics, 24:4:651–674.
Liang, F., Paulo, R., Molina, G., Clyde, M. A., Berger J. O. (2008). Mixtures of g Priors
for Bayesian Variable Selection. Journal of the American Statistical Association,
103(481): 410-423.
Loayza, N., and Lopez, H. J. (1997). Misalignment and Fundamentals: Equilibrium
Exchange Rates in Seven Latin American Countries (Unpublished, Washington:
World Bank).
MacDonald, R. (1995). Long-run Exchange Rate Modeling: A Survey of Recent
Evidence. Staff Papers, International Monetary Fund, Vol. 42 (September), pp.
437–98.
MacDonald, R., and Ricci, L. (2003). Estimation of the Equilibrium Real Exchange
Rate for South Africa. IMF Working Paper No. 44 (Washington: International
Monetary Fund).
McKinnon, R. I. (1963). Optimum Currency Areas. American Economic Review 53(4):
717-725.
Montiel, P. J. (1997). “Exchange Rate Policies and Macroeconomic Management in
ASEAN Countries,” in Macroeconomic Issues Facing ASEAN Countries, ed.
by J. Hicklin, Robinson, D., and Singh, A. (Washington: International Monetary
Fund).
Montiel, P. J. (1999). “Determinants of the Long-Run Equilibrium Real Exchange
Rate: An Analytical Model,” in Exchange Rate Misalignment: Concepts and
Measurement for Developing Countries, ed. by L. Hinkle and P. Montiel (New
York: Oxford University Press for the World Bank).
Mundell, R. (1961). A Theory of Optimum Currency Areas. American Economic
Review, Vol. 51 (September) pp. 627-65.
Ostry, J. D. (1988). The Balance of Trade, Terms of Trade, and Real Exchange Rate:
An Intertemporal Optimizing Framework, Staff Papers, International Monetary
Fund, 35: 541-73.
Reinhart, C. M., and Rogoff, K. S. (2004). The Modern History of Exchange Rate
Arrangements: A Reinterpretation. Quarterly Journal of Economics 119(1). 1-48.
Sala-i-Martin, X., Doppelhofer, G., and Miller, R. I. (2004). Determinants of Long-
Term Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach.
American Economic Review, 94:813–835.
Stein, J. L., P. R. Allen, and Associates. (1995). Fundamental Determinants of
Exchange Rates. (Oxford, England: Oxford University Press, Clarendon).
Stephens, M. (2000). Bayesian Analysis of Mixture Models with an Unknown
Number of Components – An Alternative to Reversible Jump Methods. Annals
of Statistics 28: 40-74.
Williamson, J. (1994). Estimating Equilibrium Exchange Rates (Washington:
Institute for International Economics).
Zellner, A. (1986). Bayesian Inference and Decision Techniques: Essays in Honor
of Bruno de Finetti, chapter On Assessing Prior Distributions and Bayesian
Regression Analysis with g-Prior Distributions. North-Holland: Amsterdam.
of the Real Exchange Rate in South Africa,” in Development Issues in South
Africa, Ed. By Ibrahim Elbadawi, I., and Hartzenberg, T. (London: Macmillan).
Broda, C. (2002). Terms of Trade and Exchange Rate Regimes in Developing
Countries. Federal Reserve Bank of New York.
Brown, P., Vannucci, M., and Fearn, T. (1998). Multivariate Bayesian Variable
Selection and Prediction. Journal of the Royal Statistical Society B, 60:627–641.
Cardenas, M. (1997) La Tasa de Cambio en Colombia (Bogota: Cuadernos
Fedesarallo).
Cashin, P., Cespedes, L., and Sahay, R. (2002). Developing Country Real Exchange
Rates: How Many are Commodity Countries?. IMF Working Paper 02/223
(Washington: International Monetary Fund).
Cassel, G. (1918). Abnormal Deviations in International Exchanges. The Economic
Journal 28(112): 413-415.
Chen, Y-C., and Rogoff, K. (2002). Commodity Currencies and Empirical Exchange
Rate Puzzles. IMF Working Paper 02/27 (Washington: International Monetary
Fund).
Chipman, H. (1996). Bayesian Variable Selection with Related Predictors. Canadian
Journal of Statistics, 24:17–36.
Chipman, H., George, E., and McCulloch, R. (2001). The Practical Implementation
of Bayesian Model Selection. Institute of Mathematical Statistics Lecture Notes
Monograph Series Vol. 38. Beachwood, Ohio.
Ciccone, A., and Jarociński, M. (2010). Determinants of Economic Growth: Will
Data Tell?. American Economic Journal: Macroeconomics, 2(4): 222-246.
Clark, P.B. and R. MacDonald. (1999). “Exchange Rates and Economic Fundamentals:
A Methodological Comparison of BEERs and FEERs” in R. MacDonald and J Stein
(eds) Equilibrium Exchange Rates, Kluwer: Amsterdam. And IMF Working
Paper 98/67 (Washington: International Monetary Fund, March 1998)
Crespo Cuaresma, J., Doppelhofer, G., and Feldkircher, M. (2014). The Determinants
of Economic Growth in European Regions. Regional Studies 48(1): 44-67.
De Gregorio, J., Giovannini, A., and Wolf, H. (1994). International Evidence on
Tradables and Nontradables Inflation. European Economic Review 38:1225-44.
Detken, C., Dieppe, A., Henry, J., Smets, F., and Marin, C. (2002). Determinants
of the Effective Real Exchange Rate of the Synthetic Euro: Alternative
Methodological Approaches. Australian Economic Papers 41(4): 404-436.
Driver, R., and Wren-Lewis, S. (1997). Real Exchange Rates in the Year 200
(Washington: Institute for International Economics).
Drine, I., and Rault, C. (2015). “Learning about the Long-Run Determinants of Real
Exchange Rates for Developing Countries: A Panel Data Investigation” in Panel
Data Econometrics Theoretical Contributions and Empirical Applications 307-
325.
Edwards, S. (1993). Openness, Trade Liberalization, and Growth in Developing
Countries. Journal of Economic Literature 31 (3):1358–1393.
Edwards, S. (1994). “Real Monetary Determinants of Real Exchange Rate Behavior:
Theory and Evidence from Developing Countries,” in Estimating Equilibrium
Exchange Rates, ed. by J. Williamson (Washington: Institute for International
Economics).
Elbadawi, I., and Soto, R. (1994). Capital Flows and Long-Term Equilibrium Real Exchange Rates: Chile (Unpublished, Washington: World Bank).
Eicher, T. S. and Papageorgiou, C., and Raftery, A. E. (2011). Default priors and
predictive performance in Bayesian model averaging, with application to
growth determinants. Journal of Applied Econometrics 26(1): 30-55.
Faruqee, H. (1995). Long-Run Determinants of the Real Exchange Rate: A Stock-
Flow Perspective. IMF Staff Papers, Palgrave Macmillan, 42(1): 80-107.
Feldkircher, M. (2012). Forecast Combination and Bayesian Model Averaging: A
Prior Sensitivity Analysis. Journal of Forecasting, 31(4): 361-376.
Feldkircher, M. and Zeugner, S. (2015). Bayesian Model Averaging Employing
Fixed and Flexible Priors: The BMS Package for R. Journal of Statistical Software
68(4).
Fernández, C., Ley, E., and Steel, M. F. (2001). Benchmark Priors for Bayesian
Model Averaging. Journal of Econometrics, 100:381–427.
Foster, D. P., and George, E. I. (1994). The Risk Inflation Criterion for Multiple
Regression. The Annals of Statistics, 22:1947-1975.
Frankel, J. (1995). Monetary Regime Choice for a Semi-Open Country, in Capital
Controls, Exchange Rates and Monetary Policy in the World Economy, edited
by Sebastian Edwards, (Cambridge, England: Cambridge University Press).
GEM Commodities. (2014). http://data.worldbank.org/data-catalog/commodityprice-
data.
George, E. I. (2010). Dilution Priors: Compensating for Model Space Redundancy.”
In Berger, J. O., Cai, T. T., and Johnstone, I. M. (eds.), Borrowing Strength:
Theory Powering Applications, Festschrift for Lawrence D. Brown, Volume
6 of Collections, pp. 158-165. Institute of Mathematical Statistics, Beachwood,
Ohio, USA.
George, E. I., and Foster, D. P. (2000). Calibration and Empirical Bayes Variable
Selection. Biometrika, 87(4), 731-747.
Ghei, N., and Pritchett, L. (1999). “The Three Pessimisms: Real Exchange Rates
and Trade Flows in Developing Countries,” in Exchange Rate Misalignment:
Concepts and Measurement for Developing Countries, ed. by L. Hinkle and P.
Montiel (New York: Oxford University Press for the World Bank).
Goldfajn, I., and Valdes, R. (1999). The Aftermath of Appreciations. Quarterly
Journal of Economics. Vol. 114 (February), Pp. 229–62.
Hansen, M. H., and Yu, B. (2001). Model Selection and the Principle of Minimum
Description Length. Journal of the American Statistical Association, 96(454): 746-
774.
Hinkle, L., and Montiel, P. J. (1999). Estimating Equilibrium Real Exchange Rates
in Developing Countries (New York: Oxford University Press for the World
Bank).
Hoeting, J. A., Madigan, D., Raftery, A. E., and Volinsky, C. T. (1999). Bayesian
Model Averaging: A Tutorial. Statistical Science, 14, No. 4:382–417.
Imam, P. and Minoiu, C. (2011). The Equilibrium Exchange Rate of Mauritius:
Evidence from Two Structural Models. Emerging Markets Finance & Trade /
November–December 2011, Vol. 47, No. 6, pp. 134–147.
IMF. (2008). Mauritius: Selected Issues. IMF Country Report No. 08/237, The
International Monetary Fund. Washington DC.
Kass, R. and Raftery, A. (1995). Bayes Factors. Journal of the American Statistical
Association, 90:773–795.
Khan, M. S., and Ostry, J. D. (1991). Response of the Equilibrium Real Exchange
Rate to Real Disturbances in Developing Countries. IMF Working Papers 91/3
International Monetary Fund.
Kia, A. (2013). Determinants of the Real Exchange Rate in a Small Open Economy:
Evidence from Canada. Journal of International Financial Markets, Institutions &
Money 23(1): 163-178.
Lane, P. R., and Milesi-Ferretti, G. M. (2000). Long-Term Capital Movements. NBER
Working Paper No. 8366 (Cambridge, MA: National Bureau of Economic
Research).
Lee, J., G. M. Milesi-Ferretti, J. Ostry, A. Prati, and Ricci, L. A. (2008). Exchange
Rate Assessments: CGER Methodologies. IMF Occasional Paper No. 261
(Washington: International Monetary Fund).
LeSage, J. P. and Parent, O. (2007). Bayesian Model Averaging for Spatial
Econometric Models. Geographical Analysis, 39:3:241–267.
Ley, E. and Steel, M. F. (2009). On the Effect of Prior Assumptions in Bayesian
Model Averaging with Applications to Growth Regressions. Journal of Applied
Econometrics, 24:4:651–674.
Liang, F., Paulo, R., Molina, G., Clyde, M. A., Berger J. O. (2008). Mixtures of g Priors
for Bayesian Variable Selection. Journal of the American Statistical Association,
103(481): 410-423.
Loayza, N., and Lopez, H. J. (1997). Misalignment and Fundamentals: Equilibrium
Exchange Rates in Seven Latin American Countries (Unpublished, Washington:
World Bank).
MacDonald, R. (1995). Long-run Exchange Rate Modeling: A Survey of Recent
Evidence. Staff Papers, International Monetary Fund, Vol. 42 (September), pp.
437–98.
MacDonald, R., and Ricci, L. (2003). Estimation of the Equilibrium Real Exchange
Rate for South Africa. IMF Working Paper No. 44 (Washington: International
Monetary Fund).
McKinnon, R. I. (1963). Optimum Currency Areas. American Economic Review 53(4):
717-725.
Montiel, P. J. (1997). “Exchange Rate Policies and Macroeconomic Management in
ASEAN Countries,” in Macroeconomic Issues Facing ASEAN Countries, ed.
by J. Hicklin, Robinson, D., and Singh, A. (Washington: International Monetary
Fund).
Montiel, P. J. (1999). “Determinants of the Long-Run Equilibrium Real Exchange
Rate: An Analytical Model,” in Exchange Rate Misalignment: Concepts and
Measurement for Developing Countries, ed. by L. Hinkle and P. Montiel (New
York: Oxford University Press for the World Bank).
Mundell, R. (1961). A Theory of Optimum Currency Areas. American Economic
Review, Vol. 51 (September) pp. 627-65.
Ostry, J. D. (1988). The Balance of Trade, Terms of Trade, and Real Exchange Rate:
An Intertemporal Optimizing Framework, Staff Papers, International Monetary
Fund, 35: 541-73.
Reinhart, C. M., and Rogoff, K. S. (2004). The Modern History of Exchange Rate
Arrangements: A Reinterpretation. Quarterly Journal of Economics 119(1). 1-48.
Sala-i-Martin, X., Doppelhofer, G., and Miller, R. I. (2004). Determinants of Long-
Term Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach.
American Economic Review, 94:813–835.
Stein, J. L., P. R. Allen, and Associates. (1995). Fundamental Determinants of
Exchange Rates. (Oxford, England: Oxford University Press, Clarendon).
Stephens, M. (2000). Bayesian Analysis of Mixture Models with an Unknown
Number of Components – An Alternative to Reversible Jump Methods. Annals
of Statistics 28: 40-74.
Williamson, J. (1994). Estimating Equilibrium Exchange Rates (Washington:
Institute for International Economics).
Zellner, A. (1986). Bayesian Inference and Decision Techniques: Essays in Honor
of Bruno de Finetti, chapter On Assessing Prior Distributions and Bayesian
Regression Analysis with g-Prior Distributions. North-Holland: Amsterdam.
Published
2018-07-31
How to Cite
Njindan Iyke, B. (2018). MACRO DETERMINANTS OF THE REAL EXCHANGE RATE IN A SMALL OPEN SMALL ISLAND ECONOMY: EVIDENCE FROM MAURITIUS VIA BMA. Buletin Ekonomi Moneter Dan Perbankan, 21(1), 57-80. https://doi.org/10.21098/bemp.v21i1.922
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Copyright (c) 2018 Bernard Njindan Iyke
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
Buletin Ekonomi Moneter dan Perbankan / Bulletin of Monetary Economics and Banking is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
