(Luận văn) exchange rate and trade balance, a new approach using big mac index for the case of thailand

t to ng UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM hi ep INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS w n lo VIETNAM - NETHERLANDS ad ju y th PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS yi pl ua al EXCHANGE RATE & TRADE BALANCE: n A NEW APPROACH USING BIG MAC INDEX FOR THE CASE OF THAILAND n va ll fu oi m nh at A thesis submitted in partial fulfilment of the requirements for the degree of z MASTER OF ARTS IN DEVELOPMENT ECONOMICS z k n Dr VO HONG DUC a Lu Academic Supervisor: om l.c gm VO THE ANH jm ht vb BY n va y te re HO CHI MINH CITY, DECEMBER 2014 th t to ng ACKNOWLEDGEMENTS hi ep It is assistance, guidance, and encouragement that contribute to the success of this thesis Therefore, I would like to express my gratitude to those who always stand by w n me during periods of writing thesis lo ad My profound appreciation and sincere thanks must first be expressed to my y th academic supervisor, Dr Vo Hong Duc, Director of Economic Regulation Authority in ju yi Perth, Australia, for his interest, encouragement, and guidance throughout thesis- pl writing process from initial themes to entire finish, especially during boring time of n ua al reading the final draft n va I would like to express my grateful thanks to Assc Prof Dr Nguyen Trong Hoai, ll fu Dr Truong Dang Thuy, Dr Phung Thanh Binh, and Dr Pham Khanh Nam, Lectures at oi m Department of Economics Development at University of Economics (HCMC), for their nh helpful commands and valuable pieces of advice during the time I write the thesis at Special thanks are extended to Dr Le Van Chon for his invaluable econometric z z guidance Thanks to such academic commands, advice, and guidance, I could finish the vb thesis on the best way jm ht I am be grateful to not only staff members at Department of Economics k gm Development at University of Economics (HCMC) but also my classmates at VNPMDE 19 for their help and support and for offering such a warm and friendly studying l.c om atmosphere a Lu Most importantly, I am indebted to my parents for financing my study as well as n va for their constant love and moral support This thesis could not be finished without n their comprehension y te re th i t to ng ABSTRACT hi ep This thesis focuses on achieving two main objectives: (i) an evaluation of the Thailand’s currency to confirm whether a currency is over- or undervalued during the w n period from 1980 to 2013 for the case of Thailand; and (ii) a consideration of the lo ad effects of a currency’s devaluation on trade balance for the case of Thailand In this y th study, these effects are considered in different aspects such as the determinants of a ju trade balance of Thailand; and the long run relationship between bilateral exchange yi pl rate and Thailand’s trade balance al n ua In relation to the first objective, the prominent feature of the study is to use the va Big Mac Index (BMI), the first ever study of this kind conducted in Vietnam, for n evaluating Thailand’s currency and to apply this evaluation in the context of the link fu ll between exchange rate and trade balance Nevertheless, the common-used index, the m oi Consumer Price Index (CPI), is also utilized to compare the effectiveness of BMI with at nh that of the CPI z z Theoretical grounds for evaluating a currency in term of purchasing power parity ht vb (PPP) theory are first presented, together with the theory of the link between currency’s k jm devaluation and trade balance Next, the empirical studies associated with such theory gm are discussed Empirical models and results are reported accordingly To obtain the first objective, the PPP hypothesis is required to be satisfied in l.c om terms of panel cointegration tests The fully modified OLS (FMOLS) technique is a Lu adopted to determine the equilibrium exchange rate for evaluation process On the n grounds of the tests of PPP, the panel-based unit root tests as developed by Breitung va n (2001) and the panel cointegration tests by Pedroni (1999, 2001, 2004) and Kao (1999) ii th the relation to evaluate Thailand’s currency, the results illustrate that (i) the valuation y based exchange rate and a weak evidence of the PPP for BMI-based exchange rate In te re are adopted The empirical results confirm a solid validity of PPP for the case of CPI- t to of Thailand currency using CPI-based exchange rate is fairly consistent to that of BMI- ng hi based exchange rate with an exception of the outcomes during the 1997 Asian ep financial crisis; and (ii) the Big Mac exchange rate is better when bilaterally evaluating w the Thailand Baht to US dollar n lo The second main objective - a consideration of the effects of a currency’s ad y th devaluation on trade balance - could be achieved by the two procedures The first ju procedure is to analyze how changes on exchange rate policy, fiscal policy, and yi monetary policy affect Thailand’s trade balance In this task, effects of devaluation on pl ua al trade balance are examined on various scenarios: (i) the entire sample of 62 countries n who are trading partners with Thailand; (ii) different geography (between regions and va regions of countries); (iii) different income levels; and (iv) during different periods in n ll fu which Thailand’s currency is over- or under-valued Both OLS method and IV oi m technique are employed because of an endogeneity problems as mentioned in previous nh studies The empirical findings indicate that the exchange rate policy plays a central at role in explaining Thailand’s trade balance and the fiscal and monetary policies are z z beneficial in some cases vb jm ht The second procedure is to examine the long run relationship between a k devaluation of Thailand’s currency and trade balance with the applications of the gm panel-based co-integration tests by Pedroni (1999, 2001, 2004) and Kao (1999) and the om l.c FMOLS model The panel FMOLS estimations illustrate that a devaluation of Thailand Baht could provide positive effects on trade balance in the long run, especially for the a Lu groups of country with high income, upper middle income, in America, and Europe n The individual FMOLS regressions between Thailand and each of her 62 trading va n partners indicate that the devaluation of Thailand’s currency would stimulate th iii y with the other 10 countries and inconclusive conclusion for the others te re Thailand’s trade performance with over 20 trading partners, but hurt its performance t to ng ABBREVIATIONS hi ep PPP Purchasing Power Parity Big Mac Index w BMI n lo ad CPI ju y th M-L Consumer Price Index Marshall-Lerner yi pl OLS Ordinary Least Squares ua al Fully Modified Ordinary Least Squares IMF International Monetary Fund VND Vietnam Dong IV Instrumental Variable OECD Organization for Economic Cooperation and Development VAR Vector Autoregressive ARDL Autoregressive Distributed Lag ECM Error Correction Model n FMOLS n va ll fu oi m at nh z z k jm ht vb om l.c gm n a Lu n va y te re th iv t to ng hi ep Contents LISTS OF FIGURES viii w n lo CHAPTER ad 1.1 ju y th INTRODUCTION Problem Statement yi pl Research Objectives 1.3 The Structure of the Thesis n ua al 1.2 va n CHAPTER fu ll LITERATURE REVIEW m Theoretical Grounds oi 2.1 nh at 2.1.1 PPP Theory z z 2.1.2 Alternative approaches to devaluation theory ht vb Conceptual framework 12 2.3 Empirical reviews 13 k jm 2.2 gm 2.3.1 Test of PPP Theory 13 om l.c 2.3.2 Evaluation of a currency 15 a Lu 2.3.3 Determinants of a Trade Balance 16 n n va 2.3.4 Devaluation and Trade Balance 17 th v y THAILAND’S TRADE BALANCE AND 25 te re CHAPTER 25 t to ITS BIG MAC INDEX 25 ng hi ep 3.1 Thailand’s Trade Balance 25 3.2 Big Mac Index 27 w n lo CHAPTER 31 ad RESEARCH METHODOLOGY 31 yi Panel cointegration test 32 pl 4.2 Panel unit root test 31 ju y th 4.1 al n ua 4.2.1 Kao’s cointegration test 32 n va 4.2.2 Pedroni cointegration test 33 fu Fully modified OLS approach 36 4.4 Empirical models 37 ll 4.3 oi m nh at 4.4.1 Test of PPP theory 37 z z 4.4.2 Evaluation of Thailand’s currency 39 vb jm ht 4.4.3 Determinants of Thailand’s Trade Balance 39 k 4.4.4 Devaluation and Thailand’s Trade Balance 45 gm CHAPTER 47 l.c om DATA AND RESEARCH FINDINGS 47 a Lu Data description 47 5.2 Empirical results 49 n 5.1 n va th vi y 5.2.2 Evaluation of Thailand’s currency 52 te re 5.2.1 Test of PPP theory 49 t to 5.2.3 Determinants of Thailand’s trade balance 56 ng hi 5.2.4 Devaluation and Thailand’s Trade Balance 63 ep CHAPTER 73 w n lo CONCLUSION 73 ad 6.1 Conclusions 73 yi Limitations 77 pl 6.3 Implications for research and policies 76 ju y th 6.2 al n ua REFERENCE 79 n va APPENDIX 86 ll fu oi m at nh z z k jm ht vb om l.c gm n a Lu n va y te re th vii t to ng LISTS OF FIGURES hi Figure 2.1: Conceptual framework for exchange rate effects on trade balance 12 ep Figure 3.1: Thailand’s trade balance during 1995-2013 periods 26 w n Figure 5.1: Misalignments of nominal exchange rate based on CPI and BMI 53 lo ad ju y th yi LISTS OF TABLES pl n ua al Table 3.1: The structure of Thailand’ trade classified by currency 27 n va Table 5.1: Data Description 48 ll fu Table 5.2: Unit root test for PPP testing 50 oi m Table 5.3: Panel cointegration test for PPP 51 at nh Table 5.4: Results of OLS and IV estimation for determinants of Thai trade balance 57 z Table 5.5: Estimation results for undervaluation and overvaluation periods 59 z vb Table 5.6: Estimation results for countries within each of the seven sub-samples 61 jm ht Table 5.7: Results of Breitung (2001) unit root test - level and first difference 64 k gm Table 5.8: Cointegration test 65 l.c Table 5.9: Panel results of FMOLS estimation 67 om n a Lu Table 5.10: Individual results of FMOLS estimation 70 n va y te re th viii t to ng CHAPTER hi INTRODUCTION ep 1.1 Problem Statement w n lo Exchange rate is possibly one of the most concerned subjects among academics, ad exporters, importers, investors as well as policy-makers because its vitally important y th ju roles played in the international economics While academics have concerned and yi developed theories of disequilibrium and equilibrium real exchange rate, the policy- pl ua al makers concentrate more on exchange rate adjustment in order to examine its effects on the economy Additionally, exchange rate risk is a key element related directly to n n va the costs and profits for importers, exporters as well as foreign investors Furthermore, ll fu it is argued that developing countries have tendency to devaluate their currency in oi m order to gain the relative competition Given the importance of exchange rate in the nh economy, issues in relation to exchange rate attract my interest and that this a key at reason for my choice to make a topic for the thesis z z In February 2014, with the opening of the first ever branch of McDonald’s, a vb jm ht giant US fast-food company in Ho Chi Minh City, Viet Nam, the Economists Magazine have added the Vietnam Dong (VND) to its collection of Big Mac Index k gm (BMI) This index provides McDonald’s burger prices in all different parts of the world l.c in terms of local and foreign currencies The index is considered as a lighthearted guide om in order to evaluate whether a currency of a particular country of interest is at its a Lu correct level The index has been increasingly well-recognized as a global standard n with its existence in several international economics books and many academic studies va n The thesis aims to evaluate the real value of Thailand Baht and to consider the th y opted to study due to several reasons First, according to Bahmani-Oskooee and te re link between Thailand Baht depreciation and Thailand’s trade balance Thailand is t to The first shortcoming is the data The exchange rates of countries in Europe have ng hi been quoted in terms of Euro since 1999 and Euro currency is quoted in the central ep bank of Thailand from 2001 Therefore, the bilateral exchange rate for most European w countries is calculated on the application of a moving average technique Chiu (2010) n lo used the fixed numbers to calculate the bilateral exchange rate This raises the problem ad of measurement errors y th ju The second shortcoming is that the trade balance and real exchange rate variables yi are stationary with the panel-based unit root tests As such, it is not suitable when using pl ua al FMOLS for the entire data as well as sub-samples All variables including trade n balance, bilateral real exchange rate, domestic GDP, and foreign GDP are non- va stationary in terms of individual series; these variables should be treated as an n ll fu individual series rather than panel data However, this paper provides panel evidences at nh proper policy implications oi m in order to gain a consistency, to make it easy for comparison, and to recommend z Finally, there are a number of studies analyzing the lengthy effects of exchange z vb rate on trade balance in association with the phenomenon of J-curve and the well-noted jm ht Marshall-Lerner condition However, this thesis has not placed an analysis on these k issues om l.c gm n a Lu n va y te re th 78 t to ng REFERENCE hi ep Alexander, S S (1952) Effects of a devaluation on a trade balance IMF Staff Papers, 2(2), 263–278 w Alexander, S S (1959) Effects of a devaluation: A simplified synthesis of slasticities and absorption approaches The American Economic Review, 49(1), 22–42 n lo ad Arora, S., Bahmani-Oskooee, M., & Goswami, G (2003) Bilateral J-curve between India and her trading partners Applied Economics, 35(9), 1037–1041 doi:10.1080/0003684032000102172 ju y th yi Baharumshah, A Z (2001) The effect of exchange rate on bilateral trade balance : new evidence from Malaysia and Thailand Asian Economic Journal, 15(3), 291– 312 pl n ua al n va Bahmani-Oskooee, M (1985) Devaluation and the J-Curve : Some Evidence from LDCs The Review of Economics and Statistics, 67(3), 500–504 fu ll Bahmani-Oskooee, M (1993) Macro-Economic determinants of Australia’s current account, 1977-86: A reexamination Weltwirtschaftliches Archiv, 129(2), 411– 417 oi m nh at Bahmani-oskooee, M M (1992) What are the long-run determinants of the US trade balance ? 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Colombia, ChileMexico, PanamaPeru, United States pl n ua al Afica and Western Benin, Coted' Ivoire, Egypt, Iran, Israel, Kuwait, Nigeria, Oman, Asia Saudi Arabia, South Africa va High income Australia, Austria, Belgium,Brunei, Canada, Cyprus, Czech Republic, Chile, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, South Korea, Kuwait n Asia and Oceania Australia, Bangladesh, Brunei,Cambodia, China, Hong Kong, India, Indonesia, Japan, South Korea, Lao PDR, Malaysia, Nepal, New Zealand, Pakistan, Philippines, Singapore, SriLanka, Vietnam ll fu oi m at nh z z jm ht vb middle Brazil, Bulgaria, Colombia, China, Hungary, Iran, Malaysia, Mexico, Panama, Peru, Romania, South Africa, Turkey k l.c gm Upper income om Lower middle and Bangladesh, Benin, Cambodia, Coted' Ivoire, Egypt, India, Indonesia, low income Lao PDR, Nepal, Nigeria, Pakistan, Philippines, SriLanka, Vietnam n a Lu n va y te re th 86 t to ng Appendix B: hi Diagnostics tests ep  Test of multicollinearity w As presented in Gujarity (2011, p 71-74), there are five ways to detect n lo multicollinearity phenomenon in the model In this thesis, the variance-inflating factor ad y th (VIF) approach is used to check the multicollinearity VIF is a measure of degree to ju which the variance is inflated in OLS estimation owing to collinearity The VIF is yi calculated as follows: pl al n ua 𝑉𝐼𝐹 = 1 − 𝑟𝑖𝑗2 va n where rij is the coefficient of correlation between two variables i and j, fu ll respectively The rule of thumb to identify multicollinearity is that the value of VIF is m ivvif after ivreg2 command at z Test of heteroscedasticity z  nh Stata command: oi greater than 10 vb jm ht This thesis performs heteroscedasticity test by Pagan and Hall’s (1983) for k instrumental variable (IV) regression The test also presents the related standard gm heteroscsedasticity test by White/ Koenker with OLS or IV regression.The null om l.c hypothesis is of no heteroscedasticity, the test statistic is distributed as chi-squared with degrees of freedom equal the number of indicator variables If the results fail to reject n va Test of autocorellation 87 th test was originally proposed for a particular linear Generalized Method of Moments y This thesis uses autocorrelation test by Arellano-Bond (1991) in panel data The te re  ivhettest after ivreg2 command n Stata command: a Lu the null hypothesis, meaning that the disturbance is homoscedasticity t to dynamic panel data estimator, but it is more applicable than other panel-based ng hi autocorrelation tests like Wooldridge (2002) It can be applied in a variety estimation ep methods such as linear GMM regressions, ordinary least squares (OLS) and two-stage w least-squares (2SLS) It can also be made consistent in the presence of various patterns n lo of error covariance ad ju  abar, lags (number) after ivreg2 command y th Stata command: Test of endogenity yi pl This thesis applied the endogenity test in which one or more endogenous al n ua variables could be implemented The test was first proposed by Durbin (1954) and va separately by Wu (1973) and Hausman (1978) The null hypothesis is that the specified n endogenous variables could be treated as exogenous ones The test statistic is fu ll distributed as chi-squared with degrees of freedom equal to the number of variables m oi tested A rejection of the null hypothesis indicates that effects of endogenous nh at regressors' on the estimation are meaningful, thus IV techniques are required The test z is presented when the option of endogtest (regressors) is added after ivreg2 or xtivreg2 z k jm ht vb command om l.c gm n a Lu n va y te re th 88 t to ng Appendix C: hi Results of IV estimation for determinants of Thailand’s trade balance ep  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir w  ivvif n ad D.rer 1.19 D.gdpr 1.18 D.govgdpr 1.18 D.m2gdpr 1.08 D.rir 1.02 ju y th VIF pl lo Variable yi n ua al 1.13 n va Mean VIF ll fu oi m  ivhettest at nh OLS heteroskedasticity test(s) using levels of IVs only z Ho: Disturbance is homoscedastic z Chi-sq(5)P-value = 0.3992 ht vb White/Koenker nR2 test statistic: 5.138 k jm  abar, lag(2) Pr > z = 0.0000 Arellano-Bond test for AR(2): z = -0.78 Pr > z = 0.4348 om  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir, cluster(id) l.c gm Arellano-Bond test for AR(1): z = -9.40 n a Lu n va y te re th 89 t to ng Appendix D: hi Results of IV estimation for determinants of Thailand’s trade balance ep Undervaluation Overvaluation Undervaluation Overvaluation w Entire sample n CPI BMI BMI -0.107 -2.007 0.276 -0.153 -0.0797 (-0.12) (-1.45) (0.27) (-0.22) (-0.12) -2.747*** -1.482 -2.649** -1.647* (-3.47) (-1.41) (-2.23) (-2.01) 0.0441 0.107 -0.208 (0.14) (0.46) (-0.56) -0.402 -0.113 -0.313 (-0.23) (-1.11) 0.0448 -0.0396 lo CPI ad D.rer ju y th yi pl D.gdpr -1.733** n ua al (-2.57) -0.144 n -0.128 va D.m2gdpr ll fu (-0.56) -0.536* -0.699** (-1.89) (-2.25) 0.0528 0.0270 0.0969 (1.13) (0.59) (0.85) 0.0520** 0.100** 0.0510* 0.0432 (2.60) (2.12) (1.88) (1.66) N 1201 681 520 254 Endog_test 3.879 5.076 2.021 3.236 0.147 P-value 0.0489 0.0243 0.1552 0.0721 0.7017 oi at nh D.govgdpr m (-0.46) z (-0.94) z jm ht vb D.rir (0.74) (-0.97) k gm _cons 0.0350* om l.c (1.90) a Lu 214 n n va y te re th 90 t to ng hi Upper middle income Lower middle and low income Asia and Oceania Europe America Africa and Western Asia 0.367 -0.325 -0.435 0.589 1.468* -0.440 -2.960 (0.71) (-0.21) (-0.27) (0.41) (1.78) (-0.22) (-0.97) -1.555 -1.565 -1.662 -0.349 -1.176 -3.452 -2.432 (-1.54) (-1.05) (-0.47) (-1.15) (-1.32) (-0.96) 0.456 -1.178** -0.602** 0.0832 -1.061 0.783 (-2.62) (-2.25) (0.27) (-0.98) (0.98) -0.719 -0.153 -0.202 -0.701 -0.259 (-0.40) (-0.72) (-0.49) (-0.19) -0.0227 0.0764 0.212 0.0409 (0.96) (1.15) (0.22) 0.0258 0.0903 0.116 (1.08) 176 ep High income w D.rer n lo ad ju y th D.gdpr (-1.53) yi pl D.m2gdpr 0.0906 ua al (0.61) (0.84) n -0.276 (-0.42) (-0.69) -0.00175 0.131 0.0736 (-0.05) (1.04) (0.51) 0.0560** 0.0426 0.0243 0.0148 (2.30) (1.40) (0.61) (1.50) (1.07) N 616 294 291 426 416 183 Endog_test 0.028 0.031 0.044 2.466 1.143 P-value 0.8676 0.8604 0.8345 0.1163 0.2851 n -0.253 ht va D.govgdpr ll oi m nh (-0.79) at z z _cons fu D.rir (-1.12) vb (0.79) k jm gm 4.231 0.6502 om l.c 0.0379 0.206 n a Lu n va y te re th 91 t to ng Appendix E: hi ep STATA COMMAND IN THE THESIS  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir w n  ivvif lo ad  ivhettest y th  abar,lag(2) ju  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir, cluster(id) yi pl  xtivreg2 tb gdpr m2gdpr govgdpr rir (rer= l(1/2).rer m2 thai_m2 reserve thai_reserve ir ua al thai_ir), fd endog(rer) orthog(gdpr) cluster(id) small n  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir if under_cpi==x, cluster(id) va  xtivreg2 tb gdpr m2gdpr govgdpr rir (rer= l(1/2).rer m2 thai_m2 reserve thai_reserve ir n ll fu thai_ir) if under_cpi==i, fd endog(realer) orthog(gdpr) cluster(id) small oi m  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir if under_bmi==x, cluster(id) nh  xtivreg2 tb gdpr m2gdpr govgdpr rir (rer= l(1/2).rer m2 thai_m2 reserve thai_reserve ir at thai_ir) if under_bmi==x, fd endog(realer) orthog(gdpr) cluster(id) small z  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir if income==i, cluster(id) z ht vb  xtivreg2 tb gdpr m2gdpr govgdpr rir (rer= l(1/2).rer m2 thai_m2 reserve thai_reserve ir jm thai_ir) if income==i, fd endog(realer) orthog(gdpr) cluster(id) small k  ivreg2 d.tb d.rer d.gdpr d.m2gdpr d.govgdpr d.rir if region==j, cluster(id) gm  xtivreg2 tb gdpr m2gdpr govgdpr rir (rer= l(1/2).rer m2 thai_m2 reserve thai_reserve ir om l.c thai_ir) if region=j, fd endog(realer) orthog(gdpr) cluster(id) small (in which x=0,1; i=1,2,3; and j=1,2,3,4) n a Lu n va y te re th 92