Current Account & Real Exchange Rate Dynamics in the Caribbean and Latin America Compared to the G7 Countries

Abstract

This paper analyses the impact of temporary monetary shocks and permanent productivity shocks on the exchange rate and current account in Jamaica, Argentina, Bolivia, Chile, Columbia, Costa Rica, Mexico, Paraguay and Peru following the technique by Lee and Chinn [1] who analysed the same for the G7 countries. Our findings indicate that during the period 2005-2014, permanent productivity shocks have a greater long term effect on the real exchange rate, but relatively little effect on the current account, while temporary shocks have greater effect on the current account and exchange rate in the short run, but not on either variable in the long run. The same results as in Lee and Chinn [1] for the G7 countries except the US hold for Argentina, Bolivia, Chile, Columbia, Costa Rica, Jamaica, Mexico, Paraguay and Peru. The results are also consistent with the sticky price model of Obstfeld and Rogoff [2] . Lee and Chinn [1] postulate that, the greater impact of a permanent productivity shock in the US economy may be due to a substantial swing in the US foreign currency policy relative to other G7 countries. The stronger impact of temporary shocks on the current account in the Caribbean and Latin American Countries as well as in the other G7 countries may be attributed to nominal price movements that alter the relative price structure between countries. The latter results, display no significant pricing to market effect resulting from exchange rate overshooting caused from a monetary shock.