The NATREX: an Alternative Approach Theory and Empirical Verifications

Abstract

The research on equilibrium real exchange rate determination is still in progress. In the recent past the NATREX (NATural Real EXchange rate) approach by Jerome Stein and his co-authors has formulated a theoretical framework for the long-run natural real exchange rate. The model has satisfactorily undergone empirical verifications for several industrialised countries. In this paper we develop and estimate a NATREX model for the multilateral real exchange rate of the Italian lira. The theoretical model qualifies the original framework in order to take into account the peculiarities of the Italian experience in the period under examination (1976-1995). The estimation of the empirical model, a system of simultaneous nonlinear dynamic equations, is done via full information maximum likelihood, which constitutes an alternative approach to the NATREX “tradition”. Our estimates confirm the validity of the NATREX theory for the Italian economy. In particular, our in-sample simulations for the long-run equilibrium real exchange rate confirm the analysis of the real misalignment of the Italian lira made by the Bank of Italy. JEL classification number: F31, F41, F43, F47 Key words:equilibrium real exchange rate, real misalignment, NATREX

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