MACRO DETERMINANTS OF THE REAL EXCHANGE RATE IN A SMALL OPEN SMALL ISLAND ECONOMY: EVIDENCE FROM MAURITIUS VIA BMA
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.
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
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
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-
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
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
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-
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,
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-
Hinkle, L., and Montiel, P. J. (1999). Estimating Equilibrium Real Exchange Rates
in Developing Countries (New York: Oxford University Press for the World
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
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
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
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,
Loayza, N., and Lopez, H. J. (1997). Misalignment and Fundamentals: Equilibrium
Exchange Rates in Seven Latin American Countries (Unpublished, Washington:
MacDonald, R. (1995). Long-run Exchange Rate Modeling: A Survey of Recent
Evidence. Staff Papers, International Monetary Fund, Vol. 42 (September), pp.
MacDonald, R., and Ricci, L. (2003). Estimation of the Equilibrium Real Exchange
Rate for South Africa. IMF Working Paper No. 44 (Washington: International
McKinnon, R. I. (1963). Optimum Currency Areas. American Economic Review 53(4):
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
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.
Unless otherwise indicated, each paper published in The Bulletin of Monetary Economics and Banking. Authors do not need to contact the journal to obtain rights to reuse their own material. They are automatically granted permission to do the following:
- Reuse the article in print collections of their own writing.
- Present a work orally in its entirety.
- Use an article in a thesis and/or dissertation.
- Reproduce an article for use in the author's courses. (If the author is employed by an academic institution, that institution also may reproduce the article for teaching purposes.)
- Reuse a figure, photo and/or table in future commercial and noncommercial works.
- Post a copy of the paper.
- Link to the journal site containing the final edited PDFs created by the publisher.
Unless otherwise indicated, the authors and the journal grant permission to reproduce and distribute for nonprofit educational uses material published in the journal, provided that: (1) in the case of copies distributed in class, students are charged no more than the cost of duplication; (2) the copied work is well identified with a proper notice of copyright affixed to each copy.
Permission to reproduce and to distribute any work published in The Bulletin of Monetary Economics and Banking should be directed to author(s). All such reproduction must identify the author(s), the Journal, the volume, the number of the first page, and the year of the work’s publication in the Journal.