Panel Estimations of PPP and Relative Price Models for CEECs: Lessons for Real Exchange Rate Modelling

The paper contributes to the recent empirical literature on real exchange rates in CEECs. Instead of estimating a complete model, the PPP and relative price models (two main components of the real exchange rate) are investigated separately. All empirical tests are conducted in the heterogonous dynamic panel framework. The unbalanced panel includes generally nine CEECs (Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic and Slovenia) over 1993-2002. Models are estimated by two econometric methods: FMOLS and PMGE. The trend appreciation of nominal exchange rates deflated with tradables prices is found in most of CEECs. The appreciation was mainly driven by tradables inflation. Formal econometric tests, based on the explicit estimation of constrained coefficients of PPP model, do not support the strong version of relative PPP. This outcome is invariant to the use of bilateral or multilateral exchange rates, different numeraire currency or different specifications of the PPP model with regard to dependent variable. Evidence is provided that the trend appreciation is explained by the non-tradables processing component effect. It is demonstrated that this mechanism plays an important role also in determination of relative prices.