As described previously, frictions to trade imply the presence of significant nonlinearities in SRER dynamics.
First, we determine whether the SETAR specification is superior to a unit root process for each SRER using the Enders and Granger (1998) threshold unit root test.
A failure to reject the null hypothesis implies that the SRER is nonstationary and consequently prices in two locations are disconnected.
Tables 2A, 2B, and 2C show the estimated threshold bands for each SRER for the three country pairs.
Tables 6A, 6B, and 6C report the estimated thresholds for each SRER, allowing for a different mean for the real exchange rate during the Tequila Crisis.
Using a SETAR model, we find strong evidence of nonlinearities in SRER dynamics across Mexico, Canada, and the United States in the pre- and post-NAFTA periods.
The normative target, SRER framework has been built around econometric trade equations relating exports and imports to fundamental variables such as the real exchange rate, the terms of trade, external debt, and domestic and foreign economic activity.
In the SRER framework the path of sustainable debt can be approximated by considering the initial stock of debt and the country specific sustainable debt target for the end of the simulation period.
Nevertheless, the impact of changes in the sustainable debt to GDP ratio on the SRER estimates is relatively small: a 10 percentage point change in the ratio generated a change in the equilibrium real exchange rate of 0.
Data consistency is crucial for the SRER calculations, given the endogenous relationship between various variables, such as domestic and foreign demand or trade and financial flows.
We interpret the difference between an estimate of the SRER and the observed real effective exchange rate in two ways.
For 1998-2007 we compare our SRER estimates with observed values of effective real exchange rates and our estimates suggest that, first, forerunners' currencies were mostly overvalued and, second, latecomers' currency misalignments were volatile, with a gradual overvaluation trend towards the end of the period (see figure 3).