Threshold Impact of Remittances on Real Exchange Rates for WAEMU: A Panel Smooth Transition Regression Approach

Abstract

This paper explores the nonlinear relationship between workers’ remittances and real effective exchange rates for West African Economic and Monetary Union (WAEMU) member countries using the panel smooth transition regression (PSTR). The PSTR was estimated with one transition function and one location parameter as dictated by the diagnostic tests. The diagnostic tests reveal that the relationship between workers’ remittances and real effective rates is nonlinear. The estimated threshold value is 3.07%. The results reveal that increases in workers’ remittances have a depreciating effect on real effective exchange rates in regime one, associated with threshold value of less than 3.07%. However, in the second regime when the threshold value is greater than or equal to 3.07%, increases in workers remittances have an appreciating impact on real effective exchange rates. These results substantiate that the relationship between workers’ remittances and real effective exchange rates is asymmetric and as such should be modeled accordingly. Above all, the results confirm the presence of Dutch disease effect in the second regime where the estimated coefficient on workers’ remittances is negative and statistically significant. However, there is no evidence of Dutch disease effect in the first regime where the regression coefficient on workers remittances is positive and also statistically significant. Policy implications are discussed.

Keywords

Dutch disease real effective exchange rate PSTR linearity test workers’ remittances

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