> Our primary focus is the estimate of β in equation (1). If an increase in remittances leads to a real exchange appreciation we should find that β _>_ 0. If, however, remittances have no impact on the real exchange rate then we should find β _=_ 0. Although it is theoretically possible here we do not consider the possibility of β _<_ 0, since this would imply that remittances contribute to real exchange rate depreciation.<sup>9</sup> (See the technical annex for a discussion.)

The previous model can easily be extended to allow remittances to have a different impact in Latin America and in the rest of the world by simply adding and additional regressor to the specification in equation (1):<sup>10</sup> where _lac_ is a dummy variable that takes a value of 1 if the country in question is in Latin America and 0 otherwise.

One additional issue that needs attention is the specific set of control variables that are included in _x_ . Here we follow to a large extent the strategy in Amuedo-Dorantes and Pozo (2004) and consider the terms of trade, government expenditure, the world real interest rate, and GDP per capita income. These variables would capture respectively the effects of potential external shocks, fiscal policy differences, changes in external financial conditions, and productivity gains.<sup>11</sup> Despite the broad similarities between equations (1) and (2) and those estimated by Dorantes and Pozo (2004) there are a number of important differences. First, our results are based on a large cross national dataset rather than on a limited number of countries (in the case of Dorantes and Pozo, 2004, 13 Latin American countries). In fact, if Latin American migration patterns are different from those of other regions, this could also be reflected in a differentiated effect of remittances on the real exchange rate.

Second, we focus on changes in the exchange rate rather than on its levels. The reason for this is that since the real effective exchange rate variable is an index, it is no possible to make cross country comparisons on the basis of the levels of the variable.<sup>12</sup> Fixed effects estimation can somewhat mitigate this problem but it is not likely to fully address it in a satisfactory way. Note that this lack of cross country comparability also prevents us from estimating dynamic models for the real exchange rate where for example the changes in the variable of interest are

> 9 This however would require that the main effect of remittances on the exchange rate is through the growth channel described above and that the country has a positive net foreign asset position.

> 10 This can occur if regional migration flows patterns are different and as result migrants remit for different purposes. Once again remittances that result in higher consumption will likely lead to an appreciation of the real exchange rate whereas remittances that lead to higher investment may have less of an effect.

> 11 The remittances data are as in Aggarwal, Demiguc-Kunt, and Martinez Peria (2005) and the data come from the IMF’s _World Economic Outlook 2005_ database. As for the rest of the variable, the terms of trade and per capita growth variables come from the _World Development Indicators_ database, government consumption is from the _World Economic Outlook 2005_ database, and the world real interest is computed using the US interest rate (6month) and US producer price index from the _International Financial Statistics_ .

> 12 For example, the base year all the countries in the sample will have the same value, say 100; clearly, this does not imply that the real exchange rate level is comparable among them.

13