Showing papers on "Currency published in 1999"

One Money, One Market: Estimating the Effect of Common Currencies on Trade

Abstract: A gravity model is used to asses the separate effects of exchange rate volatility and currency unions on international trade. The panel data set I use includes bilateral observations for five years spanning 1970 through 1990 for 186 countries. In this data set, there are over one hundred pairings and three hundred observations, in which both countries use the same currency. I find a large positive effect of a currency union on international trade, and a small negaitve effect of exchange rate volatility, even after controlling for a host of features, including the endogenous nature of the exchange rate regime. These effects are statistically significant and imply that two countries that share the same currency trade three times as much as theoy would with different currencies. EMU may thus lead to a large increase in internationel trade, with all that entails.

Exchange Rates and Financial Fragility

Abstract: In this paper we analyze three views of the relationship between the exchange rate and financial fragility: (1) the moral hazard hypothesis, according to which pegged exchange rates offer implicit insurance against exchange risk and thereby encourage reckless borrowing and lending; (2) the original sin hypothesis, which emphasizes an incompleteness in financial markets which prevents the domestic currency from being used to borrow abroad or to borrow long term even domestically; and (3) the commitment problem hypothesis, which sees financial crises as resulting from neither moral hazard nor original sin but from the weakness of the institutions that address commitment problems. We examine the evidence on these hypotheses and draw out their implications for exchange-rate policy in emerging markets

One Money, One Market: Estimating the Effect of Common Currencies on Trade

Abstract: A gravity model is used to assess the separate effects of exchange rate volatility and currency unions on international trade. The panel data set I use includes bilateral observations for five years spanning 1970 through 1990 for 1986 countires. In this data set, there are over one hundred pairings and three hundred observations, in which both countries use the same currency. I find a large positive effect of a currency union on international trade, and a small negative effect of exchange rate volatility, even after controlling for a host of features, including the endogenuous nature of the exchange rate regime. These effects are statistically significant and imply that two countires that share the same currency trade three times as much as they would with different curencies. EMU may thus lead to a large increase in international trade, with all that entails.

No Single Currency Regime Is Right for All Countries or at All Times

Abstract: This essay considers some prescriptions that are currently popular regarding exchange rate regimes: a general movement toward floating, a general movement toward fixing, or a general movement toward either extreme and away from the middle. The whole spectrum from fixed to floating is covered (including basket pegs, crawling pegs, and bands), with special attention to currency boards and dollarization. One overall theme is that the appropriate exchange rate regime varies depending on the specific circumstances of the country in question (which includes the classic optimum currency area criteria, as well as some newer criteria related to credibility) and depending on the circumstances of the time period in question (which includes the problem of successful exit strategies). Latin American interest rates are seen to be more sensitive to US interest rates when the country has a loose dollar peg than when it has a tight peg. It is also argued that such relevant country characteristics as income correlations and openness can vary over time, and that the optimum currency area criterion is accordingly endogenous.

Are Currency Crises Predictable? A Test

Abstract: This paper evaluates three models for predicting currency crises that were proposed before 1997. The idea is to answer the question: if we had been using these models in late 1996, how well armed would we have been to predict the Asian crisis? The results are mixed. Two of the models fail to provide useful forecasts. One model provides forecasts that are somewhat informative though still not reliable. Plausible modifications to this model improve its performance, providing some hope that future models may do better. This exercise suggests, though, that while forecasting models may help indicate vulnerability to crisis, the predictive power of even the best of them may be limited.

Financial Market Contagion in the Asian Crisis

Abstract: This paper tests for evidence of contagion between the financial markets of Thailand, Malaysia, Indonesia, Korea, and the Philippines. We find that correlations in currency and sovereign spreads increase significantly during the crisis period, whereas the equity market correlations offer mixed evidence. We construct a set of dummy variables using daily news to capture the impact of own-country and cross-border news on the markets. We show that after controlling for own-country news and other fundamentals, there is evidence of cross-border contagion in the currency and equity markets. Copyright 1999, International Monetary Fund

A Simple Model of Monetary Pollicy and Currency Crises

Abstract: This paper analyzes the optimal interest rate policy in currency crises. Firms are credit constrained and have debt in domestic and foreign currency, a situation that may easily lead to a currency crisis. An interest rate increase has an ambiguous effect on firms since it both makes more difficult to borrow and may decrease the foreign currency debt burden. In some cases it is actually best to decrase the interest rate. We also show how these issues are related to the development of the financial system.

Hedging and liquidation under transaction costs in currency markets

Abstract: We consider a general semimartingale model of a currency market with transaction costs and give a description of the initial endowments which allow to hedge a contingent claim in various currencies by a self-financing portfolio. As an application we obtain a result on the structure of optimal strategies for the problem of maximizing expected utility from terminal wealth.

Banking and currency crises: how common are twins?

Abstract: The coincidence of banking and currency crises associated with the Asian financial crisis has drawn renewed attention to causal and common factors linking the two phenomena. In this paper, we analyze the incidence and underlying causes of banking and currency crises in 90 industrial and developing countries over the 1975-97 period. We measure the individual and joint ("twin") occurrence of bank and currency crises and assess the extent to which each type of crisis provides information about the likelihoood of the other.

Monetary Policy in Dollarized Economies

Abstract: Dollarization - the holding by residents of a substantial portion of their assets in foreign-currency-denominated assets- is a common feature of developing and transition economies, and therefore typical of many countries with IMF - supported adjustment programs This paper analyzes policy issues that arise-and various monetary strategies that may be pursued- when the monetary sector is dollarized, and it considers the implications that dollarization has for the design of IMF programs

Liquidity Crises in Emerging Markets: Theory and Policy

Abstract: We build a model of financial sector illiquidity in an open economy. Illiquidity is defined as a situation in which a country's consolidated financial system has potential short-term obligations that exceed the amount of foreign currency available on short notice. We show that illiquidity is key in the generation of self-fulfilling bank and/or currency crises. We discuss the policy implications of the model and study issues associated with capital inflows and the maturity of external debt, the role of real exchange depreciation, options for financial regulation, fiscal policy, and exchange rate regimes.

The determinants of banking crises : evidence from industrial and developing countries

Abstract: Vulnerability to crises in the banking sector appears to be associated with these factors: a weak macroeconomic environment characterized by slow GDP growth and high inflation, vulnerability to sudden capital outflows, low liquidity in the banking sector, a high share of credit to the private sector, past credit growth, the existence of explicit deposit insurance, and weak institutions. In the 1980s and 1990s several countries experienced banking crises. Demirguc-Kunt and Detragiache try to identify features of the economic environment that tend to breed problems in the banking sector. They do so by econometrically estimating the probability of a systemic crisis, applying a multivariate logit model to data from a large panel of countries, both industrial and developing, for the period 1980-94. Included in the panel as controls are countries that never experienced banking problems. The authors find that crises tend to occur in a weak macroeconomic environment characterized by slow GDP growth and high inflation. When these effects are controlled for, neither the rate of currency depreciation nor the fiscal deficit are significant. Also associated with a higher probability of crisis are vulnerability to sudden capital outflows, low liquidity in the banking sector, a high share of credit to the private sector, and past credit growth. Another factor significantly (and robustly) associated with increased vulnerability in the banking sector is the presence of explicit deposit insurance, suggesting that moral hazard has played a major role. Finally, countries with weak institutions (as measured by a law and order index) are more likely to experience crises. This paper-a product of the Development Research Group, World Bank, and the Research Department, International Monetary Fund-is part of a larger effort to understand the causes of banking crises.

A Self-Help Guide for Emerging Markets

Abstract: Like death and taxes, international economic crises cannot be avoided. They will continue to occur as they have for centuries past. But the alarmingly rapid spread of the 1997 Asian crisis showed how shifting perceptions alone can disrupt even fundamentally stable countries. In the wake of Russia's default, skyrocketing interest rates in emerging markets underlined these economies' vulnerability to investor skittishness. Unfortunately, there is no international "911" that emerging markets can dial when facing economic collapse. Neither the International Monetary Fund (imf) nor a new global financial architecture will make the world less dangerous. Instead, countries that want to avoid a devastating rerun of the 1997-98 crisis must learn to protect themselves. And self-protection requires more than avoiding bad policies that make a currency crisis inevitable, for the threat of contagion makes even the virtuous vulnerable to currency runs. Liquidity is the key to financial self-help. A country that has substantial international liquidity?large foreign currency reserves and a ready source of foreign currency loans?is less likely to be the object of a currency attack. Substantial liquidity also enables a country already under a speculative siege to defend itself better and make more orderly financial adjustments. The challenge is to find ways to increase liquidity at reasonable cost.

Political Contagion in Currency Crises

Abstract: Existing models of contagious currency crises are summarized and surveyed, and it is argued that more weight should be put on political factors. Towards this end, the concept of political contagion introduced, whereby contagion in speculative attacks across currencies arises solely because of political objectives of countries. A specific model of membership' contagion is presented. The desire to be part of a political-economic union, where maintaining a fixed exchange rate is a condition for membership and where the value of membership depends positively on who else is a member, is shown to give rise to potential contagion. We then present evidence suggesting that political contagion may have been important in the 1992-3 EMS crisis.

Current-Account Sustainability in Transition Economies

Abstract: Recent episodes of currency crisis have been associated with large, growing, and eventually unsustainable current-account imbalances. The Mexican peso crisis of 1994 and the 1997 currency turmoil in a number of Asian countries (in particular Thailand, Malaysia, and the Philippines) appear to have been partly triggered by unsustainable current-account imbalances. Following the Mexican peso crisis of 1994, the IMF devised a warning mechanism aimed at an early recognition of potentially unsustainable current-account imbalances. In this regard, a large number of Eastern and Central European countries in transition were experiencing large and growing current-account imbalances in the 1996 to 1997 period. Deficits in excess of 5 percent of GDP (an in many cases closer to 10 percent of GDP) were observed in Croatia, the Czech Republic, the Slovak Republic, Poland, Estonia, Latvia, Lithuania, and Moldova. Moreover, similar to the crisis episodes in Mexico and East Asia, a number of Central and Eastern European countries had weak financial systems, had adopted in the 1990s semifixed exchange-rate regimes aimed at controlling inflation and were experiencing significant real appreciation of their currencies. As a combination of fixed-rate regimes, real appreciation, current-account worsening, short-term foreign debt accumulation, and weak financial systems had contributed to the earlier currency crises in Mexico and Southeast Asia, it is important to study whether the current-account imbalances in Central and Eastern Europe would be sustainable or whether there are significant risks that currency crises would also occur in the transition economies.

The Suitability of ASEAN for a Regional Currency Arrangement

Abstract: This paper examines the costs, benefits, preconditions, and implications of an Association of Southeast Asian Nations (ASEAN) regional currency arrangement that is assumed to culminate in a regional currency. On economic criteria, ASEAN appears less suited for a regional currency arrangement than Europe before the Maastricht Treaty, although the difference is not large. The transition to European Monetary Union (EMU) indicates that the path toward a common currency is fraught with difficulty. A firm political commitment would seem to be vital to ensuring that an attempt to form a regional currency arrangement is not viewed as simply another fixed exchange rate regime, open to speculative crises.

Transition Strategies and Nominal Anchors on the Road to Greater Exchange-Rate Flexibility

Abstract: This essay considers strategies that developing and emerging-market economies might use when seeking to exit from currency pegs. It also considers techniques for completing the move to greater flexibility, as well as the scope for adopting inflation targeting as a nominal anchor following an exit from a currency peg.

The weightless world: strategies for managing the digital economy

Abstract: The Weightless World is the first book to map an economic world that has been turned upside down by digital technology and global business. How will our careers, businesses, and governments change in a world where bytes are the only currency and where the goods that shape our lives--global financial transactions, computer code, and cyberspace commerce--literally have no weight? Addressing such problems as economic inequity and unemployment, Diane Coyle calls on individuals and governments to develop a new politics of weightlessness so that the economic benefits can be shared fairly. She proposes the creation of a radical center as the way to a new era of human creativity and economic prosperity.

Return migration to Jamaica and its development potential.

Abstract: Return migration to Jamaica is associated closely with the existence and nature of the transnational linkages established between migrants and their home country, especially at the level of the household and family. Remittances invariably precede, accompany and follow the actual return of migrants and comprise money as well as a range of consumer goods. Data on the number of returning migrants to Jamaica have been collected officially only since 1992; other information is derived from field studies. The figures show that the US is the source of most return migrants to Jamaica, with the United Kingdom second. Likewise, there are few official statistics on remittances, especially of those entering the country through informal channels. Nevertheless, data on the receipt of money through the Bank of Jamaica, indicate that during the 1990s remittances as a percentage of GDP exceeded that of the traditional foreign currency earners of bauxite and sugar. Growing awareness of the potential of the Jamaican overseas community has led the Government of Jamaica to establish programmes, including The Return of Talent programme, supported by the International Organization for Migration (IOM), to encourage the return of nationals. Different types of return migrants have the potential to make different kinds of contributions to national development – some through their skills, educational and professional experience, others through the financial capital which they transfer for investment or as retirement income. However, the most significant development potential of return lies in the social and economic conditions in Jamaica itself. If confidence levels are high, there will be little difficulty in attracting persons to return and financial transfers and investments will increase. Furthermore, the social and economic environment largely conditions the extent to which skills and talent as well as the financial capital are effectively utilized.

The international effects of monetary and fiscal policy in a two-country model

Abstract: This paper develops a two-country dynamic general equilibrium model with slowly adjusting prices to re-examine the well known analysis by Mundell (1968 Chapter 18) on the international transmission effects of monetary and fiscal policy. We show that the critical factor governing the effects of monetary policy is the currency of export price invoicing, while the critical factor for the effects of fiscal policy is the structure of international assets markets. By contrast, the currency of invoicing is essentially irrelevant for the effects of fiscal policy, while the structure of international assets markets is quantitatively unimportant for the international effects of monetary policy. We present VAR evidence of a positive output comovement and real exchange rate depreciation between the US and the other G7 economies in response to US monetary shocks. This is shown to accord well with the model where export prices are invoiced in foreign currency. Section

Corporate Risk Management for Multinational Corporations: Financial and Operational Hedging Policies

Abstract: Under what conditions will a multinational corporation alter its operations to manage its risk exposure? We show that multinational firms will engage in operational hedging only when both exchange rate uncertainty and demand uncertainty are present. Operational hedging is less important for managing short-term exposures, since demand uncertainty is lower in the short term. Opera- tional hedging is also less important for commodity-based firms, which face price but not quantity uncertainty. When the fixed costs of establishing a plant are low or the variability of the exchange rate is high, a firm may benefit from establishing plants in both the domestic and foreign location. Capacity allocated to the foreign location relative to the domestic location will increase when the variability of foreign demand increases relative to the variability of domestic demand or when the expected profit margin is larger. For firms with plants in both a domestic and foreign location, the foreign currency cash flow generally will not be independent of the exchange rate and consequently the optimal financial hedging policy cannot be implemented with forward contracts alone. We show that the optimal financial hedging policy can be implemented using foreign currency call and put options and forward contracts.

Domestic Political Institutions and Exchange Rate Commitments in the Developing World

Abstract: Policymakers use a fixed exchange rate regime to signal their commitment to low inflation and to exchange rate stability. Increasing economic integration and the rise of democratic institutions make it more difficult for policymakers to maintain the credibility of this commitment. We use binary probit (with a variety of corrections for autocorrelated and heteroscedastic disturbances) to test hypotheses relating democratic institutions to exchange rate regime choice on a sample of 76 developing countries over the period 1973‐1994. The empirical analysis indicates that domestic political preferences—as measured by the structure of domestic political institutions and the fractionalization of the party system—influence exchange rate regime choice. We find that floating exchange rate regimes are more likely in democratic than in nondemocratic polities and that democratic polities with majoritarian electoral systems are more likely to fix their exchange rates than those with systems of proportional representation. The growth of international capital markets is truly extraordinary. Cross-border capital flows dwarf those of international trade: recent estimates suggest that foreign exchange trading alone now exceeds one trillion dollars a day. The magnitude and volatile nature of international capital flows has led some political economists to suggest that increased economic integration and capital mobility has become so pervasive that it now acts as a “structural characteristic of the international system, similar to anarchy” (Keohane and Milner, 1996:257). These scholars point to globalization as a crucial factor leading to a convergence of economic policy in the industrialized world. While a wave of economic liberalization has swept OECD economies, governments in developing countries still use a variety of traditional economic tools to protect the relative autonomy of their domestic policies. Vital in this process is exchange rate policy for it is the exchange rate that serves as a buffer between international and domestic markets. Even after the collapse of the Bretton Woods system of pegged exchange rates, most developing countries continue to fix the value of their currency to that of their major trading partner. The logic is clear: by fixing the domestic currency’s value to that of a trading partner, exchange rate volatility is minimized. As a result, bilateral flows of capital and goods are not disrupted by exchange rate uncertainty and