Showing papers on "Currency published in 2002"

Fear of Floating

Abstract: In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates“soft pegs”--for these meltdowns. Adherents to that view advise countries to allow their currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether “official labels” provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of “fear of floating.” Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called “demise of fixed exchange rates” is a myth--the fear of floating is pervasive, even among some of the developed countries. We present an analytical framework that helps to understand why there is fear of floating.

The Economics of Exchange Rates

Abstract: Description Contents Resources Courses About the Authors In the last few decades exchange rate economics has seen a number of developments, with substantial contributions to both the theory and empirics of exchange rate determination. Important developments in econometrics and the increasingly large availability of high-quality data have also been responsible for stimulating the large amount of empirical work on exchange rates in this period. Nonetheless, while our understanding of exchange rates has significantly improved, a number of challenges and open questions remain in the exchange rate debate, enhanced by events including the launch of the Euro and the large number of recent currency crises. This volume provides a selective coverage of the literature on exchange rates, focusing on developments from within the last fifteen years. Clear explanations of theories are offered, alongside an appraisal of the literature and suggestions for further research and analysis.

An Estimate of the Effect of Common Currencies on Trade and Income

Abstract: To quantify the implications of common currencies for trade and income, we use data for over 200 countries and dependencies In our two-stage approach, estimates at the first stage suggest that belonging to a currency union/board triples trade with other currency union members Moreover, there is no evidence of trade-diversion Our estimates at the second stage suggest that every one percent increase in a country’s overall trade (relative to GDP) raises income per capita by at least one third of a percent We combine the two estimates to quantify the effect of common currencies on output Our results support the hypothesis that important beneficial effects of currency unions come through the promotion of trade

Global Microstructures: The Virtual Societies of Financial Markets

Abstract: Using participant‐observation data, interviews, and trading transcripts drawn from interbank currency trading in global investment banks, this article examines regular patterns of integration that characterize the global social system embedded in economic transactions. To interpret these patterns, which are global in scope but microsocial in character, this article uses the term “global microstructures.” Features of the interaction order, loosely defined, have become constitutive of and implanted in processes that have global breadth. This study draws on Schutz in the development of the concept of temporal coordination as the basis for the level of intersubjectivity discerned in global markets. This article contributes to economic sociology through the analysis of cambist (i.e., trading) markets, which are distinguished from producer markets, and by positing a form of market coordination that supplements relational or network forms of coordination.

How Much Do Firms Hedge with Derivatives

Abstract: Previous research offers little large-sample evidence on the magnitude of non-financial firms' risk exposure hedged by financial derivatives. Among 234 large non-financial derivatives users, if the median firm simultaneously experiences a three standard deviation change in interest rates, currency exchange rates, and commodity prices, its entire derivatives portfolio will generate, at most, $15 million in current cash flow and will rise in value by $31 million. These amounts are modest relative to firm size, operating cash flows, investing cash flows and other firm benchmarks. The findings indicate corporate derivatives use is a small piece of non-financial firms' overall risk profile, and suggest the need to rethink some empirical research documenting the economic importance of firms' derivative use.

'New' Views on the Optimum Currency Area Theory: What is EMU Telling Us?

Abstract: This paper surveys the optimum currency area (OCA) literature. It is organised into four phases: the "pioneering phase" which put forward the OCA theory and its properties, the "reconciliation phase" when its diverse facets were combined, the "reassessment phase" that led to the "new OCA theory", and the "empirical phase" during which the theory was subject to due empirical scrutiny. We make systematic reference to the European economic and monetary union (EMU) to which the OCA theory has been most frequently applied. All pioneering contributions are still relevant. Several early weaknesses have now been amended. Meanwhile, the balance of judgements has shifted in favour of currency unions. They are now deemed to generate fewer costs in terms of the loss of autonomy of domestic macroeconomic policies, and there is greater emphasis on the benefits. Looking ahead we are confronted with two distinct paradigms - specialisation versus "endogeneity of OCA".

Optimal Currency Areas

Abstract: As the number of independent countries increases and their economies become more integrated, we would expect to observe more multicountry currency unions. This paper explores the pros and cons for different countries to adopt as an anchor the dollar, the euro, or the yen. Although there appear to be reasonably well-defined euro and dollar areas, there does not seem to be a yen area. We also address the question of how trade and comovements of outputs and prices would respond to the formation of a currency union. This response is important because the decision of a country to join a union would depend on how the union affects trade and comovements.

Currency Unions and International Integration

Abstract: This paper characterizes the integration patterns of international currency unions (such as the CFA Franc Zone). We empirically explore different features of currency unions, and compare them to countries with sovereign monies by examining the criteria for MundellOs concept of an optimum currency area. We find that members of currency unions are more integrated than countries with their own currencies. For instance, we find that currency union members have more trade and less volatile real exchange rates than countries with their own monies; business cycles are more highly synchronized across currency union countries than across countries with sovereign monies.

Pass-through and Exposure

Abstract: Firms differ in the extent to which they “pass through” changes in exchange rates into foreign currency prices and in their “exposure” to exchange rates—the responsiveness of their profits to changes in exchange rates. Because pricing affects profitability, a firm’s pass-through and exposure should be related. This paper develops models of exporting firms under imperfect competition to study these related phenomena. From these models we derive the optimal pass-through decisions and the resulting exchange rate exposure. The models are estimated on eight Japanese export industries using both the price data pass-through and financial data for exposure. EXCHANGE RATES CAN HAVE A MAJOR inf luence on the pricing behavior and profitability of exporting and importing firms. Firms differ in the extent to which they “pass through” the change in exchange rates into the prices they charge in foreign markets. They also differ in their “exposure” to exchange rates— the responsiveness of their profits to changes in exchange rates. Previous papers have studied either pass-through or exposure, but none has studied these two phenomena together. Yet, because pricing directly affects profitability, the exposure of a firm’s profits to exchange rates should be governed by many of the same firm and industry characteristics that determine pricing behavior. This paper develops models of firm and industry behavior that are used to study these closely related phenomena together. It also provides estimates of pass-through and exposure behavior using data from Japanese export industries. To examine pass-through behavior and exchange rate exposure, we model a firm with sales to a foreign export market. This exporting firm competes with a foreign firm in that export market. The costs of the exporting firm are based primarily in the local ~domestic! currency, while the foreign firm

The Big Problem of Small Change

Abstract: The Big Problem of Small Change offers the first credible and analytically sound explanation of how a problem that dogged monetary authorities for hundreds of years was finally solved. Two leading economists, Thomas Sargent and Francois Velde, examine the evolution of Western European economies through the lens of one of the classic problems of monetary history--the recurring scarcity and depreciation of small change. Through penetrating and clearly worded analysis, they tell the story of how monetary technologies, doctrines, and practices evolved from 1300 to 1850; of how the "standard formula" was devised to address an age-old dilemma without causing inflation. One big problem had long plagued commodity money (that is, money literally worth its weight in gold): governments were hard-pressed to provide a steady supply of small change because of its high costs of production. The ensuing shortages hampered trade and, paradoxically, resulted in inflation and depreciation of small change. After centuries of technological progress that limited counterfeiting, in the nineteenth century governments replaced the small change in use until then with fiat money (money not literally equal to the value claimed for it)--ensuring a secure flow of small change. But this was not all. By solving this problem, suggest Sargent and Velde, modern European states laid the intellectual and practical basis for the diverse forms of money that make the world go round today. This keenly argued, richly imaginative, and attractively illustrated study presents a comprehensive history and theory of small change. The authors skillfully convey the intuition that underlies their rigorous analysis. All those intrigued by monetary history will recognize this book for the standard that it is.

Preventing Currency Crises in Emerging Markets

Abstract: Economists and policymakers are still trying to understand the lessons of recent financial crises in emerging markets. In this volume, academics, public officials and economists explore the causes of and effective policy responses to international currency crises. Topics covered include exchange rate regimes, contagion, the current account of the balance of payments, the role of private sector investors and of speculators, the reaction of the official sector, capital controls, bank supervision and weaknesses, and the roles of cronyism, corruption and large players.

A Balance Sheet Approach to Financial Crisis

Abstract: The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis. The paper also discusses the potential of macroeconomic policies and official intervention to mitigate the cost of such a crisis.

A Theory of the Currency Denomination of International Trade

Abstract: Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modelling. The 'New Open Economy Macroeconomics' literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant macroeconomic and policy implications. In this paper we solve for the optimal invoicing choice by integrating this micoeconomic decision at the firm level into a general equilibrium open economy model. Strategic interactions between firms play a critical role in the analysis. We find that the less competition firms face in foreign markets, as reflected in market share and product differentiation, the more likely they will price in their own currency. We also show that when a set of countries forms a monetary union, the new currency is likely to be used more extensively in trade than the sum of the currencies it replaces. JEL Classification: F31, F41

Perceptions of SME Growth Constraints in Nigeria

Abstract: This study investigates the factors that influence the growth, performance, and development of small and medium-sized enterprises (SMEs) in Nigeria and what implications these factors have for policy. The study is justified for a number of reasons. Most importantly, since its independence, the Nigerian government has been spending an immense amount of money obtained from external funding institutions for entrepreneurial and small business development programs, which have generally yielded poor results (Mainbula 1997). Given the large domestic market and plethora of raw materials in Nigeria, there is little progress in terms of manufacturing value-added products, either for import substitution, exports, or employment creation. It therefore becomes pertinent to identify the factors that impede small business development in Nigeria. For this study, 32 small business entrepreneurs were interviewed across the country. In addition, other sources were interviewed to check and confirm the validity of the entrepreneu rs' responses. Research Methodology A mixed-method strategy is one in which more than one method of approach is used in data collection and analysis while conducting research (Romano 1989). This approach is similar to what Mikkelsen (1995) and Denzin (1978) described as triangulation. The multiple-method strategy was adopted for this study to reduce the possibility of personal bias by not depending on only one method of approach or response coming from only one firm or sector. Adopting this method of approach supports the authenticity of the study. Both qualitative and quantitative data were used in a variety of ways, including a detailed overview of survey results in terms of a general profile and a model of Nigerian small firms. Semi-structured interviews based on open-ended, flexible questionnaires and some structured interviews were conducted with several groups of people interested or involved with the small business sector in Nigeria. The idea behind this was to obtain cross-referencing data and some independent confirmation of data, as well as a range of opinions. Input from the following groups were solicited: (1) government officials who formulate and implement policies on SME promotion and industrial development in Nigeria; (2) officials responsible for raw material supply to small companies; (3) managers of other large scale businesses operating in the same sector and economy as the SMEs; (4) representatives of development banks who may be requested to give loans to small-scale businesses; (5) industrial experts and consultants who conduct research and are well-informed about the present state of the industrial sector in Nigeria; and (6) selected customers who buy and distribute products as retailers to the public or to other small businesses or larger firms. The Perceptions of Constraints on Small Business in Nigeria What the 32 small firms studied in Nigeria considered to be the main constraints on their firms' growth and overall performance are presented in Table 1. In addition, some entrepreneurs indicated that government policies and attitudes of public officials adversely affect their businesses, especially the harsh economic policy of the structural adjustment programme (SAP) implemented by the government in 1986. The policy caused the value of the national currency to decline. Most small businesses could not afford to train their workers, and manufacturers found it difficult to obtain foreign exchange to order or purchase machinery and spare parts. There is also the problem of frequent harassment by government officials who extort money from the businesses. Poor infrastructure, including bad roads, inadequate water shortage, erratic electric supply and a poor telecommunications system are additional obstacles. Lack of these facilities cost most firms higher overheads because they have to be responsible for obtaini ng such facilities at their own expense. …

Default, Currency Crises and Sovereign Credit Ratings

Abstract: Sovereign credit ratings play an important role in determining the terms and the extent to which countries have access to international capital markets. In principle, there is no reason why changes in sovereign credit ratings should be expected to systematically predict a currency crisis. In practice, however, in developing countries there is a strong link between currency crises and default. About 85 percent of all the defaults in the sample are linked with currency crises. The results presented here suggest that sovereign credit ratings systematically fail to anticipate currency crises--but do considerably better predicting defaults. Downgrades usually follow the currency crisis--possibly highlighting how currency instability increases default risk.

Stock Prices and Exchange Rates: Are they Related? Evidence from South Asian Countries

Abstract: I. INTRODUCTION The issue of whether stock prices and exchange rates are related or not has received considerable attention after the East Asian crisis. During the crisis the countries affected saw turmoil in both currency and stock markets. If stock prices and exchange rates are related and the causation runs from exchange rates to stock prices, then the crisis in the stock markets can be prevented by controlling the exchange rates. Moreover, developing countries can exploit such a link to attract/stimulate foreign portfolio investment in their own countries. Similarly, if the causation runs from stock prices to exchange rates then authorities can focus on domestic economic policies to stabilise the stock market. If the two markets/prices are related then investors can use this information to predict the behaviour of one market using the information on other market.

Real Sources of European Currency Policy: Sectoral Interests and European Monetary Integration

Abstract: In the thirty years before Economic and Monetary Union was achieved, European currency policies varied widely among countries and over time. In this article, I argue that the sectoral impact of regional exchange-rate arrangements, in particular their expected real effects on European trade and investment, exerted a powerful influence on the course of European monetary integration. The principal benefit of fixing European exchange rates was facilitation of cross-border trade and investment within the European Union (EU); the principal cost of fixed rates was the loss of national governments' ability to use currency policy to improve their producers' competitive position. Empirical results indeed indicate that a stronger and more stable currency was associated with greater importance of manufactured exports to the EU's hard-currency core, while depreciations were associated with an increase in the net import competition faced by the country's producers. This suggests a powerful impact of real factors related to trade and investment, and of private interests concerned about these factors, in determining national currency policies.

On Currency Crises and Contagion

Abstract: This paper analyzes the role of contagion in the currency crises in emerging markets during the 1990s. It employs a non-linear Markov-switching model to conduct a systematic comparison and evaluation of three distinct causes of currency crises: contagion, weak economic fundamentals, and sunspots, i.e. unobservable shifts in agents' beliefs. Testing this model empirically through Markov-switching and panel data models reveals that contagion, i.e. a high degree of real integration and financial interdependence among countries, is a core explanation for recent emerging market crises. The model has a remarkably good predictive power for the 1997-98 Asian crisis. The findings suggest that in particular the degree of financial interdependence and also real integration among emerging markets are crucial not only in explaining past crises but also in predicting the transmission of future financial crises.

Crises now and then: what lessons from the last era of financial globalization?

Abstract: We consider the operation of international capital markets in two periods of globalization, before 1914 and after 1971, with a focus on the crisis problem. We explore the idea that the incidence of crises in these two periods reflects how capital flows were embedded in the larger economic system. Other authors have made similar connections, suggesting that the international monetary framework was responsible for the relatively short-lived and mild nature of pre-World War I financial crises. However, we show that currency crises in fact were of longer duration before 1914. Only for banking and twin crises is there evidence that recovery was faster then than now. This leads us to a somewhat different view of the role of the monetary regime in the propagation of financial crises. A key difference between then and now, we suggest, is that prior to 1914 banking crises were less prone to undermine confidence in the currency, and to thereby compound financial problems, in the countries that were at the core of the international monetary system.

The Demand for Money, Financial Innovation, and the Welfare Cost of Inflation: An Analysis with Household Data

Abstract: We use microeconomic data on households to estimate the parameters of the demand for currency derived from a generalized Baumol‐Tobin model. Our data set contains information on average currency, deposits, and other interest‐bearing assets; the number of trips to the bank; the size of withdrawals; and ownership and use of ATM cards. We model the demand for currency accounting for adoption of new transaction technologies and the decision to hold interest‐bearing assets. The interest rate and expenditure flow elasticities of the demand for currency are close to the theoretical values implied by standard inventory models. However, we find significant differences between individuals with an ATM card and those without. The estimates of the demand for currency allow us to calculate a measure of the welfare cost of inflation analogous to Bailey’s triangle, but based on a rigorous microeconometric framework. The welfare cost of inflation varies considerably within the population but never turns out to be very lar...

Ten Lessons for ICT and Education in the Developing World

Abstract: World Links for Development Program The World Bank Institute T skills to productively transform knowledge and information into innovative products and services will define successful knowledge economies. Because knowledge and information have become the most important currency for productivity, competitiveness, and increased wealth and prosperity, nations have placed greater priority on developing their human capital. Governments around the world are thus focusing on strategies to increase access to and improve the quality of education. Decision makers find themselves asking key questions: What defines a quality education in today’s global information-based economy? Has education kept pace with a rapidly changing world? Are there good models for reform that we can follow?

On the Desirability of a Regional Basket Currency Arrangement

Abstract: This paper constructs a theoretical model of international trade in order to examine an optimal exchange rate regime for (Asian) emerging market economies that export goods to the United States, Japan, and neighboring countries. The optimality of the exchange rate regime is defined as minimizing the fluctuation of trade balances, in the environment where the yen–dollar exchange rate fluctuates exogenously. Since the de facto dollar peg regime is blamed as one of the factors that caused the Asian currency crisis, the question of the optimal exchange rate regime is quite relevant in Asia. The novelty of this paper is to show how an emerging market economy's choice of the exchange rate regime (or weights in the basket) is dependent on the neighboring country's. The dollar weights in the currency baskets of the two countries are determined as a Nash equilibrium. We show that they may be stuck at the dollar peg system in both stable and unstable equilibrium cases. Even in a stable equilibrium case, there are multiple equilibria and a coordination failure may occur. J. Japan. Int. Econ., September 2002, 16(3), pp. 317–334. Department of Commerce and Management, Hitotsubashi University, Kunitachi, Tokyo 186-8601, Japan; and Institute of Economic Research, Hitotsubashi University, Kunitachi, Tokyo 186-8601, Japan; Research Center for Advanced Science and Technology, University of Tokyo, Meguro, Tokyo 153-8904, Japan. © 2002 Elsevier Science (USA). Journal of Economic Literature Classification Numbers: F31, F33, O11.

Does the Current Account Matter

Abstract: The purpose of this paper is to investigate in detail the behavior of the current account in emerging economies, and in particular its role if any in financial crises. Models of current account behavior are reviewed, and a dynamic model of current account sustainability is developed. The empirical analysis is based on a massive data set that covers over 120 countries during more than 25 years. Important controversies related to the current account including the extent to which current account deficits help predict currency crises are also analyzed. Throughout the paper I am interested in analyzing whether there is evidence supporting the idea that there are costs involved in running 'very large' deficits. Moreover, I investigate the nature of these potential costs, including whether they are particularly high in the presence of other type of imbalances.(This abstract was borrowed from another version of this item.)

Honey, I Shrunk the Currency Union Effect on Trade

Abstract: NE of the puzzles in empirical international trade is the difficulty offinding a large and statistically significant negative effect of exchange ratevariability on trade. Business managers (and also policymakers) often claim thatcurrency fluctuations are a major obstacle for international economic integration.Since volatile exchange rates generally imply uncertainty about external returns,large and frequent changes in the exchange rate are widely expected to lower thebilateral amount of trade, holding other things constant. Surprisingly, then, asubstantial body of empirical work has hardly found any association betweenexchange rate volatility and trade. In fact, this empirical result has become bynow so established that most of the latest studies do not aim to weaken thefinding, but rather try to provide explanations for it, such as the availability ofhedging instruments (see, for example, Wei, 1999).Recently, however, Andrew Rose (2000) has turned the puzzle on its head.Analysing the effect of currency unions on trade, he finds that a completeelimination of exchange rate variability not only increases trade, but that theeffect is strikingly large. In particular, Rose finds that two countries that share acommon currency trade three times more with one another than with countriesthat use a different currency.This result, apart from being notable for itself, is particularly interesting forat least two reasons. First, there has been recently a growing tendencytowards the establishment of currency unions. In Europe, twelve countrieshave decided to give up their national currencies for the euro. Moreover, agrowing number of countries seek to cure domestic economic problems byfull dollarisation, i.e. adopting a foreign currency as legal tender. Examplesinclude Ecuador in the case of the US dollar and the former Yugoslavianrepublic of Montenegro in the case of the Deutschmark. Rose’s results, then,

Managed Floating Plus

Abstract: In this analysis, Morris Goldstein examines currency-regime choices for emerging economies that are heavily involved with private capital markets. The author argues that the best regime choice for such economies would be managed floating plus, where "plus" is shorthand for a framework that includes inflation targeting and aggressive measures to discourage currency mismatching. Goldstein argues that if managed floating were enhanced in this way, it would retain the desirable features of a flexible rate regime while addressing the nominal anchor and balance-sheet problems that have historically underpinned a "fear of floating" and handicapped the performance of managed floating in emerging economies. The author also shows why managed floating plus is superior to four alternative currency-regime options - an adjustable peg system, a "BBC (basket, band, crawl) regime", a currency board, and dollarization.

Predicting Emerging Market Currency Crashes

Abstract: This paper assesses the extent to which crashes in emerging market currencies are predictable using simple logit models based on lagged macroeconomic and financial data. To evaluate our model, we calculate trading strategies in which an investor goes long or short in the currency depending on whether crash probabilities are low or high. When we estimate the model on part of the data and then use the parameter estimates to generate predictions for the remainder of the sample, we find that substantial profits may be made. Furthermore, the model correctly forecasts major crashes even on an out-of-sample basis.

Too Sensational: On the Choice of Exchange Rate Regimes

Abstract: Most of the literature on exchange rate regimes has focused on the developed countries. Since the recent crises in emerging markets, however, attention has shifted to the choice of exchange rate regimes for developing countries, especially those that are more integrated into the world capital markets. In Too Sensational, W. Max Corden presents a systematic and accessible overview of the choice of exchange rate regimes. Reviewing many types of regimes, he shows how the choice of an exchange rate regime is related to both fiscal policy and trade policy.Building on the theory of optimum currency areas, Corden develops an analytic framework of three approaches (nominal anchor, real targets, and exchange rate stability) and three polar exchange rate regimes (absolutely fixed, pure floating, and fixed but adjustable). He considers all other regimes to be mixtures of two or three of the polar regimes.Beginning with theory and later turning to case studies of countries in Asia, Europe, and Latin America, Corden focuses on how economies react to negative and positive shocks under various exchange rate regimes. He examines in particular the Asian and Latin American currency crises of the 1990s. He concludes that although "too sensational" crises have discredited fixed but adjustable regimes, the extremes of absolutely fixed regimes or pure floating regimes need not be chosen.

Boom-Bust Cycles in Middle Income Countries: Facts and Explanation

Abstract: In this paper we characterize empirically the comovements of macro variables typically observed in middle income countries, as well as the boom-bust cycle that has been observed during the last two decades. We find that many countries that have liberalized their financial markets, have witnessed the development of lending booms. Most of the time the boom gradually decelerates, but sometimes the boom ends in twin currency and banking crises and is followed by a protracted credit crunch that outlives a short-lived recession. We also find that during lending booms there is a real exchange rate appreciation, and the nontradables (N) sector grows faster than the tradables (T) sector. Meanwhile, the opposite is true in the aftermath of crisis. We argue that these comovements are generated by the interaction of two characteristics of financing typical of middle income countries: risky currency mismatch and asymmetric financing opportunities across the N and T sectors Copyright 2002, International Monetary Fund