Showing papers on "Currency published in 2004"

Marginal Gains: Monetary Transactions in Atlantic Africa

Abstract: In America, almost all the money in circulation passes through financial institutions every day. But in Nigeria's "cash and carry" system, 90 percent of the currency never comes back to a bank after it's issued. What happens when two such radically different economies meet and mingle, as they have for centuries in Atlantic Africa? The answer is a rich diversity of economic practices responsive to both local and global circumstances. In "Marginal Gains," Jane I. Guyer explores and explains these often bewildering practices, including trade with coastal capitalism and across indigenous currency zones, and within the modern popular economy. Drawing on a wide range of evidence, Guyer demonstrates that the region shares a coherent, if loosely knit, commercial culture. She shows how that culture actually works in daily practice, addressing both its differing scales of value and the many settings in which it operates, from crisis conditions to ordinary household budgets. The result is a landmark study that reveals not just how popular economic systems work in Africa, but possibly elsewhere in the Third World.

Balance Sheet Effects, Bailout Guarantees and Financial Crises

Abstract: This paper provides a model of boom-bust episodes in middle-income countries. It is based on sectoral differences in corporate finance: the nontradables sector is special in that it faces a contract enforceability problem and enjoys bailout guarantees. As a result, currency mismatch and borrowing constraints arise endogenously in that sector. This sectoral asymmetry allows the model to replicate the main features of observed boom-bust episodes. In particular, episodes begin with a lending boom and a real appreciation, peak in a self-fulfilling crisis during which a real depreciation coincides with widespread bankruptcies, and end in a recession and credit crunch. The nontradables sector accounts for most of the volatility in output and credit. In the last two decades, many middle-income countries have experienced boom-bust episodes centred around balance-of-payments crises. There is now a well known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large "fundamental" shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output. This paper proposes a theory of boom-bust episodes that emphasizes sectoral asymmetries in corporate finance. It is motivated by an additional set of facts that has received little attention in the literature: the tradables (T-) and nontradables (N-) sectors fared quite differently in most boom-bust episodes. While the N-sector was typically growing faster than the T-sector during a boom, it fell harder during the crisis and took longer to recover afterwards. Moreover, most of the guaranteed credit extended during the boom went to the N-sector, and most bad debt later surfaced there. Our analysis is based on two key assumptions that are motivated by the institutional environment of middle-income countries. First, N-sector firms are run by managers who issue debt, but cannot commit to repay. In contrast, T-sector firms have access to perfect financial markets. Second, there are systemic bailout guarantees: lenders are bailed out if a critical mass of borrowers defaults. The first part of this paper derives optimal investment and financing choices for the N-sector when these imperfections are present. We show that both borrowing constraints and a risky currency mismatch of assets and liabilities arise in equilibrium. Moreover, even in a world with no exogenous shocks, self-fulfilling crises can occur. The second part of this paper

Technological infrastructure and international competitiveness

Abstract: The paper is probably the first written paper using the concept of ‘the national innovation system’ and it analyses how technological infrastructure differs between countries and how such differences are reflected in international competitiveness. It makes a critical review of new (in the 1980s) developments in the theory of international trade and confronts them with recent empirical results. It shows how competitiveness cannot be explained by wage rates/prices/currency rates. Technological leadership gives absolute rather than comparative advantage and technological leadership will reflect institutions supporting coupling, creating, clustering comprehending and coping in connection with technology. The analysis is rooted in historical context through references to Friedrich List and his criticism of Adam Smith and laissez-faire. Special emphasis is put on List's concept of mental capital. Finally, the analytical arguments are illustrated by the catching-up and forging ahead of first Germany and later Japan. The paper concludes that disequilibria in international trade will be persistent and that for laggard economy the free trade doctrine may be unduly restrictive. Another conclusion is that public investment in technological infrastructure and intellectual capital is crucial for successful economic development. It is pointed out that there is a need to couple education, science, trade and industry policy in order to build competitiveness.

"Does One Soros make a difference? A theory of currency crises with large and small traders"

Abstract: Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signaling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there is no large investors, small investors attach the currency when fundamentals are stronger. Yet, the difference can be small, or null, depending on the relative precision of private information of the small and large investors. Adding signaling makes the influence of the large trader on small traders behaviour much stronger.

Bailouts or Bail-Ins?: Responding to Financial Crises in Emerging Economies

Abstract: Roughly once a year, the managing director of the International Monetary Fund, the U.S. treasury secretary and in some cases the finance ministers of other G-7 countries will get a call from the finance minister of a large emerging market economy. The emerging market finance minister will indicate that the country is rapidly running out of foreign reserves, that it has lost access to international capital markets and, perhaps, that is has lost the confidence of its own citizens. Without a rescue loan, it will be forced to devalue its currency and default either on its government debt or on loans to the country's banks that the government has guaranteed. This book looks at these situations and the options available to alleviate the problem. It argues for a policy that recognizes that every crisis is different and that different cases need to be handled within a framework that provides consistency and predictability to borrowing countries as well as those who invest in their debt.

The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries

Abstract: In this paper we explore some implications of the revived' Bretton Woods system for exchange market intervention and reserve management in periphery countries. Financial policies in these countries are seen as a component of a more general portfolio management policy in which the formation of an efficient domestic capital stock is a key objective. Because intervention in financial markets is an important part of their development strategy, intervention in exchange and financial markets has, and we argue will continue to be, large and persistent enough to generate predictable deviations of exchange rates and relative yields in industrial country financial markets from normal cyclical patterns. We argue that management of the currency composition of international reserves by emerging market governments and central banks is unlikely to alter these conclusions.

The East Asian Dollar Standard, Fear of Floating, and Original Sin

Abstract: Before the crisis of 1997-98, the East Asian economies — except for Japan but including China — pegged their currencies to the U.S. dollar. To avoid further turmoil, the IMF now argues that these currencies should float more freely. However, our econometric estimations show that the dollar's predominant weight in East Asian currency baskets has returned to its pre-crisis levels. By 2002, the day-to-day volatility of each country's exchange rate against the dollar has again become negligible. In addition, most governments are rapidly accumulating a "war chest" of official dollar reserves, which portends that this exchange rate stabilization will come to extend over months or quarters. From the doctrine of "original sin" applied to emerging-market economies, we argue that this fear of floating is entirely rational from the perspective of each individual country. And, although Japan remains an important outlier, their joint pegging to the dollar benefits the East Asian dollar bloc as a whole.

Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment

Abstract: In the light of the importance of foreign direct investment (FDI) for the promotion of economic development, this paper examines the impact of the changes in the real exchange rate and its volatility on FDI. Examining Japan's FDI by industries, we found that the depreciation of the currency of the host country attracted FDI, while the high volatility of the exchange rate discouraged FDI. Our results suggest the need to avoid over-valuation of the exchange rate and to maintain stable but flexible exchange rate in order to attract FDI.

Have trading rule profits in the currency markets declined over time

Abstract: Previous studies have reported mixed results regarding the success of technical trading rules in currency markets. Abnormal returns were observed in many studies using data up to the mid 1980s, while more recent studies generally report less success for technical trading rules. This paper tests whether moving average trading rule profits have declined over the period from 1971 to 2000. If so, previous profits may represent a temporary inefficiency that has since been eliminated in the currency markets. The hypothesis is tested using 18 exchange rate series over a longer time period than in previous studies. Rules are optimized for successive 5-year in-sample periods from 1971 to 1995 and tested over subsequent 5-year out-of-sample periods. Results show that risk-adjusted trading rule profits have declined over time-from an average of over 3% in the late 1970s and early 1980s to about zero in the 1990s. Thus, market inefficiencies reported in previous studies may have been only temporary inefficiencies.

Thirty Years of Current Account Imbalances, Current Account Reversals and Sudden Stops

Abstract: In this paper I analyze the anatomy of current account adjustments in the world economy during the past three decades. The main findings may be summarized as follows: (i) Major reversals in current account deficits have tended to be associated with “sudden stops” of capital inflows. (ii) The probability of a country experiencing a reversal is captured by a small number of variables that include the (lagged) current account to GDP ratio, the external debt to GDP ratio, the level of international reserves, domestic credit creation, and debt services. (iii) Current account reversals have had a negative effect on real growth that goes beyond their direct effect on investments. (iv) There is persuasive evidence indicating that the negative effect of current account reversals on growth will depend on the country's degree of openness. More open countries will suffer less-in terms of lower growth-than countries with a lower degree of openness. (v) I was unable to find evidence supporting the hypothesis that countries with a higher degree of dollarization are more severely affected by current account reversals than countries with a lower degree of dollarization. And (vi) the empirical analysis suggests that countries with more flexible exchange rate regimes are able to accommodate the shocks stemming from a reversal better than countries with more rigid exchange rate regimes.

The Monetary Geography of Africa

Abstract: Africa is working toward the goal of creating a common currency that would serve as a symbol of African unity. The advantages of a common currency include lower transaction costs, increased stability, and greater insulation of central banks from pressures to provide monetary financing. Disadvantages relate to asymmetries among countries, especially in their terms of trade and in the degree of fiscal discipline. More disciplined countries will not want to form a union with countries whose excessive spending puts upward pressure on the central bank's monetary expansion. In The Monetary Geography of Africa , Paul Masson and Catherine Pattillo review the history of monetary arrangements on the continent and analyze the current situation and prospects for further integration. They apply lessons from both experience and theory that lead to a number of conclusions. To begin with, West Africa faces a major problem because Nigeria has both asymmetric terms of trade --it is a large oil exporter while its potential partners are oil importers --and most important, large fiscal imbalances. Secondly, a monetary union among all eastern or southern African countries seems infeasible at this stage, since a number of countries suffer from the effects of civil conflicts and drought and are far from achieving the macroeconomic stability of South Africa. Lastly, the plan by Kenya, Tanzania, and Uganda to create a common currency seems to be generally compatible with other initiatives that could contribute to greater regional solidarity. However, economic gains would likely favor Kenya, which, unlike the other two countries, has substantial exports to its neighbors, and this may constrain the political will needed to proceed. A more promising strategy for monetary integration would be to build on existing monetary unions --the CFA franc zone in western and central Africa and the Common Monetary Area in southern Africa. Masson and Pattillo argue that the goal of a creating a single African currency is probably beyond reach. Economic realities suggest that grand new projects for African monetary unions are unlikely to be successful. More important for Africa's economic well-being will be to attack the more fundamental problems of corruption and governance.

Controlling Currency Mismatches in Emerging Markets

Abstract: In most of the currency crises of the 1990s, the largest output falls have occurred in those emerging economies with large currency mismatches, a phenomenon that occurs when assets and liabilities are denominated in different currencies such that net worth is sensitive to changes in the exchange rate. Currency mismatching makes crisis management much more difficult since it constrains the willingness of the monetary authority to reduce interest rates in a recession (for fear of initiating a large fall in the currency that would bring with it large-scale insolvencies). The mismatching also produces a "fear of floating" on the part of emerging economies, sometimes inducing them to make currency-regime choices that are not in their own long-term interest.

Exchange Rate, Exchange Rate Volatility and Foreign Direct Investment

Abstract: In the light of the importance of foreign direct investment (FDI) for the promotion of economic development, this paper examines the impact of the changes in the real exchange rate and its volatility on FDI. Examining Japan's FDI by industries, we found that the depreciation of the currency of the host country attracted FDI, while the high volatility of the exchange rate discouraged FDI. Our results suggest the need to avoid over-valuation of the exchange rate and to maintain stable but flexible exchange rate in order to attract FDI.

Adjusting china's exchange rate policies

Abstract: In this paper the author argues that China's exchange rate policy is seriously flawed given its current macroeconomic circumstances and its longer-term policy objectives. The main conclusions are the following: (i) the RMB is significantly under-valued; (ii) China has been "manipulating" its currency, contrary to the IMF rules of the game; (iii) it is in China's own interest, as well as in the interest of the international community, for China to initiate an appreciation of the RMB soon; and (iv) China should neither stand pat with its existing currency regime nor opt for a freely floating RMB and completely open capital markets. Instead, China should undertake a "two step" currency reform. Step one would involve a switch from a unitary peg to the US dollar to a basket peg, a 15-25 percent appreciation of the RMB, and wider margins around the new peg. Existing controls on China's capital outflows would be either maintained or liberalized only marginally, at least in the short run. Step two, to be implemented later when China's banking system is considerably stronger than it is today, would involve a transition to a "managed float," along with a significant liberalization of China's capital outflows.

Just How Undervalued is the Chinese Renminbi

Abstract: Given that the value of China's currency has been hot topic recently, this paper explores the equilibrium levels of China's real and nominal exchange rates. Employing a Johansen cointegration framework, we focus on the behavioral equilibrium exchange rate (BEER) and permanent equilibrium exchange rate (PEER) models. Our results suggest that, while the renminbi is somewhat undervalued against the dollar, the misalignment is not nearly as exaggerated as many popular claims.

The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries

Abstract: In this paper we explore some implications of the revived' Bretton Woods system for exchange market intervention and reserve management in periphery countries. Financial policies in these countries are seen as a component of a more general portfolio management policy in which the formation of an efficient domestic capital stock is a key objective. Because intervention in financial markets is an important part of their development strategy, intervention in exchange and financial markets has, and we argue will continue to be, large and persistent enough to generate predictable deviations of exchange rates and relative yields in industrial country financial markets from normal cyclical patterns. We argue that management of the currency composition of international reserves by emerging market governments and central banks is unlikely to alter these conclusions.

The basket-peg, dollar-peg, and floating: A comparative analysis

Abstract: The topic of this paper is the optimal exchange rate regime for a small open economy. We argue that the best exchange rate regime depends on the policy goal. Small open economies, such as those that experienced the recent currency and economic crises in Asia, should decide for themselves what their policy goals are, and then choose the exchange rate regime that is most conducive to achieving those goals. Adopting a basket-peg with trade weights will not in general be the optimal choice. In comparison to the dollar-peg, there are three possible advantages to the peg against the basket comprising two currencies, say the dollar and the yen. If the policy goal is to maintain monetary policy autonomy, then the best exchange rate regime is floating exchange rates, provided the autonomy is used wisely. J. Japanese Int. Economies 18 (2) (2004) 183–217.

Reclaiming Development: An Alternative Economic Policy Manual

Abstract: PART I. INTRODUCTION 1. Introduction PART II. MYTHS AND REALITIES ABOUT DEVELOPMENT 2. Myth I: History shows that free markets are best. 3. Myth II: Neo-liberalism works. 4. Myth III: Globalisation cannot and should not be stopped. 5. Myth IV: The (neo-liberal) American model of capitalism represents the ideal that all developing countries should seek to replicate. 6. Myth V: The East Asian model is idiosyncratic the Anglo-American model is universal. 7. Myth VI: Developing countries need discipline. Discipline is provided by international institutions like the IMF and the WTO, and by independent domestic institutions, such as currency boards. PART III. POLICY ALTERNATIVES 8. Policy alternatives I: Trade and industry 9. Policy alternatives II: Privatisation and Property Rights 10. Policy alternatives III: International private capital flows 11. Policy alternatives IV: Domestic financial regulation 12. Policy alternatives V: Macroeconomic policies and institutions PART IV. CONCLUSION 13. Conclusion Endnotes References Suggestions for further reading

Sudden stops and the Mexican wave: currency crises, capital flow reversals and output loss in emerging markets

Abstract: Sudden Stops are the simultaneous occurrence of a currency/balance of payments crisis with a reversal in capital flows (Calvo, 1998). We investigate the output effects of financial crises in emerging markets, focusing on whether sudden-stop crises are a unique phenomenon and whether they entail an especially large and abrupt pattern of output collapse (a “Mexican wave†). Despite an emerging theoretical literature on Sudden Stops, empirical work to date has not precisely identified their occurrences nor measured their subsequent output effects in broad samples. Analysis of Sudden Stops may provide the key to understanding why some currency/balance of payments crises entail very large output losses, while others are frequently followed by expansions. Using a panel data set over the 1975-97 period and covering 24 emerging-market economies, we distinguish between the output effects of currency crises, capital inflow reversals, and sudden-stop crises. We find that sudden-stop crises have a large negative, but short-lived, impact on output growth over and above that found with currency crises. A currency crisis typically reduces output by about 2-3 percent, while a Sudden Stop reduces output by an additional 6-8 percent in the year of the crisis. The cumulative output loss of a Sudden Stop is even larger, around 13-15 percent over a three-year period. Our model estimates correspond closely to the output dynamics of the ‘Mexican wave’ (such as seen in Mexico in 1995, Turkey in 1994 and elsewhere), and out-of-sample predictions of the model explain well the sudden (and seemingly unexpected) collapse in output associated with the 1997-98 Asian Crisis. The empirical results are robust to alternative model specifications, lag structures and using estimation procedures (IV and GMM) that correct for bias associated with estimation of dynamic panel models with country-specific effects. Our study supports the hypothesis that sudden stops have a much larger adverse effect on output than other forms of currency attack, and explains the wide divergence in economies’ performances following international financial crises. Establishing this empirical regularity for emerging market economies is the first step in empirically identifying the transmission mechanism through which sudden stops have such large output effects.

Assessing Early Warning Systems: How Have they Worked in Practice?

Abstract: Since 1999, the IMF's staff has been tracking several early-warning-system (EWS) models of currency crisis. The results have been mixed. One of the long-horizon models has performed well relative to pure guesswork and to available non-model-based forecasts, such as agency ratings and private analysts' currency crisis risk scores. The data do not speak clearly on the other long-horizon EWS model. The two short-horizon private sector models generally performed poorly.

Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality

Abstract: Openness to trade is one factor that has been identified as determining whether a country is prone to sudden stops in capital inflow, currency crashes, or severe recessions Some believe that openness raises vulnerability to foreign shocks, while others believe that it makes adjustment to crises less painful Several authors have offered empirical evidence that having a large tradable sector reduces the contraction necessary to adjust to a given cut-off in funding This would help explain lower vulnerability to crises in Asia than in Latin America Such studies may, however, be subject to the problem that trade is endogenous We use the gravity instrument for trade openness, which is constructed from geographical determinants of bilateral trade We find that openness indeed makes countries less vulnerable, both to severe sudden stops and currency crashes, and that the relationship is even stronger when correcting for the endogeneity of trade