Showing papers on "Currency published in 2010"

Financial Stability, the Trilemma, and International Reserves

Abstract: The rapid growth of international reserves, a development concentrated in the emerging markets, remains a puzzle. In this paper, we suggest that a model based on financial stability and financial openness goes far toward explaining reserve holdings in the modern era of globalized capital markets. The size of domestic financial liabilities that could potentially be converted into foreign currency (M2), financial openness, the ability to access foreign currency through debt markets, and exchange rate policy are all significant predictors of reserve stocks. Our empirical financial-stability model seems to outperform both traditional models and recent explanations based on external short-term debt.

Do Peso Problems Explain the Returns to the Carry Trade

Abstract: We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We investigate whether these payoffs reflect a peso problem. We argue that they do. We reach this conclusion by analyzing the payoffs to the hedged carry trade, in which an investor uses currency options to protect himself from the downside risk from large, adverse movements in exchange rates

Financial Exchange Rates and International Currency Exposures

Abstract: Our goal in this project is to gain a better empirical understanding of the international financial implications of currency movements. To this end, we construct a database of international currency exposures for a large panel of countries over 19902004. We show that trade-weighted exchange rate indices are insufficient to understand the financial impact of currency movements. Further, we demonstrate that many developing countries hold short foreign-currency positions, leaving them open to negative valuation effects when the domestic currency depreciates. However, we also show that many of these countries have substantially reduced their foreign currency exposure over the last decade. Last, we show that our currency measure has high explanatory power for the valuation term in net foreign asset dynamics: exchange rate valuation shocks are sizable, not quickly reversed and may entail substantial wealth shocks.

Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle

Abstract: A major puzzle in international finance is that high interest rate currencies tend to appreciate (forward discount puzzle). Motivated by the fact that only a small fraction of foreign currency holdings is actively managed, we calibrate a two-country model in which agents make infrequent portfolio decisions. We show that the model can account for the forward discount puzzle. It can also account for several related empirical phenomena, including that of "delayed overshooting." We also show that making infrequent portfolio decisions is optimal as the welfare gain from active currency management is smaller than the corresponding fees.

Currency Choice and Exchange Rate Pass-Through

Abstract: In the open economy macro literature with nominal rigidities, the currency in which goods are priced has important implications for optimal monetary and exchange rate policy and for exchange rate pass-through. We show, using novel data on currency and prices for U.S. imports, that even conditional on a price change, there is a large difierence in the pass-through of the average good priced in dollars (25%) versus non-dollars (95%). We document this to be the case across countries and within disaggregated sectors. This flnding contradicts the assumption in an important class of models that the currency of pricing is exogenous. We present a model of endogenous currency choice in a dynamic price setting environment and show that the predictions of the model are strongly supported by the data.

The Initial Impact of the Crisis on Emerging Market Countries

Abstract: To understand the diverse impact of the crisis across emerging market countries, we explore the role of two shocks—the collapse in trade and the sharp decline in financial flows—in the transmission of the crisis from the advanced economies. We first develop a simple open economy model, which allows for imperfect capital mobility and potentially contractionary effects of currency depreciation due to foreign debt exposure. We then look at the cross-country evidence. The data suggest a strong role for both trade and financial shocks. Perhaps surprisingly, the data give little econometric support for a central role of either reserves or exchange rate regimes. We end by presenting case studies for Latvia, Russia, and Chile.

Optimal monetary policy in open economies

Abstract: This chapter studies optimal monetary stabilization policy in interdependent open economies, by proposing a unified analytical framework systematizing the existing literature. In the model, the combination of complete exchange-rate pass-through ('producer currency pricing') and frictionless asset markets ensuring efficient risk sharing, results in a form of open-economy 'divine coincidence': in line with the prescriptions in the baseline New-Keynesian setting, the optimal monetary policy under cooperation is characterized by exclusively inward-looking targeting rules in domestic output gaps and GDP-deflator inflation. The chapter then examines deviations from this benchmark, when cross-country strategic policy interactions, incomplete exchange-rate pass-through ('local currency pricing') and asset market imperfections are accounted for. Namely, failure to internalize international monetary spillovers results in attempts to manipulate international relative prices to raise national welfare, causing inefficient real exchange rate fluctuations. Local currency pricing and incomplete asset markets (preventing efficient risk sharing) shift the focus of monetary stabilization to redressing domestic as well as external distortions: the targeting rules characterizing the optimal policy are not only in domestic output gaps and inflation, but also in misalignments in the terms of trade and real exchange rates, and cross-country demand imbalances.

Gaming system and a method of gaming

Abstract: A gaming system including: a plurality of credit meters arranged to store different types of credits including a first credit meter for storing first credits; a currency converter arranged to convert from currency to first credits and from first credits to currency at a fixed rate; a game controller arranged to implement a game in which wagers are placed by a player in first credits, the gaming system arranged to enable a player to establish a balance of second credits on a second credit meter of the plurality of credit meters; and an exchange rate controller arranged to control an effective exchange rate between first credits and second credits to vary over time.

Bank Negara Malaysia

Abstract: Bank Negara — Malaysia's central bank — reported on March 31, 1994 staggering foreign exchange losses of Malaysian Ringgit M$ 5.7 billion (equivalent to $2.1 billion), which followed an even larger loss of M$9 billion in 1992 ($3.3 billion). Jaffar bin Hussein—Bank Negara's long serving governor—was forced to resign on April 1, 1994 the day following the disclosure of the mammoth foreign exchange losses. Under normal central banking practices, such losses would have been the result of costly and legitimate but unsuccessful attempts by Bank Negara's at stemming the rise of its currency due to speculative capital inflows (see Box A). Indeed, in January 1994, The Economist reported that Bank Negara had declared war on “currency speculators,” who were buying Ringgits in anticipation of its appreciation. “But as the world's foreign exchange dealers well know, Bank Negara has long been a big punter in the currency market itself. In the last two years, its boldness has been matched only by its incompetence.” Indeed, as early as 1988, Jaffar had announced that to the traditional goals of providing safety and liquidity in managing its foreign exchange reserves, Bank Negara henceforth would add “profit optimization and market expertise,” which soon became a code word for currency speculation.

Exporting and Firm Performance: Chinese Exporters and the Asian Financial Crisis

Abstract: We ask how export demand shocks associated with the Asian financial crisis affected Chinese exporters. We construct firm-specific exchange rate shocks based on the precrisis destinations of firms' exports. Because the shocks were unanticipated and large, they are a plausible instrument for identifying the impact of exporting on firm productivity and other outcomes. We find that firms whose export destinations experience greater currency depreciation have slower export growth and that export growth leads to increases in firm productivity and other firm performance measures. Consistent with “learning-by-exporting,” the productivity impact of export growth is greater when firms export to more developed countries.

Uncertainty and Currency Crises: Evidence from Survey Data

Abstract: This paper studies empirically how uncertainty affects speculation in the foreign exchange markets. We use the dispersion of survey forecasts of key macroeconomic variables to measure uncertainty about fundamentals. We find that uncertainty has a non-monotone effect on exchange rate pressures: namely, uncertainty heightens speculative pressures when expected fundamentals are good and eases them when they are bad. We prove that this prediction arises from a broad class of currency crisis theories, ranging from first-generation to global-game models. We also show that the proposed empirical strategy remains valid in the presence of forecasters with strategic objectives and use a novel set of instrumental variables to address potential endogeneity bias.

Macroeconomic Determinants of Carry Trade Activity

Abstract: Carry trades - a popular strategy in the foreign exchange market - are long positions in high interest rate currencies financed by borrowing low interest rate currencies. Such positions are held as long as i) there remains a significant interest rate differential between the two currency groups and/or ii) exchange rate risk remains low. When either or both such conditions are violated positions are typically unwound, triggering rapid movements in the exchange rate level and its volatility and spillovers to other asset classes as well as to real activity. The recent global deleveraging has clearly evidenced the strength of this channel. From a financial standpoint, the mechanics of the carry trade has been recently examined in Brunnermeier et al. (2009). They showed that shocks to interest rate differentials lead to carry trade activity and to significant reactions in the bilateral exchange rates vis-a-vis the US dollar that they analyse. Starting from their paper, we take a more macroeconomic standpoint and aim to identify what kind of structural shock can generate the implications of their interest rate differential shock. To this aim we add two macroeconomic variables and two indicators of confidence to the 4-variable financial VAR of Brunnermeier et al. (2009) and use sign restrictions on the impulse responses of the resulting larger VAR to identify four macroeconomic shocks. We evidence that although all shocks may potentially have effects on developments in the interest rate differential and the exchange rate level that overall make carry trading profitable in the short run, demand shocks and confidence shocks only are associated with longer-term gains from carry trade activity, relative to supply and monetary policy shocks. This finding also supports the widely reported idea that sentiment boosts position taking. We also provide a measure of the potential gain/losses experienced by the actual positioning of market participants in the foreign exchange futures market, conditional on their ability to correctly anticipate the nature of the prevailing macroeconomic shock.

Determinants of FDI in BRICS Countries: A panel analysis

Abstract: This study examines the factors determining FDI inflows of BRICS countries using annual dataset from the period 1975 to 2007 (for Russia required data set is available from 1990 onwards). The study employs Panel data analysis and finds that the selected variables Market size, Labour cost, Infrastructure, Currency value and Gross Capital formation as the potential determinants of FDI inflows of BRICS countries. The Economic Stability and Growth prospects (measured by inflation rate and Industrial production respectively), Trade openness (measured by the ratio of total trade to GDP) are seems to be the insignificant determinant of FDI inflows of the BRICS countries. The empirical results are robust in general for alternative variables determining FDI flows.

Currency Unions in Prospect and Retrospect

Abstract: We critically review the recent literature on currency unions and discuss the methodological challenges posed by the empirical assessment of their costs and benefits. In the process, we provide evidence on the economic effects of the euro. In particular, and in contrast with estimates of the trade effect of other currency unions, we find that the euro's impact on trade has been close to zero. After reviewing the costs and benefits of joining a currency union, we conclude with some open questions on normative and positive aspects of the theory of currency unions, emphasizing the need for a unified welfare-based framework to weigh their costs and gains.

Migrant Remittances and Exchange Rate Regimes in the Developing World

Abstract: This article argues that the international financial consequences of immigration exert a strong influence on the choice of exchange rate regimes in the developing world. Over the past two decades, migrant remittances have emerged as a significant source of external finance for developing countries, often exceeding conventional sources of capital such as foreign direct investment and bank lending. Remittances are unlike nearly all other capital flows in that they are stable and move countercyclically relative to the recipient country’s economy. As a result, they mitigate the costs of forgone domestic monetary policy autonomy and also serve as the “risk-sharing” mechanism required by standard political economy models of currency unions. The observable implication of these arguments is that remittances increase the likelihood that policymakers adopt fixed exchange rates. An analysis of data on de facto exchange rate regimes and a newly available dataset on remittances for up to 74 developing countries from 1983 to 2004 provides strong support for these arguments; the results are robust to instrumental variable analysis and the inclusion of multiple economic and political control variables.

Global Currency Hedging

Abstract: Over the period 1975 to 2005, the U.S. dollar (particularly in relation to the Canadian dollar), the euro, and the Swiss franc (particularly in the second half of the period) moved against world equity markets. Thus, these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the U.S. dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.

An Optimum Currency Area Odyssey

Abstract: The theory of optimum currency areas was conceived and developed in three highly influential papers, written by Mundell (1961), McKinnon (1963) and Kenen (1969). Those authors identified characteristics that potential members of a monetary union should ideally possess in order to make it feasible to surrender a nationally-tailored monetary policy and the adjustment of an exchange rate of a national currency. We trace the development of optimum-currency-area theory, which, after a flurry of research into the subject in the 1960s, was relegated to intellectual purgatory for about 20 years. We then discuss factors that led to a renewed interest into the subject, beginning in the early 1990s. Milton Friedman plays a pivotal role in our narrative; Friedman's work on monetary integration in the early 1950s presaged subsequent optimum-currency-area contributions; Mundell's classic formulation of an optimal currency area was aimed, in part, at refuting Friedman's "strong" case for floating exchange rates; and Friedman's work on the role of monetary policy had the effect of helping to revive interest in optimum-currency-area analysis. The paper concludes with a discussion of recent analytical work, using New Keynesian models, which has the promise of fulfilling the unfinished agenda set-out by the original contributors to the optimum-currency-area literature, that is, providing a consistent framework in which a country's characteristics can be used to determine its optimal exchange-rate regime.

Adjustment Under a Currency Peg: Estonia, Latvia and Lithuania During the Global Financial Crisis 2008-09

Abstract: The paper traces the Baltics’ adjustment strategy during the 2008-09 global financial crisis. The abrupt end to the externally-financed domestic demand boom triggered a severe output collapse, bringing per capita income levels back to 2005/06 levels. In response to this shock, the Baltics undertook an internal devaluation that relied on unprecedented fiscal and nominal wage adjustment, steps to preserve financial sector stability as well as complementary efforts to facilitate voluntary private debt restructuring. One-and-half years on, the strategy is making good progress but not yet complete. Confidence in the exchange rate was maintained, the banking system was supported by its parent banks, external imbalances and inflation have largely disappeared, competitiveness is improving, and fiscal deficits are gradually being brought back towards pre-crisis levels. However, amid record levels of unemployment, further reforms are needed to foster a return to more balanced growth, fiscal sustainability, and a healthier banking system.

Banking and Debt Crises in Europe: The Dangerous Liaisons?

Abstract: The potential mutation of the Sub-Prime banking crisis into a sovereign debt one in Euro area countries is investigated. After reviewing the criteria used to measure the debt vulnerability, the balance sheet approach (BSA) is presented in order to illustrate the potential connections between these two types of crises. A graphical analysis yields evidence that at the end 2009 the probability of observing a Euro area country defaulting is less likely than six month before. Nevertheless, the serious threats, which concern Greece and Ireland, do not permit us to exclude the occurrence of a contagious, or self-fulfilling, sovereign debt or currency crises in Euro area in the future.

Corporate hedging and shareholder value

Abstract: Although theory suggests that corporate hedging can increase shareholder value in the presence of capital market imperfections, empirical studies show overall mixed support for rationales of hedging with derivatives. Although various empirical challenges and limitations advise some caution with regard to the interpretation of the existing evidence, the results are consistent with derivatives use being just one part of a broader financial strategy that considers the type and level of financial risks, the availability of risk management tools, and the operating environment of the firm. Moreover, corporations rely heavily on pass-through, operational hedging, and foreign currency debt to manage financial risk.

The Politics of Monetary Policy

Abstract: In this paper we critically review the literature on the political economy of monetary policy, with an eye on the questions raised by the recent financial crisis. We begin with a discussion of rules versus discretion. We then examine the issue of Central Banks independence both in normal times, in times of crisis. Then we review the literature of electoral manipulation of policies. Finally we address international institutional issues concerning the feasibility, optimality and political sustainability of currency unions in which more than one country share the same currency. A brief review of the Euro experience concludes the paper.

Sovereign Wealth Funds: Threat or Salvation?

Abstract: Sovereign wealth funds (SWPs)--investment funds overseen by one nation, funded by its foreign currency reserves but managed separately from official currency reserves--are not a new phenomenon in international finance. But recently, they have become a reoccurring headline and a topic of great interest in international economics, due in part to their signficant impact on international markets. Total holdings of international assets by SWFs have grown to at least $3.5 trillion and international reserves--which can be used for similar purposes--have risen to nearly $7 trillion. Given their significant presence, SWFs can raise national security concerns aand questions about the integrity of investment practices. This timely book first traces the origins of SWFs and the buildup of international reserves. It then describes the potential political and economic power issues raised by these large holdings of cross-border assets for three entities: the countries that own them, host countries, and the international financial system. To evaluate the integrity of these funds: Truman presents an updated "scoreboard" of the funds; the "scoreboard" comprises 33 elements, which are divided into four categories: structure, governance, transparency and accountability, and behavioral rules. This ground-breaking "scoreboard" contributed to the development of a set of generally accepted principles and practices--the Santiago Principles--used by the International Monetary Fund. Finally, Truman discusses the evolving role of SWFs in the context of the global economic and financial crisis and its aftermath. This volume offers policy recommendations for countries that manage funds and those countries that expect to receive investments from them in the future.

The Global Credit Crunch and Foreign Banks' Lending to Emerging Markets: Why did Latin America Fare Better?

Abstract: The recent global financial turmoil raised questions about the stability of foreign banks' financing to emerging market countries. While foreign banks' lending growth to most emerging market regions contracted sharply, lending to Latin America and the Caribbean (LAC) was significantly more resilient. Analyzing detailed BIS data on global banks' lending to LAC countries - whether extended directly by their headquarters abroad or by their local affiliates in host countries - we show that the propagation of the global credit crunch was significantly more muted in countries where most of foreign banks' lending was channeled in domestic currency. We also show that foreign banks' involvement in LAC has differed in fundamental ways from that in other regions, with most of their lending to LAC conducted by their local subsidiaries, denominated in domestic currency and funded from a domestic deposit base. These characteristics help explain why LAC has not been struck as hard as other emerging markets by the global deleveraging and pullback in foreign banks' lending.

Exchange Rate Regimes and the Stability of the International Monetary System

Abstract: The member countries of the IMF collaborate to try to ensure orderly exchange arrangements and promote a stable system of exchange rates, recognizing that the essential purpose of the international monetary system is to facilitate the exchange of goods, services, and capital, and to sustain sound economic growth. The paper reviews the stability of the overall system of exchange rates by examining macroeconomic performance (inflation, growth, crises) under alternative exchange rate regimes; implications of exchange rate regime choice for interaction with the rest of the system (external adjustment, trade integration, capital flows); and potential sources of stress to the international monetary system.