Showing papers on "Exchange rate published in 1976"

Expectations and Exchange Rate Dynamics

Abstract: The paper develops a theory of exchange rate movements under perfect capital mobility, a slow adjustment of goods markets relative to asset markets, and consistent expectations. The perfect foresight path is derived and it is shown that along that path a monetary expansion causes the exchange rate to depreciate. An initial overshooting of exchange rates is shown to derive from the differential adjustment speed of markets. The magnitude and persistence of the overshooting is developed in terms of the structural parameters of the model. To the extent that output responds to a monetary expansion in the short run, this acts as a dampening effect on exchange depreciation and may, in fact, lead to an increase in interest rates.

A Monetary Approach To The Exchange Rate: Doctrinal Aspects And Empirical Evidence

Abstract: This paper deals with the determinants of the exchange rate and develops a monetary view (or more generally, an asset view) of exchange rate determination. The first part traces some of the doctrinal origins of approaches to the analysis of equilibrium exchange rates. The second part examines some of the empirical hypotheses of the monetary approach as well as some features of the efficiency of the foreign exchange markets. Special emphasis is given to the role of expectations in exchange rate determination and a direct observable measure of expectations is proposed. The direct measure of expectations builds on the information that is contained in data from the forward market for foreign exchange. The empirical results are shown to be consistent with the hypotheses of the monetary approach.

How Far Can We Push The "Law of One Price"?

Abstract: Students exposed to the pure theory of international trade have been seduced by visions of an imaginary world with few goods, each typically produced by several countries but nevertheless homogeneous. In the assumed absence of transport costs and trade restrictions, perfect commodity arbitrage insures that each good is uniformly priced (in common currency units) throughout the world-the "law of one price" prevails. In reality the law of one price is flagrantly and systematically violated by ernpirical data. This paper presents evidence that exchange rate changes substantially alter the relative dollar-equivalent prices of the most narrowly defined domestic and foreign manufactured goods for which prices can readily be matched. Moreover, these relative price effects seem to persist for at least several years and cannot be shrugged off as transitory. In other words, for manufactured goods selected from the most disaggregated commodity lists for which U.S. and foreign prices can be matched, the products of different countries exhibit relative price behavior which marks them as differentiated products, rather than nearperfect substitutes. To clarify discussion it is useful to distinguish two contexts in which the law of one price is valid from a third context in which the law of one price does not hold. First, in a comparison of U.S., European, and Japanese prices of various well-defined steel items (plate, galvanized sheet, coldrolled sheet, and hot-rolled sheet) c.i.f. for delivery in a common port, Laurence Rosenberg found that relative dollar prices charged by different countries were fairly constant over time and were not significantly affected by exchange rate realignments. The dollar prices of primary commodities are also generally considered to be fairly independent of country of origin.' These are cases in which the products of different countries are close to identical, or near-perfect substitutes, so that any price disparities would be rapidly eliminated by commodity arbitrage. Second, in the absence of restrictions on commodity arbitrage, a product of any single country sold competitively in two different markets (foreign or domestic) would also obey the law of one price in the sense that its dollarequivalent prices in the two markets could not differ by more than the cost of transportation between these markets. Many U.S. manufactured goods do not have near-perfect substitutes on the lists of products manufactured abroad, however, and in this third context the law of one price is denied as an empirical proposition. Agricultural tilling machinery produced in the United States, for example, is apparently not a close substitute for agricultural tilling machinery produced in Germany. More generally, the most disaggregated groupings of manufactured goods for which both U.S. and German prices are readily available are dominated by products for which German dollar price indexes diverge over time from U.S. dollar price indexes2 in a manner that is strongly correlated with exchange rate movements. This divergence is evident in comparisons of U.S. wholesale transactions prices and German export transactions prices for various 2and 3-digit sectors of the WPI industry breakdown (Section I),

The Exchange Rate, The Balance Of Payments and Monetary and Fiscal Policy Under A Regime of Controlled Floating

Abstract: This paper considers the extension of the fundamental principles of the monetary approach to balance of payments analysis to a regime of floating exchange rates, with active intervention by the authorities to control rate movements It makes four main points First, the exchange rate is the relative price of different national monies, rather than national outputs, and is determined primarily by the demands and supplies of stocks of different national monies Second, exchange rates are strongly influenced by asset holder’s expectations of future exchange rates and these expectations are influenced by beliefs concerning the future course of monetary policy Third, “real” factors, as well as monetary factors, are important in determining the behavior of exchange rates Fourth, the problems of policy conflict which exist under a system of fixed rates are reduced, but not eliminated, under a regime of controlled floating A brief appendix develops some of the implications of “rational expectations” for the theory of exchange rates

The Exchange Rate And The Balance of Payments In The Short Run and in The Long Run: A Monetary Approach

Abstract: This paper analyzes, by way of a dynamic model, the role of momentary asset equilibrium and expectations in the determination of the exchange rate in the short run, and the role of the process of asset accumulation in the determination of the time path from momentary to long-run equilibrium.

The Theory of Flexible Exchange Rate Regimes and Macroeconomic Policy

Abstract: This paper develops three perspectives on the determination of exchange rates and their interaction with macroeconomic equilibrium and aggregate policies. A long- run view characterizes exchange rate determination in terms of monetary and real factors where the real aspects include an explicit consideration of relative price structures. A short-run or “liquidity” view of the exchange rate emphasizes the role of asset market equilibrium and expectations. A policy view, finally, analyses the effectiveness of aggregate policies and points out that in the short-run nominal disturbances will tend to be transmitted internationally. The paper concludes with an analysis of dual exchange rate systems as a stabilizing policy in the presence of speculative disturbances.

The Relative Stability of Alternative Exchange Rate Systems in the Presence Of Random Disturbances

Abstract: The relative advantages of fixed and flexible exchange rates have been debated at length in the literature.l One of the most important aspects of this debate concerns the relative stability of the two systems in the face of random disturbances. But despite the importance of this problem and the fact that it has been discussed at some length in a rather general way, it has so far received surprisingly little formal analysis. A rnost recent exception is the paper by Fischer [3] which compares the asymptotic stability of the two exchange rate systems within the context of a simple monetarist model of the balance of payments.2 However, his model is perhaps overly simple in that it abstracts from several important factors; most significantly it excludes international capital flows. On the other hand, Argy and Porter [2] consider the short-run (one period) instability in a simple Keynesian model where capital is perfectly mobile internationally. In this paper we examine the stability of a small open economy subject to various random disturbances and operating under both fixed and flexible exchange rates in turn, in the intermediate but most realistic case where capital is only imperfectly mobile internationally. This case turns out to be important, since the degree of capital mobility is shown to play a crucial role in determining the relative stability of the two exchange rate systems. Our primary consideration is the first period or

Sharing Risks of Deferred Payment

Abstract: : Because uncertainty often enters into economic transactions when payment is deferred, it may be advantageous to make the amount of payment depend on the occurrence of uncertain events. This general method of accomplishing risk-sharing is studied and its relevance is discussed in two cases: (1) uncertainty over the rate of inflation and cost-of-living escalators; (2) uncertainty over the exchange rate and foreign currency payment plans.

Effects of an exchange rate change on agricultural trade

Abstract: A theoretical model is reviewed and used to evaluate the effects of currency devaluation or revaluation on production, consumption, trade, and price in both exporting and importing countries. The model is applied to the effects of devaluation on the agricultural sector, when supply and demand are inelastic. Based on the analysis, devaluation will have only a small impact on agricultural trade. What effect there is will be primarily on price rather than quantity.

An Integrated Theory of Exchange Rate Equilibrium

Abstract: This brief paper will show that (a) a theoretical equilibrium state of the world exists in the absence of capital controls and trade barriers when prices for the same goods in different markets are equal, after translation at the spot exchange rate; (b) differences in rates of aggregate price change in different markets eventually cause offsetting exchange rate changes which restore condition (a); (c) returns on equivalent securities denominated in different currencies but covered in the forward market are almost instantaneously equalized; (d) the market's expected rate of change of the exchange rate equals, to a close approximation, the control-free interest rate differential between the two currencies; (e) in the absence of predictable exchange market intervention by central banks, the interest rate differential is the best possible forecaster of the future spot rate; and (f) the forward rate also provides the best forecast of the future spot rate. A final corollary identifies a relationship between inflation rates and international interest rate differentials.

Project Evaluation, Shadow Prices, and Trade Policy

Abstract: The problem of how to determine the appropriate shadow prices of primary inputs for the evaluation of new projects in an open economy subject to distortions is discussed. These shadow prices are compared with the corresponding free-trade and actual market prices. It is shown that if the distortion is an output subsidy or tax on existing production, the optimal intervention for new projects is subsidies and taxes on primary factors equal to the difference between the shadow prices and the market prices and not an output subsidy or single shadow exchange rate to provide offsetting protection for the new project. It is also shown that projects viable under free trade may reduce welfare if they are introduced into a distorted economy, while projects that would increase welfare in these circumstances might not be viable under free trade.

Multilateral and Bilateral Measures of Effective Exchange Rates in a World Model of Traded Goods

Abstract: When the exchange rates of most of the major trading nations of the world are floating, the two-country theory of the balance of payments with traded and nontraded goods needs to be modified to take account of the multiplicity of foreign price levels for tradable goods.' This note develops the relationship between the price of traded goods in a single country and changes in exchange rates in all other countries, using a simplified version of the IMF's Multilateral Exchange Rate Model (MERM) (see Artus and Rhomberg 1973). Some notable simplifications are obtained under small-country assumptions. The standard technique for dealing with a group of floating rates is the concept of effective exchange rate (see Economic Report of the President 1974, pp. 220-26). When there are n countries floating, the movement of the dollar exchange rate may give a very inaccurate idea of real changes in the international purchasing power of any given currency. The effective exchange rate for a country can be defined as a weighted average of the exchange rates of its trading partners, with all rates being measured relative to some base year. An index can then be computed by comparing the actual exchange rate of the country with the weighted average of the rates of its trading partners. The simplest type of weighting system is a bilateral system of weights, using either export shares or import shares or an average of both. For example, an export-weighted effective rate index can be defined as in equation (1), where

Elasticity, Absorption, Keynesian Multiplier, Keynesian Policy, and Monetary Approaches to Devaluation Theory: A Simple Geometric Exposition

Abstract: The history of balance-of-payments theory since the early 1930's has been one of successive "approaches" of increasing degrees of theoretical sophistication. Five stages of analysis (conceptually if not always chronologicallv) may be distinguished: the simple "elasticity" approach following the classic paper by Joan Robinson, the "absorption" approach, the Keynesian "multiplier" approach, the Keynesian "policy" approach pioneered by James Meade, and most recently the "monetary" approach stemming from the work of Robert Mundell. Differences between these approaches have occasionally been the focus of sharp controversy, most notably in the case of the elasticity and absorption approaches, and recentlv in the case of the monetary approach as contrasted with other approaches that have in common an emphasis on elasticities or the influence of exchange rate changes on trade flows via relative price changes and international elasticities. The purpose of the present note is to bring out the key differences between these alternative approaches, as exemplified by a simple case that can be illustrated by a simple diagram. The simple case is that of devaluation by a single country in a world economy so large that macro-economic repercussions of devaluation on real incomes, world money demand relative to supply, and the prices of imported goods can be ignored. A further simplification is the assumption that export supply is perfectly elastic in response to domestic currency price (cost of production is constant) short of "full employment," interpreted as a specific level of total output, after which point supply is perfectly inelastic. For simplicity, also, where the analysis involves full-emplovment conditions the initial equilibrium point is assumed to coincide with exact full employment. Finally, international security transactions are assumed absent, all capital movements taking the form of money flows; and all money is assumed to be international money, to avoid problems (important in reality) of substitution between international reserve assets and "domestic credit." The last assumption raises the problem that a devaluation alters the amount of domestic money valued in foreign currency, and vice versa; this problem is ignored until the end of the exposition. Figure 1 graphs income earned from export sales X plus domestic purchase of homeproduced goods cE against domestic expenditure E, both measured in domestic unit values of domestic product (at some point below it will be convenient to assume measurement in terms of foreign currency unit

The impact of devaluation on u.s. agricultural exports

Abstract: The 1971 and 1973 official devaluations of the US dollar have often been cited as a pivotal cause for the enormous price rises in agricultural products in 1972 and 1973 This article presents two studies that test the hypothesis that exchange rate changes have a significant effect on the demand for US agricultural exports The first is a cross-sectional study of the demand for US agricultural exports by major US trading partners in 1971-73 The second looks at the exchange rate changes of other countries and their demand for five agricultural commodities imported from the United States as well as the world during 1954-69 Both studies support the thesis that the special circumstances present in the agricultural sector negate the effects of exchange rate changes on the demand for US agricultural exports

The Firm Under Pegged and Floating Exchange Rates

Abstract: This article seeks to answer the question about the impact of floating exchange rates on international trade and investment by comparing the costs and risks encountered by traders under floating rates with those under pegged rates. Data indicate that transactions costs are five to ten times higher under floating rates, with the larger increases associated with the more volatile currencies. Exchange risk is measured under the two exchange rate systems by comparing the mean forecast errors between the forward rate and the spot rate at the maturity of the forward contracts and the standard deviations of these forecast errors; both mean and standard deviation have increased by a factor of five to ten. Finally price risk, which involves variations in the domestic price of tradeables as a result of changes in exchange rates, is shown to be substantially higher under the floating rate system.

Experiences of Flexible Exchange Rates in Earlier Periods: Theories, Evidence and a New View

Abstract: Flexible exchange rates in earlier periods have usually meant that one or more countries left a metallic standard for some time. Three episodes dominate the historical material in this article: Sweden in the 18th century, England in the early 19th century and the period during and immediately after World War I. In all three cases there was a serious economic debate about the causes of the fluctuations in exchange rates. Two main views on this issue can be distinguished. One is that the fluctuations were caused by exogenous shifts in different items of the balance of payments. The other view attributes this role to the money supply. It is shown that theoretically both are possible, but that changes in the money supply probably predominate. This conclusion seems to be consistent with the empirical evidence.

The Dual Roles of the Government Budget and the Balance of Payments in the Movement from Short-Run to Long-Run Equilibrium

Abstract: I. Introduction and background, 346.—II. A two-asset model with trade, 349.—III. Instantaneous equilibrium with a flexible exchange rate, 355.—IV. Stock equilibrium with a flexible exchange rate, 357.—V. Monetary and fiscal policy reconsidered, 361.—VI. Stock equilibrium with a fixed exchange rate, 364.—Appendix: Determinant condition for stock equilibrium, 366.

Monetary Theory and Policy in an Open Economy

Abstract: This paper identifies several respects in which analysis of the macro-economics of small open economies has to be modified beyond its development a decade ago, with special reference to the effectiveness of monetary and fiscal policies under alternative exchange rate regimes. Capital movements must be viewed in the context of portfolio equilibrium rather than as continuous flows. Room must be made in monetarist formulations for holdings of foreign money. The impact of changes in exchange rates on nominal factor prices should be taken into account. And the effect of the exchange rate regime on the magnitude of the stabilization task must figure in any evaluation of alternative exchange rate regimes. Suggestions are made along each of these lines.

A Monetary Approach to Afghanistan's Flexible Exchange Rate

Abstract: The monetary approach to balance-of-payments theory now so much in vogue has, in econometric analysis, been applied mainly to countries operating under f1xed exchange rate systems. Afghanistan provides an unusual application of the monetary approach in the case of flexible exchange rates. Except during the Second World War, Afghanistan's foreign exchange rate has been freely determined by market forces. The history of foreign exchange markets can be traced back to the time when the great overland trade routes passed through Afghanistan. Although foreign exchange transactions take place in most towns, physical marketplaces now exist only in Kabul and Kandahar. The Kabul foreign exchange marketplace (known as the money bazaar) is situated in a courtyard or saray near the center of town. In 1973 it contained about 35 principal dealers and 50 to 60 agents or partners operating on small commissions. Five principals and a dozen agents were conducting business in the Kandahar bazaar in the same year. Each principal rents one of the small offices in the saray, installs desk, safe, telephone and calculating machine, and opens for business. Agents solicit business at the entrance to the saray and escort customers to their principals. Da Afghanistan Bank, the central bank of Afghanistan, has recorded daily the rates of foreign exchange prevailing in the Kabul money bazaar, as quoted by at least three of the larger dealers. Monthly averages of the daily afghani rate against the dollar, Indian rupee and Pakistani rupee for the period 1953-1973 are shown in Figure 1. Given the dearth of economic statistics on the Afghan economy, this consistent series of free-market exchange rates is of considerable value for several types of analytical work. Exchange rates, the money stock, and government revenue

Approaches To Exchange Rate Analysis—An Introduction

Abstract: It is the fate of social scientists to shoot at moving targets. At about the time when macro economists started to understand the operations of a world economy with fixed exchange rates, or adjustable pegs, the system was replaced with a regime with considerable exchange rate flexibility, occasionally even floating rates. As a consequence, prevailing “embryos” to a theory of the balance of payments for a regime of flexible rates—as formulated by Milton Friedman, James Meade, Egon Sohmen and others—were suddenly put into empirical test and found to be in need of some modification. The same can be said about theoretical suggestions concerning the performance of stabilization policy under alternative exchange rate regimes, as formulated inter alia by Marcus Fleming and Robert Mundell.

World Inflation Under Flexible Exchange Rates

Abstract: Under a system of fixed exchange rates the phenomenon of inflation is a world phenomenon. This statement is derived from price-theoretical considerations with respect to the price formation of tradeable goods in the world goods market and it is independent of any explanation of inflation, whether it is Keynesian or monetarist, of a sociological or of any other type.

Manufactured Exports and Protection in Developing Countries: A Cross-Country Analysis*

Abstract: The underlying theory of the hypothesis to be tested can be briefly stated as follows: Import barriers allow a country to balance its international payments at a higher exchange rate than would otherwise be possible. Whether these barriers are erected for balance-of-payments reasons, government revenue, or to protect domestic industry as part of an import-substitution strategy, the effect in all cases is to overvalue the exchange rate. An overvalued exchange rate is likely to discourage manufactured exports in two ways: First, imported inputs or domestically produced import-competing inputs will have to be purchased by the export industries at above world prices. Second, a protected industry can tolerate relatively more inefficiency than an unprotected industry. There is evidence that in many developing countries tariffs and quantitative import restrictions are high in comparison to protection levels in industrialized countries today and at similar stages in their development.2 There is also evidence that the performance of developing countries in exporting manufactures generally has been rather poor, although in recent years a few countries have recorded substantial gains in this area. It is the hypothesis of this study that relative levels of protection are a significant factor in explaining this recent diversity of experience. In order to provide