Showing papers on "Exchange rate published in 1979"

On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials

Abstract: Much of the recent work on floating exchange rates goes under the name of the "monetary" or "asset" view; the exchange rate is viewed as moving to equilibrate the international demand for stocks of assets, rather than the international demand for flows of goods as under the more traditional view. But within the asset view there are two very different approaches. These approaches have conflicting implications in particular for the relationship between the exchange rate and the interest rate. The first approach might be called the "Chicago" theory because it assumes that prices are perfectly flexible.' As a consequence of the flexible-price assumption, changes in the nominal interest rate reflect changes in the expected inflation rate. When the domestic interest rate rises relative to the foreign interest rate, it is because the domestic currency is expected to lose value through inflation and depreciation. Demand for the domestic currency falls relative to the foreign currency, which causes it to depreciate instantly. This is a rise in the exchange rate, defined as the price of foreign currency. Thus we get a positive relationship between the exchange rate and the nominal interest differential. The second approach might be called the "Keynesian" theory because it assumes that prices are sticky, at least in the short run.2 As a consequence of the sticky-price assumption, changes in the nominal interest rate reflect changes in the tightness of monetary policy. When the domestic interest rate rises relative to the foreign rate it is because there has been a contraction in the domestic money supply relative to domestic money demand without a matching fall in prices. The higher interest rate at home than abroad attracts a capital inflow, which causes the domestic currency to appreciate instantly. Thus we get a negative relationship between the exchange rate and the nominal interest differential. The Chicago theory is a realistic description when variation in the inflation differential is large, as in the German hyperinflation of the 1920's to which Frenkel first applied it. The Keynesian theory is a realistic description when variation in the inflation differential is small, as in the Canadian float against the United States in the 1950's to which Mundell first applied it. The problem is to develop a model that is a realistic description when variation in the inflation differential is moderate, as it has been among the major industrialized countries in the 1970's. This paper develops a model which is a version of the asset view of the exchange rate, in that it emphasizes the role of expectations and rapid adjustment in capital markets. The innovation is that it combines the Keynesian assumption of sticky prices with the Chicago assumption that there are secular rates of inflation. It then turns out that the exchange rate is negatively related to the nominal interest differential, but positively related to the expected long-run inflation differential. The exchange rate differs from, or "overshoots," its equilibrium value by an amount *Assistant professor, University of California-Berkeley. An earlier version of this paper was presented at the December 1977 meetings of the Econometric Society in New York. I would like to thank Rudiger Dornbusch, Stanley Fischer, Jerry Hausman, Dale Henderson, Franco Modigliani, and George Borts for comments. 'See papers by Jacob Frenkel and by John Bilson. 2The most elegant asset-view statement of the Keynesian approach is by Rudiger Dornbusch (1976c), to which the present paper owes much. Roots lie in J. Marcus Fleming and Robert Mundell (1964, 1968). They argued that if capital were perfectly mobile, a nonzero interest differential would attract a potentially infinite capital inflow, with a large effect on the exchange rate. More recently, Victor Argy and Michael Porter, Jiirg Niehans, Dornbusch (1976a,b,c), Michael Mussa (1976) and Pentti Kouri (1 976a,b) have introduced the role of expectations into the Mundell-Fleming framework.

Anticipated Shocks and Exchange Rate Dynamics

Abstract: The paper extends Dornbusch's analysis of exchange rate dynamics to include the case where changes in government policy are anticipated before they occur. It is demonstrated that simply the announcement of an expansionary policy will cause the exchange rate to jump, which induces an expansionary impact on the economy even before the policy is implemented.

A Critique of Exchange Rate Treatment in Agricultural Trade Models

Abstract: The recent theoretical and empirical literature on the role of exchange rates in agricultural prices and trade is reviewed. Specifically, alternative specifications of the exchange rate in excess demand functions are considered. Results show that the specification most common in recent theoretical and empirical work is unnecessarily restrictive and may bias the resulting analysis. Several less restrictive specifications for empirical research are suggested.

The Stability of Exchange Rate Dynamics under Perfect Myopic Foresight

Abstract: The stability of financial markets under conditions of perfect foresight has recently been a subject discussed extensively by monetary economists; see e.g. Sidrauski [1967], Burmeister and Dobell [1970], Nagatani [1970], Olivera [1971], Sargent and Wallace [1973], Black [1974]. One of the main findings to come out of this literature is that the dynamics of such markets under perfect foresight will typically be associated with "saddle-point type" instability. That is, unless the initial conditions happen to place the system somewhere on the stable arm of the saddle point, the system will tend to arch around the equilibrium and ultimately to diverge from it. One financial market of particular importance is the foreign exchange market. In a recent article, Dornbusch [1976] has developed an interesting model analyzing the role of exchange rate expectations in the dynamic adjustment of the exchange rate following an exogenous change in monetary policy. While most of his analysis is based on an arbitrary regressive expectations hypothesis, he also considers what he calls "consistent expectations," when the hypothesis he introduces is consistent with a form of perfect myopic foresight.2 This is obviously desirable, since as he argues, perfect myopic foresight is the only assumption which is not arbitrary and does not in general involve systematic forecasting errors. At first sight, the stability of the Dornbusch model under consistent expectations may appear to contradict the above monetary literature. The purpose of this paper is therefore to investigate more fully the relationship of the Dornbusch analysis to the perfect foresight model. It is shown how the introduction of perfect myopic foresight into his model does indeed generate saddle point type behavior. Stability of the system can then be achieved by following a procedure originally outlined by Sargent and Wallace [1973].3 Essentially this involves

Capital Mobility and the Choice of Exchange Rate System

Abstract: In recent papers, Fischer [1977a] and Turnovsky [1976] have examined the stabilizing features of fixed exchange rates as compared with flexible exchange rates.' The Fischer and Turnovsky papers differ in several important respects: i) Turnovsky allows capital mobility and allows price prediction errors to have real effects through an expectations augmented Phillips Curve while Fischer assumes away both problems; ii) the Fischer analysis allows for the consideration of underlying real and monetary disturbances as being the driving forces of fluctuations in economic variables such as prices while the Turnovsky analysis considers only the foreign price fluctuationi itself, assuming explicitly a zero correlatioln between foreign price fluctuations and other movements in foreign variables ;2 iii) Turnovsky assumnes that aln appropriate criterion for choosing between fixed anld flexible exchange rates is the minimization of domestic output variance while Fischer, whose output is fixed, uses the minimizatioll of domestic consumption variance as his criterion of choice. The present paper provides a simple model which fills in some of the gaps between the Fischer and the Turnovsky analyses. In particular I will follow Turnovsky by allowing capital mobility and a version of the Phillips Curve but will incorporate the more satisfactory Fischer analysis of underlying disturbances. Further, the criterion function used presently for the comparison of fixed and flexible rates follows Barro [1976] and Gray [1976] by assuming that it is appropriate to choose the exchange rate system which minimizes domestic price prediction errors. One novel element in the present modeling strategy lies in the adoption of "extended small counitry analysis," which refers to a situation where both a small coulntry and the rest of the world are modeled explicitly. This type of modeling is a blend of the standard techniques of small country analysis and two country analysis. The assumption that the country under examination is small is retained but the structure of the rest of the world is revealed to small

Exchange Market Pressure in Postwar Brazil: An Application of the Girton-Roper Monetary Model

Abstract: This study applies Lance Girton and Don Roper's (hereafter G-R) monetary model of exchange market pressure to the postwar Brazilian monetary experience. The model was designed specifically for the Canadian managed float during the period 1952-62. The object of their model is to explain what they term "exchange market pressure"; that is, the pressure on foreign exchange reserves and the exchange rate when there exists an excess of domestic money supply over money demand in a managed floating exchange rate regime. The basic theoretical proposition is that any such excess supply of money can be relieved by an exchange depreciation, a loss in foreign reserves, or, in the context of a managed float, by some combination of the two. In this sense, the G-R managed float model used here is firmly rooted in the modern monetary approach to exchange rates and the balance of payments.' Brazil provides a particularly good example for testing this approach, not only because it is in many senses a unique example of a postwar managed float system, but also because it can be treated as a "small, open" economy in the sense that world prices and monetary conditions faced by Brazil are taken as given. This particularly suits the purpose of most modern monetary models which make this assumption and obviates the problems of monetary dependence and neutralization dealt with in the pioneering G-R paper. Specifically, the small-country assumption permits us to devise a simple one-country equation of managed floating which depends upon four essential ingredients: 1) money demand, 2) money supply, 3) purchasing power parity, and 4) monetary equilibrium.2 Furthermore, in Brazil a much greater proportion of exchange market pressure was absorbed by exchange rate depreciation than in the Canadian case where changes in reserves were large relative to exchange rate movements. In short, postwar Brazil provides a singularly good opportunity to test the monetary model of exchange market pressure. Section I briefly states the essential elements of the monetary model, and derives the equation to be tested for the Brazilian experience from 1955 to 1975. Section II reports empirical results for the exchange market pressure model, and Section III examines the applicability of the relative version of purchasing power parity for the time period considered. Section IV summarizes the results and discusses the merits of the monetary approach in light of the Brazilian experience.

Money exchanger apparatus

Abstract: There is provided a money exchanger apparatus comprising exchange rate input means adapted to enter exchange rates used when exchanging moneys or securities of a single country or plural countries other than a specific country into the currency of the specific country, numerical value information input means adapted to enter numerical information such as the amount and kind of moneys or securities to be exchanged, memory means for storing numerical value information, computing means for calculating the amount and kind of currency of the specific country from the numerical value information indicative of moneys or securities of the country other than the specific country, said information being delivered by the numerical information storing memory means, and from the exchange rate stored in said memory means, and disbursing means for paying out exchange money of the specific country based on the results of computations performed by the computing means.

Foreign Exchange Rate Forecasting Techniques: Implications for Business and Policy

Abstract: FOREIGN EXCHANGE RATE FORECASTING is a growth industry. At least 23 commercial services throughout the world, employing a variety of techniques, now provide foreign exchange rate forecasts. The purpose of this paper is to review and evaluate these techniques and services and to consider the implications of the findings for business and policy. The paper first considers whether foreign exchange rate forecasting is futile in light of the evidence that the foreign exchange market is an efficient market. Ten major forecasting services that rely in whole, or in large part, on formal models or decision rules are then evaluated on the basis of their predictive accuracy. Finally, the implications of the findings are considered for corporations trying to manage their foreign exchange exposure and for policy makers concerned about exchange rate stability.

Towards a Consistent Comparison of Alternative Exchange Rate Systems

Abstract: Equilibrium allocations of alternative exchange rate regimes are compared in an intertemporal framework. When money serves only as a store of value, the same real allocations are attainable under all regimes. However, if money also serves other functions, there are equilibria under the fixed rate system that eliminate those under floating rates, and vice versa.

Macro-Economic Adjustment with Import Price Shocks: Real and Monetary Aspects

Abstract: In this paper we explore in detail the various ways by which the introduction of intermediate imports affects the comparative statics and the dynamics of adjustment in an open economy. The importance of integrating the role of intermediate imports into a theory of macro-economic adjustment derives from the particular set of events that have affected the industrial economies in the 1970's -- the unprecedented rise in raw materials prices, in particular the oil price shock, and the concomitant inflation and widespread unemployment. The analysis lays out in detail the separate workings of the commodity labor and exchange rate markets, under various adjustment mechanisms, with the objective of obtaining empirically quantifiable hypotheses. An empirical study based on the present formulation has been prepared by the authors (see Bruno and Sachs (1979) ) .

Exchange Risk Implications of International Portfolio Diversification

Abstract: This paper evaluates the systematic risk of foreign exchange by deriving efficient sets of international portfolios from six national viewpoints. The composition of these portfolios is examined and the effect of different exchange rate risks is discussed theoretically and tested empirically. The paper shows that in the context of international portfolios, exchange risk matters much less than would be expected.

Wages and Unemployment in Australia

Abstract: This paper reviews various models that may be used to analyze the inflation-unemployment problem in Australia. The focus is on the unemployment problem, rather than on inflation, and on the role of wages, nominal and real, in affecting this problem. Models discussed include the Popular Keynesian, Phillips Curve, Fixed Coefficient and Neoclassical Models. The possibility of increasing returns is considered. Australian evidence bearing on the appropriateness of these models is discussed. The effect of demand expansion on the exchange rate and hence real wages is stressed. Some emphasis is placed on the concept of ‘union-voluntary’ unemployment. At the end possible solutions to the unemployment problem are summarized.

Short- and Long-Run Effects of Monetary and Fiscal Policies under Flexible Exchange Rates and Perfect Capital Mobility

Abstract: Following the pioneering papers by John M. Fleming and Robert Mundell, a substantial literature has accumulated incorporating the Keynesian analysis of the effects of monetary and fiscal policies in the open economy under flexible exchange rates and perfect capital mobility. The general policy result which followed from this line of research has been the verification of the presumption that monetary policy is an effective stabilization tool under flexible exchange rates, while the ability of fiscal policy to affect the level of economic activity varies inversely with the degree of international capital mobility. The key to the results lies in the differential effect of both policies on the direction of the induced capital flows and thus on exchange rate movements. The latter in turn affect the trade balance and aggregate demand. To my knowledge, however, all authors have either been concerned with the derivation of short-run or "impact" multipliers describing the effects of monetary and fiscal policy on the level of economic activity or have otherwise ignored the "longer-run" effects of policy-induced changes in the level of international indebtedness and the service of that debt. Abstracting from growth and persistent shocks, it is reasonable to assume that, given enough time following the policy change, individuals will adjust their international portfolios of assets to the new desired proportions such that capital flows eventually cease. When long-run portfolio equilibrium is thus reached, the service account deficit of the balance of payments must necessarily be equal to the net export surplus (the trade balance), the exchange rate being the natural instrument through which this long-run external balance condition is achieved. It is therefore natural to conceive of the long-run level of the service account as the primary determinant of the long-run trade balance. In view of the above and the fact that in a Keynesian-type economy the trade balance plays a crucial role in the determination of the level of economic activity through its effects on aggregate demand, it follows that a longerrun analysis of the effects of monetary and fiscal policy cannot logically ignore the consequences of those policies for the service account. In this paper I intend to explore the longrun implications of induced changes in the level of the service account for the effects of monetary and fiscal policy; in the process of doing so, I will develop a simple model whose basic structure resembles that of Fleming and Mundell although it is modified to explicitly incorporate the stocks of domestic and foreign securities held. In order to provide the reader with a clearer perspective on the problem at hand, let us first discuss the impact effects of monetary and fiscal policy in the context of the standard short-run model. Given the Keynesian structure of the economy either policy will increase domestic income (and employment) only to the extent that it succeeds in expanding aggregate demand of which the trade balance is one component. At a given exchange rate, expansionary fiscal policy would increase aggregate demand but at the expense of a higher domestic interest rate (the "crowding out" effect); *Columbia University. I am indebted to G. Borts, L. Girton, and D. Henderson for their comments and suggestions. A preliminary version of this paper was written while I was visiting scholar at the Division of International Finance of the Board of Governors of the Federal Reserve System. The views expressed here should not be interpreted as necessarily those of the Board.

Expectations and Output-Inflation Tradeoffs in a Fixed-Exchange-Rate Economy

Abstract: This paper develops and estimates a model of output-inflation tradeoffs (or reverse Phillips curves) for a fixed-exchange-rate economy. The main focus of the analysis is on the role of information and economic agents' expectations in the generation of aggregate economic fluctuations. The model embodies the hypothesis of rational expectations, as well as different versions of the natural-rate hypothesis. These hypotheses, central to the current macroeconomic literature, are formulated and tested. The model is estimated by the full- information-maximum-likelihood method on quarterly data for Italy covering the 1955-70 period.

Trade policy for developing countries

Abstract: Although some issues remain unsettled, expert opinion and lessons of experience have begun to converge in recent years on trade policy measures that make sense for an individual developing country. Trade policy must be made on three levels, all of which are treated here -- strategic choices, economy-wide management including exchange rate policy, and detailed setting of incentives in relation to particular products and industries. Along with the underlying relationships at each level, attention is focused on practical lessons of experience concerning the policy instruments available, their proper design and use, and complications that arise in a world of harsh realities. Social repercussions of trade policy are also considered. Part I is concerned mainly with trade policy for purposes of industrial development, e.g., how to expand manufactured exports along with production for the home market. Part II examines relationships of trade policy with social and political systems and goals, for example, its effects on poverty, and how it interacts with repression or redistribution. Part III looks at how to achieve a successful transition from an unsatisfactory to a desirable trade policy regime.

An Example of Exchange Rate Overshooting

Abstract: Advocates of flexible exchange rates have long held that allowing exchange rates to adjust at market determined speeds provides a degree of order to international financial markets that is missing from the system of pegged but adjustable rates. Advocates of pegged but adjustable rates have claimed just the opposite; in their view, a flexible rate system is likely to be dominated by speculators whose actions will result in excessive exchange rate variability. These two views of the foreign exchange market were put to the test in the early 1970's when the major industrial countries moved to a system of flexible rates. As the data has accumulated, advocates of the flexible rate system have been perplexed by the large and abrupt movements shown by some key exchange rates (e.g., the U.S. dollar-Deutschmark rate). These data are clearly consistent with the foreign exchange market's being dominated by "badly behaved" speculators. The important question then is whether or not these data are necessarily inconsistent with the view that flexible exchange rates do not exhibit excessive fluctuations but rather exhibit fluctuations consistent

An empirical analysis of the interrelationships among equity markets under changing exchange rate systems

Abstract: The purpose of this article is to investigate the interrelationships between seven stock markets (Germany, France, Italy, the Netherlands, Belgium, the United Kingdom and U.S.A.) over the period 1969–1976. The impact of flexible exchange rates on the various correlation coefficients is shown to be rather low. The results show a trend towards higher segmentation between the various stock exchanges, which means larger opportunities for international diversification. Finally the relationships between stock index variations and exchange rate fluctuations are analyzed.

The Russian Balance of Payments, the Gold Standard, and Monetary Policy: A Historical Example of Foreign Capital Movements

Abstract: This paper reports new calculations of foreign investment in Russia between 1881 and 1913. As the major recipient of foreign capital under the gold standard, Russia provides an ideal case study of capital flows among countries. The conclusions are that the influx of foreign investment into Russia following convertibility was much more substantial than the early estimates suggested and that the Russian growth rate was raised by about 0.5 percent annually as a consequence of the gold standard. The major cost of achieving convertibility was that two-thirds of official borrowing abroad between 1885 and 1897 was used to acquire gold reserves, but the ensuing growth benefits which are estimated far outweigh these costs. The Russian case confirms the standard portfolio theory of capital movements, and the relationship between the demand and supply of fiat money explains observed variations in the exchange rate.

Industrial Investment in an "Export" Economy: The Brazilian Experience Before 1914

Abstract: Cotton textile production, the main manufacturing activity in pre-1914 Brazil, is shown to have developed largely in response to stimuli arising from two sources: (a) exchange rate instability, which impelled cloth merchants to the production side of the business: this can be seen as a risk-averting diversification of investment: (b) an increasingly protective tariff system, which enabled the manufacturing undertakings to survive and grow even under adverse exchange-rate conditions. Those findings challege the view that early Brazilian industrialization was not the object of deliberate government policies, and suggest that the analysis of exchange rate policies may be relevant to the understanding of the industrialization process in export economies.

The Influence of Exchange Rate Changes on Prices: A Study of 18 Industrial Countries

Abstract: A key issue in contemporary economic policy-making concerns the effect of exchange rate changes on prices. The traditional view of exchange rate movements, prevalent up to the 1 960s, took it almost for granted that a devaluation would reduce the foreign currency price of exports and increase the home currency price of imports. The empirical debate centred on the price elasticities of demand for those exports and imports. If the elasticities were sufficiently large, the devaluation would "work"; i.e., the volume effects (higher exports, lower imports) would outweigh the adverse movement in the terms of trade (cheaper exports, dearer imports) and the trade balance would improve (Robinson, 1947). This classic analysis was essentially static and was attacked on the grounds that it ignored the long-run effect on prices of a parity change. These effects are taken account of by the monetary view of the balance of payments, which stresses the effect of balance of payments disequilibrium on the money supply and hence on prices. On this view (summarized in Johnson, 1972) a devaluation may initially create a balance of payments surplus, but this will then increase the money supply and set in motion an inflationary process which restores the price level of the devaluing country, measured in foreign currency terms, to its pre-devaluation level. At this point the external surplus disappears and the country is back in its original position, but with a once-for-all increase in its reserves, accumulated while the price adjustment was occurring. The above analysis justifies the claim that the exchange rate, being an essentially monetary phenomenon, can affect only "money things" (i.e. the general price level) and cannot permanently change the underlying real phenomena such as the trade balance or the terms of trade. This view of exchange rate changes can be justified by another line of argument: the tradeable output of each country has a determinate real value. In other words, if trade was conducted by barter, a hundred Leyland Minis would be freely exchanged for some definite number of Volkswagen Golfs or Renaults 5s, the "real barter rate of exchange" of those goods. In equilibrium, UK, French and German prices and exchange rates should be such that the sterling value of the hundred Minis should, when converted into German marks or French francs at the market rate of exchange, exactly purchase the number of Volkswagens or Renaults given by the real barter rate of exchange. Clearly, a change in the exchange rate is not going to alter people's preferences for Minis as against Volkswagens or Renaults. Hence, starting from a position in which prices and exchange rates are in equilibrium, any exchange rate change must in the long run be completely offset by price movements which restore the real rate at which Minis are exchanged for Volkswagens and Renaults.

Graph Theoretic Approaches to Foreign Exchange Operations

Abstract: Trading in currencies in order to obtain the best possible exchange rate is known as arbitrage and can broadly be divided into three categories:1) Space Arbitrage––transactions to take advantage of discrepancies between rates quoted at the same time in different markets2) Time Arbitrage––transactions to take advantage of discrepancies between forward margins for different maturities3) Interest Arbitrage––transactions to take advantage of discrepancies between yield on short-term investments in different currencies This form of arbitrage can be split into (a) Covered and (b) Uncovered (speculative) interest arbitrage The former variety uses today's forward rate for forward conversion back into our holding currency; the latter allows the dealer to use the spot rate existing in the future