Showing papers on "Exchange rate published in 1984"

Rational and Self-Fulfilling Balance-of-Payments Crises

Abstract: The recent balance-of-payments literature shows that-speculative attacks on a pegged exchange rate must sometimes-occur if the path of the rate is riot to offer abnormal profit opportunities. Such attacks are fully rational, as they reflect the market's response to a regime breakdown that is inevitable.This paper shows that, given certain expectations about policy, balance-of-payments crises can also be purely self-fulfilling events. In such cases even a permanently viable regime maybreak down, and the economy will possess multiple equilibria corresponding to different subjective assessments of the probability of collapse. The behavior of domestic interest rates and foreign reserves will naturally reflect the possibility of a speculative attack. Work on foreign-exchange crises derives from the natural-resource literature initiated by Salant and Henderson (1978),where the definition of "abnormal" profit opportunities is straightforward. Because the definition is not always straight-forward in a monetary context, this paper also shows how crises occur in a discrete-time stochastic monetary model when an eventual breakdown is inevitable.

Are Real Interest Rates Equal Across Countries? An Empirical Investigation of International Parity Conditions

Abstract: This paper conducts empirical tests of the equality of real interest rates across countries. The empirical evidence strongly rejects the hypothesis of real rate equality and the joint hypotheses of uncovered interest parity and ex ante relative PPP, or the unbiasedness of forward rate forecasts and ex ante relative PPP. The evidence suggests that it is worth studying open economy macroeconomic models which allow: 1) domestic real rates to differ from world rates, 2) time varying risk premiums in the forward market, or 3) deviations from ex ante relative PPP. THE RELATIONSHIP OF REAL interest rates across countries is of central importance to our understanding of open economy macroeconomics. In some models where there is costless international arbitrage in goods and financial assets, real interest rates for comparable securities should be equal across countries. This has been a feature of much of the early research in the monetary approach to exchange rates, e.g., Frenkel [11] and Bilson [2]. On the other hand, finance theory indicates that risk premia may well differ for comparable securities denominated in different currencies (Solnick [27], Roll and Solnick [26], Stulz [28], Fama and Farber [7], Hansen and Hodrick [17], and Dornbusch [6]), and more recent theoretical models in the exchange rate literature, such as Dornbusch [5], Frankel [10], and Mussa [24], depend on real rates differing between countries in the short run. The proposition that real rates are equal across countries is worth studying

Empirical Models of the Exchange Rate: Separating the Wheat from the Chaff

Abstract: Various popular exchange rate models (a standard monetary model, a portfolio balance model, and sticky-price models) are estimated and evaluated using U.S.-Canadian data for the 1970s. Nonnested hypothesis tests demonstrate that none are correctly specified. The data suggest: 1) the exchange rate persistence observed is not fully explained by any of the models; 2) the small Durbin-Watson statistics indicate longer lags are required; 3) the current account is a useful explanatory variable; 4) the portfolio balance model fits the data well, but has potentially serious problems measuring the stock of foreign assets.(This abstract was borrowed from another version of this item.)

Exchange rate theory and practice

Abstract: This volume grew out of a National Bureau of Economic Research conference on exchange rates held in Bellagio, Italy, in 1982. In it, the world's most respected international monetary economists discuss three significant new views on the economics of exchange rates - Rudiger Dornbusch's overshooting model, Jacob Frenkel's and Michael Mussa's asset market variants, and Pentti Kouri's current account/portfolio approach. Their papers test these views with evidence from empirical studies and analyze a number of exchange rate policies in use today, including those of the European Monetary System.

Balance-of-Payments Crises and Devaluation

Abstract: The collapse of a fixed exchange rate is typically marked by a sudden balance-of-payments crisis in which"speculators" fleeing from the domestic currency acquire a large portion of the central bank's foreign exchange holdings.Faced with such an attack, the central bank often withdraws temporarily from the foreign exchange market, allowing the exchange rate to float freely before devaluing and returning to a fixed-rate regime. This paper links the timing of the initial speculative attack to the magnitude of the expected devaluation and to the length of the transitional period off loating. An implication of the analysis is that there exist devaluations so sharp and transition periods so short that acrisis must occur the moment the market first learns that the current exchange parity will eventually be altered. For sufficiently long transition periods, the floating exchange rate"overshoots" its new peg before appreciating back toward it;for shorter periods, the rate depreciates monotonically to its new fixed level. Accordingly, the central bank's return tothe foreign exchange market can occasion a capital outflow or a capital inflow.

The Exact Timing of the Collapse of an Exchange Rate Regime and Its Impact on the Relative Price of Traded Goods

Abstract: As OF FEBRUARY 28, 1983, ninety-four countries are classified as having a fixed exchange rate regime: 38 are pegged to the U.S. dollar, 13 to the French franc, 14 to the Special Drawing Right, and 24 to different baskets of currencies. The choice of a fixed exchange rate peg implies a specific monetary discipline, namely monetary growth equal to the growth rate of the currency (or currencies) to which a country is pegged. Monetary policy is thus subject to an exchange rate rule rather than to either a monetary growth rule or alternatively to discretionary policy. A fixed exchange rate is a specific case of an active crawling peg where the preannounced rate of change in the exchange rate is zero. Active crawling peg rules whereby the exchange rate is adjusted downward by a preannounced amount over a specified period of time have been practiced in various places, particularly in Latin America. Recent experiments include Argentina beginning December 1978, Brazil during the 1980 calendar year, Chile from February 1978 to June 1979, Jamaica from May 1978 to May 1979, Portugal from August 1977 to June 1979, and Uruguay beginning October 1978.1 At times, the prean-

Asset Markets, Exchange Rates and the Balance of Payments

Abstract: This paper, written as a chapter for a Handbook of International Economics, reviews developments in the theory of international monetary economics from the late 1960's through the early 1980's. Following a review of the operation of the monetary mechanism of balance of payments adjustment in the context of the Mundell-Fleming model, the paper reviews the more modern analysis of the dynamics of balance of payments adjustment under fixed exchange rates and of exchange rate determination under flexible exchange rates. Beginning with a simple exposition of the monetary mechanism, the model is then extended to incorporate sluggish wage and output adjustments, endogenous monetary policy and sterilization operations, multiplicity of tradable and nontradable goods, large countries, capital mobility and portfolio balance. The review then turns to an exposition of exchange rate theory, starting with the monetary approach to exchange rate determination. Issues discussed in this context include purchasing power parities, nontraded goods, the real exchange rate, currency substitution and the interaction between real and monetary factors in effecting exchange rates.The paper proceeds with a presentation of a more general framework that views the question of exchange rate determination as part of the general theory of the determination of asset prices, and which highlights the unique role of expectations. The general framework is then applied to characterize the interaction between the balance of payments and the equilibrium real exchange rate.The paper concludes with a brief discussion of some empirical issues of exchange rate analysis.

Domestic and Foreign Disturbances in an Optimizing Model of Exchange- Rate Determination

Abstract: This paper analyzes the effects of various disturbances of domestic and foreign origin in a small open economy under imperfect capital mobility in which the behavioral relationships are derived from optimization by the private sector. In this model the domestic economy jumps instantaneously to its new equilibrium following a change in either the domestic monetary growth rate or domestic fiscal policy. In response to a disturbance in either the foreign interest rate or inflation rate,the economy undergoes an initial partial jump towards its new equilibrium,which it there after approaches gradually. The implications of these results for exchange rate adjustment and the insulation properties of flexible exchange rates are discussed.

Real Balances, the Exchange Rate and Indexation: Real Variables in Disinflation

Abstract: The recent appreciation of the dollar is widely believed to have reduced the output costs of the disinflation. But there remains the question of whether those early gains have to be repaid when the exchange rate depreciates.The first question taken up is the effect of real exchange rate appreciation on the sacrifice ratio, or output cost, of disinflation. There is no unambiguous presumption that exchange rate appreciation reduces the sacrifice ratio. The direct favorable effects of cheaper imports on consumer prices, on the prices of imported inputs, and on wage demands, may be outweighed by the unemployment resulting from the reduced demand for exports. In the second part of the paper I examine the affects of wage indexation on the sacrifice ratio. Economists have argued that wage indexation speeds up disinflation; policymakers take the opposite view. The distinction between ex ante and ex post indexing, defined in the paper, explains these different views. Ex ante wage indexation speeds up disinflation. With expost indexation the real wage automatically rises when the inflation rate falls. Even so, ex post indexing may speed up disinflation. But there has to be subsequent downward adjustment of the wage if long-term unemployment is to be prevented.

Currency Preferences, Purchasing Power Risks, and the Determination of Exchange Rates in an Optimizing Model

Abstract: MOST RECENT RESEARCH on the theory of exchange rate determination treats the exchange rate as the relative price of two assets: domestic money and foreign money. The value of an asset depends on the distribution of its return. However, most of the research has dealt with models in which there is no uncertainty. The present paper focuses on questions that cannot be addressed in a world of certainty, because in such a world an asset is never risky. It investigates how purchasing power risks affect the determination of exchange rates. This investigation is pursued in a fairly general optimizing model. The present research is related to some recent work in international economics and in financial economics. It follows the approach of Obstfeld (1981) and Stockman (1980) in that it uses an optimizing model and takes into account the role of government transfers in the flow budget constraint of individuals. As in Calvo and Rodriguez (1977), Stockman (1980), and others, the fact that holdings of foreign monies are useful to domestic individuals is taken into account. Finally, the paper uses techniques developed in papers in the finance literature which build on Merton's (1973) asset-pricing model and use a concept of equilibrium developed in

Real Exchange Rate Effects of Fiscal Policy

Abstract: This paper develops a framework for analyzing the effects of fiscal policy on the real exchange rate. The short-run impact of various types of fiscal measures are considered as well as the dynamics of adjustment to long-run steady states. The analysis and related simulations suggest that the effect of fiscal policy changes on the real exchange rate can vary widely and will depend closely on a number of structural features, including the degree of asset substitutability,the composition of government spending, and the initial size of the public debt and net external position.

Use of (Time-Domain) Vector Autoregressions to Test Uncovered Interest Parity

Abstract: In this paper, a vector autoregression model (VAR) is proposed in order to test uncovered interest parity (UIP) in the foreign exchange market Consider a VAR system of the spot exchange rate (yen/dollar), the domestic (US) interest rate and the foreign (Japanese) interest rate, describing the interdependence of the domestic and international financia lmarkets Uncovered interest parity is stated as a null hypothesis that the current difference between the two interest rates is equal to the difference between the expected future (log of) exchange rate and the (log of) current spot exchange rate Note that the VAR system will yield the expected future spot exchange rate as a k-step ahead unconditional prediction Hence, the null hypothesis is stated as nonlinear cross-equational restrictions for the three-equation VAR system Then UIP is tested by the Wald test between the unrestricted and restricted systems A test of UIP with a maintained hypothesis of covered interest parity, becomes a hypothesis test of efficiency without risk premium, that is,the forward exchange rate isthe unbiased predictor of the future spot exchange rate, and information is efficiently used in its prediction Our results are compared to the efficiency test with a single equation using the Hansen-Hodrick procedure for the same data set

The Recent Decline in Agricultural Exports: Is the Exchange Rate the Culprit?

Abstract: OS/as S. Batten is a senior economist and Michael 11 Be/on gia is an economist at the Federal Resenie Bank of St Louis. Sarah R. Driver provided research assistance. ‘Chattin and Lee (1983), p. 19. ‘Schuh (1984), p. 244. Other papers drawing a similar causal relationship between exchange rates and agricultural exports include Chambers and Just (1982), Tweeten (1983) and Hathaway (1983). The problem with these statements is that such simple analyses generally are inadequate in establishing a cause-and-effect relationship between exchange rates and agricultural exports. First, the comparison in chart I fails to distinguish nominal changes in exchange rates, which reflect changes in relative rates of inflation across countries, from real changes in exchange rates, which reflect structural changes. An analysis of the impact of exchange rates on trade must first separate these two types of exchange rate changes, because only changes in real magnitudes influence trade flows.

The Capital Inflows Problem Revisited: a Stylized Model of Southern Cone Disinflation

Abstract: In the late 1970s countries in Latin America's Southern Cone attempted to lower domestic inflation rates through the progressive reduction of a preannounced rate of exchange-rate devaluation. The stabilization programs gave rise to massive capital inflows, real exchange-rate appreciation, and current-account deficits. This paper develops a stylized intertemporal framework in which the effects of a preannounced exchange-rate oriented disinflation scheme can be studied. It is shown that even when agents have perfect foresight and markets clear continuously, the "capital inflows" problem and the associated real appreciation may result.While unanticipated, permanent inflation changes are neutral in the paper,anticipated inflation is neutral only in exceptional circumstances. A preannounced disinflation operates by altering the path of an expenditure -based real domestic interest rate that depends on expected changes in the prices of liquidity services and nontradable consumption goods. Alternatively, by raising future real balances, anticipated disinflation may cause an incipient change in the time path of consumption's marginal utility, leading agents to revise consumption plans. It is noteworthy that disinflation's long-run effect on the real exchange rate more than reverses its short-run effect. If disinflation occasions a real appreciation on impact, say, the relative price of tradables must rise in the long run so that the economy can service the additional external debt incurred in the transition period.

The Open Economy: Implications for Monetary and Fiscal Policy

Abstract: The exchange rate has by 1984 become as central to United States economic policy discussions as it has long been in the rest of the world. In this paper we show how the standard closed-economy macroeconomic model -- the Phillips curve augmented IS-LM analysis -- has to be modified for the United States to take account of the economy's international interactions. The only key structural equation that goes unamended is the money demand equation. Foreign prices,foreign activity, and foreign asset yields in the goods and asset markets appearas important determinants of domestic activity, prices, and interest rates. We show that international interactions exert an important effect on the manner in which monetary and fiscal policies operate. The Phillips curve is much steeper under flexible than fixed interest rates. A tight money policy leads to appreciation under flexible rates, and thus to more rapid disinflation. Fiscal expansion, because it induces currency appreciation, is less inflationary under flexible than fixed exchange rates, but it also involves more crowding out. We show that these effects are in practice significantly large for the United States economy.

The Demand for International Reserves and Monetary Equilibrium: Some Evidence From Developing Countries

Abstract: Traditionally, two alternative explanations have been offered for the behavior of international reserves through time. On the one hand, the literature on the demand for international reserves postulates that reserves movements respond to discrepancies between desIred and actual reserves. Onthe other hand, according to the monetary approach to the balance of payments,changes in international reserves will be related to excess demands or excess supplies for money. The purpose of this paper is to empirically integrate these two basic explanations for international reserves movements. This is done by estimating a dynamic equation that explicitly allows reserves movements to reflect the monetary authority's excess demand for international reserves, and the public's excess demand for money. The results obtained,using a sample of 23 developing countries that maintained a fixed exchange rate during period 1965-1972, confirm the hypothesis that reserves movements respond both to monetary factors and to differences between actual and desired reserves. These results indicate that the exclusion of monetary considerations from the dynamic analysis of international reserves will yield biased coefficients.

Real Exchange Rate Effects of Fiscal Policy

Abstract: This paper develops a framework for analyzing the effects of fiscal policy on the real exchange rate. The short-run impact of various types of fiscal measures are considered as well as the dynamics of adjustment to long-run steady states. The analysis and related simulations suggest that the effect of fiscal policy changes on the real exchange rate can vary widely and will depend closely on a number of structural features, including the degree of asset substitutability,the composition of government spending, and the initial size of the public debt and net external position.

Employment and Real Wages in the Inter-War Period

Abstract: There was a wide measure of agreement that uniform tariff, the proceeds from which were to be unemployment in Britain during the 1920s was used to subsidise exports. aggravated by lack of international competitiveness. There was, however, a difference of emphasis This was the basic issue underlying the debate over between those like Keynes who considered that the the return to the gold standard. The experience of problem of the stickiness of money wages could be the restored gold standard did much to confirm the overcome by a suitable adjustment of the exchange arguments of those like Keynes who had claimed rate or tax/subsidy scheme for foreign trade and that sterling was overvalued at $4.86. This view of those like Pigou (1931) who were less convinced of the problems of adjustment to an overvalued the benefits of exchange rate adjustment. Pigou exchange rate has been endorsed by both Johnson questioned whether wage earners would accept (1975) and Friedman and Schwartz (1963). A major constant money wages if prices were to rise as a element in competitiveness was the level of real result of devaluation. The period in which workers wages. Britain's difficulties in the inter-war period could be tricked into accepting a reduction in real were made more acute by the increase in the cost of wages through an unexpected rise in prices relative labour between 1913 and 1924. This reflected the to money wages might be relatively short. Hence the sharp rise in wages in the First World War and the benefits of devaluation in stimulating output and post-war boom of 1919-20, which was only partly employment could not be sustained, corrected in the recession of 1921-2. The reduction This debate, which accepted the need for an in working hours in 1919, when normal weekly hours increase in competitiveness but centred upon how were reduced from 53 hours to 47, also raised the such an improvement might be achieved, was cut cost of employing labour. As a result hourly real short by the abandonment of the goid standard in wages in 1924 were 28 per cent higher than in 1913 mi and the contemporaneous world depression. and real wages measured in terms of own product Real wages rose despite the depreciation of sterling were increased by 20 per cent, while output per head in im because of the stegp dedine in impQrt pric£S had risen by only 5 per cent over the same period. of both food and raw materials A reducti0n in real The increased cost of employing labour was particuwaggs was Jess urg£nt jn the 193Qs than in the 192Qs larly noted and emphasised by Clay (1929). A competitive edge had been gained by the floating The rise in real and own product real wages of the pound on the suspension of the gold standard, occurred when changes were taking place in the Improved competitiveness was subsequently eroded international economy which were adverse to by the devaluation of the dollar in 1933 and Britain's traditional export industries. The fall in devaluations of the French franc in 1936 and 1938. demand for traditional exports, such as coal, cotton, Attempts to increase competitiveness by reducing iron and steel and ships came at a time when Britain real waggs jn {he 193Qs did not seem attractive was suffering from increased labour costs for dombecause of the proliferation of quantitative restric estic reasons. tions on trade. Little would have been gained by A reduction in real wages in the 1920s would have measures to increase British competitiveness, since assisted the competitivenes of Britain's ailing staple they cou,d have been countered b retaliatory industries as well as encouraging the growth of measures of other countries, employment in more labour-intensive sectors of the economy, such as distribution and services. In view What is surprising about the arguments of of the high degree of stability of money wages after Beenstock et al. is that they emphasise the impor 1923, a reduction in real wages would have been tance of real wage behaviour in the 1930s. This is much easier to achieve by a downward adjustment of paradoxical in view of the acute concern of contem the exchange rate rather than by cuts in money poraries over real wages in the 1920s, which is hardly wages. A reduction in real wages was implied by mentioned by Beenstock et ai, and their greatly Keynes's arguments for returning to gold at a lower reduced significance in the 1930s because of the parity. It was also implied by the recommendation of breakdown of international trade, the Macmillan Committee (1931) for the exchange (i)T. :r—: : f —rr-r: ; :— v & v 'Ihe author is grateful to Gillian McNamara for computing rate to be maintained and imports to be subject to a assistance.