Showing papers on "Exchange rate published in 1991"

Optimum Currency Areas

Abstract: An optimum currency area refers to the ‘optimum’ geographical domain having as a general means of payments either a single common currency or several currencies whose exchange values are immutably pegged to one another with unlimited convertibility for both current and capital transactions, but whose exchange rates fluctuate in unison against the rest of the world. ‘Optimum’ is defined in terms of the macroeconomic goal of maintaining internal and external balance. Internal balance is achieved at the optimal trade-off point between inflation and unemployment (if such a trade-off really exists), and external balance involves both intra-area and inter-area balance of payments equilibrium.

Target Zones and Exchange Rate Dynamics

Abstract: This paper develops a simple model of exchange rate behavior under a target zone regime. It shows that the expectation that monetary policy will be adjusted to limit exchange rate variation affects exchange rate behavior even when the exchange rate lies inside the zone and is thus not being defended actively. Somewhat surprisingly, the analysis of target zones turns out to have a strong formal similarity to problems in option pricing and investment under uncertainty.

Invested interests: the politics of national economic policies in a world of global finance

Abstract: Capital moves more rapidly across national borders now than it has in at least fifty years and perhaps in history. This article examines the effects of capital mobility on different groups in national societies and on the politics of economic policymaking. It begins by emphasizing that while financial markets are highly integrated within the developed world, many investments are still quite specific with respect to firm, sector, or location. It then argues that contemporary levels of international capital mobility have a differential impact on socioeconomic groups. Over the long run, increased capital mobility tends to favor owners of capital over other groups. In the shorter run, owners and workers in specific sectors in capital-exporting countries bear much of the burden of adjusting to increased capital mobility. These patterns can be expected to lead to political divisions about whether or not to encourage or increase international capital market integration. The article then demonstrates that capital mobility also affects the politics of other economic policies. Most centrally, it shifts debate toward the exchange rate as an intermediate or ultimate policy instrument. In this context, it tends to pit groups that favor exchange rate stability against groups that are more concerned about national monetary policy autonomy and therefore less concerned about exchange rate stability. Similarly, it tends to drive a wedge between groups that favor an appreciated exchange rate and groups that favor a depreciated one. These divisions have important implications for such economic policies as European monetary and currency union, the dollar-yen exchange rate, and international macroeconomic policy coordination.

Openness and inflation: theory and evidence

Abstract: This paper points out and tests a straight forward but previously unnoticed prediction of models in which the absence of precommitment in monetary policy leads to excessive inflation. Because unanticipated monetary expansion leads to real exchange rate depreciation, and because the harms of real depreciation are greater in more open economies, the benefits of surprise expansion are decreasing in the degree of openness. Thus, under discretionary policy-making, money growth and inflation will be lower in more open economies. After presenting a simple theoretical model demonstrating this prediction of the theory, the paper examines the link between openness and inflation using cross-country data. The data reveal a strong negative link between openness and inflation.

The economics of exchange rates

Abstract: The purpose of this course is to overview the literature in 5 key areas of the Economics of Exchange Rates. The areas are: Exchange rate regimes issues; purchasing power parity and the PPP puzzle; nominal exchange modelling; real exchange rate modelling; the new open economy macroeconomics and exchange rate behaviour; the economics of fixed exchange rates – speculative attack models and the target zone literature. I take an approach which is supportive of a macro-basedfundamentals view of the exchange rate determination process.

The Significance of Technical Trading-Rule Profits in the Foreign Exchange Market: a Bootstrap Approach

Abstract: In this paper, we present new evidence on the profitability and statistical significance of technical trading rules in the foreign exchange market. We utilize a new data base, currency futures contracts for the period 1976-1990, and we implement a new testing procedure based on bootstrap methodology. Using this approach, we generate thousands of new exchange rate series constructed by random reordering of each original series. We then measure the profitability of the technical rules for each new series. The significance of the profits in the original series is assessed by comparison to the empirical distribution of results derived from the thousands of randomly generated series. Overall, our results suggest that simple technical trading rules have very often led to profits that are highly unusual. Splitting the entire 15-year sample period into three 5-year periods reveals that on average the profitability of some trading rules declined in the 1986-1990 period although profits remained positive (on average) and significant in many cases.

The Collapse of Purchasing Power Parities during the 1970s

Abstract: This paper reviews and analyzes the empirical record of exchange rates and prices during the 1970's and the analysis is based on the experience of the Dollar/Pound, the Dollar/French Franc and the Dollar/DM exchange rates. Section 2 presents the evidence on PPP during the 1970's and contrasts it with the evidence from the 1920's -- a period during which the doctrine held up reasonably well. This analysis is relevant for assessing whether the flexible exchange rate system was successful in providing national economies with an added degree of insulation from foreign shocks, and whether it provided policymakers with an added instrument for the conduct of macroeconomic policy. The evidence regarding deviations from purchasing power parities is also relevant for determining whether there is a case for managed float. Section 3 attempts to explain what went wrong with the performance of the doctrine during the 1970's. It examines the hypothesis that the departures from PPP are a U.S. phenomenon, as well as the hypothesis that the departures are due to large changes in inter-sectoral relative price changes within the various economies. Given that the predictions of the simple versions of PPP do not hold up, section 4 proceeds in examining the question of whether national price levels have been independent of each other. Section 5 addresses the question of whether exchange rates and national price levels are comparable and whether in principle one should have expected them to be closely linked to each other. The main point that is being emphasized is that there is an important intrinsic difference between exchange rates and national price levels which stems from the basset market theory' of exchange rate determination. This theory implies that the exchange rate, like the prices of other assets, is much more sensitive to expectations concerning future events than national price levels and as a result, in periods which are dominated by news' which alter expectations, exchange rates are likely to be much more volatile than national price levels and departures from PPP are likely to be the rule rather than the exception. Finally, section 6 concludes the paper with some policy implications.

The Role of Acquisitions in Foreign Direct Investment: Evidence from the U.S. Stock Market

Abstract: This paper examines foreign direct investment by studying shareholder wealth gains for 1273 U.S. firms acquired during the period 1970-1987. Three findings stand out. First, cross-border takeovers are more frequent in research and development intensive industries than are domestic acquisitions; furthermore, in three-fourths of cross-border transactions the buyer and seller are in related industries. These industry patterns suggest that costs and imperfections in product markets play an important role in foreign direct investment. Second, targets of foreign buyers have significantly higher wealth gains than do targets of U.S. firms. This cross-border effect is comparable in size to the wealth effects of all-cash and multiple bids, two effects receiving substantial attention in the finance literature, and is robust to inclusion of these two variables. Third, while the cross-border effect on wealth gains is not well explained by industry and tax variables, it is positively related to the weakness of the U.S. dollar, indicating a significant role for exchange rate movements in foreign direct investment.

Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models

Abstract: This paper proposes a tractable and realistic nonlinear model of exchange rate dynamics, and argues that its predictions are consistent with available empirical evidence on exchange rate and interest differential behavior in real-life target zones. In our model, the exchange rate fluctuates between given boundaries for random lengths of time and jumps discretely when devaluations occur. We allow for stochastic variability in the likelihood and size of devaluations, and we provide explicit solutions for the stochastic processes followed by the exchange rate and by the expected rate of depreciation. The model produces realistic patterns of covariation between exchange rates and interest rate differentials, and provides interesting interpretations of available empirical evidence. We also specify how to infer devaluation risk from target zone data.

Growth, Macroeconomics, and Development

Abstract: The 1980s were both the lost decade of growth for much of Latin America and Africa, and the period in which -- through the new growth theory -- macroeconomists returned to the study of growth and development. The new growth theory is production function driven and concerned primarily with steady states, and has paid little attention to the role of macroeconomic policy -- as reflected for instance in the rate of inflation and the budget deficit -- in determining growth. This paper presents a variety of evidence that macroeconomic policies matter for long-run growth. First, macroeconomic variables enter the typical new growth theory cross-country regressions with statistical significance and the expected signs. Second, evidence from large multi?country case studies, and from case-studies of Chile and Cote d'Ivoire presented in the paper, shows that macroeconomic policy choices have had a significant impact on growth over periods of more than a decade. The conclusion is that macroeconomic policy choices, including the budget deficit, the exchange rate system, and those choices that determine the inflation rate, matter for long-term economic growth.

A Variance‐Ratio Test of Random Walks in Foreign Exchange Rates

Abstract: The separate variance-ratio tests under homoscedasticity and heteroscedasticity both provide evidence rejecting the random walk hypothesis, using five pairs of weekly nominal exchange rate series over the period from August 7, 1974 to March 29, 1989. The rejections cast doubt on the random walk hypothesis in exchange rates, which has received support in the existing literature. Furthermore, since the rejections are robust to heteroscedasticity, they suggest autocorelations of weekly increments in the nominal exchange rate series, which may be consistent with the exchange rate overshooting or undershooting phenomenon. IN THE PAST DECADE, there has been a consensus that nominal exchange rates follow a random walk process. Since a "unit root" and "uncorrelated increments" are both required for a random walk process, the random walk is usually supported in the existing literature either because a "unit root" component is detected in the exchange rate series or because the increment in the exchange rate is found to be serially uncorrelated. For example, Meese and Singleton (1982) and Baillie and Bollerslev (1989) both find a "unit root" component in the exchange rate series, and the evidence provided in Giddy and Dufey (1975), Cornell and Dietrich (1978), Logue, Sweeney, and Willett (1978), and Hsieh (1988) all suggest that the exchange rate series contains uncorrelated increments. In this paper, the random walk hypothesis for the nominal exchange rate series is reexamined, by applying a variance-ratio test developed in Lo and MacKinlay (1988) to five pairs of weekly nominal exchange rate series over the period from August 7, 1974 to March 29, 1989. While there are two implications of the random walk (unit root and uncorrelated increments), this paper focuses on the uncorrelated increments aspect. This is not only because there are some important departures from the random walk that unit root test cannot detect, but also because the autocorrelation aspect may yield

The Gold Standard and the Great Depression

Abstract: The Depression of the 1930s remains the ultimate testing ground for theories of macroeconomic fluctuation, while the operation of the gold standard is the ultimate measuring rod for alternative international monetary systems. Yet neither the cause of the Great Depression nor the workings of the gold standard are understood adequately. (1) One reason, my research suggests, is that they tend to be analyzed in isolation from one another when, in fact, the gold standard provides the key to understanding the Depression, and the Depression illuminates how the gold standard workes. (2) How the Gold Standard Worked The dominant explanation for the stability of the prewar gold standard emphasizes adept management by the Bank of England. The Bank is said to have stabilized the gold standard system by acting as international lender of last resort. In an influential book, Charles Kindleberger contrasted the pre-World War I situation with the interwar period, when Britain was not sufficiently powerful to stabilize the system, and the United States was not prepared to do so. (3) In an application of what has come to be known as the "theory of hegemonic stability," Kindleberger concluded that the requisite stabilizing influence was supplied adequately only when there existed a dominant power ready and able to provide it. (4) My research challenges this view. It suggests that the interwar period was hardly exceptional for the absence of a hegemon. Neither was there a country that single-handedly managed international monetary affairs prior to World War I. The prewar gold standard was a decentralized, multipolar system whose smooth operation was not attributable to stabilizing intervention by a dominant power. The stability of the prewar gold standard was attributable rather to two very different factors: credibility and cooperation. (5) The credibility of the gold standard derived from the priority attached by governments to balance-of-payments equilibrium. In the core countries--Britain, France, and Germany--there was little doubt that the authorities would take whatever steps were required to defend the central bank's gold reserves and to maintain the convertibility of the currency into gold. If one such central bank lost gold reserves and its exchange rate weakened, then funds would flow in from abroad in anticipation of the capital gains that investors in domestic assets would reap once the authorities adopted the measures needed to stem reserve losses and strengthen the exchange rate. Because there was no question about the commitment to the existing parity, stabilizing capital flows responded quickly and in considerable volume. The exchange rate strengthened of its own accord. Stabilizing capital flows thereby minimized the need for government intervention. (6) What rendered the commitment to gold credible? In part, there was little perception that policies required for external balance were inconsistent with domestic prosperity. There was no well-articulated theory of how supplies of money and credit could be manipulated to stabilize production or reduce joblessness. The working classes, possessing limited political power, were unable to challenge the prevailing state of affairs. In many countries, the extent of the franchise was still limited. Those who might have objected that restrictive monetary policy created unemployment were in no position to influence its formulation. Nor was there a belief that budget deficits or changes in the level of public spending could be used to establize the economy. Since governments followed a balanced-budget rule, changes in revenues dictated changes in public spending. Countries rarely found themselves confronted with the need to eliminate large budget deficits in order to stem gold outflows. Ultimately, however, the credibility of the prewar gold standard rested on international cooperation. Minor problems could be dispatched by tacit cooperation, generally achieved without open communication among the parties involved. …

Stopping High Inflation; An Analytical Overview

Abstract: This paper reviews the evidence on stabilization plans in high inflation countries within a unified theoretical framework. The evidence suggests that hyperinflations have been stopped almost instantaneously with no major output costs, while stabilization programs in chronic inflation countries have resulted in an initial expansion followed by a later recession, in addition to a sustained real exchange rate appreciation and current account deficits. These outcomes turn out to be consistent with the predictions of the analytical model.

The Sensitivity of Bank Stock Returns to Market, Interest and Exchange Rate Risks

Abstract: This paper presents and estimates a multifactor model of bank stock returns that incorporates market return, interest rate and exchange rate risk factors. A model of the optimizing behavior of an international banking tirm is used to derive the sensitivity coefficients of the alternative factors. Regression equations are estimated that are based on either actual or unexpected values of the underlying factors with a post-October 1979 time dummy variable and with a money-center bank dummy variable. Standard results are obtained for the market and interest rate variables while new results are derived for the exchange rate variable. The specific effects of the latter variable are found to be dependent on the time period of observation and the money-center status of banks.

Income Distribution, Inflation, and Growth: Lectures on Structuralist Macroeconomic Theory

Abstract: Structuralist macroeconomics has emerged recently as the only viable theoretical alternative for economists and practitioners in developing countries. Lance Taylor's innovative work represents a landmark in this field. It codifies a new generation of structuralist macroeconomic models that incorporate the economic power relationships of key institutions and groups, integrates both finance and real macroeconomics, and covers a diverse range of experience in the developing world over the past three decades. In an introduction Taylor explains his methodology, describes assumptions underlying the models used, and reviews theories that relate economic growth and the role of financial assets. He then takes up basic structuralist models of a closed economy and moves on to consider the open economy cases. He incorporates the latest developments in the field (inflation, financial crisis, exchange rate management, increasing returns, and the like) in a treatment that departs substantially from economic orthodoxy. Taylor first addresses the question of how to specify .closure" or define the causal structure of macro models. He also considers how income redistribution influences growth and output and how income redistribution interacts with inflation. Next, an investment-driven non-full employment growth model draws on ideas introduced earlier to illustrate how different sorts of macroeconomic policies affect short-run adjustment and growth prospects over time. Taylor then turns to the problems proposed by economic openness in a stylized semi-industrialized country, starting with international trade. A fix-price/flex-price model is developed, and additional models demonstrate cases of policy relevance as well as interactions between class conflict and growth.

Exchange-Rate-Based Stabilization under Imperfect Credibility

Abstract: This paper analyzes stabilization policy under predetermined exchange rates in a cash-in-advance, staggered-prices model. Under full credibility, a reduction in the rate of devaluation results in an immediate and permanent reduction in the inflation rate, with no effect on output or consumption. In contrast, a non-credible stabilization results in an initial expansion of output, followed by a later recession. The inflation rate of home goods remains above the rate of devaluation throughout the program, thus resulting in a sustained real exchange rate appreciation.

Speculative Attacks and Models of Balance-of-Payments Crises

Abstract: This paper reviews recent developments in the theoretical and empirical analysis of balance-of-payments crises. A simple analytical model highlighting the process leading to such crises is first developed. The basic framework is then extended to deal with a variety of issues, such as: alternative post-collapse regimes, uncertainty, real sector effects, external borrowing and capital controls, imperfect asset substitutability, sticky prices, and endogenous policy switches. Empirical evidence on the collapse of exchange rate regimes is also examined, and the major implications of the analysis for macroeconomic policy discussed.

Exchange rate volatility and trade: why is it so difficult to find any empirical relationship

Abstract: This paper discusses why previous literature has found little evidence of any effect of exchange rate variability on international trade. Methodological and statistical issues are discussed. In particular, comparisons are made of estimations based on different specifications or using different data sets and changes in the results depending on the method used are shown.

Exchange Rate Expectations: A Survey of Survey Studies

Abstract: The empirical literature on survey-based exchange rate expectations is briefly surveyed. The literature in general supports the presence of a nonzero risk premium and rejects the hypothesis of rational expectations. The crucial result is that, whereas short-run expectations tend to move away from some long-run "normal" values, long-run expectations tend to move back toward them. If this behavior of short-run expectations increases the volatility of exchange rate movements, there may be a basis for an official measure to minimize short-run exchange rate movements.

Exchange Rate Policy in Developing Countries: Some Analytical Issues

Abstract: This paper addresses analytical aspects of exchange rate policy and emphasizes the relationship among exchange rate flexibility, financial discipline, and international competitiveness.

The EMS, the EMU, and the Transition to a Common Currency

Abstract: When a central bank is about to relinquish control over its exchange rate and enter into a currency union, it faces very low reputational costs of devaluation. As with any finite-horizon game, the endpoint affects the earlier expectations of private agents, here causing them to demand higher interest rates and higher wages from countries whose currencies are relatively weak. In looking at the countries within the EMS, we find that Italian long-term interest rates as well as price and wage levels relative to those in Germany show evidence of growing gaps. We also find that the real appreciation of the lira appears to be partly due to increases in relative Italian government spending, and not just to rapid Italian productivity growth. Taken together, this evidence suggests that reputational considerations may not be enough to foster continuing convergence within the EMS. Furthermore, moving forward the date of currency union may in the short run increase both the rate of growth of the gaps and the need for ...

Speculative Attacks and Models of Balance of Payments Crises

Abstract: Recent developments in the theoretical and empirical analysis of balance of payments crises are reviewed. A simple analytical model highlighting the process leading to such crises is first developed. The basic framework is then extended to deal with a variety of issues, including alternative postcollapse regimes, uncertainty, real sector effects, external borrowing and capital controls, imperfect asset substitutability, sticky prices, and endogenous policy switches. Empirical evidence on the collapse of exchange rate regimes is also examined, and the major implications of the analysis for macroeconomic policy are discussed.

Expected and Predicted Realignments: The Ff/Dm Exchange Rate During the EMS

Abstract: An empirical model of time-varying realignment risk in an exchange rate target zone is developed Expected rates of devaluation are estimated as the difference between interest race differentials and estimated expected rates of depreciation within the exchange rate band, using French Franc/Deutsche Mark data during the European Monetary System The behavior of estimated expected rates of depreciation accord well with the theoretical model of Bertola-Svensson (1990) We are also able to predict actual realignments with some success