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Showing papers on "Exchange rate published in 1999"


Book ChapterDOI
TL;DR: The role of companies' balance sheets in determining their ability to invest, and that of capital flows in affecting the real exchange rate, has been emphasized in this paper to make sense of the emerging market crisis of 1997-98.
Abstract: In a world of high capital mobility, the threat of speculative attack becomes a central issue of macroeconomicpolicy. While “first-generation” and “second-generation” models of speculative attacks both have considerablerelevance to particular financial crises of the 1990s, a “third-generation” model is needed to make sense of thenumber and nature of the emerging market crises of 1997-98. Most of the recent attempts to produce such amodel have argued that the core of the problem lies in the banking system. This paper sketches another candidatefor third-generation crisis modeling—one that emphasizes two facts that have been omitted from formal modelsto date: the role of companies' balance sheets in determining their ability to invest, and that of capital flows inaffecting the real exchange rate.

1,186 citations


ReportDOI
TL;DR: This article analyzed three views of the relationship between the exchange rate and financial fragility: (1) the moral hazard hypothesis, according to which pegged exchange rates offer implicit insurance against exchange risk and thereby encourage reckless borrowing and lending; (2) the original sin hypothesis, which emphasizes an incompleteness in financial markets which prevents the domestic currency from being used to borrow abroad or to borrow long term even domestically; and (3) the commitment problem hypothesis, who sees financial crises as resulting from neither moral hazard nor original sin but from the weakness of the institutions that address commitment problems.
Abstract: In this paper we analyze three views of the relationship between the exchange rate and financial fragility: (1) the moral hazard hypothesis, according to which pegged exchange rates offer implicit insurance against exchange risk and thereby encourage reckless borrowing and lending; (2) the original sin hypothesis, which emphasizes an incompleteness in financial markets which prevents the domestic currency from being used to borrow abroad or to borrow long term even domestically; and (3) the commitment problem hypothesis, which sees financial crises as resulting from neither moral hazard nor original sin but from the weakness of the institutions that address commitment problems. We examine the evidence on these hypotheses and draw out their implications for exchange-rate policy in emerging markets

787 citations


Book ChapterDOI
TL;DR: The analysis of exchange rate behavior has been a perennial topic in international monetary economics as discussed by the authors, and one strand of this literature relates to the explanation of observed movements in nominal and real exchange rates in terms of relevant economic variables, while another strand focuses on assessing exchange rates relative to economic fundamentals and coming to a judgement as to whether a particular exchange rate is misaligned, i.e., over- or undervalued.
Abstract: The analysis of exchange rate behavior has been a perennial topic in international monetary economics. One strand of this literature relates to the explanation of observed movements in nominal and real exchange rates in terms of relevant economic variables. A different strand focuses on assessing exchange rates relative to economic fundamentals and coming to a judgement as to whether a particular exchange rate is misaligned, i.e., over- or undervalued. One approach taken in this latter strand of research that has been developed by Williamson (1994) involves the calculation of what is called the Fundamental Equilibrium Exchange Rate (FEER). In this approach the equilibrium exchange rate is defined as the real effective exchange rate that is consistent with macroeconomic balance, which is generally interpreted as when the economy is operating at full employment and low inflation (internal balance) and a current account that is sustainable, i.e., that reflects underlying and desired net capital flows (external balance). This exchange rate concept is denoted as “fundamental” in that it abstracts from short-term factors and emphasizes instead determinants that are important over the medium term. An assessment of a country’s exchange rate can be made by comparing its current level with the calculated FEER

742 citations


ReportDOI
TL;DR: The authors show that currency crises tend to be regional; they affect countries in geographic proximity, and that patterns of international trade are important in understanding how currency crises spread, above and beyond any macroeconomic phenomena.

713 citations


Posted Content
TL;DR: The authors used a gravity model to assess the effect of exchange rate volatility and currency unions on international trade and found that currency union may lead to a large increase in international trade, with all that entails.
Abstract: A gravity model is used to assess the separate effects of exchange rate volatility and currency unions on international trade. The panel data set I use includes bilateral observations for five years spanning 1970 through 1990 for 1986 countires. In this data set, there are over one hundred pairings and three hundred observations, in which both countries use the same currency. I find a large positive effect of a currency union on international trade, and a small negative effect of exchange rate volatility, even after controlling for a host of features, including the endogenuous nature of the exchange rate regime. These effects are statistically significant and imply that two countires that share the same currency trade three times as much as they would with different curencies. EMU may thus lead to a large increase in international trade, with all that entails.

690 citations


Book
01 Jan 1999
TL;DR: In this paper, the authors consider some prescriptions that are currently popular regarding exchange rate regimes: a general movement toward floating or fixing, or a general move toward either extreme and away from the middle.
Abstract: This essay considers some prescriptions that are currently popular regarding exchange rate regimes: a general movement toward floating, a general movement toward fixing, or a general movement toward either extreme and away from the middle. The whole spectrum from fixed to floating is covered (including basket pegs, crawling pegs, and bands), with special attention to currency boards and dollarization. One overall theme is that the appropriate exchange rate regime varies depending on the specific circumstances of the country in question (which includes the classic optimum currency area criteria, as well as some newer criteria related to credibility) and depending on the circumstances of the time period in question (which includes the problem of successful exit strategies). Latin American interest rates are seen to be more sensitive to US interest rates when the country has a loose dollar peg than when it has a tight peg. It is also argued that such relevant country characteristics as income correlations and openness can vary over time, and that the optimum currency area criterion is accordingly endogenous.

668 citations



Journal ArticleDOI
TL;DR: In this paper, the authors diagnose the symptoms of the Dutch disease in a two-sector stochastic endogenous growth model and show a statistically significant inverse relationship between the size of the primary sector and economic growth but not between the volatility of the real exchange rate and growth.
Abstract: This paper diagnoses the symptoms of the Dutch disease in a two-sector stochastic endogenous growth model. A productive, low-skill-intensive primary sector causes the currency to appreciate in real terms, thus hampering the development of a high-skill-intensive secondary sector and thereby reducing growth. Moreover, the volatility of the primary sector generates real-exchange-rate uncertainty and may thus reduce investment and learning in the secondary sector and hence also growth. Cross-sectional and panel regressions based on data for 125 countries in the period 1960–1992 confirm a statistically significant inverse relationship between the size of the primary sector and economic growth, but not between the volatility of the real exchange rate and growth.

529 citations


ReportDOI
TL;DR: In this paper, the authors construct model-free estimates of daily exchange rate volatility and correlation, covering an entire decade, using high-frequency data on Deutschemark and Yen returns against the dollar.
Abstract: Using high-frequency data on Deutschemark and Yen returns against the dollar, we construct model-free estimates of daily exchange rate volatility and correlation, covering an entire decade. In addition to being model-free, our estimates are also approximately free of measurement error under general conditions, which we delineate. Hence, for all practical purposes, we can treat the exchange rate volatilities and correlations as observed rather than latent. We do so, and we characterize their joint distribution, both unconditionally and conditionally. Noteworthy results include a simple normality-inducing volatility transformation, high contemporaneous correlation across volatilities, high correlation between correlation and volatilities, pronounced and highly persistent temporal variation in both volatilities and correlation, clear evidence of long-memory dynamics in both volatilities and correlation, and remarkably precise scaling laws under temporal aggregation.

508 citations


ReportDOI
TL;DR: In this paper, the authors measure the proportion of U.S. real exchange rate movements that can be accounted for by movements in the relative prices of nontraded goods, at all possible h...
Abstract: This study measures the proportion of U.S. real exchange rate movements that can be accounted for by movements in the relative prices of nontraded goods. The decomposition is done at all possible h...

470 citations


Posted Content
TL;DR: In this article, the authors construct model-free estimates of daily exchange rate volatility and correlation, covering an entire decade, using high-frequency data on Deutschemark and Yen returns against the dollar.
Abstract: Using high-frequency data on Deutschemark and Yen returns against the dollar, we construct model-free estimates of daily exchange rate volatility and correlation, covering an entire decade. In addition to being model-free, our estimates are also approximately free of measurement error under general conditions, which we delineate. Hence, for all practical purposes, we can treat the exchange rate volatilities and correlations as observed rather than latent. We do so, and we characterize their joint distribution, both unconditionally and conditionally. Noteworthy results include a simple normality-inducing volatility transformation, high contemporaneous correlation across volatilities, high correlation between correlation and volatilities, pronounced and highly persistent temporal variation in both volatilities and correlation, clear evidence of long-memory dynamics in both volatilities and correlation, and remarkably precise scaling laws under temporal aggregation.

Journal ArticleDOI
TL;DR: This article showed that the relative prices of non-traded goods in each country should reflect the relative productivity of labor in the traded and nontraded sectors, while purchasing power parity holds for traded goods.

Journal Article
TL;DR: In this article, a consensus on the importance of preventing exchange rate misalignment has not provided systematic guidance on definitions and measurement, and the authors argue that growing financial integration has increased the urgency of providing accurate measures of long-run equilibrium exchange rates.
Abstract: The 1994 devaluation of CFA francs in West Africa, the Mexican currency crisis in that same year, and the Asian crises that erupted in mid-1997 are reminders of the severe dislocations that can be caused by exchange rate misalignment. However a consensus on the importance of preventing exchange rate misalignment has not provided systematic guidance on definitions and measurement. Recent macroeconomic disruptions support the argument that growing financial integration has increased the urgency of providing accurate measures of long-run equilibrium exchange rates. For its analytical depth and its practical techniques for measurement, Exchange Rate Misalignment is an invaluable resource for policymakers and foreign exchange specialists in both the public and private sectors.

Journal ArticleDOI
TL;DR: In this article, the use of a new bootstrap method for small-sample inference in long-horizon regressions is illustrated by analysing the longhorizon predictability of four major exchange rates, and the findings are reconciled with those of an earlier study by Mark.
Abstract: The use of a new bootstrap method for small-sample inference in long-horizon regressions is illustrated by analysing the long-horizon predictability of four major exchange rates, and the findings are reconciled with those of an earlier study by Mark (1995). While there is some evidence of exchange rate predictability, contrary to earlier studies, no evidence is found of higher predictability at longer horizons. Additional evidence is presented that the linear VEC model framework underlying the empirical study is likely to be misspecified, and that the methodology for constructing bootstrap p-values for long-horizon regression tests may be fundamentally flawed. Copyright © 1999 John Wiley & Sons, Ltd.

Journal ArticleDOI
TL;DR: In this article, the macroeconomic determinants of migrants' remittances to their countries of origin were investigated using data for Egypt and they found that both exchange rate and interest rate differentials are important in attracting remittance flows through official channels.

Journal ArticleDOI
TL;DR: The authors showed that monetary policy shocks may lead to large uncovered interest rate parity (UIP) deviations, which is consistent with overshooting, and implies that the over-shooting cannot be driven by Dornbusch's mechanism.

Journal ArticleDOI
TL;DR: In this paper, the authors investigate whether current economic activities in Korea can explain stock market returns by using a cointegration test and a Granger causality test from a vector error correction model.

Journal ArticleDOI
TL;DR: In this article, a multivariate framework for evaluating and improving multivariate density forecasts is proposed, and conditions under which a technique of density forecast "calibration" can be used to improve deficient density forecasts are provided.
Abstract: We provide a framework for evaluating and improving multivariate density forecasts. Among other things, the multivariate framework lets us evaluate the adequacy of density forecasts involving cross-variable interactions, such as time-varying conditional correlations. We also provide conditions under which a technique of density forecast “calibration” can be used to improve deficient density forecasts, and we show how the calibration method can be used to generate good density forecasts from econometric models, even when the conditional density is unknown. Finally, motivated by recent advances in financial risk management, we provide a detailed application to multivariate high-frequency exchange rate density forecasts.

Journal ArticleDOI
TL;DR: In this paper, the authors review some of the evidence and discuss the economic magnitude of this predictability and analyze the profitability of these trading rules in connection with central bank activity using intervention data from the Federal Reserve.

Journal ArticleDOI
TL;DR: In this paper, the authors extend the Dixit-Pindyck model for varying degrees of uncertainty and price drift, and specifically for the case where that uncertainty is caused by exchange rate volatility.
Abstract: Conventional wisdom has it that increasing price or exchange rate uncertainty will depress investment. Using the Dixit-Pindyck model, we find that there are situations where this will happen; and situations where it does not. There are threshold effects which allows us to identify when rising volatility would increase or decrease investment; and also to identify which types of industries would gain, and which would suffer, from a move to fixed exchange rates. This is important for monetary union in Europe since it is likely that, even if trade is insensitive to exchange rate volatility, investment with its longer horizon will be affected. Textbook theories of investment under uncertainty present a rather oversimplified rule for a firm deciding whether to invest or not. If the project's expected net present value (NPV) is positive, the firm invests; otherwise it does not. This implies that if the investment is reversible, the firm will simply disinvest if the NPV turns negative. But if investment is irreversible, then if a firm decides not to invest, it will never invest. This is not a realistic approach. Given uncertainty, firms often find it convenient to wait rather than to commit themselves one way or another. Waiting is therefore a proper alternative to investing or not investing; and firms will be confronted with an 'invest-wait-do not invest' decision, rather than an 'invest-do not invest' one. Dixit and Pindyck (1994) have developed a model in which the option value of an investment project is evaluated to represent the value of waiting. That option value then becomes part of the investment costs because, once an irreversible investment is made, the possibility of exercising this option to invest later on, when better information is available, has been lost. Thus the decision rule is still 'invest if NPV> 0, otherwise do not invest', but the NPV now represents the present value of the expected revenues, less the value of the option to invest later, less the present value of any other investment costs. In this paper we extend the Dixit-Pindyck model for varying degrees of uncertainty and price drift, and specifically for the case where that uncertainty is caused by exchange rate volatility. Such an extension is important, not only because it is a new development, but also because we need to understand how monetary union will affect investment expenditures in Europe. For simplicity we assume the domestic prices are fixed, and that the only uncertainty is in the exchange rate and hence the domestic value of foreign currency revenues. That leaves us with various problems. The first is to determine the threshold at which exchange rate/price uncertainty is sufficient to affect investment adversely. Second, under what conditions does that uncertainty actually reduce investment? Third, do exchange rate misalignments or exchange rate volatility damage investment more? We show that answers to such questions can be [C55]

Journal ArticleDOI
01 Jan 1999
TL;DR: In this article, it was shown that the business cycle affiliation of ERM member countries has shifted from the United States to Germany since the formation of the ERM, bolstered by the growing links in trade between the EU countries.
Abstract: Successful exchange rate regimes impose policy disciplines that are likely to lead to conformity in the business cycles of the participating countries. This conjecture is borne out in the paper by the evidence in it that the business cycle affiliation of ERM member countries has shifted from the United States to Germany since the formation of the ERM. This effect is bolstered by the growing links in trade between the EU countries. The United Kingdom is conspicuous among the latter in that its business cycle affiliation did not change in the period covered by the study.

Posted Content
TL;DR: In this article, the authors present a detailed critique of the common currency arrangements of the Economic and Monetary Union, embodied in the laws and emerging procedural arrangements that govern the actions of its key institutions: the European Central Bank and the European System of Central Banks.
Abstract: The paper contains a detailed critique of the common currency arrangements of the Economic and Monetary Union, embodied in the laws and emerging procedural arrangements that govern the actions of its key institutions: the European Central Bank and the European System of Central Banks. The main message here is 'Great idea, shame about the execution'. A number of improvements are then proposed. Some of these require amending the Treaty, including an end to the rule that each EMU member's national central bank has a seat on the Governing Council or the removal of the power of the Council of Ministers to give 'general orientations' for exchange rate policy. Others, notably in the areas of accountability, openness and transparency, could be implemented immediately, including publication of voting records, minutes and the inflation forecast. Improved arrangements are also advocated for the co-ordination of monetary and fiscal policy. And the article calls for a European Parliament that can both bark and bite.

BookDOI
TL;DR: The authors examined the empirical links between current account deficits and a broad set of economic variables proposed in the literature and found that a rise in domestic output growth generates a larger current account deficit.
Abstract: The authors examine the empirical links between current account deficits and a broad set of economic variables proposed in the literature. To accomplish this, they complement and extend previous research by using a large, consistent set of macroeconomic data on public and private domestic savings, external savings, and national income variables; focusing on developing economies by drawing on a panel data set for 44 developing countries and annual information for the period 1966-95; adopting a reduced-form approach rather than holding to a particular structural model; distinguishing between within-country and cross-country effects; and employing a class of estimators that controls for the problems of simultaneity and reverse causation. Among their findings: Current account deficits in developing countries are moderately persistent. A rise in domestic output growth generates a larger current account deficit. Increases in savings rates have a positive effect on the current account. Shocks that increase the terms of trade or cause the real exchange rate to appreciate are linked with higher current account deficits. Either higher growth rates in industrial economies or higher international interest rates reduce the current account deficit in developing economies.

Journal ArticleDOI
TL;DR: The authors argue that a principal cause of the 1997 Asian currency crisis was large prospective deficits associated with implicit bailout guarantees to failing banking systems, and that the expectation that these future deficits would be at least partially financed by seigniorage revenues or an inflation tax on outstanding nominal debt led to a collapse of the fixed exchange rate regimes in Asia.
Abstract: This paper argues that a principal cause of the 1997 Asian currency crisis was large prospective deficits associated with implicit bailout guarantees to failing banking systems. The expectation that these future deficits would be at least partially financed by seigniorage revenues or an inflation tax on outstanding nominal debt led to a collapse of the fixed exchange rate regimes in Asia. We articulate this view using a simple model whose key feature is that a speculative attack is inevitable once the present value of future government deficits rises. We present empirical evidence in support of the key assumptions underlying our interpretation of the crisis.

Journal ArticleDOI
TL;DR: In this article, the authors focus on the rationality of inflation expectations, i.e., the extent to which agents form expectations without making systematic mistakes in their beliefs about what inflation will be.
Abstract: of real interest rates and cash flows for decisions concerning investment expenditures. International capital flows and exchange rate movements hinge in large part on expected real yield differentials across countries. The Federal Reserve needs reliable measures of expected inflation to formulate and gauge the thrust of monetary policy. In fact, inflation expectations have become more important to the Fed given the diminished stability of the link between the monetary aggregates and GDP expenditures since the early 1980s, and the greater role which has been thrust upon expected real short-term interest rates in the implementation of Federal Reserve policy. The issue of rationality of inflation expectations-that is, the extent to which agents form expectations without making systematic mistakes in their beliefs about what inflation will be-is important. If inflation expectations are formed rationally, labor and financial markets will strongly tend to neutralize the potential redistributive effects of inflation over time. Financial capital will flow efficiently within and across national borders. Moreover, some of the stronger claims of new classical macroeconomics, like the claim that only unexpected monetary policy actions will

Journal ArticleDOI
TL;DR: In this article, the authors test for and model non-linearities in the real effective exchange rates of 10 major industrial countries (the G-10) and apply the STAR (Smooth Transition Autoregressive) family of models.

Journal ArticleDOI
TL;DR: A detailed critique of the common currency arrangements of the Economic and Monetary Union, embodied in the laws and emerging procedural arrangements that govern the actions of its key institutions: the European Central Bank and the European System of Central Banks, is given in this paper.
Abstract: The paper contains a detailed critique of the common currency arrangements of the Economic and Monetary Union, embodied in the laws and emerging procedural arrangements that govern the actions of its key institutions: the European Central Bank and the European System of Central Banks. The main message here is ''Great idea, shame about the execution''. A number of improvements are then proposed. Some of these require amending the Treaty, including an end to the rule that each EMU member''s national central bank has a seat on the Governing Council or the removal of the power of the Council of Ministers to give ''general orientations'' for exchange rate policy. Others, notably in the areas of accountability, openness and transparency, could be implemented immediately, including publication of voting records, minutes and the inflation forecast. Improved arrangements are also advocated for the co-ordination of monetary and fiscal policy. And the article calls for a European Parliament that can both bark and bite.

Journal ArticleDOI
TL;DR: The authors showed that domestic political institutions have a significant effect on exchange-rate regime choice, even after controlling for systemic, macroeconomic, and other political variables, such as electoral defeat and timing.
Abstract: Since the collapse of the Bretton Woods system, countries have been able to choose from a variety of exchange-rate arrangements. We argue that politicians' incentives condition the choice of an exchange-rate arrangement. These incentives reflect the configuration of domestic political institutions, particularly electoral and legislative institutions. In systems where the cost of electoral defeat is high and electoral timing is exogenous, politicians will be less willing to forgo their discretion over monetary policy with a fixed exchange rate. In systems where the costs of electoral defeat are low and electoral timing is endogenous, politicians are more likely to adopt a fixed exchange-rate regime. Consequently, differences in domestic political systems can help account for variations in the choice of exchange-rate arrangements. We test this argument using constrained multinomial logit and binomial logit on a sample of twenty democracies over the period 1974–95. Domestic political institutions have a significant effect on exchange-rate regime choice, even after controlling for systemic, macroeconomic, and other political variables.

Journal ArticleDOI
TL;DR: In this article, the authors present a methodology for calculating bilateral equilibrium exchange rates for a panel of currencies in a way that guarantees global consistency, using a theoretical model that encompasses the balance of payments and the Balassa-Samuelson approaches to real exchange rate determination.
Abstract: This paper presents a methodology for calculating bilateral equilibrium exchange rates for a panel of currencies in a way that guarantees global consistency. The methodology has three parts: a theoretical model that encompasses the balance of payments and the Balassa-Samuelson approaches to real exchange rate determination; an unobserved components decomposition in a cointegration framework that identifies a time-varying equilibrium real exchange rate; and an algebraic transformation that extracts bilateral equilibrium nominal rates. The results uncover that, by the start of Stage III of the European Economic and Monetary Union (EMU), the euro was significantly undervalued against the dollar and the pound, but overvalued against the yen. The paper also shows that the four major EMU currencies locked their parities with the euro at a rate close to equilibrium.

BookDOI
01 Sep 1999
TL;DR: In this article, the effects of exchange rate volatility on bilateral trade flows are analyzed through use of a gravity model and panel data from western Europe, and the results seem to be robust with respect to the particular measures representing exchange rate uncertainty.
Abstract: This paper analyzes the effects of exchange rate volatility on bilateral trade flows. Through use of a gravity model and panel data from western Europe, exchange rate uncertainty is found to have a negative effect on international trade. The results seem to be robust with respect to the particular measures representing exchange rate uncertainty. Particular attention is reserved for problems of simultaneous causality, stemming from the endogenous behavior of monetary authorities. The negative correlation between trade and bilateral volatility remains significant after controlling for the simultaneity bias.