Showing papers on "Exchange rate published in 2002"

Fear of Floating

Abstract: In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates“soft pegs”--for these meltdowns. Adherents to that view advise countries to allow their currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether “official labels” provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of “fear of floating.” Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called “demise of fixed exchange rates” is a myth--the fear of floating is pervasive, even among some of the developed countries. We present an analytical framework that helps to understand why there is fear of floating.

The Modern History of Exchange Rate Arrangements: A Reinterpretation

Abstract: We develop a novel system of re-classifying historical exchange rate regimes. One difference between our study and previous classification efforts is that we employ an extensive data base on market-determined parallel exchange rates. Our 'natural' classification algorithm leads to a stark reassessment of the post-war history of exchange rate arrangements. When the official categorization is a form of peg, roughly half the time our classification reveals the true underlying monetary regime to be something radically different, often a variant of a float. Conversely, when official classification is floating, our scheme routinely suggests that the reality was a form of de facto peg. Our new classification scheme points to a complete rethinking of economic performance under alternative exchange rate regimes. Indeed, the breakup of Bretton Woods had a far less dramatic impact on most exchange rate regimes than is popularly believed. Also, contrary to an influential empirical literature, our evidence suggests that exchange rate arraignments may be quite important for growth, trade and inflation. Our newly compiled monthly data set on market-determined exchange rates goes back to 1946 for 153 countries.

The Economics of Exchange Rates

Abstract: Description Contents Resources Courses About the Authors In the last few decades exchange rate economics has seen a number of developments, with substantial contributions to both the theory and empirics of exchange rate determination. Important developments in econometrics and the increasingly large availability of high-quality data have also been responsible for stimulating the large amount of empirical work on exchange rates in this period. Nonetheless, while our understanding of exchange rates has significantly improved, a number of challenges and open questions remain in the exchange rate debate, enhanced by events including the launch of the Euro and the large number of recent currency crises. This volume provides a selective coverage of the literature on exchange rates, focusing on developments from within the last fifteen years. Clear explanations of theories are offered, alongside an appraisal of the literature and suggestions for further research and analysis.

Order Flow and Exchange Rate Dynamics

Abstract: Macroeconomic models of nominal exchange rates perform poorly. In sample, R2 statistics as high as 10 percent are rare. Out of sample, these models are typically out-forecast by a naive random walk. This paper presents a model of a new kind. Instead of relying exclusively on macroeconomic determinants, the model includes a determinant from the field of microstructure—order flow. Order flow is the proximate determinant of price in all microstructure models. This is a radically different approach to exchange rate determination. It is also strikingly successful in accounting for realized rates. Our model of daily exchange-rate changes produces R2 statistics above 50 percent. Out of sample, our model produces significantly better short-horizon forecasts than a random walk. For the DM/$ spot market as a whole, we find that $1 billion of net dollar purchases increases the DM price of a dollar by about 1 pfennig.

Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates

Abstract: The central puzzle in international business cycles is that real exchange rates are volatile and persistent. The most popular story for real exchange rate fluctuations is that they are generated by monetary shocks interacting with sticky goods prices. We quantify this story and find that it can account for some of the observed properties of real exchange rates. When prices are held fixed for at least one year, risk aversion is high and preferences are separable in leisure, the model generates real exchange rates that are as volatile as in the data. The model also generates real exchange rates that are persistent, but less so than in the data. If monetary shocks are correlated across countries, then the comovements in aggregates across countries are broadly consistent with those in the data. Making asset markets incomplete or introducing sticky wages does not measurably change the results.

Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange

Abstract: Using a new dataset consisting of six years of real-time exchange rate quotations, macroeconomic expectations, and macroeconomic realizations (announcements), we characterize the conditional means of U.S. dollar spot exchange rates versus German Mark, British Pound, Japanese Yen, Swiss Franc, and the Euro. In particular, we find that announcement surprises (that is, divergences between expectations and realizations, or 'news') produce conditional mean jumps; hence high-frequency exchange rate dynamics are linked to fundamentals. The details of the linkage are intriguing and include announcement timing and sign effects. The sign effect refers to the fact that the market reacts to news in an asymmetric fashion: bad news has greater impact than good news, which we relate to recent theoretical work on information processing and price discovery.

Monetary Policy and Exchange Rate Volatility in a Small Open Economy

Abstract: We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to simple representation in domestic inflation and the output gap. We use the resulting framework to analyze the macroeconomic implications of three alternative rule-based policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.

A Century of Purchasing-Power Parity

Abstract: This paper investigates purchasing-power parity (PPP) since the late nineteenth century. I collected data for a group of twenty countries over 100 years, a larger historical panel of annual data than has ever been studied. The evidence for long-run PPP is favorable using recent multivariate and univariate tests of higher power. Residual variance analysis shows that episodes of floating exchange rates have generally been associated with larger deviations from PPP, as expected; this result is not attributable to significantly greater persistence (longer half-lives) of deviations in such regimes, but is due to the larger shocks to the real exchange rate process in such episodes. In the course of the twentieth century, there was relatively little change in the capacity of international market integration to smooth out real exchange rate shocks. Instead, changes in the size of shocks depended on the political economy of monetary and exchange rate regime choice under the constraints imposed by the trilemma.

Exchange Rate, Equity Prices and Capital Flows

Abstract: We develop an equilibrium model in which exchange rates, stock prices and capital flows are jointly determined under incomplete forex risk trading. Incomplete hedging of forex risk, documented for U.S. global mutual funds, has three important implications: 1) exchange rates are almost as volatile as equity prices when the forex liquidity supply is not infinitely price elastic; 2) higher returns in the home equity market relative to the foreign equity market are associated with a home currency depreciation; 3) net equity flows into the foreign market are positively correlated with a foreign currency appreciation. The model predictions are strongly supported at daily, monthly and quarterly frequencies for 17 OECD countries vis-...-vis the U.S. Moreover, correlations are strongest after 1990 and for countries with higher market capitalization relative to GDP, suggesting that the observed exchange rate dynamics is indeed related to equity market development.

Pass-through and Exposure

Abstract: Firms differ in the extent to which they “pass through” changes in exchange rates into foreign currency prices and in their “exposure” to exchange rates—the responsiveness of their profits to changes in exchange rates. Because pricing affects profitability, a firm’s pass-through and exposure should be related. This paper develops models of exporting firms under imperfect competition to study these related phenomena. From these models we derive the optimal pass-through decisions and the resulting exchange rate exposure. The models are estimated on eight Japanese export industries using both the price data pass-through and financial data for exposure. EXCHANGE RATES CAN HAVE A MAJOR inf luence on the pricing behavior and profitability of exporting and importing firms. Firms differ in the extent to which they “pass through” the change in exchange rates into the prices they charge in foreign markets. They also differ in their “exposure” to exchange rates— the responsiveness of their profits to changes in exchange rates. Previous papers have studied either pass-through or exposure, but none has studied these two phenomena together. Yet, because pricing directly affects profitability, the exposure of a firm’s profits to exchange rates should be governed by many of the same firm and industry characteristics that determine pricing behavior. This paper develops models of firm and industry behavior that are used to study these closely related phenomena together. It also provides estimates of pass-through and exposure behavior using data from Japanese export industries. To examine pass-through behavior and exchange rate exposure, we model a firm with sales to a foreign export market. This exporting firm competes with a foreign firm in that export market. The costs of the exporting firm are based primarily in the local ~domestic! currency, while the foreign firm

Openness, imperfect exchange rate pass-through and monetary policy. NBB Working Paper Nr. 19

Abstract: This paper analyses the implications of imperfect exchange rate passthrough for optimal monetary policy in a linearised open-economy dynamic general equilibrium model calibrated to euro area data. Imperfect exchange rate pass through is modelled by assuming sticky import price behaviour. The degree of domestic and import price stickiness is estimated by reproducing the empirical identified impulse response of a monetary policy and exchange rate shock conditional on the response of output, net trade and the exchange rate. It is shown that a central bank that wants to minimise the resource costs of staggered price setting will aim at minimising a weighted average of domestic and import price inflation.

The modern history of exchange rate arrangements: A reinterpretation

Abstract: We develop a novel system of re-classifying historical exchange rate regimes One difference between our study and previous classification efforts is that we employ an extensive data base on market-determined parallel exchange rates Our 'natural' classification algorithm leads to a stark reassessment of the post-war history of exchange rate arrangements When the official categorization is a form of peg, roughly half the time our classification reveals the true underlying monetary regime to be something radically different, often a variant of a float Conversely, when official classification is floating, our scheme routinely suggests that the reality was a form of de facto peg Our new classification scheme points to a complete rethinking of economic performance under alternative exchange rate regimes Indeed, the breakup of Bretton Woods had a far less dramatic impact on most exchange rate regimes than is popularly believed Also, contrary to an influential empirical literature, our evidence suggests that exchange rate arraignments may be quite important for growth, trade and inflation Our newly compiled monthly data set on market-determined exchange rates goes back to 1946 for 153 countries

Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?

Abstract: Exchange rate regime optimality, as well as monetary policy effectiveness, depends on the tightness of the link between exchange rate movements and import prices. Recent debates hinge on whether producer-currency-pricing (PCP) or local currency pricing (LCP) of imports is more prevalent, and on whether exchange rate passthrough rates are endogenous to a country’s macroeconomic conditions. We provide cross-country and time series evidence on both of these issues for the imports of twenty-five OECD countries. Across the OECD and especially within manufacturing industries, there is compelling evidence of partial pass-through in the short-run– rejecting both PCP and LCP. Over the long run, PCP is more prevalent for many types of imported goods. Higher inflation and exchange rate volatility are weakly associated with higher pass-through of exchange rates into import prices. However, for OECD countries, the most important determinants of changes in pass-through over time are microeconomic and relate to the industry composition of a country’s import bundle.

Exchange Rate Pass-Through, Exchange Rate Volatility, and Exchange Rate Disconnect

Abstract: This paper explores the hypothesis that high volatility of real and nominal exchange rates may be due to the fact that local currency pricing eliminates the pass-through from changes in exchange rates to consumer prices. Exchange rates may be highly volatile because in a sense they have little effect on macroeconomic variables. The paper shows the ingredients necessary to construct such an explanation for exchange rate volatility. In addition to the presence of local currency pricing, we need a) incomplete international financial markets, b) a structure of international pricing and product distribution such that wealth effects of exchange rate changes are minimized, and c) stochastic deviations from uncovered interest rate parity. Together, it is shown that these elements can produce exchange rate volatility that is much higher than shocks to economic fundamentals, and `disconnected' from the rest of the economy in the sense that the volatility of all other macroeconomic aggregates are of the same order as that of fundamentals.

Noise Trading and Exchange Rate Regimes

Abstract: Policy-makers often justify their choice of fixed exchange rate regimes as a shelter against nonfundamental influences in the foreign exchange market. This paper proposes a framework, based on endogenous noise trading, which makes sense of the policy-makers' view. We show that as a result of multiple equilibria, the model violates Mundell's "Incompatible Trinity:" under some conditions, it is possible to reduce the volatility of the exchange rate without any sacrifice in terms of monetary autonomy. We provide empirical evidence supportive of the existence of a nonfundamental channel in the link between exchange rate regimes and exchange rate volatility. If … markets come to believe exchange rate stability is not itself a significant policy objective, we should not be surprised that snowballing cumulative movements can develop that appear widely out of keeping with current balance-of-payments prospects or domestic price movements. At that point, freely floating exchange rates, instead of delivering on the promise of money autonomy for domestic monetary or other policies, can greatly complicate domestic economic management [Paul Volcker 1978–79, p. 9].

Political System Transparency and Monetary Commitment Regimes

Abstract: Central bank independence (CBI) and fixed exchange rates are alternative monetary commitments that differ in transparency. While CBI is opaque and difficult to monitor, a commitment to a fixed exchange rate is easily observed. Political systems also vary in terms of transparency. I argue that the transparency of monetary commitments and the transparency of political systems are substitutes. Where political decision making is opaque (autocracies), governments must look to a commitment that is more transparent and constrained (fixed exchange rates) than the government itself. The transparency of the monetary commitment substitutes for the transparency of the political system to engender low inflation. Where the political process is transparent (democracies), a formal commitment to CBI can produce lower inflation because private agents and the political opposition are free to detect and punish government interference with the central bank. Statistical results indicate that (1) autocracies are more likely to adopt exchange-rate pegs than democracies, and (2) CBI is effective in limiting inflation in nations with high levels of political transparency.

Openness, Imperfect Exchange Rate Pass-Through and Monetary Policy

Abstract: This paper analyses the implications of imperfect exchange rate pass-through for optimal monetary policy in a linearised open-economy dynamic general equilibrium model calibrated to euro area data Imperfect exchange rate pass through is modelled by assuming sticky import price behaviour The degree of domestic and import price stickiness is estimated by reproducing the empirical identified impulse response of a monetary policy and exchange rate shock conditional on the response of output, net trade and the exchange rate It is shown that a central bank that wants to minimise the resource costs of staggered price setting will aim at minimising a weighted average of domestic and import price inflation

Modern Hyper- and High Inflations

Abstract: Since 1947, hyperinflations (by Cagan's definition) in market economies have been rare. Much more common have been longer inflationary processes with inflation rates above 100 percent per annum. Based on a sample of 133 countries, and using the 100 percent threshold as the basis for a definition of very high inflation episodes, this paper examines the main characteristics of such inflations. Among other things, we find that (i) close to 20 percent of countries have experienced inflation above 100 percent per annum; (ii) higher inflation tends to be more unstable; (iii) in high inflation countries, the relationship between the fiscal balance and seigniorage is strong both in the short and long-run; (iv) inflation inertia decreases as average inflation rises; (v) high inflation is associated with poor macroeconomic performance; and (vi) stabilizations from high inflation that rely on the exchange rate as the nominal anchor are expansionary.

Preventing Currency Crises in Emerging Markets

Abstract: Economists and policymakers are still trying to understand the lessons of recent financial crises in emerging markets. In this volume, academics, public officials and economists explore the causes of and effective policy responses to international currency crises. Topics covered include exchange rate regimes, contagion, the current account of the balance of payments, the role of private sector investors and of speculators, the reaction of the official sector, capital controls, bank supervision and weaknesses, and the roles of cronyism, corruption and large players.

Real Exchange Rate Volatility and Economic Openness: Theory and Evidence

Abstract: This paper relates the volatility of the trade-weighted effective real exchange rate to the degree of trade openness of an economy. The theoretical part presents an intertemporal monetary model of a small open economy with nominal rigidities. Both monetary and aggregate supply shocks are shown to produce (ceteris paribus) smaller real exchange rate movements if the country is more open to foreign trade. Empirical evidence on a cross section of forty-eight countries confirms this relationship: Differences in trade openness explain a large part of the cross-country variation in the volatility of the effective real exchange rate.

Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina's Lessons

Abstract: This paper offers an alternative explanation for t he fall of Argentina's Convertibility Program based on the country's vulnerability to Sudden Stops in capital flows. Sudden Stops are typically accompanied by a substantial increase in the real exchange rate that wreaks havoc in countries that are heavily dollarized in their liabilities, turning otherwise sustainable fiscal and corporate sector positions into unsustainable ones. In particular, we stress that the required change in relative prices is larger the more closed an economy is in terms of its sup ply of tradable goods. By contrasting Argentina's performance relative to other Latin American countries that were also subject to the Sudden Stop triggered by the Russian crisis of 1998, we identify key vulnerability indicators that separated Argentina from its peers. This document also provides an explanation for the political maelstrom that ensued after the Sudden Stop, based on a War of Attrition argument related to the wealth redistribution conflict triggered by the Sudden Stop and fiscal collapse. This framework also provides elements to rationalize the banking crisis that accompanied the fall of Convertibility.

The Effect of Mandated Market Risk Disclosures on Trading Volume Sensitivity to Interest Rate, Exchange Rate, and Commodity Price Movements

Abstract: We hypothesize that firms' 10‐K market risk disclosures, recently mandated by SEC Financial Reporting Release No. 48 (FRR No. 48), reduce investors' uncertainty and diversity of opinion about the implications, for firm value, of changes in interest rates, foreign currency exchange rates, and commodity prices. We argue that this reduced uncertainty and diversity of opinion should dampen trading volume sensitivity to changes in these underlying market rates or prices. Consistent with this hypothesis, we find that after firms disclose FRR No. 48‐mandated information about their exposures to interest rates, foreign currency exchange rates, and energy prices, trading volume sensitivity to changes in these underlying market rates and prices declines, even after controlling for other factors associated with trading volume. The observed declines in trading volume sensitivity are consistent with FRR No. 48 market risk disclosures providing useful information to investors.

Exchange Rate Uncertainty and Agricultural Trade

Abstract: Using a sample of bilateral trade flows across ten developed countries between 1974 and 1995, this article explores the effect of exchange rate uncertainty on the growth of agricultural trade as compared to other sectors. Based on a gravity model that controls for other factors likely to determine bilateral trade, the results show that real exchange rate uncertainty has had a significant negative effect on agricultural trade over this period. Moreover, the negative impact of uncertainty on agricultural trade has been more significant compared to other sectors.

The Evolution of Exchange Rate Regimes Since 1990 Evidence from De Facto Policies

Abstract: This paper presents a monthly database on de facto exchange rate regimes that covers all IMF members since 1990. Information from IMF country reports and other sources, including exchange rate data, is utilized to determine de facto exchange rate policies. Countries are categorized based on these policies using the IMF nomenclature adopted in 1999. This approach ensures the forward compatibility of the database. The database is then used to examine whether the bipolar view of exchange regimes holds with de facto regimes. It is found that the proportion of countries adopting intermediate regimes has indeed been shrinking in favor of greater flexibility or greater fixity, especially for countries more integrated with international markets. Analyses based on Markov chains of regime transitions, however, provide (mixed) evidence against the bipolar view.