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on International Finance |
| By: | Rasmus Fatum (University of Alberta; University of California, Santa Cruz); Michael Hutchison (University of California Santa Cruz Economics Department) |
| Abstract: | Japanese official intervention in the foreign exchange market is of by far the largest magnitude in the world, despite little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. This paper investigates the effectiveness of intervention using recently published official daily data and an event study methodology. The event study better fits the stochastic properties of intervention and exchange rate data, i.e. intense and sporadic bursts of intervention activity juxtaposed against a yen/dollar rate continuously changing, than standard time-series approaches. Focusing on daily Japanese and US official intervention operations, we identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run (less than one month). This result holds even when intervention is not associated with (simultaneous) interest rate changes, whether or not intervention is "secret" (in the sense of no official reports or rumors of intervention reported over the newswires), and against other robustness checks. Large-scale (amounts over $1 billion) intervention, coordinated with the Bank of Japan and the Federal Reserve working in unison, give the highest success rate. During the period that the Bank of Japan has reduced interbank rates to 0.5 percent and below (from September 1995), however, only one intervention operation has been coordinated with the Fed and the success rate has been correspondingly low. |
| Date: | 2003–11–24 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:scciec:1034&r=ifn |
| By: | Doireann Fitzgerald (University of California Santa Cruz Economics Dept.) |
| Abstract: | The empirical "gravity" equation is extremely successful in explaining bilateral trade. This paper shows how a multi-country model of specialization and costly trade (i.e. a microfounded gravity model) can be applied to explain empirical exchange rate puzzles. One such puzzle is the fact that nominal exchange rates are enormously volatile, but that this volatility does not appear to affect inflation. The gravity model is very successful in explaining this puzzle. In a sample of 25 OECD countries in the post- Bretton Woods period, the gravity prediction of inflation substantially outperforms the purchasing power parity prediction. The gravity prediction matches the volatility of actual inflation, and tracks its path closely. The superior performance of the gravity prediction is explained primarily by the fact that it takes account of the interaction of specialization with home bias. The stability of inflation in very open economies is explained in addition by the fact that the size of bilateral trade is negatively correlated with bilateral exchange rate volatility. |
| Keywords: | Exchange rate disconnect, Trade, Gravity equation, |
| Date: | 2004–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:scciec:1041&r=ifn |
| By: | Rasmus Fatum (University of Alberta; University of California, Santa Cruz); Michael King (Bank of Canada) |
| Abstract: | This paper contains an empirical analysis of high-frequency data on official Bank of Canada intervention and exchange rates (quoted at the end of every 5-minute interval over every 24-hour period). The data-set covers the January 1995 to September 1998 period and is of particular interest as it spans over two distinctly different intervention regimes one characterized by purely rules-based ("mechanistic") intervention versus one characterized by both rules-based and discretionary intervention. This unique feature of the data allows for a test of the hypothesis that discretionary intervention is more effective than rules-based intervention. Additionally, the paper introduces the issue of currency co-movements to the intervention literature. Employing an event-study methodology and different criteria for success, we find that intervention does not systematically affect movements in the CAD/USD or reduce realized price volatility. This is the case for both rules-based and discretionary intervention |
| Keywords: | Foreign Exchange Intervention; Intraday Data; Event Studies; Currency Co-movement, |
| Date: | 2004–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:scciec:1047&r=ifn |
| By: | Doireann Fitzgerald (University of California Santa Cruz Economics Dept.) |
| Abstract: | The empirical "gravity" equation is extremely successful in explaining bilateral trade. This paper shows how a multi-country model of specialization and costly trade (i.e. a microfounded gravity model) can be applied to explain empirical exchange rate puzzles. One such puzzle is the fact that nominal exchange rates are enormously volatile, but that this volatility does not appear to affect inflation. The gravity model is very successful in explaining this puzzle. In a sample of 25 OECD countries in the post- Bretton Woods period, the gravity prediction of inflation substantially outperforms the purchasing power parity prediction. The gravity prediction matches the volatility of actual inflation, and tracks its path closely. The superior performance of the gravity prediction is explained primarily by the fact that it takes account of the interaction of specialization with home bias. The stability of inflation in very open economies is explained in addition by the fact that the size of bilateral trade is negatively correlated with bilateral exchange rate volatility. |
| Keywords: | Exchange rate disconnect, Trade, Gravity equation, |
| Date: | 2004–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1003&r=ifn |
| By: | Rasmus Fatum (University of Alberta; University of California, Santa Cruz); Michael Hutchison (University of California Santa Cruz Economics Department) |
| Abstract: | Japanese official intervention in the foreign exchange market is of by far the largest magnitude in the world, despite little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. This paper investigates the effectiveness of intervention using recently published official daily data and an event study methodology. The event study better fits the stochastic properties of intervention and exchange rate data, i.e. intense and sporadic bursts of intervention activity juxtaposed against a yen/dollar rate continuously changing, than standard time-series approaches. Focusing on daily Japanese and US official intervention operations, we identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run (less than one month). This result holds even when intervention is not associated with (simultaneous) interest rate changes, whether or not intervention is "secret" (in the sense of no official reports or rumors of intervention reported over the newswires), and against other robustness checks. Large-scale (amounts over $1 billion) intervention, coordinated with the Bank of Japan and the Federal Reserve working in unison, give the highest success rate. During the period that the Bank of Japan has reduced interbank rates to 0.5 percent and below (from September 1995), however, only one intervention operation has been coordinated with the Fed and the success rate has been correspondingly low. |
| Date: | 2003–11–24 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1025&r=ifn |
| By: | Yin-Wong Cheung (University of California, Santa Cruz); Menzie Chinn (University of Wisconsin, Madison); Eiji Fujii (University of Tsukuba, Japan) |
| Abstract: | The linkages between the People's Republic of China and the other Chinese economies of Hong Kong and Taiwan are assessed, and compared against those with Japan and the US. We first characterize the time series behavior of three criteria of integration, namely real interest parity, uncovered interest parity, and relative purchasing power parity. There is evidence that these parity conditions tend to hold over longer periods between the People's Republic of China and all other economies, although they do not hold instantaneously. Overall, the magnitude of deviations from the parity conditions is shrinking over time. Amongst all, however, Hong Kong exhibits indications of a more advanced level of integration with the mainland. We also find that evidence is surprisingly positive for integration with the US. We then turn to examining the determinants of the degree of integration. Regression results suggest that the degrees of financial and integration depend upon the extent of capital controls, foreign direct investment linkages as well as exchange rate volatility. |
| Keywords: | uncovered interest parity, real interest parity, purchasing power parity, exchange rates, capital mobility, market integration, |
| Date: | 2003–06–16 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1032&r=ifn |
| By: | Yin-Wong Cheung (University of California, Santa Cruz); Menzie Chinn (University of Wisconsin, Madison); Antonio Garcia Pascual (International Monetary Fund) |
| Abstract: | Previous assessments of forecasting performance of exchange rate models have focused upon a narrow set of models typically of the 1970's vintage. The canonical papers in this literature are by Meese and Rogoff (1983, 1988), who examined monetary and portfolio balance models. Succeeding works by Mark (1995) and Chinn and Meese (1995) focused on similar models. In this paper we re-assess exchange rate prediction using a wider set of models that have been proposed in the last decade: interest rate parity, productivity based models, and a composite specification incorporating the real interest differential, portfolio balance and nontradables price channels. The performance of these models is compared against two reference specifications the purchasing power parity and the Dornbusch-Frankel sticky price monetary model. The models are estimated in error correction and first-difference specifications. Rather than estimating the cointegrating vector over the entire sample and treating it as part of the ex ante information set as is commonly done in the literature, we also update the cointegrating vector, thereby generating true ex ante forecasts. We examine model performance at various forecast horizons (1 quarter, 4 quarters, 20 quarters) using differing metrics (mean squared error, direction of change), as well as the "consistency" test of Cheung and Chinn (1998). No model consistently outperforms a random walk, by a mean squared error measure; however, along a direction-of-change dimension, certain structural models do outperform a random walk with statistical significance. Moreover, one finds that these forecasts are cointegrated with the actual values of exchange rates, although in a large number of cases, the elasticity of the forecasts with respect to the actual values is different from unity. Overall, model/specification/currency combinations that work well in one period will not necessarily work well in another period. |
| Keywords: | exchange rates, monetary model, productivity, interest rate parity, purchasing power parity, forecasting performance, |
| Date: | 2003–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1033&r=ifn |
| By: | Yin-Wong Cheung (University of California, Santa Cruz); Menzie Chinn (University of Wisconsin, Madison); Antonio Garcia Pascual (International Monetary Fund) |
| Abstract: | Previous assessments of nominal exchange rate determination have focused upon a narrow set of models typically of the 1970's vintage, including monetary and portfolio balance models. In this paper we re-assess the in-sample fit and out-of-sample prediction of a wider set of models that have been proposed in the last decade, namely interest rate parity, productivity based models, and "behavioral equilibrium exchange rate" models. These models are compared against a benchmark model, the Dornbusch-Frankel sticky price monetary model. First, the parameter estimates of the models are compared against the theoretically predicted values. Second, we conduct an extensive out-of-sample forecasting exercise, using the last eight years of data to determine whether our in-sample conclusions hold up. We examine model performance at various forecast horizons (1 quarter, 4 quarters, 20 quarters) using differing metrics (mean squared error, direction of change), as well as the "consistency" test of Cheung and Chinn (1998). We find that no model fits the data particularly well, nor does any model consistently out-predict a random walk, even at long horizons. There is little correspondence between how well a model conforms to theoretical priors and how well the model performs in a prediction context. However, we do confirm previous findings that out-performance of a random walk is more likely at long horizons. |
| Keywords: | exchange rates, monetary model, productivity, interest rate parity, behavioral equilibrium exchange rate model, forecasting performance, |
| Date: | 2003–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1034&r=ifn |
| By: | Yin-Wong Cheung (University of California, Santa Cruz); Menzie Chinn (University of Wisconsin, Madison); Eiji Fujii (University of Tsukuba, Japan) |
| Abstract: | The status of real and financial integration of China, Hong Kong, and Taiwan is investigated using monthly data on one-month interbank rates, exchange rates, and prices. Specifically, the degree of integration is assessed based on the empirical validity of real interest parity, uncovered interest parity, and relative purchasing power parity. There is evidence these parity conditions tend to hold over longer periods, although they do not hold instantaneously. Overall, the magnitude of deviations from the parity conditions is shrinking over time. In particular, China and Hong Kong appear to have experienced significant increases in integration during the sample period. It is also found that exchange rate variability plays a major role in determining the variability of deviations from these parity conditions. |
| Keywords: | uncovered interest parity, real interest parity, purchasing power parity, exchange rates, capital mobility, market integration, |
| Date: | 2003–10–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucscec:1039&r=ifn |
| By: | Inoue, Atsushi; Rossi, Barbara |
| Abstract: | This paper examines the major interest groups in the debate over allowing the wholesale re-importation of prescription drugs through the Pharmaceutical Market Access Act. By making use of the logit model, we see the effects that each of these groups has had on the voting behavior of the 108 th Congress on the bill. We find evidence suggesting that Representatives are maximizing their electoral prospects: Contributions from pharmaceutical manufacturers and HMOs significantly influence the probability of voting for the Bill. Similarly, Representatives are sensitive to their constituency’s interest: employment in pharmaceutical manufacturing and the presence of senior citizens are also taken into account. However, the decision was by and large a partisan one: Party affiliation was the most important factor in passing the Bill. |
| Keywords: | currency crises, forecasting, leading indicators, diffusion index, exchange rates |
| JEL: | F30 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:duk:dukeec:05-02&r=ifn |
| By: | Alexandre MINDA (LEREPS-GRES) |
| Abstract: | This paper will analyse the debate about official dollarization in Latin America. Because of the opportunity cost of dollarization, replacing a national currency by a foreign currency is a solution of last resort to the financial instability of emerging economies. To clarify the discussion, a taxonomy of dollarization regimes is drawn up in order to make an inventory of officially dollarized countries, territories and dependencies. The foundations for adopting complete dollarization are analysed through three elements : an account of the limits to corner solutions, the identification of the economic contexts which are favourable to the adoption of foreign currencies and the reasons behind the legitimacy crisis of national currencies. To determine what is at stake in such decisions, cost advantage analysis mentions, first of all, the expected benefits highlighted by the advocates of complete dollarization. A detailed study of its potential impact will then allow us to evaluate the induced costs of the disappearance of national currencies. Finally, by looking at emerging countries that have adopted this exchange regime, the limits of adopting such a solution are underlined, particularly by the fact that the disappearance of national currencies implies an abandonment of monetary sovereignty and a loss of a powerful symbol of national assertion and identity. |
| Keywords: | Dollarization, Latin America, exchange rate regime, monetary sovereignty |
| JEL: | E E F F |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:grs:wpegrs:2005-02&r=ifn |
| By: | Nelson C. Mark; |
| Abstract: | When central banks set nominal interest rates according to an interest rate reaction function, such as the Taylor rule, and the exchange rate is priced by uncovered interest parity, the real exchange rate is determined by expected inflation differentials and output gap differentials. In this paper I examine the implications of these Taylor-rule fundamentals for real exchange rate determination in an environment where market participants are ignorant of the numerical values of the model's coefficients but attempt to acquire that information using least-squares learning rules. I find evidence that this simple learning environment provides a plausible framework for understanding real dollar--DM exchange rate dynamics from 1976 to 2003. The least-squares learning path for the real exchange rate implied by inflation and output gap data exhibits the real depreciation of the 70s, the great appreciation (1979.4-1985.1) and the subsequent great depreciation (1985.2-1991.1) observed in the data. An emphasis on Taylor-rule fundamentals may provide a resolution to the exchange rate disconnect puzzle. |
| JEL: | F4 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11061&r=ifn |
| By: | Menzie D. Chinn; Guy Meredith |
| Abstract: | The hypothesis that interest rate differentials are unbiased predictors of future exchange rate movements has been almost universally rejected in empirical studies. In contrast to previous studies, which have used short-horizon data, we test this hypothesis using interest rates on longer-maturity bonds for the U.S., Germany, Japan and Canada. The results of these long-horizon regressions are much more positive %u2013 the coefficients on interest differentials are of the correct sign, and most are closer to the predicted value of unity than to zero. These results are robust to the use of different data frequencies, sample periods, yield definitions, and base currencies. We appeal to an econometric interpretation of the results, which focuses on the presence of simultaneity in a cointegration framework. |
| JEL: | F21 F31 F41 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11077&r=ifn |
| By: | Ozge Senay; Alan Sutherland |
| Abstract: | A dynamic general equilibrium model of a small open economy is presented where agents may choose the frequency of price changes. A fixed exchange rate is compared to inflation targeting and money targeting. A fixed rate generates more price flexibility than the other regimes when the expenditure switching effect is relatively weak, while money targeting generates more flexibility when the expenditure switching effect is strong. These endogenous changes in price flexibility can lead to changes in the welfare performance of regimes. But, for the model calibration considered here, the extra price flexibility generated by a peg does not compensate for the loss of monetary independence. Inflation targeting yields the highest welfare level despite generating the least price flexibility of the three regimes considered. |
| JEL: | E52 F41 F42 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11092&r=ifn |
| By: | Arslan Razmi (University of Massachusetts Amherst) |
| Abstract: | The effects of FDI inflows on the external accounts of developing economies have been largely ignored in recent years. This paper contributes to filling this gap by developing a formal framework. Our economy consists of; (1) a non-tradable goods sector, and (2) a tradable goods sector in the form of an export processing zone operated by transnational corporations. The effects on the balance of payments are shown to depend on several interesting factors. By attempting to shed light on how various actors are affected by policy choices, this study highlights the political economy considerations involved as policy makers pursue various goals. The results raise concerns regarding recent trends in investment liberalization. JEL Categories: F21, F23, F41 |
| Keywords: | Foreign direct investment, structuralist models, non-tradable goods, tradable goods, balance of payments, investment liberalization, export processing zones, wage suppression, performance requirements, distributional conflicts, real exchange rates. |
| Date: | 2005–03 |
| URL: | http://d.repec.org/n?u=RePEc:ums:papers:2005-03&r=ifn |