nep-ifn New Economics Papers
on International Finance
Issue of 2005‒03‒20
twelve papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rates and Asymmetric Shocks in Small Open Economies By Alexius, Annika; Post, Erik
  2. Monetary Policies and Fiscal Policies in Emerging Markets By Ugo Panizza
  3. What Drives Business Cycles in a SmallOpen Economy with a Fixed Exchange Rate? By Niels Arne Dam; Jesper Gregers Linaa
  4. On the Link between Exchange-Rate Regimes and Monetary-Policy Autonomy: The European Experience By Forssbaeck, Jens; Oxelheim, Lars
  5. The real picture: Industry specific exchange rates for the euro area By Simón Sosvilla-Rivero; Sonia Pangusión
  6. Structural Breaks in Volatility: Evidence from the OECD Real Exchange Rates By Amalia Morales-Zumaquero; Simon Sosvilla-Rivero
  7. Instability in Exchange Rates of the World Leading Currencies: Implications of a Spatial Competition Model among Central Banks By Dirk Engelmann; Jan Hanousek; Evzen Kocenda
  8. Beliefs about Exchange-Rate Stability: Survey Evidence From the Currency Board in Bulgaria By Neven T. Valev; John A. Carlson
  11. THE ROLE AND NATURE OF MARKET SENTIMENT IN THE 1992 ERM CRISIS By Oreste Napolitano; Alberto Montagnoli; Rosaria Rita Canale
  12. Stabilization via Currency Board By Jutta Maute

  1. By: Alexius, Annika (Department of Economics); Post, Erik (Department of Economics)
    Abstract: If floating exchange rates stabilize shocks rather than create shocks, a country that joins a monetary union or fixes its exchange rate looses a stabilizing mechanism. We use a first difference structural VAR on trade weighted macroeconomic data to study the role of floating exchange rates for five "small open economies" with inflation targets. By including both domestic and foreign variables and using a combination of long and short-run restrictions, we identify asymmetric shocks more carefully than previous studies. Only in Sweden and Canada does the nominal exchange rate appreciate significantly in response to asymmetric demand shocks and depreciate to asymmetric supply shocks. Most exchange rate movements are caused by speculation and are not responses to fundamental shocks. However, these exchange rate shocks have negligible effects on output and inflation. Our findings indicate that exchange rates are neither stabilizing nor destabilizing but may be loosely characterized as disconnected from the rest of the economy.
    Keywords: Exchange rates; asymmetric shocks; structural VAR
    JEL: F31
    Date: 2005–03–15
  2. By: Ugo Panizza (Research Department, Inter-American Development Bank)
    Abstract: This paper surveys possible monetary policy options for emerging market countries. As the paper does not seek to enter into the fix versus flex debate, it only considers monetary policy options for countries with a flexible exchange rate. After making the point that the conduct of monetary policy requires a nominal anchor and surveying different types of nominal anchors, the paper suggests that most academics and policymakers agree on the fact that inflation targeting should be the nominal anchor of choice. Hence, the paper describes the main characteristics of an inflation targeting regime and discusses its applicability to emerging market countries. Next, the paper recognizes the necessity of coordination between fiscal and monetary policy and points out that, in order to conduct countercyclical fiscal policies, emerging market countries need to build fiscal institutions that allow accumulating surpluses during periods of economic expansion. The paper concludes by studying the applicability of inflation targeting to Egypt and finds mixed support for this option.
    Keywords: Monetary Policy, Fiscal Policy, Inflation targeting, Egypt
    Date: 2004–12
  3. By: Niels Arne Dam (Institute of Economics, University of Copenhagen); Jesper Gregers Linaa (Institute of Economics, University of Copenhagen)
    Abstract: We decompose the Danish business cycle into ten structural shocks using an open-economy DSGE model with infrequent determination of prices and wages which we estimate with Bayesian techniques. Consistent with the Danish monetary policy regime, we formulate an imperfect peg on the foreign exchange rate and analyse the resulting monetary transmission mechanism. We find that the Danish business cycle is dominated by stochastic movements in the labour supply in the long term, while demand shocks play a major role in the short term. Remarkably, the role of technology is negligible, and foreign factors only contribute little to the Danish business cycle, especially in the long term. With respect to the estimation, we generally find believable estimates although the degree of price stickiness is remarkably high.
    Keywords: open economy, peg, business cycles, Bayesian estimation
    JEL: E3 E4 F4
    Date: 2005–03
  4. By: Forssbaeck, Jens (Institute of Economic Research); Oxelheim, Lars (The Research Institute of Industrial Economics)
    Abstract: We investigate monetary-policy autonomy under different exchange-rate regimes in small, open European economies during the 1980s and 1990s. We find no systematic link between ex post monetary-policy autonomy and exchange rate regimes. This result is enforced for countries/periods with alternative nominal targets. Our interpretation of the results is that over the medium and long term following an ‘independent’ target for monetary policy, which does not deviate much from the targets of those countries to which one is closely financially integrated, is as constraining as locking the exchange rate to some particular level
    Keywords: Exchange Rate Regimes; Monetary Policy Autonomy; Capital Mobility
    JEL: E42 E52 F41
    Date: 2005–03–15
  5. By: Simón Sosvilla-Rivero; Sonia Pangusión
    Abstract: The evolution of the exchange rate of the euro vis-à-vis the currencies of the trade partners have an effect on the Euro Area's industrial price indices and, therefore, in the economy as a whole. In general, when referring to the exchange rate as a variable that affects such indices and the competitiveness, the discussion is based upon the effective real exchange rate (i. e., the euro as an index weighted with the currencies of the Euro Area´s main trade partners, being the weights assigned to each currency the proportion of each trade partner on the total trade in the Euro Area). Nevertheless, the evolution of the exchange rate of the euro vis-à-vis the US dollar, the Japanese yen or the Chinese Yuan, to name a few, could have different effects on different products or industries, because the trade weight of USA, Japan or China also varies among products or industries. Therefore, although the importance of some countries in a specific industry could be very different to its wight in the aggregate index for the whole Euro Area, the effective exchange rater indices do not take into account such fact. The aim of this paper is to construct an industry-specific effective exchange rate aggregate that accounts for such differences, taking into account the main trade partners in each industry.
  6. By: Amalia Morales-Zumaquero; Simon Sosvilla-Rivero
    Abstract: This paper analyses whether volatility changes in the real exchange rates (RERs) of the OECD industrial countries are associated with a specific nominal exchange rate regime. To that end, we examine RER behaviour during the period 1960-2003, thereby covering both the Bretton Woods system of fixed exchange rates and the adoption of generalised floating exchange rates from 1973. We make use of an econometric methodology based on Hansen’s (1997) approximation to the p-values of the supreme, exponential and average statistics developed by Andrews (1993) and Andrews and Ploberger (1994). This methodology allows us to obtain a profile of p-values and to delimit periods of stability and instability in the variance of real exchange rates. For most countries in our sample, there is evidence in favour of the non-neutrality of the nominal exchange rate regime regarding real exchange rate volatility.
  7. By: Dirk Engelmann; Jan Hanousek; Evzen Kocenda
    Abstract: We use a spatial competition based model in a two-stage game setup to assess whether equilibrium in exchange rates among the leading currencies is attainable. We show that a stable equilibrium can be reached in the case of two leading currencies, but not in the case of three. In our model, central banks of leading currencies attract, through the workings of their objective and policy, small currencies that tie with leading currencies via exchange rate regimes. This can be thought of as a competition to link smaller currencies to a leading currency that is motivated by the fact that such a tie greatly reduces volatility within such an informal “currency area”. Our theoretical findings are supported by empirical evidence. Since firms, traders, and countries currently recognize three leading currencies and their economic behavior reflects this, we may expect disagreement on overvaluation or undervaluation of certain currencies to continue.
    Keywords: exchange rates, exchange rate regimes, central bank policy, monetary union, spatial competition
    JEL: C72 E42 E58 N20 O23
    Date: 2004–06–01
  8. By: Neven T. Valev; John A. Carlson
    Abstract: We use unique survey data from Bulgaria’s currency board to examine the reasons for persistent incomplete credibility of a financial stabilization regime. Although it produced remarkably positive effects in terms of sustained low inflation since 1997, the currency board has not achieved full credibility. This is not uncommon in other less-developed countries with fixed exchange rate regimes. Our results reveal that incomplete credibility is explained primarily by concerns about external economic shocks and the persistent high unemployment in the country. Past experiences with high inflation do not rank among the top reasons to expect financial instability in the future.
    Keywords: Credibility, Currency Boards, Financial Stabilization Programs
    JEL: E5 F3
    Date: 2004–06–01
  9. By: Sharon Eicher
    Abstract: Dollarization comes in several forms. The type that this paper examines is asset substitution, when savers hold dollar assets in bank accounts, instead of local currency. It is limited to the transition economy of Kazakhstan. This paper estimates demand for dollar accounts and shows that avoidance of inflation risk, rather than avoidance of exchange rate devaluation of savings, is the most important in explaining dollarization. This result is unexpected. This study examines data from Kazakhstan. Kazakhstan is seen as having a strong banking system and a healthy economy for a former Soviet Republic. It is seen as one of the most market-oriented, FSU countries. However, Kazakhstan also has a large demand for a means of storing savings in dollars, rather than in the local currency. This is particularly curious, when the local currency is appreciating relative to the U.S. dollar. This demand in less prosperous FSU countries is likely to be even greater. The paper combines data and statistical methods with anecdotal information in order to improve our understanding of a paradoxical occurrence.
    Date: 2004–05–01
  10. By: Guglielmo Maria Caporale; Mario Cerrato
    Abstract: This paper provides further empirical results on the relationship between black market and official exchange rates in six emerging economies (Iran, India, Indonesia, Korea, Pakistan, and Thailand). First, it applies both time series techniques and heterogeneous panel methods to test for the existence of a long-run relation between these two types of exchange rates. Second, it tests formally the validity of the proportionality restriction implying a constant black-market premium. Third, in addition to the long-run equilibrium, it also analyses the short-run dynamic responses of both markets to shocks. Evidence of market inefficiency and incomplete (or longlived) reversion to long-run equilibrium is found. This implies that financial managers can only partially reduce the exchange rate risk, whilst monetary authorities can effectively pursue their policy objectives by imposing foreign exchange or direct controls.
    Date: 2005–03
  11. By: Oreste Napolitano; Alberto Montagnoli; Rosaria Rita Canale
    Abstract: This paper attempts to explain the importance of the role of the speculators in determining the 1992 ERM crisis, and the effects that the policy of maintaining external parity had on internal growth. We focus on a different way through which expectations are formed about the macroeconomic fundamentals independently of the behaviour of the monetary policy. In the present model, agents’ rational beliefs do not emerge from arbitrary circumstances but only when the value of the exchange rate, kept under control by the central bank, did not correspond to the expected value and to the current wide-spread beliefs in the market.
  12. By: Jutta Maute (Universität Hohenheim)
    Abstract: The breakdown of the Argentine currency board in early 2002 produced a number of obituaries that often quite rashly declared the country’s monetary constitution since 1991 the main responsible for its recent near-catastrophic economic collapse. Contrary to such rather one-sided negative ascriptions to the currency board system, the intention of this paper is to give a comprehensive and balanced description of the currency board model in theory, as well as to name its functioning conditions under today’s economic and political conditions prevailing in developing and transforming countries. It will become clear that the success of a currency board in terms of lasting stabilization of an economy not only depends on its initial design (e.g. the choice of the anchor currency, of the exchange rate, the legal and institutional fixings) but also on an ongoing process of economic and institutional reform that extends from a general macroeconomic and especially public sector streamlining to banking sector reforms, product and labour market deregulation, and to a general realignment of the economy towards exportorientation and international competitiveness. The extent to which these reforms are tackled and completed decides over the degree to which the economy is able to absorb real shocks without incurring high economic and social adaptation costs, hence over the degree to which a country is able to benefit from the currency board’s strengths without falling victim to its potentially severe weaknesses. Along with some basic reflections about the concept and motivation of modern currency boards, sections 1-3 give a brief overview over the historical background of the currency board idea as well as of its implementation. Section 4 focuses on the constitutional elements of a currency board, while section 5 provides the core of the discussion of pros and cons of currency boards, depicting the system’s strengths and weaknesses as well as the conditions under which they materialize. Section 6 will discuss under which circumstances a currency board is a good choice for a country, and ask whether less strict stabilization policies might be able to deliver the hoped-for benefits less costly. Some problems related to the questions of duration and termination of currency boards are addressed in section 7. Finally, section 8 will give a brief exposition of the idea of dual currency boards as a theoretical extension of the currency board model which promises to eliminate one of the biggest immanent threats to a currency board.
    Keywords: New Economic Geography, Foreign Direct Investment, Multinational Enterprises
    JEL: E5

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