nep-ifn New Economics Papers
on International Finance
Issue of 2005‒05‒07
thirteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Is the Proposed East African Monetary Union an Optimal Currency Area? A Structural Vector Autoregression Analysis By Steven K. Buigut; Neven Valev
  2. Beliefs about Exchange-Rate Stability: Survey Evidence from the Currency Board in Bulgaria By Neven T. Valev; John A. Carlson
  3. Exchange Rate Pass-Through Effects: A Disaggregate Analysis of Colombian Imports of Manufactured Goods By Hernán Rincón; Edgar Caicedo; Norberto Rodríguez
  4. Were Verbal Efforts to Support the Euro Effective? A High-Frequency Analysis of ECB Statements By David-Jan Jansen; Jakob de Haan
  5. Adjustment to the Asymmetric Shocks and Currency Unions: the Case of Belarus and Russia By Charnavoki Valery
  6. Robust Monetary Policy in a Small Open Economy By Kai Leitemo; Ulf Söderstrom
  7. On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate By Jeffrey Frankel
  8. The Impact of Monetary Policy on the Exchange Rate: A Study Using Intraday Data By Jonathan Kearns; Phil Manners
  9. Third-Currency Effects in a Tri-Polar Model of Foreign Exchange By Martin Melecky
  10. The Revived Bretton Woods System seen from the Benches - Lessons for Europe from a Three-Asset-Portfolio Model By Sebastian Dullien
  11. International Financial Adjustment By Pierre-Olivier Gourinchas; Hélène Rey
  12. Exchange Rate Determination from Monetary Fundamentals: an Aggregation Theoretic Approach By William Barnett; Chang Ho Kwag
  13. Don’t Frighten the Horses – the Political Economy of Singapore’s Foreign Exchange Rate Regime since 1981 By Peter Wilson; Gavin Peebles

  1. By: Steven K. Buigut; Neven Valev (Andrew Young School of Policy Studies, Georgia State University)
    Abstract: The treaty of 1999 to revive the defunct East African Community (EAC) ratified by Kenya, Uganda, and Tanzania came into force on July 2000 with the objective of fostering a closer co-operation in political, economic, social, and cultural fields. To achieve this, an East Africa Customs Union protocol was signed in March 2004. A Common Market, a Monetary Union, and ultimately a Political Federation of East Africa states is planned. Though the question of a monetary union has been discussed in the political arena there has been no corresponding empirical study on the economic viability of such a union. This article fills the gap and assesses whether the political force driving the EAC towards a monetary union has economic basis. In particular, we focus on the symmetry of the underlying shocks across the East African economies as a precondition for forming an optimum currency area (OCA). As Mundell (1961) and McKinnon (1963) describe, the member countries of a monetary union do not have independent monetary policy, which differs from that of the union as a whole; governments cannot use monetary and exchange rate policies to react to a country-specific shock. How serious this limitation is for the union countries depends on the degree of asymmetry of shocks and the speed with which the economies adjust to these shocks. If disturbances are distributed symmetrically across union countries, a common response will suffice. If, however, the countries face mostly asymmetric shocks, the retention of policy autonomy is beneficial.
    Keywords: East African, Monetary Union, Optimal Currency Area, Structural Vector Autoregression Analysis
    Date: 2004–09–01
  2. By: Neven T. Valev (Andrew Young School of Policy Studies, Georgia State University); 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
    Date: 2004–11–01
  3. By: Hernán Rincón; Edgar Caicedo; Norberto Rodríguez
    Abstract: Colombian monthly data covering the period from 1995:01 to 2002:11 and ECM, fixed and time-varying parameters and Kalman filter techniques are used in this paper to quantify the exchange rate pass-through effects on import prices within a sample of manufactured imports. Also, whether the foreign exchange and inflation regimes affect the degree of pass-through is evaluated. The analytical framework used was a mark-up model. The main finding is that the long-run pass-through elasticities for the industries in the sample are stable and go from 0.1 to 0.8 and the short-run ones are unstable and go from 0.1 to 0.7, supporting mark-up hypotheses, in contrast to the hypotheses of perfect market competition and complete pass-through. The findings also show evidence of the variability and different degrees of pass-trough among manufacturing sectors, which confirm the importance of using dynamic models and disaggregate data for an analysis of the pass-through. Both, the hypothesis that under a floating regime there is a low degree of pass-through and the hypothesis that a low inflation environment has the same result are not supported.
    Keywords: Pass-through effects; PPP;Imperfect competition;Floating regime;Low inflation environment;Fixed parameter model; Time-varying parameter model; Kalman filtering.
    JEL: F31 F41 E31 E52 C32 C51 C52
  4. By: David-Jan Jansen; Jakob de Haan
    Abstract: This paper studies the effects of verbal interventions by European cen-tral bankers on high-frequency euro-dollar exchange rates. We find that ECB verbal interventions have had only small and short-lived effects. Ver- bal interventions which are reported in news report headlines are more likely to be successful, whereas verbal interventions on days with releases of macroeconomic data are less successful. There is no difference in the effects of comments by members of the ECB Executive Board and presi- dents of national central banks.
    Keywords: verbal intervention; high-frequency exchange rates; European Central Bank; sign test
    JEL: E58 F31 C14
    Date: 2005–04
  5. By: Charnavoki Valery
    Abstract: The paper analyzes mechanism of adjustment to the asymmetric shocks in terms of trade in possible currency union of Belarus and Russia. It is emphasized the role of real exchange rate in this process. An empirical analysis based on panel data confirms the asymmetric effect of fuel price changes on the equilibrium real exchange rate in two countries. At the same time, according to our estimates, real exchange rate changes affect significantly real output and its structure in Belarus. On the base of analysis provided, conclusion is made about necessity to create a fiscal stabilization mechanism which would allow to smooth negative effect of asymmetric shocks on Belarusian economy under currency union.
    Keywords: Belarus, Russia, currency union, asymmetric shocks, terms of trade, real exchange rate.
    JEL: C23 E42 F31 F33
    Date: 2005–05–04
  6. By: Kai Leitemo; Ulf Söderstrom
    Abstract: This paper studies how a central bank’s preference for robustness against model misspecification affects the design of monetary policy in a New-Keynesian model of a small open economy. Due to the simple model structure, we are able to solve analytically for the optimal robust policy rule, and we separately analyze the effects of robustness against misspecification concerning the determination of inflation, output and the exchange rate. We show that an increased central bank preference for robustness makes monetary policy respond more aggressively or more cautiously to shocks, depending on the type of shock and the source of misspecification.
  7. By: Jeffrey Frankel
    Abstract: Fixed and flexible exchange rates each have advantages, and a country has the right to choose the regime suited to its circumstances. Nevertheless, several arguments support the view that the de facto dollar peg may now have outlived its usefulness for China. (1) China's economy is on the overheating side of internal balance, and appreciation would help easy inflationary pressure. (2) Although foreign exchange reserves are a useful shield against currency crises, by now China's current level is fully adequate, and US treasury securities do not pay a high return. (3) It becomes increasingly difficult to sterilize the inflow over time, exacerbating inflation. (4) Although external balance could be achieved by expenditure reduction, e.g., by raising interest rates, the existence of two policy goals (external balance and internal balance) in general requires the use of two independent policy instruments (e.g., the real exchange rate and the interest rate). (5) A large economy like China can achieve adjustment in the real exchange rate via flexibility in the nominal exchange rate more easily than via price flexibility. (6) The experience of other emerging markets points toward exiting from a peg when times are good and the currency is strong, rather than waiting until times are bad and the currency is under attack. (7) From a longer-run perspective, prices of goods and services in China are low -- not just low relative to the United States (.23), but also low by the standards of a Balassa-Samuelson relationship estimated across countries (which predicts .36). In this specific sense, the yuan was undervalued by approximately 35% in 2000, and is by at least as much today. The paper finds that, typically across countries, such gaps are corrected halfway, on average, over the subsequent decade. These seven arguments for increased exchange rate flexibility need not imply a free float. China is a good counter-example to the popular "corners hypothesis" prohibition on intermediate exchange rate regimes.
    JEL: F0
    Date: 2005–04
  8. By: Jonathan Kearns (Reserve Bank of Australia); Phil Manners (Reserve Bank of Australia)
    Abstract: This paper uses intraday data to estimate the effect of changes in monetary policy on the exchange rate. We use an event study with carefully selected sample periods for four countries (Australia, Canada, New Zealand and the United Kingdom) to ensure that the change in monetary policy is exogenous to the exchange rate. Intraday data allow us to use a short event window, which improves the accuracy of estimates, and demonstrates that the change in policy is rapidly incorporated into the exchange rate. On average, an unanticipated tightening of 25 basis points is found to appreciate the exchange rate by around 0.35 per cent, with estimates for the individual countries ranging from ¼–½ of a per cent. The estimation indicates that monetary policy changes account for only a small part of the observed variability of exchange rates in these countries. We also find that changes in monetary policy have substantially different effects on the exchange rate depending on how they alter expectations regarding future policy. Surprises that cause expectations of future policy to be revised by the full amount of the surprise are found to have a larger impact on the exchange rate (around 0.4 per cent) than surprises that only bring forward an anticipated change in policy and do not change expectations of future policy (around 0.2 per cent).
    Keywords: exchange rates; monetary policy; intraday data
    JEL: F31 G14
    Date: 2005–04
  9. By: Martin Melecky (School of Economics, University of New South Wales)
    Abstract: This paper investigates possible contribution of third-currency effects to exchange rate movements. It reopens the subject of currency substitution and examines whether the third-currency effects change when the third-currency is a complement as opposed to when it is a substitute for currencies appearing in a bilateral exchange rate quote. The analysis and tests are carried out within a simple macro-econometric model with one common permanent component driving the system of bilateral exchange rates for the US dollar, the Japanese yen and the euro.
    Keywords: Exchange Rate Modeling, Currency Substitution, Third-currency Effects
    JEL: F31 F36 F42
    Date: 2005–04–29
  10. By: Sebastian Dullien (Financial Times Deutschland)
    Abstract: The paper develops a three-asset-portfolio model to analyse consequences of foreign exchange market operations by Asian central banks on the exchange rates between euro, dollar and yen. Both an analytical as well as a graphical solution is presented. It is found that -- contrary to public belief -- the purchase of dollar assets by Asian central banks strengthens the dollar against both euro and yen. A diversification of Asian central bank reserves from dollar into euro would weaken the dollar against both other currencies. Thus, such a diversification would be incompatible with Asian currency pegs. However, it is shown that Asian central banks could alter their relative portfolio composition while keeping the peg intact if they would shift from intervening against the dollar into intervening against the euro.
    Keywords: foreign exchange interventions, exchange rates, revived Bretton-Woods-System
    JEL: F31
    Date: 2005–05–05
  11. By: Pierre-Olivier Gourinchas (Economics Department, University of California, Berkeley); Hélène Rey (Department of Economics & Woodrow Wilson School,, Princeton University)
    Abstract: The paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country's net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.
    Keywords: Meese-Rogoff, external adjustment, net foreign assets, valuation effects, exchange rates
    JEL: F31 F32
    Date: 2005–05–05
  12. By: William Barnett (University of Kansas); Chang Ho Kwag (POSCO Research Institute)
    Abstract: We incorporate aggregation and index number theory into monetary models of exchange rate determination in a manner that is internally consistent with money market equilibrium. Divisia monetary aggregates and user-cost concepts are used for money supply and opportunity-cost variables in the monetary models. We estimate a flexible price monetary model, a sticky price monetary model, and the Hooper and Morton (1982) model for the US dollar/UK pound exchange rate. We compare forecast results using mean square error, direction of change, and Diebold-Mariano statistics. We find that models with Divisia indexes are better than the random walk assumption in explaining the exchange rate fluctuations. Our results are consistent with the relevant theory and the 'Barnett critique.'
    Keywords: Exchange rate, forecasts, vector error correction, aggregation theory, index number theory, Divisia index number
    JEL: E
    Date: 2005–05–05
  13. By: Peter Wilson (Department of Economics, National University of Singapore); Gavin Peebles
    Abstract: In this paper we explore the links between Singapore’s foreign exchange rate regime since 1981 and the broader aspects of its political economy. Singapore has been remarkably successful in achieving fast growth, low and stable price inflation and a strong external position. An important part of this strategy has been its managed floating exchange rate regime, which is generally regarded as being successful, but this needs to be viewed within the broader context of the government’s ‘pragmatic socialism’ to keep inflation low and stable as the bedrock for attracting inflows of mobile foreign capital to sustain long-run export competitiveness, and an economic strategy based on high levels of centralized saving and investment, a high degree of government involvement in the economy and the relentless accumulation of foreign exchange reserves. Indeed, part of the reason why managed floating has been successful in Singapore has been because the credibility of monetary policy has been enhanced through the government’s command over resources and its ability to respond quickly and flexibly to changes in economic circumstances using, where necessary, unorthodox policies of demand management to cut business costs. Exchange rate policy, therefore, becomes an integral part of the policy to redistribute income to capital to sustain employment and prevent mobile firms from leaving Singapore. By the early 1990s the imperative became to diversify the structure of the economy away from exclusive reliance on a predominantly foreign manufacturing base and to reduce the extent of government involvement in the economy and it became harder to justify high levels of centralized saving and investment. The dilemma is that the government is finding it difficult to extricate itself from the economy without compromising policy effectiveness, and there is little evidence that dependence of the economy on foreign capital and labour has diminished.
    Keywords: Exchange Rate, People’s Action Party, Political Economy, Singapore
    JEL: F4 O10 P16

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