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on International Finance |
| By: | Sebastian Edwards; Roberto Rigobon |
| Abstract: | We use high frequency data and a new econometric methodology to evaluate the effectiveness of controls on capital inflows. We focus on Chile's experience during the 1990s and investigate whether controls on capital inflows reduced Chile's vulnerability to external shocks. We recognize that changes in the controls will affect the way in which different macro variables relate to each other. We take this problem seriously, and we develop a methodology to deal explicitly with it. The main findings may be summarized as follows: (a) A tightening of capital controls on inflows depreciates the exchange rate. (b) We find that the "vulnerability" of the nominal exchange rate to external factors decreases with a tightening of the capital controls. And (c), we find that a tightening of capital controls increases the unconditional volatility of the exchange rate, but makes this volatility less sensitive to external shocks. |
| JEL: | F30 F32 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11434&r=ifn |
| By: | Federico Ravenna (Economics Department, University of California) |
| Abstract: | We show that the credibility gain from permanently committing to a fixed exchange rate by joining the European Monetary Union can outweigh the loss from giving up independent monetary policy if the domestic monetary authority does not enjoy full credibility. Using a DSGE model, this paper shows that when the central bank enjoys only limited credibility a pegged exchange rate regime yields a lower loss compared to an inflation targeting policy, even if this policy ranking would be reversed in a full-credibility environment. There exists an initial stock of credibility that must be achieved for a policy-maker to adopt inflation targeting over a strict exchange rate targeting regime. Full credibility is not a precondition, but exposure to foreign and financial shocks and high steady state inflation make joining the EMU relatively more attractive for a given level of credibility. The theoretical results are consistent with empirical evidence we provide on the relationship between credibility and monetary regimes using a Bank of England survey of 81 central banks. |
| Keywords: | Inflation targeting, Credibilty, Open Economy, Exchange Rate Regimes, Monetary Policy |
| JEL: | E52 E31 F02 F41 |
| Date: | 2005–05–12 |
| URL: | http://d.repec.org/n?u=RePEc:onb:oenbwp:98&r=ifn |
| By: | Sebastian Edwards |
| Abstract: | In this paper I analyze the role of foreign advisors in stabilization programs. I discuss from an analytical perspective why foreigners may help a developing country's government put in place a successful stabilization program. This framework is used to analyze Chile's experience with anti-inflationary policies in the mid 1950s. In 1955-58 Chile implemented a stabilization package with the advice of the U.S. consulting firm of Klein-Saks. The Klein-Saks program took place in a period of acute political confrontation. After what was considered to be an initial success -- inflation declined from 85% in 1955 to 17% in 1957 -- the program failed to achieve durable price stability. I argue that the foreign advisors of the Klein-Saks Mission gave initial credibility to the stabilization program launched in 1955. But providing initial credibility was not enough to ensure success. Congress failed to act decisively on the fiscal front. Consequently the fiscal imbalances that had plagued Chile for a long time were reduced, but not eliminated. I present empirical results on the evolution of inflation, exchange rates and interest rates that support my historical analysis. |
| JEL: | F30 F32 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11429&r=ifn |
| By: | Rangan Gupta (University of Connecticut) |
| Abstract: | The paper develops a standard neoclassical growth model in an overlapping generations framework of a financially repressed small open economy, and analyzes the effects of financial liberalization on steady-state capital stock. Repression is severe "enough" to generate an unofficial money market. The economy is also characterized by capital controls and crawling peg exchange rate regime. The following observations are made: Deregulation of interest rate reduces the steady-state stock of capital, while reduction in the multiple reserve requirements and increases in the rate of crawling, enhances it. The paper thus advocates financial liberalization policies to be oriented towards reduction of reserve requirements rather than interest rate deregulation. |
| Keywords: | Financial Repression; Capital Stock and Investment; Uno±cial Financial Markets. |
| JEL: | E22 E44 E52 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:uct:uconnp:2005-20&r=ifn |
| By: | Esteban Gómez; Diego Vásquez; Camilo Zea |
| Abstract: | Derivatives are contingent claims that complete financial markets. Their use allow agents and firms to ameliorate the impact over consumption, production and investment given a change in relative prices induced by an active monetary policy. In this sense, derivatives generate in some cases a loss in the effectiveness of the traditional monetary transmission channels in the short run, and in others, they promote an increase in the speed of transmission itself. Using an investment model, the impact of the use of interest rate and exchange rate derivatives in the dilution of colombian monetary channels is verified. Empirical exercises suggest that monetary policy has lost effectiveness in the short run. In spite of the surprise this result may offer given the relative immatureness of domestic derivative markets, the marginal effect of these instruments appears to be significant, in the face of local financial markets' imperfections. In addition, not only the hedge directly taken by firms with access to this instruments matter; there could be hedging spill- overs whenever commercial banks use derivatives, which allow for a more stable and cheap credit supply for firms with no access to those markets. The natural recommendation deriving from this conclusion suggests an urgent analysis of the derivatives impact over the speed of monetary transmission in Colombia. |
| Keywords: | Derivatives; |
| JEL: | E22 |
| Date: | 2005–05–31 |
| URL: | http://d.repec.org/n?u=RePEc:col:000070:001001&r=ifn |
| By: | Jönsson, Kristian (Research Department, Central Bank of Sweden) |
| Abstract: | Two-sector models with traded and non-traded goods have problems accounting for the stylized fact that the real exchange rate appreciates and consumption booms for several years following trade liberalization, or exchange-rate-based stabilization programs, in small open economies. The paper studies three potential solutions to this ‘price-consumption puzzle’ and evaluates their quantitative importance in calibrated simulations of Spain’s accession to the European Community in 1986. Extending the standard two-sector framework, the paper investigates the effects of relative productivity growth in the traded sector along the lines of Balassa-Samuelson, of time-to-build, and of habit formation in preferences. In contrast to previous studies, we find that habit formation on its own does not enable the model to account for the observed real exchange rate and consumption dynamics. The analysis shows that a calibrated version of the model augmented with all three mechanisms can account for much of the price-consumption dynamics after trade liberalization, without losing explanatory power for other real variables in the Spanish economy after 1986. |
| Keywords: | Non-traded goods; Balassa-Samuelsson; Time-to-build; Habit formation; Dynamic general equilibrium |
| JEL: | C68 F41 |
| Date: | 2005–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0187&r=ifn |
| By: | Anna Pavlova; Roberto Rigobon |
| Abstract: | This paper examines the co-movement among stock market prices and exchange rates within a three-country Center-Periphery dynamic equilibrium model in which agents in the Center country face portfolio constraints. In our model, international transmission occurs through the terms of trade, through the common discount factor for cash flows, and, finally, through an additional channel reflecting the tightness of the portfolio constraints. Portfolio constraints are shown to generate endogenous wealth transfers to or from the Periphery countries. These implicit transfers are responsible for creating contagion among the terms of trade of the Periphery countries, as well as their stock market prices. Under a portfolio constraint limiting investment of the Center country in the stock markets of the Periphery, stock prices also exhibit a flight to quality: a negative shock to one of the Periphery countries depresses stock prices throughout the Periphery, while boosting the stock market in the Center. |
| JEL: | G12 G15 F31 F36 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11440&r=ifn |
| By: | Efrem Castelnuovo (University of Padua) |
| Abstract: | In this paper we assess the stability of open economy backward-looking Phillips curves estimated over two different exchange rate regimes. The pseudo-data employed in our econometric exercise come from the simulation of a New-Keynesian hybrid model suited for performing monetary policy analysis. Two main results arise: i) in most of the simulated scenarios the estimated reduced-form Phillips curves turn out to be unstable. However, if the structural new-keynesian model is predominantly - even if not fully - backward-looking, the estimated reduced-form parameters are stable; ii) the Chow-breakpoint test tends to underestimate the importance of regime-shifts in small samples. |
| Keywords: | Lucas Critique, forwardness, backward looking Phillips curves, exchange rates, Chow test. |
| JEL: | E17 E52 F41 |
| Date: | 2005–06–28 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0506017&r=ifn |
| By: | Mohamed Ben Abdallah (TEAM); Iuliana Matei (TEAM) |
| Abstract: | The aim of this paper is to test empirically the impact of the contagion effect on the credibility of the exchange rate during the international financial crises between 1997 and 2001 for five CEECs : Hungary, Poland, Czech Republic, Slovakia and Russia. We find that : (1) the contagion effect is an important factor in order to determine the exchange rate ; (ii) the linkages between anticipations of devaluation and the economic fundamentals depends on the currency considered. The low number of the independent variables shows the difficulties to measure the determinants of the operators behaviour. The increase of the volatility expectations seems to be justified by a sudden return of the markets because of the contagion effect. Our results emphasize also that the Russian crisis had more impact on the economies of these countries, fact that confirms the regional character of the crisis. |
| Keywords: | Contagion, exchange rate credibility, CEECs. |
| JEL: | F30 F40 G10 |
| Date: | 2005–05 |
| URL: | http://d.repec.org/n?u=RePEc:mse:wpsorb:bla05044&r=ifn |