nep-ifn New Economics Papers
on International Finance
Issue of 2005‒07‒25
sixteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Relative Price Volatility Under Sudden Stops: The Relevance of Balance Sheet Effects By Guillermo A. Calvo; Alejandro Izquierdo; Rudy Loo-Kung
  3. Choice of Monetary and Exchange Regimes in ECOWAS: An Optimum Currency Area Analysis By Chantal Dupasquier; Patrick N. Osakwe; Shandre M. Thangavelu
  4. Estonian Inflation Model By Urmas Sepp; Andres Vesilind; Ülo Kaasik
  5. Assessment of the Euro\'s implications for European economic development By Iika Korhonen; Mare Randveer
  6. Equilibrium exchange rate of the Estonian kroon, its dynamics and impacts of deviations By Fabio Filipozzi
  7. Monetary transmission mechanism in Estonia - some theorethical considerations and stylized aspects By Raoul Lättemäe
  8. Monetary transmission mechanism in Estonia - empirical model By Rasmus Pikkani
  9. Accession to EMU and exchange rate policies in Central Europe - decision under institutional constraints By Andreas Freytag
  10. Integrated monetary and exchange rate frameworks: are there empirical differences? By Lucio Vinhas de Souza
  11. Aspects of the Sustainability of Estonian Currency Board Arrangement By Urmas Sepp; Martti Randveer
  12. Nominal and real convergence in Estonia: the Balassa-Samuelson (Dis)connection By Balàzs Ègert
  13. The relationship between REER and trade flows in the context of the equilibrium exchange rate By Reimo Juks
  14. Exchange rate pass-through to Estonian prices By Aurelijus Dabušinskas
  15. Estimating the equilibrium exchange rate of the Estonian kroon By Marit Hinnosaar; Hannes Kaadu; Lenno Uusküla
  16. Does the market pick up on the total value added to the peruvian companies by a devaluation of ... By EVA RAQUEL PORRAS

  1. By: Guillermo A. Calvo; Alejandro Izquierdo; Rudy Loo-Kung
    Abstract: Sudden Stops are associated with increased volatility in relative prices. We introduce a model based on information acquisition to rationalize this increased volatility. An empirical analysis of the conditional variance of the wholesale price to consumer price ratio using panel ARCH techniques confirms the relevance of Sudden Stops and potential balance-sheet effects as key determinants of relative-price volatility, where balance-sheet effects are captured by the interaction of a proxy for potential changes in the real exchange rate (linked to the degree of external leverage of the absorption of tradable goods) and a measure of domestic liability dollarization.
    JEL: F31 F32 F34 F41
    Date: 2005–07
  2. By: Grand Nathalie (Institut de la Méditerranée, Marseille, FRANCE); Dropsy Vincent (California State University, Fullerton, USA)
    Abstract: Morocco and Tunisia have started to open their markets to international trade and capital flows in order to bolster investment and growth. These liberalization programs require important adjustments in their economic policies, in particular their exchange rate regimes and monetary policies. This objective of this paper is to examine why Morocco and Tunisia should progressively opt for greater exchange rate flexibility as well as a monetary policy based on inflation targeting rather than exchange rate targeting and money-growth rules, as their markets are increasingly liberalized. First, their past economic policies are reviewed and analyzed. Second, the theoretical sources of inflation (cost push and demand pull factors as well as factors due to financial liberalization) are identified. Third, a Markov switching model with time-varying transition probabilities is estimated for Morocco and Tunisia to provide important information concerning the mechanisms underlying inflation regime changes. The empirical results provide evidence that high inflation regimes are more persistent in Morocco than in Tunisia, and that inflation regime switches can be explained by external shocks in the 1970s, and by the sound fiscal and monetary policies in the mid-1980s. Finally the institutional and operational conditions for the success of an inflation-targeting framework are outlined.
    Keywords: Markov switching; Inflation; Inflation targeting, Monetary policy, Central Banks; Policy Designs and Consistency; Policy Coordination; Morocco; Tunisia
    JEL: E
    Date: 2005–07–18
  3. By: Chantal Dupasquier (UN Economic Commission for Africa); Patrick N. Osakwe (UN Economic Commission for Africa); Shandre M. Thangavelu (Department of Economics, National University of Singapore)
    Abstract: There are plans by five West African countries to establish a second monetary zone in the sub-region by December 2009. In this paper we ask whether a monetary union is the appropriate exchange rate regime for the sub-region based on economic criteria. We address the issue using a rigorous theoretical framework that captures the crucial trade-off between the savings in transaction costs, resulting from a common currency, and the macroeconomic stabilization benefits of a flexible exchange rate regime. The main result is that a flexible exchange rate regime dominates a monetary union in the ECOWAS subregion.
    Keywords: Exchange rates; Regimes; Welfare; Transaction costs; West Africa
    JEL: E52 F33 F41
  4. By: Urmas Sepp; Andres Vesilind; Ülo Kaasik
    Abstract: The objective of model-building was an inflation model suitable for prognosis as well as for simulation. The model serves two purposes. First of all, it is a tool for analysing inflation. Secondly, it is part of the model of Estonian economy, which completes the adjustment loop of the macromodel. The theoretical background of the inflation model derives from four basic features of Estonian economy. Namely, Estonia is: a small and open economy, a transitional economy, economy under currency board arrangement and a market economy. When estimating the model, inflation was decomposed into a) underlying inflation which is a long-run process and b) inflation deviations from the equilibrium which are caused by the short-run impact of inflation factors. The underlying inflation, which reflects the convergence, is determined as a trend. The latter was specified as a time function, ARMA process, moving average and HP filter, whereas the best result was obtained with time function. According to modelling output the short run dynamics of the inflation are determined by three main factors - demand pressure reflected by the GDP gap, exchange rate of the US dollar (which is proxy for foreign prices), and administrative action for correcting regulated prices. The adequacy of the model has been tested on the basis of ex post and ex ante prognosis. The model provided acceptable results in the simulation of endogenous and exogenous shocks
  5. By: Iika Korhonen; Mare Randveer
    Abstract: This paper assesses the impacts of Economic and Monetary Union and the euro on developments within the EU and globally. The emphasis is on euro-11 countries and the eight most advanced accession candidates in Central and Eastern Europe. The single currency completes the project for a single market in Europe, and overall, clear efficiency gains for participating countries are expected. Low, stable interest rates should spur investment and the single currency should promote the formation of large, liquid capital markets, eventually transforming the structure of financial intermediation within the euro area. Although participating countries achieved a high degree of nominal convergence in the 1990s, this process now appears to have ended. Moreover, the conduct of a common monetary policy becomes more problematic with countries at different phases in the economic cycle. Accession candidates may use a variety of foreign exchange rate regimes before they join the EU, but ultimately their economic policies become a matter of common interest. Pressure to peg to the euro obviously increases as membership approaches, but there is compelling evidence that countries should hold back on pegging to the euro until they have achieved sufficient convergence to attain credibility for a policy of fixed exchange rates.
  6. By: Fabio Filipozzi
    Abstract: The aim of the analysis presented here is to examine the behaviour of the real exchange rate of the Estonian kroon, to estimate its equilibrium value and investigate its impact on the competitiveness of Estonian economy. A brief account on possible measures of the real exchange rate (RER) is given, and then the real effective exchange rate (REER) weighted with domestic and foreign consumer price indices (CPI) is chosen for the estimation. A model for the equilibrium real exchange rate (ERER) determination suitable for a small open economy as Estonia is outlined and provides a theoretical basis for understanding what kind of fundamentals can affect real exchange rate behaviour. Given the short sample considered here, a single equation estimation method is used. The choice of fundamentals is determined both by particular features of the Estonian economy and data constraint. The fundamentals finally adopted are productivity differential between tradeables and nontradeables sectors, investment share, resource balance and nominal effective exchange rate. Having detected the existence of one cointegration vector between RER and fundamentals, it is possible to estimate the long-run relationship linking them and an error correction mechanism in order to have some information on short-run behaviour of the real exchange rate. Estimation results are then used to construct both ERER series and misalignment measures. To do this, some hypotheses on equilibrium/sustainable levels of fundamentals are set and discussed. Our simulation hence brings us to conclude that an appreciation of RER in the sample period occurred together with an appreciation of its equilibrium level. The latter appreciated slower, hence the initial undervaluation was corrected and the difference between RER and its equilibrium level shrank, leading to a slight overvaluation after the Russian crisis.
  7. By: Raoul Lättemäe
    Abstract: The monetary system in Estonia is based on the currency board arrangement. The strong commitments and rule-based features of currency board imply that there is no active monetary policy in Estonia - all necessarily monetary adjustments are left to the market forces. Under fixed exchange rate and free capital mobility Estonian monetary conditions are therefore closely linked with monetary policy in Europe - in addition to the changes in Estonian risk-premium, interest rate developments in Europe can directly influence Estonian interest rates. Those monetary signals transmit widely into Estonian financial sector and ultimately into Estonian real sector through various channels. Some theoretical and intuitive aspects that can affect this process in Estonia have gained special attention in this paper.
  8. By: Rasmus Pikkani
    Abstract: Estonia has conducted effectively monetary policy according to currency board arrangement for nine years already. For this Estonia has traded off its freedom in active monetary policy operations for nominal anchoring economy through exchange rate. In this context Estonian own monetary policy actions could hardly make any difference and Estonian monetary conditions are heavily relying on decisions made by the issuer of anchor currency. At the same time, there are number of factors having influence on the degree of dependence on foreign monetary factors, most important of which is the openness of the economy to all balance of payments flows and the strength of the domestic banking sector. A mix of all possible factors and decision-making rules in the economy specifies directly the speed and the strength of transmission of foreign monetary signal into domestic economy. The aim of the current paper is to study transmission of ECB monetary policy decisions into Estonian economy. Additionally, absorption of unanticipated foreign and domestic monetary shocks are analysed. For this, rather small macroeconometric model with 11 behavioural equations is specified and estimated. Special emphasis is given on the formation of domestic interest rates and on the intermediation of domestic and foreign funds by domestic banking sector over shock periods. As a result, it is found that the transmission of ECB monetary policy actions over European inter-bank money market into Estonian economy is relatively fast. This is probably mostly due to high openness of the economy and to high price and wage flexibility in Estonia.
  9. By: Andreas Freytag
    Abstract: Currently, five Central and Eastern European (CEE) countries are negotiating about the membership in the European Union: Czech Republic, Estonia, Hungary, Poland and Slovak Republic. There is a broad consensus that they will eventually become members of the European Monetary Union. This requires careful analysis of the appropriate exchange rate regime prior to the accession. The exchange rate arrangement of the EU applicants plays an important - but not exclusive - role in their policy-mix. The history of transition economies as well as of other emerging markets illustrates that exchange rate policies as such are not a distinctive factor for the success and failure of monetary policy with respect to price stability. In this paper it is argued that this outcome has not emerged by chance. There is no naturally superior exchange rate regime that can be applied to all advanced countries in transition aiming at stability. By way of contrast, an exchange rate arrangement is part of the monetary regime, which itself is a component of the economic order. The latter consists of both politically chosen and spontaneously evolved institutions. This leads to the hypothesis that the choice of an exchange rate arrangement in CEE is constrained by this institutional setting. The theoretical considerations as well as empirical evidence indeed suggest that for guaranteeing stability, beside the legal monetary commitment (part of which being the exchange rate regime) the institutional framework in the country is decisive. If the latter matches the commitment, the credibility of a monetary regime is relatively high, obviously encouraging monetary stability. Therefore, the institutional setting in each country should be analysed extensively before an exchange rate arrangement is chosen.
  10. By: Lucio Vinhas de Souza
    Abstract: The aim of the paper is to empirically estimate whether the different monetary and exchange rate frameworks observed in the accession countries of Central and Eastern Europe and the Baltic States do yield different outcomes in terms of level and variance of a set of nominal and real variables. The author follows and extends the methodology developed by Kuttner and Posen (2001), who perform a combined analysis of the individual effects of exchange rate regimes, central bank independence and announced targets in nominal variables for a large set of developed and developing countries. They also estimate that a set-up combining a free float, an independent currency board and inflation targeting yields an outcome that mimics the price stabilisation advantages of a hard peg without its drawbacks in terms of extreme volatility. This sample of countries, not covered by the Kuttner and Posen study, supports their conclusions for both nominal and real variables, testing for both the individual and combined effects of the frameworks and indicating that a flexible exchange rate regime, coupled with CBI and DIT, would be Pareto-improving when compared to harder regimes.
  11. By: Urmas Sepp; Martti Randveer
    Abstract: The main aim of the paper is to examine different aspects of the sustainability of Estonian CBA. For this purpose the paper gives an overview of CBA in general, describes the rationale for the choice of the CBA in Estonia and uses model simulations to assess its sustainability. It also analyses whether the preconditions for the successful performance of the CBA are in place in Estonia and discusses the compatibility of Estonian CBA to the EMU and ERM 2. The analysis in the paper shows that CBA is a suitable exchange rate regime for Estonia. It is argued that the preconditions for a well-functioning CBA - resilient financial sector, flexible wage and employment system and prudent fiscal policy - are in place. The sustainability of the CBA is also supported by model simulations, which show that shocks hitting Estonian economy do not cause convergence of the Estonian economy from the long-run path. Based on the above-mentioned results, the paper concludes that the currency board arrangement is the best exchange rate regime for Estonia before the full participation in the third stage of the EMU.
  12. By: Balàzs Ègert
    Abstract: The objective of the paper is to analyse the nominal and real convergence process in Estonia drawing on the Balassa-Samuelson (B-S) framework. A 15-sectoral breakdown for GDP and a 5-digit level CPI data disaggregation with over 260 items is used for the period 1993:Q1 to 2002:Q1 to show that the productivity differential is related to the GDP-deflator relative price of non-tradable goods in the long run. Furthermore, the role of regulated prices in the CPI basket is also investigated - we show that excluding regulated prices makes it possible to detect a robust relationship between productivity and the relative price of market services in CPI. The B-S effect could have possibly contributed to CPI by a yearly average of 2-3% over the sample period, and more specifically 1-4% at the beginning of the period and 0.5-1% in 2000 and 2001. The potential long-run impact of the B-S effect in Estonia is estimated to amount to 1-2%. Analysis of the influence of the B-S effect on the inflation differential and the real appreciation of the exchange rate against Finland, Sweden, Germany and the UK, shows that, whereas the inflation differential attributable to the B-S effect seems to have been higher in the early 1990s, it better explains the real appreciation occurring in recent years.
    Keywords: convergence, transition, Balassa-Samuelson effect, productivity, relative prices, tradable goods, regulated prices, real exchange rate
  13. By: Reimo Juks
    Abstract: The paper focuses on the time-series analysis of the traditional trade equations. The results from the cointegration, ARDL and Granger causality analyses of trade elasticities cast some doubt on the usefulness of the internal-external balance approach to the equilibrium exchange rate. The long-run impact of the REER on trade flows turned out to be statistically insignificant, being independent of method and specification of the model employed. The latter implies a secondary role for the REER in achieving a sustainable position of external balance.
    Date: 2003–11–20
  14. By: Aurelijus Dabušinskas
    Abstract: The objective of the paper is to further our understanding of the relationship between changes in the nominal exchange rate and prices in a small open economy. The paper uses data from 1995 Q1-2003 Q1 for Estonia to investigate the exchange rate pass-through to import, producer and consumer prices, both total and disaggregated. Although the currency board arrangement eliminates exchange rate fluctuations from a very significant share of the Estonian effective currency basket, the remaining variation in the nominal exchange rate can be regarded as exogenous (determined by the anchor currency), a useful feature when estimating the pass-through. In the case of import unit values, the pass-through tends to be statistically significant for textiles and commodity-type goods, such as petroleum, non-metal mineral products and basic metals. In the case of producer prices, the long-run pass-through is evident in textiles and chemical products. Point estimates of the long-run pass-through to aggregate import and producer prices fall between 40 and 50%, though the precision of these estimates is low. In contrast, no significant exchange rate pass-through is estimated to consumer prices, measured by total CPI or its tradable component.
    Date: 2003–12–20
  15. By: Marit Hinnosaar; Hannes Kaadu; Lenno Uusküla
    Abstract: The paper presents empirical estimations of the equilibrium exchange rate of the Estonian kroon. The behavioural equilibrium exchange rate (BEER) approach is used to analyse the dynamics of the real effective exchange rate in the time period from 1995 to 2002. The estimates range from a 15% undervaluation to a small overvaluation of the kroon in the beginning of the period and indicate a position close to equilibrium in 2002.
    Keywords: equilibrium exchange rate, BEER, cointegration, Estonia
    JEL: C22 F31
  16. By: EVA RAQUEL PORRAS (Instituto de Empresa)
    Abstract: The main goal of this paper is to test a form of market efficiency in the Lima Stock Exchange. This study examines how the individual stock prices of two selected companies are affected by three standard deviation changes in the exchange rate between the Peruvian Nuevo Sol and the US dollar. The main question that drives this paper is whether the market picks up on the total value added to these Peruvian companies by a devaluation of the Peruvian Nuevo Sol. The findings of this study suggest that, in reference to the companies studied, the Peruvian, stock market does not impound instantly the impact that a change on the exchange rate has in the value of these corporations.
    Keywords: Currency markets, Event study, Exchange rate, Market Efficiency
    Date: 2004–12

This nep-ifn issue is ©2005 by Yi-Nung Yang. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.