nep-ifn New Economics Papers
on International Finance
Issue of 2005‒09‒11
sixteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Daily Effects of Foreign Exchange Intervention: Evidence from Official Bank of Canada Data By Rasmus Fatum
  2. Exchange Rate Interventions and Insurance: Is “Fear of Floating” a Cause For Concern? By Francisco Gallego; Geraint Jones
  3. Incentives from exchange rate regimes in an institutional context By Ashima Goyal
  4. Foreign Exchange Intervention and Monetary Policy in Japan, 2003-04 By Rasmus Fatum; Michael M. Hutchison
  5. Macroeconomic Shocks and Foreign Bank Assets By Claudia M. Buch; Kai Carstensen; Andrea Schertler
  6. Exchange Rate Policy in a Dollarized Economy: A CGE Analysis for Bolivia By Rainer Schweickert; Rainer Thiele; Manfred Wiebelt
  7. Contractionary Currency Crashes in Developing Countries By Jeffrey A. Frankel
  8. Probability of Insolvency. By Marcelo Reyes M.; Eugenio Saavedra G
  9. Effective Cross-Hedging for Commodity Currencies By Chakriya Bowman
  10. From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege By Pierre-Olivier Gourinchas; Hélène Rey
  12. A PHILLIPS CURVE FOR CHINA By Joerg Scheibe; David Vines
  13. Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing By Hamid Faruqee; Douglas Laxton; Dirk Muir; Paolo Pesenti
  14. Recovering market expectations of FOMC rate changes with options on federal funds futures By John B. Carlson; Ben R. Craig; William R. Melick
  15. Estimating the COP Exchange Rate Volatility Smile and the Market Effect of Central Bank Interventions: A CHARN Approach By Juan Manuel Julio; Norberto Rodríguez; Héctor Manuel Zárate
  16. TRANSPACIFIC TRADE IMBALANCES: CAUSES AND CURES By Jong-Wha Lee; Warwick J. McKibbin; Yong Chul Park

  1. By: Rasmus Fatum (School of Business, University of Alberta)
    Abstract: This paper analyzes the effects of official, daily Bank of Canada intervention in the CAD/USD exchange rate market over the January 1995 to September 1998 period. Using an event study methodology and different criteria for effectiveness, movements in the CAD/USD exchange rate over the 1 through 10 days surrounding intervention events are investigated. It is shown that Bank of Canada intervention was systematically associated with both a change in the direction and a smoothing of the CAD/USD exchange rate. Bank of Canada intervention did not, however, succeed in reducing the volatility of the CAD/USD exchange rate. Additionally, the paper introduces the issue of currency co-movements to the intervention literature. It is shown that the effects of intervention are weakened when adjusting for general currency co-movements against the USD, suggesting that currency co-movements should be taken into account when addressing the effects of central bank intervention aimed at managing a minor currency vis-à-vis a major currency.
    Keywords: foreign exchange intervention; event studies; currency co-movement
    JEL: E58 F31 G14 G15
    Date: 2005–06
  2. By: Francisco Gallego; Geraint Jones
    Abstract: Fear of floating” is one of the central empirical characteristics of exchange rate regimes in emerging markets. However, while some view “fear of floating” in terms of the optimal ex post monetary response to external shocks, protecting balance sheets and avoiding inflation, others have argued that from an ex ante perspective such a policy leads to private sector underinsurance against sudden stops. A commitment to floating during potential crises would increase the incentives of the private sector to conserve international liquidity. This paper develops a model of the optimal exchange rate regime when both ex ante and ex post concerns are present. Since it is only “fear of floating” during potential sudden stops which undermines insurance, we reexamine the data on exchange rate regimes for evidence that exchange rate flexibility is state-contingent. We find most emerging markets exhibit non-contingent policies with a uniformly low level of flexibility, which together with an absence of substituteinsurance policies supports the claim that greater exchange rate flexibility during sudden stops would be desirable for such countries. However, more recent floats with intermediate levels of credibility exhibit little state contingency because of a uniformly high degree of flexibility. More established floats with high credibility exhibit statecontingent regimes, retaining a capacity for discretionary intervention, but floating during potential crises. Exchange rate flexibility is associated with increased private sector hoarding of dollar assets and reduced incidence of sudden stops. Together the evidence suggests that the insurance benefits to floating for emerging markets can be substantial and that the credibility of the monetary policy framework is central to successful implementation of this policy.
    Date: 2005–09
  3. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: In a simple open EME macromodel, calibrated to the typical institutions and shocks of a densely populated emerging market economy, a monetary stimulus preceding a temporary supply shock can lower interest rates, raise output, appreciate exchange rates, and lower inflation. Simulations generalize the analytic result with regressions validating the parameter values. Under correct incentives, such as provided by a middling exchange rate regime, which imparts limited volatility to the nominal exchange rate around a trend competitive rate, forex traders support the policy. The policy is compatible with political constraints and policy objectives, but analysis of strategic interactions brings out cases where optimal policy will not be chosen. Supporting institutions are required to coordinate monetary, fiscal policy and markets to the optimal equilibrium. The analysis contributes to understanding the key issues for countries such as India and China that need to deepen markets in order to move to more flexible exchange rate regimes.
    Keywords: Exchange rate, hedging, supply shocks, EMEs, incentives, politics
    JEL: F31 F41
    Date: 2005–07
  4. By: Rasmus Fatum (School of Business, University of Alberta); Michael M. Hutchison (Department of Economics, University of California)
    Abstract: This article examines the rationale behind the massive increase in Japanese foreign exchange market intervention operations in 2003-04, and evaluates its effectiveness both in limiting yen exchange rate appreciation and influencing the direction of monetary policy. The two main questions addressed in this study are: Was the intervention effective in slowing exchange rate appreciation compared to a counterfactual case with no intervention? And, has intervention on such a large scale authorized by the Ministry of Finance been able to directly influence liquidity creation or indirectly influence the stance of Bank of Japan policy?
    Keywords: foreign exchange intervention; Japanese monetary policy
    JEL: E51 E58 F31
    Date: 2004–10
  5. By: Claudia M. Buch; Kai Carstensen; Andrea Schertler
    Abstract: Changes in foreign asset holdings are one channel through which agents adjust to macroeconomic shocks. In this paper, we test whether foreign bank assets change as a result of domestic and foreign macroeconomic shocks. We frame our empirical analysis in a standard new open economy macro model in which financial markets are imperfectly integrated. We test the implications of this model using dynamic panel models for changes in foreign bank assets. We find evidence that nominal interest rate differentials and inflation differentials drive changes in foreign bank assets permanently, while growth rate differentials and exchange rates have only a temporary effect.
    Keywords: international banking, macroeconomic shocks
    JEL: F3 F41
    Date: 2005–06
  6. By: Rainer Schweickert; Rainer Thiele; Manfred Wiebelt
    Abstract: In this paper, a real-financial CGE model is employed for Bolivia to simulate the macroeconomic and distributional effects of exchange rate policy in a highly dollarized economy. Overall, dollarization appears to matter more through real than through financial-sector effects. The main macroeconomic result of the simulations is that the potential of nominal devaluation to smooth the adjustment path after a negative shock primarily depends on the absence of wage indexation. Only if nominal wages are constant in the short run, devaluation reduces unemployment and cushions the reduction of real GDP induced by the shock. Financial de-dollarization tends to be contractionary in Bolivia but different degrees of financial dollarization hardly change the real sector effects. As concerns distributional effects, nominal devaluation in no circumstance reduces the poverty effect of the external shock. Even the significant short-run macroeconomic expansion that occurs without wage indexation does not translate into significant poverty alleviation, which is due to the fact that the real value of transfers received by households decreases in this case.
    Keywords: Dollarization, Poverty, Computable General Equilibrium Model, Bolivia
    JEL: O16 D3 C68
    Date: 2005–07
  7. By: Jeffrey A. Frankel
    Abstract: To update a famous old statistic: a political leader in a developing country is almost twice as likely to lose office in the 6 months following a currency crash as otherwise. This difference, which is highly significant statistically, holds regardless whether the devaluation takes place in the context of an IMF program. Why are devaluations so costly? Many of the currency crises of the last ten years have been associated with output loss. Is this, as alleged, because of excessive reliance on raising the interest rate as a policy response? More likely it is because of contractionary effects of devaluation. There are various possible contractionary effects of devaluation, but it is appropriate that the balance sheet effect receives the most emphasis. Passthrough from exchange rate changes to import prices in developing countries is not the problem: this coefficient fell in the 1990s, as a look at some narrowly defined products shows. Rather, balance sheets are the problem. How can countries mitigate the fall in output resulting from the balance sheet effect in crises? In the shorter term, adjusting promptly after inflows cease is better than procrastinating by shifting to short-term dollar debt, which raises the costliness of the devaluation when it finally comes. In the longer term, greater openness to trade reduces vulnerability to both sudden stops and currency crashes.
    Date: 2005–08
  8. By: Marcelo Reyes M.; Eugenio Saavedra G
    Abstract: This paper analyzes the problem of the balance sheet of an agent that invests in currencies different than those she finances. Assuming a constant rate of return and fixed financing costs, the agent can face the event of insolvency due to swings in the relevant exchange rate that is assumed to follow a geometric Brownian motion. Then, the process is generalized to allow dependency of the diffusion coefficient on the level of the exchange rate, reproducing many of the properties encountered in empirical studies of financial asset prices. The resulting hyperbolic process is calibrated via a martingale estimating function, and then we approximate the probability that the value of assets fails to match the value of liabilities at a given future date. The findings are consistent regardless the volatility assumption of the process. Finally, we give some insights to minimize the probability of such event.
    Date: 2005–09
  9. By: Chakriya Bowman (Asia Pacific School of Economics and Government, Australian National University)
    Abstract: There has been little evidence in the past to support the use of commodity-currency cross-hedges (Demaskey and Pearce, 1998; Benet, 1990; Eaker and Grant, 1987). However, this paper shows that if currencies can be defined as commodity currencies, as per Chen and Rogoff (2003) and Cashin, Ce´spedes and Sahay (2004), commodity-currency cross-hedges are effective and beneficial. Two commodity currencies, the Papua New Guinea kina and the Australian dollar, are shown here to be effectively hedged by commodity futures. Multiple commodity hedges generally improved performance, with four-commodity basket hedges effective for both currencies.
    Keywords: foreign exchange, cross-hedging, commodity currency
    JEL: F31 G15
    Date: 2005–06
  10. By: Pierre-Olivier Gourinchas; Hélène Rey
    Abstract: Does the center country of the International Monetary System enjoy an "exorbitant privilege" that significantly weakens its external constraint as has been asserted in some European quarters? Using a newly constructed dataset, we perform a detailed analysis of the historical evolution of US external assets and liabilities at market value since 1952. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. Interestingly, this excess return increased after the collapse of the BrettonWoods fixed exchange rate system. It is mainly due to a "return discount": within each class of assets, the total return (yields and capital gains) that the US has to pay to foreigners is smaller than the total return the US gets on its foreign assets. We also find evidence of a "composition effect": the US tends to borrow short and lend long. As financial globalization accelerated its pace, the US transformed itself from a World Banker into a World Venture Capitalist, investing greater amounts in high yield assets such as equity and FDI. We use these findings to cast some light on the sustainability of the current global imbalances.
    JEL: F3 N1
    Date: 2005–08
  11. By: Iris Claus
    Abstract: This paper assesses the effects of bank leding in a small open economy with a floating exchange rate and sticky prices. A theoretical model with costly financial intermediation is developed for New Zealand. The results show that long-run and business cycle effects of bank lending are small. Whether firms borrow from financial intermediaries or public debt markets is unlikely to affect economic activity. In other words, the financial structure, or degree to which a country's financial system is intermediary based or market based, does not matter.
    JEL: E32 E44 E50 F41
    Date: 2005–05
  12. By: Joerg Scheibe; David Vines
    Abstract: This paper models Chinese inflation using an output gap Phillips curve. Inflation modelling for the world's sixth largest economy is a still under-researched topic. We estimate a partially forward-looking Phillips curve as well as traditional backward-looking Phillips curves. Using quarterly data from 1988 to 2002, we estimate a vertical long-run Phillips curve for China and show that the output gap, the exchange rate, and inflation expectations play important roles in explaining inflation. We adjust for structural change in the economy where possible and estimate regressions for rolling sample windows in order to test for and uncover gradual structural change. We evaluate a number of alternative output gap estimates and find that output gaps which are derived from prodcution function estimations for the Chinese economy are of more use in estimating a Phillips curve than output gaps derived from simple statistical trends. Partially forward-looking Phillips curves provide a better fit than backward-looking ones. The identification of a non-increasing exchange rate effect on inlation during a period of large import growth hints at increased pricing to market behaviour by importers. This result is relevant to policies regarding possible exchange rate liberalisation in China.
    JEL: E12 E31 E32
    Date: 2005–02
  13. By: Hamid Faruqee; Douglas Laxton; Dirk Muir; Paolo Pesenti
    Abstract: This paper re-examines the implications, risks, and attendant policies surrounding global rebalancing of current accounts through the lens of a dynamic, multi-region model of the global economy. In the baseline scenario, world macroeconomic imbalances of the early 2000s can be attributed to a combination of six related but distinct tendencies: (i)expansionary U.S. fiscal policy, (ii) declining rate of U.S. private savings, (iii) increased foreign demand for U.S. assets, particularly in Asia, (iv) strong productivity growth in emerging Asia, (v) lagging productivity growth in Japan and the euro area, and (vi) gaining export competitiveness in emerging Asia. The baseline projects stabilizing U.S. public and foreign debt (albeit at higher levels) and a gradual depreciation of the dollar, allowing the U.S. external deficit to gradually move to a sustainable level. An alternative scenario, involving a sudden portfolio reshuffling in the rest of the world, would result in higher U.S. real interest rates, a significantly weaker dollar, with harmful effects on U.S. (and possibly global) growth. More flexible exchange rates in emerging Asia can help reduce variability in both regional output and inflation. Other simulations consider the effects of U.S. fiscal adjustment, as well as growth-enhancing structural reforms in Europe and Japan.
    JEL: E66 F32 F47
    Date: 2005–08
  14. By: John B. Carlson; Ben R. Craig; William R. Melick
    Abstract: This paper demonstrates how options on federal funds futures, which began trading in March 2003, can be used to recover the implied probability density function (PDF) for future Federal Open Market Committee (FOMC) interest rate outcomes. The discrete nature of the choices made by the FOMC allows for a very straightforward recovery of the implied PDF using ordinary least squares (OLS) estimation. This simple recovery method stands in contrast to the relatively complicated PDF recovery techniques developed for options written on assets such as equities, foreign exchange, or commodity futures where the underlying prices are most appropriately modeled as being drawn from continuous distributions. The OLS estimation is used to recover PDFs for single FOMC meetings as well as PDFs for joint estimation of multiple FOMC meetings, and allows for the imposition of restrictions on the recovered probabilities, both within and across FOMC meetings. Finally, recovered probabilities are used to assess the impact of data releases and Fed communication on the perceived likelihood of actual policy outcomes.
    Keywords: Federal Open Market Committee ; Monetary policy ; Interest rate futures
    Date: 2005
  15. By: Juan Manuel Julio; Norberto Rodríguez; Héctor Manuel Zárate
    Abstract: In this paper we estimated a volatility model for COP/US under two different samples, one containing the information before the “discretional interventions” started, and the other using the whole sample. We use a nonparametric approach to estimate the mean and “volatility smile” return functions using daily data. For the pre-interventions sample, we found a nonlinear expected return function and, surprisingly, a nonsymmetric “volatility smile”. These lack of linearity and symmetry are related to absolute returns above 1,5% and 1,0%, respectively. We also found that the “discretional interventions” did not shift the mean response function, but moved the expected returns along the line towards the required levels. In contrast, the “volatility smile” tends to increase in a non-symmetric way after accounting for “discretional interventions”. The Sep/29/2004 announcement does not seem to have had any effect on the expected conditional mean or variance functions, but the Dec/17/2004 announcement seems to be related to non-symmetric effects on the volatility smile. We concluded that the announcement of discretional intervention by the monetary authority was more efficient when time and amount were unannounced.
    Keywords: Volatility Smile,
    JEL: C14
    Date: 2005–07–30
  16. By: Jong-Wha Lee; Warwick J. McKibbin; Yong Chul Park
    Abstract: This paper explores the causes of the transpacific trade imbalances using an empirical global model. It also evaluates the impact of various policies to reduce these imbalances. We find that the fundamental cause of trade imbalance since 1997 is changes in saving-investment gaps, attributed to the surge of the US fiscal deficits and the decline of East Asia's private investment after the 1997 financial crisis. Our stimulation results show that a revaluation of East Asia's exchange rates by 10 percent (effectively a shift in monetary policy) cannot resolve the imbalances. We find East Asia's concerted efforts to stimulate aggregate demand can have significant impacts on trade balances globally, but the impact on the US trade balance is not large. US fiscal contraction is estimated to have large impacts on the US trade position overall and on the bilateral trade imbalances with East Asian economies. These results suggest that in order to improve the transpacific imbalance, macroeconomic adjustment will need to be made on both sides of the Pacific.
    JEL: F32 F42

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