nep-ifn New Economics Papers
on International Finance
Issue of 2005‒10‒15
thirteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rate Pass-through in a Small Open Economy By Pål Boug, Ådne Cappelen and Torbjørn Eika
  2. Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies By Enrique G. Mendoza
  3. Current account and real exchange rate dynamics in the G-7 countries By Lee,J.; Chinn,M.D.
  4. Sectoral Exchange Rate Pass-through: A Tale of Two Policy Regimes in India By Helena Marques; Sushanta Mallick
  5. China’s exchange rate policy: the case against abandoning the dollar peg By James Laurenceson
  6. Financial Sector Reform in China By Michael Thorpe
  7. Estimates of Foreign Exchange Risk Premia: A Pricing Kernel Approach By Lorenzo Cappiello; Nikolaos Panigirtzoglou
  8. An Empirical Characterisation of Speculative Pressure: A Comprehensive Panel Study Using LDV Models in High Frequency By Tassos Anastasatos; Ian R. Davidson
  9. "A Theory of International Currency and Seigniorage Competition" By Yiting Li; Akihiko Matsui
  10. How Homogenous are Currency Crises? A Panel Study using Multiple-Response Models By Tassos Anastasatos; Ian R. Davidson
  11. Real Interest Rate Linkages in the Pacific Basin Region By Philip Inyeob Ji; Jae H. Kim
  12. Optimal Monetary Policy Rules in A Simple Stochastic Macro Model: China's Evidence By Shengzu Wang; Shen Guo
  13. Making Explosive Cocktails: recipes and costs for 26 Crises from 1823 to 2003 By Néstor Adrián Amado; Ana María Cerro; Osvaldo Meloni

  1. By: Pål Boug, Ådne Cappelen and Torbjørn Eika (Statistics Norway)
    Abstract: Several small open economies switched to inflation targeting during the 1990s, thereby giving up various forms of exchange rate targeting in favour of flexible exchange rates. Norway did the same early in 2001, and has thereafter experienced highly varying nominal exchange rates with consumer price inflation dropping far below the target during 2003 and 2004. Knowledge of the degree of exchange rate pass-through to import prices and further to consumer prices is essential for inflation targeting. The literature suggests that pass-through is greater to import prices than to consumer prices, which presumably is related to the role of distributors in the economy. We present empirical evidence on these issues for Norway by estimating import price equations and a dynamic model of the distributors pricing behaviour. Using a large-scale macroeconometric model of the Norwegian economy, we find exchange rate pass-through to import prices to be quite rapid in the short run, while pass-through to consumer prices seems to be modest. We show that, among the numerous channels through which the exchange rate operate, trade margins in the distribution sector act as cushions to exchange rate fluctuations, thereby being one of the main important source for the delay in pass-through. In spite of moderate pass-through to consumer prices, we find inflationary effects of exchange rate changes even in the short run, an insight important for inflation targeting central banks.
    Keywords: Exchange rate pass-through; pricing behaviour; the distribution sector; econometric modelling and macroeconomic analysis
    JEL: C51 C52 E31 F31
    Date: 2005–06
  2. By: Enrique G. Mendoza
    Abstract: The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis of a 30-year sample of monthly data shows that movements in the price of nontradables relative to tradables account for up to 70 percent of the variability of the real exchange rate during these periods. The paper proposes a model in which this stylized fact, and the Sudden Stops that accompanied the collapse of Mexico's managed exchange rates, could result from an endogenous amplification mechanism operating via nontradables prices in economies with dollarized liabilities and credit constraints. The key feature of this mechanism is Irving Fisher's debt-deflation process. Numerical evaluation suggests that the Fisherian deflation effects on consumption, the current account, and relative prices dwarf those induced by the standard balance sheet effect typical of the Sudden Stops literature.
    JEL: F30 F41 G11
    Date: 2005–10
  3. By: Lee,J.; Chinn,M.D. (University of Wisconsin-Madison, Social Systems Research Institute)
    Date: 2004
  4. By: Helena Marques (Loughborough University); Sushanta Mallick (Loughborough University)
    Abstract: This paper uses panel data to analyse the extent to which the prices of India’s imports and exports in nine product groups react to exchange rate changes before (1980-90) and after (1991-2001) a change in policy that included the adoption of a flexible exchange rate regime and an acceleration of trade liberalisation. It finds that for all the nine groups of Indian industries the null hypothesis of complete pass-through from exchange rate changes into import prices cannot be rejected. On the contrary, the results suggest that Indian exporters appear to have to some degree passed through exchange rate changes into foreign currency export prices in three industry groups in the 1980s and in six groups of industries in the 1990s. The increase in the number of sectors exhibiting some degree of pass-through in the 1990s, relative to the 1980s, may be partly attributable to the elimination of currency and trade controls. Whilst the pass-through into import prices does not exhibit a structural break around 1991, a Chow test revealed the existence of such structural break in pass-through into export prices. The pass-through to import prices seems to be exogenous (determined by external factors), but the pass-through to export prices appears to be endogenous (driven by internal factors, mostly trade and exchange rate policies).
    Keywords: sectoral exchange rate pass-through, pricing-to-market, panel estimation, India
    JEL: F13 F14 F31 F41
    Date: 2004–03
  5. By: James Laurenceson (EAERG - School of Economics, The University of Queensland)
    Abstract: This paper critically comments on the policy literature surrounding China’s exchange rate regime. It first seeks to expose as myths several popularly raised contentions regarding the dollar peg employed by China, including the belief that the RMB is clearly undervalued and that its value is a prominent cause of the U.S trade deficit. The paper then describes a consensus position that has emerged which argues that in the interests of better promoting its own macroeconomic stability, China should abandon the peg in favor of a more flexible exchange rate regime. We see numerous weaknesses in this position but a few stand out. Available data do not suggest that flexible regimes outperform fixed regimes in terms of inflationary outcomes. Moving to a flexible regime is also far from proximate policy response to the problems that are in evidence in China’s economy. Institutional realities that make moving to a flexible regime difficult also appear to have been seriously overlooked. The paper concludes by noting that in the longer term moving to a more flexible regime may be in China’s best interests. But for now, the focus needs to be firmly in the area of domestic financial reform.
  6. By: Michael Thorpe
    Abstract: China currently maintains an exchange rate fixed against the US dollar and a (relatively) closed capital account, while exercising an independent, controlled interest rate environment. Domestic and international pressures have been mounting for the Chinese government to re-adjust the currency peg or allow more flexibility in the exchange rate and to free up the capital account to foster greater integration with global markets. Given the need for developing a more mature financial system to meet the needs of a growing market economy and with unrestricted foreign bank entry in 2007, there is also a need for less regulated and more market driven interest rates. To the extent that authorities seek to maintain exchange rate stability while easing capital controls, they must forsake monetary independence. This is the so-called macroeconomic policy "trilemma" constraining macroeconomic policy makers generally. The need for continuing reform of China's currently fragile domestic banking system further influences the nature and timing of policy options. This paper reviews recent macroeconomic management performance in China and assesses the options facing policy makers for reform of the financial system given the current environment and subject to the constraint of existing institutional arrangements.
    Keywords: China, banking, financial repression, exchange rate, capital
    JEL: G2 O16 E44
    Date: 2005
  7. By: Lorenzo Cappiello (European Central Bank); Nikolaos Panigirtzoglou (Queen Mary, University of London)
    Abstract: The goal of this study is to measure market prices of risk and the associated foreign exchange risk premia extending the approach proposed by Balduzzi and Robotti (2001) to an international framework. Estimations of minimum variance stochastic discount factors permits the determination of market prices of risk, which, in turn, in an international framework, allow to compute foreign exchange risk premia. Market prices of risk are time-varying and surge during financial turmoil. This may be interpreted as an increase of the investors’ coefficient of risk aversion during turbulent financial markets. Foreign exchange risk premia are also time-varying and they exhibit most variation from the early ‘70s onwards, when the Bretton Wood exchange rate system collapsed.
    Keywords: Foreign exchange, Risk premia, Pricing kernel
    JEL: G12 G15 F31
    Date: 2005–10
  8. By: Tassos Anastasatos (Dept of Economics Univ. of Loughborough); Ian R. Davidson (Business School Univ. of Loughborough)
    Abstract: This article provides a general and robust empirical examination of speculative pressure on various exchange rate regimes using an unusually large panel of monthly data for developed countries, analyzed within the framework of Limited-Dependent Variable (LDV) models with various innovations and extensions. In comparison to studies with lower frequency data, significant differences are found in linking crises with macroeconomic, financial and political fundamentals, despite the noise increasing tendency of higher frequency data. Considerable heterogeneity in the events surrounding crises is documented, rendering globally applicable rules for prediction and prevention inappropriate. The findings are robust to different specifications but the definition of crisis has a bearing on its predictability.
    Keywords: Currency crises; speculative pressure; exchange rate; devaluation; Limited-dependent variable models.
    JEL: F31 C23 C25 E44 G15
    Date: 2004–08
  9. By: Yiting Li (Department of Economics, National Twaiwan University); Akihiko Matsui (Faculty of Economics, University of Tokyo)
    Abstract: This paper explicitly considers strategic interaction between governments to study currency competition and its effects on the circulation of currencies and welfare in a two-country, two-currency search theoretic model. Each government uses seigniorage to provide public goods. Agents consume private goods, and the public goods of their own country. We have several findings. The negative impact of a country's inflationary policy on the realm of circulation of its currency imposes an inflation discipline: the more open a country is, the stronger is the discipline. The worldwide circulation of a currency increases seigniorage and welfare and decreases the inflation rate of the issuing country compared to autarky. The other country, since the tax base is reduced due to the use of foreign currency, raises its inflation rate. However, there is a limit on the rate beyond which it cannot maintain the circulation of national money. Under strategic interaction between governments in selecting equilibrium, the larger country would try to lower the inflation rate to make its currency circulate abroad, while the other country may also lower the inflation rate to sustain its national currency as the sole medium of exchange.
    Date: 2005–09
  10. By: Tassos Anastasatos (Dept of Economics Univ. of Loughborough); Ian R. Davidson (Business School Univ. of Loughborough)
    Abstract: This paper presents formal evidence that currency episodes display heterogeneity in terms of their evolution, their impact on the inflicted economy and their links with financial, political and macroeconomic fundamentals. Limited-dependent variable models for ordered and unordered outcomes along with their heteroskedastic and random effects extensions are applied on a large panel of data comprising 40 years of monthly observations on 23 developed countries. Heterogeneity, complemented by indications of self-fulfilling expectations and noise, suggest that time and region specific predictive approaches and policy responses are more useful than trying to base analysis and policy decisions on more general patterns. Results are established with formal specification tests.
    Keywords: Currency crises; speculative pressure; exchange rate; devaluation; Limited-dependent variable models.
    JEL: F31 C23 C25 E44 G15
    Date: 2004–12
  11. By: Philip Inyeob Ji; Jae H. Kim
    Abstract: This paper examines the linkage of real interest rates of a group of Pacific-Basin countries with a focus on East Asia. We consider monthly real interest rates of the US, Japan, Korea, Singapore, and Thailand from 1980 and 2004. The impulse response analysis and half-life estimation are conducted in a multivariate setting, adopting the bias-corrected bootstrap as a means of statistical inference. It is found that the degree of capital market integration has increased after the Asian financial crisis in 1997. The evidence suggests that the crisis has substantially changed the nature of the short run interactions among the real interest rates. Before the crisis, both the US and Japanese capital markets dominated the region. However, after the crisis, the dominance of the Japanese market has completely disappeared, while the US remains as a sole dominant player.
    Keywords: Financial crisis, Bias-correction, Bootstrapping, Capital market Integration, Half-life, Impulse response analysis, Vector autoregression.
    JEL: F36 E44
    Date: 2005–10
  12. By: Shengzu Wang (McGill University); Shen Guo (Concordia University)
    Abstract: In this paper we apply a simple macro model to explore and evaluate certain optimal monetary policy rules for China's economy. To be more consistent with the central bank (the People's Bank of China)'s behaviour, we use money supply as a monetary policy instrument rather than the commonly used interest rate. Policy rules are optimal in terms of minimizing the predetermined loss functions, and the parameters of these rules are determined by stochastic simulation. Different forms of policy rule and loss function are considered, especially for exchange rate volatility and money supply volatility. The optimality of monetary policy rules is evaluated by comparing the shifts of policy frontiers.
    Keywords: Monetary Policy Rule, Loss Function, Stochastic Simulation, Policy Frontier, China
    JEL: C15 E47 E52
    Date: 2005–10–08
  13. By: Néstor Adrián Amado (UNSTA); Ana María Cerro (UNSTA & Universidad Nacional de Tucumán, Argentina); Osvaldo Meloni (Universidad Nacional de Tucumán, Argentina)
    Abstract: Crises, like “explosive cocktails” are made by mixing powerful ingredients. Argentina has made 26 “explosive cocktails” since 1823. How many ingredients are needed to make an “explosive cocktail”? Which are these ingredients? Which is the most expensive mix? This paper attempts to identify the different recipes that ended up in economic crisis throughout argentine economic history by means of the regression tree analysis technique. The paper also measures Argentina’s crises costs in terms output losses. We follow the methodology used by the IMF (1998), that is, computing cumulative output lost relative to trend. It is found that there are four explosive mixes, having Fiscal Deficit, Real Exchange Rate Overvaluation, Bank Deposit growth rate decline and the ratio of External Debt to Exports as the key ingredients. The most frequent crises are those having high fiscal deficit; though average cost is higher for crises mixing moderate fiscal with strong decline in Real Bank Deposits, presumably entailing banking crises.
    Keywords: Currency Crises, Regression Tree Analysis, Crises Costs
    JEL: F1 F2
    Date: 2005–10–06

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