nep-ifn New Economics Papers
on International Finance
Issue of 2005‒10‒22
forty-two papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Can Higher Reserves Help Reduce Exchange Rate Volatility? By Ketil Hviding; M. Nowak; Luca Antonio Ricci
  2. Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries By Vivian Z. Yue; Samir Jahjah
  3. The Empirics of Foreign Exchange Intervention in Emerging Markets: The Cases of Mexico and Turkey By Roberto Pereira Guimarães; Cem Karacadag
  4. Parity Reversion in Real Exchange Rates: Fast, Slow or Not at All? By Paul Cashin; C. John McDermott
  5. Exchange Rate Pass-Through in the Euro Area: The Role of Asymmetric Pricing Behavior By Hamid Faruqee
  6. From Fixed to Float: Operational Aspects of Moving Towards Exchange Rate Flexibility By Gilda Fernandez; Cem Karacadag; Rupa Duttagupta
  7. Remoteness and Real Exchange Rate Volatility By Claudio Bravo-Ortega; Julian di Giovanni
  8. Capital Account Liberalization and the Real Exchange Rate in Chile By Guillermo R. LeFort-Varela
  9. Setting the Stage for a National Currency in the West Bank and Gaza: The Choice of Exchange Rate Regime By S. Beidas; Magda E. Kandil
  10. The Equilibrium Real Exchange Rate in a Commodity Exporting Country: Algeria's Experience By Taline Koranchelian
  11. Real Exchange Rates in Developing Countries: Are Balassa-Samuelson Effects Present? By Mohsin S. Khan; Ehsan U. Choudhri
  12. Structural Factors Affecting Exchange Rate Volatility: A Cross-Section Study By Jorge Iván Canales Kriljenko; Karl Friedrich Habermeier
  13. Exchange Rate Regimes and Trade By Christopher Adam; David Cobham
  14. China: Sources of Real Exchange Rate Fluctuations By Tao Wang
  15. Trade Costs and Real Exchange Rate Volatility: The Role of Ricardian Comparative Advantage By Claudio Bravo-Ortega; Julian di Giovanni
  16. Financial Globalization and Exchange Rates By Gian Maria Milesi-Ferretti; Philip R. Lane
  17. The Importance of Nontradable Goods%u2019 Prices in Cyclical Real Exchange Rate Fluctuations By Ariel Burstein; Martin Eichenbaum; Sergio Rebelo
  18. Are Emerging Market Countries Learning to Float? By Dalia Hakura
  19. Explicit and Implicit Targets in Open Economies By Silvia Sgherri
  20. Exchange Rates in Central Europe: a Blessing or a Curse? By Alain Borghijs; Louis Kuijs
  21. New Rates from New Weights By Sarma Jayanthi; Tamim A. Bayoumi; Jaewoo Lee
  22. Cataclysms and Currencies: Does The Exchange Rate Regime Matter for Real Shocks? By Rodney Ramcharan
  23. Will you Buy My Peg? The Credibility of a Fixed Exchange Rate Regime as a Determinant of Bilateral Trade By Emilia Magdalena Jurzyk; Bernhard Fritz-Krockow
  24. Balance Sheets, Exchange Rate Policy, and Welfare By Ivan Tchakarov; Selim Elekdag
  25. Exits from Heavily Managed Exchange Rate Regimes By Ashoka Mody; Eisuke Okada; Enrica Detragiache
  26. Monetary and Exchange Rate Dynamics During Disinflation: An Empirical Analysis By Andrés Arias; Lei Zhang; A. Javier Hamann
  27. An Estimated Small Open Economy Model of the Financial Accelerator By Ivan Tchakarov; Selim Elekdag; Alejandro Justiniano
  28. Inflation Targeting and Exchange Rate Rules in an Open Economy By Eric Parrado
  29. Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive? By Yin-Wong Cheung; Menzie David Chinn; Antonio Garcia Pascual
  30. Labor Productivity and Real Exchange Rate: The Balassa-Samuelson Disconnect in the Former Yugoslav Republic of Macedonia By Boileau Loko; Anita Tuladhar
  31. Hedging Foreign Exchange Risk in Chile: Markets and Instruments By Jorge A. Chan-Lau
  32. Deriving Market Expectations for the Euro-Dollar Exchange Rate from Option Prices By Noureddine Krichene
  33. The Composition of Capital Flows: Is South Africa Different? By Norbert Funke; Faisal Ahmed; Rabah Arezki
  34. Structural Reforms and the Exchange Rate Regime: A Panel Analysis for the World versus OECD Countries By Ansgar Belke; Bernhard Herz; Lukas Vogel
  35. Foreign Exchange Market Volatility in EU Accession Countries in the Run-up to Euro Adoption: Weathering Uncharted Waters By Ádám Kóbor; István P. Székely
  36. Currency Crises in Developed and Emerging Market Economies: A Comparative Empirical Treatment By Thomson Fontaine
  37. Choosing the Correct Currency Anchor For a Small Economy: The Case of Nepal By Sibel Yelten
  38. Were Bid-Ask Spreads in the FX Market Excessive During the Asian Crisis? By Törbjörn I. Becker; Amadou N. R. Sy
  39. Macroeconomic Implications of the Transition to Inflation Targeting and Capital Account Liberalization in Romania By Nikolay Gueorguiev; Pelin Berkmen
  40. Singapore's Unique Monetary Policy: How Does it Work? By Eric Parrado
  41. Foreign Exchange Market Organization in Selected Developing and Transition Economies: Evidence from a Survey By Jorge Iván Canales Kriljenko
  42. Unit Roots, Nonlinear Cointegration and Purchasing Power Parity By Alfred A. Haug; Syed A. Basher

  1. By: Ketil Hviding; M. Nowak; Luca Antonio Ricci
    Abstract: This paper studies the role of an increase in foreign exchange reserves in reducing currency volatility for emerging market countries. The study employs a panel of 28 countries over the period 1986-2002. Several control variables are introduced in the regressions to account for other factors affecting exchange rate volatility (monetary and external indicators as well as conventional macroeconomic fundamentals). The paper controls for the endogeneity induced by the role of the exchange rate regime, since the regime can affect both the level of reserves and exchange rate volatility. The results provide ample support for the proposition that holding adequate reserves reduces exchange rate volatility. The effect is strong and robust; moreover, it is nonlinear and appears to operate through a signaling effect.
    Keywords: Exchange rate variability , Reserves , Reserves adequacy ,
    Date: 2004–10–14
  2. By: Vivian Z. Yue; Samir Jahjah
    Abstract: We test the hypothesis of a link between exchange rate policy and sovereign bonds. We analyze the effect of exchange rate policies on supply and credit spreads of sovereign bonds issued by developing countries. An exchange rate policy is captured by the de facto exchange rate regime and the real exchange rate misalignment. The main findings are: (1) real exchange rate overvaluation significantly increases sovereign bond issue probability and raises bond spreads; (2) spreads and the likelihood of issuing bonds depend on the exchange rate regime; (3) exchange rate misalignment under a hard peg significantly increases bond spreads; (4) in time of debt crises, exchange rate policy also greatly affects the sovereign bond market, especially through exchange rate overvaluation.
    Keywords: Exchange rate regimes , Bond issues , Developing countries , Debt , Credit , Financial crisis , Economic models ,
    Date: 2004–11–15
  3. By: Roberto Pereira Guimarães; Cem Karacadag
    Abstract: This paper analyzes the effects of intervention on the level and volatility of the exchange rate in Mexico and Turkey, two emerging countries that have floating exchange rate regimes. The paper finds mixed evidence on the effectiveness of intervention. In Mexico, foreign exchange sales have a small impact on the exchange rate level and raise short-term volatility, while in Turkey, intervention does not appear to affect the exchange rate level but reduces its shortterm volatility. In both cases, the findings are consistent with officially stated policy objectives, which aim to minimize the effect of intervention on the exchange rate, but cast doubt on claims that intervention is a useful tool for smoothing volatility. Although these findings cannot be generalized to other emerging markets, intervention's apparently limited effectiveness highlights the need for central banks to use their scarce foreign reserves selectively and parsimoniously.
    Keywords: Intervention , Mexico , Turkey , Emerging markets , Exchange market developments , Foreign exchange reserves , Floating exchange rates , Capital flows , Economic models ,
    Date: 2004–07–29
  4. By: Paul Cashin; C. John McDermott
    Abstract: Consensus estimates put the half-life of deviations from purchasing power parity (PPP) at about four years (Rogoff, 1996). However, conventional least squares estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks, this study uses median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. The paper tests for PPP using real effective exchange rate data for 90 developed and developing countries in the post-Bretton Woods period. Support for PPP is found, as the majority of countries experience finite deviations of real exchange rates from parity. The speed of parity reversion is found to be typically much faster for developed countries than for developing countries, and to be considerably faster for countries with flexible nominal exchange rate regimes in comparison with countries having fixed nominal exchange rate regimes.
    Keywords: Purchasing power parity , Real effective exchange rates , Flexible exchange rate policy , Economic models ,
    Date: 2004–08–04
  5. By: Hamid Faruqee
    Abstract: Exchange rate pass-through in a set of euro area prices along the pricing chain is examined. Using a vector autoregression (VAR) approach, the empirics analyze the joint time-series behavior of the euro exchange rate and a system of euro-area prices in response to an exchange rate shock. The impulse-response functions from the VAR estimates are used to identify-in a 'new open economy macroeconomics model'-those key behavioral parameters that best replicate the pattern of exchange rate pass-through in the euro area. Area-wide prices are found to display incomplete pass-through, consistent with euro currency-pricing and pricing-to-market behavior. The results are compared to those for the other major industrial economies, and suggest that, as with the United States, "expenditure-switching" effects on the current account still operate but are generally small.
    Keywords: Exchange rates , Prices , Economic models ,
    Date: 2004–02–10
  6. By: Gilda Fernandez; Cem Karacadag; Rupa Duttagupta
    Abstract: This paper identifies the institutional and operational requisites for transitions to floating exchange rate regimes. In particular, it explores key issues underlying the transition, including developing a deep and liquid foreign exchange market, formulating intervention policies consistent with the new regime, establishing an alternative nominal anchor in the context of a new monetary policy framework, and building the capacity of market participants to manage exchange rate risks and of supervisory authorities to regulate and monitor them. It also assesses the factors that influence the pace of exit and the appropriate sequencing of exchange rate flexibility and capital account liberalization.
    Keywords: Exchange rate policy , Foreign exchange , Exchange markets , Intervention , Capital account liberalization , Flexible exchange rate policy ,
    Date: 2004–07–29
  7. By: Claudio Bravo-Ortega; Julian di Giovanni
    Abstract: This paper examines the impact of trade costs on real exchange rate volatility. The channel is examined by constructing a two-country Ricardian model of trade, based on the work of Dornbusch, Fischer, and Samuelson (1977), which shows that higher trade costs result in a larger nontradable sector. This, in turn, leads to higher real exchange rate volatility. We provide empirical evidence supporting the channel.
    Keywords: Real effective exchange rates , Exchange rate variability , Trade models ,
    Date: 2005–01–13
  8. By: Guillermo R. LeFort-Varela
    Abstract: After the failure of the early 1980s, a second attempt at capital account liberalization was gradually carried out in Chile during the 1990s, this time in parallel with increased exchange rate flexibility. Capital account regulations were applied to support the independent monetary policy committed to the inflation target, while the exchange rate was quasi-pegged within a band that targeted the real exchange rate (RER). Still, the policy framework directed at stabilizing the RER appears to have been of limited effectiveness, with the surges and sudden-stops in capital flows playing an important role in RER dynamics. Foreign exchange market intervention appears not to have affected the RER while reserve requirement appears to have exerted a depreciating effect. Government spending and import tariffs, appear to be significant tools to moderate the real appreciation thus providing one additional reason for adopting a countercyclical fiscal policy and accelerating trade openness
    Keywords: Capital account liberalization , Chile , Real effective exchange rates , Foreign exchange , Intervention , Reserve requirements , Capital flows ,
    Date: 2005–07–15
  9. By: S. Beidas; Magda E. Kandil
    Abstract: This paper sheds light on the quantitative behavioral responses of key economic variables in the Palestinian economy in the face of major economic shocks and draws implications for the choice of an exchange rate regime should a decision be taken to introduce a national currency. Time-series regression analysis shows that (i) wages and prices are flexible in the face of various shocks; (ii) the real wage appears rigid in the face of various shocks and increases despite higher unemployment; (iii) an appreciation of the new Israeli Sheqalim real effective exchange rate decreases exports and imports; and (iv) money demand appears stable in the face of exchange rate shocks. Although a fixed exchange rate system may initially be desirable to establish credibility of the new currency, some flexibility of the exchange rate is desirable over time.
    Keywords: Exchange rate regimes , West Bank and Gaza Strip , Currencies , Currency substitution ,
    Date: 2005–04–15
  10. By: Taline Koranchelian
    Abstract: Drawing on the existing literature, I estimate a long-run equilibrium real exchange rate path for Algeria. I find that the Balassa-Samuelson effect together with real oil prices explain the long-run evolution of the equilibrium real exchange rate in Algeria. The half-life of the deviation of the real exchange rate from the estimated equilibrium level is about nine months, similar to that in other commodity-exporting countries. The general conclusions are that: (i) there is a time-varying long-run equilibrium exchange rate in Algeria as in other commodity-exporting countries; and (ii) the real effective exchange rate of the Algerian dinar at end-2003 was broadly in line with this equilibrium.
    Keywords: Exchange rates , Algeria , Commodities , Exports ,
    Date: 2005–07–20
  11. By: Mohsin S. Khan; Ehsan U. Choudhri
    Abstract: There is little empirical research on whether Balassa-Samuelson effects can explain the long-run behavior of real exchange rates in developing countries. This paper presents new evidence on this issue based on a panel data sample of 16 developing countries. The paper finds that the traded-nontraded productivity differential is a significant determinant of the relative price of nontraded goods, and the relative price in turn exerts a significant effect on the real exchange rate. The terms of trade also influence the real exchange rate. These results provide strong verification of Balassa-Samuelson effects for developing countries.
    Keywords: Real effective exchange rates , Developing countries , Productivity ,
    Date: 2004–10–13
  12. By: Jorge Iván Canales Kriljenko; Karl Friedrich Habermeier
    Abstract: The paper examines factors affecting exchange rate volatility, with an emphasis on structural features of the foreign exchange regime. It draws for the first time on detailed survey data collected by the IMF on foreign exchange market organization and regulations. Key findings are that decentralized dealer markets, regulations on the use of domestic currency by nonresidents, acceptance of Article VIII obligations, and limits on banks' foreign exchange positions are associated with lower exchange rate volatility. The paper also provides support for earlier results on the influence of macroeconomic conditions and the choice of exchange rate regime on volatility.
    Keywords: Structural adjustment , Exchange rates , Foreign exchange ,
    Date: 2004–08–24
  13. By: Christopher Adam; David Cobham
    Abstract: A 'new version' gravity model is used to estimate the effect of de facto exchange rate regimes, as classified by Reinhart and Rogoff (2004), on bilateral trade. The results indicate that, while participation in a common currency union is typically strongly 'protrade' - as first suggested by Rose (2000) - other exchange rate regimes which lower the exchange rate uncertainty and transactions costs associated with international trade between countries are significantly more pro-trade than the default regime of a 'double float'. They suggest that the direct and indirect effects of exchange rate regimes on uncertainty and transactions costs tend to outweigh the trade-diverting substitution effects. In addition, there is evidence that membership of different currency unions by two countries has pro-trade effects, which can be understood in terms of a large indirect effect on transactions costs. Tariff-equivalent monetary barriers associated with each of the exchange rate regimes are also calculated.
    Keywords: Gravity models, geography, trade, exchange rate regime, currency union, transactions costs, tariff-equivalent barriers
    JEL: F10 F33 F49
    Date: 2005
  14. By: Tao Wang
    Abstract: This paper reviews the evolution of China's real effective exchange rate between 1980 and 2002, and uses a structural vector autoregression model to study the relative importance of different types of macroeconomic shocks for fluctuations in the real exchange rate. The structural decomposition shows that relative real demand and supply shocks account for most of the variations in real exchange rate changes during the estimation period. The paper also finds that supply shocks are as important as nominal shocks in accounting for real exchange rate fluctuations, in contrast with other studies that show that, in industrial countries, nominal shocks are more important in explaining real exchange rate fluctuations.
    Keywords: Real effective exchange rates , China ,
    Date: 2004–02–17
  15. By: Claudio Bravo-Ortega; Julian di Giovanni
    Abstract: This paper examines the impact of trade costs on real exchange rate volatility. We incorporate a multi-country Ricardian model of trade, based on the work of Eaton and Kortum (2002), into a macroeconomic model to show how bilateral real exchange rate volatility depends on relative technological differences and trade costs. These differences highlight a new channel, in which the similarity of a pair of countries' set of suppliers of traded goods affects bilateral exchange rate volatility. We then test the importance of this channel using a large panel of cross-country data over 1970-97, and find strong evidence supporting the channel.
    Date: 2005–01–25
  16. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: The founders of the Bretton Woods System 60 years ago were primarily concerned with orderly exchange rate adjustment in a world economy that was characterized by widespread restrictions on international capital mobility. In contrast, the rapid pace of financial globalization during recent years poses new challenges for the international monetary system. In particular, large gross cross-holdings of foreign assets and liabilities mean that the valuation channel of exchange rate adjustment has grown in importance, relative to the traditional trade balance channel. Accordingly, this paper empirically explores some of the interconnections between financial globalization and exchange rate adjustment and discusses the policy implications.
    Keywords: Globalization , Financial assets , Capital flows , Exchange rates , Emerging markets , Economic models ,
    Date: 2005–01–18
  17. By: Ariel Burstein; Martin Eichenbaum; Sergio Rebelo
    Abstract: Changes in the price of nontradable goods relative to tradable goods account for roughly 50 percent of the cyclical movements in real exchange rates.
    JEL: F31
    Date: 2005–10
  18. By: Dalia Hakura
    Abstract: The paper finds that exchange rate flexibility in emerging market countries has increased over the past decade. This "learning to float" appears to have involved a strengthening of monetary and financial policy frameworks aimed at directly addressing the key vulnerabilities that give rise to the "fear of floating." The results in the paper suggest that the trend toward greater exchange rate flexibility, alongside a strengthening of banking supervision, has afforded emerging market countries more monetary policy independence.
    Keywords: Emerging markets , Developed countries , Floating exchange rates , Monetary policy ,
    Date: 2005–06–01
  19. By: Silvia Sgherri
    Abstract: Under a flexible inflation targeting regime, should policymakers avoid any reaction to movements in the foreign exchange market? Using data for six advanced open economies explicitly targeting inflation, the paper examines empirically whether real exchange rate disequilibria systematically affect the conduct of monetary policy. Estimates indicate that monetary policy responses in inflation-targeting, open economies have changed significantly, as the institutional framework for the conduct of monetary policy has evolved. In particular, an explicit target for core inflation and a greater use of the expectation channel of monetary policy appear to be key features of the newest policy framework. In this context, central banks are unlikely to react to regular fluctuations in the exchange rate.
    Keywords: Inflation targeting , Interest rate policy , Exchange rates , Monetary policy ,
    Date: 2005–09–20
  20. By: Alain Borghijs; Louis Kuijs
    Abstract: Central European accession countries (CECs) are currently considering when to adopt the euro. From the perspective of macroeconomic stabilization, the cost or benefit of giving up a flexible exchange rate depends on the types of asymmetric shocks hitting the economy and the ability of the exchange rate to act as a shock absorber. Economic theory suggests that flexible exchange rates are useful in absorbing asymmetric real shocks but unhelpful in the case of monetary and financial shocks. For five CECs-the Czech Republic, Hungary, Poland, the Slovak Republic, and Slovenia-empirical results on the basis of a structural VAR suggest that in the CECs the exchange rate appears to have served as much or more as an unhelpful propagator of monetary and financial shocks than as a useful absorber of real shocks.
    Keywords: Exchange rates , Czech Republic , Hungary , Poland , Slovak Republic , Slovenia ,
    Date: 2004–01–23
  21. By: Sarma Jayanthi; Tamim A. Bayoumi; Jaewoo Lee
    Abstract: This paper describes the result and the methodology of updating nominal and real effective exchange rate weights on the basis of trade data over 1999-2001. The underlying framework is an updated version of the IMF's current effective exchange rate calculation, which uses weights largely based on 1989-91 data. Since then, substantial changes have occurred in international trade relations, warranting a recalculation of effective exchange rate indices on the basis of new trade patterns. Updated weights show that the United States and developing countries (most notably China) have grown in their importance in global trade, while Japan and the European Union have declined, with substantial implications for the path of the dollar and exchange rate effects of emerging market crises since 1995.
    Keywords: Interest rates , Exchange rates , Economic models ,
    Date: 2005–06–01
  22. By: Rodney Ramcharan
    Abstract: Does the choice of exchange rate regime affect the way an economy's adjustment to real shocks? Exploiting the randomness of natural shocks, this paper assesses empirically the often contrasting answers found in the theoretical literature. The evidence supports key themes in this literature, and points to an important tradeoff between regimes. First, adverse natural shocks are associated with both higher investment and foreign direct investment (FDI) only in developing countries with fixed rate regimes. Second, over a 24-month horizon, growth rebounds earlier in flexible rate regimes. Third, in the long run, more adverse shocks are associated with higher growth and investment only in predominantly fixed regimes. Thus, while claims of faster adjustment to real shocks under flexible rate arrangements have merit, so does the idea that exchange rate variability can impede investment. And the benefits from faster adjustment may come at the cost of foregoing the long run productivity benefits embodied in the larger investment response in fixed rate regimes.
    Keywords: Exchange rate regimes , Investment ,
    Date: 2005–05–10
  23. By: Emilia Magdalena Jurzyk; Bernhard Fritz-Krockow
    Abstract: This paper examines the relationship between fixed exchange rate arrangements and trade using a gravity model of international trade together with bilateral trade data from 24 countries from the Caribbean and Latin America for the period 1960-2001. The analysis indicates that a credible fixed peg has a positive impact on the value of bilateral trade. Moreover, the positive impact on trade is more pronounced with a stricter definition of the fixed peg or a longer duration of the peg. This supports the argument that the credibility of an exchange rate peg is an important element to determine bilateral trade. There is, however, no evidence to suggest that a currency union provides additional benefits.
    Keywords: Exchange rate regimes , Latin America , Bilateral trade , Currency pegs , Economic models ,
    Date: 2004–09–14
  24. By: Ivan Tchakarov; Selim Elekdag
    Abstract: The debate about the appropriate choice of exchange rate regime is fundamental in international economics. This paper develops a small open-economy model with balance sheet effects and compares the performance of fixed and flexible exchange rate regimes. The model is solved up to a second-order approximation which allows us to address the issue of risk and welfare rigorously. The paper identifies threshold levels of the debt-to-GDP ratio above which fixed exchange rate regimes are welfare superior to monetary policy rules that imply flexible exchange rate regimes. The results suggest that emerging market economies that suffer from a relatively high level of indebtedness and are constrained in their pursuit of optimal monetary policy, could find it beneficial to opt for a fixed exchange rate regime.
    Keywords: Exchange rate policy , Capital markets , Economic models ,
    Date: 2004–04–26
  25. By: Ashoka Mody; Eisuke Okada; Enrica Detragiache
    Abstract: A widely held nostrum is that countries should exit heavily managed exchange rate regimes when the going is good, rather than when the exchange rate is under pressure to depreciate. Have countries followed this advice in practice? And, if so, how good has the going been? We find that in the past 25 years or so, almost all exits to more flexible regimes were followed by a depreciation of the exchange rate, and that exits were about evenly divided between disorderly and orderly cases. A logit econometric model, indicates that the general circumstances of orderly and disorderly exits have been broadly similar: an overvalued real exchange rate, falling reserves, a difficult fiscal position, and high world interest rates. Wellestablished pegs were less likely to end.
    Keywords: Exchange rate regimes , Economic models ,
    Date: 2005–03–07
  26. By: Andrés Arias; Lei Zhang; A. Javier Hamann
    Abstract: Based on the observed behavior of monetary aggregates and exchange rates, we classify inflation-stabilization episodes into two categories: de facto exchange rate-based stabilizations (ERBS) and non-ERBS. Unlike the standard de jure ERBS studied in the literature, de facto ERBS encompass cases in which the central bank intervenes in the foreign exchange market but does not preannounce the use of an exchange rate anchor. The number of the de facto ERBS is twice as large as that of de jure ERBS. Output dynamics during disinflation do not differ significantly between these two groups. We conclude that empirical studies on the effects of exchange rate anchors must seek to disentangle the effects of their announcement from those related to their role in the remonetization process.
    Keywords: Monetary policy , Disinflation , Exchange rates , Economic stabilization ,
    Date: 2005–03–01
  27. By: Ivan Tchakarov; Selim Elekdag; Alejandro Justiniano
    Abstract: This paper develops a small open economy model where entrepreneurs partially finance investment using foreign currency denominated debt subject to a risk premium above and beyond international interest rates. We use Bayesian estimation techniques to evaluate the importance of balance sheet vulnerabilities combined with the presence of the financial accelerator for emerging market countries. Using Korean data, we obtain an estimate for the external risk premium, indicating the importance of the financial accelerator and potential balance sheet vulnerabilities for macroeconomic fluctuations. Furthermore, our estimates of the Taylor rule imply a strong preference to smooth both exchange rate and interest rate fluctuations.
    Keywords: Financial sector , Current account , Exchange rates , Savings , Economic models ,
    Date: 2005–03–14
  28. By: Eric Parrado
    Abstract: This paper provides a simple dynamic neo-Keynesian model that can be used to analyze the impact of monetary policy that considers inflation targeting in a small open economy. This economy is characterized by imperfect competition and short-run price rigidity. The main findings of the paper are that, depending on what shocks affect the economy, the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime and the inflation index being targeted. First, in the presence of real shocks, flexible exchange rates dominate managed exchange rates, while for nominal shocks the reverse is true. Second, domestically generated inflation targeting is preferable to CPI inflation targeting, because the former is more stabilizing not only in relation to both measures of inflation, but also to the output gap and the real exchange rate. Finally, flexible inflation targeting outperforms strict inflation targeting in terms of welfare.
    Keywords: Inflation targeting , Exchange rates , Monetary policy , Economic models ,
    Date: 2004–02–20
  29. By: Yin-Wong Cheung; Menzie David Chinn; Antonio Garcia Pascual
    Abstract: We reassess exchange rate prediction using a wider set of models that have been proposed in the last decade. The performance of these models is compared against two reference specifications-purchasing power parity and the sticky-price monetary model. The models are estimated in first-difference and error-correction specifications, and model performance is evaluated at forecast horizons of 1, 4, and 20 quarters, using the mean squared error, direction of change metrics, and the "consistency" test of Cheung and Chinn (1998). Overall, model/specification/currency combinations that work well in one period do not necessarily work well in another period.
    Keywords: Exchange rates , Monetary measures , Productivity , Interest rates , Purchasing power parity , Forecasting models ,
    Date: 2004–05–14
  30. By: Boileau Loko; Anita Tuladhar
    Abstract: This paper seeks to investigate the transmission mechanisms linking productivity to the real exchange rate in the former Yugoslav Republic of Macedonia. At first glance, the stylized facts-low labor productivity growth and a trend real depreciation-suggest that a Balassa- Samuelson effect is in play. We find that the relationship between the two is not a result of the traditional Balassa-Samuelson effect. Instead, the depreciation of the real exchange rate reflects mainly the behavior of prices in the tradable sector. We argue that the depreciating real exchange rate may reflect a prolonged transition associated with slow technological growth and the low quality of the country's tradable-goods basket.
    Keywords: Productivity , Yugoslavia , Labor markets , Real effective exchange rates ,
    Date: 2005–06–16
  31. By: Jorge A. Chan-Lau
    Abstract: Policy makers have expressed interest in fostering the development of local foreign exchange derivatives markets with a view to reducing risks arising from currency mismatches between assets and liabilities in the corporate sector. This paper assesses foreign exchange exposure in the corporate sector in Chile, analyzes the current state of the foreign exchange derivatives market in Chile, and argues that liquid and developed foreign exchange derivatives markets can help promote financial stability.
    Keywords: Foreign exchange , Chile , Markets , Currencies ,
    Date: 2005–03–04
  32. By: Noureddine Krichene
    Abstract: Option prices provide valuable information on market expectations. This paper attempts to extract market expectations, as conveyed by an implied risk-neutral probability distribution, from option prices for the dollar-euro exchange rate. Returns' volatilities are inferred from observed and interpolated option prices. To address robustness, two distributions, one from actual data and the other from interpolated data, were computed. The main conclusion of the paper is that traders have wide-ranging expectations, and large movements in either direction would not occur as a surprise. The main implication for monetary policy is that should markets become too volatile, then intervention may be required.
    Keywords: Emerging markets , Euro , U.S. dollar , Exchange rates , Prices , Economic models ,
    Date: 2004–10–22
  33. By: Norbert Funke; Faisal Ahmed; Rabah Arezki
    Abstract: Over the past decade, South Africa has attracted relatively little foreign direct investment (FDI), but considerable amounts of portfolio inflows. In this context, the objective of the paper is twofold: to identify the determinants of the level and composition of capital flows to emerging markets and to draw policy conclusions for South Africa. We estimate a dynamic panel for up to 81 emerging markets using GMM (Generalized Method of Moments) techniques. The results suggest that further trade and capital control liberalization would increase the share of FDI. Additionally, a reduction in exchange rate volatility would affect the composition of capital flows in favor of FDI.
    Keywords: Capital flows , South Africa , Exchange rates , Foreign investment ,
    Date: 2005–03–11
  34. By: Ansgar Belke (University of Hohenheim and IZA Bonn); Bernhard Herz (University of Bayreuth); Lukas Vogel (University of Bayreuth)
    Abstract: We test the significance of the relationship between the exchange rate regime and the degree of structural reforms by estimating panel regressions for a world and an OECD country sample. The empirical results suggest a positive correlation between on the one side the adoption of an exchange rate rule and on the other side overall structural reforms as well as reforms in the money and banking sector in the broad country sample. For government size and for market regulation, we do not find any robust significant effect, however. The results do not confirm the main implication of Calmfors-type models, namely a higher degree of reforms under monetary policy autonomy. They corroborate conditional policy convergence and, partly, that limiting monetary policy autonomy fosters structural reforms.
    Keywords: exchange rates, monetary policy regime, liberalisation, panel data, political economy of reform
    JEL: D78 E52 E61
    Date: 2005–10
  35. By: Ádám Kóbor; István P. Székely
    Abstract: The paper analyzes foreign exchange market volatility in four Central European EU accession countries in 2001-2003. By using a Markov regime-switching model, it identifies two regimes representing high- and low-volatility periods. The estimation results show not only that volatilities are different between the two regimes but also that some of the cross-correlations differ. Notably, cross-correlations increase substantially for two pairs of currencies (the Hungarian forint-Polish zloty and the Czech koruna-Slovak koruna) in the high-volatility period. The paper concludes by discussing the policy implications of these findings.
    Keywords: Exchange markets , Czech Republic , Hungary , Poland , Slovak Republic , Euro , Economic models ,
    Date: 2004–02–10
  36. By: Thomson Fontaine
    Abstract: This paper takes a step in empirically testing the implications of a number of theoretical models that attempt to highlight the dynamics behind currency crises. By focusing on countries with broadly disparate economic and political arrangements, the study attempts to determine the extent to which these variables matter in affecting the probabilities of currency crises occurring. The empirical findings provide support for the view that, in general, a deterioration in economic fundamentals and the pursuit of lax monetary policy can contribute to currency crises. The experiences of several emerging market economies suggests that the sustainability of exchange rate policy depends both on adequate policy responses to the shocks to the economy and on the fragility of the economic, financial, and political system.
    Keywords: Currencies , Developed countries , Emerging markets , Financial crisis , Exchange rates ,
    Date: 2005–02–02
  37. By: Sibel Yelten
    Abstract: This paper uses the Sjaastad model to estimate the optimal currency area for the Nepalese rupee and concludes that, currently, Nepal may be reasonably well off with its peg to the Indian rupee. As its economy opens and its trade base and trading partners expand, it may want to reevaluate whether moving toward an exchange rate basket including the U.S. dollar may be a better policy choice. The regression results indicate that, currently, the prices of imported goods in Nepal are solely influenced by India, suggesting that with the peg to the Indian rupee, Nepal can isolate the import side of its economy completely from external shocks. On the export side, the regression results indicate that Nepalese export prices seem, to a large extent, to be influenced by U.S. prices. However, the export price index had to be constructed, and the construction methodology is likely to entail an overestimation of the impact of the U.S. dollar.
    Keywords: Monetary unions , Nepal , Asia , Financial crisis , Exchange rates , Currencies , Currency pegs , Economic models ,
    Date: 2004–08–16
  38. By: Törbjörn I. Becker; Amadou N. R. Sy
    Abstract: Bid-ask spreads for Asian emerging market currencies increased sharply during the Asian crisis. A key question is whether such wide spreads were excessive or explained by models of bid-ask spreads. Precrisis estimates of standard models show that spreads during the crisis were in most cases tighter than spreads predicted by the models and there are few cases of excessive spreads. The result is largely explained by the substantial increase in exchange rate volatility during the crisis and to some extent by the level change. The empirical models have greater explanatory power for emerging- than for mature-market currencies.
    Keywords: Exchange markets , Asia , Financial crisis , Emerging markets , Currencies ,
    Date: 2005–03–01
  39. By: Nikolay Gueorguiev; Pelin Berkmen
    Abstract: In the near future, Romania will introduce inflation targeting and fully liberalize its capital account. This paper aims to analyze, in a dynamic general-equilibrium model with sticky prices and monopolistic competition, how these two profound changes will affect the ability of monetary policy to pursue its objective of price stability. In particular, the resilience of the current and future monetary policy regimes to shocks is evaluated against two welfare criteria: a standard central bank loss function containing the deviations of inflation, output, and the real exchange rate from their equilibrium values, and the compensating variation measure of Lucas (1987).
    Keywords: Inflation targeting , Romania , Monetary policy , Capital account liberalization ,
    Date: 2004–12–27
  40. By: Eric Parrado
    Abstract: The Monetary Authority of Singapore, instead of relying on short-term interest rates or monetary aggregates as its monetary policy instrument, conducts policy by managing the trade-weighted exchange rate index (TWI). This paper investigates how this operating procedure actually works. For empirical purposes, it assumes the authorities follow a reaction function that aims the TWI at stabilizing expected inflation and maintaining output at potential. A partial adjustment mechanism is included to dampen the actual changes in the exchange rate. The estimates confirm that the major focus of monetary policy in Singapore is controlling inflation. The estimated changes in the TWI track the actual change relatively well, and the estimated parameters are as expected. Accordingly, they support the hypothesis that monetary policy in Singapore can be described by a forward-looking policy rule that reacts to both inflation and output volatility. The results suggest that Singapore's monetary policy has mainly reacted to large deviations in the target variables, which is consistent with monetary policy's medium-term orientation.
    Keywords: Monetary policy , Singapore , Exchange rate policy , Inflation ,
    Date: 2004–02–05
  41. By: Jorge Iván Canales Kriljenko
    Abstract: The foreign exchange market microstructures in developing and transition economies are characterized by the results from the IMF's 2001 Survey on Foreign Exchange Market Organization. The survey found that these markets are usually unified onshore spot markets for U.S. dollars, where transactions are concentrated at the bank-customer level. The trading mechanisms are usually dealer or mixed dealer/auction markets; the degree of transparency is often low; settlement systems remain risky; and the scope for price discovery is variable.
    Keywords: Exchange markets , Developing countries , Transition economies ,
    Date: 2004–01–27
  42. By: Alfred A. Haug (Department of Economics, York University); Syed A. Basher (Department of Economics, York University)
    Abstract: We test long¨Crun PPP within a general model of cointegration of linear and nonlinear form. Nonlinear cointegration is tested with rank tests proposed by Breitung (2001). We start with determining the order of integration of each variable in the model, applying relatively powerful DF¨CGLS tests of Elliott, Rothenberg and Stock (1996). Using monthly data from the post¨CBretton Woods era for G¨C10 countries, the evidence leads to a rejection of PPP for almost all countries. In several cases the price variables are driven by permanent shocks that differ from the ones that drive the exchange rate. Also, nonlinear cointegration cannot solve the PPP puzzle.
    Keywords: Purchasing power parity; unit roots; nonlinear cointegration
    JEL: C22 F40
    Date: 2003–01

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