nep-ifn New Economics Papers
on International Finance
Issue of 2005‒10‒29
seventeen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Uncovered Interest Rate Parity and the Expectations Hypothesis of the Term Structure: Empirical Results for the U.S. and Europe By Ralf Brüggemann; Helmut Lütkepohl
  2. The Feasibility of a Fixed Exchange Rate Regime for New EU-members: Evidence from Real Exchange Rates By Bertrand Candelon; Clemens Kool; Katharina Raabe; Tom van Veen
  3. Exchange Rate Pass-Through to Domestic Prices in Pakistan By Zulfiqar Hyder; Sardar Shah
  4. New Evidence on the Puzzles. Results from Agnostic Identification on Monetary Policy and Exchange Rates. By Almuth Scholl; Harald Uhlig
  5. Global Imbalances and Exchange Rate Adjustment By José De Gregorio
  6. Has Exchange Rate Pass-Through Really Declined in Canada? By Hafedh Bouakez; Nooman Rebei
  7. Currency Manipulation versus Current Account Manipulation By Junning Cai
  8. Econometrics of the forward premium puzzle By Stephen E. Haynes; Avik Chakraborty
  9. External Debt and Exchange Rate Overshooting: The Case of Selected East Asian Countries By Victor Pontines; Reza Siregar
  10. The Role of Inflation Differentials in Regional Adjustment: Evidence from the United States By Ivo J.M. Arnold; Clemens J.M. Kool
  11. Real Exchange Rate Overshooting RBC Style By Patrick Minford; Prakriti Sofat; Eric Nowell; David Meenagh
  12. Robust Lessons about Practical Early Warning Systems By Beckmann, Daniela; Menkhoff, Lukas; Sawischlewski, Katja
  13. On the equality of Real Interest Rates across borders in Integrated Capital Markets By Patrick Minford; David Peel
  15. European Integration, FDI and the Internal Geography of Trade: Evidence from Western European Border Regions By Miren Lafourcade and Elisenda Paluzie
  16. Foreign Direct Investment, Regional Geographical and Market Conditions, and Regional Development: A Panel Study on China By Mei Wen
  17. Capital Controls: An Evaluation By Nicolas Magud; Carmen M. Reinhart

  1. By: Ralf Brüggemann; Helmut Lütkepohl
    Abstract: A system of U.S. and euro area short- and long-term interest rates is analyzed. According to the expectations hypothesis of the term structure the interest rate spreads should be stationary and according to the uncovered interest rate parity the difference between the U.S. and euro area longterm interest rates should also be stationary. If all four interest rates are integrated of order one, one would expect to find three linearly independent cointegration relations in the system of four interest rate series. Combining German and European Monetary Union data to obtain the euro area interest rate series we find indeed the theoretically expected three cointegration relations, in contrast to previous studies based on different data sets.
    Keywords: Expectations hypothesis of the term structure, uncovered interest rate parity, unit roots, cointegration analysis
    JEL: C32
    Date: 2005–04
  2. By: Bertrand Candelon; Clemens Kool; Katharina Raabe; Tom van Veen
    Abstract: In this paper, we estimate fundamental bilateral real exchange rates for a group of eight accession countries using a panel-cointegration approach for the period 19932003. We document a significant positive link between productivity levels and the corresponding real exchange rate levels. Future rises in productivity cannot be excluded on the basis of either our own analysis or the literature as a whole. Consequently, inflation pressure and real exchange rate appreciation in the accession countries probably remain a fact of life in the near future. The extent to which this is a problem for a fixed nominal exchange rate regime is hard to determine. Price dynamics in the accession countries are still quite flexible to accommodate substantial real exchange rate movements even when the nominal exchange rate is rather fixed; moreover, that price adjustment is mostly an internal process for the accession countries. Overall we conclude that a fixed exchange rate regime for each of the accession countries would be feasible in itself, despite possible future real exchange rate appreciations due to either the BalassaSamuelson effect or demand shifts. We find current misalignments to be small, robust and generally in line with the literature. This implies current exchange rate levels provide a reasonable indication of the level at which a parity exchange rate could be set.
    Keywords: real exchange rate, misalignments, Balassa-Samuelson, panel cointegration
    Date: 2005–03
  3. By: Zulfiqar Hyder (State Bank of Pakistan); Sardar Shah (State Bank of Pakistan)
    Abstract: This paper assesses the extent to which the movements in exchange rate affect domestic wholesale and consumer prices in Pakistan by analyzing data from January 1988 to September 2003. The empirical model is a recursive VAR, suggested by McCarthy (2000), incorporating a distribution chain of pricing. Impulse response function and variance decomposition are used to measure the exchange rate pass-through to domestic prices. The major findings of this paper are: (1) the exchange rate movements have only a moderate effect on domestic prices, i.e., exchange rate pass-through is low; (2) the exchange rate pass-through is more stronger in wholesale price index (WPI) relative to consumers price index (CPI); (3) the impact of pass-through on domestic prices spreads over 12 months, however, the effect is mostly felt in the first four months; (4) the exchange rate pass-through to consumer prices have further weakened after the free float of Rupee/Dollar parity in July 2000; (5) within the WPI commodity groups, the exchange rate pass- through is stronger in ‘Fuel & Lighting’ and ‘Manufactures’ groups while in the case of CPI, pass-through is more pronounced in ‘Transport & Communication’ and ‘Fuel & Lighting’ group. Furthermore, the exchange rate pass-through to domestic prices is much stronger in higher inflationary environment during Jan-88 to Dec-97 relative to lower inflationary environment down the road.
    Keywords: Exchange Rate Pass-through, Domestic Prices, Impulse Response Function, Variance Decomposition
    JEL: E
    Date: 2005–10–22
  4. By: Almuth Scholl; Harald Uhlig
    Abstract: Past empirical research on monetary policy in open economies has found evidence of the ’delayed overshooting’, the ’forward discount’ and the ’exchange rate’ puzzles. We revisit the effects of monetary policy on exchange rates by applying Uhlig’s (2005) identification procedure that involves sign restrictions on the impulse responses of selected variables. We impose no restrictions on the exchange rate to leave the key question as open as possible. The sign restriction methodology avoids the “price puzzles” of the identification strategies used by Eichenbaum-Evans (1995) and by Grilli-Roubini (1995, 1996), which are particularly pronounced, when using an updated data set. We find that the puzzles regarding the exchange rates are still there, but that the quantitative features are different. In response to US monetary policy shocks, the peak appreciation happens during the first year after the shock for the US-German and the US-UK pair, and during the first two years for the US-Japan pair. This is consirably quicker than the three-year horizon found by Eichenbaum-Evans. There is a robust forward discount puzzle implying a large risk premium. We study this issue, introducing and calculating conditional Sharpe ratios for a Bayesian investor investing in a hedged position following a US monetary policy shock. For foreign monetary policy shocks, we find more robust results than with the Grilli-Roubini recursive identification strategy: the posterior distribution regarding the exchange reaction looks rather similar across countries and VAR specifications. In particular, we find that there seems to be considerable uncertainty regarding the initial reaction of the exchange rate. Quantitatively, monetary policy shocks seem to have a minor impact on exchange rate fluctuations.
    Keywords: vector autoregressions, agnostic identification, forward discount bias puzzle, exchange rate puzzle, exchange rates, monetary policy
    JEL: C32 E58 F31 F42
    Date: 2005–07
  5. By: José De Gregorio
    Date: 2005–09
  6. By: Hafedh Bouakez; Nooman Rebei
    Abstract: Several empirical studies suggest that exchange rate pass-through has declined in recent years in industrialized countries. Results for Canada also indicate that, in the 1990s, import and consumer prices became less responsive to exchange rate movements. These findings are based on reducedform regressions that are typically motivated by partial-equilibrium models of pricing. Bouakez and Rebei instead use a structural, general-equilibrium approach to test the premise that exchange rate pass-through has decreased in Canada. Their approach consists in estimating a dynamic stochastic general-equilibrium model for Canada over two subsamples, which cover the periods before and after the Bank's adoption of inflation targeting. The authors then use impulse-response analysis to assess the stability of exchange rate pass-through across the two subsamples. Their results indicate that pass-through to Canadian import prices has been rather stable, while passthrough to Canadian consumer prices has declined in recent years. Counterfactual experiments reveal that the change in monetary policy regime is largely responsible for this decline.
    Keywords: Business fluctuations and cycles; Economic models; Exchange rates; Inflation and prices; International topics
    JEL: F3 F4
    Date: 2005
  7. By: Junning Cai (University of Hawaii at Manoa)
    Abstract: It is said that a country’s currency peg can become currency manipulation representing protracted government intervention in the foreign exchange market that gives it unfair competitive advantage in international trade yet prevents effective balance of payments in its trade partners. Regarding this widespread fallacy, this paper explains why currency peg is not currency manipulation even when it keeps a country’s currency undervalued. We clarify that 1) government is inherently a major player in the financial market and hence “no protracted intervention” is a meaningless guideline for designating currency manipulation; 2) exchange rate flexibility is neither a sufficient nor a necessary condition for fixing current account imbalance and hence currency peg would not prevent effective current account adjustments; and 3) as far as causing “unfair” trade advantage is concerned, currency peg is less guilty than the attempt to prevent or fix current account imbalance; and obligating a country to adjust its currency to accommodate its trade partners’ current account management would unfairly impair this country’s trade advantage.
    Keywords: currency manipulation; current account; exchange rate; RMB controversies
    JEL: E52 F31 F32
    Date: 2005–10–24
  8. By: Stephen E. Haynes; Avik Chakraborty (Department of Economics, University of Tennessee)
    Abstract: This paper explores from a new perspective the forward premium puzzle, i.e., why a regression of the change in the future spot exchange rate on the forward premium paradoxically yields a coefficient that is frequently negative. This traditional specification is compared theoretically and empirically to a "level" regression of the future spot rate on the current forward rate, which does not display the puzzle. We explore both non-rationality and risk premium explanations. The general conclusionis that, with non-rationality, any modest deviation from unity in the level coefficient becomes greatly magnified in the forward premium coefficient because of the stationary/nonstationary properties of the relevant variables, thereby generating the puzzle.
    Keywords: Forward premium puzzle, Spot and forward exchange rates, Foreign exchange market efficiency, Non-rationality in foreign exchange markets
    JEL: F30 F31
    Date: 2005–10–15
  9. By: Victor Pontines (University of Adelaide); Reza Siregar (University of Adelaide)
    Abstract: The accumulations of foreign debts had indeed been at a rapid phase, particularly during the last few years leading to the outbreak of the 1997 financial crises in the four most severely effected economies, namely Indonesia, the Philippines, Thailand and Korea. Interestingly, during the same period, the rates of overshooting of these East Asian currencies have also been found to increase considerably. The objective of this paper is to evaluate whether the rapid accumulation of external debts, especially since 1994, has contributed to the overshooting of the East Asian countries’ currencies starting late 1997.
    Keywords: External Debt, East Asian Countries, Exchange Rate and Overshooting
    JEL: F3 F4
    Date: 2005–10–21
  10. By: Ivo J.M. Arnold; Clemens J.M. Kool
    Abstract: Within a monetary union, regional inflation differentials lead to a competition between the real interest rate and wealth channels on the one hand and the real exchange rate channel on the other hand in the transmission of regional shocks. This may have implications for the length and vehemence of regional business cycles. This paper tries to quantify how these forces work against each other using regional data for the United States. Our estimates indicate that, following an increase in the regional inflation rate, in the short run the pro-cyclical effect through the real interest rate and wealth channels is strongest. After a period of about 3-4 years the cumulative worsening of the competitive position asserts its influence. Regional cycles in the housing market have a clear pro-cyclical effect and are, on their part, affected by regional real interest rates and real growth.
    Keywords: monetary union, regional effects, inflation differentials, monetary transmission
    JEL: E58
    Date: 2003–11
  11. By: Patrick Minford (Cardiff Business School); Prakriti Sofat (Cardiff Business School); Eric Nowell; David Meenagh (Cardiff Business School)
    Abstract: The objective of this paper is to establish the ability of a Real Business Cycle model to account for the behaviour of the real exchange rate (RXR), using UK experience as our empirical focus. We specify a dynamic general equilibrium open economy model based on optimising decisions of rational agents; the first order conditions from the households. and firms' optimisation problems are used to derive the behavioural equations of the model. As we model the UK, a medium-sized open economy, we take the world economy as given. We keep the model in its non- linear form and hence solve it numerically. The interaction with the rest of the world comes in the form of uncovered real interest rate parity and current account both of which are explicitly micro-founded. The paper discusses simulation results of a 1 percent productivity shock, which shows clearly that on impact RXR appreciates and then goes back to a new depreciated equilibrium, producing a business cycle. This deterministic simulation is very encouraging to the idea that the behaviour of RXR may be explicable within an RBC context. Ultimately to test whether our model is consistent with the facts, we bootstrap our model to generate pseudo RXR series and check if the ARIMA parameters estimated for the data lie within 95% confidence limits implied by our model. We find that our model tells quite a good story, the gyrations of the RXR can be explained within an RBC framework.
    Date: 2005
  12. By: Beckmann, Daniela; Menkhoff, Lukas; Sawischlewski, Katja
    Abstract: Early warning systems (EWSs) are subject to restrictions that apply to exchange rates in general: fundamentals matter but their influence is small and unstable. Despite this limitation four major lessons emerge: First, EWSs have robust forecasting power and thus help policy-makers to prevent crises. Second, policy-makers must decide about some EWSs elements, such as the sensitivity of the forecasts. Third, EWSs performance is increased by taking a logit model, shorter samples and a regional approach. Fourth, the finding of contagion may motivate policy to shield its economy against inefficient international financial markets.
    Keywords: early warning system, currency crises, emerging markets
    JEL: F33 F31
    Date: 2005–10
  13. By: Patrick Minford (Cardiff Business School); David Peel
    Abstract: The purpose in this letter is first to review briefly the empirical results on the relationship between real interest rates and real exchange rates; this empirical literature provides little support for the hypothesis of Roll that expected real interest rates are equal in general. Our second aim is to discuss the theoretical conditions that have to be met for his hypothesis to hold.
    Keywords: Real interest rates; Real Exchange rates; Roll
    JEL: F31 C22 C51
    Date: 2005
  14. By: Sarbajit Chaudhuri (Dept. of Economics, Calcutta University, India)
    Abstract: In a production structure reasonable for a developing economy this note shows that there may arise a conflict between the worldwide liberalized trade policies in agriculture, which raise the price of the economy’s primary exportable commodity, and the inflow of foreign capital into the economy. However, if the economy strictly adheres to the different facets of the agricultural trade liberalization policies, e.g. the removal of the indirect farm subsidies, the paper argues that the possible conflict may be avoided. The paper provides a theoretical basis for the removal of the farm subsidies if the economy wants to develop its technologically more advanced sectors with an adequate supply of foreign capital.
    Keywords: Liberalized trade policy in agriculture; foreign capital inflow; rate of return on foreign capital; fertilizer subsidy
    JEL: F10 F13 O19
    Date: 2005–10–23
  15. By: Miren Lafourcade and Elisenda Paluzie (Universitat de Barcelona)
    Abstract: In this paper we use a gravity model to study the trade performance of French and Spanish border regions relatively to non-border regions, over the past two decades. We find that, controlling for their size, proximity and location characteristics, border regions trade on average between 62% and 193% more with their neighbouring country than other regions, and twice as much if they are endowed with good cross border transport infrastructures. Despite European integration, however, this trade outperformance has fallen for the most peripheral regions within the EU. We show that this trend was linked in part to a shift in the propensity of foreign investors to move their affiliates from the regions near their home market to the regions bordering the EU core.
    Keywords: Trade, Gravity, Border Regions, European Integration, Foreign Direct Investment
    JEL: F15 F23 R12 R58
    Date: 2005
  16. By: Mei Wen
    Abstract: This paper uses regional panel data to investigate the mechanism of how FDI has contributed to China’s regional development through quantifying regional marketization level. It is found that FDI inflow generates a demonstration effect in identifying regional market conditions for investment in fixed assets and hence affects industrial location. In addition, its effects on regional export and regional income growth varied across east, central and west China since the second half of the 1990s, depending on FDI-orientation in different regions. In east China, geographical advantage in export attracts FDI inflow and FDI promotes export. In addition, rise of FDI-GDP ratio increases regional share in industrial value added in east China. These effects contribute positively to regional income growth in east China although there is a direct crowding out effect between FDI and domestic investment (as input) in growth. In contrast, the negative impact of FDI inflow in central China on regional export orientation weakens its contribution to regional income growth. Furthermore, contribution of improvement of market mechanism to regional development is evidenced in attracting FDI, in promoting export and directly contributing to regional income growth.
    Keywords: Export-oriented FDI and import substitute FDI, marketization, industrial location, and regional growth
    JEL: F23 O53 P52 R11
    Date: 2005
  17. By: Nicolas Magud (University of Oregon Economics Department); Carmen M. Reinhart (University of Maryland and NBER)
    Abstract: The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success” and (iv) the empirical studies lack a common methodology—furthermore these are significantly “overweighted” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies only in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia.
    Date: 2005–06–01

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