nep-ifn New Economics Papers
on International Finance
Issue of 2005‒11‒05
sixteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange rate pass-through to import prices in the Euro area By Jose Manuel Campa; Linda S. Goldberg; Jose M. Gonzalez-Minguez
  2. Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets By Shu Wu
  3. A Re-Examination of the Border Effect By Yuriy Gorodnichenko; Linda Tesar
  4. Foreign Exchange Controls, Fiscal and Monetary Policy, and the Black Market Premium By Mohsen Fardmanesh; Seymour Douglas
  5. "Is Money Neutral in the Long Run?" By Burton Abrams; Russell Settle
  6. The duration of fixed exchange rate regimes By Sébastien Wälti;
  7. International Price Dispersion in State-Dependent Pricing Models By Virgiliu Midrigan
  8. The China Currency Problem: A Reply to Albert Keidel By Thomas I. Palley
  9. Monetary and Exchange Rate Policy Coordination in ASEAN 1 By William H. Branson; Conor N. Healy
  10. Monetary Policy under Sudden Stops By Vasco Cúrdia
  11. Exchange Market Pressure, Monetary Policy, and Economic Growth: Argentina in 1993 - 2004 By Clara Garcia; PNuria Malet
  12. Lessons from Italian Monetary Unification By James Foreman-Peck
  14. On the predictability of common risk factors in the US and UK interest rate swap markets: Evidence from non-linear and linear models. By Ilias Lekkos; Costas Milas; Theodore Panagiotidis
  15. How Important are Financial Frictions in the U.S. and Euro Area? By Queijo, Virginia
  16. Vertical specialization and the border effect puzzle By Kei-Mu Yi

  1. By: Jose Manuel Campa; Linda S. Goldberg; Jose M. Gonzalez-Minguez
    Abstract: This paper presents an empirical analysis of transmission rates from exchange rate movements to import prices, across countries and product categories, in the euro area over the last fifteen years. Our results show that the transmission of exchange rate changes to import prices in the short run is high, although incomplete, and that it differs across industries and countries; in the long run, exchange rate pass-through is higher and close to 1. We do not find compelling evidence that the introduction of the euro caused a structural change in exchange rate pass-through. Although some estimated point elasticities have declined, structural breaks in exchange rate pass-through into import prices are evident only in a limited sample of manufacturing industries. And since the euro was introduced, industries producing differentiated goods have been more likely to experience reduced rates of exchange rate pass-through to import prices. Exchange rate changes continue to lead to large changes in import prices across euro-area countries.
    Keywords: Imports - Prices ; Foreign exchange rates ; Euro ; Industries
    Date: 2005
  2. By: Shu Wu (Department of Economics, The University of Kansas)
    Abstract: This paper shows that even adjusted for the time-varying risk premiums implied by the yield curves across countries, uncovered interest parity is still strongly rejected by the data. Moreover, factors that predict the excess bond returns are found not significant at all in predicting the foreign exchange returns. These results reject the joint restrictions on the exchange rate and interest rates imposed by dynamic term structure models, suggesting that foreign exchange markets and bond markets may not be fully integrated and we have to look beyond interest rate risk in order to understand the exchange rate anomaly.
    Keywords: forward premium puzzle, the term structure of interest rates
    JEL: F31 G12
    Date: 2005–10
  3. By: Yuriy Gorodnichenko; Linda Tesar
    Abstract: This paper reexamines the evidence on the border effect, the finding that the border drives a wedge between domestic and foreign prices. We argue that the border effect can be inflated by the volatility and persistence of the nominal exchange rate and by the cross-country heterogeneity in the distribution of within-country price differentials. We develop a simple framework to separate the border effect from these confounding factors. Using price data from Engel and Rogers (1996) and Parsley and Wei (2001), we show that after controlling for the confounding factors the border effect between the U.S. and Canada and the U.S. and Japan is negligible.
    JEL: F3 F40 F41
    Date: 2005–10
  4. By: Mohsen Fardmanesh; Seymour Douglas
    Abstract: This paper examines the relationship between the official and parallel exchange rates, in three Caribbean countries, Guyana, Jamaica and Trinidad, during the 1985-1993 period using cointegration, Granger causality, and reduced form methods. The official and parallel rates are cointegrated in all three countries, but with significant average disparity between them in Guyana and Trinidad, which unlike Jamaica applied infrequent and large adjustments to their official rates. The causation is bi-directional in the case of Jamaica and uni-directional, with changes in the official rate Granger causing changes in the parallel rate, in the cases of Guyana and Trinidad, reflecting the difference in their official exchange rate policies. Our reduced form estimates indicate that exchange controls, expansionary fiscal and monetary policy, and changes of government mostly have the expected positive effect on the black market premium. After past values of the premium, exchange controls exert the strongest impact on the premium.
    Keywords: Foreign Exchange Controls, Black Market Exchange Rate, Black Market Premium, Cointegration, Granger Causality
    JEL: F31
    Date: 2003–12
  5. By: Burton Abrams (Department of Economics,University of Delaware); Russell Settle (Department of Economics,University of Delaware)
    Abstract: The traditional neoclassical open-economy flexible exchange rate model is expanded to include a “credit channel” by incorporating a bank loan market. The new “credit view” model provides substantially different predictions concerning the neutrality of money and the types of autonomous shocks that might affect the real exchange rate.
    Keywords: Credit Channel, Monetary policy, Fixed Exchange Rates, Money Neutrality
    JEL: F41 E51
    Date: 2005
  6. By: Sébastien Wälti; (Department of Economics, Trinity College Dublin; )
    Abstract: This paper studies the survival of fixed exchange rate regimes. The probability of an exit from a fixed exchange rate regime depends on the time spent within this regime. In such a context durations models are appropriate, in particular because of the possible non-monotonic pattern of duration dependence. Non-parametric estimates show that the pattern of duration dependence exhibits non-monotonic behaviour and that it differs across types of economies. This behaviour persists when we control for time-varying covariates in a proportional hazard specification. We conclude that how long a regime has lasted will affect the probability that it will end, in a non-monotonic fashion.
    JEL: F30 F31 F41
    Date: 2005–08
  7. By: Virgiliu Midrigan (Ohio State University)
    Abstract: Studies of disaggregated international price data document a robust, positive relationship between nominal exchange (NER) volatility and the variability of international relative prices. This relationship is interpreted as evidence that sticky prices rather than trade frictions are the source of the large law of one price deviations across locations. This paper shows that an explicitly micro-founded, menu-cost model predicts a hump-shaped rather than a monotonic relationship between relative price and nominal exchange rate volatility. The hump occurs at higher nominal exchange rate volatilities the less tradeable the goods are. We use this implication of the model to identify the size of the physical barriers that separate nations. Ad valorem trade costs as large as 50 percent are necessary for the model to generate the type of international relative price movements observed in the data.
    Keywords: PPP, Law of One Price, menu costs, trade costs
    JEL: E30 F41
    Date: 2005–11–01
  8. By: Thomas I. Palley
    Abstract: In a recent policy brief Albert Keidel (2005) argues that China’s exchange rate is not a problem, and that focusing on China’s currency is a risky distraction for U.S. economic policy. This paper replies to Keidel, and diametrically disagrees with his analysis. The paper has four principal conclusions which are: 1) China’s exchange rate is under-valued and is a significant problem; 2) The China exchange rate problem is part of a broader East Asian (and even global) exchange rate problem; 3) China needs to improve its performance regarding WTO compliance; and 4) Chinese manufacturing must shift from export-led growth to domestic demand-led growth.
    Date: 2005
  9. By: William H. Branson; Conor N. Healy
    Abstract: This paper develops the basis for monetary and exchange rate coordination in Asia as part of a package of monetary integration that could support growth and poverty reduction. This could be achieved directly through coordinated exchange rate stabilization, and indirectly through the implications of this for reserve pooling and investment in an Asian development fund (ADF) and through development of the Asian bond market (ABM). Macro policy coordination could be viewed as a necessary condition for further development of both reserve pooling via the Chiang Mai Initiative (CMI) and of the ABM. The paper analyzes the trade structure of ASEAN and China in terms of both geographic sources of imports and markets for exports, and of the commodity structure of trade. The similarities of the geographic and commodity trade structures across the region are consistent with adoption of a common currency basket for stabilization, and with an argument for monetary integration across the region along the lines of Mundell (1961) on optimum currency areas. The paper constructs currency baskets and real effective exchange rates (REERs) for the countries in the region. Since their trade patterns are quite similar and their policies are already implicitly coordinated, their REERs tend to move together. This means that ASEAN and China are already moving toward integration in practical effect. Explicit movement toward coordination could support surveillance and reserve-sharing under the CMI, and release reserves to be invested in an ADF.
    JEL: F33 F41 G15
    Date: 2005–10
  10. By: Vasco Cúrdia (Princeton University)
    Abstract: Emerging markets are often exposed to sudden stops of capital inflows. What are the effects of monetary policy in such an environment? To answer this question, the paper proposes a model with the typical elements of an emerging market economy. Credit frictions generate balance sheet effects, debt is denominated in foreign currency, production requires an imported input, and households have access to the international capital market only indirectly, through their ownership of leveraged firms. In the model, a sudden stop is generated by a change in the perceptions of foreign lenders, which leads to an increase in the cost of borrowing. The paper then compares the response of the economy to a sudden stop under alternative monetary policy rules. A first result is that the recession is most acute in a fixed exchange rate regime. Taylor rules reacting to inflation and output are more stabilizing. The comparison of policies also suggests that, rather than focus on whether to increase or decrease interest rates, it is more important to influence agents' expectations about future monetary policy. Furthermore, the flexible price equilibrium is attained if the monetary policy is set to completely stabilize the domestic price index.
    Keywords: sudden stops, monetary policy, emerging markets, financial crises
    JEL: E5 F3 F4
    Date: 2005–10–31
  11. By: Clara Garcia; PNuria Malet
    Abstract: The pressure in the exchange market against a particular currency has been frequently measured as the sum of the loss of international reserves plus the loss of nominal value of that currency. This paper follows the tradition of investigating the interactions between such measure of exchange market pressure (EMP) and monetary policy; but it also questions the usual omission of output growth in the empirical investigations of the interrelations between EMP, domestic credit, and interest rates. The focus of this work is Argentina between 1993 and 2004. As in previous studies, we found some evidence of a positive and double-direction relationship between EMP and domestic credit. But output growth also played a role in the determination of EMP, even more than domestic credit or interest rates. Also, there is some evidence that EMP affected growth negatively.
    Date: 2005
  12. By: James Foreman-Peck (Cardiff Business School)
    Abstract: This paper examines whether the states brought together in the Italian monetary union of the nineteenth century constituted an optimum monetary area, either before or after unification. Interest rate shocks indicate close relations between states in northern Italy but negative correlations between the North and the South before unification, suggesting some advantages of continued Southern monetary independence. The proportion of Southern Italian trade with the North was small, in contrast to intra- Northern trade, and therefore monetary independence imposed a light burden. Changes in the wheat market indicate that the South and North after unification (though not probably because of it) increasingly specialised according to their comparative advantages. Coupled with differences in economic behaviour of the Southern economy, this meant that monetary policies appropriate for the North were less so for the South. In the face of agricultural shocks originating in the New World and in France, the South would have gained from depreciating its exchange rate against the North or against the non-Italian world. As it was, nineteenth century Italian monetary union did not create the conditions for its own success, contrary to the findings of Frankel and Rose (1998) for the later twentieth century.
    JEL: E42 N23 F15 F33
    Date: 2005
  13. By: Philip Arestis; Guglielmo Maria Caporale; Andrea Cipollini; Nicola Spagnolo
    Abstract: In this paper we examine whether during the 1997 East Asian crisis there was any contagion from the four largest economies in the region (Thailand, Indonesia, Korea and Malaysia) to a number of developed countries (Japan, UK, Germany and France).Following Forbes and Rigobon (2002), we test for contagion as a significant positive shift in the correlation between asset returns, taking into account heteroscedasticity and endogeneity bias. Furthermore, we improve on earlier empirical studies by carrying out a full sample test of the stability of the system that relies on more plausible (over)identifying restrictions. The estimation results provide some evidence of contagion, in particular from Japan (the major international lender in the region), which drastically cut its credit lines to the other Asian countries in 1997.
    Date: 2005–04
  14. By: Ilias Lekkos (Eurobank Ergasias); Costas Milas (Keele University); Theodore Panagiotidis (Loughborough University)
    Abstract: This paper explores the ability of common risk factors to predict the dynamics of US and UK interest rate swap spreads within a linear and a non-linear framework. We reject linearity for the US and UK swap spreads in favour of a regime-switching smooth transition vector autoregressive (STVAR) model, where the switching between regimes is controlled by the slope of the US term structure of interest rates. The first regime is characterised by a "flat" term structure of US interest rates, while the alternative is characterised by an "upward" sloping US term structure. We compare the ability of the STVAR model to predict swap spreads with that of a non-linear nearest-neighbours model as well as that of linear AR and VAR models. We find some evidence that the nearest-neighbours and STVAR models predict better than the linear AR and VAR models. However, the evidence is not overwhelming as it is sensitive to swap spread maturity. We also find that within the non-linear class of models, the nearest-neighbours model predicts better than the STVAR model US swap spreads in periods of increasing risk conditions and UK swap spreads in periods of decreasing risk conditions.
    Keywords: Interest rate swap spreads, term structure of interest rates, regime switching, smooth transition models, nearest-neighbours, forecasting.
    JEL: C51 C52 C53 E43
    Date: 2005–09
  15. By: Queijo, Virginia (Institute for International Economic Studies, Stockholm University)
    Abstract: This paper aims to evaluate the importance of frictions in credit markets for business cycles in the U.S. and the Euro area. For this purpose, I modify the DSGE financial accelerator model developed by Bernanke, Gertler and Gilchrist (1999) and estimate it using Bayesian methods. The model is augmented with frictions such as price indexation to past inflation, sticky wages, consumption habits and variable capital utilization. My results indicate that financial frictions are relevant in both areas. Using the Bayes factor as criterion, the data favors the model with financial frictions both in the U.S. and the Euro area in five different specifications of the model. Moreover, the size of the financial frictions is larger in the Euro area.
    Keywords: DSGE models; Bayesian estimation; financial accelerator
    JEL: C11 C15 E32 E40 E50 G10
    Date: 2005–08–01
  16. By: Kei-Mu Yi
    Abstract: A large body of empirical research finds that a pair of regions within a country tends to trade 10 to 20 times as much as an otherwise identical pair of regions across countries. In the context of the standard trade models, the large “border effect” is problematic, because it is consistent only with high elasticities of substitution between goods and/or high unobserved national border barriers. The author proposes a resolution to this puzzle based on vertical specialization, which occurs when regions or countries specialize only in particular stages of a good’s production sequence. The author develops a Ricardian model of intra-national and international trade, and shows how endogenous vertical specialization magnifies the effects of border barriers such as tariffs. He calibrates the model to match relative wages, trade shares, and vertical specialization for the U.S. and Canada. The model implies a much smaller border barrier and border effect than previous estimates.
    Date: 2005

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