nep-ifn New Economics Papers
on International Finance
Issue of 2006‒09‒30
eight papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Accounting for the source of exchange rate movements: new evidence By Katie Farrant; Gert Peersman
  2. What Drives Heterogeneity in Foreign Exchange Rate Expectations : Deep Insights from a New Survey By Christian Dreger; Georg Stadtmann
  3. Foreign exchange market interventions as monetary policy By Post, Erik
  4. Real Exchange Rate Dynamics With Endogenous Distribution Costs By Mulraine, Millan L. B.
  5. Affine term structure models for the foreign exchange risk premium By Luca Benati
  6. Arbitrage and equilibrium in unbounded exchange economies with satiation By Cuong Le Van; Nizar Allouch; Frank H. Page
  7. Monetary Cooperation in the North American Economy By David Laidler
  8. Fiscal Policies, External Deficits, and Budget Deficits By Michel Normandin

  1. By: Katie Farrant; Gert Peersman
    Abstract: This paper analyses the role of the real exchange rate in a structural vector autoregression framework for the United Kingdom, euro area, Japan and Canada versus the United States. A new identification strategy is proposed building on sign restrictions. The results are compared to the benchmark conventional approach of Clarida and Gali based on long-run zero restrictions. Although the restrictions are derived from the same theoretical model, the results are strikingly different. In contrast to the benchmark model, an important role for nominal shocks in explaining real exchange rate fluctuations is found.
  2. By: Christian Dreger; Georg Stadtmann
    Abstract: Foreign exchange rate expectations play a central role in virtually all monetary models for the open economy. Therefore, it is extremely important to gain empirical insights into the expectations formation process. In this paper, we use a unique disaggregated data set to model the expectations of the Yen/USD exchange rate of about 50 leading foreign exchange rate professionals. The survey includes not only forecasts of the exchange rate, but also for macroeconomic fundamentals, like GDP growth, inflation, and interest rates. Different expectations of fundamentals might lead to different views of exchange rate dynamics. Using panel models, we are able to confirm the het-erogeneity of exchange rate expectations often detected by former authors. More impor-tant, we provide strong evidence regarding the likely source of heterogeneity. In line with forward looking models for the exchange rate, expected fundamentals have a sub-stantial impact on exchange rate expectations, thereby challenging the backward look-ing evidence of previous studies. However, the heterogeneity in the expectations of macroeconomic fundamentals is not sufficient to explain the heterogeneity in exchange rate expectations.
    Keywords: Exchange rate expectations, heterogeneity of expectations, expected fundamentals
    JEL: F31 F37 C23
    Date: 2006
  3. By: Post, Erik (Department of Economics)
    Abstract: This paper sets up a simple model for interventions and interest rate setting assuming that the policy maker cares about deviations in inflation from a target level. Under a quadratic cost of interest rate adjustments and interventions the policy maker should use a combination of interest rate adjustment and interventions. According to the model interventions (purchases of foreign currency) will be negatively correlated with interest rate deviations from the steady state level but positively correlated with interest rate deviations pertaining to non-stabilizing motives or a binding zero lower bound. The model also predicts that interventions will be decreasing in inflation expectations and in the real exchange rate but increasing the expected interventions. Interventions are shown to be positively serially correlated if the policy maker cares about the future. Following the theoretical model closely two sets of regression results are presented using both Two Stage Least Squares and an Ordered Probit model. The empirical analysis uses daily intervention data for Australia, Japan and Sweden. Overall, the predictions of the model is supported in most dimensions indicating that interventions have been used in a way that is consistent with monetary policy considerations.
    Keywords: foreign exchange interventions; monetary policy; central banks
    JEL: E52 E58 F31
    Date: 2006–09–26
  4. By: Mulraine, Millan L. B.
    Abstract: The importance of distribution costs in generating the deviations from the law of one price has been well documented. In this paper we show that a two-country flexible price dynamic general equilibrium model driven by exogenous innovations to technology, and with a localized distribution services sector can replicate the key dynamic features of the real exchange rate. In doing so, the paper identifies the importance of two key channels for real exchange rate dynamics. That is, we show: (i) that shocks in the real sector are important contributors to movements in the real exchange rate, and (ii) that the endogenous wedge created by distribution costs of traded goods is a significant source of fluctuation for the real exchange rate, and the overall macro-economy as a whole. The evidence presented here demonstrates that this model - without any nominal rigidities, can account for up to 89% of the relative volatility in the real exchange rate.
    Keywords: Distribution costs; Real exchange rate dynamics; Law of one price
    JEL: E32 F41 E37
    Date: 2006–09
  5. By: Luca Benati
    Abstract: This paper uses two affine term structure models from the Duffie-Kan class - a three-factor Cox-Ingersoll-Ross model, and a three-factor model in the spirit of Longstaff and Schwartz - to extract historical estimates of foreign exchange risk premia for the pound with respect to the US dollar. The term structures of interest rates for the two countries are estimated jointly, together with the dynamics of the nominal exchange rates between them, via maximum likelihood. The likelihood function is computed via the Kalman filter, and is maximised numerically with respect to unknown parameters. Particular attention is paid to the robustness of the results across models; to the overall (filter plus parameter) econometric uncertainty associated with risk premia estimates; and to the ability of estimated structures to replicate Fama's 'forward discount anomaly'. The paper's main results may be summarised as follows. First, risk premia estimates are not consistent across the two models. Second, both models fail to replicate the forward discount anomaly, with theoretical values of ? in the Fama regressions implied by estimated structures being consistently positive at all horizons from 1 to 12 months.
  6. By: Cuong Le Van (CES - Centre d'Economie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I]); Nizar Allouch (Queen Mary, University of London - [Queen Mary, University of London]); Frank H. Page (University of Alabama - [University of Alabama])
    Abstract: In his seminal paper on arbitrage and competitive equilibrium in unbounded exchange economies, Werner (Econometrica, 1987) proved the existence<br />of a competitive equilibrium, under a price no-arbitrage condition, without assuming either local or global nonsatiation. Werner's existence result<br />contrasts sharply with classical existence results for bounded exchange economies which require, at minimum, global nonsatiation at rational allocations.<br />Why do unbounded exchange economies admit existence without local or global nonsatiation? This question is the focus of our paper. First, we show that in unbounded exchange economies, even if some agents' preferences are satiated, the absence of arbitrage is suffcient for the existence of competitive equilibria, as long as each agent who is satiated has a nonempty set of useful net trades - that is, as long as agents' preferences satisfy weaknonsatiation. Second, we provide a new approach to proving existence in unbounded exchange economies. The key step in our new approach is to transform the original economy to an economy satisfying global nonsatiation such that all equilibria of the transformed economy are equilibria of the<br />original economy. What our approach makes clear is that it is precisely the condition of weak nonsatiation - a condition considerably weaker than local<br />or global nonsatiation - that makes possible this transformation.
    Keywords: Arbitrage, Asset Market Equilibrium, Nonsatiation, Recession Cones.
    Date: 2006–09–18
  7. By: David Laidler (University of Western Ontario)
    Abstract: The economic integration of North America, unlike that of Europe, has no parallels on the political front, and U.S. economic and political interests are world-wide, while those of Canada and Mexico are predominantly regional. These facts have important implications for the degree of policy integration, not least in monetary matters, that is feasible within NAFTA. Each member has an interest in the monetary stability of the others, but a common currency -- even a pegged exchange rate system -- is not desirable without a significantly greater degree of labour market integration than currently exists, and without a willingness on the part of the U.S. authorities to subordinate national to regional interests in their policy making. Absent these preconditions, monetary stability within NAFTA is best achieved by each country pursuing its own domestic stability, while maintaining the current high degree of formal and informal communications about economic conditions and policy intentions implicit in current arrangements.
    Keywords: NAFTA; economic integration; currency unions; exchange rate regimes; monetary policy; inflation targets
    JEL: E41 E58 E61 F15 F33 F42
    Date: 2006
  8. By: Michel Normandin
    Abstract: This paper studies the effects of fiscal policies on external and budget deficits. From a tractable small open-economy, overlapping-generation model, the effects are measured by the responses of the external deficit to an increase in the budget deficit due to a tax-cut. The responses are positively affected by the birth rate and the degree of persistence of the budget deficit. Empirical results for the G7 countries over the post-1975 period reveal that the values of birth rate are small for all, but one, countries; but the responses of external and budget deficits are substantial and persistent for most countries. In particular, the fiscal policy has the most important effects on the external deficits for Canada, Japan, and the United States; somewhat smaller impacts for France, Germany, and the United Kingdom; and negligible effects for Italy.
    Keywords: Agents' Superior Information, Birth Rate, Impact and Dynamic Responses, G7 Countries, Orthogonality Restrictions
    JEL: E62 F32 F41
    Date: 2006

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