nep-ifn New Economics Papers
on International Finance
Issue of 2006‒11‒18
nineteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The short and long-run determinants of the real exchange rate in Mexico By Antonia López Villavicencio; Josep Lluís Raymond Bara
  2. Real equilibrium exchange rates. A panel data approach for advanced and emerging economies. By Antonia López Villavicencio
  3. Home bias in global bond and equity markets - the role of real exchange rate volatility By Michael Fidora; Marcel Fratzscher; Christian Thimann
  4. Price Impacts of Deals and Predictability of the Exchange Rate Movements By Takatoshi Ito; Yuko Hashimoto
  5. Optimal exchange rate regimes: Turning Mundell-Fleming's dictum on its head By Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
  6. Open Economy Codependence: U.S. Monetary Policy and Interest Rate Pass-through By Bluedorn, John; Bowdler, Christopher
  7. Pass through of exchange rates to consumption prices: What has changed and why? By Campa, Jose M.; Goldberg, Linda S.
  8. Exchange-Rate Arrangements and Financial Integration in East Asia: On a Collision Course? By Hans Genberg
  9. The Historical Origins of U.S. Exchange Market Intervention Policy By Michael D. Bordo; Owen Humpage; Anna J. Schwartz
  10. Aggregate Supply and Demand, the Real Exchange Rate and Oil Price Denomination By Yiannis Stournaras
  11. Market Power, Innovative Activity and Exchange Rate Pass-Through By Sophocles N. Brissimis; Theodora S. Kosma
  12. Central Bank Independence, Exchange Rate Policy and Inflation Persistence Empirical Evidence on Selected EMU Countries By Athanasios Papadopoulos; Moïse Sidiropoulos
  13. A Behavioral Finance Model of the Exchange Rate with Many Forecasting Rules By Paul De Grauwe; Pablo Rovira Kaltwasser
  14. Real Exchange Rate Dynamics and Output Contraction under Transition By Christos Papazoglou
  15. Domestic and Foreign Influences on Canadian Prices over Exchange Rate Cycles, 1974 to 1996 By Baldwin, John R.; Yan, Beiling
  16. Europe's Hard Fix: The Euro Area By Otmar Issing
  17. Financial Cooperation in East Asia By Kunimune, Kozo
  18. Capital Flows, Capital Account Liberalisation and the Mediterranean Countries By Heather D. Gibson; Nicholas T. Tsaveas; Thomas Vlassopoulos
  19. The Effect of the Euro on Foreign Direct Investment By Pavlos Petroulas

  1. By: Antonia López Villavicencio (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona); Josep Lluís Raymond Bara (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: This paper explores the real exchange rate behavior in Mexico from 1960 until 2005. Since the empirical analysis reveals that the real exchange rate is not mean reverting, we propose that economic fundamental variables affect its evolution in the long-run. Therefore, based on equilibrium exchange rate paradigms, we propose a simple model of real exchange rate determination which includes the relative labor productivity, the real interest rates and the net foreign assets over a long period of time. Our analysis also considers the dynamic adjustment in response to shocks through impulse response functions derived from the multivariate VAR model.
    Keywords: real exchange rate, purchasing power parity, Balassa-Samuelson effect, error correction models, bounds cointegration test.
    JEL: C32 F31 F41 F49
    Date: 2006–10
  2. By: Antonia López Villavicencio (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: Based on an behavioral equilibrium exchange rate model, this paper examines the determinants of the real effective exchange rate and evaluates the degree of misalignment of a group of currencies since 1980. Within a panel cointegration setting, we estimate the relationship between exchange rate and a set of economic fundamentals, such as traded-nontraded productivity differentials and the stock of foreign assets. Having ascertained the variables are integrated and cointegrated, the long-run equilibrium value of the fundamentals are estimated and used to derive equilibrium exchange rates and misalignments. Although there is statistical homogeneity, some structural differences were found to exist between advanced and emerging economies.
    Keywords: Equilibrium exchange rates, panel data, cointegration, emerging economies, misalignments, error correction models.
    JEL: C33 F31 F41
    Date: 2006–11
  3. By: Michael Fidora (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Christian Thimann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper focuses on the role of real exchange rate volatility as a driver of portfolio home bias, and in particular as an explanation for differences in home bias across financial assets. We present a Markowitz-type portfolio selection model in which real exchange rate volatility induces a bias towards domestic financial assets as well as a stronger home bias for assets with low local currency return volatility. We find empirical support in favour of this hypothesis for a broad set of industrialised and emerging market countries. Not only is real exchange rate volatility an important factor behind bilateral portfolio home bias, but we find that a reduction of monthly real exchange rate volatility from its sample mean to zero reduces bond home bias by up to 60 percentage points, while it reduces equity home bias by only 20 percentage points. JEL Classification: F30, F31, G11, G15.
    Keywords: Home bias, exchange rate volatility, risk, portfolio investment, global financial markets; capital flows.
    Date: 2006–10
  4. By: Takatoshi Ito; Yuko Hashimoto
    Abstract: This paper examines the price impact and the predictability of the exchange rate movement using the transaction data recorded in the electronic broking system of the spot foreign exchange market. The number of actual deals at the ask (or bid side) for a specified time interval may be regarded as "order flows" to buy (or sell) in Richard Lyons' work. First, the contemporaneous impact of order flows on the quote and deal prices are analyzed. Second, the price predictability is examined. Our forecasting equations of the exchange rate for the next X minutes (X=1, 5, 15, 30) show that coefficients are significantly different from zero in both 5-min and 1-min forecast horizons, but the significance disappears in the 30-minute interval. The t-statistics become larger as the prediction window becomes shorter. Price impacts of deals at one side of the market are significant but short-lived. Market participants, if they can observe and analyze all the transactions information in real time, may be able to extract information to predict the price movements in the following next few minutes.
    JEL: F31 F33 G15
    Date: 2006–11
  5. By: Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
    Abstract: A famous dictum in open economy macroeconomics -- which obtains in the Mundell-Fleming world of sticky prices and perfect capital mobility -- holds that the choice of the optimal exchange rate regime should depend on the type of shock hitting the economy. If shocks are predominantly real, a flexible exchange rate is optimal, whereas if shocks are mainly monetary, a fixed exchange rate is optimal. There is no obvious reason, however, why this paradigm should be the most appropriate one to think about this important issue. Arguably, asset market frictions may be as pervasive as goods market frictions (particularly in developing countries). In this light, we show that in a model with flexible prices and asset market frictions, the Mundell-Fleming dictum is turned on its head: flexible rates are optimal in the presence of monetary shocks, whereas fixed rates are optimal in response to real shocks. We thus conclude that the choice of an optimal exchange rate regime should depend not only on the type of shock (real versus monetary) but also on the type of friction (goods versus asset market).
    JEL: F41
    Date: 2006–11
  6. By: Bluedorn, John; Bowdler, Christopher
    Abstract: We analyze the international transmission of interest rates under pegged and non-pegged exchange rate regimes, demonstrating that transmission depends upon the informational properties of a base countryÂ’s interest rate change. We differentiate between interest rate movements which are predictable/unpredictable and dependent/independent (i.e., a function of non-monetary factors such as cost-push inflation). Under capital mobility, we show that predictable or dependent interest rate changes should elicit interest rate pass-through for an imperfectly credible peg that is less than unity, whilst interest rate changes that are unpredictable and independent should elicit pass-through greater than unity. Using a real-time identification of unpredictable and independent U.S. federal funds rate changes, we provide evidence consistent with these propositions. When the federal funds rate change is unpredictable and independent, the joint hypothesis of unit within-month pass-through to pegs and zero within-month pass-through to non-pegs cannot be rejected. The same hypothesis is strongly rejected following actual, aggregate federal funds rate changes which include predictable and dependent components. In a dynamic context, we find that maximum interest rate pass-through to pegs is delayed. Moreover, even though there is a full transmission of unpredictable and independent federal funds rate changes, they explain only a small portion of pegged regime interest rate changes. Keywords; interest rate pass-through, monetary policy identification, open economy trilemma, exchange rate regime. JEL Classification: F33, F41, F42
  7. By: Campa, Jose M. (IESE Business School); Goldberg, Linda S. (Bank of New York)
    Abstract: In this paper, we use cross-county and time series evidence to argue that retail price sensitivity to exchange rates may have increased over the past decade. This finding applies to traded goods, as well as to non-traded goods. We highlight three reasons for changing pass through at the level of retail prices of goods. First, pass through may have declined at the level of import prices, but the evidence is mixed over types of goods and countries. Second, there has been a large expansion of imported input use across sectors. This means that the costs of imported goods as well as home tradable goods have heightened sensitivity to import prices and exchange rates. The final channel we consider is whether there have been changing sector expenditures on distribution services, with the direction of change negatively correlated with pass through into final consumption prices. We find that this channel, which has been a means of insulating consumption prices from import content and exchange rates, has not systematically changed in recent years. The balance of effects weighs in favor of increased sensitivity of consumption prices to exchange rates, even if exchange-rate pass-through into import prices has declined for some types of goods.
    Keywords: Exchange rate; pass through; import prices; distribution margins; consumer prices; imported inputs;
    Date: 2006–09–11
  8. By: Hans Genberg (Hong Kong Monetary Authority)
    Abstract: Financial integration in Ease Asia is actively being pursued and will in due course lead to substantial mobility of capital between economies in the region. Plans for monetary cooperation as a prelude to monetary integration and ultimately monetary unification are also proposed. These plans often suggest that central banks should adopt some form of common exchange rate policy in the transition period towards full monetary union. This paper argues that this is a dangerous path in the context of highly integrated financial markets. An alternative approach is proposed where independent central banks coordinate their monetary policies through the adoption of common objectives and by building an appropriate institutional framework. When this coordination process has progressed to the point where interest rate developments are similar across the region, and if in the meantime the required institutional infrastructure has been build, the next step towards monetary unification can be taken among those central banks that so desire. The claim is that this transition path is likely to be robust and will limit the risk of currency crises.
    Keywords: Regional and International Currency Arrangements
    JEL: F41 F15 F33
    Date: 2006–05
  9. By: Michael D. Bordo; Owen Humpage; Anna J. Schwartz
    Abstract: The present set of arrangements for U.S. exchange market intervention policy was largely developed after 1961 during the Bretton Woods era. However, that set had important historical precedents. In this paper we examine precedents to current arrangements, focusing on three historical eras: pre-1934 operations; the Exchange Stabilization Fund operations beginning in 1934; and the Bretton Woods era. We describe operations by the Second Bank of the United States in the pre-Civil War period and then operations by the U.S. Treasury in the post-Civil War period. After establishment of the Federal Reserve in 1914, the New York Fed engaged in isolated exchange market policies in the 1920s and 1930s, first under the direction of the Governor Benjamin Strong until his death in 1928, thereafter, under the direction of his successor, George Harrison. We then examine operations of the Exchange Stabilization Fund that the Gold Reserve Act of 1934 created as a Treasury Department agency. We exploit unique unpublished sources to analyze its dealings with the Banque de France and the Bank of England before and after the Tripartite Agreement. Finally, based on a unique data set of all U.S. Treasury and Federal Reserve foreign-exchange transactions, we discuss U.S. efforts from 1961 through 1972 to defend the dollar's parity under the Bretton Woods system.
    JEL: E42 N10
    Date: 2006–11
  10. By: Yiannis Stournaras (Bank of Greece and University of Athens)
    Abstract: In an aggregate supply, aggregate demand model of an open economy with imperfect competition in labour and product markets, the effectiveness of monetary and fiscal policies depends on the degree of wage indexation, the exchange rate regime and the currency denomination of the international prices of raw materials, such as oil. In a two country world with a floating exchange rate, real consumer wage rigidity and the prices of imported raw materials fixed in the currency of Country 2, monetary policy is effective only in Country 2, but fiscal policy is relatively more effective in Country 1. These results may explain certain characteristics and have certain implications for economic policy in the US and the Eurozone.
    Keywords: Open economy macroeconomics, real exchange rate, oil price denomination
    JEL: F41 Q43
    Date: 2005–07
  11. By: Sophocles N. Brissimis (Bank of Greece, Economic Research Department and University of Piraeus); Theodora S. Kosma (Bank of Greece, Economic Research Department)
    Abstract: This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.
    Keywords: Exchange rate pass-through; market power; innovative activity; multivariate cointegration
    JEL: C32 F39 L13 O31
    Date: 2005–04
  12. By: Athanasios Papadopoulos (Department of Economics, University of Crete, Greece); Moïse Sidiropoulos (Université Louis Pasteur, FRANCE)
    Abstract: The purpose of this paper is to provide theoretical arguments and explore for empirical evidence for the rationale that low inflation persistence may be achieved either by setting up an independent Central Bank or by an exchange-rate based policy. Our theoretical analysis states that the degree of Central Bank independence and exchange rate policy changes affect the inflation persistence. In addition, our empirical analysis, which concerns with selected EMU countries (France, Germany, Greece, Italy and Spain for the period 1980-1998) validates the argument. In this exercise the most likely date for the change in regime is detected by a procedure based upon the recent work of Perron (1997), where the null hypothesis of a unit root is set against the alternative of stationarity about a single broken trend line.
    Keywords: Exchange rate policy, Central Bank independence, inflation persistence, EMU
    JEL: E31 E42 E58 C22
  13. By: Paul De Grauwe; Pablo Rovira Kaltwasser
    Abstract: This paper presents a behavioral finance model of the exchange rate. Agents forecast the exchange rate by means of very simple rules. They can choose between three groups of forecasting rules: fundamentalist, extrapolative and momentum rules. Agents using a fundamentalist rule are not able to observe the true value of the fundamental exchange and therefore have to rely on an estimate of this variable to make a forecast. Based on simulation analysis we find that two types of equilibria exist, a fundamental and a non-fundamental one. Both the probability of finding a particular type of equilibrium and the probability of switching between different types of equilibria depend on the number of rules available to agents. Furthermore, we find that the exchange rate dynamics is sensitive to initial conditions and to the risk perception about the underlying fundamental. Both results are dependent on the number of forecasting rules.
    JEL: C53 F31
    Date: 2006
  14. By: Christos Papazoglou (Bank of Greece, Economic Research Department and Panteion University)
    Abstract: Two major stylized facts that emerged during the early transition experience of the economies of Central and Eastern Europe were the fall in output and the appreciation of the real exchange rate. In this paper, we attempt to give a theoretical explanation, beyond that found in the existing literature, for the emergence of these two facts, which relies on the role of two basic characteristics of these economies in the early stages of transition. The first refers to their structure involving the existence of an almost liberalized price system for domestic output, a large part of which, however, was still produced by state firms and the second to the nature of the disturbances they initially encountered.
    Keywords: Transition economies, real exchange rate dynamics, output decline, structural reform, price liberalization.
    JEL: F41
    Date: 2005–11
  15. By: Baldwin, John R.; Yan, Beiling
    Abstract: The paper examines the pricing behaviour of 81 Canadian manufacturing industries from 1974 to 1996. It explores the domestic and foreign factors that affect price formation in Canada and the circumstances in which Canadian prices respond to foreign (U.S.) influences (the law of one price), as opposed to domestic factors (i.e., labour, energy costs and productivity growth). It finds that: (1) Canadian manufacturing prices are, on average, set using a mixture of a cost mark-up pricing rule and the law-of-one-price rule: both domestic factors (such as input prices and productivity) and foreign factors (such as competing U.S. prices) exert important influences on Canadian prices; (2) Canadian prices are more sensitive to U.S. prices if the industry faces higher import competition and if home and foreign products are less differentiated. Compared to prices of domestic products, prices of imported foreign products are more responsive to foreign prices. However, the price of imports also responds to Canadian prices; though this pricing-to-market phenomenon is reduced as imports increase in importance; (3) Industry differences exist. Domestic prices respond more to productivity changes in industries where competition is more intense and where products are more homogeneous. Imports respond more to domestic factors when they account for a smaller share of the domestic market; (4) As the pressure from foreign markets increases, in a period of an appreciating Canadian dollar, changes in prices are influenced more by fluctuations in foreign prices. In comparison, when the pressure from foreign markets decreases, in a period of a depreciating Canadian dollar, changes in Canadian prices are more responsive to input cost changes at home. Disequilibria that were generated by previous shocks are overcome more quickly during periods when the exchange rate appreciated.
    Keywords: National accounts, Manufacturing, Economic conditions, Industry measures and analysis, Manufacturing industries
    Date: 2006–11–08
  16. By: Otmar Issing ((European Central Bank))
    Keywords: Regional and International Currency Arrangements
    JEL: F41 F15 F33
    Date: 2006–05
  17. By: Kunimune, Kozo
    Abstract: This paper addresses the rationale for financial cooperation in East Asia. It begins by giving a brief review of developments after the Asian currency crisis, and argues that enhancing regional financial cooperation both quantitatively and qualitatively will require: (1) upgrading surveillance capabilities in the region, and (2) creating a clear division of labor between regional institutions and the IMF. It also mentions the issue of membership and the background forces that have led to the duplication of similar forums in East Asia. Although the concern over crisis management is the central issue in East Asian financial cooperation, other issues such as exchange rate policy coordination and fostering regional capital markets are discussed as well.
    Keywords: International Financial Cooperation, IMF, International finance, International cooperation, East Asia, Southeast Asia
    JEL: F36 O19 O53
    Date: 2006–08
  18. By: Heather D. Gibson (Bank of Greece, Economic Research Department); Nicholas T. Tsaveas (Bank of Greece, Economic Research Department); Thomas Vlassopoulos (Bank of Greece, Economic Research Department)
    Abstract: This paper examines questions related to possible capital account liberalisation in the Mediterranean countries. First, we provide an overview of the extent to which these countries have capital controls along with their exchange rate regimes and some basic macroeconomic aggregates. Second, we examine the case for capital account liberalisation, along with the prerequisites for successful liberalisation. Here we consider issues such as sequencing and possible benefits of synchronisation. Finally, we examine the experience with capital flows – both FDI and other capital flows. We explain these flows and use the past experience of these countries to draw some conclusions for the successful opening up of the capital account.
    Keywords: capital account liberalisation, Mediterranean countries, capital flows
    JEL: F32 F21 F36
    Date: 2006–02
  19. By: Pavlos Petroulas (Bank of Greece, Economic Research Department)
    Abstract: In this paper the recent effect of the European Monetary Union on inward FDI-flows is examined. We use a difference-in-differences approach for both a gravity based- as well as a general equilibrium approach. The estimated results show that the introduction of the euro raises inward FDI by 14 to 16 percent within the euro area by 11 to 13 percent from non-member and weakly by 8 percent to non-member countries. Moreover the geographical effects of the euro are explored. The results show partial agglomeration tendencies for the euro area. There are also some indications of increased importance of vertical specialization in the sample.
    Keywords: Foreign Direct Investment, EMU, Panel Data
    JEL: F21 F0 C23
    Date: 2006–10

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