nep-ifn New Economics Papers
on International Finance
Issue of 2006‒12‒04
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Can We Explain the Long-Term Real Equilibrium Exchange Rates through Purchasing Power Parity (PPP)?: An Empirical Investigation (1965 – 1995) By Feridun, Mete
  2. Time-Varying Exchange Rate Exposure and Exchange Rate Pass-Through By Kizys, Renatas; Pierdzioch, Christian
  3. Purchasing Power Parity: The Irish Experience Re-visited By Derek Bond; Michael J. Harrison; Edward J. O'Brien
  4. Monetary-Exchange Rate Policy and Current Account Dynamics By Malik, Hamza
  5. Structural Effects of a Real Exchange Rate Revaluation in China: A CGE Assessment By Willenbockel, Dirk
  6. Understanding the Backus-Smith Puzzle: It’s the (Nominal) Exchange Rate, Stupid By Hess, Gregory; Shin, Kwanho
  7. Monetary Policy before Euro Adoption: Challenges for EU New Members By Filacek, Jan; Horvath, Roman; Skorepa, Michal
  8. Reversibility of Different Types of Capital Flows to Emerging Markets By Sula, Ozan; Willett, Thomas D.
  9. East Asian Financial Crisis of 1997 Revisited: Is it Possible to Devise an Early Warning System? By Feridun, Mete

  1. By: Feridun, Mete
    Abstract: Purchasing Power Parity (PPP) is the most conventional and fundamental means through which the long-term equilibrium exchange rate can be explained. This article examines the monthly and quarterly data from January 1965 – Janu-ary 1995 aiming at testing the validity of PPP as a long-term equilibrium condi-tion for the bilateral exchange rates between US Dollar and the currencies of a set of five industrialized countries, namely Germany, France, Australia, Canada, and the United Kingdom, using Augmented Dickey Fuller (ADF) unit root test. Results indicate that both monthly and quarterly US Dollar – Canadian Dollar real exchange rates are stationary. In case of US Dollar – Australian Dollar real exchange rate, only monthly data is found to be stationary. Strong evidence emerges that US Dollar – French Franc, US Dollar – German Mark, and US Dollar – Great Britain Pound exchange rates are non-stationary, which invalidates the PPP hypothesis.
    Keywords: purchasing power parity; exchange rate determination; unit root test
    JEL: E00
    Date: 2005–02
  2. By: Kizys, Renatas; Pierdzioch, Christian
    Abstract: We report evidence of a time-varying link between returns on national stock market indexes and exchange rate returns (exchange rate exposure). We use this evidence to make inferences regarding the potential sources of changes over time in exchange rate pass-through. Using monthly data for 14 industrialized countries for the period 1975–2006, we document the existence of a long-run cointegration relation between exchange rate exposure and the industry composition of a country’s imports. The evidence of a cointegration relation between exchange rate exposure and openness to trade is weak. Our findings also suggest that, in the short run, exchange rate exposure is not endogenous to a country’s rate of inflation or to inflation uncertainty.
    Keywords: Stock market returns; exchange rate exposure; exchange rate pass-through
    JEL: F31 F37 G15
    Date: 2006–10
  3. By: Derek Bond (University of Ulster); Michael J. Harrison (Department of Economics, Trinity College); Edward J. O'Brien (European Central Bank)
    Abstract: This paper looks at issues surrounding the testing of purchasing power parity using Irish data. Potential difficulties in placing the analysis in an I(1)/I(0) framework are highlighted. Recent tests for fractional integration and nonlinearity are discussed and used to investigate the behaviour of the Irish exchange rate against the United Kingdom and Germany. Little evidence of fractionality is found but there is strong evidence of nonlinearity from a variety of tests. Importantly, when the nonlinearity is modelled using a random field regression, the data conform well to purchasing power parity theory, in contrast to the findings of previous Irish studies, whose results were very mixed.
    JEL: C22 F31 F41
    Date: 2006–11
  4. By: Malik, Hamza
    Abstract: A dynamic stochastic general equilibrium monetary model with incomplete and imperfect asset markets, monopolistic competition and staggered nominal price rigidities is developed to shed light on the role of exchange rate and its relation with current account dynamics in the formulation of monetary-exchange rate policies. The paper shows that because of incomplete risk sharing, due to incomplete asset markets, the dynamic relationship between real exchange rate and net foreign assets affect the behaviour of domestic inflation and aggregate output. This, in turn, implies that the optimal monetary policy entail a response to net foreign asset position or the real exchange rate gap defined as the difference between actual real exchange rate and the value that would prevail with flexible prices and complete asset markets. In comparing the performance of alternative monetary-exchange rate policy rules, an interesting and fairly robust result that stands out is that ‘dirty floating’ out-performs flexible exchange rate regime with domestic inflation targeting.
    Keywords: optimal monetary policy; incomplete asset markets; net foreign assets; current account dynamics; inflation targeting; exchange rate policy.
    JEL: E52 F41
    Date: 2005–08
  5. By: Willenbockel, Dirk
    Abstract: The misalignment of the Chinese currency exposed by the rapid build-up of China’s foreign exchange reserves over the past few years has been the subject of considerable recent debate. Recent econometric studies suggest a Renminbi undervaluation on the order of 10 to 30%. The modest revaluation of July 2005 is widely perceived as insufficient to correct China’s balance-of-payments disequilibrium and has not silenced charges that China is engaging in persistent one-sided currency manipulation. Within China there are widespread concerns regarding the adverse employment effects of a major revaluation on labour-intensive export sectors, yet the likely magnitude of these effects remains a controversial issue. The paper aims to shed light on this question by simulating the structural effects of a real exchange rate revaluation that lowers the current account surplus-GDP by 4 percentage-points using a 17-sector computable general equilibrium model of the Chinese economy.
    Keywords: Renminbi undervaluation; real exchange rate misalignment; applied general equilibrium analysis
    JEL: F40 F17 C68
    Date: 2006–04
  6. By: Hess, Gregory; Shin, Kwanho
    Abstract: Backus, Kehoe and Kydland (BKK 1992) showed that if international capital markets are complete, consumption growth correlations across countries should be higher than their corresponding output growth correlations. In stark contrast to the theory, however, in actual data the consumption growth correlation is lower than the output growth correlation. By assuming trade imperfections due to non-traded goods, Backus and Smith (1993) showed that there is an additional impediment that works to lower the consumption growth correlation. While Backus and Smith’s argument was successful in partially explaining the low growth correlation puzzle, it contributed to generating another puzzle because the data forcefully showed that consumption growth is negatively correlated with the real exchange rate, which is a violation of the theory. In this paper, by decomposing the real exchange rate growth of the OECD countries into the nominal exchange rate growth and the inflation differential, we find that nominal exchange rate movements are the main source for the Backus-Smith puzzle. We find that the nominal exchange rate moves counter-cyclically with consumption movements, which is a violation of the risk sharing theory with non-traded goods. We also find that the violations are more pronounced when nominal exchange rate changes are larger in absolute value . In contrast, the negative of bilateral inflation differentials is positively correlated with bilateral consumption movements. The latter finding is in accordance with the theory. Furthermore, using intranational data for the United States where the nominal exchange rate is constant, the Backus-Smith puzzle disappears, although complete risk sharing is rejected.
    Keywords: Risk Sharing; Exchange Rate
    JEL: F36 E44 E32 E21 F31
    Date: 2006–02
  7. By: Filacek, Jan; Horvath, Roman; Skorepa, Michal
    Abstract: This article analyzes the main issues for monetary policy in new EU member states before their euro adoption. These are typically rooted in the challenge of fulfilling concurrently of the Maastricht inflation and exchange rate criterion, as these countries are experiencing equilibrium real exchange rate appreciation. In this article we first distinguish between the wording, written interpretation and “revealed” interpretation of the inflation and exchange rate criteria. Then we discuss the options for monetary policy in the period of fulfilment of these criteria in terms of its transparency, its continuity with the previous monetary policy regime, the choice of central parity for the ERM II, the setting of the fluctuation bandwidth, the probability of fulfilment of both criteria and the impact on economic stability.
    Keywords: monetary policy; euro adoption; ERM II; EU
    JEL: E58 F42 F33 E52
    Date: 2006–09–25
  8. By: Sula, Ozan; Willett, Thomas D.
    Abstract: Most of the emerging market currency crises are accompanied by sharp reversals or “sudden stops” of capital inflows. We investigated whether some types of capital flows are more likely to reverse than others during these crises. Foreign direct investment is usually considered stable while portfolio investment is frequently depicted as the least reliable type of flow. Recent statistical testing has yielded conflicting results on this issue. We argue that a major problem with recent studies is that the degree of variability of capital flows during normal or inflow periods may give little clue to their behavior during crises and it is the latter that is most important for policy. Using data for 35 emerging economies for 1990 through 2003, we confirm that direct investment is the most stable category, but find that private loans on average are as reversible as portfolio flows.
    Keywords: Capital flows; currency crises; volatility of capital flows; reversibility of capital flows; Emerging Markets; private loans; portfolio flows; foreign direct investment.
    JEL: F32
    Date: 2006–01
  9. By: Feridun, Mete
    Abstract: This study examines the causes of the East Asian financial crisis and presents an early warning system based on data from Mmalaysia, Iindonesia, Tthailand, Ssingapore, and Pphilippines during 1982:1–1998:1 through a panel probit regression model using 20 monthly macroeconomic and financial sector variables. Results indicate that the significant variables are current account/GDPgdp, domestic credit/terms of trade, lending and deposit rate spread, and foreign direct investment/GDPgdp. Evidence further suggests that the probability of the crisis increases with an increase in domestic credit/Mm1, imports, and foreign direct investment/Tthe probability of the crisis increases with a decrease in exports, stock prices, terms of trade, current account, and lending and deposit rate spread. model correctly indicates 64% of the crises and 77% of the tranquil periods even with a cut-off probability of 10%.
    Keywords: Asian financial crisis; probit model; early warning systems
    JEL: F0
    Date: 2006–01
  10. By: Paulo Gala; Claudio R. Lucinda
    Date: 2006
  11. By: Christiane R. Albuquerque; Marcelo S. Portugal
    Date: 2006

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