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on International Finance |
| By: | Martin Bodenstein |
| Abstract: | The real exchange rate is very volatile relative to major macroeconomic aggregates and its correlation with the ratio of domestic over foreign consumption is negative (Backus-Smith puzzle). These two observations constitute a puzzle to standard international macroeconomic theory. This paper develops a two country model with complete asset markets and limited enforcement for international financial contracts that provides a possible explanation of these two puzzles. The model performs poorly with respect to asset pricing. However, with limited enforcement for both domestic and international financial contracts, the model's asset pricing implications are brought into line with the empirical evidence, albeit at the expense of raising real exchange rate volatility. |
| Keywords: | Foreign exchange rates |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:884&r=ifn |
| By: | Honohan, Patrick |
| Abstract: | Although the worldwide growth in dollarization of bank deposits has recently slowed, it has already reached very high levels in dozens of countries. Building on earlier findings that allowed the main cross-country variations in the share of dollars to be explained in terms of national policies and institutions, this paper turns to analysis of short-run variations, particularly the response of dollarization to exchange rate changes, which is shown to be too small to warrant ‘fear of floating’ by dollarized economies. But high dollarization is shown to increase the risk of depreciation and even suspension, as indicated by interest rate spreads. While specific policy is needed to deal with the risks associated with dollarization, the underlying causes of unwanted dollarization should also be tackled. |
| Keywords: | Banking; Developing countries; Dollarization; Exchange rates |
| JEL: | E44 F36 O24 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6205&r=ifn |
| By: | Eijffinger, Sylvester C W; Goderis, Benedikt |
| Abstract: | This paper examines the effect of monetary policy on the exchange rate during currency crises. Using data for a number of crisis episodes between 1986 and 2004, we find strong evidence that raising the interest rate: (i) has larger adverse balance sheet effects and is therefore less effective in countries with high domestic corporate short-term debt; (ii) is more credible and therefore more effective in countries with high-quality institutions; iii) is more credible and therefore more effective in countries with high external debt; and (iv) is less effective in countries with high capital account openness. We predict that monetary policy would have had the conventional supportive effect on the exchange rate during five of the crisis episodes in our sample, while it would have had the perverse effect during seven other episodes. For four episodes, we predict a statistically insignificant effect. Our results support the idea that the effect of monetary policy depends on its impact on fundamentals, as well as its credibility, as suggested in the recent theoretical literature. They also provide an explanation for the mixed findings in the empirical literature. |
| Keywords: | capital account openness; currency crises; external debt; institutions; monetary policy; short-term debt |
| JEL: | E52 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6217&r=ifn |
| By: | Joshua Hausman; Jon Wongswan |
| Abstract: | This paper documents the impact of U.S. monetary policy announcement surprises on foreign equity indexes, short- and long-term interest rates, and exchange rates in 49 countries. We use two proxies for monetary policy surprises: the surprise change to the current target federal funds rate (target surprise) and the revision to the path of future monetary policy (path surprise). We find that different asset classes respond to different components of the monetary policy surprises. Global equity indexes respond mainly to the target surprise; exchange rates and long-term interest rates respond mainly to the path surprise; and short-term interest rates respond to both surprises. On average, a hypothetical surprise 25-basis-point cut in the federal funds target rate is associated with about a 1 percent increase in foreign equity indexes and a 5 basis point decline in foreign short-term interest rates. A surprise 25-basis-point downward revision in the path of future policy is associated with about a ½ percent decline in the exchange value of the dollar against foreign currencies and 5 and 8 basis points declines in short- and long-term interest rates, respectively. We also find that asset prices’ responses to FOMC announcements vary greatly across countries, and that these cross-country variations in the response are related to a country’s exchange rate regime. Equity indexes and interest rates in countries with a less flexible exchange rate regime respond more to U.S. monetary policy surprises. In addition, the cross-country variation in the equity market response is strongly related to the percentage of each country’s equity market capitalization owned by U.S. investors (a financial linkage), and the cross-country variation in short-term interest rates’ responses is strongly related to the share of each country’s trade that is with the United States (a real linkage) |
| Keywords: | Interest rates ; Foreign exchange rates ; Monetary policy ; International finance |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:886&r=ifn |
| By: | Ilan Noy (Department of Economics, University of Hawaii at Manoa); Joseph P. Joyce (Department of Economics, Wellesley College) |
| Abstract: | We evaluate the claim that the International Monetary Fund precipitated financial crises during the 1990s by pressuring countries to liberalize their capital accounts prematurely. Using data from a panel of developing economies from 1982-98, we examine whether the changes in the regime governing capital flows took place during participation in IMF programs. We find evidence that IMF program participation is correlated with capital account liberalization episodes during the 1990s. We verify the robustness of our results using alternative indicators of capital account openness. To determine whether decontrol was premature, we compare the economic and financial characteristics of countries that decontrolled during IMF programs with those of countries who did so independently and find some evidence of IMF-led premature liberalizations. |
| Keywords: | IMF programs; capital account liberalization |
| JEL: | F3 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:hai:wpaper:200706&r=ifn |
| By: | Ilan Noy (Department of Economics, University of Hawaii at Manoa); Tam B. Vu (Department of Economics, University of Hawaii at Hilo) |
| Abstract: | We examine the impact of capital account policies on FDI inflows. Using an annual panel dataset of 83 developing and developed countries for 1984-2000, we find that capital account openness is positively but only very moderately associated with the amount of FDI inflows after controlling for other macroeconomic and institutional measures. To a large extent, other country characteristics seem to determine FDI inflows instead of capital account policies. Furthermore, we find that capital controls are easily circumvented in corrupt and politically unstable regimes. We conclude that liberalizing the capital account is not sufficient to generate increases in inflows unless it is accompanied by a lower level of corruption or a decrease in political risk. |
| Keywords: | Foreign direct investment, capital controls, capital flows, capital account liberalization |
| JEL: | F21 F36 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:hai:wpaper:200708&r=ifn |
| By: | Cédric Tille; Eric van Wincoop |
| Abstract: | The sharp increase in both gross and net international capital flows over the past two decades has prompted renewed interest in their determinants. Most existing theories of international capital flows are based on one-asset models, which have implications only for net capital flows, not for gross flows. Moreover, because there is no portfolio choice, these models allow no role for capital flows as a result of assets? changing expected returns and risk characteristics. In this paper, we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. After showing why standard first- and second-order solution methods no longer work in the presence of portfolio choice, we extend these methods, giving special treatment to the optimality conditions for portfolio choice. We apply our solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach identifies the time-varying portfolio shares that result from assets? time-varying expected returns and risk characteristics as a potential key source of international capital flows. |
| Keywords: | Capital movements ; International finance ; Portfolio management |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:280&r=ifn |
| By: | Roberto Frenkel |
| Abstract: | This article, originally published in Spanish in La Nación, December 31, 2006, explains the mechanics of the Argentine Central Bank's intervention in exchange rates markets to target a stable and competitive exchange rate, a macroeconomic policy that has played a significant role in Argentina's economic growth since 2002. |
| JEL: | E58 E52 E42 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:epo:papers:2007-3&r=ifn |
| By: | David, Antonio C. |
| Abstract: | The author evaluates the effectiveness of policy measures adopted by Chile and Colombia, aiming to mitigate the deleterious effects of pro-cyclical capital flows. In the case of Chile, according to his Generalized Method of Moments (GMM) analysis, capital controls succeeded in reducing net short-term capital flows but did not affect long-term flows. As far as Colombia is concerned, the regulations were capable of affecting total flows and a lso long-term ones. In addition, the co-integration models indicate that the regulations did not have a direct effect on the real exchange rate in the Chilean case. Nonetheless, the model used for Colombia did detect a direct impact of the capital controls on the real exchange rate. Therefore, the results do not seem to support the idea that those regulations were easily evaded. |
| Keywords: | Macroeconomic Management,Capital Flows,Economic Theory & Research,Economic Stabilization,Financial Economics |
| Date: | 2007–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:4175&r=ifn |
| By: | Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe |
| Abstract: | The key question asked by standard monetary models used for policy analysis is how do changes in short term interest rates affect the economy. All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:650&r=ifn |
| By: | martawardaya, Berly; Salotti, Simone |
| Abstract: | Policymakers in modern and open economies face a macroeconomic trilemma (Obstfeld, Shambaugh, and Taylor 2005). There are three main sought-after objectives: 1. to stabilize the exchange rate; 2. to enjoy free international capital mobility 3. to engage in a monetary policy oriented toward domestic goals. Three main questions that we try to answer are : How the crisis exacerbated by international investor racing to pull out their capital from affected coutnries? Can capital control reduce it? Can capital control reduce contagion effect and regional financial instability? Using game theoritical framework and insight from behavioral economics, we analyzed herd behaviour of international investors in the time of financial crisis. Under free international capital mobility, uncertainty and lack of coordination among investors with short-horizon, we found prisoner dilemma type of arrangement that exacerbated financial crisis. Applying the anylisis to multi-stage game with government, we found that a credible threat of capital control could reduce herd behaviour and escape the worst of financial crisis. Therefore, fredom to employ capital control is a policy tool that enable escape from the trilemma and pursue all three goals at the same time. We modify the framework to include multiple countries under financial crisis and fear of contagion. We found the ability to impose capital control, under certain conditions, will isolate the crisis and reduce contagion effect. We also explore the critical value when capital control should be enacted with regard to domestic economic condition, on which government political mandate base upon, and differences of reactions in relation to political regime. We conclude by citing incidences of insistance toward comitment against capital control by IMF in loans approcal and US in free trade agreement as misdirected, unncessesary and even harmful in some cases. |
| Keywords: | Asiena crisis; game theory; capital control |
| JEL: | F32 C72 |
| Date: | 2006–11–24 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:2073&r=ifn |