nep-ifn New Economics Papers
on International Finance
Issue of 2007‒06‒02
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Home Bias and Purchasing Power Parity: Evidence from the G-7 Countries By Nikolaos Mylonidis; Dimitrios Sideris
  2. Long run macroeconomic relations in the global economy By Stephane Dees; Sean Holly; M. Hashem Pesaran; L. Vanessa Smith
  3. Fiscal Policy and the Exchange Rate-Current Account Nexus By Jun Il Kim
  4. The Dynamic Relationship between Stock Prices and Exchange Rates: evidence for Brazil By Benjamin M. Tabak
  5. Stiglitz Versus the IMF on the Asian Debt Crisis: An Intertemporal Model with Real Exchange Rate Overshooting By Kirsanova, Tatiana; Menzies, Gordon; Vines, David
  6. Nonlinear Mechanisms of the Exchange Rate Pass-Through: a Phillips curve model with threshold for Brazil By Arnildo da Silva Correa; André Minella
  7. Modeling and Forecasting the Malawi Kwacha-US Dollar Nominal Exchange Rate By Simwaka, Kisu

  1. By: Nikolaos Mylonidis (University of Ioannina); Dimitrios Sideris (Bank of Greece and University of Ioannina)
    Abstract: Recent studies in the international economics literature emphasize the role of home bias in explaining a number of empirical puzzles. In the present study, we test for the following hypotheses: (i) that a home bias effect, which is nevertheless falling over time as traded goods markets become more integrated and consumption preferences become more similar across developed countries, influences the relationship among nominal exchange rates, domestic prices and foreign prices, and (ii) that incorporation of the home bias effect in the empirical specification of PPP enhances the robustness of the theory. We perform a panel data analysis using quarterly observations for the G-7 economies in the post-Bretton Woods era. The results confirm our hypotheses.
    Keywords: PPP; Home bias; Panel data
    JEL: F31 C33
    Date: 2007–04
  2. By: Stephane Dees (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Sean Holly (Faculty of Economics and CIMF, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom.); M. Hashem Pesaran (Faculty of Economics and CIMF, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom.); L. Vanessa Smith (CEFAP, Judge Business School, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, United Kingdom.)
    Abstract: This paper focuses on testing long run macroeconomic relations for interest rates, equity, prices and exchange rates suggested by arbitrage in financial and goods markets. It uses the global vector autoregressive (GVAR) model to test for long run restrictions in each country/region conditioning on the rest of the world. Bootstrapping is used to compute both the empirical distribution of the impulse responses and the log-likelihood ratio statistic for over-identifying restrictions. The paper also examines the speed with which adjustments to the long run relations take place via the persistence profiles. We find strong evidence in favour of the UIP and to a lesser extent the Fisher equation across a number of countries, but our results for the PPP are much weaker. Also the transmission of shocks and subsequent adjustments in financial markets are much faster than those in goods markets. JEL Classification: C32, E17, F47, R11.
    Keywords: Global VAR, Fisher relationship, Uncovered Interest Rate Parity, Purchasing Power Parity, persistence profile.
    Date: 2007–05
  3. By: Jun Il Kim
    Abstract: By using a simple intertemporal model of the current account, I show that the exchange rate elasticity of the trade balance would ceteris paribus be smaller for countries with higher government spending ratios (relative to GDP) and with more limited scope for private consumption smoothing. This finding may have important implications for the design of adjustment programs and for resolving current global imbalances. It could also help explain and reconcile mixed empirical findings on trade elasticities.
    Keywords: Exchange rates , Current account , Balance of trade , Fiscal policy , Consumption , Economic models ,
    Date: 2007–02–06
  4. By: Benjamin M. Tabak
    Abstract: This paper studies the dynamic relationship between stock prices and exchange rates in the Brazilian economy. We use recently developed unit root and cointegration tests, which allow endogenous breaks, to test for a long run relationship between these variables. We performed linear, and nonlinear causality tests after considering both volatility and linear dependence. We found that there is no long-run relationship, but there is linear Granger causality from stock prices to exchange rates, in line with the portfolio approach: stock prices lead exchange rates with a negative correlation. Furthermore, we found evidence of nonlinear Granger causality from exchange rates to stock prices, in line with the traditional approach: exchange rates lead stock prices. We believe these findings have practical applications for international investors
    Date: 2006–11
  5. By: Kirsanova, Tatiana; Menzies, Gordon; Vines, David
    Abstract: This paper develops a real model of financial crisis, and uses it to elucidate the controversy between Joe Stiglitz and the IMF concerning the Asian financial crisis. Borrowers of foreign capital are bound by lending contracts to pay the world rate of return on their borrowing, following an adverse shock; by assumption, they do not default. This is onerous, since the shock makes the marginal product of capital fall to less than the world rate of return, and creates a debt overhang on which interest must be paid. The country faces a choice. It could choose to pay these extra interest obligations on its debt overhang -- a transfer -- in every period, raise taxes in order to meet these obligations, and thereby gradually reduce capital to its new lower level, at which point there would no longer be a debt overhang. We describe this as the `IMF strategy'. Alternatively the country could choose the `Stiglitz strategy': it could immediately borrow internationally the sum of all the future interest obligations on its debt overhang, perhaps with the assistance of the IMF. It would need to raise taxes in order to meet the interest costs on that extra borrowing. But the fiscal cost of doing this would be finite and the fiscal costs would be equally spread across time. The short run tax burden would thus be smaller. We show that balance sheet effects mean that the real exchange rate can greatly overshoot in the IMF strategy, whereas it need not overshoot in the Stiglitz strategy. That will lessen the `crisis' aspects of the short run responses to the shock.
    Keywords: debt overhang; financial crisis; fiscal adjustment
    JEL: F31
    Date: 2007–05
  6. By: Arnildo da Silva Correa; André Minella
    Abstract: This paper investigates the presence of nonlinear mechanisms of pass-through from the exchange rate to inflation in Brazil. In particular, it estimates a Phillips curve with a threshold for the pass-through. The paper examines whether the short-run magnitude of the pass-through is affected by the business cycle, direction and magnitude of exchange rate changes, and exchange rate volatility. The results indicate that the short-run pass-through is higher when the economy is growing faster, when the exchange rate depreciates above some threshold and when exchange rate volatility is lower. These results have important implications for monetary policy and are possibly related to pricing-to-market behavior, menu costs of price adjustment and uncertainty about the degree of persistence in exchange rate movements.
    Date: 2006–11
  7. By: Simwaka, Kisu
    Abstract: This study develops a blended version of the monetary and portfolio models for the MK/USD exchange rate, and assesses the forecasting performance of the model against a simple random walk. The results indicate that the model performs better than the simple random walk on the 6, 12 and 24 months forecasting horizons. However, the model does not perform well on the 3-month horizon, which is supported by theory suggesting that exchange rate movements are not driven by fundamentals in the short term. We also add a variable drift term to the random walk process and compare its performance against both the simple random walk and the fundamental model. The results show that random walk (with a variable drift) performs better than the other models in out-of-sample process at both short term and long term horizons. This result suggests that this (the random walk with a drift) process might be the best tool for exchange rate forecasting on all the forecast horizons. When it comes to exchange rate forecasting in the long term, a fundamental model might still be the best alternative. Regarding the structural model (with fundamental determinants of nominal exchange rate), the empirical results indicate that a worsening current account balance and decreases in net external flows result the depreciation of exchange rates. This is in line with practical experience. On the other hand, higher domestic interest rates have an insignificant impact on exchange rate. In an economy with several structural bottlenecks and poor infrastructural services, high interest rates cannot be expected to induce capital flows. A rise in domestic inflation is associated with a deprecated exchange rate. Lastly, consistent with theoretical expectations, another significant finding is that an easing in monetary policy (increase in money supply growth) is associated with a depreciation of the exchange rate. These findings lead us to make the following conclusions. Developments in the current account balance have implications on the exchange rate market. Measures aimed at improving the current account position, for example through exports, are also instrumental in stabilizing the exchange rate – through appreciation. Considering that Malawi has been traditionally depending on tobacco as its chief foreign exchange earner, and taking into account the anti-smoking campaign militating against the crop amidst low prices, it is imperative that Malawi should diversify into other foreign exchange earner (for instance tourism) in order to ensure macroeconomic stability, which itself is a pre-requisite for economic growth and therefore poverty reduction. Thus, policies that influence exports and imports of goods and services also determine exchange rate movements. Likewise, prospects concerning funding for a donor aid dependent economy like ours may influence the direction of market forces in determining the exchange rate movements. Big swings in external funding could cause instability Therefore, government’s credibility regarding the use of external public funds and implementation of related reforms is important in as far as stability of the foreign exchange market and overall macroeconomic stability are concerned. The insignificant impact of higher domestic interest on attracting capital flows calls for the need for government to address some structural bottlenecks. For instance, infrastructure services such road network and utilities (electricity and water supply) require improvement. Otherwise, currently, Malawi needs lower interest rates in order to reduce the cost of credit necessary for private sector development. The general picture from the results is that developments in the external sector of the economy, which are not under the ambit of domestic authorities, probably contributed more to fluctuations of the Malawi kwacha. If indeed the above diagnosis is accurate, the policy implications of government’s ability in influencing the behavior of the exchange rate is limited. This is because the ability of a small economy like that of Malawi to fully insulate itself from external shocks is constrained. It will mainly be confined to limiting the contributions of inconsistencies in domestic policy and administering some confidence building measures, at least in the short-term-to medium term It is worthy to note that divergent opinions exist as to the usefulness of devaluation (or depreciation) as a policy tool. There are those that believe devaluation as a policy tool can boost exports and so crate jobs. It should be noted however that since the kwacha was floated in 1994, it has been on a depreciating trend almost continuously without corresponding gains from the export sector. Without losing sight of the interest of exporters, it should be noted that a depreciated kwacha has implications in terms of increased import expenditures (oil import bill), government debt service, domestic inflation and cost of imported intermediate inputs. In the short term, what we should strive as a nation is to have a stable Malawi kwacha exchange rate. In the long run, the viable option is in ensuing a competitive export market is increased productivity among exporting firms. This may include export diversification and implementing measures to limit market imperfections.
    JEL: F31 F00
    Date: 2007–05–25

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