nep-ifn New Economics Papers
on International Finance
Issue of 2007‒06‒11
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. A Saddlepoint Approximation to the Distribution of the Half-Life Estimator in an Autoregressive Model: New Insights Into the PPP Puzzle By Qian Chen; David E. Giles
  2. Exchange Rate Fundamentals and Order Flow By Martin D. D. Evans; Richard K. Lyons
  3. Exchange Rate Pass-Through and Domestic Inflation: A Comparison between East Asia and Latin American Countries By ITO Takatoshi; SATO Kiyotaka
  4. Fiscal Shocks, the Trade Balance, and the Exchange Rate By Faik Koray; W. Douglas McMillin
  5. Estimation of the Equilibrium Real Exchange Rate in Russia: Trade-Balance Approach By Nadezhda Ivanova
  6. Interventions in the Foreign Exchange Market: Effectiveness of Derivatives and Other Instruments By Walter Novaes; Fernando N. de Oliveira
  7. Foreign Exchange, Interest and the Dynamics of Public Debt in Latin America By Carlos E. Schonerwald da Silva; Matías Vernengo
  8. Segmented Asset Markets and Optimal Exchange Rate Regimes By Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
  9. Bank Restructuring in Asia: Crisis management in the aftermath of the Asian financial crisis and prospects for crisis prevention -Malaysia- By ITO Takatoshi; HASHIMOTO Yuko

  1. By: Qian Chen (China Academy of Public Finance and Public Policy, Central University of Finance & Economics); David E. Giles (Department of Economics, University of Victoria)
    Abstract: We derive saddlepoint approximations for the density and distribution functions of the half-life estimated by OLS from an AR(1) or AR(p) model. Our analytic results are used to prove that none of the integer-order moments of these half-life estimators exist. This provides an explanation for the unreasonably large estimates of persistency associated with the purchasing power parity “puzzle”, and it also explains the excessively wide confidence intervals reported in the empirical PPP literature.
    Keywords: Saddlepoint approximation, half-life estimator, PPP puzzle
    JEL: C13 C22 F31 F41
    Date: 2007–05–28
  2. By: Martin D. D. Evans; Richard K. Lyons
    Abstract: We address whether transaction flows in foreign exchange markets convey fundamental information. Our GE model includes fundamental information that first manifests at the micro level and is not symmetrically observed by all agents. This produces foreign exchange transactions that play a central role in information aggregation, providing testable links between transaction flows, exchange rates, and future fundamentals. We test these links using data on all end-user currency trades received at Citibank over 6.5 years, a sample sufficiently long to analyze real-time forecasts at the quarterly horizon. The predictions are borne out in four empirical findings that define this paper's main contribution: (1) transaction flows forecast future macro variables such as output growth, money growth, and inflation, (2) transaction flows forecast these macro variables significantly better than the exchange rate does, (3) transaction flows (proprietary) forecast future exchange rates, and (4) the forecasted part of fundamentals is better at explaining exchange rates than standard measured fundamentals.
    JEL: F31 G12 G14
    Date: 2007–06
  3. By: ITO Takatoshi; SATO Kiyotaka
    Abstract: Currency crises, accompanied by large devaluation, tend to have significant impacts on the domestic economy. If the exchange rate also depreciates in real terms, the economy can take advantage of the export price competitiveness to promote its exports. In contrast, if the currency devaluation induces an increase in domestic inflation, the currency value in real terms will return toward the pre-crisis level, which results in a loss of the export price competitiveness and, hence, a slow recovery from the severe economic downturn. This paper analyzes the degree of domestic price responses to the exchange rate changes in crisis-hit countries in East Asian and Latina American countries and Turkey in order to reveal why the post-crisis inflation performance was very different across countries. The structural vector autoregression (VAR) technique is applied to examining exchange rate pass-through. The degree of exchange rate pass-through is found to be higher in Latin American countries and Turkey than in East Asian countries with a notable exception of Indonesia. In particular, Indonesia, Mexico, Turkey and, to a lesser extent, Argentina show a strong response of CPI to the exchange rate shock. More noteworthy is that excessive supply of base money played an important role in increasing the domestic inflation rate in Indonesia, while such effect is not observed in other countries, which indicates the importance of credible monetary policy committed to price stability in order to prevent the post-crisis inflation. Shock transmission from import prices or PPI to CPI is quite large in Indonesia, Mexico and Turkey. This finding implies that the channel of shocks at different stage of pricing chain may be an additional factor in high domestic inflation.
    Date: 2007–06
  4. By: Faik Koray; W. Douglas McMillin
    Abstract: This paper investigates empirically, using a VAR model, the response of the exchange rate and the trade balance to fiscal policy shocks for the U.S. economy during the period 1981:3-2006:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the trade balance improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising trade balance deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.
  5. By: Nadezhda Ivanova (CEFIR)
    Abstract: The paper estimates the equilibrium real exchange rate (ERER) in Russia for 1995-20065 using the partial-equilibrium version of the trade-balance approach. The three-good framework is applied, allowing distinction between the RER for imports and RER for exports. The terms of trade are viewed as exogenous. Russia’s export demand is regarded as infinitely price elastic, implying the estimation of export supply function. Russian imports are assumed to be demand determined. The estimation of the trade-volume equations is based on the search of cointegrating relationships. The import elasticities are in line with estimates obtained in other studies. The estimations for the export supply equation confirm “supply elasticity pessimism”. The ERER simulations reveal the degree of rouble overvaluation of 25%-40%, depending on the measure of the RER used, before the August 1998 crisis. In recent years, given the surge in oil prices and pro-active exchange rate policy of the Bank of Russia, the rouble appears to be substantially undervalued. In 2004-2006, given the surge in oil prices and pro-active exchange rate policy of the Bank of Russia, the rouble appears to be substantially undervalued: by 40-70% on average, depending on the measure of the RER used.
    Keywords: Equilibrium Real Exchange Rate, Trade Elasticities, Russia
    JEL: C22 E52 F4
    Date: 2007–05
  6. By: Walter Novaes (PUC/RJ); Fernando N. de Oliveira (IBMEC Business School - Rio de Janeiro and Central Bank of Brazil)
    Abstract: This paper discusses the effectiveness in Brazil of the traditional instruments of exchange rate interventions (spot interventions and interest rates) as well as instruments based on exchange rate derivatives (swaps and dollar indexed public bonds). We show that in periods of high volatility of the nominal exchange rate the instruments are not capable of significantly modifying the dynamics of the nominal exchange rate. In periods of low volatility of the nominal exchange rate, in contrast, both the traditional instruments and the derivative instruments are effective. These results are robust to the two techniques of estimation employed: GMM in continuous time and in discrete time.
    Keywords: Central Bank, intervention in the foreign exchange market, foreign exchange derivatives
    JEL: E58 F31 E52
    Date: 2007–06–05
  7. By: Carlos E. Schonerwald da Silva; Matías Vernengo
    Abstract: The relationship between the exchange rate and public debt is intermediated by two mechanisms. On the one hand, exchange rate devaluation implies higher payment on local currency over the debt denominated in foreign currency. On the other hand, the rise of public debt leads a perception of higher default risk, forcing capital outflows and a devaluation of the exchange rate. The present paper develops a simple model where the exchange is crucial to analyze public debt dynamics. The paper also discusses the recent trajectory of the public debt in Latin America. The dynamics of the exchange rate is important for developing countries that do not have strong currencies and have a significant portion of public debt denominated in US dollars (original sin). Also, primary budget surpluses were crucial for the consistent and significant reduction of the public debt-to-GDP ratio. Hence, the economic expansion has created a larger fiscal space for Latin American economies to expand infrastructure and social spending, and reduce unemployment levels.
    Keywords: Exchange Rate, Public Debt, Latin America
    JEL: F31 H60 O54
    Date: 2007–02
  8. By: Amartya Lahiri; Rajesh Singh; Carlos A. Vegh
    Abstract: This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction, alternative exchange rate regimes have different implications for real allocations in the economy. In particular -- and contrary to standard results under sticky prices -- we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.
    JEL: F3 F40 F41
    Date: 2007–06
  9. By: ITO Takatoshi; HASHIMOTO Yuko
    Abstract: This paper analyzes the bank restructuring process in Malaysia from the currency crisis of 1997 to present. Even though the banking sector in Malaysia had relatively lower NPLs compared to other Asian countries, financial sector suffered financial crisis and various problems emerged. This paper covers topics such as setting up financial restructuring agencies, a scheme of capital injection to weak banks, and a corporate restructuring process conducted by the Malaysian government. Plans of Mergers/ closures of banks, setting up an asset management company, a recapitalization agency, and a corporate debt restructuring committee, such as Pengurusan Danaharta Nasional Berhad (Danaharta), Danamodal Nasional Berhad (Danamodal), and the Corporate Debt Restructuring Committee (CDRC), were accompanied by several policy measures such as an exchange rate system pegged to the U.S. dollar, capital controls, and a fiscal stimulus package. Through these measures, the authorities, to some extent, succeeded in bringing down NPLs and in merging several banks to some extent. The reform was considered basically completed by 2002. The banking sector was reorganized with 10 banking groups, and two of the restructuring agencies were closed by 2003.
    Date: 2007–06

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