nep-ifn New Economics Papers
on International Finance
Issue of 2007‒08‒27
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rate Models Are Not as Bad as You Think By Charles Engel; Nelson C. Mark; Kenneth D. West
  2. Random Walk Expectations and the Forward Discount Puzzle By Philippe BACCHETTA; Eric VAN WINCOOP
  3. Canada's Pioneering Experience with a Flexible Exchange Rate in the 1950s: (Hard) Lessons Learned for Monetary Policy in a Small Open Economy By Michael Bordo; Ali Dib; Lawrence Schembri
  4. Aggregate Trading Behavior of Technical Models and the Yen/Dollar Exchange Rate By Stephan Schulmeister
  5. Currency Appreciation and Current Account Adjustment By Michael B. Devereux; Hans Genberg
  6. A Nash Threat Game of Passing Through Exchange Rate Mechanism II By Christian Fahrholz
  7. A Portfolio Theory of International Capital Flows By Michael B. Devereux; Makoto Saito
  8. The Illusion of Precision and the Role of the Renminbi in Regional Integration By Yin-wong Cheung; Menzie D. Chinn; Eiji Fujii
  9. Behavior Equilibrium Exchange Rate and Misalignment of Renminbi: A Recent Empirical Study By Jinzao Chen
  10. The impact exchange rate shocks on sectoral activity and prices in the euro area. By Elke Hahn
  11. Exchange-Rate Arrangements and Financial Integration in East Asia: On a Collision Course? By Hans Genberg

  1. By: Charles Engel; Nelson C. Mark; Kenneth D. West
    Abstract: Standard models of exchange rates, based on macroeconomic variables such as prices, interest rates, output, etc., are thought by many researchers to have failed empirically. We present evidence to the contrary. First, we emphasize the point that "beating a random walk" in forecasting is too strong a criterion for accepting an exchange rate model. Typically models should have low forecasting power of this type. We then propose a number of alternative ways to evaluate models. We examine in-sample fit, but emphasize the importance of the monetary policy rule, and its effects on expectations, in determining exchange rates. Next we present evidence that exchange rates incorporate news about future macroeconomic fundamentals, as the models imply. We demonstrate that the models might well be able to account for observed exchange-rate volatility. We discuss studies that examine the response of exchange rates to announcements of economic data. Then we present estimates of exchange-rate models in which expected present values of fundamentals are calculated from survey forecasts. Finally, we show that out-of-sample forecasting power of models can be increased by focusing on panel estimation and long-horizon forecasts.
    JEL: F31 F41
    Date: 2007–08
  2. By: Philippe BACCHETTA; Eric VAN WINCOOP
    Abstract: Two well-known, but seemingly contradictory, features of exchange rates are that they are close to a random walk while at the same time exchange rate changes are predictable by interest rate differentials. In this paper we investigate whether these two features of the data may in fact be related. In particular, we ask whether the predictability of exchange rates by interest differentials naturally results when participants in the FX market adopt random walk expectations. We find that random walk expectations can explain the forward premium puzzle, but only if FX portfolio positions are revised infrequently. In contrast, with frequent portfolio adjustment and random walk expectations, we find that high interest rate currencies depreciate much more than what UIP would predict.
    Keywords: excess returns; incomplete information; predictability
    JEL: E4 F3 G1
    Date: 2007–01
  3. By: Michael Bordo; Ali Dib; Lawrence Schembri
    Abstract: This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950–1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macroeconomic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result.
    Keywords: Exchange rates; Economic models
    JEL: E32 E37 F31 F32 N1
    Date: 2007
  4. By: Stephan Schulmeister (WIFO)
    Abstract: The study analyses the interaction between the trading behaviour of 1,024 moving average and momentum models and the fluctuations of the yen/dollar exchange rate. I show first that these models would have exploited exchange rate trends quite profitably between 1976 and 1999. I then show that the aggregate transactions and positions of technical models exert an excess demand pressure on currency markets since they are mostly at the same side of the market. When technical models produce trading signals they are either buying or selling, when they maintain open positions they are either long or short. A strong interaction prevails between exchange rate movements and the transactions triggered by technical models. An initial rise of the exchange rate due to news, e.g., is systematically lengthened through a sequence of technical buy signals.
    Keywords: Exchange rate, Technical Trading, Speculation, Heterogeneous Agents
    Date: 2007–06–08
  5. By: Michael B. Devereux (University of British Columbia); Hans Genberg (Hong Kong Monetary Authority, Hong Kong Institute for Monetary Research)
    Abstract: A central aspect of the recent debate on global imbalances and the US current account deficit is the role of the exchange rate peg being followed by China and other Asian economies. While one view has stressed the need for Asian currency appreciation, another focuses on the importance of fiscal adjustment and more generally adjustment in relative savings rates in the US and Asian economies. This paper develops a simple two-region open economy macroeconomic model to analyze the alternative impacts of currency appreciation and fiscal adjustment on the current account. We stress a number of structural features of emerging Asian economies that may make currency appreciation an ineffective means of current account adjustment relative to fiscal policy changes. In addition, we note that there may be a welfare conflict between regions on the best way to achieve adjustment.
    Keywords: Current Account, Currency Appreciation
    JEL: E52 E58 F41
    Date: 2006–12
  6. By: Christian Fahrholz (School of Business and Economics, Friedrich-Schiller University Jena, Germany.)
    Abstract: Following entrance into the European Union, Central Eastern European Countries (CEECs) are expected to join the European Monetary Union (EMU). These countries may incur considerable costs over the course of their passing through the required Exchange Rate Mechanism II (ERM-II). However, with enough bargaining leverage CEECs may be able to pass some of these costs on to current EMU-members. In turn, a CEEC's leverage depends on their ability to wield successful brinkmanship via an exchange-rate policy characterized by a 'threaten-thy-neighbor' strategy. A two-stage Nash-threat game captures the essentials of the CEECs' phase of ERM-II pass through.
    Keywords: Threat game, Nash-bargaining solution, exchange-rate policy, EU-enlargement, EMU
    JEL: C72 C78 F33 F51
    Date: 2007–08–22
  7. By: Michael B. Devereux (University of British Columbia); Makoto Saito (Hitotsubashi University)
    Abstract: This paper constructs a model in which the currency composition of national portfolios is an essential element in facilitating capital flows between countries. In a two country environment, each country chooses optimal nominal bond portfolios in face of real and nominal risk. Current account deficits are financed by increases in domestic currency debt, but balanced by increases in foreign currency credit. This is combined with an evolution of risk-premiums such that the rate of return on the debtor country¡¦s gross liabilities is lower than the return on its gross assets. This ensures stability of the world wealth distribution.
    Date: 2006–09
  8. By: Yin-wong Cheung (University of California, Santa Cruz); Menzie D. Chinn (University of Wisconsin, Madison and NBER); Eiji Fujii (University of Tsukuba)
    Abstract: The debate on renminbi (RMB) revaluation has not subsided, despite the policy change announced by the Chinese authorities in July 2005. In this chapter, we show that the evidence of RMB undervaluation may not be as strong as it appears. Specifically, depending on the method used, the evidence ranges from slight overvaluation to undervaluation. Even in the case of undervaluation, the results are not significant in the statistical sense. We also note that China is playing an important economic role in Asia and has established a complex production and trade network with its neighboring economies, which complicates the calculation of the equilibrium exchange rate. Thus, a change in Chinese exchange rate policy in response to demands from foreign countries and short-run considerations may have undesirable effects on the economies of China and the Asian region.
    Keywords: exchange rate policy, regional integration, market integration, purchasing power parity, Balassa-Samuelson, currency misalignment.
    JEL: F31 F41
    Date: 2006–12
  9. By: Jinzao Chen
    Abstract: This paper employs the behavioral equilibrium exchange rate (BEER) model to estimate the equilibrium real exchange rate of Renminbi (RMB) and the exchange rate misalignment in China, which covers the period from 1994q1 to 2006q2. Using the most precise and recent data, the main findings of the paper are that (1) since 1994q1, RMB equilibrium exchange rate has exhibited a steady appreciation, but from the 1999q3 to the recent period, it started to depreciate. And (2) that RMB real exchange rate has been under-valuated during the most part of sample period, but this misalignment has a trend to become smaller and small, and in recent after-reform period, a small degree of over-evaluation replaces this under-valuation.
    Keywords: Behavior equilibrium exchange rate, cointegration, misalignment, Renminbi
    JEL: F31 F32 F41 C32
    Date: 2007–06
  10. By: Elke Hahn (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: This paper investigates the impact of exchange rate shocks on sectoral activity and prices in the euro area. Using a VAR framework it provides evidence on the magnitude and speed of the impact of exchange rate shocks on activity in all main euro area sectors and on activity and producer prices in a large set of sub-sectors of industry (excluding construction). Substantial heterogeneity in the impact of exchange rate shocks across sectors is identified as regards both activity and prices. According to our results, among the main euro area sectors an exchange rate shock has the strongest impact on value added in industry (excl. construction) and trade and transportation services. Within industry (excl. construction), among its main sub-sectors all of the impact on production comes via manufacturing, while among the main industrial groupings (MIGs), capital and intermediate goods production respond most strongly. As regards the impact on prices, among the sub-sectors of industry (excl. construction), the impact is largest on producer prices in electricity, gas and water supply, and in line with this producer prices in MIG energy are most sensitive to an exchange rate shock. JEL Classification: C32, E31.
    Keywords: Exchange Rate Pass-Through, Sectoral Activity and Prices, Euro area.
    Date: 2007–08
  11. By: Hans Genberg (Hong Kong Monetary Authority, Hong Kong Institute for Monetary Research)
    Abstract: Financial integration in East 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.
    Date: 2006–11

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