nep-ifn New Economics Papers
on International Finance
Issue of 2007‒11‒10
ten papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  2. A Monetary Approach to Exchange Rate Dynamics in Low-Income Countries: Evidence from Kenya By Nandwa, Boaz; Mohan, Ramesh
  3. Optimal monetary policy with a regime-switching exchange rate in a forward-looking model By Fernando Alexandre; Pedro Bação; John Driffill
  4. Foreign Capital and Economic Growth in the First Era of Globalization By Michael D. Bordo; Christopher M. Meissner
  5. Sticky prices and sectoral real exchange rates By Patrick J. Kehoe; Virgiliu Midrigan
  6. Optimal Informed Trading in the Foreign Exchange Market By Vitale, Paolo
  7. Modelling multilateral trade resistance in a gravity model with exchange rate regimes By Christopher Adam; David Cobham
  8. Theory and Empirics of Real Exchange Rates in Developing Countries By Raimundo Soto; Ibrahim A. Elbadawi.
  9. Exchange rate volatility and export performance: A cointegrated VAR approach By Pål Boug and Andreas Fagereng
  10. The Complex Response of Monetary Policy to the Exchange Rate By Costas Milas; Christopher Martin; Ram Sharan Kharel

  1. By: Juan Carlos Cuestas (Universidad de Alicante)
    Abstract: The aim of this paper is to analyse the empirical fulfilment of PPP in a number of Central and Eastern European countries. For this purpose we apply two different unit root tests in order to control for two sources of nonlinearities, i.e. Bierens (1997) and Kapetanios, Shin and Snell (2003). We find that PPP holds in most of these countries once account has been taken of nonlinear deterministic trends and smooth transitions.
    Keywords: PPP, Real Exchange Rate, Unit Roots, nonlinearities, Central and East Europe
    JEL: C32 F15
    Date: 2007–10
  2. By: Nandwa, Boaz; Mohan, Ramesh
    Abstract: The flexible price monetary model assumes that both the purchasing power parity (PPP) and uncovered interest parity (UIP) hold continuously. In addition, the model posits that money market equilibrium exists, which helps to determine the exchange rate. This paper explores exchange rate determination in low-income economies by applying a monetary model to Kenya to examine the exchange rate dynamics in a post-float exchange rate regime. We apply a multivariate cointegration and error correction model (ECM) to investigate whether the long-run exchange rate equilibrium and the rate of adjustment to the long-run equilibrium hold, respectively. Finally, we evaluate the relative performance of ECM versus a random walk framework in the out-of-sample forecasting. We find that the random walk performs better than the restricted model.
    Keywords: Exchange rate; volatility; regime changes; Kenyan Shilling
    JEL: C32 F31 E58 C53
    Date: 2007–11–02
  3. By: Fernando Alexandre (Universidade do Minho - NIPE); Pedro Bação (GEMF and Universidade de Coimbra); John Driffill (Birkbeck College, University of London)
    Abstract: We evaluate the macroeconomic performance of different monetary policy rules when there is exchange rate uncertainty. We do this in the context of a non-linear rational expectations model. The exchange rate is allowed to deviate from its fundamental value and the persistence of the deviation is modeled as a Markov switching process. Our results suggest that taking into account the switching nature of the economy is important only in extreme cases.
    Keywords: : Exchange Rates, Monetary Policy, Markov Switching.
    JEL: E52 E58 F41
    Date: 2007
  4. By: Michael D. Bordo; Christopher M. Meissner
    Abstract: We explore the association between economic growth and participation in the international capital market. In standard growth regressions, we find mixed evidence of any association between economic growth and foreign capital inflows. If there is an impact, it comes with a long lag and it is transitory having no impact on either the steady state or the short run growth rate. This suggests a view that there were long gestation lags of large fixed investments and it is also consistent with a neoclassical growth model. We also argue for a negative indirect channel via financial crises. These followed on the heels of large inflows and sudden stops of capital inflows often erasing the equivalent of several years of growth. We then take a balance sheet perspective on crises and explore other determinants of debt crises and currency crises including the currency composition of debt, debt intolerance and the role of political institutions. We argue that the set of countries that gained the least from capital flows in terms of growth outcomes in this period were those that had currency crises, foreign currency exposure on their national balance sheets, poorly developed financial markets and presidential political systems. Countries with credible commitments and sound fiscal and financial policies avoided major financial crises and achieved higher per capita incomes by the end of the period despite the potential of facing sudden stops of capital inflows, major current account reversals and currency crises that accompanied international capital markets free of capital controls.
    JEL: E22 F21 F32 F43 N1 N20
    Date: 2007–11
  5. By: Patrick J. Kehoe; Virgiliu Midrigan
    Abstract: The classic explanation for the persistence and volatility of real exchange rates is that they are the result of nominal shocks in an economy with sticky goods prices. A key implication of this explanation is that if goods have differing degrees of price stickiness then relatively more sticky goods tend to have relatively more persistent and volatile good-level real exchange rates. Using panel data, we find only modest support for these key implications. The predictions of the theory for persistence have some modest support: in the data, the stickier is the price of a good the more persistent is its real exchange rate, but the theory predicts much more variation in persistence than is in the data. The predictions of the theory for volatiity fare less well: in the data, the stickier is the price of a good the smaller is its conditional variance while in the theory the opposite holds. We show that allowing for pricing complementarities leads to a modest improvement in the theory’s predictions for persistence but little improvement in the theory’s predictions for conditional variances.
    Date: 2007
  6. By: Vitale, Paolo
    Abstract: We formulate a market microstructure model of exchange determination we employ to investigate the impact of informed trading on exchange rates and on foreign exchange (FX) market conditions. With our formulation we show how strategic informed agents influence exchange rates via both portfolio-balance and information effects. We outline the connection which exists between the private value of information, market efficiency, liquidity and exchange rate volatility. Our model is also consistent with recent empirical research on the microstructure of FX markets.
    Keywords: exchange rate dynamics; foreign exchange micro structure; order flow; private information
    JEL: D82 G14 G15
    Date: 2007–11
  7. By: Christopher Adam; David Cobham
    Abstract: In estimating a gravity model it is essential to analyse not just bilateral trade resistance, the barriers to trade between a pair of countries, but also multilateral trade resistance (MTR), the barriers to trade that each country faces with all its trading partners. Without correctly modelling MTR, it is impossible either to obtain accurate estimates of the effects on trade of exchange rate regimes and other variables or to perform accurate counterfactual simulations of trade patterns under other assumptions about exchange rate regimes or other variables. In this paper we implement a number of different ways of modelling MTR – both for a standard gravity model and for an extended model which includes a full range of bilateral exchange rate regimes – notably several variants of the technique developed by Baier and Bergstrand (2006), which turn out to produce broadly similar results. We then illustrate our preferred approach by carrying out simulations of the effects of the creation of an East African currency union and the effects of a withdrawal from EMU by Italy.
    Keywords: gravity, geography, trade, exchange rate regime, currency union, transactions costs, multilateral trade resistance.
    JEL: F10 F33 F49
    Date: 2007–11
  8. By: Raimundo Soto (Instituto de Economía. Pontificia Universidad Católica de Chile.); Ibrahim A. Elbadawi.
    Abstract: This paper develops a general equilibrium model of the real exchange rate for a small open economy, taking into account often overlooked characteristics of developing economies, such as the presence of significant aid flows, terms of trade variability, distorting trade taxes, and concentration of exports on natural resources. The equilibrium RER results from the intertemporal, optimal decisions of households on consumption, production, and trade of different goods, conditional upon government policies and external conditions. The model derives a concept of the sustainable current account based on the yield of the discounted present value of net exports which provides a rigorous framework for the computation of the equilibrium RER and misalignment indexes. We test the model in a sample of 73 developing countries in the 1970-2004 period using the PMG estimator proposed by Pesaran et al. (1999) and find it to be an encompassing representation of the data. We also develop a methodology to compute the misalignment of the real exchange rate, which requires to compute the permanent components of the determinants of the RER and to identify the equilibrium path for each country.
    Keywords: Real exchange rates, general equilibrium, misalignment, panel data.
    JEL: F31 F37 C23
    Date: 2007
  9. By: Pål Boug and Andreas Fagereng (Statistics Norway)
    Abstract: During the last decades Norwegian exporters have ƒ{ despite various forms of exchange rate targeting ƒ{ faced a rather volatile exchange rate which may have influenced their behaviour. Recently, the shift to inflation targeting and a freely floating exchange rate has brought about an even more volatile exchange rate. We examine the causal link between export performance and exchange rate volatility across different monetary policy regimes within the cointegrated VAR framework using the implied conditional variance from a GARCH model as a measure of volatility. Although treating the volatility measure as either a stationary or a non-stationary variable in the VAR, we are not able to find any evidence suggesting that export performance has been significantly affected by exchange rate uncertainty. We find, however, that volatility changes proxied by blip dummies related to the monetary policy change from a fixed to a managed floating exchange rate and the Asian financial crises during the 1990s enter significantly in a dynamic model for export growth ƒ{ in which the level of relative prices and world market demand together with the level of exports constitute a significant cointegration relationship. A forecasting exercise on the dynamic model rejects the hypothesis that increased exchange rate volatility in the wake of inflation targeting in the monetary policy has had a significant impact on export performance.
    Keywords: Exports; exchange rate volatility; GARCH; CVAR; forecasting
    JEL: C51 C52 F14 F17
    Date: 2007–11
  10. By: Costas Milas (Keele University, UK and The Rimini Centre for Economics Analysis, Italy.); Christopher Martin (Brunel University, UK); Ram Sharan Kharel (Brunel University, UK)
    Abstract: We estimate a flexible non-linear monetary policy rule for the UK to examine the response of policymakers to the real exchange rate. We have three main findings. First, policymakers respond to real exchange rate misalignment rather than to the real exchange rate itself. Second, policymakers ignore small deviations of the exchange rate; they only respond to real exchange under-valuations of more than 4% and over-valuations of more than 5%. Third, the response of policymakers to inflation is smaller when the exchange rate is over-valued and larger when it is under-valued. None of these responses is allowed for in the widely-used Taylor rule, suggesting that monetary policy is better analysed using a more sophisticated model, such as the one suggested in this paper.
    Keywords: monetary policy, asset prices, nonlinearity
    JEL: C51 C52 E52 E58
    Date: 2007–07

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