nep-ifn New Economics Papers
on International Finance
Issue of 2008‒01‒19
eight papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Integration of Financial Markets in SAARC Countries: Evidence Based on Uncovered Interest rate Parity Hypothesis By Khan, Muhammad Arshad; Sajid, Muhammad Zubair
  2. Political and institutional factors in regime change in the ERM: An application of duration analysis By Simón Sosvilla-Rivero; Francisco Pérez-Bermejo
  3. International Money and Finance By Paul Hallwood; Ronald MacDonald
  4. How Falling Exchange Rates 2000-2007 Have Affected the U.S. Economy and Trade Deficit (Evaluated Using the Federal Reserve's G-10 Exchange Rate) By John J. Heim
  5. Demand shocks and trade balance dynamics By José García-Solanes; Jesús Rodríguez; José L. Torres
  6. Technology Capital and the U.S. Current Account By Ellen R McGrattan; Edward C Prescott
  7. Post-EMS exchange risk trends: A comparative perspective between Euro, British Pound and Japanese Yen excess returns against US Dollar By Yolanda Santana-Jiménez; Jorge V. Pérez-Rodríguez
  8. Real Exchange Rate Overshooting in Real Business Cycle Model - An Empirical Evidence From India By Minford, Patrick; Pal, Soubarna

  1. By: Khan, Muhammad Arshad; Sajid, Muhammad Zubair
    Abstract: This paper examines interest rate linkages among four SAARC countries vis-a-vis United State using monthly data over the period 1990M1 to 2006M3. The emperical findings suggest the existance of single cointegrating vector between SAARC countries interest rates and US interest rate. The result further suggest that except India, the coefficient restriction for Pakistan, Sri Lanka and Bangladesh are met segnificantly. However, in the case of India, the coefficient associated with foreign interest rate is far from the predicted value of UIP.The adjustment coefficient indicate no two ways causility. We also impemented the cointegration test within the SAARC countries. The test results suggest the existance of the one cointegrating vector.the existance of one cointegrating vector indicates the low degree of money markets integration in the region. Moreover, in the long run except Indian interest rate, other interest rates exerted positive impact on Pak-interest rate. Short Run Error Correction model is also estimated. the results suggest that Pakistani, Indian and Sri Lankan interest rates act as equlibrating factors in the long run, while no dynamic interaction between Pak-interst rate and Bangladesh-interest rate have been seen so far.
    Keywords: Financial markets integration; Interest Parity
    JEL: F15 G15 F36
    Date: 2007
  2. By: Simón Sosvilla-Rivero (FEDEA and Universidad Complutense de Madrid); Francisco Pérez-Bermejo (KPMG-Spain)
    Abstract: This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an augmented target-zone model, explicitly incorporating political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the money supply, the real exchange rate, the interest in Germany and the central parity deviation would have negatively affected the duration of a given central parity, while credibility and the price level in Germany would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.
    Keywords: Duration analysis, political variables, exchange rates, European Monetary System
    JEL: C41 D72 F31 F33
    Date: 2007–10
  3. By: Paul Hallwood (University of Connecticut); Ronald MacDonald (University of Glasgow)
    Abstract: We discuss the effectiveness of pegged exchange rate regimes from an historical perspective, drawing conclusions for their effectiveness today. Starting with the classical gold standard period, we point out that a succession of pegged regimes have ended in failure; except for the first, which was ended by the outbreak of World War I, all of the others we discuss have been ended by adverse economic developments for which the regimes themselves were partly responsible. Prior to World War II the main problem was a shortage of monetary gold that we argue is implicated as a cause of the Great Depression. After World War II, more particularly from the late-1960s, the main problem has been a surfeit of the main international reserve asset, the US dollar. This has led to generalized inflation in the 1970s and into the 1980s. Today, excessive dollar international base money creation is again a problem that could have serious consequences for world economic stability.
    Keywords: Bretton Woods, exchange rate expectations gold standard, new Bretton Woods, realignment expectations, pegged exchange rates, target zone, world economic instability
    JEL: F31 F33 N20
    Date: 2008–01
  4. By: John J. Heim (Department of Economics, Rensselaer Polytechnic Institute, Troy, NY 12180-3590, USA)
    Abstract: Falling exchange rates reduce the purchasing power of the dollar, increasing import prices. Higher import prices have two effects. (1) A substitution effect that shifts demand from imported to domestically produced goods. (2) An income effect that reduces the total amount of real income available for spending on domestic goods and foreign goods. Based on U.S. 1960 - 2000 data, this paper estimates an econometric model that finds that the income effects of falling exchange rates overwhelms the substitution effects, causing a net negative influence on the GDP and income. Results indicate demand for both imported and domestic consumer and investment goods is adversely affected because the income effect is so dominant.. For investment goods, there was virtually no substitution effect out of imported goods when import prices rose due to a falling exchange rate. Declining real income also caused decreased demand for domestically produced investment goods. For consumer goods, the substitution effect stimulated domestic demand, but was more than offset by the negative effect of declining income. The decrease in demand for domestic goods and services was 3.6 times as large as the decrease in demand for imports. Therefore, the trade deficit fell far less in dollars than the GDP. The study estimates that, other things equal, the trade deficit would fall from 4.3% to 2.1% of the GDP as a result of a large twenty percent weakening of the dollar, such as occurred 2000-07. Had the exchange rate not fallen during this period, we estimate the average annual growth rate of the U.S. economy would have been 3.7%, not the 2.7% it has actually averaged, assuming sufficient capital and labor availability to do so. Finally, we find that a falling trade deficit induced by falling exchange rates, reduces the size of the annual transfer of U.S. assets to foreigners needed to finance the deficit, but does not result in a faster rate of net growth for U.S. assets, because declining income also reduces domestic savings by a comparable amount.
    JEL: E00 F40 F43
    Date: 2008–01
  5. By: José García-Solanes (Universidad de Murcia); Jesús Rodríguez (Universidad Pablo de Olavide); José L. Torres (Universidad de Málaga)
    Abstract: This paper studies the current account dynamics in the G-7 countries plus Spain. We estimate a SVAR model which allows us to identify three different shocks: supply shocks, real demand shocks and nominal shocks. We use a different identification procedure from previous work based on a microfounded stochastic open-economy model in which the real exchange rate is a determinant of the Phillips curve. Estimates from a structural VAR show that real demand shocks explain most of the variability of current account imbalances, whereas, contrary to previous findings, nominal shocks play no role. The results we obtain are consistent with the predictions of a widely set of open-economy models and illustrate that demand policies are the main responsible of trade imbalances.
    Keywords: Current account, SVAR
    JEL: F3
    Date: 2007–06
  6. By: Ellen R McGrattan; Edward C Prescott
    Date: 2008–01–09
  7. By: Yolanda Santana-Jiménez (Universidad de Las Palmas de Gran Canaria); Jorge V. Pérez-Rodríguez (Universidad de Las Palmas de Gran Canaria)
    Abstract: This paper studies the exchange rate risk of Euro, Pound and Yen against US Dollar before and after the EMU. The key question is to analyse the impact of the Euro to exchange rate risks. The risk is measured by estimating risk price coefficient (RPC) from an excess return equation. A conditional heteroskedastic variance model with time-varying mean is estimated for this purpose. Recursive estimates are used to examine the evolution of the parameters and to find out time-varying risk premia. Results show that after a period of adaptation following the introduction of the Euro, the Euro/US Dollar RPC decreased.
    Keywords: Exchange rate risk, GARCH-M, risk-price, times series, recursive estimation
    JEL: G15
    Date: 2007–10
  8. By: Minford, Patrick (Cardiff Business School); Pal, Soubarna
    Abstract: The objective of this paper is to establish the ability of a Real Business Cycle (RBC) model to account for the behaviour of the real exchange rate, using Indian data (1966-1997). We calibrate the dynamic general equilibrium open economy model (Minford, Sofat 2004) based on optimising decisions of rational agents, using annual data for India. The first order conditions from the households' and firms' optimisation problem are used to derive the behavioural equations of the model. The interaction with the rest of the world comes in the form of uncovered real interest rate parity and current account both of which are explicitly micro-founded. The paper discusses the simulation results of 1 percent per annum productivity growth shock, which shows that the real exchange rate appreciates and then goes back to a new equilibrium (lower than the previous one), producing a business cycle. Thus the behaviour of the real exchange rate may be explicable within the RBC context. Finally we test our model and evaluate statistically whether our calibrated model is seriously consistent with the real exchange rate data, using bootstrapping procedure. We bootstrap our model to generate pseudo real exchange rate series and find that the ARIMA parameters estimated for the actual real exchange rate data lie within the 95% confidence limits constructed by bootstrapping. We find the same result for the nominal rigidity version of the RBC model. So we conclude that the behaviour of the Indian real exchange rate (US $ / Indian Rupees) can be explained by RBC.
    Date: 2008–01

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