nep-ifn New Economics Papers
on International Finance
Issue of 2008‒01‒26
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Testing for Purchasing Power Parity in Cointegrated Panels By Pär Österholm; Mikael Carlsson; Johan Lyhagen
  3. Do Reserve Portfolios Respond to Exchange Rate Changes Using a Portfolio Rebalancing Strategy? An Econometric Study Using COFER Data By Ewe-Ghee Lim
  4. Aid, growth, and real exchange rate dynamics By Thierfelder, Karen; Robinson, Sherman; Page, John; Go, Delfin S.; Devarajan, Shantayanan
  5. Equilibrium Exchange Rates: Assessment Methodologies By Peter Isard
  6. The Demand for Currency Substitution By Seater, John J.
  7. Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organization By Aaditya Mattoo; Arvind Subramanian
  8. The Role of Institutional Quality in a Currency Crisis Model By Yi Wu
  9. Globalization and the Sustainability of Large Current Account Imbalances: Size Matters By Joshua Aizenman; Yi Sun
  10. A Model of Exchange-Rate-Based Stabilization for Turkey By Ozlem Aytac
  11. A forewarning indicator system for financial crises: the case of six central and eastern european countries By Irène Andreou; Gilles Dufrénot; Alain Sand-Zantman; Aleksandra Zdzienicka-Durand

  1. By: Pär Österholm; Mikael Carlsson; Johan Lyhagen
    Abstract: This paper applies the maximum likelihood panel cointegration method of Larsson and Lyhagen (2007) to test the strong PPP hypothesis using data for the G7 countries. This method is robust in several important dimensions relative to previous methods, including the well-known issue of cross-sectional dependence of error terms. The findings using this new method are contrasted to those from the Pedroni (1995) cointegration tests and fully modified OLS and dynamic OLS esimators of the cointegrating vectors. Our overall results are the same across all approaches: The strong PPP hypothesis is rejected in favour of weak PPP with heterogenenous cointegrating vectors.
    Date: 2007–12–20
  2. By: Khan, Muhammad Arshad; Qayyum, Abdul
    Abstract: This paper presents the empirical evidence on purchasing power parity (PPP) for Pak-rupee vis-à-vis US-dollar exchange rate using Johansen (1988) and Johansen and Juselius (1990) multivariate cointegration and bound testing approach to cointegration (Pesaran et al., 2001) over the period 1982Q2-2005Q4. We find a considerable support for the existence of long-run PPP. Furthermore, the results of error-correction suggest that nominal exchange rate plays an important role in eliminating deviations from long-run PPP. The results further suggest that there is high degree of foreign exchange and goods markets integration. One major policy implication derived from the findings of this study is that the monetary authorities should contain money supply growth in order to stabilize prices and reduce balance of payments deficits.
    Keywords: Exchange Rate; Purchasing power parity; Cointegration
    JEL: F00 C32 F36
    Date: 2007–12
  3. By: Ewe-Ghee Lim
    Abstract: This paper tests whether reserve portfolios respond to exchange rate changes with a portfolio rebalancing strategy, which requires the purchase of depreciating currencies and sale of appreciating ones. The paper finds empirical support for the strategy, in particular that dollar depreciation/appreciation results in rebalancing switches vis-a-vis the other major reserve currency, the euro; valuation changes in the minor currencies tend to result in switches among themselves. The finding implies that currency diversifications in response to exchange rate changes have thus far tended to be stabilizing for exchange markets; it also helps explain the relative stability of reserve currency shares.
    Keywords: Exchange rates , Reserves , euro , U.S. dollar , Exchange markets ,
    Date: 2007–12–27
  4. By: Thierfelder, Karen; Robinson, Sherman; Page, John; Go, Delfin S.; Devarajan, Shantayanan
    Abstract: Devarajan, Go, Page, Robinson, and Thierfelder argued that if aid is about the future and recipients are able to plan consumption and investment decisions optimally over time, then the potential problem of an aid-induced appreciation of the real exchange rate (Dutch disease) does not occur. In their paper, " Aid, Growth and Real Exchange Rate Dynamics, " this key result is derived without requiring extreme assumptions or additional productivity story. The economic framework is a standard neoclassical growth model, based on the familiar Salter-Swan characterization of an open economy, with full dynamic savings and investment decisions. It does require that the model is fully dynamic in both savings and investment decisions. An important assumption is that aid should be predictable for intertemporal smoothing to take place. If aid volatility forces recipients to be constrained and myopic, Dutch disease problems become an issue.
    Keywords: Economic Theory & Research,Debt Markets,Currencies and Exchange Rates,Emerging Markets,
    Date: 2008–01–01
  5. By: Peter Isard
    Abstract: The paper describes six different methodologies that have been used to assess the equilibrium values of exchange rates and discusses their limitations. It applies several of the approaches to data for the United States as of 2006, illustrates that different approaches sometimes provide substantially different assessments, and asks which methodologies deserve the most weight in such situations. It argues that while it is generally desirable to consider the implications of several different approaches, since different approaches provide different types of perspectives, two of the methodologies seem particularly relevant for identifying threats to macroeconomic stability and growth.
    Date: 2007–12–28
  6. By: Seater, John J.
    Abstract: A transactions model of the demand for multiple media of exchange is developed. Some results are expected, and others are both new and surprising. There are both extensive and intensive margins to currency substitution, and inflation may affect the two margins differently, leading to subtle incentives to adopt or abandon a substitute currency. Variables not previously considered in the literature affect currency substitution in complex and somewhat unexpected ways. In particular, the level of income and the composition of consumption expenditures are important, and they interact with the other variables in the model. Independent empirical work provides support for the theory.
    Keywords: Currency substitution, Dollarization
    JEL: E31 E41 E42
    Date: 2008
  7. By: Aaditya Mattoo (The World Bank); Arvind Subramanian (Peterson Institute for International Economics)
    Abstract: Two aspects of global imbalances--undervalued exchange rates and sovereign wealth funds (SWFs--require a multilateral response. For reasons of inadequate leverage and eroding legitimacy, the International Monetary Fund (IMF) has not been effective in dealing with undervalued exchange rates. We propose new rules in the World Trade Organization (WTO) to discipline cases of significant undervaluation that are clearly attributable to government action. The rationale for WTO involvement is that there are large trade consequences of undervalued exchange rates, which act as both import tariffs and export subsidies, and that the WTO's enforcement mechanism is credible and effective. The WTO would not be involved in exchange rate management, and our proposals do not entail the WTO displacing the IMF: Rather, they would harness the comparative advantage of the two institutions, with the IMF providing the essential technical expertise in the WTO enforcement process. On SWFs, there is a bargain to be struck between countries with SWFs, which want secure and liberal access for their capital, and capital-importing countries that have concerns about the objectives and operations of SWFs. The WTO is the natural place to strike this bargain. Its services agreement, the General Agreement on Trade in Services (GATS), already covers investments by SWFs, and other agreements offer a precedent for designing disciplines for SWFs. Placing exchange rates and SWFs on the trade negotiating agenda may help revive the Doha Round by rekindling the interest of a wide variety of groups, many of whom are currently disengaged from the round.
    Keywords: exchange rates, undervaluation, sovereign wealth funds, World Trade Organization, International Monetary Fund
    JEL: F21 F31 F32 F53
    Date: 2008–01
  8. By: Yi Wu
    Abstract: This paper is a theoretical study of the impact of institutional quality on currency crises from a public finance point of view. Recent empirical studies leave little doubt that weak institutions, including high levels of corruption, hinder economic performance. After the East Asian crisis, many observers have pointed to widespread corruption and crony capitalism as an underlying cause. Despite the popularity of the claim, there are only limited empirical and especially theoretical studies on the link between institutional quality and currency crises. This paper intends to fill in this void. We model institutional weakness as an inefficiency of the tax collection system. The model derived here shows that institutional weakness generally increases the likelihood of the existence of a self-fulfilling crisis equilibrium, and leads to larger currency devaluation when crises happen. However, this relationship could reverse when institutional weakness is very severe.
    Keywords: Financial crisis , Corruption , Tax collection , Tax systems ,
    Date: 2008–01–10
  9. By: Joshua Aizenman; Yi Sun
    Abstract: This paper evaluates the sustainability of large current account imbalances in the era when the Chinese GDP growth rate and current account/GDP exceed 10%. We investigate the size distribution and the durability of current account deficits during 1966-2005, and report the results of a simulation that relies on the adding-up property of global current account balances. Excluding the US, we find that size does matter: the length of current account deficit spells is negatively related to the relative size of the countries' GDP. We conclude that the continuation of the fast growth rate of China, while maintaining its large current account/GPD surpluses, would be constrained by the limited sustainability of the larger current account deficits/GDP of countries that grow at a much slower rate. Consequently, short of the emergence of a new "demander of last resort," the Chinese growth path would be challenged by its own success.
    JEL: F15 F21 F32 F43
    Date: 2008–01
  10. By: Ozlem Aytac (Indiana University Bloomington)
    Abstract: The literature on the exchange-rate-based stabilization has focused almost exclusively in Latin America. Many other countries however, such as Egypt, Lebanon and Turkey; have undertaken this sort of programs in the last 10-15 years. I depart from the existing literature by developing a model specifically for the 2000-2001 heterodox exchange-rate-based stabilization program in Turkey: When the government lowers the rate of crawl, the rate of domestic credit creation is set equal to the lower rate of crawl, bond sales finance the fiscal deficit, and money growth occurs only through capital inflows. Without appealing to high intertemporal elasticity of substitution, the model does very well at replicating the magnitude of the current account deficit (5.5% of GDP predicted vs. 5% of GNP actual), the peak in total consumption spending (10.08% predicted vs. 9.6% actual), average growth rate in total consumption spending (6.7% predicted vs. 6% actual), the peak in durables spending (37.06% predicted vs. 39.5% actual), and the average growth rate in durables spending (24% predicted vs. 27.4% actual) observed in Turkey following the inception of the program.
    Keywords: inflation, exchange-rate-based stabilization, durables
    JEL: E31 E63 F41
    Date: 2008–01
  11. By: Irène Andreou; Gilles Dufrénot; Alain Sand-Zantman; Aleksandra Zdzienicka-Durand
    Date: 2007

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