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on International Finance |
| By: | Jón Steinsson |
| Abstract: | Existing empirical evidence suggests that real exchange rates exhibit hump-shaped dynamics. I show that this is a robust fact across nine large, developed economies. This fact can help explain why existing sticky-price business cycle models have been unable to match the persistence of the real exchange rate. The recent literature has focused on models driven by monetary shocks. These models yield monotonic impulse responses for the real exchange rate. It is extremely difficult for models that have this feature to match the empirical persistence of the real exchange rate. I show that in response to a number of different real shocks a two-country sticky-price business cycle model yields hump-shaped dynamics for the real exchange rate. The hump-shaped dynamics generated by the model are a powerful source of endogenous persistence that allows the model to match the long half-life of the real exchange rate. |
| JEL: | F31 F41 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13910&r=ifn |
| By: | Viktoria Hnatkovska; Amartya Lahiri; Carlos A. Vegh |
| Abstract: | What is the relationship between interest rates and the exchange rate? The empirical literature in this area has been inconclusive. We use an optimizing model of a small open economy to rationalize the mixed empirical findings. The model has three key margins. First, higher domestic interest rates raise the demand for deposits, and, hence, the money base. Second, firms need bank loans to finance the wage bill, which reduces output when domestic interest rates increase. Lastly, higher interest rates raise the government’s fiscal burden, and, therefore, can lead to higher expected inflation. While the first effect tends to appreciate the currency, the remaining two effects tend to depreciate it. We then conduct policy experiments using a calibrated version of the model and show the central result of the paper: the relationship between interest rates and the exchange rate is non-monotonic. In particular, the exchange rate response depends on the size of the interest rate increase and on the initial level of the interest rate. Moreover, we also show that the model can replicate the heterogeneous responses of the exchange rate to interest rate innovations in several developing economies. |
| JEL: | E52 F41 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13925&r=ifn |
| By: | Monzur Hossain (American Internationla University-Bangladesh(AIUB)) |
| Abstract: | This paper reviews the empirical literature on the choice of exchange rate regime. Prominent issues include: (i) the choice based on fundamentals, shocks, financial structure, and political ideology; (ii) the “bipolar view†or “hollowing out hypothesis†and its validity; (iii) regime choice in emerging economies, and (iv) the discrepancy between declared and actual regime, and its consequence on the analysis of currency regime choice. Although much has been learned in each approach, this survey highlights the areas of research in which our understanding of exchange rate regime transition is still incomplete. Observed data rejects the validity of the bipolar view. Moreover, it is seen that a substantial amount of countries diverge from their de jure regime without declaration, which needs to be taken into account for drawing a valid conclusion on the choice of a regime. From the survey it may be concluded that no empirical regularities regarding the choice of a currency regime have emerged yet. |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:aiu:abewps:45&r=ifn |
| By: | Marcio M. Janot; Márcio G. P. Garcia; Walter Novaes |
| Abstract: | "Third-generation currency crises models" argue that capital losses from exchange-rate depreciation propagate the crises to the productive sector. To test these models, we use a firm-level dataset that allows us to measure currency mismatches around the 2002 Brazilian currency crisis. We find that, between 2001 and 2003, firms that shortly before the crisis had large currency mismatches decreased their investment rates by 8.1 percentual points, relatively to other public firms. Moreover, we show that the currency depreciation implied large competitive gains for the exporters, and yet the investment of exporters with large currency mismatches fell by 12.5 percentual points, relatively to other exporters. The estimated falls in investment are economically very relevant, thereby corroborating the relevance of third generation models negative balance sheet effects. |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:162&r=ifn |
| By: | Joshua Aizenman; Yothin Jinjarak |
| Abstract: | This paper studies the association between the current account and real estate valuation across countries, subject to data availability [43 countries, of which 25 are OECD], during 1990-2005. We find robust and strong positive association between current account deficits and the appreciation of the real estate prices/(GDP deflator). Controlling for lagged GDP/capita growth, inflation, financial depth, institution, urban population growth and the real interest rate; a one standard deviation increase of the lagged current account deficits is associated with a real appreciation of the real estate prices by 10%. This real appreciation is magnified by financial depth, and mitigated by the quality of institutions. Intriguingly, the economic importance of current account variations in accounting for the real estate valuation exceeds that of the other variables, including the real interest rate and inflation. Among the OECD countries, we find evidence of a decline overtime in the cross country variation of the real estate/(GDP deflator), consistent with the growing globalization of national real estate markets. Weaker patterns apply to the non-OECD countries in the aftermath of the East Asian crisis. |
| JEL: | F15 F21 F32 R21 R31 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13921&r=ifn |
| By: | Andrea Ferrero; Mark Gertler; Lars E.O. Svensson |
| Abstract: | We explore the implications of current account adjustment for monetary policy within a simple two-country DSGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well. |
| JEL: | E0 F0 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13906&r=ifn |
| By: | Frait, Jan (Czech National Bank); Komárek, Luboš (Czech National Bank) |
| Abstract: | The paper aims to enrich the debate on the overvaluation/undervaluation of China yuan Renminbi (CNY) against USD and JPY by applying the concept of the Debt-Adjusted Real Exchange Rate (DARER). This approach is offering to monetary policy makers another indicator for more responsive management of this important economic variable. The general motivation for constructing DARER is the fact that long-term current account surplus (deficits) is linked with capital outflows (inflows), which often leads to real undervaluation (overvaluation) of domestic currency. DARER can signal to the authorities that the real exchange rate is becoming unsustainable in the medium term. Based on the DARER approach we also introduce three indicators of exchange rate misalignment. |
| Keywords: | Exchange rate ; current account ; misalignment ; China ; DARER |
| JEL: | E58 F31 F32 F37 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:850&r=ifn |
| By: | J. Isaac Miller (Department of Economics, University of Missouri-Columbia) |
| Abstract: | Standard target zone exchange rate models are based on a nonlinear function of an unobserved economic fundamental, which is defined as the log of the domestic money stock plus exogenous velocity shocks that are generally assumed to follow a random walk. A critical and widespread assumption in the literature is that this fundamental is bounded, similarly to the target zone exchange rates themselves. We use seven techniques to estimate the unobserved fundamentals driving a wide variety of exchange rates that have traded under target zone regimes at different times over the past two decades. Two of these techniques involve a nonlinear filter that is not well-known to econometricians, but which has clear advantages over more well-known filters. We then test the estimated fundamentals for unboundedness, using non-standard unit root tests that have recently been shown to have good power against bounded, nonlinear alternatives. Finally, we use maximum deviations of the estimated fundamentals to show that de facto empirical bands on these estimates generate implausible elasticities. Our empirical results cast serious doubt on the theoretical assumption that such fundamentals are bounded. |
| Keywords: | target zone exchange rates, economic fundamental, Kalman filter, unscented Kalman filter, rescaled range statistic |
| JEL: | C13 C32 |
| Date: | 2008–04–07 |
| URL: | http://d.repec.org/n?u=RePEc:umc:wpaper:0803&r=ifn |
| By: | Menzie D. Chinn; Jeffrey A. Frankel |
| Abstract: | The euro has arisen as a credible eventual competitor to the dollar as leading international currency, much as the dollar rose to challenge the pound 70 years ago. This paper uses econometrically-estimated determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, rate of return, and liquidity in the relevant home financial center (as measured by the turnover in its foreign exchange market). There is a tipping phenomenon, but changes are felt only with a long lag (we estimate a weight on the preceding year’s currency share around .9). The equation correctly predicts out-of-sample a (small) narrowing in the gap between the dollar and euro over the period 1999-2007. This paper updates calculations regarding possible scenarios for the future. We exclude the scenario where the United Kingdom joins euroland. But we do take into account of the fact that London has nonetheless become the de facto financial center of the euro, more so than Frankfurt. We also assume that the dollar continues in the future to depreciate at the trend rate that it has shown on average over the last 20 years. The conclusion is that the euro may surpass the dollar as leading international reserve currency as early as 2015. |
| JEL: | E42 F0 F02 F31 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13909&r=ifn |