nep-ifn New Economics Papers
on International Finance
Issue of 2012‒03‒14
thirteen papers chosen by
Vimal Balasubramaniam
National Institute of Public Finance and Policy

  1. Trilemma and Financial Stability Configurations in Asia By Joshua Aizenman
  3. International Financial Integration and Crisis Intensity By Andrew K. Rose
  4. Net Foreign Asset (Com)position: Does Financial Development Matter? By Robert Vermeulen; Jakob de Haan
  5. Exchange Rate Pass-Through, Domestic Competition,and Inflation: Evidence from the 2005/08 Revaluationof the Renminbi By Raphael Anton Auer
  6. The emergence of the Classical Gold Standard By Matthias Morys
  7. Monetary policy under alternative exchange rate regimes in Central and Eastern Europe By Ziegler, Christina
  8. Global Imbalances in a World of Inflexible Real Exchange Rates and Capital Controls By Andrew Hughes Hallett; Juan Carlos Martinez Oliva
  9. Management of Exchange Rate Regimes in Emerging Asia By Ramkishen S. Rajan
  10. Impact of US Quantitative Easing Policy on Emerging Asia By Peter J. Morgan
  11. Prospects for Monetary Cooperation in East Asia By Yung Chul Park; Chi-Young Song
  12. The Impossible Trinity and Capital Flows in East Asia By Stephen Grenville
  13. The International Regulatory Regime on Capital Flows By Federico Lupo Pasini

  1. By: Joshua Aizenman (Asian Development Bank Institute (ADBI))
    Abstract: This paper takes stock of recent research dealing with the degree to which the trilemma choices of Asian countries facilitated a smoother adjustment during the global crisis of 2008– 2009, and the way the region has been coping with the adjustment to the postcrisis challenges. We point out that emerging Asia has converged to a middle ground of the trilemma configuration : limited financial integration, a degree of monetary independence, and controlled exchange rate buffered by sizable international reserves. This configuration, with the proper management of balance sheet exposure and public finances, facilitated a smoother adjustment of emerging Asia to the crisis, and was instrumental in inducing the rapid resumption of growth. The swings of financial flows, from large deleveraging of foreign positions in 2008 to the renewed inflows in 2010, validate the insight of the public finance approach to financial integration : the gains from deeper financial integration should be balanced against the costs of growing exposure to turbulences. A key lesson of the crisis is the need to apply a comprehensive cost/benefit approach to prudential policies, to the regulation of external borrowing and of domestic financial intermediation, and to the accumulation and use of international reserves. We illustrate these results in the context of the challenges facing emerging Asia’s adjustment during the global financial crisis, and the postcrisis policy stance dealing with the renewed inflows of capital.
    Keywords: Financial Stability, emerging Asia, financial integration, monetary independence, controlled exchange
    JEL: F31 F32 F33 F36
    Date: 2011–11
  2. By: Peter Bofinger
    Abstract: The discussion on exchange rate policy is dominated by the so-called “impossible trinity”. According to this principle an autonomous monetary policy, a control over the exchange rate and free capital movements cannot be achieved simultaneously. In this paper, a strategy of managed floating is developed that allows transforming the “impossible trinity” into a “possible trinity”. If a central bank targets an exchange rate path which is determined by uncovered interest parity (UIP), it can at the same time set its policy rate autonomously. As a UIP path removes the incentives for carry-trade, it is also compatible with capital mobility. The approach can be used unilaterally to prevent carry trade as a central bank can always prevent an appreciation of its currency. But it can also be applied bilaterally or multilaterally. Successful examples are the European Monetary System and the exchange rate policy of Slovenia before its EMU membership.
    Date: 2011
  3. By: Andrew K. Rose (Asian Development Bank Institute (ADBI))
    Abstract: This paper analyzes the causes of the 2008–2009 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. The analysis is conducted on a cross-section of 85 economies; I focus on international financial linkages that may have both allowed the crisis to spread across economies, and/or provided insurance. The model of the cross-economy incidence of the crisis combines 2008–2009 changes in real gross domestic product (GDP), the stock market, economy credit ratings, and the exchange rate. The key domestic determinants of crisis incidence that I consider are taken from the literature, and are measured in 2006 : real GDP per capita; the degree of credit market regulation; and the current account, measured as a fraction of GDP. Above and beyond these three national sources of crisis vulnerability, I add a number of measures of both multilateral and bilateral financial linkages to investigate the effects of international financial integration on crisis incidence. I ask three questions, with a special focus on Asian economies. First, did the degree of an economy’s multilateral financial integration help explain its crisis? Second, what about the strength of its bilateral financial ties with the United States and the key Asian economics of the People’s Republic of China, Japan, and the Republic of Korea? Third, did the presence of a bilateral swap line with the Federal Reserve affect the intensity of an economy’s crisis? I find that neither multilateral financial integration nor the existence of a Fed swap line is correlated with the cross-economy incidence of the crisis. There is mild evidence that economies with stronger bilateral financial ties to the United States (but not the large Asian economies) experienced milder crises. That is, more financially integrated economies do not seem to have suffered more during the most serious macroeconomic crisis in decades. This strengthens the case for international financial integration; if the costs of international financial integration were not great during the Great Recession, when could we ever expect them to be larger?
    Keywords: financial integration, financial crisis, financial linkage, Asian economies
    JEL: E65 F30
    Date: 2012–01
  4. By: Robert Vermeulen; Jakob de Haan
    Abstract: We investigate the relationship between a country’s domestic financial development and the (composition of its) net foreign asset position using a pooled mean group estimator and data for 51 countries during the period 1970-2007. The results show that financial development reduces a country’s long-run net foreign asset position. In addition, financial development leads to higher net equity and lower net debt positions. These findings confirm the theoretical predictions of Mendoza et al. (2009). The results are robust to using different indicators of financial development and inclusion of the level of development of a country in the cointegrating relationship.
    Keywords: net foreign assets; financial development; financial integration; pooled mean group estimator
    JEL: F30 F41 G15
    Date: 2012–03
  5. By: Raphael Anton Auer
    Abstract: This paper quantifies the effect of the government-controlled appreciation of the Chinese renminbi (RMB) vis-à-vis the USD from 2005 to 2008 on the prices charged by US producers. As the RMB during that time was pegged to a basket of currencies, the empirical strategy must account for the fact that the currencies included in the basket may have directly affected US prices. Thus, the pre-2005 period is used to filter out the effects of other exchange rates on import and producer prices. Additionally, utilizing the remainder of the sample, the pure effect of an RMB appreciation on US import prices and, in turn, the effect of RMB-induced US import price fluctuations on US producer prices is established. In a panel spanning the period from 1994 to 2010 and including 417 manufacturing sectors, the main finding emerging from this empirical strategy is that import prices pass into producer prices at an average rate of 0.7. This finding supports the view that the markets for domestic and imported manufactured goods are well integrated. Consequently, even if the exchange rate affects import prices only to a small extent, it may have a substantial impact on inflation, as it exerts a sizeable impact on the competitive environment of domestic producers and the prices that they charge.
    Keywords: Price Complementarities, Exchange Rate Pass Through, China, Inflation, Markups
    JEL: F11 F12 F14 F15 F16 F40 E31 L16
    Date: 2012
  6. By: Matthias Morys
    Abstract: This paper asks why the Classical Gold Standard (1870s - 1914) emerged: Why did the vastmajority of countries tie their currencies to gold in the late 19th century, while there was onlyone country – the UK – on gold in 1850? The literature distinguishes a number of theories toexplain why gold won over bimetallism and silver. We will show the pitfalls of these theories(macroeconomic theory, ideological theory, political economy of choice between gold andsilver) and show that neither the early English lead in following gold nor the German shift togold in 1873 were as decisive as conventional accounts have it. Similarly, we argue that thesilver supply shock materializing in the early 1870s was only the nail in the coffin of silverand bimetallic standards. Instead, we focus on the impact of the 1850s gold supply shock (dueto the immense gold discoveries in California and Australia) on the European monetarysystem. Studying monetary commissions in 13 European countries between 1861 and 1874,we show that the pan-European movement in favour of gold monometallism was motivatedby three key factors: gold being available in sufficient quantities to actually contemplate thetransition to gold monometallism for a larger number of countries (while silver had becomeextremely scarce in the bimetallic bloc, which was the single most important currency area interms of GDP), widespread misgivings over the working of bimetallism and the fact that goldcould encapsulate substantially more value in the same volume than silver (i.e. coinconvenience). In our view, then, the emergence of the Classical Gold Standard was imminentin the late 1860s; which European country would move first – which is often erroneouslyattributed to Germany – is of secondary importance.
    Date: 2012–01
  7. By: Ziegler, Christina
    Abstract: Monetary policy in CEE is an important determinant in the wage bargaining process, because trade unions have to predict inflation as one component of future real wages. This paper scrutinizes whether countries in CEE that officially announce an inflation target are tempted to act time-inconsistently and switch from the announced inflation target to an exchange rate target in order to sustain higher output via surprise inflation. If market participants discover the time-inconsistency, they will adjust their inflation expectations, which result in higher average rates of price increases. The time-inconsistent behavior in central bank interest rate setting is modeled by several Taylor rules. An empirical application provides evidence that some monetary authorities in CEE such as the Czech Republic and Slovakia have acted timeinconsistent and have focused on the exchange rate in periods of official inflation targeting, which might have contributed to higher average rates of inflation and welfare losses. Furthermore, uncertainty in wage determination process has risen due to a harder predictability of productivity and inflation as components of future nominal wages. --
    Keywords: monetary policy,Taylor rules,exchange rate regime,Central and Eastern Europe,inflation targeting
    JEL: E52 E58 F31 O52 P20
    Date: 2012
  8. By: Andrew Hughes Hallett (Asian Development Bank Institute (ADBI)); Juan Carlos Martinez Oliva
    Abstract: This paper addresses the issue of international payments in a stock-flow framework, by capturing the interaction between the current account balance and international assets portfolios of domestic and foreign investors. It is argued that the stability of such interaction may be affected by shifts in the preferences of investors, by the relative rate of return of different assets, and—more in general—by institutional settings. The model is then used for policy analysis purposes to derive the conditions for the existence of dynamic equilibria, and if they can be attained, under the assumption of market-distorting policy choices.
    Keywords: exchange rate, current account balance, Applied General Equilibrium model, capital controls, dynamic equilibria
    JEL: F13 F32 F34
    Date: 2011–12
  9. By: Ramkishen S. Rajan (Asian Development Bank Institute (ADBI))
    Abstract: This paper revisits the issue of exchange rate regimes in emerging Asia. It is divided into two main parts. The first part compares de jure and de facto exchange rate regimes in Asia over the decade 1999–2009. It finds that while Asia is home to a wide array of exchange rate regimes, there are signs of gradual movement towards somewhat greater exchange rate flexibility in many of the regional countries. However, the propensity for foreign exchange intervention and exchange rate management among regional central banks remains fairly high in many instances. Beyond a general reluctance of many Asian economies to allow for a “benign neglect†of their currencies both in terms of managing volatility as well as in terms of “leaning against the wind,†the sustained stockpiling of reserves in developing and emerging Asian economies since 2000 (interrupted only briefly by the global financial crisis) suggests that they are more sensitive to exchange rate appreciations than to depreciations. This is the focus of the second part of the paper. We find there to be evidence of an apparent “fear of appreciation†which is manifested in asymmetric exchange rate intervention—i.e., a willingness to allow depreciations but reluctance to allow appreciations. This policy of effective exchange rate undervaluation is rather unorthodox from a neoclassical sense, but is consistent with a development policy centered on suppressing the price of non-tradable goods relative to tradables (i.e., real exchange rate undervaluation). The paper concludes with a few observations on the management of Asian currencies in light of the global financial crisis and concerns about global imbalances.
    Keywords: exchange rate regime, emerging Asia, global financial crisis, foreign exchange intervention, central bank
    JEL: F14 F31 F41
    Date: 2011–11
  10. By: Peter J. Morgan (Asian Development Bank Institute (ADBI))
    Abstract: The adoption of quantitative easing (QE) policy by the United States (US) Federal Reserve Bank since early 2009 has aroused widespread concerns in Asia and elsewhere regarding its possible impact in terms of the weakening of the US dollar and stimulating capital outflows to emerging economies that might increase inflationary pressures in them. This report investigates possible impacts of US quantitative easing policy on Asian economies and financial markets. Our basic approach is to take the period of November 2009–October 2010, when no quantitative easing took place, as a baseline period against which we can compare the effects of quantitative easing on monetary flows during the “QE1†and “QE2†periods. We estimate that about 40% of the increase in the US monetary base in the QE1 period leaked out in the form of increased gross private capital outflows and about one-third leaked out during the first two quarters of the QE2 period. An excess private financial capital inflow to Emerging Asia of $9 billion per quarter was estimated for the first two quarters of the QE2 period, which was relatively consistent with the estimated amounts of the excess increases in foreign exchange reserves and the monetary base in the region during that period. However, this amount is small, and hence was unlikely to have a significant impact on financial markets, economic activity or inflation. We also investigate the impacts of QE policy on regional bond yields and exchange rates using event window analysis, and find that the greatest impacts were a stronger Korean won and lower bond yields in Indonesia.
    Keywords: financial markets, capital outflows, quantitative easing, the US, Emerging Asia
    JEL: E43 E52 E58 F31 F32
    Date: 2011–11
  11. By: Yung Chul Park (Asian Development Bank Institute (ADBI)); Chi-Young Song
    Abstract: The purpose of this paper is to reexamine the exchange rate policy of the Republic of Korea, and its role in promoting financial and monetary cooperation in East Asia in the wake of the 2008 global financial crisis. The Republic of Korea would not actively participate in any discussion of establishing a regional monetary and exchange rate arrangement as it is expected to maintain a weakly managed floating regime. The People’s Republic of China (PRC) has been fostering the yuan as an international currency, which will lay the groundwork for forming a yuan area among the PRC; the Association of Southeast Asian Nations JEL Classification : F3, F4 (ASEAN); Hong Kong, China; the PRC; and Taipei,China. Japan has shown less interest in assuming a greater role in East Asia’s economic integration due to deflation, a strong yen, slow growth, and political instability. Japan would not eschew free floating. These recent developments demand a new modality of monetary cooperation among the Republic of Korea, Japan, and the PRC. Otherwise, ASEAN+3 will lose its rationale for steering regional economic integration in East Asia.
    Keywords: exchange rate policy, Monetary cooperation, financial cooperation, Republic of Korea, East Asia
    JEL: F3 F4
    Date: 2011–10
  12. By: Stephen Grenville (Asian Development Bank Institute (ADBI))
    Abstract: The Impossible Trinity doctrine still holds a powerful sway over policymakers, advisors (particularly the International Monetary Fund [IMF]) and academia. In East Asia over the past decade, however, most countries have been able to maintain open capital markets, monetary policy independence, and a fair degree of management over their exchange rates. This is because the Impossible Trinity model does not fit the actual circumstances very closely. Capital flows are dominated by factors other than interest differentials, external inflows have been successfully sterilized, the connection between base money and monetary policy settings is not close, and the authorities’ management of the exchange rates has been aimed at keeping the rate close to the medium-term equilibrium, not susceptible to speculators. This is not to deny that there are difficult policy issues in the interaction between capital inflows, monetary policy, and the exchange rate. These interactions do in fact make good policymaking very challenging. The key problem is that the Wicksellian “natural†interest rate will differ quite substantially between developing and mature countries, presenting a structural problem rather than the cyclical problem envisaged in the Impossible Trinity. Rather than base the policy mind-set on the Impossible Trinity, it would be better to have in mind something along the lines of the Williamson band/basket/crawl and a notion of the fundamental equilibrium exchange rate.
    Keywords: impossible trinity, East Asia, capital flows
    JEL: F21 F31 F32
    Date: 2011–11
  13. By: Federico Lupo Pasini (Asian Development Bank Institute (ADBI))
    Abstract: Capital controls and exchange restrictions are used to restrict international capital flows during economic crises. This paper looks at the legal implications of these restrictions and explores the current international regulatory framework applicable to international capital movements and current payments. It shows how international capital flows suffer from the lack of a comprehensive and coherent regulatory framework that would harmonize the patchwork of multilateral, regional, and bilateral treaties that currently regulate this issue. These treaties include the Articles of Agreement of the International Monetary Fund (IMF Articles), the General Agreement on Trade in Services (GATS), free-trade agreements, the European Union treaty, bilateral investment treaties, and the Organization for Economic Co-operation and Development (OECD) Code of Liberalization of Capital Movements (OECD Code of Capital Movement). Each of these instruments regulate differently capital movements with little coordination with other areas of law. This situation sometimes leads to regulatory overlaps and conflict between different sources of law. Given the strong links between capital movements and trade in services, this paper pays particular attention to the rules of the GATS on capital flows and discusses the policy space available in the GATS for restricting capital flows in times of crisis.
    Keywords: international capital flows, capital controls, exchange restrictions, regulatory framework, international capital movement
    JEL: F13 F31 F32 F53
    Date: 2011–12

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