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on International Finance |
| By: | Oleg Itskhoki; Dmitry Mukhin |
| Abstract: | The Mussa (1986) puzzle is the observation of a sharp and simultaneous increase in the volatility of both nominal and real exchange rates following the end of the Bretton Woods System of pegged exchange rates in 1973. It is commonly viewed as a central piece of evidence in favor of monetary non-neutrality because it is an instance in which a change in the monetary regime caused a dramatic change in the equilibrium behavior of a real variable (the real exchange rate) and is often further interpreted as direct evidence in favor of models with nominal rigidities in price setting. This paper shows that the data do not support this latter conclusion because there was no simultaneous change in the properties of the other macro variables, nominal or real. We show that an extended set of Mussa facts equally falsifies both conventional flexible-price RBC models and sticky-price New Keynesian models as explanations for the Mussa puzzle. We present a resolution to the broader Mussa puzzle based on a model of segmented financial market — a particular type of financial friction by which the bulk of the nominal exchange rate risk is held by financial intermediaries and is not shared smoothly throughout the economy. We argue that rather than discriminating between models with sticky versus flexible prices, or monetary versus productivity shocks, the Mussa puzzle provides sharp evidence in favor of models with monetary non-neutrality arising in the financial market, suggesting the importance of monetary transmission via the risk premium channel. |
| JEL: | E30 E40 E50 F30 F40 G10 |
| Date: | 2021–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28950&r= |
| By: | Georgios Georgiadis (European Central Bank); Helena Le Mezo (European Central Bank); Arnaud Mehl (European Central Bank); Cédric Tille (IHEID, Graduate Institute of International and Development Studies, Geneva) |
| Abstract: | The US dollar plays a dominant role in the invoicing of international trade, albeit not an exclusive one as more than half of global trade is invoiced in other currencies. Of particular interest are the euro, with a large role, and the renminbi, with a rising role. These two currencies are well suited to contrast the roles of economic fundamentals and policies, as European policy makers have taken a neutral stance in contrast to the promotion of the international role of the renminbi by the Chinese authorities. We assess the drivers of invoicing using the most recent and comprehensive data set for 115 countries over 1999-2019. We find that standard mechanisms that foster use of a large economy's currency predicted by theory ‒ i.e. strategic complementarities in price setting and integration in cross-border value chains ‒ underpin use of the dollar and the euro for trade with the United States and the euro area. These mechanisms also support the role of the dollar, but not the euro, in trade between non-US and non-euro area countries, making the dollar the globally dominant invoicing currency. Fundamentals and policies have played a contrasted role for the use of the renminbi. We find that China's integration into global trade has further strengthened the dominant status of the dollar at the expense of the euro. At the same time, the establishment of currency swap lines by the People's Bank of China has been associated with increases in renminbi invoicing, with an adverse effect on dollar use that is larger than for the euro. |
| Keywords: | International trade invoicing; dominant currency paradigm; markets vs. policies |
| JEL: | F14 F31 F44 |
| Date: | 2021–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:gii:giihei:heidwp12-2021&r= |
| By: | Jasper Hoek; Steven B. Kamin; Emre Yoldas |
| Abstract: | Rising U.S. interest rates are often thought to be bad news for emerging market economies (EMEs) as they increase debt burdens, trigger capital outflows, and generally cause a tightening of financial conditions that can lead to financial crises. Indeed, as shown in Figure 1 below, the rise in the federal funds rate (the black line) during the Volcker disinflation of the early 1980s was associated with a sharp rise in the incidence of financial crises in EMEs (the green bars). |
| Date: | 2021–06–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfn:2021-06-23-2&r= |