Fixed Exchange Rates and Banking Crises: When Does the Former Prevent the Latter?

Because monetary policy is constrained in fixed exchange rate regimes, banks should expect fewer money‐financed bailouts and therefore manage their risks more carefully when exchange rates are fixed than when they are flexible. It follows that we should observe fewer banking crises in countries with formal currency pegs. The 1990s however are littered with occurrences of banking crises in countries with fixed exchange rates. This paper asks whether banks in those countries could have adopted excess risk expecting money‐financed bailouts or whether their pegs discouraged such moral hazard‐type risks.     

Openness and the case for flexible exchange rates

Models of stabilization in open economy traditionally emphasize the role of exchange rates as a substitute for nominal price flexibility in fostering relative price adjustment. This view has been recently criticized on the ground that, to the extent that prices are sticky in local currency, the exchange rate does not play the stabilizing role envisioned by the received wisdom. An important question is whether, for this very reason, stabilization policies should limit exchange rate movements, or even eliminate them altogether. In this paper, I re-assess this issue by extending the [Corsetti Giancarlo, and Paolo Pesenti. 2001. Welfare and Macroeconomic Interdependence. Quarterly Journal of Economics 116 (2), 421–446.] model to allow for home bias in consumption—so that I can exploit the advantages of closed-form solutions. While this extension leaves most properties of the model unaffected, home bias implies that the real exchange rate in an efficient equilibrium is not constant, but fluctuates with the terms of trade. The weight that monetary authorities optimally place on stabilizing domestic marginal costs is increasing in home bias: with asymmetric shocks, fixed exchange rates are incompatible with efficient monetary rules. Yet, the adverse welfare consequences of exchange rate movements constrain the optimal intensity of monetary responses to domestic shocks. Openness matters: in our specification each country produces an equal share of the world value added; the lower the import content of consumption, the higher the exchange rate volatility implied by optimal stabilization rules. In relatively closed economy, optimal monetary rules tend to converge, regardless of the nature of nominal rigidities in the exports market.     

OUTLOOK FOR THE EUROPEAN MONETARY UNION: THE MESSAGE FROM EASTERN EUROPE

The European Community (EC) seems headed toward monetary union, either with "permanently" fixed exchange rates or with a common currency. Ceteris paribus, the breakup of the Soviet empire in Eastern Europe makes monetary union less desirable. One can expect further shocks from the East. Analyzing stock markets' reactions to events in the East from late 1988 to early 1990 shows that these shocks typically differentially affect EC members, particularly Germany. These differential shocks often call for adjustments in relative national price levels, which can be accomplished most easily with exchange-rate adjustments. The likelihood of such pressures reduces the credibility of a system of pegged rates and makes the system more vulnerable to speculative runs. A common currency is more credible by its nature but may give an inflationary bias to the European Monetary Union.     

Transmission of monetary policy and exchange rate shocks under foreign currency lending

This paper analyses the differences in reaction of domestic and foreign currency lending to monetary and exchange rate shocks, using a panel VAR model estimated for the three biggest Central and Eastern European countries (Poland, the Czech Republic and Hungary). Our results point toward a drop in domestic currency loans and an increase of foreign currency credit in reaction to monetary policy tightening in Poland and Hungary, suggesting that the presence of foreign currency debt weakens the transmission of monetary policy. A currency depreciation shock leads to an initial decline in foreign currency lending, but also in loans denominated in domestic currency as central banks react to a weaker exchange rate by increasing the interest rates. However, after several quarters, credit in foreign currency accelerates, indicating that borrowers start using it to substitute for depressed domestic currency lending.     

Institutional changes and shifting ideas: a constitutional analysis of the Euro

This paper uses the logical tools of Constitutional Economics to analyze the creation of the Euro, considering the entire process as the outcome of a conflict between different rules or, if you will, between different monetary systems, moving from the system of flexible exchange rates to a system of fixed exchange rates and ultimately to the single currency. The conflict between monetary systems has been acted out according to the single states’ collective preference functions, with both full employment and price stability figuring among the weights of said preference functions. The “solution” of the single currency was conceived when the body of information available to the policymakers was “simplified” by the new classical macro-economy taking a hegemonic role.     

Modelling the Eurozone as an Extraordinary Exchange Rate Union

The Trans-European Automated Real-Time Gross settlement Express Transfer system (TARGET) imbalances within the Eurozone can be interpreted as a sign of a missing balance of payments adjustment mechanism for the member countries. As the Eurozone lacks a fiscal union, in theory it is more of an exchange rate union or a system of fixed exchange rates than a monetary union. This paper will show why the TARGET is a crucial indicator for the Eurozone not being a monetary union but instead an exchange rate union, and why countries holding TARGET liabilities against the European System of Central Banks can be compared to a reserve currency country, like the US under the Bretton-Woods System.     

Self-fulfilling Currency Crises and Central Bank Independence

We develop a model of a fixed exchange rate peg arrangement derived from the Barro–Gordon model of rules versus discretion. It is shown that the fixed peg is vulnerable to self-fulfilling currency crises in which the unemployment rate increases, the credibility of the rule decreases, but, paradoxically, the reputation of the policy-maker improves. Delegating monetary policy to an independent central banker does not prevent this type of crisis from arising, and can even make it more costly.
JEL Classification: F 3; F 4     

MONETARY CREDIBILITY VS. VOTER APPROVAL: POLITICAL INSTITUTIONS AND EXCHANGE‐RATE STABILIZATION DURING CRISES

This paper analyzes how political institutions affect the execution of exchange‐rate policy. By focusing on policy‐makers' responses to the emergence of speculative pressure on their currencies, we argue that the effect of democratic institutions on exchange‐rate stability is likely to be conditioned by the officially announced exchange‐rate regime. Officially fixed exchange rates are the main instrument of autocrats to signal commitment to long‐term stability. Autocratic governments with strictly fixed exchange rates are thus more likely to defend their exchange rates than autocrats with an intermediate regime because the latter implicitly signal that they care less about monetary stability. In contrast, democrats defend more often in intermediately than in fully fixed official regimes by using a combination of external and internal adjustments, which reduce the negative effects of a devaluation on voters. Our analysis of 189 currency crises between 1975 and 1999 supports this conditional effect.     

Costs and benefits of unilateral euroization in central eastern Europe

Countries unable or unwilling to join a monetary union can replicate most membership effects unilaterally through either a currency board or the formal replacement of domestic currency by that of the Union. Potential benefits include lower transaction costs, lower interest rates, and lower exposure to speculative attacks. Costs include initial reserves, inadequate response to asymmetric shocks, loss of seigniorage, no lender of last resort. Expected costs and benefits have probably been exaggerated. Net effects depend primarily on the degree of monetary, real, and institutional convergence. Positive net advantages will accrue to countries that are either already converging, or wish to use a single currency to speed up convergence — especially if small. There is no legal or economic justification for EU aversion to unilateral euroization in accession candidate countries. JEL classification: F33, F36, E58, P33.     

Open-Economy Macroeconomics: Developments in Theory and Policy

This paper views developments in open-economy macroeconomics through the lens of the debate over European monetary unification. The empirical tendency for nominal exchange rate regimes to affect the variability of nominal and real exchange rates alike can be rationalized by sticky-price theories or models of asset-market liquidity effects. But plausible liquidity models have difficulty generating enough persistence to match the data. Thus, the macroeconomic stabilization costs of forgoing the exchange-rate realignment option seem pertinent. It is argued that our theories of efficiencies due to a common currency remain unsatisfactory, despite recent advances. The paper concludes by reviewing theories of currency crisis     

Fiscal consolidation under imperfect credibility

This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor monetary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.     

Hot Money Flows,Cycles in Primary Commodity Prices,and Financial Control in Developing Countries

Because the U.S. Federal Reserve’s monetary policy is at the center of the world dollar standard, it has a first-order impact on global financial stability. However, except during international crises, the Fed focuses on domestic American economic indicators and generally ignores collateral damage from its monetary policies on the rest of the world. Currently, ultra-low interest rates on short-term dollar assets ignite waves of hot money into Emerging Markets (EM) with convertible currencies. When each EM central bank intervenes to prevent its individual currency from appreciating, collectively they lose monetary control, inflate, and cause an upsurge in primary commodity prices internationally. These bubbles burst when some accident at the center, such as a banking crisis, causes a return of the hot money to the United States (and to other industrial countries) as commercial banks stop lending to foreign exchange speculators. World prices of primary products then collapse. African countries with exchange controls and less convertible currencies are not so attractive to currency speculators. Thus, they are less vulnerable than EM to the ebb and flow of hot money. However, African countries are more vulnerable to cycles in primary commodity prices because food is a greater proportion of their consumption, and—being less industrialized—they are more vulnerable to fluctuations in prices of their commodity exports. Supply-side shocks, such as a crop failure anywhere in the world, can affect the price of an individual commodity. But joint fluctuations in the prices of all primary products—minerals, energy, cereals, and so on—reflect monetary conditions in the world economy as determined by the ebb and flow of hot money from the United States, and increasingly from other industrial countries with near-zero interest rates.     

Assessing independent monetary policy in small, open and euroized countries: evidence from Western Balkan

This article approaches to the optimum currency area from the empirical side by investigating the costs of adoption of a single currency for small, open and euroized Western Balkan countries (WBC). Using several econometric techniques, this study attempts to answer three questions relevant for monetary integration of the WBC and similar transition countries: What are the constraints on an independent monetary policy? What is the need for operating an independent monetary policy? and What is the ability to conduct an independent monetary policy? The constraints on independent monetary policy in most of the WBC at this stage are relatively serious because of high levels of openness and euroization. They limit the ability of the central bank, which is oriented to price stability, to use the nominal exchange rate for achieving other goals (for example, output stabilization). Regarding the second question, the results from structural VAR framework suggest a low synchronization for supply and demand shocks between the WBC and the euro area, indicating potentially high costs of losing independent monetary policy. Furthermore, the results from Kalman filter technique inform that the shock convergence process is slow or absent in the WBC vis-à-vis the euro area. Regarding the last question, the results from cointegration and VAR analysis suggest that the ability to conduct an independent monetary policy, assessed by analyzing the interest rate channel as the most prominent transmission channel in the euro area, is relatively weak in the WBC.     

Asymmetric Shocks and Monetary Policy in a Currency Union

We analyze the conduct of monetary policy in a currency union in the face of asymmetric shocks. In particular, we compare the stabilization properties of a currency union versus alternative exchange rate arrangements. The relative performance of a currency union is shown to depend on the extent of economic integration in patterns of consumption and production and on the relative weights placed on price stability versus employment stability in the monetary authority's objective function.
JEL classification : F 33; F 40     

Macroprudential policy and the inward transmission of monetary policy: The case of Chile,Mexico, and Russia

This paper studies whether domestic macroprudential policy may attenuate the inward transmission of monetary policy shocks from the United States to domestic bank lending growth in three emerging market economies—Chile, Mexico, and Russia. Identification relies on banks’ heterogeneous exposure to prudential policies and the fact that foreign monetary policy shocks are exogenous from the perspective of these economies. After analyzing the effects of the aggregate domestic prudential policy stance, we focus on specific prudential policies targeting mortgage and consumer loans, as well as foreign‐currency deposits. Although our overall results are mixed, we find evidence that the strength of international monetary policy spillovers varies depending on the stance of domestic macroprudential policy. In particular, a tighter reserve requirement stance over foreign‐currency deposits in Chile dampens the effect of an international monetary policy shock on domestic local‐currency lending, but reinforces that on foreign‐currency lending, whereas in Russia, it dampens the effect on both local‐currency and foreign‐currency lending, although to different degrees. Prudential policies targeting the asset side of banks’ balance sheets, such as mortgage loans or consumer credit, are found to amplify international monetary policy spillovers in some cases and attenuate it in others, depending on the country context.     

Monetary union or currency competition? Currency arrangements for monetary stability in East and West

Recent events in the European Monetary System on the one hand and monetary disintegration in the former Soviet Union on the other hand have revived interest in the question of how to design and choose a monetary regime for both parts of Europe that ensures monetary stability. The objective of monetary stability can be achieved either by complete monetary union or by currency competition. Building on Hayek's ideas, I argue that both regimes are viable solutions depending on the circumstances. The paper first focuses on the misperceived benefits of flexible exchange rates, making the case for monetary union in Western Europe. However, monetary union is no alternative for Eastern Europe and the former Soviet Union. Instead currency competition could be used to retain the benefits of flexible exchange rates and to foster monetary stability at the same time.     

How should emerging economies float their currencies?

Floating exchange rates seem to be gaining ground in Latin America, East Asia and the transition economies. The recent crises left many economies with no alternative but to float. Others have moved toward floating, searching for greater flexibility and insulation from external shocks. The question for most emerging market economies, then, is no longer to float or not to float, but how to float. Four issues arise in this regard. The first is how to float and have low inflation. The second is whether floating provides as much insulation as conventional theory predicts, especially in the presence of dollarized liabilities. Which leads to the third point: the relationship between the stability of the exchange rate and that of the financial system. The fourth is how to conduct monetary policy under a float, and the role of inflation targeting. We consider each of these points in turn, and conclude that a workable model of how to float seems to be emerging from the so‐far successful experience of countries like Chile and Brazil. It involves the adoption of an inflation target as the main anchor for monetary policy, coupled with a monetary policy reaction function that — aside from reacting to the output gap and other determinants of the inflation rate — reacts also partially to movements in the nominal exchange rate. JEL classification: F3, F4, E4, E5     

贸易结算货币的新选择:稳定的篮子货币——对“金砖五国”货币合作的探讨

文章研究"金砖五国"货币合作的可能形式,构建了稳定的篮子货币作为贸易结算货币,为货币合作提供政策建议。文章首先考察了汇率之间的关系,认为一种货币的加权几何平均汇率能够消除不同货币表示币值的差异,在此基础上构建了篮子货币指数;其次研究了篮子货币波动最小的货币权重的选取,通过最优化方法获得最优权重;最后模拟计算了"金砖五国"篮子货币的权重,并探讨了如何把篮子货币最优权重转化为具体的货币篮子,同时给出了篮子货币和各国货币之间的汇率关系。     

Do Monetary Unions Make Economic Sense? Evidence from the Scandinavian Currency Union, 1873–1913

Popular propositions as to what constitutes a successful single currency area are examined by looking at the Scandinavian Currency Union (1873–1913) formed by Denmark, Norway and Sweden. Applying a frequently used indicator of the desirability of monetary union, we study the symmetry of country-specific structural shocks (measured net of the non-Scandinavian influence) in these three countries. It is found that country-specific shocks are not highly symmetric. This conclusion is also supported by the absence of clear-cut differences between the pattern of structural shocks in Belgium and structural shocks in the Scandinavian countries. This suggests that the three Scandinavian countries did not form an optimum currency area during the period 1873–1913.
JEL classification : F 15; F 33; N 13     

Behavioural equilibrium exchange rate and total misalignment: evidence from the euro exchange rate

In the present paper we attempt to investigate whether the nominal exchange rate of the euro against the currencies of the four major trading partners of the eurozone, namely China, Japan, the UK and the USA, converges or not to its equilibrium level. Applying recent unit root and system cointegration techniques in the presence of structural shifts in the data, our results indicate that there exist an equilibrium relationship between each of the euro/yuan, euro/yen, euro/UK pound and euro/US dollar nominal exchange rates and the fundamentals defined by the monetary model. Following these results, our modified Behavioural Equilibrium Exchange Rate model suggests that at the end of the estimated period, the euro/Chinese yuan and the euro/UK pound nominal exchange rates follow an equilibrium process. Our empirical results also imply that the single European currency is considered as overvalued against the US dollar, while it is considered as undervalued against the Japanese currency.