Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period

In this paper, we explore the relationship between real exchange rates and real interest rate differentials in the United States, Germany, Japan, and the United Kingdom. Contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant, we find little evidence of a stable relationship between real interest rates and real exchange rates. We consider both in-sample and out-of-sample tests. One hypothesis that is consistent with our findings is that real disturbances (such as productivity shocks) may be a major source of exchange rate volatility.     

Mussa redux and conditional PPP

The extreme persistence of real exchange rates found commonly in post-Bretton Woods data does not hold in the preceding fixed exchange rate period, when the half-life was roughly half as large in our sample. This finding supports sticky price models as an explanation for real exchange rate behavior, extending the classic argument of Mussa (1986) from a focus on short-run volatility to long-run dynamics. Two thirds of the rise in real exchange rate variance observed across exchange rate regimes is attributable to greater persistence of responses to shocks, including greater price stickiness, rather than to greater variance of shocks themselves.     

Political shocks, international reserves and the real exchange rate—The Argentine case

Exogenous shocks to international reserves are introduced as an indicator for exchange rate adjustments. These reserves shocks are identified for Argentina in the 1970s, and they appear to have been induced by political upheavals as well as by changes in the external terms of trade. Granger and modified Sims causality tests indicate that the shocks to reserves did lead the real exchange rate. From the seemingly erratic series of mini and maxi devaluations, a rule of crawling/galloping peg is estimated, with the reserves shocks as significant independent variables that affected the pace of devaluations. The crawling peg, used as an instrument to pursue an international reserves target, was the channel through which changes in the political and economic environment of the country were transmitted to fluctuations of its real exchange rate.     

The impact of real exchange rate shocks on manufacturing workers: An autopsy from the MORG

We study the impact of large real exchange rate shocks on workers in sectors initially more exposed to international trade using the Current Population Survey’s (CPS) Merged Outgoing Rotation Group (MORG) from 1979 to 2010 combined with new annual measures of imported inputs, a proxy for offshoring. We find that in periods when US relative prices are high, and imports surge relative to exports, workers in sectors with greater initial exposure to international trade were more likely to be unemployed or exit the labor force a year later, but did not experience significant declines in wages conditional on being employed. Contrary to the usual narrative, we find negative wage effects for higher-wage, but not lower-wage workers, particularly for those who are less-educated.     

Effects of Monetary Policy Shocks on Farm Prices and Exchange Rates in Korea

The effects of monetary policy shocks on farm prices and exchange rates in Korea are empirically investigated by using vector auto-regression models with sign restrictions on impulse responses. The main empirical results are as follows. First, (contractionary) monetary policy shocks have significantly negative effects on real farm prices. Second, the SR effect on farm prices is significant but short-lived. The dynamic response of farm prices is consistent with the predictions of the “overshooting” model. Third, the effects of monetary policy shocks on farm prices are more significant than the effects of monetary policy shocks on exchange rates.     

Retracted: Risk Management in Financial Institutions

We study risk management in financial institutions using data on hedging of interest rate and foreign exchange risk. We find strong evidence that institutions with higher net worth hedge more, controlling for risk exposures, across institutions and within institutions over time. For identification, we exploit net worth shocks resulting from loan losses due to declines in house prices. Institutions that sustain such shocks reduce hedging significantly relative to otherwise-similar institutions. The reduction in hedging is differentially larger among institutions with high real estate exposure. The evidence is consistent with the theory that financial constraints impede both financing and hedging.     

Real exchange rate persistence and monetary policy rules

The objective of this paper is to analyze the effects of alternative monetary rules on real exchange rate persistence. Using a two-country stochastic dynamic general equilibrium with nominal price stickiness and local currency pricing, we will show how the persistence of purchasing power parity deviations can be related to a monetary theory of these deviations. When monetary policy lean against the wind, there is no relationship of proportionality between the time during which prices remain sticky and the persistence of the response of the real exchange rate: in this case high nominal price rigidity is not sufficient, per se, in generating any persistence following a monetary shock. Moreover, we emphasize the role of interest rates smoothing policies and relative price stickiness within countries in understanding the relationship between the real exchange rate and monetary shocks. With reasonable parameters values, a wide range of monetary policy rules can generate real exchange rate autocorrelations around the ones observed in the data.     

Sticky information and sticky prices

In the U.S. and Europe, prices change at least once a year. Yet nominal macro shocks seem to have real effects lasting well beyond a year. “Sticky information” models, as posited by Mankiw and Reis [2002. Sticky information versus sticky prices: a proposal to replace the new Keynesian Phillips curve. Quarterly Journal of Economics 117, 1295–1328], Sims [2003. Implications of rational inattention. Journal of Monetary Economics 50(3), 665–690], and Woodford [2003. Princeton University Press: Princeton, NJ], can reconcile micro flexibility with macro rigidity. We simulate a sticky information model in which price setters update information on macro shocks less frequently than information on micro shocks. We then examine price changes in the micro data underlying the U.S. CPI. Empirical price changes react to old information, just as sticky information models predict.     

Fiscal shocks and real exchange rate dynamics: Some evidence for Latin America

This paper analyses the effects of fiscal shocks in selected Latin American countries using a two-country model for output, labour input, government spending and relative prices. Dynamic simulation techniques are then applied, in particular to shed light on the possible effects of fiscal imbalances on the real exchange rate. Using quarterly data over the period 1980-2006, we find that in a majority of cases fiscal shocks are the main driving force of real exchange rate fluctuations.     

The behaviour of the real exchange rate: Evidence from regression quantiles

We test for mean reversion in real exchange rates using a recently developed unit root test for non-normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of different magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. It, therefore provides a detailed mapping of the real exchange rate behaviour, while being a robust alternative to previous unit root tests. The latter is confirmed by a simulation analysis comparing the power of the alternative tests. As concerns the real exchange rate, our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER.     

Persistence of dollarization after price stabilization

Credit contracts in developing countries are often denominated in foreign currencies, even after many of these economies succeeded in controlling inflation. This paper proposes a new interpretation of this apparent puzzle based on the demand for insurance against real shocks: the fact that devaluations occur more frequently in adverse states of the world provides a motive for holding dollar assets. This approach implies a complementarity between the optimal monetary policy and the currency denomination of contracts. When a large proportion of liabilities is denominated in a foreign currency, the optimal exchange rate volatility is low, which reinforces the demand for dollar assets.     

Productivity,Demand, and Regulated Price Effects Revisited: An Analysis of the Real Bilateral Exchange Rates of Four New EU Member States

This paper examines the behavior of internal price ratios and bilateral real exchange rates of a group of four new EU member states-Estonia, Hungary, Slovakia, and Slovenia. We employ a dynamic ordinary least squares panel estimator to investigate the relative importance of demand and supply influences on the internal and external exchange rates of these countries. Our analysis shows that both supply- and demand-side effects are important, though supply-side effects dominate. The paper also examines the role that administrated or regulated prices and the productivity of the distribution sector play in real exchange rate dynamics. We show that administrated prices have been a powerful force behind price and real exchange developments for our group of accession countries.     

Monetary policy,exchange rates and stock prices in the Middle East region

A structural vector autoregressive model is employed to investigate the impact of monetary policy and real exchange rate shocks on the stock market performance of Kuwait, Oman, Saudi Arabia, Egypt and Jordan. In order to identify the structural shocks both short run and long run restrictions are applied. Unlike previous literature the contemporaneous interdependence between the financial variables is left unrestricted to give a more accurate depiction of the relationships. The heterogeneity of the results reflects the different monetary policy frameworks and stock market characteristics of these countries. Mainly, monetary policy and the real exchange rate shocks have a significant short run impact on the stock prices of the countries that apply a relatively more independent monetary policy and flexible exchange rates.     

House Price Booms,Current Account Deficits,and Low Interest Rates

Domestic factors, such as credit and preference shocks, can explain the negative correlation between house prices and the current account in the U.S. and several other countries before the recent crisis. These shocks, however, cannot account for the fall of world real interest rates observed in the data. Expansionary monetary policy shocks in the U.S., coupled with exchange rate pegs to the dollar in emerging economies, are crucial to understanding the evolution of the real interest rate. Yet, monetary policy factors play virtually no role for house prices and the current account.     

Optimal fiscal and monetary policy with sticky prices

In this paper I consider the role of state-contingent inflation as a fiscal shock absorber in an economy with nominal rigidities. I study the Ramsey equilibrium in a monetary model with distortionary taxation, nominal non-state-contingent debt, and sticky prices. With sticky prices, the Ramsey planner must balance the shock absorbing benefits of state-contingent inflation against the associated resource misallocation costs. For government spending processes resembling post-war experience, introducing sticky prices generates striking departures in optimal policy from the case with flexible prices. For even small degrees of price rigidity, optimal policy displays very little volatility in inflation. Tax rates display greater volatility compared to the model with flexible prices. With sticky prices, tax rates and real government debt exhibit behavior similar to a random walk. For government spending processes resembling periods of intermittent war and peace, optimal policy displays extreme inflation volatility even when the degree of price rigidity is large. As the variability in government spending increases, smoothing tax distortions across states of nature becomes increasingly important, and the shock absorber role of inflation is accentuated.     

Costly Information,Planning Complementarities,and the Phillips Curve

Sticky information models capture the sluggish response of aggregate prices to monetary shocks but fail to match the magnitude and frequency of price changes at the microlevel. This paper shows that accounting for the endogenous decision of when to acquire new information about different shocks can help overcome this shortcoming. In the calibrated model, prices change frequently and by large amounts in response to idiosyncratic shocks but sluggishly to monetary shocks. The paper also highlights that many predictions of the sticky information and rational inattention models are the same and thus robust to different specifications of information processing costs.     

Import Tariff and Exchange Rate Transmission in a Small Open Economy

ABSTRACT

We present a small open economy DSGE model with internal and external sticky prices in an incomplete exchange rate pass-through environment. Import tariff is included as another variable that affects the law of one price. The model is calibrated for the Brazilian economy, and the responses of endogenous variables to shocks in import tariff, aggregate supply, monetary policy, and foreign interest are analyzed. The long-run effect of the first shock is deterioration in the terms of trade because the exchange rate appreciation following this shock offsets the initial effect of the increase in import tariff.     

Price,output, and exchange rate movements in the open economy

Since the advent of managed floating it has come to be accepted as a stylized fact that short-run deviations from purchasing power parity are both substantial and persistent. Two explanations of these deviations have been advanced in the literature. One emphasizes the role of changes in non-traded goods prices while the other views deviations from purchasing power parity as being due to sticky goods prices and slow adjustment of goods markets. This paper presents yet a third possible explanation of deviations from purchasing power parity — they may be necessary in order to facilitate the relative price changes that are required to maintain equilibrium in the face of unanticipated shocks. In addition, the issue of exchange rate overshooting is addressed. Whereas the sticky price models view exchange rate overshooting and exchange rate volatility as symptoms of some fundamental disequilibrium, the perspective taken here is that these events are, in principle, compatible with a world in which all markets clear continuously.     

U.S. real exchange rate fluctuations and relative price fluctuations

Traditional theory attributes fluctuations in real exchange rates to changes in the relative price of nontraded goods. This paper studies the relation between the United States’ bilateral real exchange rate and the associated bilateral relative price of nontraded goods for five of its most important trade relationships. We find that this relation depends crucially on the choice of price series used to measure relative prices and on the choice of trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. Even in cases where there is a strong relation between the real exchange rate and the relative price of nontraded goods, however, a large fraction of real exchange rate fluctuations is due to deviations from the law of one price for traded goods.     

Drivers of Exchange Rate Dynamics in Selected CIS Countries: Evidence from a Factor-Augmented Vector Autoregressive (FAVAR) Analysis

We investigate the likely sources of exchange rate dynamics in selected member countries of the Commonwealth of Independent States (CIS; Russia, Kazakhstan, Ukraine, Kyrgyzstan, Azerbaijan, and Moldova) over the past decade (1999-2010). Evidence is based on country VARs augmented by a regional common-factor structure (FAVAR model). The models include nominal exchange rates, the common factor of exchange rates in the CIS countries, and international drivers such as global trade, share prices, and oil price. Global, regional, and idiosyncratic shocks are identified in a standard Cholesky fashion. Their relevance for exchange rates is explored by a decomposition of the variance of forecast errors. The impact of global shocks on the development of exchange rates has increased, particularly if financial shocks are considered. Because of the recent global financial crisis, regional shocks have become more important at the expense of global shocks.