Inflation,interest and exchange rates in the transition1

Central and Eastern European economies have made extraordinary progress in their trade and exchange regimes. Surprisingly, instant convertibility was established for a great variety of exchange rate regimes. In spite of diversity, all these countries have followed a common pattern: severe initial undervaluation - the cost of speed and unrestricted trade - followed by rapid real revaluation and incipient protectionism. Since 1994 in many cases an embarrass de richesse has appeared: high capital inflows which are either inflationary or costly to sterilize. A major cause of these flows - or at any rate of the high cost of sterilization - is the presence of significant interest rate differentials higher than required to cover the risk of devaluation. These are the necessary consequence of a policy of positive real interest rates and of real revaluation from excessively undervalued exchange rates. Lower interest rates are recommended, both to stem financial capital inflows and to reduce the cost of their sterilization.     

The influence of money and the rate of interest on the rate of inflation in a financially repressed economy: the case of Turkey

In this paper we discuss a recent paper by Stephen E. Haynes in which he relates electoral cycles in political support to electoral cycles in economic variables. Haynes finds that the cycle in support for Republican presidents is explained by the cycle in economic variables, whereas the cycle in support for Democratic presidents is not. In our opinion this shortcoming is due to his specification of the popularity function. Haynes estimates a popularity function which incorporates the notion that voters reward the incumbent for favourable outcomes (score hypothesis). Our popularity function combines the score hypothesis and the notion that voters cast their ballots for the party that best fits the current economic situation (issue hypothesis). We show that the electoral cycle in popularity of both Republican and Democratic presidents is explained very well by the cycle in economic variables.     

Revisiting the interest rate–exchange rate nexus: a Markov-switching approach

In this paper the interest rate–exchange rate nexus and the effectiveness of an interest rate defense are investigated empirically. I present a reduced form evidence which characterizes the empirical relationship between interest rates and exchange rates. I use a Markov-switching specification of the nominal exchange rate with time-varying transition probabilities. Empirical evidence from six developing countries: Indonesia, South Korea, the Philippines, Thailand, Mexico, and Turkey indicates that raising nominal interest rates leads to a higher probability of switching to a crisis regime. Thus, the empirical results presented here may support the view that a high interest rate policy is unable to defend the exchange rate. Unlike other studies which consider linear models only, my findings are robust and consistent over different countries and crisis episodes (Asian 1997 crises, Mexico 1994 crisis, and Turkey 1994, 2001 crises). In order to explain the empirical findings, I construct a simple theoretical model by incorporating an interest rate rule in the model proposed by Jeanne and Rose (2002) [Jeanne, O., Rose, A.K., 2002. Noise trading and exchange rate regimes, Quarterly Journal of Economics. 117 (2) 537–569]. The model has multiple equilibria, and under plausible conditions, higher exchange rate volatility is associated with higher interest rates.     

Inflation,growth and exchange rate regimes in small open economies

Summary. This paper compares the merits of alternative exchange rate regimes in small open economies where financial intermediaries perform a real allocative function, there are multiple reserve requirements, and credit market frictions may or may not cause credit rationing. Under floating exchange rates, raising domestic inflation can increase production if credit is rationed. However, there exist inflation thresholds: increasing inflation beyond the threshold level will reduce domestic output. Endogenously arising volatility may be observed independently of the exchange rate regime. Private information - with high rates of domestic inflation - increases the scope for indeterminacy and economic fluctuations.Received: 26 March 2002, Revised: 29 October 2002JEL Classification Numbers: E32, E44, F33.P.L. Hernandez-Verme: I would like to thank Leonardo Auernheimer, Valerie Bencivenga, Dean Corbae, Scott Freeman, Todd Keister, Beatrix Paal, and Maxwell Stinchcombe for very helpful comments and suggestions. Very special thanks are due to Bruce D. Smith. The paper also benefited from the discussions in the seminars in CIDE, the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Kansas City, Indiana University, ITAM, Purdue University, the Second Annual Missouri Economics Conference, Texas A&M, the University of Missouri and the University of Texas at Austin.     

Covered interest rate parity: the Australian case

In differentiating between long-run and instantaneous covered interest parity and in introducing domestic influences (proxied by unanticipated growth in the monetary base) as short-run determinants of domestic interest rates, this study sheds new light on the interest parity relationship in the Australian context. Indeed the results of the empirical tests indicate that previous studies have misspecified the dynamics of the relationship, omitted significant domestic influences, and consequently produced biased estimates.     

Inflation and output dynamics with a floating exchange rate

The purpose of this paper is to extend a simple monetarist model of price output fluctuations in a closed economy to the case of a small open economy with a floating exchange rate. Trade and capital flows are explicitly incorporated into the model, exchange rate expectations and inflation expectations are treated separately and exchange rate expectations are integrated into the demand for money function. The properties of the model are investigated under the limiting cases of perfect capital mobility and zero capital mobility. Stability conditions and short run price-output trade-offs are derived and the conclusions for cyclical output patterns are deduced. It is also shown how the short run movement of the exchange rate deviates from purchasing power parity in a systematic fashion.     

Foreign interest rate shocks and exchange rate regimes in East Asia

Using a theoretical dynamic stochastic general equilibrium model and an empirical panel vector autoregression, we assess the transmission of foreign real interest rate shocks on the volatility of various key macroeconomic variables in nine small open economies in East Asia taking into account the role of exchange rate regimes. Both the theoretical and empirical findings confirm the hypothesis that flexible exchange rate may work as a shock absorber when the economy is hit by foreign real interest rate shocks. The findings suggest a clear trade-off between the volatility of real exchange rate and real output to foreign interest rate shocks, both the US and G7 real interest rates, where the responses of real output are mitigated in countries that have more flexible exchange rate regime.     

Real exchange rates and real interest rate differentials: A present value interpretation

Although the real exchange rate-real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral US real exchange rate data spanning the period 1978-2007. Instead of testing one particular model, we build on Campbell and Shiller [1987. Cointegration tests of present-value models. Journal of Political Economy 95, 1062-1088] to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.     

我国汇率与存款利率的关系研究：2000.1-2007.8

本文通过对2000年1月到2007年8月期间的人民币汇率与利率的关系进行了格兰杰因果检验,并采用单位根检验,建立VAR模型,通过脉冲响应函数和方差分解分析了二者的关系。结果表明,汇率变动影响着居民储蓄存款利率的变化较为显著,而居民储蓄存款利率影响汇率变动的力度较弱。我国存在着阻碍汇率利率联动的制度、经济等因素。     

Estimating the equilibrium real exchange rate: the case of Turkey

This article is the first attempt in the literature to investigate the effects of public social security on aggregate consumption in a time-series setting for a developing country, Turkey that has one of the most generous social security systems in the organization for economic cooperation and development (OECD) region. In order to quantify the social security variable, this article uses the social security wealth (SSW) series calculated for Turkey in a separate study. This study indicates that SSW is the largest part of the household wealth in Turkey, and therefore should not be ignored in the aggregate consumption studies. The results show that its effect on consumption is positive and robust.     

Measuring bank competition under binding interest rate regulation: the case of China

Many empirical studies suggest that financial reform promoted bank competition in most mature and emerging economies. However, some earlier studies that adopted conventional approaches to measure competition have concluded that bank competition in China declined during the past decade, despite progressive reforms implemented since the 1980s. We show that this apparent contradiction is the result of flawed measurement. Conventional indicators such as the Lerner index and Panzar–Rosse H-statistic fail to measure competition in Chinese loan markets properly due to the system of interest rate regulation. By contrast, the profit elasticity (PE) approach does not suffer from these shortcomings. Using balance sheet information for a large sample of banks operating in China during 1996–2008, we show that competition actually increased in the past decade when the PE indicator is used.     

Real exchange rate volatility,financial crises and exchange rate regimes

This article examines real exchange rate (RER) volatility in 80 countries around the world, during the period 1970 to 2011. Two main questions are raised: are structural breaks in RER volatility related to changes in exchange rate regimes or financial crises? And do these two events affect the permanent and transitory components of RER volatility? To answer these, we employ two complementary procedures that consist in detecting structural breaks in the RER series and decomposing volatility into its permanent and transitory components. Our results suggest that structural breaks in RER volatility coincidence with financial crises and certain changes in nominal exchange rate regimes. Moreover, our findings confirm that RER volatility does increase with the global financial crises and detect that the more flexible the exchange rate regime, the higher the volatility of the RER using a de facto exchange rate classification.     

Trade liberalisation and exchange rate pass-through: the case of textiles and wearing apparels

Studies on the relationship between exchange rates and traded goods prices typically find evidence of incomplete pass-through, usually explained by pricing-to-market behaviour. Although economic theory predicts that incomplete pass-through may also be linked to the presence of non-tariff barriers to trade, variables reflecting such a link is rarely included in empirical models. In this paper, we estimate a pricing-to-market model for Norwegian import prices on textiles and wearing apparels, controlling for non-tariff barriers to trade and shift in imports from high- to low-cost countries. We apply the cointegrated VAR approach and develop measures of foreign prices based on superlative price indices (including the Törnqvist and Fischer price indices) and a data calibration method necessary to approximate relative price levels across countries. Our measures of foreign prices thereby account for inflationary differences and varying import shares and price level differences (known as the China effect) among trading partners. We show that these measures of foreign prices, unlike standard measures used in the pricing-to-market literature, are likely to produce unbiased estimates of pass-through. Once the China effect is controlled for, we find little evidence that pass-through has changed alongside trade liberalisation.     

Explaining forecasting bias: The case of real exchange rate variance

Recent tests of the rational expections hypothesis (REH), based on the assumption that agents are risk-neutral, have yielded conflicting results when applied to foreign exchange markets. Here a two-stage procedure which does not assumej risk-neutrality is derived from a model of a utility-maximizing importer who incurs an adjustment cost if he changes his import order. Although a short-run test (based on aggregate imports) leads to rejection of the REH in the majortity of cases, a longer-ren test (based on manchinery imports) is more favourable to the null huypthesis. The observed shot-run tendency to, in effect, ignore low levels of real exchange rate variation is found to be more likely when bilateral rates have remained relatively stable, when the importingj economy is relatively closed, or when governments have announced policies of intervention to stabilize bilateral rates.     

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.     

Insights on endogenous money and the liquidity preference theory of interest

It is argued that the debate between “structuralist” and “horizontalist” has long been obscured because of inadequate treatment, in both approaches, of the credit-money supply and of the total money supply. As a result, endogenous money models still have serious limitations today. On the one hand, the bank loan markup and the loan interest rate are exogenous in the horizontalist model, which supposes that they do not depend on the money/liquidity market conditions (as if bank loans did not compete with the existing liquidity). On the other hand, although interest rates are endogenous in the structuralist model, they result from inappropriate treatment of the loan supply and money/liquidity supply. This article aims to remove these shortcomings. It offers a theoretical framework and formal modeling where the creditworthy demand for loans determines the bank loan supply, given the central bank refinancing interest rate, while the total supply and demand for liquidity-money determines the markup and the market rate of interest in accordance with Keynes’s liquidity preference theory. In this framework, the post Keynesian theory of endogenous money and Keynes’s “verticalist” view prove to be analytically complementary.