The choice of exchange rate regime: An empirical analysis for transition economies*

We analyze the choice of exchange rate regimes of the 25 transition economies in Europe and the CIS after 1990. The empirical results show that the traditional Optimum Currency Area considerations provide relevant guidance for the regime choices in these countries. Moreover, regime choices are influenced by inflation rates, cumulative inflation differentials, and international reserves sufficiency. That is, macroeconomic stabilization and the ability to commit to exchange rate pegs also play important roles. Large government deficits have ambiguous effects; they increase the likelihood of moving from flexible to intermediate regimes as well as that of moving from fixed to intermediate ones.     

The role of monetary policy credibility in explaining the decline in exchange rate pass-through in South Africa

This paper investigates the key factors that explain the documented decline in the exchange rate pass-through in South Africa over the past two decades. The paper finds that this outcome is largely due to improved monetary policy credibility. The South African Reserve Bank has become more credible since the adoption of the inflation target regime through improved communication, transparency, and independence. We show that credibility is enhanced through a gradual disinflation process and reduction of inflation volatility. As result, expectations of agents have become well-anchored at levels that are consistent with its objectives of keeping inflation within the official target range of 3–6 percent even in the presence of external shocks. This in turn reduces the exchange rate pass-through. This finding is important from a monetary policy perspective not only for South Africa but other emerging economies such as Turkey as it shows that improving monetary policy credibility is a key ingredient to reducing exchange rate pass-through.     

Monetary policy and exchange rate dynamics in the Spanish economy

As the Spanish economy gets more integrated in international markets, the real exchange rate becomes a key determinant of the monetary transmission. In this paper we trace out the dynamic response of prices, output and the exchange rate following a monetary policy shock. We estimate a structural VAR model whose identification scheme is based on the long run properties common to a large class of models. The results suggest that a small model with efficient asset markets plus nominal inertia and long run monetary neutrality, captures the essential features of the monetary transmission mechanism in Spain. The interest rate shock is well identified and the exchange rate overshoots its long run value. There are no signs of liquidity puzzle nor of price puzzle or exchange rate puzzle either.     

Analyzing exchange rate uncertainty and bilateral export growth in China: A multivariate GARCH-based approach

Dramatic changes to exchange rate policy for the world's largest exporter have arguably ushered in the optimal environment for studying the effects of exchange rate uncertainty on trade. This study builds on the recent literature by using an extremely general model that measures volatility using the flexible multivariate DCC-GARCH model to analyze the impact exchange rate uncertainty has on bilateral export growth for China's ten largest export markets. All model parameters are estimated simultaneously and lagged values of uncertainty are included for a full year, where significant effects are found. The more general methods potentially overcome issues associated with inefficient two-step methods and the assumption that volatility impacts are close to instantaneous. Using a comprehensive sample that spans 1994–2017, the paper presents evidence that exchange rate uncertainty has no impact on trade with the United States, which strongly contrasts a robust finding of trade deterring impacts for almost all remaining countries. The unifying methodology is also used to analyze nominal uncertainty itself. Here, it is found that Chinese inflation may be a positive contributor to risk in an environment where many exogenous events, such as the Asian currency crisis, are associated with periods of heightened yuan uncertainty.     

Internal and external exchange rate equilibrium in a cointegration framework. An application to the Spanish peseta

A simple cointegration methodology is used to compute the equilibrium real exchange rate for the peseta. The stock of foreign assets and the evolution of sectoral prices are considered to be the fundamentals for the real exchange rate. After testing for cointegration, we proceed to decompose the series into a permanent and a transitory component, following the method devised by Gonzalo and Granger. The permanent component of the real exchange rate corresponds to its (time-varying) equilibrium value, and the deviation of the actual real exchange rate from this equilibrium value gives an estimation of the degree of misalignment of the real exchange rate. By the end of the sample (1998:1), the peseta is estimated to be undervalued around 6%.     

Exchange rate regime classifications and exchange rate variability

It is well known that the exchange rate regime (ERR) declared to the IMF is often different from the actual regime. Several alternative schemes for de facto regime classification have been developed. In this article, we compare the ability of four popular schemes to track exchange rate variability (ERV). We find that the existing ERR classifications do not match well with the degree of ERV, especially for intermediate regimes. For instance, in the Levy-Yeyati and Sturzenegger (2003) coding, the intermediate regimes exhibit greater ERV than the floaters. On the other hand, for the Reinhart and Rogoff (2004) coding, the fixers show greater variability than some intermediates.     

Structural analysis with mixed-frequency data: A model of US capital flows

We develop a new structural Vector Autoregressive (SVAR) model for analysis with mixed-frequency data. The MIDAS-SVAR model allows to identify structural dynamic links exploiting the information contained in variables sampled at different frequencies. It also provides a general framework to test homogeneous frequency-based representations versus mixed-frequency data models. A set of Monte Carlo experiments suggests that the test performs well both in terms of size and power. The MIDAS-SVAR is then used to study how monetary policy and financial uncertainty impact on the dynamics of gross capital inflows to the US. While no relation is found when using standard quarterly data, mixed frequency analysis exploiting the variability present in the series within the quarter shows that the effect of an interest rate shock is greater the longer the time lag between the month of the shock and the end of the quarter.     

Sources of exchange rate fluctuations with Taylor rule fundamentals

This paper investigates the sources of exchange rate fluctuations when monetary policy follows a Taylor rule interest rate reaction function. We first present a simple dynamic exchange rate model with Taylor rule fundamentals which is triangular in the long-run impacts of shocks to the output market, the interest rate differential, and the Taylor rule. We then proceed to assess the relative importance of various shocks in exchange rate determination by estimating a structural VAR with long-run identification restrictions based on the triangular structure of the model. We find demand shocks to be less important than in earlier VAR studies, with both supply shocks and nominal shocks explaining a substantial part of real exchange rate fluctuations.     

Balance of payments accounting and exchange rate dynamics

The balance of payments is an accounting identity. Many wonder how the current and capital accounts, which add up to zero, can influence exchange rates. This paper shows how payment flows arising from balance of payments imbalances affect the demands for different currencies in the foreign exchange market over time. Based on a dynamical system approach, the paper demonstrates how international payments evolve depending on the joint dynamic behaviour of different balance of payments components. It finds that international payments and exchange rates interact in fundamentally different ways depending on whether a country restricts its capital inflows and outflows, whether capital flows are accommodating or autonomous and whether the exchange rate is fixed, flexible or, say, governed by a crawling peg. Empirical evidence from major industrial countries as well as from countries hit by currency crises support the paper's theoretical predictions.     

Capital inflows, fiscal discretion, and exchange rate policy

Many writers have argued for the benefits of a credible fixed exchange rate (a hard peg) as a commitment device in an open economy. But historically, fixed exchange rates have often been associated with large current account deficits and episodes of ‘over-borrowing’. This paper develops a model of capital inflows that are linked to the exchange rate regime because of endogenous fiscal policy. The key message of the paper is that a hard peg is undesirable in the absence of commitment in fiscal policy. In face of a credible fixed exchange rate, the fiscal authority subsidizes capital inflows. The economy will engage in inefficiently high international borrowing, and in welfare terms may end up worse off than under capital market autarky. To eliminate the incentive to subsidize borrowing, the monetary authority must follow a flexible exchange rate rule in which capital inflows lead to exchange rate appreciation. If fiscal policy must be financed by money creation rather than direct taxation, then a fixed exchange rate rule may cause both over-borrowing and a subsequent exchange rate crisis.     

What explains recent changes in international monetary policy attitudes toward inflation? Evidence from developed countries

This paper identifies source(s) contributing to the recent international shift in monetary policy attitudes toward inflation. Data from 18 developed countries suggests that this shift is connected to the universal increase in policy responses to economic openness in the 1990s.     

Panel cointegration and the monetary exchange rate model

This paper re-examines the validity of the monetary exchange rate model during the post-Bretton Woods era for 18 OECD countries. Our analysis simultaneously considers the presence of both cross-sectional dependence and multiple structural breaks, which have not received much attention in previous studies of the monetary model. The empirical results indicate that the monetary model emerges only when the presence of structural breaks and cross-country dependence has been taken into account. Evidence is also provided suggesting that the breaks in the monetary model can be derived from the underlying purchasing power parity relation.     

Monetary shocks,exchange rates and trade balances: Evidence from inflation targeting countries

This paper investigates the relationship among monetary policy shocks, exchange rates and trade balances in five Inflation Targeting Countries (ITCs). The investigation is based on Structural Vector Error Correction Models (SVECMs) with long run and short run restrictions. The findings reveal that a contractionary monetary policy shock leads to a decrease in price level, a decrease in output, an appreciation in exchange rate, and an improvement in trade balance in the very short run. Our findings contradict the findings of price, output, exchange rate and trade puzzles that have been found in many empirical studies. Furthermore they are consistent with the theoretical expectations regarding the effect of a contractionary policy. The only long run restriction that we imposed on our models is that money does not affect real macroeconomic variables in the long run, which is consistent with both Keynesian and monetarist approaches.     

Forex interventions and exchange rate exposure: Evidence from emerging market firms

Foreign exchange (forex) interventions by central banks have recently become too frequent in emerging markets. The effects of these interventions on exchange rate volatility are widely documented, but their implications for firm-level outcomes have rarely been examined. This study argues that forex interventions should influence the sensitivity of firms’ cash flows to currency movements. Accordingly, I address a novel question regarding the effect of forex interventions on emerging market firms’ exchange rate risk exposure. I find an asymmetric effect, such that the impact of forex purchase interventions differs from that of forex sale interventions. Moreover, the positive effects of forex sale interventions on the magnitude of firms’ exposure are more pronounced during depreciation periods. Study findings imply that firms remain unhedged, given that interventions are perceived as implicit government guarantees against currency fluctuations. Credible communication from policymakers regarding the motives for interventions by central banks would assist in alerting firms to potential currency risks.     

The impacts of economic sanctions on exchange rate volatility

This research empirically analyzes the impact of various instruments of economic sanctions on official exchange rate volatility by employing data from a panel of 23 target countries covering the period 1996–2015 and using the Least Squares Dummy Variable Corrected (LSDVC) model. Our findings suggest that economic sanctions do significantly influence the target countries’ exchange rate volatility. Specifically, we are able to see different sanction present its different effects on exchange rate volatility. Furthermore, the robustness evidence of the eliminating country as Iran, eliminating variable of political ideology, intercepting time period, cross-sectional regression analysis, using real exchange rate volatility as proxy variable and a new sanctions database, are basically consistent with the previous finding. Overall, our empirical findings offer implications for those sanctioned countries about how to stabilize their exchange rate when facing sanctions.     

On the role of money in a business cycle model of a small open economy: The case of Spain

This paper examines the consequences of introducing a cash-in-advance constraint into a small open economy business cycle model for the Spanish case. A business cycle model is built extending Correia, Neves and Rebelo's (1995) small open economy framework and Cooley and Hansen's (1995) monetary economy. Money is introduced through a cash-in-advance constraint. The stochastic simulation of the model and its comparison to Spanish data show that the model is able to mimic i) the Dolado et al. puzzle, that is, the high volatility of private consumption for this economy; ii) the Dunlop-Tarshis observation, i.e., the negative correlation between real wages and hours worked; and iii) some cyclical features of the nominal dimension.     

Financial constraints,firm entry,and exchange rate pass-through

Using a heterogeneous firm model with firm entry and endogenous markups, I study how the financial constraints of exporting firms affect exchange rate pass-through behaviors. I find that the financial constraints increase the degree of exchange rate pass-through.     

Forward-looking monetary policy and anticipated shocks to inflation

This paper extends a standard New Keynesian model to describe the effects of anticipated shocks to inflation and forward-looking monetary policy. Using the data generated from this modified model suggests that overlooking these two factors in the standard Cholesky structural vector autoregressive identification scheme will generate a price puzzle. Furthermore, this paper demonstrates that failing to account for these two factors may result in significant estimates of two other explanations of the price puzzle—the cost channel of transmission of monetary policy and indeterminacy due to violation of the Taylor principle—even though neither features in the data generating process.     

Systemic risk: The coordination of macroprudential and monetary policies in China

The literature documents the effects of monetary and macroprudential policies in controlling systemic risk, but empirical evidence of a systemwide framework that effectively coordinates the two policies is lacking. This study assesses the effectiveness, channels, and timeliness of monetary and macroprudential policies’ impacts on systemic risk in China from January 2009 to June 2018, and contributes to the discussion of how to coordinate these policies. Using an index synthesized from 28 indicators to proxy China’s systemic risk, we find the following: (1) A contractionary monetary (macroprudential) shock increases (reduces) systemic risk over the entire shock time period. (2) Macroprudential (monetary) policy is effective in the long (short) term. (3) The systemic risk intervention effect of monetary (macroprudential) policy is channeled through inflation control (asset price stability).