A MODEL OF INFLATION TRANSMISSION IN AN EXCHANGE RATE TARGET ZONE

I incorporate an exchange rate target zone with intramarginal interventions in a small open economy model. Using the method of undetermined coefficients, I solve for the price level and the nominal exchange rate to determine how price shocks from the large economy affect the small open economy. The results show that the behaviour of inflation transmission within the band differs from the behavior of inflation transmission at the edge of the band of the target zone. Foreign shocks can affect local prices in both cases but the central bank can respond through market interventions within the band while it cannot do so at the edge. Near the edge of the band, a central bank has to intervene to stop the exchange rate from breaching the band. My model predicts that if the interventions are robust, then the exchange rate is mean reverting and an exchange rate target zone can insulate an economy from foreign price shocks. Based on the model, central bank interventions contribute to long‐run price stability in a target zone regime. Finally, I empirically test the model using unit root and cointegration tests, and present some policy implications.     

International business cycles and the relative price of investment goods

Abstract Is the relative price of investment goods a good proxy for investment specific technology? We model this relative price in a flexible price international economy with two fundamental shocks, namely, the total factor productivity (TFP) shock and the investment‐specific technology (IST) shock. We show that the one‐to‐one correspondence between the IST shock and the relative price of investment goods breaks down in an international economy because of the short‐run correlation between the terms of trade and the relative price of investment goods. The data congruent negative correlation between the investment rate and the relative price of investment goods thus does not necessarily reflect decline in investment frictions (rise in IST), as suggested by many studies. A calibration experiment with the US data demonstrates that such an inverse relation between rate of investment and the relative price of investment goods basically reflects the positive effect of TFP on the terms of trade for a broad range of economies where the home bias in consumption exceeds investment and there is a sizable adjustment cost of investment.     

TOURISM,DUTCH DISEASE AND WELFARE IN AN OPEN DYNAMIC ECONOMY*

This paper examines the effects of an expansion in tourism on capital accumulation, sectoral output and resident welfare in an open economy with an externality in the traded good sector. An expansion of tourism increases the relative price of the nontraded good, improves the tertiary terms of trade and hence yields a gain in revenue. However, this increase in the relative price of nontraded goods results in a lowering of the demand for capital used in the traded sector. The subsequent de‐industrialization in the traded good sector may lower resident welfare. This result is supported by numerical simulations.     

Financial Integration in Emerging Asia: Challenges and Prospects

Using both quantity‐ and price‐based measures of financial integration, the paper shows an increasing degree of financial openness and integration in emerging Asia. Assessing the impact of a regional shock relative to a global shock on local equity and bond markets, the findings suggest that the region's equity markets are integrated more globally than regionally, although the degrees of both regional and global integration have increased significantly since the 1997/1998 Asian financial crisis. However, emerging Asia's local currency bond markets remain generally segmented, being neither regionally nor globally integrated. There are potential benefits from increased regional integration of financial markets. Financial integration at the regional level allows for the region's economies to benefit from allocation efficiency and risk diversification. Policymakers in the region must strike the right balance between maximizing the net benefits from regional and global financial openness, and minimizing the potential costs of financial contagion and crisis.     

Capital account liberalization and dynamic price discovery: evidence from Chinese cross-listed stocks

We analyse the effects of a recent financial reform (Shanghai-Hong Kong Stock Connect) that enables cross-market investment between Hong Kong and Shanghai stock exchanges. Using a VECM, we find that the reform announcement considerably narrows the equilibrium level of price disparity and strengthens the price comovement of shares that are cross-listed in both markets. The estimated equilibrium relationship is in support of the relative law of one price. We find that both markets adjust in response to a disequilibrium in price disparity, leading to a sizeable error correction activity. The Shanghai market contributes to approximately two-thirds of the price discovery process. Competition and informativeness of trading affect the relative role of price discovery in each market. Finally, the reform implementation reinforces the long-run cointegration relationship and strengthens the short-run price comovements of cross-listed stocks despite the widening price disparity during the period.     

Output and price effects of enhancing services sector competition in a large open economy

This paper studies the output and price effects of exogenous changes in the degree of competition. It is motivated by initiatives to enhance competition in services in the European Union. The paper shows that a higher degree of competition in the nontradable goods sector may have adverse implications for international price competitiveness. It highlights four channels through which enhanced competition in the non-tradable goods sector affects output and the general price level in a large, open economy (lower monopoly rents, higher wages, lower import prices, international wealth transfer) and assesses their relative importance. The conclusions suggest that the Single Market enhances output and reduces the general price level.     

The Effects of Macroeconomic Policy with a Disparity in Price Elasticity Between Private‐ and Public‐ Sector Demands

We introduce a disparity in price elasticity between government demand and consumption demand into a simple money‐in‐the‐utility‐function model. This extension demonstrates that the effect of fiscal policies on production may be positive, negative, or neutral depending on the disparity in price elasticity between sectors. Because the effect of an increase in nominal money supply with constant nominal government expenditure is the opposite to that of a fiscal policy, a fiscal policy financed by seigniorage can have positive, negative, or no effects depending on parameter values. Moreover, the effect of simultaneous implementation of expansionary–contractionary policies depends on how they are combined.     

CROSS‐MARKET TRADING IN CHINA'S LARGE STATE‐OWNED COMMERCIAL BANKS, 2006–2011

This paper examines the differential between the share prices of China's large state‐owned commercial banks traded in Shanghai versus prices observed in Hong Kong. We find a significant role for investor sentiment, as reflected in relative price‐earnings ratios, in explaining these price differentials for all four banks. The share price in Shanghai tends to move ahead of the share price in Hong Kong when more positive sentiment in Shanghai makes local investors willing to pay more for the same predicted earnings. We also identify common trends in relative bank price‐earnings ratios and price differentials across the two markets. (JEL G14, G15)     

Trade Liberalization and Welfare Inequality: A Demand‐Based Approach*

There is strong evidence suggesting that different income groups consume different bundles of goods. Hence, trade liberalization can affect welfare inequality via changes in the relative prices of goods consumed by different income groups (the price effect). In this paper, I develop a framework that enables us to explore the role of the price effect in determining welfare inequality. I find that trade liberalization does benefit some income classes more than others. In particular, I show that the relative welfare of the rich with respect to that of the poor has a hump shape as a function of trade costs.     

Equity home bias,incomplete financial markets,and nominal rigidities

Abstract This paper analyzes optimal portfolio decisions in a monetary open‐economy framework. It is found that market completeness and the specific form of nominal rigidities, namely, nominal price vs. nominal wage rigidities, matter for justifying the observed structure of equity holdings. When markets are complete, sticky prices generate a negative correlation between the non‐diversifiable labour income and the profit of domestic firms with respect to the productivity shocks, which explains why households invest little abroad. In contrast, when markets are incomplete, rigidities in goods prices result in a counterfactual ‘super home bias’, because domestic equities provide a good hedge against not only the labour income risk but also the relative price risk. Wage rigidities, however, have the opposite effect. Therefore, nominal rigidities in both goods prices and wage rates are needed to address the empirical composition of gross equity positions under incomplete markets.     

Pricing to market behaviour in European car markets

This paper investigates PTM behaviour in European car markets for a period of great interest (1993-98), taking into account the role of invoicing currency. The results indicate that local currency price stability is a strong and pervasive phenomenon across products independently of the invoicing currency. The paper offers robustness checks, tests and arguments that justify the interpretation of this finding, at least in part, as evidence of PTM. It implies the existence of market segmentation and price discrimination, despite the completion of the single market programme on 1 January 1993.     

Nonlinearity and asymmetry in the exchange rate pass‐through: What role for nominal price stickiness?

This paper examines the importance of nominal rigidity for nonlinearity and asymmetry of exchange rate pass‐through. For this purpose, we rely on company‐level data of French importing firms. We find that the well established fact that “prices rise faster than they fall,” which is characterized by the convex import price reaction function, lies primarily with the presence of nominal rigidity. Once price stickiness is controlled for, there is empirical evidence that the import price reaction function is rather concave if the linearity assumption can be rejected, indicating that firms aim primarily to protect their market share.     

Strategic competition and optimal parallel import policy

Abstract In a two‐country Hotelling type duopoly model of price competition, we show that parallel import (PI) policy can act as an instrument of strategic trade policy. The home firm’s profit is higher when it cannot price discriminate internationally if and only if the foreign market is sufficiently bigger than the domestic one. The key mechanism in the model is that the home firm’s incentive to keep its domestic price close to the optimal monopoly price affects its behavior during price competition abroad. We also analyze the welfare implications of PI policies and show that our key insights extend to quantity competition.     

Asymmetric Demand Information and Foreign Direct Investment*

We examine the FDI versus exports decision of firms competing in an oligopolistic (quantity‐setting) market under demand uncertainty and asymmetric information. Compared to a firm that chooses to export, a firm that chooses to set up a plant in the host market has superior information about local market demand. In addition to the well‐known tension between the fixed set‐up costs of investment, the additional variable costs of exports and oligopoly sizes, the incentive to invest abroad is explained by the strategic learning effect. FDI may be observed even if trade costs are zero. The analysis is robust to price competition and to the possibility that a foreign firm can engage in both FDI and exports.     

Home bias, distribution services and determinants of real exchange rates

This paper examines empirically how exogenous changes in the terms of trade affect the real exchange rate through the relative price of traded goods with Canada–US data. The relative price of traded goods is constructed using prices at the dock and retail prices. The first measure emphasizes the importance of home bias in consumption of traded goods. The second measure highlights the importance of distribution services required for consumption of traded goods. It is found that terms of trade shocks affect the relative price of traded goods using both measures. A possible interpretation of empirical findings is that home bias and distribution services are important for understanding the relative price of traded goods.     

DUALITY WITH SECTOR‐SPECIFIC EXTERNALITIES UNDER SOCIAL CONSTANT RETURNS*

We develop dual approaches to quantity and price relationships of production in a general multisectoral model with sector‐specific externalities. The production of each good exhibits socially constant returns to scale but privately decreasing returns. We find that the Stolper‐Samuelson theorem holds for factor intensity ranking from the social perspective and that the Rybczynski theorem holds for factor intensity ranking from the private perspective. The price‐output dual fails to hold in general. Moreover, we re‐establish the Heckscher‐Ohlin theorem in the two‐sector case, as well as the factor endowment–factor price and price‐output comparative statics in the high‐dimension case under proper conditions.     

Terms‐of‐Trade Shocks and Exchange Rate Regimes in a Small Open Economy*

We examine the impact of terms‐of‐trade shocks on key macroeconomic variables by numerically solving a dynamic stochastic general equilibrium model of a small open economy. The model considers nominal price rigidity under different exchange rate regimes. The numerical solutions obtained are consistent with the empirical regularities documented by Broda (2004), in which output responses to shocks are smoother in floats than in pegs; in moving from pegs to floats, the rise in nominal exchange rate volatility is coupled by the rise in real exchange rate volatility; and in both exchange rate regimes, net foreign assets is the most volatile variable.     

Import sensitive products and perverse tariff‐rate quota liberalization

Abstract This paper shows that a Tariff‐Rate‐Quota's (TRQ) minimum access expansion can perversely trigger domestic price increases. Often, TRQs have prohibitive over‐quota tariffs to mimic import quotas in providing minimum market access. In the WTO's Doha Round, it is likely that countries using TRQs will avoid aggressive tariff reductions if they increase the quota portion of TRQs. We show that when the import price lies between the unit cost of production and the price received by domestic upstream firms, an increase in import quota as a share of domestic production may cause an increase in the domestic retail price.     

Effects of cross-border capital flows on stock returns of dual-listed firms in mainland China and Hong Kong: Evidence from a natural experiment

This study analyses the effects of the Shanghai–Hong Kong Stock Market Connect policy on the price disparity between A-shares and H-shares of dual-listed companies (DLC). Using a difference-in-difference estimation method, we show that the policy decreases the relative twin cumulative abnormal returns of treated DLC by 3% and narrows the price gaps between A-shares and H-shares. We determine that the rising demand for H-shares, which are newly accessible by mainland investors, drives the price of H-shares up. By contrast, the price of A-shares remains unchanged. Further analysis reveals that cross-border capital flow is the main force of the policy.     

EXPORT SUBSIDIES VERSUS EXPORT QUOTAS WITH INCOMPLETELY INFORMED POLICY MAKERS*

This paper analyses export subsidies (price incentives) and export quotas (quantity controls) in the Brander‐Spencer (1985) model when policy makers have limited information on demand and cost structures. We examine necessary or sufficient information for policy makers to determine welfare‐enhancing policies. It is crucial that they know the elasticity value of the slope of the inverse demand curve and the market share. It is also shown that for policy makers, export quotas are superior to export subsidies under certain conditions.