Exchange rate misalignments,capital flows and volatility

This study investigates the effect of three dimensions of exchange rate misalignments—(i) distance (absolute misalignments), (ii) direction (overvaluation or undervaluation), and (iii) degree (small or large misalignments)—on the overall as well as short-cycle exchange rate volatility. Using data from 1988 to 2014, we find that relative PPP-based exchange rate misalignments increase exchange rate volatility. For developed and developing countries, this increase in volatility is driven mainly by large undervalued misalignments of the U.S. dollar. This finding might be linked to interventions targeting the loss in domestic producers’ competitiveness in global markets. Interestingly, in the case of developed countries, we find this adverse effect on exchange rate volatility also for small absolute misalignments; exchange rate movements close to equilibrium may be associated with ambiguity with respect to future movements in developed countries, which can result in higher exchange rate volatility. Further, the results suggest that, when the dollar is highly undervalued, capital flows have a stabilizing effect on exchange rate volatility in developed countries but a destabilizing effect in developing countries. The finding is consistent with investors’ strategy of taking exchange rate overvaluation and undervaluation into account when engaging in cross-border investments.     

Current account and credit growth: The role of household credit and financial depth

Understanding the impact of financial variables on the current account balance is one of the priorities of academic literature and policymakers. Evidence from a broad panel of advanced and emerging countries shows that an increase in credit growth is associated with a significant deterioration in the current account balance. When we examine the roles of the components of credit, we find that an increase in household credit causes a significant decline in the current account balance, whereas an increase in business loans has no significant effect. Therefore, our findings indicate that the significant negative impact of credit growth on the current account balance is driven by household credit. Furthermore, we show that total and household credit growth rates have a stronger negative effect on the current account balance for lower levels of financial depth. Our results suggest that targeted policy measures that curb household credit growth might be more effective to reduce external imbalances particularly at the early stages of financial deepening.     

The role of fiscal policies for external imbalances: Evidence from the European Union

We revisit the relation between budget deficits and current account deficits for 28 European Union countries from 1996 to 2019. We find that an increase in budget deficit of 1 pp of GDP results in a deterioration of the current account deficit of 0.318 pp of GDP, which supports the Twin Deficits Hypothesis. On the other hand, dynamic panel estimates partially corroborate the Ricardian Equivalence Hypothesis in the presence of a fiscal rules index. In addition: i) the relation between the two deficits is asymmetric and the negative impact of the recent Eurozone banking and sovereign debt crisis on the current account balance is observed; ii) with right-wing governments, the impact of the budget balance on the current account balance is mitigated; if the government is on the left, the impact of the budget balance on the current account balance is amplified; iii) after 2010, the budget balance positively affects the current account balance; and iv) the positive impact of the budget balance on the current account balance is higher in the cases of non-Eurozone countries, high budget deficit countries, and low exports countries, whereas it is lower in the cases of Eurozone countries, low budget deficit countries, and high exports countries.     

Determinants and Dynamics of Current Account Reversals: An Empirical Analysis

We use panel probit models with unobserved heterogeneity, state dependence and serially correlated errors in order to analyse the determinants and the dynamics of current account reversals for a panel of developing and emerging countries. The likelihood‐based inference of these models requires high‐dimensional integration for which we use efficient importance sampling. Our results suggest that current account balance, terms of trades, foreign reserves and concessional debt are important determinants of current account reversal. Furthermore, we find strong evidence for serial dependence in the occurrence of reversals. While the likelihood criterion suggest that state dependence and serially correlated errors are essentially observationally equivalent, measures of predictive performance provide support for the hypothesis that the serial dependence is mainly due to serially correlated country‐specific shocks related to local political or macroeconomic events.     

Budget deficits and the current account balance: New evidence from panel data

This study examines two distinguishing predictions of the finite-horizon open-economy macroeconomic models regarding the effect of fiscal policy on the current account balance: (1) Given the path of government expenditures, a fall in public savings has an adverse effect on the current account balance, and (2) a bond-financed increase in government expenditures exerts a larger adverse effect on the current account balance than a tax-financed alternative. These predictions are vastly different from those of the Ricardian theory. According to this view, (1) lower public savings are met by equal increases in desired private savings, and thus the current account balance does not change, and (2) the response of current account balance to a change in government spending is independent of its financing methods. Empirical analysis of 63 countries is consistent with the conventional theory.     

The Feldstein–Horioka Puzzle and Twin Deficits in Selected Countries

Hysteresis (unit root) of the current account, fiscal balance, and investment shares is found for the majority of industrial countries as well as selected emerging and transition economies between 1970 and 2001. Twin deficits are defined as a positive long-run relationship between the current account and the fiscal balance. The paper provides evidence for twin deficits in several countries, although we can see differences between the 1980s and the 1990s. Investment in some EU countries is financed to a relatively high degree at the international financial markets implying that the Feldstein–Horioka puzzle is less important in the EU.     

On the relationship between the current account and the fiscal balance: The case of Canada

This paper uses an Autoregressive Distributed Lag model to examine the long run and short run relationship between the current account and the fiscal balance, as well as other determinants, using Canadian quarterly data from 1981 to 2018. The results indicate that there is a long-run cointegrating relationship between the current account and the fiscal balance, investment, and private credit. Moreover, the relationship between the current account and the fiscal balance is positive in the long-run, thus providing support for the Keynesian Hypothesis of the fiscal balance driving the current account. Specifically, a one percentage point rise in the fiscal balance to GDP ratio yields a 0.43 percentage point rise in the current account as a percent of GDP. This positive relationship is present in the short-run as well. Finally, the findings from the error correction model yield a speed of adjustment of 0.225, hence 22.5% of the long-run adjustment in the current account occurs next period.     

PPP may hold better than you think: Smooth breaks and non-linear mean reversion in real effective exchange rates

This paper revisits some key topics in the literature on purchasing power parity (PPP). The study applies a set of newly developed unit root tests, which account for both nonlinearity and multiple smooth temporary breaks in series, to the real effective exchange rates (REERs) of 23 developed countries. The results suggest that PPP generally holds for various currency-based real rates. There is evidence in favor of linear stationarity in REERs for highly integrated economies. The REERs of most other countries tend to have nonlinear adjustment toward large long-swing type mean changes around constant equilibrium values.     

The effect of nominal exchange rate volatility on real macroeconomic performance in the CEE countries

This paper analyzes the relation between nominal exchange rate volatility and several macroeconomic variables, namely real output growth, excess credit, foreign direct investment (FDI) and the current account balance, in the Central and Eastern European EU member states. Using panel estimations for the period between 1995 and 2008, we find that lower exchange rate volatility is associated with higher growth, higher stocks of FDI, higher current account deficits, and higher excess credit. At the same time, the recent evidence seems to suggest that following the global financial crisis, “hard peg” countries may have experienced a more severe adjustment process than “floaters”. The results are economically and statistically significant and robust.     

人民币汇率对贸易影响的实证分析:一个文献综述

本文从三个角度——研究视角、变量性质、计量模型发展,对当前汇率对贸易差额影响的文献进行梳理,认为下一步的研究,应该将研究的视角选择在不同国家不同地区不同行业上,使用双边变量,在综合考虑其他各种影响贸易的因素,如直接投资、财政补贴等,以结构向量自回归模型为基础,进一步的细分结构性冲击,结合经济理论以及前人的研究结果,综合运用各种约束方法对汇率对贸易影响的问题做进一步的研究。     

The effects of exchange rate fluctuations on the stock market and the affecting mechanisms: Evidence from BRICS countries

Using data from BRICS countries, we apply the TVP-VAR model to analyze the effects of exchange rate fluctuations on their stock markets and the mechanisms leading to those effects. We find that for BRICS countries, there are similarities as well as differences in the extent, direction, and duration of the effects of exchange rate changes on the stock market. As for the affecting mechanisms, Brazil is almost entirely driven by the financial account, while the current account is dominant for Russia, whereas India, China, and South Africa depend on both mechanisms.     

Are exchange rates less important for trade in a more globalized world? Evidence for the new EU members

We evaluate the effect of exchange rate misalignments on the balance of trade and the role that global value chain participation plays in this effect for 11 new European Union member states. Using heterogeneous panel cointegration methods, we first estimate the real equilibrium exchange rate and detect episodes of currency misalignment. We find asymmetric effects of real currency misalignments: overvaluation has a negative effect, but undervaluation has no effect on the trade balance. Additionally, we find that global value chain participation weakens the effect of currency misalignments on the balance of trade. Therefore, our results suggest that globalization reduces the role of exchange rates in stimulating the domestic economy.     

Fiscal deficits and current account deficits

Recent fiscal stimulus packages depend for their effectiveness on the assumption of non-Ricardian savings behavior. We show that, under the same assumption, higher fiscal deficits can have problematic implications if they turn out to be permanent. First, if they occur in large countries they significantly raise the world real interest rate. Second, they cause a short run current account deterioration equal to around 50% of the fiscal deficit deterioration. Third, the longer run current account deterioration equals almost 75% for a large economy such as the United States, and almost 100% for a small open economy.     

Exchange Rate Adjustment in Partially Liberalized Economy

This paper develops a model of exchange rate determination in partially liberalized post-socialist economy that operates under soft budget constraints in nontradable sectors. The model captures the factors that determine the evolution of a country's external balance during the initial phase of economic liberalization. Three types of disturbances are the center of analysis: liberalization of trade and foreign exchange regime, devaluation, and price liberalization. We show that the real exchange rate appreciation may either improve or worsen the trade balance depending on the sources of this appreciation. Thus, we argue that the real exchange rate cannot reflect true country's competitiveness unless all sectors are equally exposed to hard budget constraints. The model implications are further analyzed through the empirical evidence on the relationship between the real exchange rate and trade balance in three selected East European countries.     

现行人民币汇率制度的可持续性探析——兼论“中间汇率制度消失论”

近年来兴起的"中间汇率制度消失论"已成为主流经济学界判断发展中国家汇率制度选择的主要理论依据.它建议发展中国家应实行汇率制度的端点解.通过对当前人民币汇率制度可持续性进行分析,证实现阶段中国的货币政策管理水平、经济结构调整、就业压力以及金融市场不完善等现状不允许中国在中短期内实行"端点"汇率制度;现行的人民币"软钉住"美元的汇率政策应是当前以及未来相当长时期内中国的最佳选择.     

Impact of China's currency valuation and labour cost on the US in a trade and exchange rate model

Ricardian dynamic general equilibrium analyses show that under free trade arrangements a low income country with lower wage cost and large endowment of labour has comparative advantage in trade. Efficiency gains from this enhance economic growth and welfare of households simultaneously in both low income and advanced economies. Theoretical predictions are empirically validated here with structural VAR analysis based on quarterly data over the time period 1995:1 to 2009:1 on China's relative wage cost, interest rate differential, real effective exchange rate (REER), relative GDP and the US current account balance. It is shown how the relative prices of labour, capital and the currency affect the economic activity in China and current account balance in the US. With free capital inflows and outflows and restrictions on labour mobility, comparative advantage of China and the trade deficit of the US will both be minimised if China allows real appreciation of the Yuan and complete adjustment in prices. Higher production cost and prices in China could reduce welfare of Chinese households and the trade imbalance of the US, while higher relative GDP of China lowers the current account balance for the US.     

Asymmetric effects of exchange rate changes on the Malaysia-China commodity trade

Previous research that considered the response of the trade balance between Malaysia and China to exchange rate changes used a linear model and did not find any significant long-run link. Suspecting that the results suffer from aggregation bias as well as ignoring nonlinear adjustment of the exchange rate, we consider the trade balance of 59 industries that trade between the two countries and use a nonlinear ARDL model to show that almost a third of the industries are affected by ringgit depreciation against the yuan, in an asymmetric manner. The largest industry, which accounts for more than 25% of the trade, is found to benefit from ringgit depreciation while not being hurt by appreciation. In total, 15 industries that account for 40% of the trade enjoy this property.     

THE ECONOMICS, POLITICAL AND FINANCIAL IMPLICATIONS OF AGEING POPULATIONS

It is likely that most developed countries will see populations shrink over the coming generations. This brings with it various problems that are highlighted in this article. However, one medium-term benefit of the process of ageing may be a return to a higher level of saving in the USA. This will bring the US current account back towards balance.     

Demography and the U.S. current account deficit

We examine whether aging in the trading partners of the U.S. has affected their demand for foreign (i.e., U.S.) assets enough to materially affect the U.S. current account balance. There is reason to think that demography may be at work in international capital flows because the standard life-cycle model of consumption behavior predicts that a household's age will influence its saving behavior. Moreover, simple national accounting identities link a country's current account balance to its savings–investment imbalance. Thus, differences in national age-profiles should affect the current account. To test this theory's plausibility and significance, I simulate a multi-region overlapping generations model that is calibrated to match the demographic differences among the major industrialized countries over the past 50 years. In the model, it is found that these differences can explain some of the observed long-term capital movements in the G-7. In particular, the model does a good job of predicting the size and timing of U.S. current account deficits.     

Modelling Currency Crises in Emerging Markets: A Dynamic Probit Model with Unobserved Heterogeneity and Autocorrelated Errors*

The paper investigates the causes of currency crises in emerging markets. We estimate the probability of a currency crisis by applying maximum smoothly simulated likelihood to a dynamic LDV model. This approach allows us to take explicit account of the existence of intertemporal links between crises. The results show that currency crises are influenced by real, monetary, debt and global variables. Past banking crises are significant determinants of the probability of currency crises. Moreover, countries that sharply devalued in the past are less prone to experience another currency crisis. We find evidence of unobserved heterogeneity, which may reflect differences in the countries’ institutional/historical background. Finally, the determinants of currency crises differ by type of exchange rate regime.