Hysteresis in an Open Economy Model

This paper explores the properties of an open economy model in which real exchange rate overshooting has a permanent impact on the rate of unemployment via a hysteresis mechanism. The magnitude of this effect depends on the slope of the short-run Phillips curve, the speed with which expectations adjust in the labour market, and on the speed with which capacity adjusts to changes in capacity utilisation. However, it does not depend on how open the economy is, although the dynamics of the adjustment process (including the extent of the initial jump in the exchange rate following a change in monetary policy) do depend on this factor.     

Understanding Exchange Rate Movements during the 2008 Financial Crisis

During the 2008 financial crisis, many advanced economies, whose banking systems suffered significant capital losses, experienced large and rapid exchange rate depreciations followed by prolonged and gradual appreciation in subsequent periods. In order to understand one possible explanation of these observed exchange rate movements, we develop a simple model of a highly leveraged banking sector in which banks obtain part of their funding from abroad. A fall in bank net worth leads to foreign lenders demanding a higher risk premium on credit supplied to domestic banks. This higher risk premium can be met if the exchange rate experiences an appreciation along the adjustment path, since this raises the value of the bank's earnings in terms of the foreign currency for every period that the foreign risk premium is elevated. In order for the exchange rate to appreciate by a large amount along the adjustment path, it must initially become undervalued – relative to its long-run level – so that in equilibrium the market is willing to bid up its value in subsequent periods. This thus gives rise to the large initial depreciation of the exchange rate followed by its prolonged and gradual appreciation.     

Currency appreciation and stock market performance: Evidence from China

This paper analyzes the relationship between the change of the exchange rate and the performance of the Chinese stock market after exchange rate regime and split share structure of stock market reformed in 2005, which is important for us to understand the linkages and mechanisms between the two markets deeply. We find that the exchange rate is highly related with the stock market, and there exists long-term cointegration. The results demonstrate that in the long term, the relationship between the two variables mainly belongs to flow-oriented model; Shanghai A Share index is influenced by the exchange rate, yet Shanghai B Share index has shown less indication of long term interrelation with the exchange rate. In the short term, the relationship between the two variables mainly belongs to stock-oriented models, there are inter influence between the stock market and the exchange market. The paper further analyzes the possible influence of different sector indices to exchange rates. Finally, the paper puts forward some advices and policy suggestions.     

Rational destabilizing speculation and exchange intervention policy

The fact that speculators might incorporate psychological factors in their stock market predictions, and be right in doing so, is a fundamental feature of most portfolio balance models postulating rational expectation formation. Here the so-called “extraneous-variable” problem is focused upon as a characterization of rational, but destabilizing speculation. Perfectly rational speculators cause the exchange rate to fluctuate more than would be warranted by market fundamentals. This characterization may be incomplete, as it involves a certain indeterminacy in the solution for the exchange rate. The implications for intervention policy are somewhat unconventional.     

Market dynamics and dichotomy: evidence from Taiwanese manufacturing

In Taiwan, a dichotomous market structure is closely related to the progress of economic development. The purpose of the present article is to examine the market dynamics and dichotomous nature of Taiwanese manufacturing. A model of dynamic adjustment of industry structure is considered when both the speed of adjustment and the long-run market concentration are allowed to vary across industries. We use 118 four-digit manufacturing industries for empirical analysis of our models spanning between 1981 and 1991. Empirical findings show that both the speed of adjustment and long-run industry concentration are predominantly determined by minimum efficient scale. The speed of adjustment is much faster in a small open economy like Taiwan compared to mature economies like the US and Australia. In addition, the dichotomous nature of the market is supported in our findings for both periods, viz, 1981–1986 and 1986–1991, albeit weaker for the later period.     

Adjustment to monetary policy and devaluation under two-tier and fixed exchange rate regimes

The purpose of this paper is to determine whether a two-tier exchange rate regime is more effective than a fixed rate regime in increasing a country's ability to pursue an independent monetary policy. The analysis compares adjustment to a monetary policy and to a devaluation in the two exchange rate regimes in a portfolio model under imperfect assets substitutability. It is shown that a two-tier exchange rate regime is capable of reducing the current account effects of monetary injection or devaluation only in the long run. In the short run, however, we can get a larger current account response under a two-tier regime. These results reflect the trade-off between quantity and price adjustment.     

Reassessing the evidence of an emerging yen block in North and Southeast Asia

Using weekly observations on 9 Asian currencies from November 1976 to December 2003, we re-examine the evidence of an emerging yen block in North and Southeast Asia. In contrast to previous research that assumes instantaneous adjustment of exchange rates by the region's Central Banks to variations in the world's main global currencies, we use a dynamic general-to-specific Newey–West estimation strategy that allows gradual adjustment and calculation of both short and long run equilibrium responses. We find that there is no de facto yen block, but although the US dollar remains dominant throughout the region, the yen's influence is rising amongst a subset of the currencies since the early 1990s.     

Methodological Extensions of First-Order Adjustment Models: An Application to U.S. Industries *

This paper empirically tests two industrial-organization models with a sample of 182 U.S. industries, from to 1963 to 1967. The models extend standard models and integrate them with dynamics associated with the " persistence of profits" methodologies. We extend it by replacing the traditional cross-section profit equation with a profit-adjustment equation for U.S. industrial data. Our study measures the speed of adjustment of profits and explicitly models steady-state profits, in addition to the speed of structural adjustment and steady-state market structure. We find that the structural-adjustment speed is slower than the profit-adjustment speed and that nonzero economic profits tend to be quite persistent     

Hedging a Portfolio of Derivative Securities: A Simulation Approach

We illustrate a numerical simulation method to decompose a portfolio of derivative securities in a linear combination of dynamical risk factors. The price of the portfolio and its sensitivities are linear functions of these factors.
The method generalizes the static hedging theory proposed by Madan and Milne (1994) and applies to a dynamically complete, arbitrage free market with purely Brownian fluctuating assets. The extension to a class of market models whose volatility dynamics shows long memory and scaling behaviour is discussed and shown to be possible.
(J.E.L.: G12).     

Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economy

The paper examines implications of inflation persistence for business cycle dynamics following terms of trade shock in a small oil producing economy, under inflation targeting and exchange rate targeting regimes. It is shown that due to the ‘Walters critique’ effect, the country’s adjustment paths are slow and cyclical if there is a significant backward-looking element in the inflation dynamics and the exchange rate is fixed. It is also shown that such cyclical adjustment paths are moderated if there is a high proportion of forward-looking price setters in the economy, so that when the Phillips curve becomes completely forward-looking cyclicality in adjustment paths disappears and the response of the real exchange rate becomes hump-shaped. In contrast, with an independent monetary policy, irrespective of the degree of inflation persistence, flexible exchange rate allows to escape severe cycles, which results in a smooth response of the real exchange rate.     

Bilateral capital flows and the exchange rate: The case of the U.S.A. vis-à-vis Canada,France, West Germany and the U.K.

After a preliminary test (with generally negative results) of the interest parity assumption, an eclectic portfolio adjustment approach, which determines an exchange pressures variable (under a régime of a managed float) is constructed, for bilateral comparisons between the United States and its major trading partners taken individually. This approach to bilateral capital flows and managed exchange rate determination appears to function reasonably well, as judged by the empirical results. Interestingly, factors specific to individual exchange markets appear to play important roles in explaining bilateral capital flows and cross exchange rates, which would not occur in a Walrasian world, with global market clearing.     

Foreign exchange market interventions and the $–¥ exchange rate in the long run

This article examines whether foreign exchange market interventions conducted by the Bank of Japan are important for the dollar–yen exchange rate in the long run. We rely on a re-examination of the empirical performance of a monetary exchange rate model. This is basically not a new topic; however, we focus on two new questions. First, does the consideration of periods of massive interventions in the foreign exchange market uncover a potential long-run relationship between the exchange rate and its fundamentals? Second, do Forex interventions support the adjustment towards a long-run equilibrium value? Our results suggest that taking periods of interventions into account within a monetary model does improve the goodness of fit of an identified long-run relationship to a significant degree. Furthermore, Forex interventions increase the speed of adjustment towards long-run equilibrium in some periods, particularly in periods of coordinated forex interventions. Our results indicate that only coordinated interventions seem to stabilize the dollar–yen exchange rate in a long-run perspective.     

TAYLOR RULE REACTION COEFFICIENTS AND REAL EXCHANGE RATE PERSISTENCE

Recent literature has established a link between the persistence of real exchange rates and the degree of inertia in Taylor rule monetary policy reactions functions. This paper provides a different view on this link by investigating how the size of Taylor rule reaction coefficients impacts the adjustment dynamics of the real exchange rate. Within a stylized sticky‐price open‐economy macro model, it is demonstrated that a stronger interest rate reaction to inflation in the Taylor rule raises the convergence speed of the real exchange rate. Conversely, raising the coefficient on the output gap or attending to the exchange rate in an open‐economy version of the Taylor rule slows down real exchange rate adjustment. In all cases, more rapid convergence comes at the cost of stronger initial real exchange rate misalignments in the wake of monetary policy shocks.     

人民币汇率变动对产业结构 影响的实证研究*

汇率作为重要的价格信号,能影响我国参与国际分工的成本,改变我国生产要素的相对价格,引导国内资源的重新配置,并对我国产业结构的调整产生重要影响。本文从三次产业结构调整和不同要素密集度行业结构调整两个角度展开分析,分别研究人民币有效汇率对其影响。其中,从三次产业结构调整的角度,对国家和地区层面进行实证研究,结论表明人民币有效汇率变动对第二产业具有明显的抑制作用,而对第三产业发展具有促进作用,且对经济发达的东部地区的影响明显大于对中西部地区的影响;从资源配置的角度,以劳动力、资本要素在产品市场和要素市场的流动为切入点,对汇率变动影响产业结构变化的机理及其路径进行了深入系统的理论研究,结论表明,人民币有效汇率对资本密集型行业和技术密集型行业具有促进作用,且实际有效汇率的影响大于名义有效汇率的影响。\     

Asymmetric adjustment costs and the dynamics of housing supply

This paper examines aggregate dynamics on the supply side of the housing market. The representative firm's intertemporal profit maximisation problem is considered under asymmetric adjustment costs. The hypothesis of asymmetric adjustment costs is also examined empirically using Irish data. Several interesting insights into the dynamics of housing supply are uncovered. These include support for the proposition that the adjustment costs of expanding housing output are greater than those associated with a contraction, evidence of threshold points beyond which adjustment starts to speed up and also the existence of a continuum of equilibria between these thresholds where no adjustment occurs at all.     

Sources of volatility in stock returns in emerging markets

In this study, the short-term fluctuations in the monthly returns on composite indexes of 17 emerging markets affected by the financial crises in the late 1990s and 2000 are decomposed with vector autoregressive estimates. The results are compared to the behaviour of variation in returns in developed markets. Three different models are estimated for each market. Due to first order autocorrelations, lagged returns contribute significantly to return volatility in emerging markets. Decomposition of variances indicates that dividend yield and interest rate are determining factors of volatility, but at varying degrees in different emerging markets. However, the role of dividend yield is not as strong as it is in the developed markets as efficient markets hypothesis would imply. In some cases, exchange rates significantly influence market volatility. Fluctuations in the world portfolio return have a small effect on return volatility in national markets. However, there are significant differences across all emerging markets that point to differences in market structures and particular conditions in each country. Significant contributions of interest rates, exchange rates and inflation imply the role of monetary and fiscal policy as precedents of financial crises.     

Exchange rate indeterminacy in portfolio balance, Mundell-Fleming and uncovered interest rate parity models

With full stock/flow accounting respected, the two-country openeconomy portfolio balance model has just two independent equationsfor asset market clearing. It can determine home and foreigninterest rates but not the exchange rate. If asset market equilibriavary smoothly over time, the balance of payments equation inthe Mundell–Fleming model is not independent and cannotset the exchange rate either. The familiar fixed reserves/‘floatingrate’ vs endogenous reserves/‘fixed rate’dichotomy does not exist, and ‘fundamentals-based’econometric models of the exchange rate are bound to fail. Analternative is a two-country IS/LM model with exchange ratedynamics added. Its dynamic properties under uncovered interestrate parity are briefly explored.     

略论中国外汇储备面临的潜在资本损失

本文分析了中国巨额外汇储备面临的由本币升值汇率风险而导致的资本损失。文章从两个角度来研究该项损失:一是从央行资产负债表由于货币错配而招致的现实以及潜在资本损失的角度;二是从以一篮子货币或者一篮子商品来衡量的中国外汇储备国际购买力损失的角度。本文的结论是:中国央行资产负债表面临的资本损失是显著的;中国外汇储备国际购买力的波动显著高于市场价值的波动,尤其是用油价来衡量的外汇储备购买力波动相当剧烈。     

Exchange Rate Pass-Through in Vertically Related Markets

The paper provides a theoretical framework which addresses exchange rate pass-through within the setting of vertically related markets. In particular, foreign firms' price adjustment in response to an exchange rate shock is evaluated. This permits study of the importance of cost effects of the exchange rate shock. Recent empirical evidence indicated the relevance of these cost effects. It is shown that one can decompose the effects of an exchange rate shock on the final goods market into direct and indirect components. The indirect effect works through the input market. The degree of pass-through then depends on the relative importance of direct and indirect effects, which in turn depends on the nature of vertical structures and strategic firm behavior. It is shown that the institutional aspects of vertically related markets play a role in explaining incomplete price adjustments in both intermediate and final goods markets and the failure of PPP in the short run.     

Insulation properties of separating exchange markets

Insulation properties play an important role for countries in favour of separating rates for separating transactions. Such properties insulate the open economy from monetary and real shocks, of domestic and foreign origins. Through theoretical and numerical analyses, we find that in a unified flexible exchange rate system, portfolio holders' expectations drive the price adjustment, leading to expectations of exchange rate changes. In separating exchange markets, the financial rate reflects the instability of portfolio holders' expectations and capital flows; however, the real exchange rate and hence the macroeconomy is stable. Uncertainty of shocks ceases to affect the real sector of the economy.