Flexible exchange rates and perfect foresight: The implications of domestic monetary policy for foreign prices and stabilization policy

Zusammenfassung Flexible Wechselkurse und vollkommene Voraussicht: Implikationen der inl?ndischen Geldpolitik für die Preisentwicklung und Stabilisierungspolitik im Ausland. — Vorgestellt wird eine Variante mit zwei L?ndern und vollkommener Voraussicht, die auf dem 1976 von Dornbusch entwickelten Modell flexibler Wechselkurse basiert. Die Güterpreise in beiden L?ndern passen sich danach nur z?gernd der übernachfrage an. Die Isolierung des ausl?ndischen Preisniveaus von einem unerwarteten dauerhaften Anstieg der heimischen Geldmenge erfordert in dem Augenblick eine sprunghafte Erh?hung der ausl?ndischen Geldmenge, in dem es im Inland zum Anstieg kommt, gefolgt von einem Rückgang auf das frühere Niveau. Soll das ausl?ndische Preisniveau bei einer im voraus angekündigten Geldpolitik im Inland stabilisiert werden, dann mu\ die ausl?ndische Geldmenge zu dem Zeitpunkt sprunghaft erh?ht werden, zu dem die Ankündigung im Inland erfolgt. Die weitere zeitliche Entwicklung der Geldversorgung im Ausland h?ngt von bestimmten Parametern des Modells ab, die n?her erl?utert werden.

---

Résumé Taux de change flexibles et la prévision parfaite: les implications des politiques monétaires locales pour les prix et la politique de stabilisation à l’étranger. — L’auteur présente une version de prévision parfaite et à deux pays d’un modèle des taux de change flexibles développé par Dornbusch en 1976. Les prix des biens dans les deux pays s’ajustent inertement à l’excès de demande. L’isolation du niveau de prix étranger d’une imprévue augmentation permanente du stock monétaire rend nécessaire un saut en stock monétaire étranger au moment où l’augmentation locale se passe, suivie par une réduction jusqu’au niveau initial. La stabilisation des prix à l’étranger au cas d’une politique locale monétaire préannoncée implique un saut en masse monétaire étrangère si l’annonce est faite. Le développement subséquent de la masse monétaire dépend des certains paramètres dans le modèle.

---

Resumen Tasas de cambio flexibles y predicción perfecta: las implicaciones de la política monetaria doméstica sobre los precios externos y la política de estabilización. — Se présenta una versión de predicción perfecta de dos países de un modelo de tasas de cambio flexibles de Dornbusch de 1976. Los precios de los bienes se ajustan en ambos países lentamente al exceso de demanda. La aislación del nivel de precios extranjero de un aumento permanente no anticipado del stock monetario del pais natal requière de un salto en el stock de monedas extranjeras cuando se produce el aumento doméstico, seguido de una disminución a su nivel original. Estabilización de precios extranjeros con una pol⩼ica monetaria doméstica preanunciada envuelve un salto en la oferta monetaria extranjera cuando se hace el anuncio. La trayectoria en el tiempo de la oferta monetaria depende de ciertos parámetros en el modelo.

     

Forward exchange,short term capital flows and monetary policy

Summary This paper re-examines the relationships between short term capital flows and monetary policy, in the light of a new theoretical approach of the forward exchange market. They contend that the traditional forward exchange market theory is a misleading one as it fails to give all the importance it deserves to the distinction between covered and uncovered exchange transactions and to the actual role of the arbitrageurs. As a consequence of this analysis, they demonstrate that the problem of monetary management in an open economy must be dealt with in a way different from what has been usual, and they conclude that monetary policy, central banks' intervention on the foreign exchange market and direct controls on capital movements can still have some efficiency in the struggle against inflation, either of the domestic or the imported type.     

Flexible exchange rates,inflation and economic development

Different economies have different propensities to generate inflationary pressures, and different capacity to absorb the strains occasioned by price and wage increases. Because of economic and institutional features of less developed countries, expansionary policies may have to be undertaken in a ‘typical” developing country, more often and to a greater extent than in a ‘typical’ developed country. Even a mild rate of inflation will be damaging under a fixed-exchange-rate system, if domestic prices increase at a faster pace than prices abroad. Chronic balance-of-payments difficulties are confronted by inflationary countries that are attached to a fixed-exchange-rate system. Rather than sporadic, substantial devaluations, periodical mini-devaluations may be advisable in developing countries with a relatively high propensity to inflate.     

Deposit market deregulation,implicit deposit rates,and monetary policy

Conclusion Previous analyses of the economic effects of deposit market deregulation generally have treated the gradual elimination of deposit rate ceilings and the effective removal of barriers to bank competition for deposits as separate issues. The key implication of the analysis utilized in this paper is that there are important interactions between these two forms of deposit market deregulation and their ultimate effects on market behavior and outcomes. One aspect of this interaction concerns the payment of implicit interest on deposit balances. Although implicit interest payments usually are viewed as a response to the imposition of ceilings on explicit deposit rates, the amount of implicit interest paid by banks in fact depends crucially upon the amount of monopoly power available to banks as a result of entry restrictions. Competition in deposit markets drives the implicit interest rate to 0 even if the explicit deposit rate is regulated, and the existence of imperfect competition in deposit markets makes the payment of positive implicit deposit interest a theoretical possibility even if the explicit deposit rate ceiling is removed.At a macroeconomic level, increased bank competition enhances the monetary and interest rate impacts of gradual relaxations of a binding deposit rate ceiling. If a ceiling on the explicit deposit rate is present, increased bank rivalry for deposits resulting from deregulation reduces monetary control whether the Fed targets a market interest rate or a reserve aggregate. When there is no ceiling on the explicit deposit rate, increased bank competition has ambiguous implications for monetary policy.The present trend in regulatory policy is pushing the U.S. financial system toward an environment in which explicit deposit rates are flexible, market determined variables and interbank rivalry for deposit funds is much more competitive. The thoretical analysis of this paper indicates that the likely results of these simultaneous developments are the demise of implicit deposit interest (marginal cost pricing of transactions services) and potential complications for the c onduct of monetary policy under either a reserve-oriented operating procedure or a procedure in which the Fed targets a market interest rate. However, the directions and magnitudes of the net impacts of those forms of deregulation ultimately are empirical issues that cannot be fully resolved.via a theoretical analysis.An earlier version of this paper was circulated by the Federal Home Loan Bank Board's Office of Policy and Economic Research as Invited Research Working Paper No. 59. The author is grateful for comments received from Donald Bisenius, Michael Bradley, Richard Brown, George Kanatas, Kenneth Kopecky, Byungkyu Lee, Randall Merris, Douglas Mitchell, Steve Peterson, Richard Startz, Richard Sweeney, Bill Witte, and participants in the Indiana University Money and Banking Seminar. Views expressed in this paper do not necessarily correspond to those of the Federal Home Loan Bank Board or the Board of Governors of the Federal Reserve System. Any errors are the author's alone.     

Dual-track interest rates and the conduct of monetary policy in China

China has a dual-track interest-rate system: bank deposit and lending rates are regulated while money and bond rates are market-determined. The central bank also imposes an indicative target, which may not be binding at all times, for total credit in the banking system. We develop and calibrate a theoretical model to illustrate the conduct of monetary policy within the framework of dual-track interest rates and a juxtaposition of price- and quantity-based policy instruments. We show the transmission of monetary policy instruments to market interest rates, which, together with the indicative credit target in the banking system, ultimately are the means by which monetary policy affects the real economy. The model shows that market interest rates are most sensitive to changes in the benchmark deposit interest rates, significantly responsive to changes in the reserve requirements, but not particularly reactive to open market operations. These theoretical results are verified and supported by both linear and GARCH models using daily money and bond market data. Overall, the findings of this study help us to understand why the central bank conducts monetary policy in China the way it does, using a combination of price and quantitative instruments with differing degrees of potency in terms of their influence on the cost of credit.     

Evaluating monetary policy when nominal interest rates are almost zero

The non-negativity constraint on nominal interest rates may have been a major factor behind a putative structural break in the effectiveness of monetary policy. To check for the existence of such a break without making prior assumptions about timing, and to enable comparison between pre- and post-break monetary policy, we employ an identified Markov switching VAR framework. Estimation results support the existence of a structural break around the time when the de facto zero nominal interest rate policy was resumed and the effectiveness of monetary policy is seen to weaken since then although slightly positive effects from monetary easing still exist. J. Japanese Int. Economies 20 (3) (2006) 434–453.     

Stabilization policy under flexible exchange rates and liquidity

Summary A two country model under flexible exchange rates is developed. The model shows that changes in the interest rate resulting from monetary or fiscal expansion has indeterminant effects on prices, output, capital flows and liquidity demand for money under conditions of a less than full employment equilibrium. Stabilization policy recommendations previously respected in this context fall under suspicion.     

On the dynamic effects of monetary and fiscal policy under floating exchange rates: Simulations with an asset market model

Zusammenfassung Die dynamischen Wirkungen der Geld- und Finanzpolitik bei floatenden Wechselkursen: Simulationen mit einem verm?genstheoretischen Modell.-Der Autor fügt in ein von Dornbusch entwickeltes Modell verz?gerte Anpassungen bei der Produktion und bei den Handelsstr?men ein, um die dynamischen Wirkungen der Geld- und Finanzpolitik bei floatenden Wechselkursen zu untersuchen. Trotz der Tatsache, da\ eine monet?re Expansion anfangs die Zinss?tze senkt, kann der Wechselkurs das Niveau seines neuen langfristigen Gleichgewichts unterschreiten. Dieses Ergebnis widerspricht früheren Behauptungen von Dornbusch und Fischer. Au\erdem führt eine fiskalische Expansion immer dazu, da\ der Wechselkurs sein neues langfristiges Gleichgewichtsniveau überschreitet. Schlie\lich konvergiert das System unter Schwingungen, wenn die Anpassungsverz?gerungen bei der Produktion und bei den Handelsstr?men verh?ltnism?\ig lang sind.

---

Résumé Les effets dynamiques de la politique monétaire et fiscale sous des taux de change flottants: Des simulations avec un modèle du marché financier. — Dans cette étude on a introduit la retardation de l’ajustement de la production et des échanges commerciaux dans un modèle développé par Dornbusch pour analyser les effets dynamiques de la politique monétaire et fiscale sous des taux de change flottants. Malgré du fait que l’expansion monétaire abaisse le taux d’intérêt au début, le taux de change peut passer par au-dessous du nouveau niveau d’équilibre à long terme. Ce résultat contredit aux affirmations faites par Dornbusch et Fischer. En plus l’expansion fiscale fait toujours le taux de change passer par au-dessus de son nouveau niveau d’équilibre à long terme. Finalement, le système converge avec des oscillations si la retardation de la production et des échanges commerciaux est relativement étendue.

---

Resumen Sobre los efectos dinámicos de la política monetaria y fiscal bajo tipos de cambio flotantes: simulaciones con un modelo “asset market”. — En estre trabajo se introducen desfasajes en el ajuste del producto y en el intercambio comercial en un modelo desarrollado por Dornbusch para analizar los efectos dinámicos de la politica monetaria y fiscal bajo tipos de cambio flotantes. A pesar de que la expansion monetaria inicialmente reduce las tasas de interés, el tipo de cambio puede no alcanzar su nuevo nivel de equilibrio de largo plazo. Este resultado contradice resultados obtenidos anteriormente por Dornbusch y Fischer. Además, la expansión fiscal siempre induce al tipo de cambio a superar su nuevo nivel de equilibrio de largo plazo. Finalmente, el sistema converge con oscilaciones si los desfasajes de producto y de comercio son relativamente largos.

     

Monetary-fiscal policy assignment under floating exchange rates

Summary This paper examines the use of monetary and fiscal policy in a small country model under floating exchange rates. The government attempts to achieve a target level of economic activity and either an investment spending (output composition) or current account target. However, a choice may have to be made between the latter two objectives because a trade-off exists between them as the monetary-fiscal policy mix changes. It is shown that either monetary or fiscal policy can be assigned to the GNP target, and the second policy to one of the other targets, although the path may be oscillatory.The author is grateful to the referee for helpful comments but must absolve him from all remaining errors.     

An application of the monetary approach to black market exchange rates

Zusammenfassung Eine Anwendung des monet?ren Ansatzes zur Erkl?rung von Schwarzmarkt-Wechselkursen. — Dieser Aufsatz entwickelt einen monet?ren Ansatz zur Analyse der Schwarzmarkt-Wechselkurse unter besonderer Berücksichtigung Indiens. Der Gleichgewichtskurs auf solchen M?rkten wird in einem Modell durch die Bedingungen des Bestandsgleichgewichts bestimmt. Berücksichtigt wird dabei das m?gliche Zusammenwirken zwischen dem Schmuggel und dem Schwarzmarkt für Devisen. Die empirischen Sch?tzungen lassen vermuten, daΒ die Ausweitung der Geldmenge im Inland und der internationale Goldpreis neben anderen Faktoren einen bedeutenden EinfluΒ auf den Schwarzmarkt-Wechselkurs in Indien haben.

---

Résumé Une application de l’approche monétaire aux taux de change sur le marché noir. —Cet article développe une approche monétaire pour l’analyse des taux de change sur le marché noir en considération particulière de l’Inde. Dans le modèle, le taux de change d’équilibre sur le marché noir est déterminé par les conditions d’équilibre de stock. Le modèle permet l’interaction possible entre la fraude et le marché noir pour les monnaies étrangères. Les estimations empiriques suggèrent que l’expansion monétaire locale et le prix mondial d’or (complémentairement aux autres facteurs) ont une influence significative sur le taux de change sur le marché noir indien.

---

Resumen Una aplicación del aprocha monetaria a las tasas de cambio del mercado negro. — En este artículo se desarrolla un aprocha ?monetaria? para el análisis de las tasas de cambio del mercado negro con especial referencia a la India. En el modelo, el equilibrio de la tasa de cambio del mercado negro se determina por las condiciones del equilibrio de stock. Se permite una posible interacción entre contrabando y mercado negro de monedas extranjeras. Las estimaciones empíricas sugieren que la expansión monetaria doméstica y el precio mundial del oro (agregados a otros factores) tienen una influencia significativa sobre la tasa de cambio de mercado negro en la India.

     

Monetary policy shocks and exchange rates in Asian countries

In this paper, we empirically investigate the effects of monetary policy shocks on exchange rates in Asian countries. To do so, we use VAR models which impose sign restrictions on impulse responses to identify monetary policy shocks. We find that contractionary monetary policy shocks lead to significant exchange rate appreciation in Malaysia, the People’s Republic of China, and the Republic of Korea. However, in India, Indonesia, the Philippines and Thailand, we find either a significant depreciation or no significant effect. These results suggest that an interest rate increase (or decrease) may not necessarily shield Asian countries from exchange rate depreciation (or appreciation) pressure following a U.S. interest rate increase (or decrease).     

Uncertainty and monetary policy

The experience of monetary policy making in an uncertain environmenthas encouraged increased attention to the concept of model uncertainty,that is, uncertainty as to which is the best model. A particulardifficulty has been the need to operationalise the concept inorder to yield definitive policy recommendations. If this typeof uncertainty is unquantifiable, then a policy rule determinedby a single model may not in fact be the best approach; pluralismof method and the exercise of judgement offer a potential solution.A rigorous foundation for such an approach is available in Keynes'sphilosophical analysis of decision making under uncertainty.It is concluded that more analytical attention needs to be devotedto agents’ own model uncertainty, and to judgement. Butultimately the scope for synthesis between the model uncertaintyand Keynes uncertainty approaches rests on whether or not thesubject matter is such that knowledge of it is best representedby one formal model.     

Postwar monetary policy

Summary Monetary policy has played an active role in Dutch postwar economic policy. Essentially, it has sought to contribute to balanced economic growth by controlling the money supplyM ₂ in relation to national income. Policy measures extend to all sources of money creation-viz. bank credit, public sector finance and the balance of payments - and are predominantly of the quantitative type. This is reflected, among other things, in medium-term targets for the structure and outcome of the balance of payments and the size and coverage of the public sector's borrowing requirement. Internationally, the Netherlands favour and participate in stable exchange rate systems. This has not led to serious conflicts with domestic monetary objectives until the seventies, when excessive easing of monetary conditions had to be accepted temporarily.     

Forward exchange,short term capital flows and monetary policy: A comment

Summary In this comment it is argued that the theoretical explanation of Coulbois and Prissert of the functioning of the forward exchange market (the cambist theory) is nothing but a simplified version of the interest parity theory, because in their theory the horizontal arbitrage function implicitly plays a dominant role.Further some critical remarks are made concerning the role of non-bank arbitrages and the influence of interest arbitrage on the spot rate, on the size of the international short-term capital movements and on the domestic money supply.They want to thank Mr. William Schep for his helpful comments with regard to the translation into English of the original text.     

Market discipline and monetary policy

The effects of forward looking expectations of future inflationon equilibrium inflation and interest rates are examined withinan imperfect information framework. Expectations of future inflationaffect equilibrium in a manner similar to an increase in thecentral bank's weight on future social welfare, making it morelikely an opportunistic central bank will actually deliver onits announced inflation targets, and output expansions can ariseeven if the central banker is revealed to be a low inflationtype. The model also illustrates the channels through whichinflation scares raise current real interest rates.     

On the volatility of exchange rates: Tests of monetary and portfolio balance models of exchange rate determination

Zusammenfassung Zu den Schwankungen von Wechselkursen: Tests von monet?ren und Portfolio-Modellen der Wechselkursbestimmung. - Anhand einer Methodologie, die aus der Literatur des Finanzwesens übernommen wurde, wird in diesem Aufsatz getestet, ob die beobachteten Schwankungen der Wechselkurse durch die beobachteten Schwankungen der Determinanten erkl?rt werden k?nnen. Gem?\ den monet?ren und Portfolio-Modellen sind diese Determinanten: Geldversorgung, Einkommen, Unterschiede in den Inflationsraten und Angebot von Verm?genstiteln. Die Ergebnisse scheinen unabh?ngig davon zu sein, welches Modell benutzt wird. Sie zeigen, da\ die Ver?nderungen der Wechselkurse innerhalb des EWS mit Hilfe von Ver?nderungen der Determinanten erkl?rt werden k?nnen, da\ aber die Ver?nderlich-keit anderer Wechselkurse (USS/DM, Yen/DM, sfr/DM) viel gr?\er ist, als aufgrund der Schwankungen der Determinanten zu erwarten w?re.

---

Resumen Sobre el test de volatilidad de tipos de cambio aplicado a modelos monetarios y de “portfolio balance” de determinación del tipo de cambio. - En este trabajo se utiliza una metodología tomada de la literatura financiera para determinar empíricamente si la variabilidad observada de las tasas de cambio puede explicarse con la variabilidad observada en las variables fundamentales. De acuerdo a los modelos monetarios y de “portfolio balance” las variables fundamentales son: la oferta monetaria, el ingreso, la diferencia entre las tasas de inflación y la oferta de activos. Los resultados parecen ser independientes del tipo de modelo utilizado. Ellos indican que la variabilidad de los tipos de cambio del Sistema Monetario Europeo puede explicarse en términos de las variables fundamentales, mas la variabilidad de otros tipos de cambio (US$/DM, Yen/DM, Franco Suizo/DM) es más alta que la de las variables fundamentales.

---

Résumé Sur la volatilité des taux de change: tests des modèles monétaires et de portefeuille de la détermination du taux de change. - L’auteur applique une méthodologie dérivée de la littérature des finances pour tester si la variabilité observée des taux de change peut être expliquée par la variabilité des facteurs fondamentaux. Les modèles monétaires et de portefeuille suggèrent des variables fondamentales suivantes: masse monétaire, revenu national, différence en inflation et l’offre des valeurs actives. Les résultats semblent être indépendants du modèle appliqué. Ils indiquent que la variabilité des taux de change intra-SME peut être expliquée en terme des variables fondamentales, mais la variabilité des autres taux de change (US$/DM, Yen/DM, Swiss Frank/DM) est plus grande qu’on pourrait l’expliquer par des telles variables.

     

Bank competition and monetary policy

There is an apparent theoretical discrepancy between the effects of monetary policy shocks on economies with differently competitive banking sectors. We employ cross-country data to investigate this hypothesis with two different approaches. First, using aggregate data we analyze the correlation between two indices: (i) a cumulative impulse response function providing an index of the effect of monetary policy shocks; and (ii) Panzar and Rosse's H-statistic as an index of the state of bank competition. Second, using disaggregated data we regress bank lending on the interaction of bank competition and monetary policy shocks. The first approach does not provide any evidence of a relationship between monetary policy shocks and bank competition. However, the second approach suggests that competition in the banking industry leads to smaller monetary policy effects on bank lending.