Ireland's innovative governmental policies promoting internationalisation

The importance of innovation is reflected in the policy strategies that have been adopted by countries that have gained competitive advantage over the last two decades. In today's competitive global economy, Ireland has been acknowledged for its governmental policies and policy dynamics that have created a competitive market site for FDI. These policies have been based on continual policy innovation. The purpose of this paper is to analyse the governmental policies and policy dynamics within the Irish context of internationalisation. From this analysis a model of government influence on FDI in Ireland is developed. The main conclusions are that the success of the Irish model of internationalisation can be attributed to its innovative character. If Ireland's success is to extend into the future, it will have to continue to pursue innovation in the approach it adopts to internationalisation.     

Exchange rate pass-through into import prices revisited: What drives it?

A large sample of developed and emerging economies is utilized to investigate import exchange rate pass-through. Panel models reveal that various economic aspects of the destination country can explain about one third of the total variation in pass-through elasticities and the remaining variation comes largely in the form of unobserved country-specific effects. Inflation, exchange rate volatility, openness and relative wealth play a clear role as drivers of emerging markets’ pass-through whereas the output gap and protectionism appear influential more generally. Nonlinearity regarding large-versus-small changes in the exchange rate is quite pervasive. Our evidence challenges the widely-held view that pass-through has been universally falling in developed markets and that it is higher for emerging markets. The economic drivers are shown to play a role as out-of-sample predictors of pass-through. The findings confirm pricing-to-market theories and have implications for the optimal conduct of monetary policy.     

Overreaction in capital flows to emerging markets: Booms and sudden stops

This paper applies the overreaction hypothesis of De Bont and Thaler [De Bont, W., Thaler, R., 1985. Does stock market overreact? Journal of Finance 40(3), 793–805], developed for stock price behavior, to capital flows to emerging markets. We find that a surge in capital flows, or what we call a capital boom, can predict future sharp contractions in capital flows, or sudden stops. We use a large list of possible economic fundamentals as control variables, and the results show that the best predictor of a sudden stop is a preceding capital boom. Moreover, the probability of a country undergoing a sudden stop increases considerably with the length of the boom: this probability more than doubles when the boom is three years old, and rises by three to four times when the boom lasts for four years. These results are interesting for two reasons. In the first place, they contradict previous studies that emphasize worsening fundamentals as the ultimate cause of a sudden stop. Second, they are of policy interest because of the enormous negative impacts that sudden stops have on the real economy.     

Globalization and portfolio risk over time: The role of exchange rate

We examine benefits of international diversification for the period 1 January 1988 to 30 June 2000. We introduce a new variable (lambda) that measures these benefits more directly than do the pairwise correlations among equity markets, which are used in most other studies. Our study shows that despite international integrations, the benefits of international diversification measured in USD persist. Using lambda, we provide evidence that the increase in co-movements between equity market returns (measured in local currencies) has been counterbalanced by movements in exchange rates. We confirm our results by subjecting the trend in lambda to several tests.     

Endogenous pricing to market and financing costs

This paper explains why relative PPP should hold more tightly in emerging markets, and why pricing to market would be observed more frequently in the OECD countries. It studies the endogenous determination of pricing to market, in a real option model with time-dependent transportation costs, where the future terms of trade are random. Allowing time-dependent transportation costs adds a dimension of investment to the pre-buying of imports, implying that financial considerations determine the frequency of pricing to market, and the deviations from relative PPP. If the expected discounted cost of last minute delivery is higher than pre-buying, one exercises the option of spot market imports if the realized terms of trade are favorable enough. Pricing to market is observed in countries characterized by low terms of trade volatility and low financing costs. In these circumstances, imports are pre-bought, and the spot market for imports is inactive. In countries where the financing costs and the terms of trade volatility are high, few imports are pre-bought, the price of imports is determined by the realized real exchange rate, and a version of relative PPP holds. With an intermediate level of terms of trade volatility and of financing costs, a mixed regime is observed. If the realized real exchange rate is weak, pricing to market would prevail, increasing consumers’ welfare by shielding them from the adverse purchasing power consequences of weak terms of trade. If the realized real exchange rate is favorable enough, more imports are purchased in the spot market, and the relative PPP would hold. Higher financing costs increase the cost of pre-buying imports, reducing thereby the frequency of pricing to market, increasing the expected relative price of imports, reducing the expected deviations from relative PPP, and reducing welfare.     

Exchange rate regime durability and performance in developing versus advanced economies

Drawing on new data and advances in exchange rate regimes’ classification, we find that countries appear to benefit by having increasingly flexible exchange rate systems as they become richer and more financially developed. For developing countries with little exposure to international capital markets, pegs are notable for their durability and relatively low inflation. In contrast, for advanced economies, floats are distinctly more durable and also appear to be associated with higher growth. For emerging markets, our results parallel the Baxter and Stockman classic exchange regime neutrality result, though pegs are the least durable and expose countries to higher risk of crisis.     

Global trends in real risk free rates

We examine real returns to government debt of the G7 countries, for both short and long maturities. Our focus is on returns to fixed income investing rather than contemporaneous yields. We find evidence that investments in the same maturity across countries may be modeled as a cointegrated process, in a vector error correction framework, with common trends separated into their permanent and transitory components for the system. Our findings are based on analysis of both short-term maturities and long-term maturities. However, the structure varies excessively across maturities and time frames, with recent data showing less integration.     

Controlling capital? Legal restrictions and the asset composition of international financial flows

How effective are capital account restrictions? We provide new answers based on a novel panel data set of capital controls, disaggregated by asset class and by inflows/outflows, covering 74 countries during 1995–2005. We find the estimated effects of capital controls to vary markedly across the types of capital controls, both by asset categories, by the direction of flows, and across countries' income levels. In particular, both debt and equity controls can substantially reduce outflows, with little effect on capital inflows, but only high-income countries appear able to effectively impose debt (outflow) controls. The results imply that capital controls can affect both the volume and the composition of capital flows.     

Have domestic or foreign factors driven European external imbalances?

This paper examines whether domestic or foreign net saving predominantly influences an economy’s international borrowing and lending with reference to the experience of western European economies that have had sizable current account surpluses and deficits since the turn of the century. It proposes that if an international lender country’s current account surplus is positively (negatively) related to its real long term interest rate, then foreign (domestic) factors are driving its external imbalance. On the contrary, for a foreign borrower country if its current account deficit is positively (negatively) related to its real long term interest rate, domestic (foreign) factors drive its external imbalance. On this basis, it shows econometrically for major European lender economies, Germany, the Netherlands, Switzerland and Sweden, that external imbalances this decade were mainly determined by foreign factors, though by domestic factors for Norway. For major borrower economies, Italy, Spain, Portugal, Ireland and the United Kingdom, the results were not significant implying that neither domestic nor foreign factors predominated over this time.     

Financial flows,financial crises,and global imbalances

In this lecture I document the proliferation of gross international asset and liability positions and discuss some consequences for individual countries’ external adjustment processes and for global financial stability. In light of the rapid growth of gross global financial flows and the serious risks associated with them, one might wonder about the continuing relevance of the net financial flow measured by the current account balance. I argue that global current account imbalances remain an essential target for policy scrutiny, for financial as well as macroeconomic reasons. Nonetheless, it is critically important for policymakers to monitor as well the rapidly evolving structure of global gross assets and liabilities.     

A portfolio balance approach to the Canadian-U.S. exchange rate

An empirical portfolio balance model based on Branson and Henderson [Branson, W. H., & Henderson, D. W. (1985). The specification and influence of assets markets. In: Jones R. W., Kenen, P. B. (Eds.), Handbook of International Economics, Volume 2, Elsevier, Amsterdam] is specified for the Canadian-U.S. exchange rate over the floating exchange rate period. Empirical implementation reveals two cointegrating vectors that closely, although not perfectly, match the home and foreign asset demands of the theoretical model. Furthermore, the exchange rate is important in the error correction process. Finally, although the significance is quantitatively and statistically modest, a simplified version of the empirical model resulting from general-to-specific procedures is able to beat a random walk at some out-of-sample forecast horizons.     

Structural breaks in volatility: Evidence for the OECD and non-OECD real exchange rates

This paper attempts to determine whether or not nominal exchange rate regimes affect the volatility of bilateral and effective real exchange rates. To that end, we examine the real exchange rate behaviour for a set of OECD and non-OECD countries during the 1960–2006 period, therefore covering both the Bretton Woods system of fixed exchange rates and the adoption of generalised floating exchange rates from 1973. We make use of an econometric methodology based on the Hansen's (Hansen, B.E., 1997. Approximate asymptotic P values for structural-change tests. Journal of Business and Economic Statistics 15 (1), 60–67) approximation to the p-values of the supreme, exponential and average statistics developed by Andrews (Andrews, D., 1993. Test for parameter instability and structural change with unknown change point. Econometrica 61 (4), 821–856) and Andrews and Ploberger (Andrews, D., Ploberger, W., 1994. Optimal tests when a nuisance parameter is present only under the alternative. Econometrica 62 (6), 1383–1414). This methodology allows us to obtain a profile of p-values and to delimit periods of stability and instability in the variance of real exchange rates. Results suggest that there is clear evidence in favour of the non-neutrality of nominal exchange rate regime regarding real exchange rate volatility for developed countries, but not in the case of developing or emerging countries.     

Can trade costs explain why exchange rate volatility does not feed into consumer prices?

If countries specialize in imperfectly substitutable goods, trade costs increase the share of expenditure devoted to domestic output, reducing the exposure of consumer price inflation to exchange rate changes. I present a multi-country flexible-price model where expenditure shares are inversely related to trade costs through a gravity equation. In this setting, consumer price inflation can be approximated as an expenditure-share-weighted average of the contributions to inflation from all countries. I use data from 24 OECD countries, 1970-2003, to estimate a structural gravity model. I combine the fitted expenditure shares from the estimation with actual data on exchange rates to construct predictions of inflation. The behavior of these predictions indicates that trade costs can explain both qualitatively and quantitatively the failure of exchange rate volatility to feed into inflation.     

A two-country NATREX model for the euro/dollar

This paper develops a NATREX (NATural Real EXchange rate) model for two large economies, the Eurozone and the United States, which are fully specified and allowed to interact. The theoretical framework, grounded on dynamic disequilibrium modelling approach in continuous time, provides the basis for empirical estimation. The model is estimated in its structural form as a simultaneous nonlinear differential equations system for the 1975–2003 period. The estimated parameters are then used to derive the simulated Euro/USD NATREX series in- and out-of-sample that offers the benchmark against which the misalignements of the actual real exchange rate are measured.     

Does the worldwide shift of FDI from manufacturing to services accelerate economic growth? A GMM estimation study

We examine the effect of manufacturing and service FDI (foreign direct investment) on their own sector growth, the spillover to the other sectors and the overall economy in host countries. We identify significant sectoral and inter-industry spillover effects with various data classifications and types of FDI flows. Evidence reveals that growth effect of manufacturing FDI operates by stimulating activity in its own (manufacturing) sector and is prevalent in Latin America-Caribbean, in Europe-Central Asia, middle to low-income countries and economies with large industry share. A surge of service FDI is likely to spur growth in service industries but hurt activity in manufacturing industries. Financial service FDI enhances growth in South-East Asia and the Pacific, high income countries and service-based economies by stimulating activity in both manufacturing and service sectors. However, nonfinancial service FDI drains resources and hurts manufacturing industry in the same group of countries. We conclude that a shift from manufacturing to service FDI is likely to lead to deindustrialization in certain regions and types of economies if this shift is spearheaded by nonfinancial FDI.     

Do improvements in government quality necessarily reduce the incidence of costly sudden stops?

Sudden stops have been linked to a number of financial crises in emerging market countries. While a large literature has developed emphasizing the importance of institutions and governance in reducing economic volatility, this paper finds that the effect of government quality on the incidence of sudden stops is non-linear. Initial improvements in governance actually increase the incidence of costly sudden stops. A possible explanation is that improved governance encourages capital inflows that can overwhelm banking systems in countries with weak institutions. What is striking is that this result holds for a large number of countries including those with average levels of institutional quality that already receive considerable inflows. Eventually, however, improving institutions does reduce the frequency of sudden stops, allowing countries to enjoy the benefits of financial globalization with fewer risks.     

Pegged Exchange Rate Regimes—A Trap?

We analyze the role of an exchange rate peg as a commitment mechanism to achieve inflation stability when multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative regime not only in order to mitigate inflation bias from time inconsistency but also to avoid high inflation equilibria. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a "trap" whereby the regime initially confers gains in anti-inflation credibility but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy.     

Noneconomic Engagement and International Exchange: The Case of Environmental Treaties

We examine the role of noneconomic partnerships in promoting international economic exchange. Since far-sighted countries are more willing to join costly international partnerships such as environmental treaties, environmental engagement tends to encourage international lending. Countries with such noneconomic partnerships also find it easier to engage in economic exchanges since they face the possibility that debt default might also spill over to hinder their noneconomic relationships. We present a theoretical model of these ideas and then verify their empirical importance using a bilateral cross-section of data on international cross-holdings of assets and environmental treaties. Our results support the notion that international environmental cooperation facilitates economic exchange.     

Globalization,exports, and effective exchange rate indices

This paper offers a new way of compiling effective exchange rate indices, which is then shown to perform generally better in prototype equations explaining total real exports than other published indices. Researchers can use this method to compile effective exchange rates, real or nominal, readily for any country. The generally superior performance, based on cointegration tests using data from four major economies, four Latin American countries, and four South East Asian countries, suggests the proposed index which uses GDP weights rather than trade weights, is more appropriate in a highly globalized world. Intensified globalization in the past two decades appears indicated by the higher elasticities of exports with respect to the real effective exchange rate over time.     

Why panel tests of purchasing power parity should allow for heterogeneous mean reversion

Recent studies of purchasing power parity (PPP) use panel tests that fail to take into account heterogeneity in the speed of mean reversion across real exchange rates. In contrast to several other severe restrictions of panel models and tests of PPP, the assumption of homogeneous mean reversion is still widely used and its consequences are virtually unexplored. This paper analyzes the properties of homogeneous and heterogeneous panel unit root testing methodologies. Using Monte Carlo simulation, we uncover important adverse properties of the panel approach that relies on homogeneous estimation and testing. More specifically, power functions are low and assume irregular shapes. Furthermore, homogeneous estimates of the mean reversion parameters exhibit potentially large biases. These properties can lead to misleading inferences on the validity of PPP. Our findings highlight the importance of allowing for heterogeneous estimation when testing for a unit root in panels of real exchange rates.