Asset Prices and Exchange Rates

We study the implications of introducing demand shocks and tradein goods into an otherwise standard international asset pricingmodel. Trade in goods gives rise to an additional channel ofinternational propagation—through the terms of trade—absentin traditional single-good models. The inclusion of demand shockshelps overturn many unrealistic implications of existing internationalfinance models in which productivity shocks are the sole sourceof uncertainty. Our model generates a rich set of implicationson how stock, bond, and foreign exchange markets co-move. Wesolve the model in closed-form, which yields a system of equationsthat can be readily estimated empirically. Our estimation validatesthe main predictions of the theory.     

Import Dependency and Structural Adjustment in Sub-Saharan Africa

One of the effects of structural adjustment programs in Sub-SaharanAfrica has been the reduction of imports in the face of scarceforeign exchange. This article takes the analysis of importdemand beyond the traditional income and price determinantsto account for factors likely to be important to Sub-SaharanAfrican countries in the 1990s. First, the effect of demandon imports is reflected by the level of absorption rather thanthe less direct income variable. Second, because adjustmentprograms may cut government consumption and, through increasesin interest rates, reduce investment, these components of absorptionare also considered independently to assess their differentialeffect on imports. Third, import barriers are often set in dollarterms to limit the use of foreign exchange. Because reliableand complete data for import restrictions are not available,the ratio of exports to debt is included as an indicator offoreign exchange availability to reflect its effect on tradebarriers and thus imports. The findings suggest that this morecomprehensive assessment of import demand will be needed ifthe size and even direction of changes in import demand in responseto policy reform is to be understood and anticipated.     

THE ECONOMICS OF NATURAL RESOURCE EXTRACTION: A PRIMER FOR DEVELOPMENT ECONOMISTS

As developing countries become major consumers of the globalsupply of commercial energy, it is essential to understand thedeterminants of future energy prices. At the same time, manydeveloping countries are relying on exports of their own naturalresources—tropical hardwoods, oil, tin, gold, and otherminerals—to generate badly needed foreign exchange. Governmentpolicies influence how much of a resource is extracted todayand how much is saved for the future. Flawed policies needlesslywaste precious national wealth.      

Trade integration, competition, and the decline in exchange-rate pass-through

Over the past 20 years, U.S. import prices have become less responsive to the exchange rate. We propose that a significant portion of this decline is a result of increased trade integration. To illustrate this effect, we develop an open economy DGE model featuring demand curves with variable elasticities so that a firm's pricing decision depends on its competitors’ prices. As a result, a foreign exporter finds it optimal to vary its markup in response to shocks that change the exchange rate, insulating import prices from exchange rate movements. With increased trade integration, exporters have become more responsive to the prices of their competitors, explaining a sizeable portion of the observed decline in the sensitivity of U.S import prices to the exchange rate.     

人民币进口汇率传递效应及国外出口商定价能力——产业视角下的实证研究

本文在局部均衡框架下建立了引入进口关税的成本加成模型分析国外出口厂商的定价行为,并构建了我国各产业的进口价格、名义有效汇率和国外出口商生产成本指数,利用分布滞后模型首次对各产业的汇率传递效应进行了实证研究。主要发现:无论短期还是长期,各产业进口价格的汇率传递效应都存在很大差异。以采掘、皮革、冶金和纺织为主的资源类产品的进口价格传递弹性普遍较高,甚至超过具有高附加值的机械产业。资源类中以进口稀有金属为主的采掘业长期传递弹性最高。短期内,几乎所有产业的外国出口厂商都会通过调整成本加成来吸收汇率变动;而在长期,汇率变动基本上对各产业进口价格都有不同程度的传递,尤其资源类产业更倾向于采取生产方货币定价方式。结果表明我国一方面可以通过汇率升值提高购买力,另一方面在产业结构调整中则强烈需要改变现有高耗能的增长模式。     

The shortage of safe assets in the US investment portfolio: Some international evidence

This paper develops a Bayesian Global VAR (GVAR) model to track the international transmission dynamics of two stylized shocks, namely a supply and demand shock to US-based safe assets. Our main findings can be summarized as follows. First, we find that (positive) supply-sided shocks lead to pronounced increases in economic activity which spills over to foreign countries. The impact of supply-sided shocks can also be seen for other quantities of interest, most notably equity prices and exchange rates in Europe. Second, a demand-sided shock leads to an appreciation of the US dollar and generally lower yields on US securities, forcing investors to shift their portfolios towards foreign fixed income securities. This yields sizable positive effects on US output, equity prices and a general decrease in financial market volatility.     

Are Chinese trade flows different?

We find that Chinese trade flows respond to economic activity and relative prices – as represented by a trade weighted exchange rate – but the relationships are not always precisely or robustly estimated. Chinese exports are generally well-behaved, rising with foreign GDP and decreasing as the Chinese renminbi (RMB) appreciates. However, the estimated income elasticity is sensitive to the treatment of time trends. Estimates of aggregate imports are more problematic. In many cases, Chinese aggregate imports actually rise in response to an RMB depreciation and decline with Chinese GDP. This is true even after accounting for the fact a substantial share of imports are subsequently incorporated into Chinese exports. We find that some of these counter-intuitive results are mitigated when we disaggregate the trade flows by customs type, commodity type, and the type of firm undertaking the transactions. However, for imports, we only obtain more reasonable estimates of elasticities when we allow for different import intensities for different components of aggregate demand (specifically, consumption vs. investment) or when we include a relative productivity variable.     

A Structural Model for Developing Countries' Manufactured Exports

A dynamic structural econometric model is developed to analyzemovements in manufactured exports and to capture lags in theadjustment to equilibrium. The model is estimated with pooledcross-section time-series data for a representative sample offifteen developing countries grouped according to their exportmarket power. The results suggest that prices, domestic productivecapacity, and external economic activity are critical determinantsof manufactured exports from developing countries. The structuralparameter estimates are used to infer the effects of changesin destination country income, distinguishing between the short-runand long-run export volume and export revenue effects. The resultsindicate that domestic economic policies that promote investmentand capacity in export-oriented activities are likely to playa key role in increasing foreign exchange earnings in developingcountries, even if growth in external demand is slow.     

International dimensions of optimal monetary policy

This paper provides a baseline general equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms and nominal rigidities. An inward-looking policy of domestic price stabilization is not optimal when firms’ markups are exposed to currency fluctuations. Such a policy raises exchange rate volatility, leading foreign exporters to charge higher prices vis-à-vis increased uncertainty in the export market. As higher import prices reduce the purchasing power of domestic consumers, optimal monetary rules trade off a larger domestic output gap against lower consumer prices. Optimal rules in a world Nash equilibrium lead to less exchange rate volatility relative to both inward-looking rules and discretionary policies, even when the latter do not suffer from any inflationary (or deflationary) bias. Gains from international monetary cooperation are related in a non-monotonic way to the degree of exchange rate pass-through.     

Do African Countries Pay More for Imports? Yes

The debt crisis and declining living standards require carefulhusbanding of critically scarce foreign exchange in most Africancountries. But economic theory suggests that smaller countries,which import from only a few international suppliers and cannotsupport competitive markets and infrastructure, would be likelyto pay more rather than less for imports. Analysis of importunit values for 1962–87 shows that the twenty Africanformer French colonies paid a price premium of 20–30 percenton average over other importers for iron and steel imports fromFrance. The losses associated with these adverse prices totaledapproximately 2 billion dollars by 1987. The study also findsthat similar price premia (of 20–30 percent) were paidby former Belgian, British, and Portuguese colonies in Africafor imports of these products from their former rulers.     

Exchange rate pass-through in emerging countries: Do the inflation environment,monetary policy regime and central bank behavior matter?

In this paper, we estimate the exchange rate pass-through (ERPT) to import and consumer prices for a sample of 14 emerging countries over the 1994Q1-2015Q3 period. To this end, we augment the traditional bivariate relationship between the nominal effective exchange rate and inflation by accounting for monetary stability proxied by the inflation environment, monetary policy regime and central bank behavior. We show that both the level and volatility of inflation, as well as adopting an inflation target or the transparency of monetary policy decisions clearly reduce ERPT to consumer prices. However, uncertainty about domestic monetary policy seems less relevant in explaining the pass-through to the price of imports.     

Time-varying stock returns and labor income risks in the US and UK

I propose and estimate conditional asset pricing models where the risk premiums of the markets are related to the conditional covariance of the markets with labor income growth within and across countries and the volatility of the markets are related to the shocks and interactions of stock returns and labor income growth. I document that the risk premiums for the US and UK stock markets are more related to the conditional covariance of returns with the labor income growth within countries than across countries. I also find significant interactions of volatilities between stock returns and labor income within countries but not across countries. The results are consistent with the hypothesis that prices of domestic stocks are determined to a greater extent by stochastic discount factors of domestic investors than foreign investors and vice versa.     

Cross-Border Investing with Tax Arbitrage: The Case of German Dividend Tax Credits

German dividends typically carry a tax credit which makes thedividend worth 42.86% more to a taxable German shareholder thanto a tax-exempt or foreign shareholder. This results in a penaltyfor foreign investors who buy and hold German dividend-payingstocks. I document that, as a result of the credit, the ex-daydrop exceeds the dividend by more than one-half of the tax credit,and show that futures and option prices embed more than one-halfof the tax credit. The existence of the credit creates opportunitiesfor cross-border tax arbitrage—in which foreign holdersof German stock transfer the dividend to German shareholders—andimplies that it is tax efficient for foreign investors to holdderivatives rather than investing directly in German stocks.The empirical findings are consistent with costly tax arbitrageactivity by German investors, who face tax risk due to antiarbitragerules. Since dividend tax credits exist in many other countries,the findings are potentially of broad interest.     

A SURVEY OF THE COSTS OF WORLD SUGAR POLICIES

The world sugar market has long been characterized by volatileprices and widespread intervention. Controls on domestic prices,demand, and supply have created an inefficient pattern of worldproduction, consumption, and trade. Without government controls,production would shift from the countries with higher cost,subsidized production (especially the European Community, Japan,and the United States) to the countries with lower costs (suchas Australia, Brazil, and Thailand). The resources saved couldthen be directed to other activities. Sugar policies in countries with high costs reduce world sugarprices quite substantially in the long run and increase pricevariability significantly; production controls in countrieswith low costs increase world prices somewhat and also increasetheir variability. What would happen if all interventions ceased? Average worldsugar prices would probably— but not definitely—rise. World prices would definitely vary less, and economicconditions would definitely improve, especially in developingcountries that depend heavily on sugar exports. But the prospectsfor substantial reform of the sugar market are not promising,even though the GATT Uruguay Round continues. This article putsforward some modest proposals for changing the existing interventionsto lessen economic distortions and reduce costs.      

Interest parity,fractional differencing,and the strength of attraction: a reexamination of the cost-of-carry futures pricing model

This article discusses the strength of attraction in the cointegration of foreign exchange futures prices and their own cash prices under a cost-of-carry futures pricing model. The memories of the residuals in cointegration regression are analyzed by using the fractional cointegration of Cheung and Lai (1993) and the data-tapered method of Hurvich and Ray (1995) with fractional-difference time-series models. The investigation includes the foreign exchange futures and cash prices of the Swiss franc, the Japanese yen, the Deutsche mark, and the British pound. Although the empirical results indicate the existence of cointegration for the foreign exchange futures and cash prices, the strength of attraction is relatively weak.     

Lessons from Experiences with High Inflation

In economies where price control has been the rule, the mostserious concern may be recognition of the inflation problem.Beyond the initial correction of subsidies there is the broaderissue of the risk of a serious inflation. This article looksat the problem of high inflation in developing countries inEurope and Latin America and draws lessons from historical experience.It analyzes the dynamics of the interaction among deficit finance,institutional innovation in financial markets, dollarization,and the shortening of wage contracts in high-inflation situations.When stabilization is undertaken, there is neither immediate,spontaneous resumption of longer adjustment periods for wagesand prices nor instant increase of real money demand to noninflationarylevels. Incomes policy—freezing exchange rates, wages,and prices—is advocated as an effective supplement tothe inevitable budget cut to make up for institutional inertiaand facilitate the start of the stabilization process.     

The effects of foreign disturbances under flexible exchange rates

Foreign fiscal expansion has a contractionary, and monetary expansion an expansionary, effect on the small economy in the real wage model. The reverse conclusions hold in the money wage model only if the income elasticity of the demand for money is one or greater. The same results hold also for the stationay state effects. This theory provides an explanation—in the policy mix of the United States—for the recent lacklustre performance of Europe. Under rational expectations, foreign monetary expansion leads to an overshooting appreciation, fiscal expansion leading to several possible exchange rate responses. The new results are produced by consistently specified money demand and import functions, the supply side, and the wealth effect.     

Real exchange rates and nontradables: A relative price approach

In this paper, we study long-run comovements of real exchange rates and relative prices of nontradables and tradables. This approach is complementary to many existing approaches to investigating real exchange rate movements. In many theoretical models of exchange rate determination, the relative prices of nontradables and tradables are linked to the real exchange rates by identities. However, they do not necessarily move with real exchange rates in reality because of many factors. For example, many tradables contain nontradable components in the form of retailing services, so that Purchasing Power Parity (PPP) may not hold for these tradable goods even in the long run. Hence real exchange rates may not move in the direction predicted by theoretical models when the producers of these tradable goods experience changes in productivity. In this paper, we identify time periods, countries and relative price measures for which comovements between real exchange rates and relative prices of nontradables and tradables are observed.     

The impact of exchange rate deviations from relative PPP equilibrium on the U.S. demand for foreign equities

Applying fixed-effects panel data, this study investigates the impact of U.S. dollar exchange rate movements during different exchange rate states (overvaluation and undervaluation) on the monthly real gross and real net purchases of foreign equities by U.S. residents over the post-Plaza Accord period. The foreign equities come from 22 developed and 25 developing countries. Previous research has posited two alternative hypotheses regarding the relationship between exchange rates and foreign investment. These are the wealth effect and the profit-oriented effect. The evidence herein suggests that these two hypotheses coexist. We find robust evidence for a negative relationship between the exchange rate movements of an undervalued U.S. dollar and the demand for foreign equities. For developed countries, the wealth effect dominates the profit-oriented effect when the U.S. dollar is overvalued, while, for developing countries, the profit-oriented effect dominates the wealth effect. The results emphasize the importance of considering exchange rate states derived from a relative PPP equilibrium when analyzing U.S. allocations to foreign equities. The findings with respect to the macroeconomic control variables are mainly in agreement with the predictions of international financial theory. Some of the results, however, disappear or become inconclusive for the period after the bankruptcy of Lehman Brothers. This may be explained by the increased uncertainty in international financial markets following this unprecedented event. The findings are robust with respect to different constructed equilibrium exchange rates.     

Early warning systems and systemic banking crises in low income countries: A multinomial logit approach

This paper estimates an early warning system (EWS) for predicting systemic banking crises in a sample of low income countries in Sub-Saharan Africa. Since the average duration of crises in this sample of countries is longer than one year, the predictive performance of standard binomial logit models is likely to be hampered by the so-called crisis duration bias. The bias arises from the decision to either treat crisis years after the onset of a crisis as non-crisis years or remove them altogether from the model. To overcome this potential drawback, we propose a multinomial logit approach, which is shown to improve the predictive power of our EWS compared to the binomial logit model. Our results suggest that crisis events in low income countries are associated with low economic growth, drying up of banking system liquidity and widening of foreign exchange net open positions.