Exchange Rates, Nominal Inertia and Inflation

This paper examines the use of the nominal exchange rate in achieving disinflation under managed exchange rate regimes. Most previous empirical studies have not explicitly identified expectations in the wage and price setting behaviour of their econometric models, despite the importance of expectations both during a disinflation and in correcting misalignments. This has meant that costs due to nominal inertia and non-neutralities have not been addressed separately from questions of credibility. We present results for the UK economy using both a theoretical and empirical model in which firms and workers form rational expectations, but where there is also nominal inertia. We identify costs in using the exchange rate to change the inflation rate, and also the costs involved in correcting any disequilibria in the real exchange rate.     

Disinflation costs in China and monetary policy regimes

This paper investigates the real effects of a disinflationary policy in China, in which we conduct a disinflation experiment in a medium-scale New Keynesian model. We highlight two key features of China's economy: the relevance of money to monetary policy rules and household inequality. For the former, we consider two monetary policy regimes: an expanded Taylor rule with money and a money supply rule. For the latter, we take into account a share of the population that is limited in its ability to participate in assets markets. Our analysis suggests that a disinflation policy is more costly when the central bank controls the money supply than the case in which the nominal interest rate is the policy instrument. Our results are driven by the different impacts of disinflation on nominal and real interest rates under the two regimes.     

On the Exchange Rate as a Nominal Anchor: The Rise and Fall of the Credibility Hypothesis

The credibility hypothesis, which was used to support the use of a pegged exchange rate arrangement as a nominal anchor mechanism, is based on restrictive analytical foundations that circumscribe its real world applicability. While all pegged exchange rate arrangements are subject to circumstances that can undermine the sustainability of the peg, exchange rate nominal anchor pegs are especially fragile because such arrangements introduce problems that are endogenous to that particular type of regime. The East Asian crisis is used to demonstrate the fragility of exchange rate nominal anchor pegs, while the case of Australia demonstrates how a floating currency escaped the contagion of the East Asian crisis.     

Policy credibility and alternative approaches to disinflation

This paper examines how central bank credibility affects the merits of a “gradualist” versus “cold turkey” approach to disinflation in a DSGE model in which private agents use optimal filtering to infer the central bank’s nominal anchor. Our analysis is applied to two episodes of sharp and deliberate monetary tightening in the United States – the post-WWI deflation and the Volcker disinflation. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach; thus, the aggressive tightening that occurred in 1920–21 did not seem warranted. In contrast, for a policy regime with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents.     

Economic stagnation in Weimar Germany: a structuralist perspective

Mexico and Argentina in the 1990s as well as Weimar Germany in the 1920s implemented similar exchange-rate-based stabilization programs which were successful in stopping inflation, but failed to generate the domestic savings and investment rates necessary for a sustainable growth path. It is argued that in both cases substantial foreign capital inflows were attracted by a stable nominal exchange rate and high interest rates, which alleviated the distributional struggle driving high inflation. However, this incentive structure caused a profit squeeze in the tradable goods sector due to an appreciating real exchange rate precipitating the ultimate collapse of the programs.     

Fractionalization and long-run economic growth: webs and direction of association between the economic and the social -- South Africa as a time series case study

In this paper it is considered that the relationship between nominal exchange rate and prices depends on the nature of the shocks impacting the economy. In order to identify the sources of nominal exchange rate and relative price fluctuations we impose long-run restrictions on the dynamics of these variables through a 2-variable and 3-variable SVAR, respectively. This methodology is applied to data on the Spanish economy and find that supply and real demand shocks move nominal exchange rates and relative prices in opposite directions. Nominal shocks, however, move both variables in the same direction. Thus, in this case, only under nominal shocks may exchange rate depreciations fuel inflation.     

Monetary disinflation in a simple two-country model

A two-country model with sluggish goods and labour markets, efficient financial markets, flexible exchange rates and perfect capital mobility is considered. The rational expectations dynamics are considerably simplified when the effects of real interest rates on investment are small. It can then be shown that simultaneous monetary disinflation has no real effects, whilst independent disinflation leads to output losses at home and gains abroad.     

我国应放弃汇率名义锚

尽管我国宣布将货币供应量作为货币政策调控目标,但是,货币供应量近年来却高速增长,造成我国物价水平不断攀升。本文通过对近年我国货币政策实际操作考察发现,我国货币政策名义锚并非货币供应量而是汇率,其他货币政策工具均受制于此。汇率名义锚使我国货币政策走入困境,央行面临着物价稳定和经济紧缩的重大取舍。历史经验告诉我们,在巨大贸易不平衡下,汇率名义锚具有不可持续性。参照国际成功经验,本文建议我国应逐步放弃汇率名义锚,渐进迈向物价名义锚,实现货币政策独立和经济良性发展。     

Hitting and hoping?: Meeting the exchange rate and inflation criteria during a period of nominal convergence

This paper analyses the effect of the nominal convergence process on the ability of Central and Eastern European Countries (CEECs) to meet both the inflation and the exchange rate criteria for Eurozone entry. The size of these convergence effects on the exchange rate (for inflation targeters) and for inflation differentials (under a fixed exchange rate) is estimated for a variety of different convergence scenarios. The key result, robust across all scenarios, is that countries with fixed exchange rates will find it much harder to simultaneously meet the criteria than inflation targeters. Probit estimates on the ability of a country to get inflation below the reference value under a fixed exchange rate show a strong effect for the relative price level.     

Revisiting the interest rate–exchange rate nexus: a Markov-switching approach

In this paper the interest rate–exchange rate nexus and the effectiveness of an interest rate defense are investigated empirically. I present a reduced form evidence which characterizes the empirical relationship between interest rates and exchange rates. I use a Markov-switching specification of the nominal exchange rate with time-varying transition probabilities. Empirical evidence from six developing countries: Indonesia, South Korea, the Philippines, Thailand, Mexico, and Turkey indicates that raising nominal interest rates leads to a higher probability of switching to a crisis regime. Thus, the empirical results presented here may support the view that a high interest rate policy is unable to defend the exchange rate. Unlike other studies which consider linear models only, my findings are robust and consistent over different countries and crisis episodes (Asian 1997 crises, Mexico 1994 crisis, and Turkey 1994, 2001 crises). In order to explain the empirical findings, I construct a simple theoretical model by incorporating an interest rate rule in the model proposed by Jeanne and Rose (2002) [Jeanne, O., Rose, A.K., 2002. Noise trading and exchange rate regimes, Quarterly Journal of Economics. 117 (2) 537–569]. The model has multiple equilibria, and under plausible conditions, higher exchange rate volatility is associated with higher interest rates.     

Real and nominal UK interest rates,ERM membership,and inflation targeting

This article estimates a two-factor term structure model to analyze the time-varying mean-reverting levels of the UK real and nominal short-term interest rates. Before and during British membership in the ERM, the mean-reverting levels of real and nominal short rates have a strong negative correlation. Afterward, when the UK implemented an inflation targeting policy, the mean-reverting levels have a strong positive correlation. The article also reports empirical evidence of a link between the time-varying central tendencies and inflation in the disinflation period before the implementation of the inflation targeting policy.     

Nonlinear Exchange Rate Adjustment and the Monetary Model

Although the empirical literature has delivered evidence in favor of nonlinearities in nominal and real exchange rate adjustment, the corresponding mechanisms with respect to the relationship between nominal exchange rates and fundamentals in general have rarely been put under any close scrutiny. This paper extends the work of other authors, who estimate exponential smooth transition autoregressive models to deviations of the exchange rate from monetary fundamentals. Using monthly data from 1976:01 to 2010:12 for the USA, UK, and Japan, this paper first adopts a cointegrated vector autoregression (VAR) framework to test for the multivariate validity of the monetary model by applying restrictions on the long‐run relationships. Then, nonlinear vector error correction models are estimated to tackle the question of whether the adjustment of the nominal exchange rate with respect to those relationships follows a nonlinear path.     

Painless disinflation? Monetary policy rules in Hungary, 1991‐99

We estimate a small structural model for inflation, the output gap, the domestic interest rate and the exchange rate for Hungary during the period of the transition (1991-99). The transmission of monetary policy impulses to macro variables is characterized in a similar fashion to that of advanced open industrial countries. In particular, in the context of our rational expectations, forward-looking model, the interest rate channel on aggregate demand and the exchange rate channel work together as parts of the same disinflation policy. We draw several conclusions on understanding and modeling the effects of monetary policy, and also on the desirable design of policy rules during the process of disinflation.
JEL classification: E17, E52, P24.     

Are Indian rice exporters able to price discriminate? Empirical evidence for basmati and non-basmati rice

The role of exchange rate fluctuations on the pricing behaviour of Indian rice exporters in their major destination markets is examined using the pricing-to-market (PTM) model. The analysis was undertaken in a context where India has emerged as a leading exporter of rice in the world market. The study distinguishes between basmati and non-basmati rice in the analysis as the destination markets differ across these two varieties. One of the key contributions of this study is that it undertakes an analysis under 3 exchange rate models, they are: nominal, real and commodity-specific exchange rates. The results from our analysis indicated the presence of non-competitive pricing behaviour of India’s rice exporters in majority of destination markets due to both the market-specific characteristics as well as exchange rate-induced effects. The amplification of exchange rate effects was more prominent in commodity-specific exchange rate model whereas local currency stabilization was more prominent under nominal and real exchange rate models. Furthermore, the analysis showed that the commodity-specific exchange rate better predicts the PTM behaviour of rice exporters.     

Should Commodity Exporters Peg to the Export Price?

To account for the specific situation of commodity exporters, pegging to export prices (PEP) has been proposed elsewhere as an alternative to other conventional monetary regimes such as an exchange rate peg or inflation targeting. PEP is supposed to deliver automatic accommodation to terms‐of‐trade shocks, while retaining the credibility gain from a nominal anchor. This paper analyzes the PEP proposal in a dynamic general‐equilibrium model and compares it with a standard Taylor rule, consumer price index (CPI)‐level targeting and a nominal exchange rate peg. Judged by the degree of output stabilization, PEP performs very similar to CPI targeting for export demand as well as domestic demand shocks and underperforms in the case of shocks to the export price. The results suggest that PEP is not superior to conventional CPI targeting from a macroeconomic stabilization perspective.     

Causal relations between nominal exchange rates and monetary fundamentals in Central and Eastern European countries

The purpose of this paper is to investigate the causal relations between nominal exchange rates and monetary fundamentals. The analysis is conducted using panel quarterly data from the period 2001–12 for Central and Eastern European countries (including Turkey) with relatively flexible exchange rate regimes. The paper reconnects the empirical literature on exchange rates in Central and Eastern European countries with the most recent findings on exchange rate determination in advanced economies. Kóyna's approach, which accounts for linkages between countries, is used in the study. The main findings indicate the existence of causal relations running from both nominal exchange rates to monetary fundamentals and in the opposite direction as well as the existence of a relatively strong link between exchange rates and differentials in the relative price of non‐tradables.     

Are there bubbles in Chinese RMB–dollar exchange rate? Evidence from generalized sup ADF tests

This article uses recently developed generalized sup ADF (GSADF) unit root tests into the analysis of nominal RMB–dollar exchange rates bubbles. Based on the results from the GSADF tests, we find strong evidence of explosive behaviour in the nominal exchange rate and investigate two bubbles there. The first bubble is during 2005–2006 which is determined neither by the relative prices of traded goods nor the relative price of nontraded goods. The second bubble busts in 2008 during subprime crisis period, and which is determined by the relative prices of traded goods but not the relative price of nontraded goods. There is no bubble before 2005 as the exchange rate is under fixed regime. As for this result, some expansionary monetary and fiscal policies are required in China since these are the most efficient and effective under a bubble burst scenario.     

HONG KONG'S INDETERMINACY PUZZLE: INSTITUTIONALIST AND ECONOMETRIC APPROACHES*

During the free-issue regime (1974–1983), Hong Kong's money supply, price level and exchange rates were wholly governed by market forces. The system did not seem to have any nominal anchor. Theoretically its price level was indeterminate, engendering what is called an indeterminacy puzzle. The paper elaborates on the concept of price level indeterminacy and undertakes the question of empirical determination of the price level indeterminacy during the free-issue regime. The empirical investigation employs two distinct approaches - institutionalist and econometric. The results of the two approaches indicate the necessity of a broader approach to historical analyses. The paper also informs us about the relationship among money supply, price level and exchange rate in a regime of fiat money without a central bank.     

Dissecting Exchange Rates and Fundamentals in the Modern Floating Era: The Role of Permanent and Transitory Shocks

In this paper, we apply a permanent–transitory decomposition method to analyze the link between nominal exchange rates and fundamentals in the modern floating era. The results suggest that transitory shocks dominate nominal exchange rate fluctuations, while permanent shocks dominate the variations in fundamentals. Therefore, the findings suggest that the nominal exchange rate should not be approximated by a pure random walk. Moreover, we find that unobserved fundamentals in the Taylor rule model can explain the transitory components in exchange rates.     

From Inflation to Growth

This paper reexamines growth in transition using panel data to 1997. It suggests that output has been strongly affected by export market growth; that inflation has been associated with weaker output only above a threshold inflation rate; that structural reform has been associated with weaker output initially, but that it stimulates higher growth thereafter; and that rapid disinflation has been associated with output losses only in the presence of pegged exchange rates.