Exchange rate and price level determination in a stochastic equilibrium model

This paper analyzes a stochastic general equilibrium model of the open economy under floating exchange rates. It is shown that increased integration of the domestic economy with the rest of the world—whether integration is considered from the viewpoint of financial or commodity markets—has differential impacts upon price and exchange rate variability with the impacts depending further upon the source of variability.     

Exchange rate dynamics under gradual portfolio adjustment

This paper generalizes the asset market approach to exchange rate determination by introducing gradual adjustment of asset-holder portfolios. The influence of different speeds of portfolio adjustment on exchange rate dynamics is considered. Asset market models characterized by instantaneous portfolio equilibrium appear as a special case. The dynamics of exchange rate adjustment following an open-market operation are shown to be qualitatively similar to those of the orthodox instantaneous portfolio equilibrium models. Thus, gradual portfolio adjustment does not compromise the qualitative results derived with the help of those models. The speed of portfolio adjustment is however shown to influence the degree of exchange rate volatility. In particular, the phenomenon of exchange rate overshooting depends crucially on the speed of portfolio adjustment.     

Export price adjustments under financial constraints

Exploiting data on the product‐destination‐level transactions of a large panel of Italian firms, we provide evidence that financial constraints affect price variation across exporters. Constrained exporters charge higher prices than do unconstrained firms that export to the same product‐destination market. This pattern is the result of a two‐fold effect. Distressed firms pass on their higher production costs through prices. However, they also charge higher mark‐ups. We explain this evidence referring to models in which rival firms produce different brands of the same product for customers with significant switching costs and producers face capital market imperfections when they need external financing. Our empirical investigations corroborate this explanation: price gaps are higher when switching costs or other forms of demand rigidity are expected to be more relevant.     

Exchange rate regime,real misalignment and currency crises

Based on 69 sample countries, this paper examines the effect of macroeconomic fundamentals on real effective exchange rates (REER) in these sample countries. Using the misalignment of actual REER from its equilibrium level, we have estimated the factors explaining the extent of currency over- or under-valuation. Overall, we find that the higher the flexibility of the currency regime, the lower is the misalignment. The estimates are robust to different sub-samples of countries. We then explore the impact of such misalignment on the probability of a currency crisis in the next period, indicating the extent to which misalignment could be used as a leading indicator of a potential crisis. This paper thus makes a new contribution to the debate on the choice of exchange rate regime by bringing together real exchange rate misalignment and currency crisis literature.     

Exchange rate dynamics in integrated markets

This paper intends to formalize the behavior of exchange rate dynamics in integrated markets. The decomposition of the exchange rate behavior in different time frequencies suggests that both stochastic and fundamental processes as well as exogenous random shocks are present in the determination of the nominal exchange rate dynamics in integrated countries. A stochastic process within a potential well captures all the elements observed in the data. In addition, the mathematical solutions shed some light on the relationship between the stochastic process and the drift found in the literature. Finally, this model provides an alternative to the Standard Target Zone Stochastic Model thus far used to analyze the exchange rate dynamics in integrated markets.     

Exchange rate dynamics and currency unification: The Ostmark-DM rate

This paper estimates a simple model of the exchange rate between the East and West German Mark immediately preceding German monetary union. Although there is a theoretical literature on exchange rate dynamics when the introduction of a fixed exchange rate is anticipated, the absence of data has limited empirical work on the subject. We show that in the first part of the sample, the DM-Ostmark exchange rate behaves as a random walk. In the second half, when monetary union appeared more likely, the exchange rate behaves as a weighted average of fundamentals and the expected “terminal” exchange rate.     

Utilizing financial market information in forecasting real growth,inflation and real exchange rate

In this paper we build an open economy extension of the Gordon (1962) valuation model that suggests a simple forecasting system for three macroeconomic variables; the real growth, inflation and real exchange rate. All the forecasting equations in our system utilize current financial market information in the form of dividend yields and short-term interest rate. Our empirical results indicate that these simple forms of financial market information are relevant for forecasting the time-varying underlying trends in the macroeconomic data for the U.K., Eurozone and Japan, when treating the U.S. as the world market.     

Exchange rate and inflation dynamics in dollarized economies

We use a panel of a hundred-plus countries with differing degrees of dollarization to perform an empirical analysis of the effects on inflation of exchange rate depreciations. The results qualify the common view that countries with higher dollarization exhibit higher inflation pass-through. We show that large depreciations tend to generate a negative impact on the pass-through coefficient, this impact being more intense the higher the level of dollarization of the economy. We interpret this as evidence that, in highly dollarized economies, the classic inflationary effects of a real depreciation—higher internal demand and imported inflation—can be offset or diminished by both the larger financial costs and the balance-sheet effect, especially if the depreciation is “large”. Additionally, the exchange rate regime is shown to matter: countries with fixed exchange rates suffer more noticeably the balance-sheet effects of large depreciations.     

Exchange rate volatility and capital inflows: role of financial development

There is vast literature examining the impact of exchange rate volatility on various macroeconomic aggregates such as economic growth, trade flows, domestic investment, and more recently capital flows. However, these studies have ignored the role of financial development while examining the impact of exchange rate volatility on capital flows. This study aims to analyze the impact of exchange rate volatility on capital inflows towards developing countries by incorporating the role of financial development over the time period 1980–2013. In this regard, the behavior of two types of capital flows is examined: physical capital inflows measured as foreign direct investment, and financial inflows quantified through remittance inflows. The empirical investigation comprises the direct as well as indirect effect of exchange rate volatility on capital inflows. The study employs dynamic system GMM estimation technique to empirically estimate the effect of exchange rate volatility on capital inflows. The empirical results of the study identify that exchange rate volatility dampens both physical and financial inflows towards developing countries. The indirect impact of exchange rate volatility through financial development, however, turns out positive and statistically significant. This finding reflects that financial development helps in reducing the harmful impact of exchange rate volatility on capital inflows. Hence, the study concludes that a developed financial system is an important channel through which developing countries may improve capital inflows in the long run.     

Exchange rates and perfect competition

The purpose of this note is to demonstrate that the commonly held belief that incomplete and perverse pass-through are incompatible with perfect competition is wrong! To this end, we consider two types of firms both operating in two countries. The demand sides of the markets of the two countries are separated and each type of firm produces its good in one of these countries. We study the effect of an exchange-rate change on the competitive equilibrium prices in each country. When producing for the foreign market causes the same costs as producing for the home market then the law of one price holds and an exchange-rate change is completely offset by price changes. Furthermore, when cost functions neither exhibit economies nor diseconomies of scope between producing for the home and producing for the foreign market then prices move in the right directions in response to an exchange-rate change. However, with general cost structures, even in this simple perfectly competitive model, perverse directions of price changes can result from an exchange-rate change.     

Non-linearity versus non-normality in real exchange rate dynamics

We distinguish non-normality from non-linearity in G7 real exchange rate dynamics by correcting the critical values of the Kapetanios et al. [Kapetanios, G., Shin, Y., Snell, A., 2003. Testing for a unit root in the non-linear STAR framework. Journal of Econometrics, 112, 359–379] test for non-normality using the wild bootstrap. Our findings validate non-linear Purchasing Power Parity net of non-normality effects.     

Real assets, financial assets, liquidity and the lemon problem

Return obtained by diversification is based on average quality. Similarly, under asymmetric information, the price at which an asset can be sold reflects the average quality of assets. Therefore, 4under some conditions, sale of an asset under asymmetric information is a useful alternative to diversification. This idea is developed with a model that incorporates a liquidity shock. One key result is that investment in real assets is higher under asymmetric information than under symmetric information. The model can explain why the ratio of real assets to financial assets is higher in emerging economies than in developed countries.     

Exchange rate dynamics in economies with portfolio rigidities

This paper studies the international transmission of productivity and monetary shocks in a general equilibrium two-country monetary model with portfolio rigidities and distribution costs in trade. The model features two types of transport costs (iceberg costs and distribution costs in terms of nontradables) and incomplete markets. The specification employed here is able to generate the domestic liquidity effect, increase in the foreign–domestic interest rate differential, and the nominal depreciation after a monetary injection. Quantitatively, the model with distribution costs as in Burstein, Neves and Rebelo (2003) performs better matching some business cycle moments, but fails to generate the high volatility of exchange rates observed in the data.     

Exchange rate pass-through,price discrimination,and US meat export prices

Exports are becoming increasingly important for US livestock and poultry producers. Consequently, meat industry participants are concerned about the potential impacts of variations in relative currency values. These effects are considered by quantifying the impacts of relative exchange rates on US beef, pork and poultry export prices. In addition, the impacts of GATT and NAFTA agreements on exchange rate pass-through are considered. The results indicate incomplete exchange rate pass-through occurs for several countries. Trade liberalization under GATT has positively influenced US beef and poultry export prices.