Inflation and interest rate derivatives for FX risk management: Implications for exporting firms under real wealth

Firms that export goods face risks such as product price, cost, and exchange rate risks. Price and cost risks can substantially reduce the FX hedging performance in real wealth. We thus investigate hedging strategies that are intended to improve the performance of the FX hedge in real terms using inflation and interest rate derivatives. The impact of these additional instruments is not clear and has only been briefly analyzed in the hedging literature so far. For this purpose, we derive variance-minimizing hedge positions of an exporting firm. A cointegrated VAR and bootstrap methods are used to evaluate the efficiencies of several hedging strategies. While inflation derivatives work better in the short run, interest rate derivatives perform better over longer hedge horizons.     

MORE PENSIONS MIS‐SELLING AHEAD: BY GOVERNMENT OF COURSE1

Not only was the infamous Pensions Mis‐selling episode of the 1990s caused directly by government legislation; government has continually mis‐sold on an enormous scale its own pension creations, the state pension schemes. The history of state pensions is a history of broken promises, yet today's pension establishment welcomes the Pension Commission's recommendation for a higher state pension. With this mindset it is hardly surprising that similar approval is given to the Commission's other main recommendation – a National Pensions Saving Scheme, which has all the hallmarks of a fiasco in the making. Furthermore to the extent there is a savings crisis, government is a clear culprit, regularly resorting to low interest rates and the printing press to favour borrowing and not saving. Nor is it surprising that government itself will retain its gold‐plated pension arrangements and in all likelihood will be exempt from these proposals.     

Can Germany save itself from negative rates?

• German inflation looks set to rise in response to diminishing slack in the economy. But this will be a mixed blessing for those in Germany hit by negative policy rates and ECB asset purchases. Higher German inflation may eliminate the need for further ECB policy action, but it is unlikely to trigger imminent rate hikes. As a result, the rise in inflation will merely lower real interest rates for German savers.
• Structural cross‐country differences mean that the ECB is better able to hit its inflation target when the peripheral economies rather than Germany are the region's growth engine. A key reason for this is that the German Phillips curve is flat by Eurozone standards, meaning that policymakers need to work hard to generate sufficient inflation in Germany to offset sustained weakness elsewhere.
• Despite this, there is evidence to suggest that the tightening labour market is beginning to push German wage growth higher. And if productivity growth remains subdued, this will lead to faster unit labour cost growth.
• While firms could respond by lowering their margins, the strength of household spending suggests that firms may be more inclined than in the past to pass on higher costs to consumers.
• In all, we expect German inflation to rise more sharply than elsewhere to around 2% in 2017, meaning that the ECB will not unveil further unconventional policy support. But it would take much sharper rises in German wage growth and inflation than in our baseline forecast to prompt the ECB to bring forward interest rate rises.

     

浅议利率波动对房地产投资信托基金的影响

房地产投资信托基金(Real estate investment trusts,REITs)的高分配收益特征使其对利率波动的敏感性较强,而房地产业自身也易受利率变化的影响。1973年和2005年美国联邦局对利率的上调对REITs价格和收益都造成了重大影响,利率上调,REITs经营成本增加,REITs的总体回报率减少,直接影响到其投资价值和回报率。     

The Evidence of History

The historical method of the 'counter-factual' is used in this symposium to shed light on the circumstances in which the welfare state came over time to supplant voluntary private services in education, health, pensions, etc. The fundamental cost of the welfare state is its displacement of these services.     

Interest rate risk in an emerging economy

The sharp decrease in inflation over the last decade—from 26% in 1990 to 4% in 2001—led the Central Bank of Chile to set its monetary policy interest rate in nominal terms since August 2001. This paper analyzes the effect of nominalization on the behavior of nominal, inflation-linked, and real interest rates, and its subsequent effects on the financial market. We find that nominalization has made nominal interest rates less volatile, while the opposite holds for inflation-linked interest rates. The effect on real interest rates is less unambiguous, but nominalization appears to have increased the cost of borrowing.     

Discounting inflation — a note

The aim of this paper is to clarify the confused issue of the effect of inflation on the discounting procedure for investment appraisal. The standard approach is considered, together with the impact of inflation, and the problem of how to adjust the standard approach to take account of inflation. The point is made that it is usually easiest to estimate expected returns in current prices, in which case the discount rate should reflect the real opportunity cost of capital, to avoid mixing real returns and nominal interest in a manner which leads to the rejection of worthwhile projects. An example is given of how the real rate of interest can be computed from the nominal rate of interest and the rate of inflation, and the difference this makes to discounting a sample project. The paper then illustrates how real rates of interest have frequently been negative over the past decade and how this implies that projects may be acceptable even if the sum of future undiscounted returns is less than the initial outlay. The conclusion drawn is that investors should maximize economic profit defined as the surplus over opportunity cost, which reduces the deterrent of nominally high interest rates, for the maximization of surplus over opportunity cost has the corollary of minimization of opportunity loss.     

UK pension policy: world leader turning laggard?

Too much is made of the 'problem' of an ageing population. The real problem in pensions provision is state pay-as-you-go. Private assets of secure title are the best route to financial independence in retirement.     

Evolving macroeconomic perceptions and the term structure of interest rates

We explore the role of evolving beliefs regarding the structure of the macroeconomy in improving our understanding of the term structure of interest rates within the context of a simple macro-finance model. Using quarterly vintages of real-time data and survey forecasts for the United States over the past 40 years, we show that a recursively estimated VAR on real GDP growth, inflation and the nominal short-term interest rate generates predictions that are more consistent with survey forecasts than a benchmark fixed-coefficient counterpart. We then estimate a simple term structure model under the assumption that investor risk attitude is driven by near-term expectations of the three state variables. When we allow for evolving beliefs about the macroeconomy, the resulting term structure model provides a better fit to the cross section of yields than the benchmark model, especially at longer maturities, and exhibits better performance in out-of-sample predictions of future yield movements.     

Can the Nation Afford Pensions?

Demography-the worsening ratio of the economically active to inactive-will make pensions in their present form unsustainable. Welfarism in the form of universal state pension provision for all can only wither-any individual wishing to do better than his neighbour will have to rely on his own savings.     

Schooling and productivity growth: evidence from a dual growth accounting application to U.S. states

This paper exploits the dual growth accounting framework to determine the effect of schooling on total-factor productivity (TFP) growth for U.S. states over 1980–2010. The paper contributes to the literature by constructing TFP growth measures, in the process, both real wage growth and real user cost growth measures at the state level. The growth accounting exercise reveals that states display considerable heterogeneity in TFP growth with both real wage growth and real user cost growth equally contributing to it. While our econometric estimates reveal significant TFP growth effects associated with college education, they are considerably lower in magnitude when compared to the earlier studies. Productivity growth effects associated with high school education remain insignificant. Our empirical findings are further validated by the use of instrumental variable estimation to address the endogeneity of the schooling variables and are also robust to the inclusion of a rich set of control variables, alternative TFP growth measures as well as to the tests to draw robust inferences in the presence of weak instruments.     

What moves housing markets: A variance decomposition of the rent–price ratio

We apply the dynamic Gordon growth model to the housing market in 23 US metropolitan areas, the four Census regions, and the nation from 1975 to 2007. The model allows the rent–price ratio at each date to be split into the expected present discounted values of rent growth, real interest rates, and a housing premium over real rates. We show that housing premia are variable and forecastable and account for a significant fraction of rent–price ratio volatility at the national and local levels, and that covariances among the three components damp fluctuations in rent–price ratios. Thus, explanations of house-price dynamics that focus only on interest rate movements and ignore these covariances can be misleading. These results are similar to those found for stocks and bonds.     

Exit problems in regime-switching models

This paper provides a general framework for pricing of perpetual American and real options in regime-switching Lévy models. In each state of the Markov chain, which determines switches from one Lévy process to another, the payoff stream is a monotone function of the Lévy process labeled by the state. This allows for additional switching within each state of the Markov chain (payoffs can be different in different regions of the real line). The pricing procedure is efficient even if the number of states is large provided the transition rates are not very large w.r.t. the riskless rates. The payoffs and riskless rates may depend on a state. Special cases are stochastic volatility models and models with stochastic interest rate; both must be modeled as finite-state Markov chains. As an application, we solve exit problems for a price-taking firm, and study the dependence of the exit threshold on the interest rate uncertainty.     

The comparative forecast performance of univariate and multivariate models: an application to real interest rate forecasting

Does the use of information on the past history of the nominal interest rates and inflation entail improvement in forecasts of the ex ante real interest rate over its forecasts obtained from using just the past history of the realized real interest rates? To answer this question we set up a univariate unobserved components model for the realized real interest rates and a bivariate model for the nominal rate and inflation which imposes cointegration restrictions between them. The two models are estimated under normality with the Kalman filter. It is found that the error-correction model provides more accurate one-period ahead forecasts of the real rate within the estimation sample whereas the unobserved components model yields forecasts with smaller forecast variances. In the post-sample period, the forecasts from the bivariate model are not only more accurate but also have tighter confidence bounds than the forecasts from the unobserved components model.     

The Real Estate Frontier

Africa's major cities are experiencing dramatic transformation as a result of growing real estate investment. This article explores whether existing theories can explain the dynamics of urban redevelopment in an African context, and how African cases can inform new theorizations of real estate driven urban transformation. Examining the utility of theories of gentrification and speculative urbanism for understanding urban redevelopment in Accra, Ghana, it argues that urban redevelopment in this city has been shaped by its particular (post)colonial history of state land acquisition and urban planning. Rather than simply identifying empirical variation on established theories, however, the article draws on recent research on commodity frontiers to propose an original theorization of urban redevelopment in Accra in terms of the production of a ‘real estate frontier’. This real estate frontier is characterized by the incremental and contested commodification of state land to enable the growth of the real estate sector in the city. The article concludes by calling for a comparative research agenda to better understand real estate frontiers globally.     

PENSION REFORM,POLITICAL PRESSURE AND PUBLIC CHOICE – THE CASE OF FRANCE

An ageing population and generous public sector pensions have put significant pressure on the funding of the French pension system making a reduction in the scope of state pension schemes imperative. Yet, as public‐choice theory would predict, lobbying by interest groups has made reform difficult to achieve.     

HOW TO CLEAR UP THE PENSIONS MESS

All three pillars of the British pensions system are crumbling. The basic state pension is unsustainable in its present form. Defined benefit occupational pension schemes are fast disappearing, and with them the retirement hopes of millions of workers. A further 3 million low-income earners are not saving enough for their retirement. And uncertainty about pensions choices is widespread. In each case the primary cause of the problem is governmental or regulatory failure. The paper makes eight general and four specific proposals for restoring the system.     

Inflationary equilibrium in a stochastic economy with independent agents

We prove the existence of stationary monetary equilibrium with inflation in a “Bewley” model with constant aggregate real variables but with idiosyncratic shocks to the endowments of a continuum of individual agents, when a central bank stands ready to borrow or lend fiat money at a fixed nominal rate of interest and the agents face borrowing constraints. We also find that, in the presence of real micro uncertainty about individual endowments, the rate of inflation is higher (equivalently, the real rate of interest is lower) than it would be in a “certainty-equivalent economy”; to wit, one in which every agent’s endowment is replaced by its expected value. Thus, underlying microeconomic uncertainty and borrowing constraints are shown to generate additional inflation.     

THE MONETARY CONUNDRUM

The broad money supply, sterling M3, has grown by 14.1 per cent (ie an annual rate of over 30 per cent) over the past six months. Over the same period the narrow money supply definition (M1) has increased by only 4.4 per cent, while the difference between the two money supply measures — broadly speaking, the interest bearing component of sterling M3 — has grown by no less than 23.1 percent. The real economy is showing all the signs of a severe monetary squeeze with stocks and imports falling rapidly, while the balance of payments and the exchange rate are exceptionally strong. Over the past six months, industrial production (excluding North Sea oil) has fallen by 7.9 per cent while wholesale prices have risen by only 4.2 per cent. Thus, there is a double conundrum: the sharply different growth trends in M1 and sterling M3, and the contrast between the explosive growth of sterling M3 and the subdued behaviour of the real economy.
One possible answer to this puzzle, spelt out in more detail in the following pages of this Forecast Release, is that the rate of interest being paid on the interest-bearing component of sterling M3 is now abnormally high. Consequently, the asset demand for the interest-bearing component of sterling M3 is exceptionally large, with the result that both the non-interest-bearing component of the money stock (ie M1) and the real economy are being squeezed Under these circumstances, the short-run behaviour of sterling M3 may not be an entirely reliable guide to the behaviour of the real economy.     

Impact of China's currency valuation and labour cost on the US in a trade and exchange rate model

Ricardian dynamic general equilibrium analyses show that under free trade arrangements a low income country with lower wage cost and large endowment of labour has comparative advantage in trade. Efficiency gains from this enhance economic growth and welfare of households simultaneously in both low income and advanced economies. Theoretical predictions are empirically validated here with structural VAR analysis based on quarterly data over the time period 1995:1 to 2009:1 on China's relative wage cost, interest rate differential, real effective exchange rate (REER), relative GDP and the US current account balance. It is shown how the relative prices of labour, capital and the currency affect the economic activity in China and current account balance in the US. With free capital inflows and outflows and restrictions on labour mobility, comparative advantage of China and the trade deficit of the US will both be minimised if China allows real appreciation of the Yuan and complete adjustment in prices. Higher production cost and prices in China could reduce welfare of Chinese households and the trade imbalance of the US, while higher relative GDP of China lowers the current account balance for the US.