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.     

US exports and time-varying volatility of real exchange rate

The effect of exchange rate volatility on trade is a controversial issue in international economics. Despite a widespread view that an increase in exchange rates volatility reduces trade, there is no real consensus on the direction or the size of the exchange rate volatility–trade level linkages. This paper investigates the relationship between US trade volume and exchange rate volatility using cointegration and error-correction models. We use conditional variances of the real effective exchange rate (REER) series modeled as a generalized autoregressive conditional heteroskedastic (GARCH) process to measure the exchange rate volatility. The cointegration results indicate a significant negative relationship between US export volume and exchange rate volatility. The short-run dynamics of the relationship, however, show that the effects of both real exchange rates and exchange rate volatility are insignificant.     

Mean reversion in long-horizon real exchange rates: Evidence from Latin America

This paper examines mean reversion in real effective exchange rates in six leading Latin American economies during the XXth century using a new data set. A unit-root approach is complemented by an error-correction model including key fundamentals such as terms of trade, trade openness and relative productivities. Unit-root testing shows a very slow process of reversion – if any – to a constant mean in the original series, rejecting the strict PPP hypothesis; however, mean reversion is found after allowing for trends and structural breaks with a half-life average of 1½ years for the six countries. We also found reversion to a conditional mean defined by the co-integrating relationship with an average half-life of 2½ years. Our estimates, although lower than the 3–5 year range that motivated the Rogoff’s puzzle, still indicate the presence of important obstacles to the adjustment process that need further investigation.     

Monetary policy spillovers and the trilemma in the new normal: Periphery country sensitivity to core country conditions

We investigate why and how the financial conditions of developing and emerging market countries (peripheral countries) can be affected by the movements in the center economies – the U.S., Japan, the Eurozone, and China. We apply a two-step approach. First, we estimate the sensitivity of countries' financial variables to the center economies [policy interest rate, stock market prices, and the real effective exchange rates (REER)] while controlling for global and domestic factors. Next, we examine the association of the estimated sensitivity coefficients with the macroeconomic conditions, policies, real and financial linkages with the center economies, and the level of institutional development. In the last two decades, for most financial variables, the strength of the links with the center economies have been the dominant factor while the movements of policy interest rate also appear sensitive to global financial shocks around the emerging market crises of the late 1990s and since the global financial crisis of 2008. While certain macroeconomic and institutional variables are important, the arrangement of open macropolicies such as the exchange rate regime and financial openness are also found to have direct influence on the sensitivity to the center economies. An economy that pursues greater exchange rate stability and financial openness faces a stronger link with the center economies through policy interest rates and real effective exchange rate (REER) movements. We also find that exchange market pressure (EMP) in peripheral economies is sensitive to the movements of the center economies' REER and EMP during and after the global financial crisis. Open macro policy arrangements, especially exchange rate regimes, also have indirect effects on the strength of financial linkages, interacting with other macroeconomic conditions. Thus, trilemma policy arrangements, including exchange rate flexibility, continue to affect the sensitivity of developing countries to policy changes and shocks in the center economies.     

Balance sheet effects on monetary and financial spillovers: The East Asian crisis plus 20

We study how the financial conditions in the Center Economies [the U.S., Japan, and the Euro area] impact other countries over the period 1986 through 2015. Our methodology relies upon a two-step approach. We focus on five possible linkages between the center economies (CEs) and the non-Center economics, or peripheral economies (PHs), and investigate the strength of these linkages. For each of the five linkages, we first regress a financial variable of the PHs on financial variables of the CEs while controlling for global factors. Next, we examine the determinants of sensitivity to the CEs as a function of country-specific macroeconomic conditions and policies, including the exchange rate regime, currency weights, monetary, trade and financial linkages with the CEs, the levels of institutional development, and international reserves. Extending our previous work (Aizenman et al., 2016), we devote special attention to the impact of currency weights in the implicit currency basket, balance sheet exposure, and currency composition of external debt. We find that for both policy interest rates and the real exchange rate (REER), the link with the CEs has been pervasive for developing and emerging market economies in the last two decades, although the movements of policy interest rates are found to be more sensitive to global financial shocks around the time of the emerging markets’ crises in the late 1990s and early 2000s, and since 2008. When we estimate the determinants of the extent of connectivity, we find evidence that the weights of major currencies, external debt, and currency compositions of debt are significant factors. More specifically, having a higher weight on the dollar (or the euro) makes the response of a financial variable such as the REER and exchange market pressure in the PHs more sensitive to a change in key variables in the U.S. (or the euro area) such as policy interest rates and the REER. While having more exposure to external debt would have similar impacts on the financial linkages between the CEs and the PHs, the currency composition of international debt securities does matter. Economies more reliant on dollar-denominated debt issuance tend to be more vulnerable to shocks emanating from the U.S.     

Impact of oil demand and supply shocks on the exchange rates of selected Southeast Asian countries

This study examines the impact of structural oil demand and supply shocks, derived from a structural vector autoregression model proposed by Kilian (2009), on the real effective exchange rates (REER) of Indonesia, Malaysia, Singapore, Thailand, and the Philippines. Our results show that the REER of these countries are not impacted by oil supply shocks. Oil-specific demand shocks affect the REER of Thailand contemporaneously and those of Indonesia, Singapore, and the Philippines with a one-month lag. However, more than one-month-old oil-specific demand shocks usually do not affect the REER of these countries.     

Nominal exchange rate volatility,relative price volatility,and the real exchange rate

We model real exchange rate, nominal exchange rate, and relative price volatility using real and nominal factors. We analyze these volatility measures across developing and industrialized countries. We find that the inclusion of nominal factors achieves a sizable reduction in the real exchange rate volatility spread between developing and industrialized countries. In addition, we find that nominal factors matter to real exchange rate volatility in the short run and the long run, and that for developing countries, a higher share of real exchange rate volatility stems from relative price volatility.     

我国外汇储备的溢出效应研究——基于引力模型的分析

本文采用2000-2015年199个国家和地区的外汇储备面板数据,基于引力模型理论,考察了我国高额外汇储备的溢出效应及对全球资产配置的影响。研究发现:我国外汇储备具有随地理距离递减的空间外溢效应,双边汇率制度关联会增加外汇储备持有比例的相似程度,而且这种溢出效应更多地表现在与中国金融发展水平类似、资本账户开放程度相近的国家之间。上述结论凸显了国家间加强外汇储备合作调整的战略意义。探究我国外汇储备的溢出效应,有利于发展中经济体更好地理解外汇储备的变动逻辑,对于完善外汇储备管理体制,参与国际宏观经济政策协调机制均具有一定的积极意义。     

The international transmission of interest rate shocks: The Federal Reserve and emerging markets in Latin America and Asia

This paper analyzes the effects of changes in the U.S. Federal Reserve's Federal Funds rate on emerging countries' interest rates using high frequency (weekly) data. I also investigate how changes in the U.S. term structure affect short term rates' differentials. Other shocks include changes in the U.S. dollar–Euro exchange rate, changes in the international price of oil, risk ratings, and the degree of capital mobility. The results indicate that there is a strong and fairly rapid transmission of changes in the Federal Funds rate into interest rates in the Latin American countries in the sample. This effect is equally large in the Asian nations in the long run. The adjustment path is different across the two regions, however. Adjustment is very fast and cyclical in Latin America; it is gradual and slower in East Asia.     

Real effective exchange rate volatility and growth: A framework to measure advantages of flexibility vs. costs of volatility

By devising a real effective exchange rate (REER) index where bilateral exchange rates are weighted for relative trade shares, we find that the REER volatility (differently from the bilateral exchange rate volatility with the dollar) has significant impact on growth of per capita income after controlling for other variables traditionally considered in conditional convergence estimates. We also find that this (cost of volatility) effect can be reconciled with the concurring negative and significant effect on growth of the adoption of a fixed exchange rate regime (advantage of flexibility effect), where the latter may be also interpreted as the cost of choosing pegged regimes without harmonization of rules and macroeconomic policies with main trading partners. The adoption of an REER volatility measure, instead of a bilateral exchange rate with the dollar, has the advantage of making it possible a joint test for these two effects. This is because, while fixed exchange rate regimes are strongly negatively correlated, and almost collinear, with bilateral exchange rate volatility with the dollar, the correlation is much weaker when considering our REER volatility measure.     

Reserve overstocking in a highly integrated world. New evidence from Asia and Latin America†

Monthly data are used to investigate reserves management in eight Asian and Latin American countries. Idiosyncratic explanatory variables enter into co-integration relationships based on a stochastic buffer stock model, where a reserve variability measure is obtained via conditional variance approaches. International factors influence the co-integration residuals (representing the excess demands for reserves), which tend to co-move within and across geographical areas. Principal components analysis is then implemented to associate their common drivers with the US fed fund effective interest rate and real-effective exchange rate. This two-step approach sheds light on some controversial aspects of reserves and exchange rate management, such as ‘fear of floating’ and mercantilist behavior. Our results suggest that the size of recent excess reserve holdings is probably overstated.     

Stock market synchronization and monetary integration

This paper focuses on the relationship between stock market comovements and monetary integration. A panel specification is used to explain bilateral stock market return correlations between fifteen developed economies over the period 1975-2006. Time fixed effects are included to capture global shocks and we also examine the role of bilateral trade linkages and international financial integration. Monetary integration leads to stronger stock market synchronization, both through the elimination of exchange rate volatility and through the common monetary policy and the convergence of inflation expectations. Trade and financial integration also contribute to higher stock market return comovements.     

Fiscal shocks and real exchange rate dynamics: Some evidence for Latin America

This paper analyses the effects of fiscal shocks in selected Latin American countries using a two-country model for output, labour input, government spending and relative prices. Dynamic simulation techniques are then applied, in particular to shed light on the possible effects of fiscal imbalances on the real exchange rate. Using quarterly data over the period 1980-2006, we find that in a majority of cases fiscal shocks are the main driving force of real exchange rate fluctuations.     

Impact of exchange rate movements on exports: An analysis of Indian non-financial sector firms

We explore the real effective exchange rate (REER) effects on the share of exports of Indian non-financial sector firms for the period 2000–2010. Our empirical analysis reveals that, on average, there has been a strong and significant negative impact from currency appreciation and currency volatility on Indian firms' export shares. Labor costs are found to intensify the exchange rate effects on trade. Further, there is evidence that the Indian firms considered here respond asymmetrically to exchange rates. For instance, the REER change effect is more likely to be driven by a negative appreciation effect than a depreciation effect. Also, Indian firms that have smaller export shares tend to have a stronger response to both REER change and volatility. Compared with those exporting goods, firms that export services are more affected by exchange rate fluctuations. The findings, especially those on asymmetric responses, have important policy implications.     

A multinomial logit approach to exchange rate policy classification with an application to growth

We model a country's de jure exchange rate policy as the choice from a multinomial logit response conditioned on the volatility of its bilateral exchange rate, the volatility of its international reserves, and the volatility of its effective exchange rate. The category with the highest predictive probability implied by the logit regressions serves as our de facto exchange rate policy. An empirical investigation into the relationship between the de facto classifications and GDP growth finds that growth is higher under stable currency-value policies. For non-industrialized countries, a more nuanced characterization of exchange rate policy finds that those who exhibit ‘fear of floating’ experience significantly higher growth.     

International price dispersion in state-dependent pricing models

Menu-cost models predict a hump-shaped relationship between real and nominal exchange rate volatility. The hump occurs at higher values of nominal exchange rate volatility, the higher trade costs and lower international substitution elasticities are. These predictions accord well with the negative relationship between relative price and nominal exchange rate volatility I document using a data set of prices collected in Eastern Europe in a volatile environment. In contrast, trade costs must be sufficiently high or international substitution elasticities low in order for the model to account for the positive correlation between real and nominal exchange rate volatility in the aggregate data.     

Political shocks, international reserves and the real exchange rate—The Argentine case

Exogenous shocks to international reserves are introduced as an indicator for exchange rate adjustments. These reserves shocks are identified for Argentina in the 1970s, and they appear to have been induced by political upheavals as well as by changes in the external terms of trade. Granger and modified Sims causality tests indicate that the shocks to reserves did lead the real exchange rate. From the seemingly erratic series of mini and maxi devaluations, a rule of crawling/galloping peg is estimated, with the reserves shocks as significant independent variables that affected the pace of devaluations. The crawling peg, used as an instrument to pursue an international reserves target, was the channel through which changes in the political and economic environment of the country were transmitted to fluctuations of its real exchange rate.     

Real Exchange Rate and External Balance: How Important Are Price Deflators?

This paper contrasts real effective exchange rate (REER) measures based on different deflators (consumer price index, GDP deflator, and unit labor cost) and discusses potential implications for the link—or lack thereof—between the REER and the external balance. We begin by comparing the evolution of different measures of REER to confirm that the choice of deflator plays a significant role in REER movements. A subsequent empirical investigation based on 35 developed and emerging market economies over 1995–2017 yields comprehensive and robust evidence that only the REER deflated by unit labor cost exhibits contemporaneous patterns consistent with the expenditure-switching mechanism. Finally, we show that a standard open-economy model with nominal rigidities and trade in intermediate goods is able to generate these aforementioned patterns.     

How much should inflation targeters care about the exchange rate?

A DSGE model is used to examine whether including the exchange rate in the central bank’s policy rule can improve economic performance. Smoothing the exchange rate helps both financially-robust economies and financially-vulnerable emerging economies in handling risk premium shocks and, given a small weight placed on the exchange rate, the effects on inflation and output volatility are minimal with demand and cost-push shocks. Financially-vulnerable economies are especially likely to benefit from exchange rate smoothing due to perverse movements of the exchange rate they experience when hit by demand shocks and being more prone to risk premium shocks.     

The emerging global financial architecture: Tracing and evaluating new patterns of the trilemma configuration

This paper investigates how the trilemma policy mix affects economic performance in developing countries. We find that greater monetary independence can dampen output volatility, while greater exchange rate stability is associated with greater output volatility, which can be mitigated by reserve accumulation; greater monetary autonomy is associated with higher inflation, while greater exchange rate stability and greater financial openness is linked with lower inflation; pursuit of exchange rate stability can increase output volatility when financial development is at an intermediate stage. Greater financial openness, when accompanied by a high level of financial development, reduces output volatility.