CURRENCY BOARD ARRANGEMENTS AS A SUPER‐FIXED ALTERNATIVE IN THE CHOICE OF EXCHANGE RATE REGIME1

Currency board arrangements (CBAs) are currently widely proposed as a super‐fixed exchange rate solution to exchange rate volatility. This paper researches the nature, operation, benefits and disadvantages of CBAs. Benefits comprise improved policy credibility, lower inflation and interest rate levels, increased economic growth, increased foreign capital flows, and sharply reduced currency speculation. These are compared with the shortcomings of CBAs, such as the absence of a lender of last resort, real exchange rate misalignments and their consequences for the economy. The paper identifies the type of country that would be the most likely candidate to benefit from a CBA.     

World-consistent equilibrium exchange rates

This paper proposes a systematic analysis of the problem of world consistency when deriving equilibrium exchange rates. World inconsistency can arise for two reasons. First, real effective misalignments of currencies out of the considered sample are implicitly assumed to be the mirror image of those of the currencies under review. Second, only N − 1 independent bilateral equilibrium exchange rates can be derived from a set of N effective rates. Here we measure the extent of these two problems by estimating equilibrium exchange rates for 15 countries of the G20 in effective as well as bilateral terms and by varying the assumptions concerning the rest of the world (RoW) and the numeraire currency. Our results show that the way the rest of the world is tackled has a major impact on the calculation of effective misalignments and especially bilateral misalignments.     

Currency Misalignments in the BRIICS Countries: Fixed Vs. Floating Exchange Rates

In the present paper we attempt to investigate whether the real effective exchange rates of the BRIICS countries, namely Brazil, Russia, India, Indonesia, China and South Africa, converge or not to their equilibrium levels. Our analysis is based on the use of an external balance model as well as the implementation of recent panel cointegration techniques. Our evidence indicates the existence of a valid long-run relationship between the real effective exchange rate, the net foreign assets, the GDP differential and the real interest rate differential for each of the six countries of our sample. Furthermore, our empirical results imply that after the adoption of a free floating exchange rate regime by Brazil, Russia, India, Indonesia and South Africa and the liberalisation of the Chinese exchange rate policy that took place during the last decade, currency misalignments have been gradually reduced, leading the real effective exchange rates of the respective currencies very close to their equilibrium levels.     

Learning about fundamentals: The widening of the French ERM bands in 1993

Learning about Fundamentals: The Widening of the French ERM Bands in 1993. — The authors incorporate a Bayesian learning model into a fairly general model of exchange rate determination in discrete time. The model is applied to the period following the widening of the French-German ERM bands in August 1993, in which a systematic underprediction of the franc can be observed until February 1994. A (substantial) part of these forecast errors can be mimicked by a Bayesian learning process. Simulations with our model show that, after the widening of the bands, agents, contrary to their initial expectations, gradually learned that the true process driving monetary conditions in France had not changed notably.     

Leading Indicators of Currency Crises: Are They the Same in Different Exchange Rate Regimes?

We investigate whether leading indicators of currency crises differ across exchange rate regimes using data for 88 countries in the period 1981–2010. Our estimates suggest that in fixed exchange rate regimes external indicators, such as deviations of the real exchange rate from trend and the growth of international reserves, have the strongest predictive power. In contrast, in floating exchange rate regimes monetary policy and credibility indicators, such as domestic credit growth and inflation, are the best leading indicators of currency crises. Both credibility and external economic indicators have predictive power in intermediate exchange rate regimes.     

Estimating the equilibrium exchange rate of the Central and Eastern European acceding countries: The challenge of euro adoption

This study estimates the equilibrium real and nominal exchange rates for five Central and Eastern European (CEE) countries. A new approach is adopted, which combines the fundamental equilibrium exchange rate (FEER) with the behavioural equilibrium exchange rate (BEER) methodology. In a VAR-based 3-equation cointegration system, we estimate structural equations for internal and external balances and link them to the real exchange rate. The estimated misalignment is used to derive equilibrium nominal exchange rates. The sustainability of an ERM-II-type exchange rate regime is investigated on ex post data, and the credibility problem of fixing the currencies of CEE countries vis-à-vis the single European currency is analysed. JEL no. E31, F31, O11, P17     

Monetary policy and EMU enlargement: Issues regarding ERM II and adoption of the euro in Estonia

The aim of the paper is to give an overview of the issues related to Estonia's entry into ERM II. For that purpose the article describes the official position of the Estonian authorities regarding entry into ERM II and the adoption of the euro, explains the rationale for early entry into ERM II, and presents the reasons for maintaining the currency board arrangement until full membership in EMU. Also, the challenges of the adoption of the euro are discussed. The article concludes that early entry into ERM II is appropriate as the perceived costs—short-term costs of fiscal consolidation and the cost of giving up independent monetary policy and flexible exchange rates as stabilization tools—are practically non-existent in Estonia. The paper argues that the high level of exchange rate stability and nominal convergence, relatively high flexibility of the economy, and integration with the euro area support the rationale for maintaining the currency board arrangement and adopting the euro early.     

What Caused the Korean Currency Crisis in 1997?*: Weak Fundamentals or Self‐fulfilling Expectations*

The present paper investigates which factor is primarily responsible for the sharp depreciation of the Korean won against the US dollar in 1997, using a bivariate vector autoregressive model of real and nominal exchange rates. In the present study, we directly identify the relative importance of fundamental and non‐fundamental factors from the raw data series on exchange rates. This approach is different from most previous studies on the Korean currency crisis, which use proxy variables to represent the two factors. The empirical results show that the collapse of the Korean currency in 1997 appears to be mostly a result of the weakened macroeconomic fundamentals of the economy with, to a limited extent, some non‐fundamental factors.     

Simple credibility tests of the ERM bands for the pound sterling and the Italian lira

This article presents evidence that the European Monetary System (EMS) bands for the Italian lira and the pound sterling were not credible for most of the period 1990–1992, and especially during the week prior to their withdrawal from the EMS system. Using a simple test, developed by Svensson, domestic interest rates for both Italy and the United Kingdom have been found to be mostly outside the rate-of-return bands implied by the official arrangements of the EMS target zone system. Furthermore, comparing implied forward rates for various maturities with the official EMS bands of both currencies, we again found that the followed monetary policies in both countries were not in general consistent with those needed to maintain an orderly functioning of the (EMS) system. The Svensson test can further be used as an indicator of potential speculative attacks on an EMS currency, and, in turn, as a signal of an emerging need to adjust the corresponding country's monetary policy.     

THE IMPACT OF EXCHANGE RATE MOVEMENTS ON FOREIGN DIRECT INVESTMENT: MARKET‐ORIENTED VERSUS COST‐ORIENTED

This paper examines the impact of exchange rate movements on foreign direct investment (FDI). We first employ a real options model to show that while the depreciation of a host country's currency tends to stimulate FDI activity of cost‐oriented firms, the depreciation tends to deter FDI activity for market‐oriented firms. With industry panel data on Taiwan's outward FDI into China over the period 1991–2002, our empirical findings indicate that the exchange rate level and its volatility in addition to the relative wage rate have had a significant impact on Taiwanese firms’ outward FDI into China. In general, the empirical results are consistent with the prediction of the theory. Our results reveal that the relationship between exchange rates and FDI is crucially dependent on the motives of the investing firms. Without considering this fact in an empirical model, the testing results might suffer from aggregations bias.     

A PANEL DATA APPROACH TO THE BEHAVIOURAL EQUILIBRIUM EXCHANGE RATE OF THE ZAR

The question of currency over- or undervaluation is often asked and implies the existence of an equilibrium exchange rate (EER). The aim of this research was to determine the long-term EER of the South African rand using the behavioural equilibrium exchange rate (BEER) methodology. This paper used a panel of data from South Africa's main trading partners to estimate the relationship between the EER and its fundamental determinants using dynamic ordinary least squares (OLS) and fully modified OLS. The average coefficients obtained describe the long-term behaviour of the individual countries' real exchange rates. Substituting the observed fundamental time series into the estimated equation derives the EER for each country and over- and undervaluation can be determined. The results indicated that the fundamental value of the exchange rate was driven by economic growth, the openness of the economy, its foreign reserves, the real gold price and capital expenditure. The exchange rate also fluctuated considerably around its equilibrium level but there is not long sustained periods of over- and undervaluation.     

The political economy of the Exchange Rate Mechanism

The apparent tendency of ERM countries other than Germany to experience high real exchange rates and to subsidize manufacturing is explained by a rational expectations model in which there is optimally asymmetric policy reaction to good and bad times—devaluation in bad, no revaluation in good. The resulting expected depreciation (at all times) causes inflation in normal and good times to be less than expected inflation, raising real wages and the real exchange rate, and creating pressures for subsidy of the traded sector.     

The misalignments in Chinese real effective exchange rate from 1994 to 2020: A counterfactual analysis

Using a novel panel data method proposed by Hisao, Ching and Wan (2012), we empirically evaluate the misalignments between the actual and counterfactual values of Chinese real effective exchange rate (REER, CPI-based) from 1994 to 2020, where “counterfactual” refers to the counterfactual scenarios that some major economic events had not happened. These events include China's accession to WTO from December 2001, the reforms of exchange rate regime in July 2005, June 2010 and August 2015, China's economic stimulus package in November 2008, and the US-China trade dispute started from March 2018. We calculate the counterfactual values for both real and nominal effective exchange rates (REER and NEER) in order to examine the channels of the misalignments. We find that the reform of China's exchange rate policy in July 2005 and August 2015 increased Renminbi's trade competitiveness in real term compare to foreign currencies, while other events decreased it or had no effects. The misalignments in REER are caused by the changes in both NEER and China's CPI.     

The lira and the pound in the 1992 currency crisis: Fundamentals or speculation?

The prevalent explanation of the Exchange Rate Mechanism (ERM) currency crisis of September, 1992 is that myopic speculation prevailed over the “fundamentals.” Our paper explores the reasons why the Italian lira and the U.K. pound were attacked and, subsequently, forced out of the ERM. The crisis was sparked by a common awareness that political unification and the commitment to monetary union had petered out in the summer of 1992, leaving the field open to speculators to pick countries with the weakest fundamentals (Italy) or with policy makers who feared jeopardizing an economic recovery by keeping the currency in the ERM (the U.K.).     

Exchange rate policy and export performance in a landlocked developing country: The case of Nepal

This paper examines the implications of Nepal's exchange rate policy for its export performance over the period 1980–2010. We first document Nepal's long-standing currency peg against the Indian rupee and that Nepal's real exchange rate appreciated substantially from the late 1990s. We then employ a gravity modeling approach to confirm that this real exchange rate appreciation has adversely affected Nepal's exports, especially to third-country markets. Nepal's exchange rate-related export competitiveness trap provides a motivation to reconsider the current peg.     

EXCHANGE RATES AND EMPLOYMENT

The analysis of exchange rates and employment has received scant attention in development economics. This is surprising, since there appears to be a number of well-defined transmission channels through which exchange rates impact on employment. In South Africa this is particularly important given the rand's higher volatility relative to other emerging economies. The main focus of this paper is to give an overview of the transmission channels through which exchange rates affect employment and to discuss the standard methodological approach to conceptualising the impact of exchange rates on employment. Given the sector-specific impact of exchange rates which are conditioned by industry characteristics, such as the degree of external orientation, there will always be winners and losers in the face of a currency shock. This means the full impact of exchange rates on employment can only be dealt with in an economy-wide framework. Results from a computable general equilibrium (CGE) model are presented to demonstrate that even in a country with unreliable employment data such as South Africa, one can still analyse exchange rate and employment issues.     

Exchange-rate policy in East Asia after the fall: how much have things changed?

This paper evaluates the changes in the exchange-rate policies of East Asian economies in the aftermath of the currency crisis and the process in which the exchange-market stability was re-established. The empirical analysis evaluates the changing roles of the yen and the US dollar in the currency baskets, the shifts in the volatility of the underlying macroeconomic fundamentals and their implications on exchange-rate management, the exchange-market perception of credibility and risk of the postcrisis exchange-rate regimes, and the process of reversion to fundamental values after the massive currency depreciation.The analysis shows that after the abandonment of the quasi-dollar peg, the yen had gained a greater weight in the currency baskets and the greater flexibility in which the exchange rates are being managed serve to accommodate the greater volatility in the macroeconomic fundamentals. The improvement in the macroeconomic conditions and the greater credibility that has been acquired by the regional monetary authorities had allowed the exchange market to stabilize and enabled the exchange rates to revert back to their fundamental values.     

SHORT‐RUN AND LONG‐RUN DETERMINANTS OF THE REAL EXCHANGE RATE IN MEXICO

This paper explores the real exchange rate behavior in Mexico from 1960 until 2005. Since the empirical analysis reveals that the real exchange rate is not mean reverting, we propose that economic fundamental variables affect its evolution in the long run. Therefore, based on equilibrium exchange rate paradigms, we propose a simple model of real exchange rate determination, which includes the relative GDP per capita, the real interest rates, and the net foreign assets over a long period of time. Our analysis also considers the dynamic adjustment in response to shocks through impulse response functions derived from the multivariate vector autoregressive (VAR) model.     

The Yen,the US dollar,and the trade weighted basket of currencies: Does the choice of anchor currencies matter in identifying incidences of speculative attacks?

Early constructions of a single crisis index known as the exchange market pressure (EMP) index have largely been based on the fluctuations of the real or nominal exchange rate of a currency against the US dollar—the most commonly accepted anchor currency in the global market. Hardly any studies have however tested the sensitivity of this crisis index to the choice of different “anchor” currencies. To address this pertinent issue, our study considers the EMP indices of the Indonesian rupiah, Malaysian ringgit and Thailand baht constructed by adopting three different exchange rates—the real effective rate, the local currency against the US dollar, and the local currency against the Japanese yen for the period of 1985–2003. The test results indicate that the reported incidences of speculative attacks are highly sensitive to the choice of anchor currencies.     

The impact of real exchange rate movements on firm performance: A case study of Taiwanese manufacturing firms

Taiwan experienced large depreciations of its currency, the New Taiwan (NT) dollar, in the late 1990s. The largest real depreciation, 13 per cent, occurred during the East Asian Financial Crisis. Since Taiwan was subjected neither to the economic turmoil of the crisis itself nor to the subsequent reforms, its experience provides a good opportunity for studying the effects of exchange rate changes on firm performance. This paper empirically examines the exchange rate effects on firm exports, domestic sales, total sales, value-added and productivity, by using data on firms listed on the Taiwan Stock Exchange merged with customs trade data covering the period of 1992–2000. Our findings indicate that the real depreciation of the NT dollar led to an increase in exports, domestic sales, total sales, value-added, and productivity. In addition, we find that the productivity improvement induced by real currency depreciation may be a result of firm scale expansion.