Structural breaks in volatility: Evidence for the OECD and non-OECD real exchange rates

This paper attempts to determine whether or not nominal exchange rate regimes affect the volatility of bilateral and effective real exchange rates. To that end, we examine the real exchange rate behaviour for a set of OECD and non-OECD countries during the 1960–2006 period, therefore covering both the Bretton Woods system of fixed exchange rates and the adoption of generalised floating exchange rates from 1973. We make use of an econometric methodology based on the Hansen's (Hansen, B.E., 1997. Approximate asymptotic P values for structural-change tests. Journal of Business and Economic Statistics 15 (1), 60–67) approximation to the p-values of the supreme, exponential and average statistics developed by Andrews (Andrews, D., 1993. Test for parameter instability and structural change with unknown change point. Econometrica 61 (4), 821–856) and Andrews and Ploberger (Andrews, D., Ploberger, W., 1994. Optimal tests when a nuisance parameter is present only under the alternative. Econometrica 62 (6), 1383–1414). This methodology allows us to obtain a profile of p-values and to delimit periods of stability and instability in the variance of real exchange rates. Results suggest that there is clear evidence in favour of the non-neutrality of nominal exchange rate regime regarding real exchange rate volatility for developed countries, but not in the case of developing or emerging countries.     

Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries

This paper analyzes how exchange rate policy affects the issuance and pricing of sovereign bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher spreads and are less likely to issue bonds. Changing a free‐floating regime to a fixed regime decreases the likelihood of bond issuance by 5.5% and increases the spread by 88 basis points on average. Countries with real overvaluation have higher spreads and higher bond issuance probabilities. The effects of real overvaluation on sovereign bonds tend to be magnified for countries with fixed exchange rate regimes.     

Is exchange rate risk priced in microfinance?

High microcredit interest rates have often been a source of criticism against the microfinance movement. Research has focused attention on the cost structure of interest rates and more recently on the macroeconomic and macro-institutional factors. While cost structure is probably the most important determinant of interest rates, other factors can also matter. This paper uses an innovative measure of foreign exchange risk to explore its impact on microcredit interest rates. We show that microfinance institutions that operate in countries with fixed exchange rate regimes tend to charge lower interest rates than those operating in countries with floating exchange rate regimes.     

Three‐Regime Asymmetric STAR Modeling and Exchange Rate Reversion

The breakdown of the Bretton Woods system and the adoption of generalized floating exchange rates ushered in a new era of exchange rate volatility and uncertainty. This increased volatility leads economists to search for economic models able to describe observed exchange rate behavior. In the present paper, we propose more general STAR transition functions that encompass both threshold nonlinearity and asymmetric effects. Our framework allows for a gradual adjustment from one regime to another and considers threshold effects by encompassing other existing models, such as TAR models. We apply our methodology to three different exchange rate data sets: one for developing countries and official nominal exchange rates, the second for emerging market economies using black market exchange rates, and the third for OECD economies.     

Fear of floating in Asia and the credibility of true floaters?

Quite often, countries commit to free floating exchange rate (ER) regimes but do not allow their ERs to float freely, exhibiting a fear of floating. We revisit ER regimes in Asia following the work of Calvo and Reinhart (2002), and also develop a new flexibility index based on probabilities gauging interventions in FX market. In light of our findings, we cannot disregard the existence of fear of floating in Asia, and find that economies widely known as truly floating economies exhibit this fear too. Further, the results validate our concerns regarding the IMF’s methodology of regime classification intermingling credible inflation targeting with fear of floating.     

Exchange rate regimes and FDI in developing countries: A propensity score matching approach

Theory suggests that regimes of relatively fixed exchange rates encourage inward foreign direct investment (FDI) relative to regimes of more flexible exchange rates. We use propensity score matching (PSM) to investigate the relationship between the exchange rate regimes of 70 developing countries and FDI into such countries using de facto regime classifications. We include a large number of variables in the logit equation that estimates the propensity score, the probability of regime choice. We also use general-to-specific modeling to get alternative, parsimonious versions. Based on four matching procedures, the average treatment effects suggest, with overall modest statistical significance, that relatively fixed de facto regimes do encourage FDI compared with relatively floating regimes. In addition, the estimated effects are sometimes economically large.     

Are There Optimal Multiple-Reserve Requirements?

A number of developing countries have adopted deficit finance regimes involving multiple- (currency and bond) reserve requirements. A key characteristic of these regimes is that the real interest rates on reservable bonds are higher than the real return rates on currency, so that the nominal interest rates on the bonds are positive. We seek an efficiency-based explanation for the existence of multiple-reserve regimes and for this key characteristic. We find that there are economies in which some of the efficient allocations can be supported only by multiple-reserve requirements, and that positive nominal bond rates may be needed to support some of these allocations. We also find that there are economies in which allocations supported by multiple-reserve regimes with negative nominal bond rates Pareto dominate single-reserve allocations, even when the latter are efficient relative to other single-reserve allocations. Journal of Economic Literature Classification Numbers: E42, E58, H62.     

Exchange rate pass-through in EMU acceding countries: Empirical analysis and policy implications

Countries that joined the European Union in 2004 have to decide when to adopt the Euro. This decision depends on the evaluation of the relative costs and benefits associated with giving up the exchange rate instrument. Recent empirical work on several new EU members has questioned the role of the exchange rate as a shock absorber, thus downplaying the potential costs in terms of macroeconomic stabilization. In this paper, we address the issue from a different perspective, emphasizing the role of pass-through from exchange rate to domestic inflation in new EU members. The focus is on four countries (Czech Republic, Hungary, Poland and Slovenia – NM-4) that have adopted some form of floating or managed exchange rate regimes. The paper reports empirical results indicating high pass-through coefficients and links them to the degree of policy accommodation. High exchange rate pass-through in NM-4 indicates that stabilization of nominal exchange rates would lower inflationary pressures and help fulfill criteria to enter the EMU.     

Dynamic efficiency of stock markets and exchange rates

We use generalized Hurst exponents to investigate long-range dependence across countries that have implemented an inflation targeting monetary policy regime and have a floating currency regime. We show that the degree of long-range dependence has changed after the 2008 crisis for equity markets but not as much for exchange rate markets. We compare results for developed and emerging economies and find that there still are some important differences but not as they were before the crisis. We also include an additional set of relevant countries and find that our results are more pronounced for inflation targeters. We discuss several implications of these results.     

De facto exchange rate regimes and currency crises: Are pegged regimes with capital account liberalization really more prone to speculative attacks?

This paper empirically examines whether de facto exchange rate regimes affect the occurrence of currency crises in 84 countries over the 1980–2001 period by using the probit model. We employ the de facto classification of Reinhart and Rogoff (2004) that allows us to estimate the impact of relatively long-lived exchange rate regimes on currency crises with much greater precision. We find that pegged regimes significantly decrease the likelihood of currency crises compared with floating regimes. By using the combined data of exchange rate regimes and the existence of capital controls, we also find interesting evidence that pegged regimes with capital account liberalization significantly lower the likelihood of currency crises compared with other regimes. These results are robust to a wide variety of samples and models. From the standpoint of the macroeconomic policy trilemma, we can conjecture that pegged regimes with capital account liberalization are substantially less prone to speculative attacks because they can enhance greater credibility in their currencies by abandoning monetary policy autonomy.     

Choice of exchange rate system and macroeconomic volatility of three Asian emerging economies

This study highlights the importance of choice of exchange rate system to macroeconomic stability of small-open emerging economies based on the outcomes of the recent exchange rate regime switches of three Asian countries – Indonesia, Malaysia, and Thailand. These countries have high similarities in their economic structures, but have reacted very differently in mitigating the economic distortion of the 1997 financial crisis, in particular in the adoption of exchange rate system. The empirical results of this study show that the amplified instability of macro-variables in Thailand and Indonesia, which was due to the crisis, were not stabilized by switching the exchange rate system to a flexible regime. The volatilities, however, were effectively stabilized after the countries made the second switch – from the independent float to the managed float with no pre-announcement. For Malaysia, a switch from the managed float to the pegged system successfully reduced the volatilities. The exchange rate misalignments of the countries, except Indonesia, were also reduced when the countries switched from a flexible to a more fixed managed float system. These empirical findings thus strongly support central banks of small-open emerging economies to adopt a more fixed, rather than a more flexible system. However, the managed float system needs to couple with efficient management to ensure a smooth and stable regime.     

Deviations from purchasing power parity under different exchange rate regimes: Do they revert and,if so,how?

We propose an empirical model for deviations from long-run purchasing power parity (PPP) that simultaneously accounts for three key features: (i) adjustment toward PPP may occur via nominal exchange rates and relative prices at different speeds; (ii) different exchange rate regimes may generate regime shifts in the structural dynamics of PPP deviations; (iii) nonlinear reversion toward PPP in response to shocks. This empirical framework encompasses and synthesizes much previous empirical research. Using over a century of data for the G5 countries, we provide evidence that long-run PPP holds, the relative importance of nominal exchange rates and prices in restoring PPP varies over time and across different exchange rate regimes, and reversion to PPP occurs nonlinearly, at a speed that is fairly consistent with the nominal rigidities suggested by conventional open economy models.     

中间汇率制度安排的理论沿革与中国实践借鉴

汇率目标区理论和有管理的浮动制度理论作为两种主要的中间汇率制度理论,各有其优缺点。国际汇率制度的演变并未明显地呈现出汇率制度的选择收敛于两极制度,中间汇率制度仍将继续构成未来实际汇率制度的重要组成部分。一国汇率制度的选择只能按照严谨的成本收益分析,根据本国的经济结构和经济特点,与其他国家的政治博弈能力,以及其他影响汇率制度选择的主导性因素,选择成本最小而又最适合本国实情的汇率制度。在中国金融渐进开放过程中,人民币汇率制度的变革趋势应是选择符合中国实情的中间汇率制度,同时要逐渐扩大人民币汇率浮动幅度。     

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.     

Exchange rate regimes and prices: The cases of Italy,Spain and the United Kingdom (1874–1998)

This paper studies the relationship among Italian, Spanish and United Kingdom prices over the period 1874–1998, for most of which the currencies of these three countries maintained a floating exchange rate regime. By using cointegration techniques with broken linear trends, we find a single vector for the period 1874–1935 and two vectors and, consequently, a single common trend for the period 1940–1998. Therefore, this paper provides new evidence of no long-run monetary independence under floating regimes. Furthermore, the price differential dynamics captured by deterministic trends in the period 1940–1998, as well as agreeing with the evidence of long-run transmission of interest rates in the floating post-Bretton Woods era, fit in perfectly with the new de facto taxonomies on exchange rates.     

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.     

The forward market in emerging currencies: Less biased than in major currencies

Many studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But, at least until recently, those studies applied only to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.     

Inflation risk and international asset returns

We show that inflation risk is priced in international asset returns. We analyze inflation risk in a framework that encompasses the International Capital Asset Pricing Model (ICAPM) of Adler and Dumas (1983). In contrast to the extant empirical literature on the ICAPM, we relax the assumption that inflation rates are constant. We estimate and test a conditional version of the model for the G5 countries (France, Germany, Japan, the UK, and the US) over the period 1975–1998 and find evidence of statistically and economically significant prices of inflation risk (in addition to priced nominal exchange rate risk). Our results imply a rejection of the restrictions imposed by the ICAPM. In an extension of our analysis to 2003, we show that even after the termination of nominal exchange rate fluctuations in the euro area in 1999, differences in inflation rates across countries entail non-trivial real exchange rate risk premia.     

International financial integration and national price levels: The role of the exchange rate regime

This paper proposes a new perspective on systematic deviations from purchasing power parity. Panel evidence for OECD countries shows that international financial integration increases the national price level under managed exchange rate regimes and lowers the price level under floating exchange rates. An open economy sticky-price model reproduces these findings by relating them to the possibility of insurance against consumption losses in internationally integrated financial markets. The utilization of insurance is reflected by relative price adjustments which manifest themselves in changes of the national price level. The direction of relative price adjustments, however, depends on the extent to which insurance is used under different exchange rate regimes: under a peg, financial integration raises the national price level; under a float, however, financial integration lowers the national price level.     

Real exchanges rates in commodity producing countries: A reappraisal

Commodity price booms, as those recorded in the last decade, may have a significant economic impact in small, commodity exporting, developing countries. Whether the impact on output is positive or negative is still unclear. It depends on various factors, notably on the impact that commodity prices can have on the real exchange rate of the commodity exporting countries. Two recent papers show that the real exchange rate appreciates when commodity prices increase. Our analysis produces new estimates of this relationship by focusing on a large sample of developing countries which are specialized in the export of one leading commodity. By using non-stationary panel techniques robust to cross-sectional dependence, we find that the price of the dominant commodity has a significant long-run impact on the real exchange rate when the exports of the leading commodity have a share of at least 20 percent in the country's total exports of merchandises. Our results also show that the larger this share, the larger the size of the impact.