Real exchange rates and real interest rate differentials: A present value interpretation

Although the real exchange rate-real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral US real exchange rate data spanning the period 1978-2007. Instead of testing one particular model, we build on Campbell and Shiller [1987. Cointegration tests of present-value models. Journal of Political Economy 95, 1062-1088] to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.     

On the relevance of exchange rate regimes for stabilization policy

This paper assesses the relevance of the exchange rate regime for stabilization policy. Using both fiscal and monetary policy, we conclude that the exchange rate regime is irrelevant. This is the case independently of the severity of price rigidities, independently of asymmetries across countries in shocks and transmission mechanisms. The only relevant conditions are on the mobility of labor and financial assets. The results can be summarized with the claim that every currency area is an optimal currency area. However, with labor mobility or tradable state-contingent assets, additional policy instruments would be required to establish the irrelevance result.     

Financial constraints,firm entry,and exchange rate pass-through

Using a heterogeneous firm model with firm entry and endogenous markups, I study how the financial constraints of exporting firms affect exchange rate pass-through behaviors. I find that the financial constraints increase the degree of exchange rate pass-through.     

Nonlinear dynamics in exchange rate deviations from the monetary fundamentals: An empirical study

This paper reexamines empirical performance of the monetary exchange rate model with nonlinear dynamics of exchange rate deviation from the monetary fundamentals. First, we apply unit root test of Park and Shintani (2005) to post-Bretton Woods exchange rate data and able to reject the null of unit root deviation from monetary fundamentals against alternative hypothesis of nonlinear stationary process for deutschemark, pound, and Swiss franc. Our empirical results find that exchange rates show high degree of mean-reversion with larger deviation and long periods of overvaluation and undervaluation of dollar. We also find empirical evidence of predictability of the monetary fundamentals at longer horizons.     

Real wage cyclicality in urban China

This paper investigates the cyclical behaviour of real wages in urban China. We find wage pro-cyclicality in the public sector and in small/medium firms, but not in the private sector and in big firms.     

Monetary policy and exchange rate dynamics in the Spanish economy

As the Spanish economy gets more integrated in international markets, the real exchange rate becomes a key determinant of the monetary transmission. In this paper we trace out the dynamic response of prices, output and the exchange rate following a monetary policy shock. We estimate a structural VAR model whose identification scheme is based on the long run properties common to a large class of models. The results suggest that a small model with efficient asset markets plus nominal inertia and long run monetary neutrality, captures the essential features of the monetary transmission mechanism in Spain. The interest rate shock is well identified and the exchange rate overshoots its long run value. There are no signs of liquidity puzzle nor of price puzzle or exchange rate puzzle either.     

Does the Euro follow the German Mark? Evidence from the monetary model of the exchange rate

This paper investigates whether German or synthetic European pre-EMU data provides the appropriate empirical basis for evaluating Euro/Dollar exchange rate behavior. Monetary exchange rate equations are estimated for both data sets over the pre-EMU period, and out-of-sample forecasts are evaluated to assess their ability to explain the Euro/Dollar exchange rate from 1999 to 2004. While forecast accuracy tests confirm the usefulness of synthetic European data for Euro exchange rate analysis, forecasts based on the German pre-EMU experience cannot even beat a random walk. Our results indicate that the Euro does not simply follow the German Mark, but that it has its origins in the other pre-EMU currencies as well.     

Revisiting the exchange rate disconnect puzzle

One of the major anomalies in International Macroeconomics is the persistent finding that the exchange rate has no empirical relationship with a variety of macroeconomic fundamentals. Dubbed the ‘exchange rate disconnect puzzle’, this article examines this issue for five Australian dollar bilateral exchange rates, using quarterly data for the period 1984:1–2015:4. A novel feature of this article is that it departs from the extant literature by using a different approach to testing for cointegration. The results show that the exchange rates and fundamentals move together in the long run. Furthermore, the results show that fundamentals Granger cause exchange rates, both in the short run and the long run.     

Minimum wage, exports and growth

Using an endogenous growth model in an open economy, we study the impact of minimum wages on growth for an innovator country. We state that a minimum wage shifts efforts from production to R&D, but only in an open economy. Thus, it speeds up long-run growth in proportional to exports. Calibrations suggest the growth surplus can be significant. An empirical study on 11 OECD countries illustrates these results. The impact on welfare is ambiguous because the minimum wage induces unemployment. However, we show that in an open economy, a minimum wage associated with unemployment benefits can Pareto dominate laissez-faire.     

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.     

Differences in exchange rate pass-through in the euro area

This paper focuses on the pass-through of exchange rate changes into the prices of imports made by euro area countries originating outside the area. Using data on import unit values for 13 different product categories for each country, we estimate industry-specific rates of pass-through across and within countries for all euro members. In the short-run, pass-through rates differ across industries and countries and are less than one. In the long-run neither full pass-through nor equality of pass-through rates across industries and countries can be rejected. Differences exist across euro area countries in the degree that a common exchange rate movement gets transmitted into consumer prices and costs of production indices. Most of these differences in transmission rates are due to the distinct degree of openness of each country to non-euro area imports rather than to the heterogeneity in the structure of imports.     

The dynamics of a complex system: The exchange rate crisis in Southeast Asia

We investigate the dynamics of the exchange rate market just after and prior to the 1997 crisis. The return of the exchange rate is well characterized by a power law, with the relaxation exponent to vary significantly across countries.     

Central bank secrecy in the foreign exchange market

This paper argues that with sticky goods prices and a forward-looking exchange rate, the central bank will only want a partial dissemination of its information about shocks to the economy. It is shown that, in such a model, the central bank may prefer to intervene secretly in the foreign exchange markets when responding in anticipation of future shocks, but openly when reacting to current shocks. The model thus provides a rationale for secrecy in central bank foreign exchange operations. The model also elucidates the relationship between the signaling and portfolio balance channels of sterilized intervention.     

Relative importance of sticky prices and sticky information in price setting

The relative importance of price and information stickiness in price setting to model and explain inflation dynamics is investigated in this study. A structural model of inflation is developed and used which combines two different models of price setting behavior: the sticky price model of the New Keynesian literature and the sticky information model of Mankiw and Reis. In a framework similar to the Calvo model, I assume that there are two types of firms. One type of firm chooses its prices optimally through forward-looking behavior—as assumed in the sticky price model. It uses all available information when deciding on prices. The other type of firm sets its prices under the constraint that the information it uses is “sticky”—as assumed in the sticky information model. It collects and processes the information necessary to choose its optimal prices with a delay. This leads to the sticky price–sticky information (SP/SI) Phillips curve that nests the standard sticky price and sticky information models. Estimations of this structural model show that both sticky price and sticky information models are statistically and quantitatively important for price setting. However, the sticky price firms make up the majority of the firms in the economy. The results are robust to alternative sub-samples and estimation methods.     

The effect of firm-level productivity on exchange rate pass-through

A heterogeneous-firm trade model can explain the recent decrease in exchange rate pass-through to aggregate US import prices as a result of decreased trade costs. This paper finds support for this explanation by testing another implication of this type of heterogeneous firm model: lower exchange rate pass-through for goods that are traded for short periods of time.     

Real exchange rate fluctuations,wage stickiness and tradability

When we classify factors of production by their tradability, the relative wage of nontraded labour influences the real exchange rate through the relative cost of distribution services. We confirm this prediction using monthly data on the sector‐level US–Canada real exchange rate and the relative wage of service‐producing labour. The relative wage accounts for 40% of the variability of the real exchange rate at a one‐month horizon. Furthermore, when we use the effective nontraded labour content to classify goods into nontraded and traded ones, the variability of the price of the nontraded‐goods basket accounts for more than half of the variability of the real exchange rate.     

The impact of exchange rate volatility on plant-level investment: Evidence from Colombia

We estimate the impact of exchange rate volatility on firms' investment decisions in a developing country setting. Employing plant-level panel data from the Colombian Manufacturing Census, we estimate a dynamic investment equation using the system-GMM estimator developed by Arellano and Bover (1995) and Blundell and Bond (1998). We find a robust negative impact of exchange rate volatility, constructed either using a GARCH model or a simple standard deviation measure, on plant investment. Consistent with theory, we also document that the negative effect is mitigated for establishments with higher mark-up or exports, and exacerbated for lower mark-up plants with larger volume of imported intermediates.     

Revisiting the interest rate–exchange rate nexus: a Markov-switching approach

In this paper the interest rate–exchange rate nexus and the effectiveness of an interest rate defense are investigated empirically. I present a reduced form evidence which characterizes the empirical relationship between interest rates and exchange rates. I use a Markov-switching specification of the nominal exchange rate with time-varying transition probabilities. Empirical evidence from six developing countries: Indonesia, South Korea, the Philippines, Thailand, Mexico, and Turkey indicates that raising nominal interest rates leads to a higher probability of switching to a crisis regime. Thus, the empirical results presented here may support the view that a high interest rate policy is unable to defend the exchange rate. Unlike other studies which consider linear models only, my findings are robust and consistent over different countries and crisis episodes (Asian 1997 crises, Mexico 1994 crisis, and Turkey 1994, 2001 crises). In order to explain the empirical findings, I construct a simple theoretical model by incorporating an interest rate rule in the model proposed by Jeanne and Rose (2002) [Jeanne, O., Rose, A.K., 2002. Noise trading and exchange rate regimes, Quarterly Journal of Economics. 117 (2) 537–569]. The model has multiple equilibria, and under plausible conditions, higher exchange rate volatility is associated with higher interest rates.     

Deforestation and the real exchange rate

Deforestation is a phenomenon that has largely been concentrated in the developing world. We construct a theoretical model of deforestation that focuses on the factors affecting the incentives to transform forested land into agricultural land. We show that: (i) lower discount rates and stronger institutions decrease deforestation; (ii) a depreciation in the real exchange rate increases deforestation in developing countries whereas the opposite obtains in developed countries; (iii) paradoxically, better institutions may exacerbate the deleterious impact of a depreciation in developing countries. These hypotheses are tested on an annual sample of 101 countries over the 1961–1988 period, and are not rejected by the data. Our results suggest that short-term macroeconomic policy, institutional factors, and the interaction between the two, are potentially important determinants of environmental outcomes.     

Sources of exchange rate fluctuations with Taylor rule fundamentals

This paper investigates the sources of exchange rate fluctuations when monetary policy follows a Taylor rule interest rate reaction function. We first present a simple dynamic exchange rate model with Taylor rule fundamentals which is triangular in the long-run impacts of shocks to the output market, the interest rate differential, and the Taylor rule. We then proceed to assess the relative importance of various shocks in exchange rate determination by estimating a structural VAR with long-run identification restrictions based on the triangular structure of the model. We find demand shocks to be less important than in earlier VAR studies, with both supply shocks and nominal shocks explaining a substantial part of real exchange rate fluctuations.