Home bias, distribution services and determinants of real exchange rates

This paper examines empirically how exogenous changes in the terms of trade affect the real exchange rate through the relative price of traded goods with Canada–US data. The relative price of traded goods is constructed using prices at the dock and retail prices. The first measure emphasizes the importance of home bias in consumption of traded goods. The second measure highlights the importance of distribution services required for consumption of traded goods. It is found that terms of trade shocks affect the relative price of traded goods using both measures. A possible interpretation of empirical findings is that home bias and distribution services are important for understanding the relative price of traded goods.     

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.     

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.     

Nonlinear adjustment of the real exchange rate towards its equilibrium value: A panel smooth transition error correction modelling

We study the nonlinear dynamics of the real exchange rate towards its behavioral equilibrium value (BEER) using a Panel Smooth Transition Regression model framework. We show that the real exchange rate convergence process in the long-run is characterized by nonlinearities for emerging economies, whereas industrialized countries exhibit a linear pattern. Moreover, there exists an asymmetric behavior of the real exchange rate when facing an over- or an undervaluation of the domestic currency. Finally, our results suggest that the real exchange rate may be unable to unwind alone global imbalances.     

The long-run convergence of exchange rates and prices in the European Union

This paper provides tests of Purchasing Power Parity (PPP) for members of the EU-27 not in the euro area, using multivariate and panel cointegration techniques, for the period since the introduction of the euro currency in 1999 until the end of 2009. The results indicate that long-run PPP holds in ten cases and that domestic prices or the nominal exchange rate is the main driver of the short-run adjustment to stationarity. These results are discussed in terms of monetary convergence in the long-run.     

Monetary shocks,exchange rates and trade balances: Evidence from inflation targeting countries

This paper investigates the relationship among monetary policy shocks, exchange rates and trade balances in five Inflation Targeting Countries (ITCs). The investigation is based on Structural Vector Error Correction Models (SVECMs) with long run and short run restrictions. The findings reveal that a contractionary monetary policy shock leads to a decrease in price level, a decrease in output, an appreciation in exchange rate, and an improvement in trade balance in the very short run. Our findings contradict the findings of price, output, exchange rate and trade puzzles that have been found in many empirical studies. Furthermore they are consistent with the theoretical expectations regarding the effect of a contractionary policy. The only long run restriction that we imposed on our models is that money does not affect real macroeconomic variables in the long run, which is consistent with both Keynesian and monetarist approaches.     

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.     

Flexible exchange rates as shock absorbers

In this paper we analyze empirically the effect of terms of trade shocks on economic performance under alternative exchange rate regimes. We are particularly interested in investigating whether terms of trade disturbances have a smaller effect on growth in countries with a flexible exchange rate arrangement. We also analyze whether negative and positive terms of trade shocks have asymmetric effects on growth, and whether the magnitude of these asymmetries depends on the exchange rate regime. We find evidence suggesting that terms of trade shocks get amplified in countries that have more rigid exchange rate regimes. We also find evidence of an asymmetric response to terms of trade shocks: the output response is larger for negative than for positive shocks. Finally, we find evidence supporting the view that, after controlling for other factors, countries with more flexible exchange rate regimes grow faster than countries with fixed exchange 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.     

Real exchange rates,asset prices and terms of trade: A theoretical analysis

This paper develops a continuous-time two-country dynamic equilibrium model, in which the real exchange rates, asset prices, and terms of trade are jointly determined in the presence of nontradable goods. The model determines the relation between the financial markets and real goods markets in the world economy and their responses to various shocks under the home bias assumption. A positive domestic supply shock induces a positive return on the domestic asset markets and a deterioration of terms of trade that improves the foreign output and boosts the foreign asset markets. Demand shocks act in the opposite way. This model also analyses the impact of change in the relative price of nontradable to tradable goods on the terms of trade and asset markets. A higher productivity growth in tradable goods than in nontradable goods leads to a higher relative price of nontradable to tradable goods, which appreciates the real exchange rate, deteriorates the terms of trade, and depresses the domestic and foreign asset markets. A lower relative price of nontradable goods depreciates the real exchange rate, improves the terms of trade, and lifts both the domestic and foreign asset markets.     

Inflation-targeting and real interest rate parity: A bias correction approach

This paper investigates whether inflation-targeting influences real interest rate parity (RIP) by a bias correction approach under cross-sectional dependence. The recursive mean adjustment (RMA) method proposed by So and Shin (1999) and Shin and So (2001) is employed to correct the downward bias in the panel unit root tests and in the half-life estimates of real interest rate differentials for traded and non-traded goods. The empirical findings differ depending on whether we apply the RMA. More importantly, the empirical results show that as more homogeneous economies become involved in terms of inflation-targeting regime, stronger mean reversion and much a tighter confidence interval are present. Thus, inflation-targeting plays an important role in providing favorable evidence for long-run RIP.     

The persistence in real exchange rate: Evidence from East Asian countries

In this article, we examine the degree of persistence in monthly real exchange rate of six East Asian countries in relation to their two major trading partners, the United States and Japan, to study the validity of PPP for the 1976:01–2009:03 period. To investigate the persistency in real exchange rate series, we use sum of the autoregressive (AR) coefficients and the confidence interval for it using grid-bootstrap procedure recently developed by Hansen (1999). We have two findings: first, we find evidence for high persistency in real exchange rate in terms of the Japanese yen for five countries and for four countries in terms of the US dollar the for the full and pre-crisis sample periods. Second, for the post-crisis period, the presence of low persistency in real exchange rate supports PPP for three countries in terms of the Japanese yen and five countries in terms of the US dollar. These findings indicate that real exchange rate series of five East Asian countries are mean-revert based on their exchange rate policies and East Asian countries can form a currency union.     

External wealth, the trade balance, and the real exchange rate

We examine the link between the net foreign asset position, the trade balance and the real exchange rate. In particular, we decompose the impact of a country's net foreign asset position (‘external wealth’) on its long-run real exchange rate into two mechanisms: the relation between external wealth and the trade balance; and, holding fixed other determinants, a negative relation between the trade balance and the real exchange rate. We also provide additional evidence that the relative price of nontradables is an important channel linking the trade balance and the real exchange rate.     

Home bias and the persistence of real exchange rates

This paper investigates the half-life of real exchange rates after taking into account the impact of home bias. Empirical results indicate that the half-life of real exchange rates is in the range of 1.5 to 2 years for four out of five countries after controlling the impact of home bias. These results support Obstfeld and Rogoff's (2000, NBER Macroeconomics Annual) view that home bias is crucial in explaining the PPP puzzle.     

Inflation targeting and exchange rate volatility smoothing: A two-target,two-instrument approach

This paper introduces a strategy to model a small open economy, whose central bank has established two simultaneous policy objectives: an inflation target, and a maximum limit for nominal exchange rate volatility. In line with the Tinbergen–Aoki condition, the monetary authority establishes two policy instruments, one for accomplishing each target: the monetary policy rate, and the stock of foreign exchange reserves. Monetary policy analysis is built around a non-microfounded augmented New Keynesian DSGE model estimated through Bayesian techniques for the Guatemalan economy. It is found that each instrument is efficient in accomplishing its own target. Nevertheless, a coordinated effort is required for central bank policymakers before employing both instruments simultaneously, in order to avoid sending mixed signals to economic agents about its monetary policy stance, and endanger the achievement of its inflation target.     

The monetary approach to exchange rates in the CEECs1

A panel dataset for six Central and Eastern European countries (Czech Republic, Hungary, Poland, Romania, Slovakia and Slovenia) is used to estimate the monetary exchange rate model with panel cointegration methods, including the Pooled Mean Group estimator, the Fully Modified Least Square estimator and the Dynamic Least Square estimator. The monetary model is able to convincingly explain the long‐run exchange rate relationships of a group of CEECs, particularly when this is supplemented by a Balassa–Samuelson effect. Our estimated long‐run monetary equations are used to compute equilibrium exchange rates. Finally, we discuss the implications for the accession of selected countries to the European Economic and Monetary Union.     

Elections, exchange rates and reform in Latin America

In this paper, we study the link between real exchange rate (RER) depreciation and elections in Latin America. Our contribution is threefold. First, we employ a statistical model that takes into account the pervasive conditional heteroskedasticity found in financial data and includes a wide range of macroeconomic variables as regressors. Second, we test whether the wave of central bank reform that swept the region has had any effect on the existence or strength of the electoral cycle in exchange rates. Third, we test an additional hypothesis, namely, that financial liberalization may also be an important variable explaining changes in electoral effects on the real exchange rate. In a panel of 9 Latin American countries with available macroeconomic data and a history of exogenous election dates, we confirm the previous findings that real depreciation intensifies after elections even when modeling the significant conditional heteroskedasticity in these data. We also show, for the first time in the literature, that post-election exchange rates are significantly less predictable. We go on to test whether central bank reform has influenced the way in which elections affect the RER in Latin America. If reform has been effective at reducing political manipulation of the exchange rate, then any relationship we see between elections and the RER before central bank reform should be mitigated in the post-reform era. We find that the relationship disappears after reform and that post-reform real exchange rates are also significantly less volatile. Finally, we show that financial liberalization seems to have a stronger effect on the conditional variance of the RER than does central bank reform, but reform has a stronger impact on the conditional mean.     

The comovement between exchange rates and stock prices in the Asian emerging markets

This study investigates the comovement between exchange rates and stock prices in the Asian emerging markets. The sample covers major institutional changes, such as market liberalization and financial crises, so as to examine how the short-term and long-term relations change after such events. The autoregressive distributed lag (ARDL) model proposed by Pesaran et al. (2001) is adopted, which allows us to deal with structural breaks easily, and to handle data that have integrals of different orders. Interest rates and foreign reserves are also included in the analysis to reduce potential omitted variable bias. My empirical results suggest that the comovement between exchange rates and stock prices becomes stronger during crisis periods, consistent with contagion or spillover between asset prices, when compared with tranquil periods. Furthermore, most of the spillovers during crisis periods can be attributed to the channel running from stock price shocks to the exchange rate, suggesting that governments should stimulate economic growth and stock markets to attract capital inflow, thereby preventing a currency crisis. However, the industry causality analysis shows the comovement is not stronger for export-oriented industries for all periods, such as industrials and technology industries, thus implying that comovement between exchange rates and stock prices in the Asian emerging markets is generally driven by capital account balance rather than that of trade.     

The U.S. trade imbalance and real exchange rate: An application of the heterogeneous panel cointegration method

The United States economy suffers from persistent trade deficits, arising from the so-called ‘global external imbalance’. Can the depreciation of the US dollar improve this phenomenon? This study for the first time applies the heterogeneous panel cointegration method to examine the long-run relationship between the real exchange rate and bilateral trade balance of the U.S. and her 97 trading partners for the period 1973–2006. Using new annual data, the empirical results indicate that the devaluation of the US dollar deteriorates her bilateral trade balance with 13 trading partners, but improves it with 37 trading partners, especially for China. In the panel cointegrated framework, a long-run negative relationship between the real exchange rate and the bilateral trade balance exists for the U.S.     

A fractionally integrated exponential STAR model applied to the US real effective exchange rate

The aim of this paper is to study the dynamics of the US real effective exchange rate by capturing non-linearity and long-memory features. In this context, we use the family of fractionally integrated STAR (FISTAR) models proposed by van Dijk et al. (van Dijk, D., Franses, P.H., and Paap, R., 2002. A non-linear longmemory model with an application to US unemployment. Journal of Econometrics 110, 135–165.) in the case when the transition function is an exponential function and we develop an estimation procedure. Indeed, these models can take into account processes characterized by several distinct dynamic regimes and persistence phenomena.