Exchange Intervention Research Articles

Monetarization of the budget constraint: Two-country model for the European Economic Community and the semi-industrial country blocks

This paper compares floating and exchange rate intervention and investigates the issue of currency substitution by adopting a two-country simulation model. Our main concern is to introduce aggregate demand and financial asymmetries in order to explore the relationship between the semi-industrial countries where the asset market is weak and there is greater influence of expected depreciation, smaller wealth effects and greater openness in aggregate demand, and the industrial countries where the countrary occurs. We assume a rational expectation with steady-state inflationary equilibrium. We simulated the influence of various aggregate demand and supply shocks when currency substitution occurs between two asymmetric countries under various exchange rate regimes. Our results show that relatively high currency substitution in money demand and aggregate demand asymmetries in the semi-industrial country benefits the industrial country.

The Arbitrage Pricing Theory and Foreign Exchange Risk Premia

This study explores the nature of the spot foreign exchange risk premium. Employing Ross's Arbitrage Pricing Theory (APT) as a vehicle, it tests the hypothesis that cross‐sectional differences in pure currency returns depend on measures of systematic (covariance) risk. These tests have greater power, in the sense of an enhanced ability to reject the hypothesis, since they explicitly allow for the possibility that idiosyncratic risk is priced. A battery of tests is unable to reject the hypothesis that expected exchange returns can be explained by a single‐factor APT. One implication of these results is that official intervention in exchange markets is unnecessary and undesirable.

Target zones and the distribution of exchange rates: An estimation method

We develop a parsimonious parameterization of exchange rate density function under target zones that enables us to estimate the approximate shapes of density curves from the exchange rate data. We find that the distributions of exchange rates can take several different shapes, which may correspond to possibly widely different monetary and exchange-rate intervention policies, including the marginal and intramarginal intervention policies discussed in previous theoretical models.

Is it signalling? Exchange intervention and the dollar-Deutschemark rate

The portfolio balance channel for sterilised intervention is tested by examining the effects of changes in relative asset supplies on the dollar-Deutschemark rate during the 1980s. In contrast to previous studies, we control for any signalling effects of central bank intervention and find a weak, but statistically significant, portfolio balance influence on the exchange rate.

The U. S. Current Account: A Long and Short Run Empirical Perspective

The persistence of the U.S. current account deficit is thought to be one of America's foremost economic problems-an omen of a decline in U.S. economic hegemony that seems even more foreboding in the wake of plans for Europe 1992. The U.S. current account balance began its sustained decline in the third quarter of 1982 having earlier hovered anywhere from an annualized surplus high of $22.2 billion to a deficit low of $26.64 billion between 1973 and 1982. Beginning in the third quarter of 1982, the U.S. current account balance registered an annualized deficit of $29 billion. This would be but one of many yet one of the smallest steps down the road to the triple digit deficits that have endured throughout the 1980s and remain today. Is the persistence of the current account deficit now in its eighth year an indication of a trend which fiscal prudence, exchange rate intervention, increases in U.S. competitiveness, or demand stimulus abroad cannot suspend in the long run? These issues are investigated by using the more recent work on unit roots and cointegration, applications that have not yet been made regarding trade issues and trade related data. Granger causality tests are also used to investigate the short run causes of the current account deficit.

Twin deficits during the 1980s: An empirical investigation

This study uses multivariate time series analysis to examine the linkages between federal budget deficits and merchandise trade deficits. Using a vectorautoregressive model, support is found for the notion that budget deficits influence trade deficits indirectly rather than directly. Evidence is obtained through causality testing and impulse response functions that the “twin deficits” are connected through the transmission mechanisms of interest rates and exchange rates. The model indicates that reducing the size of the budget deficit may prove to be at least as effective as exchange rate intervention for the purpose of reducing the size of the merchandise trade deficit.

Exchange rate policy and intervention in Japan

Exchange rate policy and intervention in Japan

Past, Present and Future Agendas

come to play a broad umbrella role in the process of international economic cooperation. This process today covers a wide range of areas from intervention in exchange markets day-by-day, to defining a response to global environmental risks posed by the possible depletion of stratospheric ozone. Officials from Summit countries and others are engaged in study, discussion and negotiation across this broad spectrum in many multilateral forums the G-7 Finance Ministers and Central Bank Governors, the World Bank, the International Monetary Fund (IMF), General Agreement on Tariffs and Trade (GATT) and my own institution, the Organisation for Economic Co-operation and Development (OECD), to name only the most visible. Bilateral discussions are also extensive.

A diffusion model for exchange rates I: Theoretical introduction

The rates of exchange between r continuously traded currencies are modelled by a diffusion process. The motivation for this kind of model is in terms of long term trends in the exchange rates combined with random fluctuations in these rates which occur as a result of continous evaluation of information by the dealers in the currency market together with a continuous revision of expectations about the short-term course of the exchange rates of the currencies they are dealing in. The formulation as a diffusion process permits considerable theoretical development. On a qualitative level, stability of exchange rates is investigated using Hashiminsky's criterion and the components of an unstable regime quite well identified. Government intervention in exchange markets may be studied at a simple level by using local times. The properties of local times suggest a certain amount of insight into how optimal intervention performs. An important feature of the diffusion formulation is the derivation of explicit formulae for the numerical calculation of quantities of interest in terms of the model. This is illustrated by partial differential equations for local times and an equation obtained from the Feynman-Kac formula which permits interpretation in terms of forward exchange rates. Numerical techniques permit explicit calculation from such equations.

Managed Floating Exchange Rates, Intervention Policy and Macroeconomic Policies

Traditionally, international monetary economists focus their attention on the framework of either a pure fixed or a pure flexible exchange rate system. With the demise of the Bretton Woods system, many countries have begun to use an intervention policy in the foreign exchange market and adopted the regime of managed floating exchange rates. Such a change has encouraged many economists into the field of this system. Although the contributions in this area are very rich, there is no systematic analysis concerning whether intervention policy will enhance or weaken the effectiveness of macroeconomic policies. That is why this article is written.

Monetary Base Management and BOP Movements: The ASEAN countries

In recent years, the world has experienced signifi cant economic instability as manifested by the wide fluctuation of key macro-economic variables. Most instabilities in less developed countries (LDCs) have been attributed to external factors, particularly since 1973, a year which saw the breakdown of the Bretton Woods system and a drastic increase in oil prices. In many cases domestic instability has augmented external stabilization issues, particularly those related to the international transmission of disturbances. Two important transmission mechanisms are prices and balance of payments (BOP). This paper focuses on the BOP and, specifically, how it affects domestic monetary conditions. It is basically a study of sterilization policies. With the advent of generalized floating regimes, mon etary authorities have gained an additional tool for monetary management?the exchange rate. Under this system, the exchange rate can also serve as an instrument for sterilizing the effects of BOP flows on money supply. Given the BOP situation, the monetary authorities can intervene in the exchange market, and intervention changes domestic high-powered money accord ingly. This mechanism is explained further in subsequent sections. This paper considers both types of sterilization policies: exchange rate intervention and the traditional tools of monetary management. Another factor which is taken into account in examining sterilization policies is offsetting pay ments flows. Other studies assume exchange rates to be fixed and hence consider only tiny effects. The concepts of offsetting flows, exchange rate intervention, and the traditional tools of monetary management are important not only in relation to sterilization but also as indepen dent factors which influence the stability of the domestic financial system. To study these concepts and interrelationships, a model incor porating (i) reaction functions of the monetary authorities and (ii) the monetary approach to BOP and exchange rate determination, is developed. The next section discusses the theoretical framework for analyzing the effects of BOP changes on the monetary base. An econometric representation of the framework is presented in the following section, and the results of the estimation of the various models are then ana lyzed with regard to the ASEAN countries. The final section presents a summary and the conclusions.

Dynamic Exchange Rate Equilibria with Uncertain Government Policy

In this paper we link two exchange rate literatures by showing how threats of asset controls yields determinate exchange rates in general equilibrium models with otherwise perfect capital markets and by showing how, for certain sequences of threats, exchange rate determination may be well explained by monetary variables. We find that in general there exists no natural exchange rate, and market rates may be sensitive to changed perceptions about future exchange rate intervention.

Rational expectations and the effect of exchange-rate intervention on the exchange rate

A theoretical model is proposed in which the exchange rate is affected by current and capital account transactions and the central bank intervenes in the foreign exchange market by buying and selling foreign exchange. The effects of this intervention on the exchange rate are explored under the assumption that exchange-rate expectations are formed rationally and solutions are obtained for the perfect and imperfect foresight cases. The paper concludes with a discussion of the non-optimality of time inconsistent policies when exchange-rate expectations are rational.

Demand for international reserves and exchange-rate intervention policy in an adjustable-peg economy

This paper develops and estimates a model of the joint determination of the official and black-market exchange rates, private and government demand for international reserves, and the rate of inflation under an adjustable-peg system. The framework presented combines and extends aspects of the monetary approach to the balance of payments and exchange-rate determination with the theory of the demand for international reserves. The role of expectations about devaluation is taken into account. The model is estimated by full-information maximum likelihood on the basis of quarterly data for Turkey.

The real exchange rate and intervention under the managed float: Dilemmas of a central banker

This paper has attempted to rationalize some recent widespread trends in the balance of payments of several countries. It has been argued that the exchange-market intervention techniques followed by certain countries especially in the presence of high capital mobility, may have contributed to the observed instability. Such a notion is not new. The innovation of the note is to demonstrate that even a gradulaist and anticipated popular intervention policy can be potentially destabilizing.

“Europe and the money muddle” revisited

The inability of European governments to negotiate the long overdue reform of an anachronistic international monetary system finally brought about its total collapse, and the “new economic policy” launched in 1971 by the Nixon Administration has certainly failed so far to remedy either the world inflation or the world recession and unemployment. The present article looks at how the world economy got to this point and how it can get out. The author first considers the role that non-monetary causes, national monetary permissiveness, international monetary institutions and policies, and the abdication of responsibility to the private market have played. Possible solutions to the principal economic problems (inflation, unemployment, balance of payments disequilibria and income disparity) are then identified in international monetary reform and exchange rate interventions. Finally the author assess the challenges that face the European Community going forward.

Testing the Monetary Approach to Devaluation in Developing Countries

The monetary approach to the balance of payments suggests that surpluses and deficits are essentially adjustment phenomena which serve to equilibrate the money stock in existence to the quantity demanded in an open economy. An increase in the domestic money supply via increased domestic credit creation, by either central or private banks, leads to larger deficits which, in turn, deplete the excess supply of money. A devaluation, however, raises domestic prices and as a result increases the demand for money, thereby leading to a temporary improvement in the balance of payments. 1 The purpose of this paper is to test the monetary approach to devaluation from a sample of 18 independent devaluations that took place in developing countries during the 1959-70 period and, at the same time, to indicate the conditions under which devaluation is successful in improving the balance of payments. In the process, the paper sheds light on two important related issues: first, the degree to which devaluation is inflationary per se, and second, the extent to which devaluation changes the price of traded goods relative to nontraded ones. Part I sets out a simple monetary model appropriate for empirical testing of the monetary approach, Part II summarizes the results of the empirical tests, and Part III focuses upon the impact of devaluation upon the terms of trade and domestic prices. The concluding section discusses Richard Cooper's (1971) test of the monetary approach and attempts to assess the weaknesses and strengths of the monetary framework.

R.Z. Aliber, National Preferences and the Scope for International Monetary Reform. - C. Michalopoulos, Payments Arrangements for Less Developed Countries: The Role of Foreign Assistance. - H.W. Mayer, The Anatomy of Official Exchange-rate Intervention Systems. - G.M. Meier. Problems of Trade Policy. Oxford, at the University Press, 1973, XV p. 288 p., £ 1.85.

R.Z. Aliber, National Preferences and the Scope for International Monetary Reform. - C. Michalopoulos, Payments Arrangements for Less Developed Countries: The Role of Foreign Assistance. - H.W. Mayer, The Anatomy of Official Exchange-rate Intervention Systems. - G.M. Meier. Problems of Trade Policy. Oxford, at the University Press, 1973, XV p. 288 p., £ 1.85.