Exchange Rate Target Research Articles

Balance-of-payments anti-crises

China and Switzerland have recently experienced foreign exchange reserve accumulation far in excess of what would be implied by the literature on optimal reserves. Using a dynamic general equilibrium model, we show that the credible expectation of an upper limit to how many reserves a country is willing to accumulate would lead to a balance-of-payments anti-crisis. This is characterized by an accelerated pre-crisis accumulation of foreign exchange reserves, followed by a collapse of the monetary target that is instantaneous under exchange rate targeting and gradual under price level targeting. We argue that Switzerland has recently experienced such an event.

Денежно-кредитная политика России в условиях кризиса

The author analyzes the challenges for monetary policy in Russia in 2014-2015, related to the strengthening of the impact of external shocks on the Russian economy. It is shown that the transition to a freely floating exchange rate and inflation targeting regime in late 2014 - early 2015 was fraught with increased financial instability and limitation of anti-crisis role of monetary policy. Practical recommendations on improvement of monetary policy in current Russian conditions are offered, including the transition to a limited discretionary policy, strengthening of the exchange rate policy and the introduction of certain restrictions on the cross-border capital flows.

Monetary and Exchange Rate Policy for Financial Stability and Growth in MENA Countries

Abstract Using the exchange rate as a nominal anchor is very successful for taking control of inflationary expectations. The countries in the MENA region switching to a more flexible exchange rate regime will mitigate the effects of external shock. Establishing Monetary Union emerges as an alternative of flexible exchange rate and inflation targeting preference for the MENA countries. As take in to account the whole findings, we cannot mention the existence of a co-ordination between all of MENA countries in terms of inflation, growth, monetary expansion and budget performance. Therefore we can say that monetary union is an inappropriate choice of exchange for countries of the region and MENA region has not complied with OCA criteria yet.

An Empirical Investigation of the Monetary Model Economic Fundamentals

This paper presents an empirical investigation of an important series called “economic fundamentals” derived from the flexible price monetary model of exchange rate determination. The model predicts that the nominal exchange rate is determined by the “economic fundamentals”, referred here as the series ft. As a result, the characteristics of the “economic fundamentals” process may influence the properties of the nominal exchange rate process. We will just use the term “fundamentals”. Nevertheless, many exchange rate models found in the literature assume an ad-hoc process for ft ignoring the fact that the specification of this process can be formally derived within the framework of the monetary model. Using data for several countries on GDP and money supplies, we construct the series ft according to the monetary model specification, and we examine some important characteristics of its empirical distribution such as skewness, kurtosis, stationarity, ARCH and GARCH properties. We observe that the series is not exactly normally distributed, as commonly assumed in many target zone models. This investigation essentially helps with modeling exchange rate and more importantly in the analysis of exchange rate target zones modeling by identifying potential restrictions that need to be taken into consideration when choosing a process for the modeling of the “economic fundamentals”.

A Target Zone Model Where the Fundamentals Follow a Geometric Brownian Motion

In this paper, we propose a model of exchange rate target zone based on a specification of the economic fundamentals known as a Geometric Brownian Motion. The rationale behind this specification is that the fundamentals series is not necessarily normally distributed as commonly assumed, as indicated by its excess kurtosis and ARCH properties. Therefore, assuming a normal specification can be problematic. The main difficulty is that with such a specification finding a closed form solution for the model becomes somehow more involved. We present some results in which the exchange rate formula is explicitly derived. Then we look at several types of central bank interventions in the foreign exchange market such as Krugman’s marginal interventions, central bank interventions a la Caballero and central bank interventions a la Flood-Garber. In addition, we present some empirical investigations where it is found that, for the most part, these exchange rate models do not fit the data well and a case where the model performs satisfactorily. We believe that the sources of the problem may reside in the complexity of estimating the models efficiently given that the theoretical approach is quite sound.

As armadilhas do tripé da política macroeconômica brasileira

RESUMOEste artigo analisa o chamado tripé da política macroeconômica brasileira, que desde 1999 tem combinado um regime de metas de inflação, um regime de taxa de câmbio flutuante e metas de superávit fiscal primário. A menos que o seu modus operandi seja alterado, o tripé não será capaz de libertar a economia brasileira de outra "possível trindade": altas taxas de juros reais, a apreciação da taxa de câmbio real e crescimento econômico muito baixo. Depois de analisar brevemente a base teórica sob o tripé macroeconômico, o artigo mostra por que este regime de política macroeconômica, se avaliado numa perspectiva de longo ou médio prazo, não tem sido capaz de garantir a estabilidade dos preços nem o crescimento econômico. Além da sugestão de romper com a estratégia brasileira de crescer com poupança externa, o documento também sugere três principais formas de mudar o modus operandi do tripé brasileiro: i) aumentar o horizonte de tempo para atingir a meta de inflação, como tem sido o experiência da maioria dos países que adotam esse regime de política monetária; ii) restaurar o papel anticíclico da política fiscal brasileira; e iii) adotar uma combinação de mecanismos que visem prevenir que a moeda brasileira entre em uma nova tendência cíclica da apreciação em termos reais.

Constrained Random Walk Models for Euro/Swiss Franc Exchange Rates: Theory and Empirics

We study the performance of the euro/Swiss franc exchange rate in the extraordinary period from September 6, 2011 and January 15, 2015 when the Swiss National Bank enforced a minimum exchange rate of 1.20 Swiss francs per euro. Within the general framework built on geometric Brownian motions (GBM), the first-order effect of such a steric constraint would enter a priori in the form of a repulsive entropic force associated with the paths crossing the barrier that are forbidden. It turns out that this naive theory is proved empirically to be completely mistaken. The clue is to realise that the random walk nature of financial prices results from the continuous anticipations of traders about future opportunities, whose aggregate actions translate into an approximate efficient market with almost no arbitrage opportunities. With the Swiss National Bank stated commitment to enforce the barrier, trader's anticipation of this action leads to a volatility of the exchange rate that depends on the distance to the barrier. This effect described by Krugman's model [P.R. Krugman. Target zones and exchange rate dynamics. The Quarterly Journal of Economics, 106(3):669-682, 1991] is supported by non-parametric measurements of the conditional drift and volatility from the data. To the best of our knowledge, our results are the first to provide empirical support for Krugman's model, likely due to the exceptional pressure on the euro/Swiss franc exchange rate that made the barrier effect particularly strong. Despite the obvious differences between brainless physical Brownian motions and complex financial Brownian motions resulting from the aggregated investments of anticipating agents, we show that the two systems can be described with the same mathematics after all. Using a recently proposed extended analogy in terms of a colloidal Brownian particle embedded in a fluid of molecules associated with the underlying order book, we derive that, close to the restricting boundary, the dynamics of both systems is described by a stochastic differential equation with a very small constant drift and a linear diffusion coefficient. As a side result, we present a simplified derivation of the linear hydrodynamic diffusion coefficient of a Brownian particle close to a wall.

The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

In the aftermath of the recent financial crisis, the central banks of small open economies such as the Swiss National Bank (SNB) implemented a unilateral one-sided exchange rate target zone vis-a-vis the euro currency to counteract deflationary pressures. Recently, the SNB abandoned its minimum exchange rate regime, arguing that after having analyzed the costs and benefits of this non-standard exchange rate policy measure, it was no longer sustainable. This paper proposes a model that allows central banks and policymakers to estimate ex-ante the costs of implementing and maintaining a unilateral one-sided target zone (in terms of the expected size of foreign-exchange interventions) and to monitor These costs during the period in which it is enforced. The model also offers central banks a tool to identify the right timing for the discontinuation of a minimum exchange rate regime. An empirical application to the Swiss case shows the ex-ante estimated size of these costs and reveals that these costs might have been substantial without the abandonment of the minimum exchange rate regime, which accords with the official statements of the SNB.

International financial shocks in emerging markets

The present paper investigates how an emerging market economy is affected when it suddenly faces a higher risk premium on international capital markets. We study this question empirically for five Latin American economies over the period 1994–2007 within a structural panel vector autoregression and analyze theoretically the transmission mechanism using a dynamic stochastic general equilibrium model (DSGE) of a small open economy. The financial shock is modeled by an unexpected increase in the risk premium of firms' foreign-currency debt. In response, the adverse shock is amplified by a feedback mechanism between currency depreciation, adverse balance sheet and risk premium effects. The theoretical model is used to study different monetary policy responses. We find that an exchange rate targeting rule that strikes a balance between exchange rate and inflation targeting allows the monetary authority to stabilize inflation and output more effectively than under a pure inflation targeting rule.

International Financial Shocks in Emerging Markets

The present paper investigates how an emerging market economy is affected when it suddenly faces a higher risk premium on international capital markets. We study this question empirically for five Latin American economies over the period 1994-2007 within a structural panel vector autoregression and analyze theoretically the transmission mechanism using a dynamic stochastic general equilibrium model (DSGE) of a small open economy. The financial shock is modeled by an unexpected increase in the risk premium of firms' foreign-currency debt. In response, the adverse shock is amplified by a feedback mechanism between currency depreciation, adverse balance sheet and risk premium effects. The theoretical model is used to study different monetary policy responses. We find that an exchange rate targeting rule that strikes a balance between exchange rate and inflation targeting allows the monetary authority to stabilize inflation and output more effectively than under a pure inflation targeting rule.

On the sustainability of exchange rate target zones with central parity realignments

Abstract I show that parity realignments alone do not suffice to ensure the long-run sustainability of an exchange rate target zone with imperfect credibility due to the gambler’s ruin problem . However, low credibility and frequent realignments can destabilize the exchange rate.

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments

I show that parity realignments alone do not suffice to ensure the long-run sustainability of an exchange rate target zone with imperfect credibility due to the gambler's ruin problem. However, low credibility and frequent realignments can destabilize the exchange rate.

A NOTE ON REMITTANCES, MONETARY REGIMES, AND NONTRADABLE INFLATION DYNAMICS

This paper examines the dynamic and desirable properties of monetary regimes in a remittances recipient economy, with emphasis on the effect on sectoral output and nontradable inflation dynamics. The findings indicate that under a fixed exchange rate regime, an increase in remittances creates increased demand for nontradable goods, and hence a rise in nontradable inflation, as well as expansion in output of nontradables. Under a nontradable inflation targeting regime, however, a decrease in nontradable inflation and an expansion in tradable goods production are observed following an increase in remittances. A near-zero nontradable inflation rate and managed variability in the nominal exchange rate typify the optimal monetary policy, suggesting that an inflation targeting regime is preferable to a fixed exchange regime under such a scenario. A VAR analysis shows that the dynamics of inflation in El Salvador and the Philippines is in consonance with those observed in the model under the fixed exchange rate and nontradable inflation targeting regimes, respectively.

Monetary policy and commodity terms of trade shocks in emerging market economies

Commodity terms of trade shocks have continued to drive macroeconomic fluctuations in most emerging market economies. The volatility and persistence of these shocks have posed great challenges for monetary policy. This study employs a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to evaluate the optimal monetary policy responses to commodity terms of trade shocks in commodity dependent emerging market economies. The model is calibrated to the South African economy. The study shows that CPI inflation targeting performs relatively better than exchange rate targeting and non-traded inflation targeting both in terms of reducing macroeconomic volatility and reducing the losses of a non-benevolent central bank. However, macroeconomic stabilisation comes at a cost of increased exchange rate volatility. The results suggest that the appropriate response to commodity induced exogenous shocks is to target CPI inflation.

What Should Central Banks Target? Evidence on the Impact of Monetary Policy Regimes on Economic Growth

Economists and policy-makers have long sought the ideal framework for monetary policy as it is arguably one of the most important tools for government to influence the economy. Exchange rate and inflation are believed to be the most appealing anchors for providing guidance to the conduct of monetary policy and are thus widely used in the real world. Most existing studies on the effect of exchange-rate arrangements and inflation targeting on economic growth suffer from the absence of a clear counterfactual, rendering it difficult to interpret their results. Based on a new classification scheme on monetary policy regimes, this paper helps to fill that gap by investigating the effect of monetary policy regimes on growth. Our results consistently support that an inflation targeting regime has a positive impact on economic growth when compared with an exchange-rate targeting regime.

Corruption, central bank (in)dependence and optimal monetary policy in a simple model

Using a simple macroeconomic model, this paper examines the interaction between corruption and central bank independence in the construction of an optimal monetary policy rule where the instrument of policy is the real interest rate. As such, we are especially interested in how the policy instrument reacts to key macroeconomic variables in the face of possible corruption (modelled here as tax leakage) and possible dependence by the central bank on the fiscal policy process. We analyse this issue by deriving optimal rules for a strict inflation targeting and a real exchange rate target regime. We find that, firstly, the existence of corruption imposes an inflationary bias on the optimal rule – even when the central bank is independent. We find, furthermore, that a central bank that exhibits some dependence exacerbates this effect.

Capital Controls and Optimal Chinese Monetary Policy

We examine optimal monetary policy under prevailing Chinese policies> – including capital controls, nominal exchange rate targets, and costly sterilization of foreign capital inflows. China’s combination of capital controls and exchange rate pegs disrupts its monetary policy, precluding adjustments that could maintain macroeconomic stability following a set of shocks that mirror its experience during the global financial crisis. However, comparing different policy regimes in a consistent DSGE framework, we find that the bulk of welfare gains achieved under full liberalization can be obtained by liberalizing either the capital account or the exchange rate. ; Previously titled: Monetary policy in a DSGE model with “Chinese Characteristics”

A Causality Test on the Gibson Paradox in Turkey

In general, it is believed that interest rate is an important instrument for central banks while struggling with inflation. However, Gibson Paradox tells the story in a different way. So how does it work in reality? This study examines the validity of Gibson Paradox in Turkey empirically by using monthly data belonging 01:2003 - 05:2015 period. According to analysis results, there is an interaction between floating exchange rate and inflation targeting and also between monetary policy base interest rate (base rate) and consumer price index (CPI). On the account of these results we reach the conclusion that Gibson paradox is valid for Turkey.

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments

On the Sustainability of Exchange Rate Target Zones with Central Parity Realignments