Fixed Exchange Rate System Research Articles

Inflation Dynamics and Nominal Adjustment in the Baltic States

The paper seeks to explain the inflationary dynamics in the Baltic countries since the mid-1990s. While single-equation estimations generally yield poor results, panel data estimations provide statistically and economically satisfactory findings. Our main result is that the observed gradual disinflation can to a large extent be explained by adjustment to international prices. Stringent fixed exchange rate systems have exerted downward pressure on inflation both directly and via expectations of future inflation. Measures of excess capacity in the labour market have no effect on inflation, while industrial output gaps have some explanatory power. Real oil price shocks have an immediate but short-lived impact on inflation.

Setting the Stage for a National Currency in the West Bank and Gaza: The Choice of Exchange Rate Regime

This paper sheds light on the quantitative behavioral responses of key economic variables in the Palestinian economy in the face of major economic shocks and draws implications for the choice of an exchange rate regime should a decision be taken to introduce a national currency. Time-series regression analysis shows that (i) wages and prices are flexible in the face of various shocks; (ii) the real wage appears rigid in the face of various shocks and increases despite higher unemployment; (iii) an appreciation of the new Israeli Sheqalim real effective exchange rate decreases exports and imports; and (iv) money demand appears stable in the face of exchange rate shocks. Although a fixed exchange rate system may initially be desirable to establish credibility of the new currency, some flexibility of the exchange rate is desirable over time.

Macroeconomic effect of capital controls as a safeguard against the capital inflow problem

Concerns that a rapid surge in capital inflow leads to loss of autonomy in macroeconomic policy, and that its reversal has significant negative effects on an economy, have motivated capital controls during the 1990s. Under a fixed exchange rate system without capital-account restrictions, a decrease in world nominal interest rates causes in a small open economy a deterioration in the current account, real exchange rate appreciation, and inflationary pressure, as pointed out by Calvo et al. (1994, 1996). This paper examines macroeconomic effects of capital-account restrictions as a policy response to the capital inflow problem under fixed exchange rates. Theoretical analysis shows that capital-account restrictions not only stem the capital inflow but also reverse the associated macroeconomic effects. The model implies that capital-account restrictions are effective measures against the capital inflow problem of emerging markets in the 1990s.

Döviz Kuru Belirsizliğinin İhracata Etkisi : Türkiye Örneği

In this paper we examined the relationship between exchange rate uncertainty and exports in Turkey. Sample period of the study is 1981, May 1, the date Turkey introduced flexible exchange rate system after quiting fixed exchange rate system, and 2001, February 22 when exchange rates were left floating. The results of this study, in which quarterly data are used, indicate that exchange rate uncertainty affects exports negatively in Turkey. This finding is valid both for long-run and short-run.

A Brief Discussion of the Effectiveness of Monetary Policy in a Fixed Exchange Rate System With Perfect Capital Mobility and an Analysis of the “Impossible Trinity” Thesis

The purpose of this essay is to discuss the effectiveness of monetary policy in a fixed exchange rate system with perfect capital mobility and an analysis of the Impossible Trinity thesis, with the IS-LM-BP framework. Section 1 analyses the implications of capital mobility. Section 2 explains the IS-LM model framework. Section 3 analyse the balance of payments. Section 4 discusses the relationship between the balance of payments and the monetary accounts. Section 5 discusses the implications of monetary policy with perfect capital mobility. Section 6 discusses the monetary policy effectiveness and conclusions.

Evaluasi Kritis Kinerja IMF dalam Krisis Asia

The IMF established after World War II is a part of world societys effort to save the world from economic depression. Initially it had well-defined purposes. With the collapse of fixed exchange rate system in 1971, the IMF lost its original purposes. The institution then brings free market ideology. Fiscal Austerity, privatization and market liberalization are the three pillars of Washington Consensus advice to help countries facing economic problem. Washington Consensus, however, was designed originally to respond economic problem in Latin America where those countries have huge deficit and loose monetary policy. It is not surprise that these recipes cannot run well in the case of the East Asia Crisis. Indeed, the IMFs advice worsened the economic crisis of the regions and spread to other regions

Returns on ADRs and arbitrage in emerging markets

In this paper we compare the distributions of ADR returns and the returns of the locally traded shares between Chile and Argentina. This comparison is interesting because both countries are emerging economies with a similar free market orientation and the trading hours in both countries virtually coincide with the trading hours in New York. Argentina and Chile differ, however, in two important aspects: During our sample period: (1) The Argentinean market was completely under a fixed-exchange rate system, while Chile maintained a flexible exchange rate regime; and (2) Argentina did not impose any restrictions on foreign investments, while Chile did. We find that the return distributions of the Chilean ADRs are significantly different from the distributions of the returns on the respective underlying Chilean shares. While the mean returns are the same, the return's S.D. are significantly different. In contrast, the hypothesis that the distributions of the returns on the Argentinean ADRs and the returns on their respective underlying shares are the same cannot be rejected. We then use a threshold model to estimate the transaction costs of trading the ADRs and the locally traded shares. We find that the transaction costs that must be added to the returns spread before arbitrage is possible were between 100 and 200 basis points for Chilean ADRs. It was between 66 and 165 basis points for the Argentinean ADRs. The daily return spread reversion caused by arbitrage activities was estimated to be approximately 30% for Chilean ADRs and 40% for Argentinean ADRs. Finally, we cannot reject the hypothesis that low liquidity was a major factor in the cost difference between the two countries.

Multiple Equilibria and the Credibility of the Brazilian 'Crawling Peg', 1995-1998

This paper studies the relationship between the probability of devaluation of the Brazilian real and the fundamentals of the economy for the period 1995-1998. We use a model of a fixed exchange rate system that allows for multiple equilibria and, therefore, makes possible the identification of self-fulfilling speculation. The devaluation probability is computed using the drift adjustment method. The model performs satisfactorily in tracking monthly devaluation expectations and presents some important advantages over a simple linear regression of macroeconomic variables on the devaluation probability. We do not find evidence that self-fulfilling speculation was at work in the period preceding the Brazilian currency crisis of January 1999. This suggests that the breakdown of the Brazilian managed exchange rate system was due to the deterioration of the fundamentals of the economy.

Mehanizam uticaja promene deviznog kursa na inflaciju

The implementation of an adequate exchange rate policy inevitably leads us to the pass-through of exchange rate changes on export prices and inflation. During the last decade of 20th century, there was a lot of research done on the pass-through of exchange rate changes from the microeconomic aspect. This approach, known as New Open Economy Macroeconomics, is theoretically grounded mainly on producers' ability to price discriminate in markets for export goods. Consistent with the established theoretical framework, the focus of this research has been directed towards studying the pass-through of exchange rate changes to export prices. Relatively few research papers, also based on theoretical grounds of basically macroeconomic character, have dealt with the pass-through of exchange rate changes to inflation. This paper observes the pass-through of exchange rate changes to inflation from the macroeconomic aspect. The starting point of our theoretical consideration of the pass-through of exchange rate changes to inflation is the well-known Dornbusch's overshooting model. The observation of the pass-through of exchange rate changes to inflation within the overshooting model allows us to observe two dimensions through which changes in the exchange rate pass through to inflation. The first dimension observes the pass-through of nominal exchange rate changes to inflation, whereas the second one observes the deviations of the nominal exchange rate from the equilibrium nominal exchange rate, having simultaneous internal and external equilibrium. The final pass-through of exchange rate changes to inflation will depend on the joint influence of both dimensions. Also, the pass-through of exchange rate changes to inflation will be observed in the countries with a fixed exchange rate system, which so far has not been a common situation in practice. We believe that exchange rate changes pass through to inflation even in a fixed exchange rate system, when a change in the exchange rate is equal to zero, which is manifested in deviations of the nominal exchange rate from the equilibrium exchange rate.

Monetary Policy in Open Economies under Imperfect Information

We compare international monetary arrangements that differ in the degree of both policy activism and exchange rate flexibility in a model with policy credibility, nominal wage rigidities and unobservable shocks. Three results stand out. First, the selection of the exchange rate regime is less important than the choice of the degree of activism. Second, unlike conventional wisdom, activistic policies tend to fare worse than passive ones. And third, a passive, fixed exchange rate system has good properties for macroeconomic stability. The results suggest that when the monetary authorities operate under conditions of incomplete information, a passive, fixed exchange rate regime represents a good overall choice.

Returns on ADRs and Arbitrage in Emerging Markets

In this paper we compare the distributions of ADR returns and the returns of the locally traded shares between Chile and Argentina. This comparison is interesting because both countries are emerging economies with a similar free market orientation and the trading hours in both countries virtually coincide with the trading hours in New York. Argentina and Chile differ, however, in two important aspects: During our sample period, (1) The Argentinean market was completely under a fixed-exchange rate system, while Chile maintained a flexible exchange rate regime and (2) Argentina did not impose any restrictions on foreign investments, while Chile did. We find that the return distributions of the Chilean ADRs are significantly different from the distributions of the returns on the respective underlying Chilean shares. While the mean returns are the same, the return's standard deviations are significantly different. In contrast, the hypothesis that the distributions of the returns on the Argentinean ADRs and the returns on their respective underlying shares are the same cannot be rejected. We then use a threshold model to estimate the transaction costs of trading the ADRs and the locally traded shares. We find that the transaction costs that must be added to the returns spread before arbitrage is possible were between 100 and 200 basis points for Chilean ADRs. It was between 66 to 165 basis points for the Argentinean ADRs. The daily return spread reversion caused by arbitrage activities was estimated to be around 30% for Chilean ADRs and 40% for Argentinean ADRs. Finally, we cannot reject the hypothesis that low liquidity was a major factor in the cost difference between the two countries.

THE MONETARY APPROACH TO THE BALANCE OF PAYMENTS: AN APPLICATION TO BARBADOS

This paper examines the monetary approach to the balance of payments in Barbados, a small open economy with a fixed exchange rate system. We use an error correction mechanism (ECM) approach which shows that the monetary approach applies to Barbados. Such an ECM approach has not been previously employed in other related studies. Our analysis has implications for monetary policy since it confirms that excessive credit expansion leads to balance of payments deficits in fixed exchange rate systems, and the monetary authorities need to hold high levels of reserves in small open economy systems to protect the exchange rate.

The Relationship Between Money and Prices: Some Historical Evidence Reconsidered

This article describes a debate about the validity of the quantity theory of money and offers further evidence against it. The evidence is primarily from the North American colonies of Virginia, New York, and Pennsylvania and regards the issue of measuring the money supply. Studies have shown that changes in colonial money and inflation are inconsistent with the quantity theory. Some have argued that those studies measure money wrong: specie belongs in the measure because the colonies were on a fixed exchange rate system with Britain; changes in colonial paper money were offset by specie flows. When specie is counted, the quantity theory stands. This study responds with evidence that the critics are wrong: the colonies had no such fixed exchange rate regime, and movements in the stock of colonial paper currency cannot have been offset by specie flows.

The impact of federal reserve intervention on exchange rate volatility: evidence from the futures markets

The collapse of Bretton Woods or the fixed exchange rate system in 1973, along with the coinciding growth in global trade, and greater mobility of capital have all contributed to an increase in exchange rate volatility. Concerns about exchange rate levels and volatility have prompted central banks to actively intervene in foreign currency markets from time to time. This paper presents an empirical investigation of the relationship between central bank intervention actions and currency volatility. This paper is distinguished from earlier studies by employing expectation-based information contained in the currency futures prices to estimate conditional volatility in the USUS$/DM and US$/¥ returns, and by incorporating the simultaneity of the relationship between the Fed's intervention operation and exchange rate volatility into the model. Results suggest a lack of relationship between Fed's intervention activity and the US$/DM conditional volatility during the 1985–1993 period. However, Fed intervention is ...

Even more on monetary policy in a small open economy

It is well known that in a small open economy with full capital mobility and a fixed exchange rate, monetary policy is ineffective in influencing real output (e.g. the works of Fleming [Int. Monetary Fund Staff Pap. 9 (1962) 369.] and Mundell [Can. J. Econ. Polit. Sci. 29 (1963) 475.]). However, Wu [Int. Rev. Econ. Finance 8 (1999) 223.] finds that when the credit channel is added to this model, monetary policy can have real effects under a fixed exchange rate system. This conclusion hinges on the assumption that open market operations have no effect on foreign exchange reserves of the central bank when evaluating how a change in monetary policy affects the loan market. This assumption is incorrect because under a fixed exchange rate regime, the quantity of foreign reserves becomes endogenous in the model. It is shown that when this assumption is relaxed, monetary policy is still ineffective in influencing output under a fixed exchange regime, even with an operative credit channel.

Debt, Growth, and Poverty in the International Monetary System (The Quaid-i-Azam Memorial Lecture)

This paper explores the relationship between debt, growth, and poverty and the international monetary system. With a well-functioning international monetary system, economic policy works well, instruments are assigned to targets appropriately, and discipline is maintained. The fixed exchange rate is contrasted with alternative monetary rules. The monetary rule is the weakest system; monetary targeting has failed in every country in which it has been tried. An advantage of the fixed exchange rate is the clue it provides to the price level, interest rate, and future monetary policy. Other things being equal, the use of a currencies basket is inferior to a single currency peg, while a freely floating exchange rate system puts itself at the mercy of speculators. The paper points out the conditions for a successful currency area as a consensus on a common inflation rate; a common basket of goods with which to measure inflation; exchange rate that must be locked; member countries must adopt a common monetary policy; and a formula must be devised for distributing and using the seigniorage profits from monetary expansion. There is a need to study the possibility of an Asian currency area and the links between the APEC and the SAARC. Regular and mutual surveillance on monetary, fiscal, and exchange rate convergence, and policies that minimise exchange rate uncertainty and work towards a currency club area based on a common anchor— initially the dollar—are needed. Setting up of an Asian Monetary Fund is also suggested, one that is closely modelled on the original IMF articles of agreement and will provide an anchored fixed exchange rate system.

Post-Crisis Exchange Rate Policy in Five Asian Countries: Filling in the "Hollow Middle"?

Following the 1997-98 financial turmoil, crisis countries in Asia moved toward either floating or fixed exchange rate systems, reinforcing the bipolar view of exchange rate regimes and the hollow middle hypothesis. But some academics have claimed that the crisis countries' policies have been similar in the post- and pre-crisis periods. This paper analyzes the evidence and concludes that, except for Malaysia, which adopted a hard peg and imposed capital controls, the other crisis countries are floating more than before, though less than real floaters do. Further, the crisis countries' policies during the post-crisis period can be justified on second-best arguments.

Post-Crisis Exchange Rate Policy in Five Asian Countries Filling in the 'Hollow Middle'?

Following the 1997-98 financial turmoil, crisis countries in Asia moved toward either floating or fixed exchange rate systems, reinforcing the bipolar view of exchange rate regimes and the hollow middle hypothesis. But some academics have claimed that the crisis countries` policies have been similar in the post- and pre-crisis periods. This paper analyzes the evidence and concludes that, except for Malaysia, which adopted a hard peg and imposed capital controls, the other crisis countries are floating more than before, though less than real floaters do. Further, the crisis countries` policies during the post-crisis period can be justified on second-best arguments.

Monetary Policy Independence in the ERM: Was There Any?

Recently proposals for introducing greater exchange rate fixity into the behavior of key exchange rates have become fashionable. One proposal, for example, suggests that a target zone arrangement for the dollar, mark and yen would represent a desirable reform of the international monetary system. The question we seek to address in this paper is how much monetary independence is likely to be conferred on a country participating in such an arrangement. Recent research for the Classical gold standard has suggested that even with a rigidly fixed exchange rate system there is still some scope for monetary independence. Here we examine the extent of monetary independence conferred by a target zone using data from the recent ERM experience. Amongst our findings is the result that countries which had a credible commitment to the target zone had more independence in the operation of their monetary policy than countries with a lesser commitment. It turns out that the monetary independence for a credible participant in a target zone arrangement is longer than that conferred by participation in a regime of rigidly fixed exchange rates, such as the Classical gold standard.

Exchange Rate Rules and Economic Policy Choices: Lessons from the Spanish and Italian Experiences of the ERM

Turbulence in international financial markets has led to renewed calls for fixed exchange rate arrangements in several parts of the world. Proponents of such arrangements often cite the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS), which from 1979 until 1993 tightly pegged the currencies of member states, as a model, arguing that it produced convergence toward sound economic policies while attributing its collapse in 1992-93 to exogenous factors (the rise in interest rates caused by German unification and some perverse incentives for currency investors entailed in the 1991 Maastricht Treaty). Taking issue with this view, this article argues that the ERM's crisis was at least partly attributable to the system's own rules of adjustment. The basis for this argument lies in an analysis of the policy strategies pursued by governments in two of the ERM's higher-inflation members (Italy and Spain) in the four-year period prior to the crisis. With the lifting of capital controls, ERM rules actually bolstered the ability of these two governments to sustain an unbalanced macroeconomic policy-mix (that is, a restrictive monetary stance without commensurate fiscal restriction) for an extended period of time, while at the same time they limited the room for expansion for governments that were committed to a more balanced policy course. The result was an acute dissociation of exchange rates from the ‘fundamentals’ of member economies that increased speculative pressures, eroded the system's credibility, and set the basis for the crisis. The experience of Spain and Italy in the ERM suggests that, in the absence of capital controls, fixed exchange rate systems that are premised too heavily on the pursuit of monetary orthodoxy in an anchor currency country, are likely to fail.