Flexible Exchange Rate Regime Research Articles

Optimal trend inflation in an open economy

We study the optimal inflation target in an open economy with a zero lower bound (ZLB) on nominal interest rates calibrated to the Euro area. When uncovered interest rate parity (UIP) holds, the optimal inflation target is smaller than in a closed economy. The key to this result is that real interest rates at the ZLB increase less as trade openness increases. This less pronounced increase in real interest rates in an open economy mitigates the contraction in aggregate demand, thus reducing the cost of ZLB. Additionally, the optimal inflation target in a monetary union is lower than in a flexible exchange rate regime: forming a monetary union results in a decrease in the optimal inflation rate by 0.24%, thereby increasing per-period welfare by 0.07%. When departures from UIP are significant, the optimal inflation target may be higher than in a closed economy, and the desirability of a monetary union increases further.

The Effects of Monetary Policy on Capital Flows: An Emerging Market Survey

We investigate whether central banks from emerging markets can attract or redirect capital flows, by bringing together the entire empirical literature into the first quan- titative meta-analysis. We dissect policy effects based on the origin of the monetary shock and type of flow. Further, we assess whether policy effects depend on factors that drive investors to either search for yields or fly to safety. Our findings indicate a mean effect size of inflows in the amount of 0.09% of quarterly GDP in response to either a 100-basis point (bp) increase in the domestic policy rate or a 100 bp reduction in the external rate. However, the effect size under a fixed effect specification is much higher (0.2%). Factors that attract inflows include output growth, foreign exchange reserves, and a more flexible exchange rate regime, while factors that deter flows include local and global risks. Finally, we find that banking flows are the most responsive to monetary policy, while foreign direct investments are the least responsive.

Impact of exchange rate on economic growth in Nigeria

This study examined the effect of exchange rate dynamics on economic growth in Nigeria from 1985 to 2021. The study utilized secondary data sources from the World Development Indicators (WDI) and the Central Bank of Nigeria (CBN) Statistical Bulletin. It employed real gross domestic product as a measure of economic growth. In addition to the official exchange rate as a proxy for exchange rate dynamics, the study integrated other domestic factors that can affect economic growth, such as trade openness and external reserves. The econometric techniques employed in the study were unit root tests, cointegration, and autoregressive distributed lag (ARDL)/bound techniques. Following the outcome of the bound test, it was reported that a long-run relationship exists between economic growth, exchange rate, trade openness, and external reserves. The long-run ARDL results reveal that the exchange rate had a positive and statistically significant effect on real GDP in Nigeria, with a unit increase in the exchange rate raising the real GDP by 0.3986 units in the long run; trade openness had a positive and not statistically significant impact on real GDP in Nigeria, suggesting that a unit increase in trade openness increases real GDP by 0.0025 units in the long run; and external reserves had a positive and statistically significant impact on real GDP in Nigeria, indicating that a unit increase in external reserves increases real GDP by 0.4007 units in the long run. Based on the results, the study recommends that the government should develop policies that stabilize the exchange rate. This could involve enhancing foreign exchange reserves management, improving the transparency and predictability of foreign exchange interventions, and possibly considering a more flexible exchange rate regime that can adapt to external shocks while maintaining stability. Policies should focus on gradually opening up the economy to international trade through strategic trade agreements that protect key domestic industries while promoting sectors where Nigeria has a competitive advantage. This approach will help mitigate any negative short-term impacts while capitalizing on long-term benefits. Keywords: Exchange Rate, Trade Openness, External Reserves and Real Gross Domestic Product.

Cross-country differences in the effects of monetary policy shocks on output and prices and their determinants

On the basis of a sample of 19 countries and using sign-restricted VAR and second-stage regression, this research investigates whether there exist differences in the effects of monetary shocks on output and prices between countries, and, if any, which country characteristics incur such differences. The VAR analysis shows that monetary policy shocks of the same magnitude generate differences in terms of the effects on output and prices between countries. The maximal responses of industrial production indexes to a 25-basis-point shock policy rate cut range from a decrease to an over 3% increase with an average of about 1–2% increase. Those of consumer price indexes range from 0.3% to around a 2% increase, with an average of 0.9% increase. The results from regression analysis imply that various country characteristics engender disparities in the responses to monetary policy shocks. The magnitude of the output responses to monetary policy shocks is larger in countries with a monetary policy framework closer to inflation-targeting, a more flexible exchange rate regime, more rapid population aging, and a more rigid labor market, and is smaller in countries with a more independent central bank and a more developed financial market. The size of the price responses is larger in countries with higher trade openness and a more rigid labor market, and smaller in countries with a monetary policy framework closer to inflation-targeting and more rapid population aging.

Exploring Inflation Dynamics with the Phillips Curve in Türkiye: Evidence from the Markov Regime Switching Model

Unlike in many advanced and emerging market economies, inflation was already a problem for the Turkish economy before the COVID-19 pandemic. During the 1990s, Türkiye experienced severe inflation, which reached three digits in some months. Although inflation was reduced to single digits in the 2000s through a successful disinflation program under an implicit inflation targeting framework with a flexible exchange rate regime, price stability became a problem again after the global financial crisis. Inflation gradually increased during the 2010s and became out of control after late 2021. This study aims to explore inflation dynamics in Türkiye using the Phillips curve framework for different inflation environments. To this end, the Phillips curve equation, augmented with the exchange rate and oil prices, is estimated using the Markov regime switching model between January 2006 and September 2023. Two regimes are identified in the sample, namely low- and high-inflation regimes. According to the estimation results, the Phillips curve is invalid in both regimes. The unemployment gap is statistically insignificant despite its negative impact on current inflation. The increasing coefficient of backward inflation in the high regime reflects the resurgent indexation behavior, which was dominant before inflation targeting was introduced in Türkiye. The positive impact of oil prices is only statistically significant in the low regime. While an increase in the exchange rate significantly raises inflation in both regimes, the effect is greater in the high-inflation regime. These empirical findings indicate that the primary issues for controlling inflation in Türkiye are inflation inertia and exchange rate stability.

How US Fiscal and Monetary Policy affect the GDP of Countries with Fixed and Flexible Exchange Rates: Estimates using Korean Data from 1963 to 2022

The simplest large country IS/LM/BP model (Mundell-Fleming Model) predicts that an increase in Government spending in the US would cause an increase in Gross Domestic Product (GDP) for countries with flexible exchange rate regimes and decreases in GDP for countries with fixed exchange rate regimes. In contrast, increases in the US money supply would cause an increase in GDP for countries with fixed exchange rate regimes and decreases in GDP for countries with flexible exchange rate regimes. This paper uses a solution to the omitted variables problem of regression analysis to estimate the effects of US fiscal and monetary policy on the Republic of Korea using quarterly data. The data splits into two sections: (1) from 1962 through 1997, Korea had a fixed exchange rate regime and (2) from 1998 through 2022, Korea had a flexible exchange rate regime. The empirical results fit the Large Country IS/LM/BP predictions.

Exchange rate uncertainty and economic fluctuations in typical emerging economies

This paper examines the role of Exchange Rate Uncertainty (ERU) in driving economic fluctuations in emerging economies using a VAR with stochastic volatility in the mean. We use the quarterly data of three typical emerging economies from 1972Q3 to 2009Q4 within a VAR model. We show that ERU plays a vital role in driving the business cycles of emerging economies. First, an ERU can provoke risks in the financial market and the real economy. Second, ERU hurts equity prices and the output growth of emerging economies. Further investigation shows that the adverse effects of ERU on output are more severe under the fixed exchange rate regime than under the flexible exchange rate regime. This finding implies that adopting the flexible exchange rate regime can help emerging economies mitigate the adverse effects of uncertainty shocks.

The relationship between Foreign Direct Investment, trade openness, exchange rate, and Gross Domestic Product per capita in Vietnam

Aim/purpose – This study explores the nexus between Foreign Direct Investment (FDI), trade openness, exchange rate, and Gross Domestic Product (GDP) per capita in Vietnam between 1986 and 2020. Design/methodology/approach – The Vector Error Correction Model (VECM) was used to evaluate the nexus between FDI, trade openness, exchange rate, and GDP per capita in Vietnam between 1986 and 2020. Moreover, the Johansen co-integration test examined the long-run relationship among these variables. Findings – Results address that GDP per capita, FDI, and trade openness may generate an appreciation of the Vietnamese currency in the short run. In the long run, we found that FDI inflows and trade openness support GDP per capita, but the depreciation of Vietnam Dong harms the economic growth of this country in the long run. The Johan- sen co-integration test confirmed a long-run association among GDP per capita, FDI inflows, trade openness, and exchange rate. Results also indicated a unidirectional cau- sality running from GDP per capita and trade openness to FDI and exchange rate. In addition, a bidirectional causality ran from FDI to the exchange rate. Research implications/limitations – Policies were recommended to facilitate macroe- conomic stability for Vietnam. First, fiscal and monetary policies should be carried out to achieve targets in macroeconomic stability, economic development, employment creation, and inflation control. Second, FDI inflows should continue to be encouraged since they accelerate economic growth. Still, FDI projects should concentrate on improving labor skills and technological progress and promoting sustainable development in crucial sectors such as agriculture, energy, and the environment. Third, fostering innovation in exports by shifting focus from raw materials and inputs exports towards processed and high-value-added commodities while also promoting exports from domestic enterprises to reduce reliance on exports from FDI enterprises. Lastly, improving flexible and active exchange rate regimes consistent with real conditions in both domestic and international markets is necessary to stabilize the exchange rate and foreign currency market in Vietnam. Originality/value/contribution – This paper contributes to the field by providing spe- cific policy recommendations for Vietnam. These recommendations aim to stabilize the economy, attract FDI, renovate exports, and implement flexible and active exchange rate regimes. Keywords: Foreign Direct Investment (FDI), trade openness, exchange rate, Gross Domestic Product (GDP) per capita. JEL Classification: E60, O11, O24.

Overview of the foreign exchange market of Ukraine in the conditions of martial law

The paper examines the peculiarities of the functioning of the currency market of Ukraine in the conditions of martial law and takes into account the aspect of economic and political components. The data of the study of the currency market of Ukraine during the war period are presented and their content is analyzed. The causes and factors influencing the formation and activity of the foreign exchange market are identified, and proposals are given for carrying out stabilization measures and minimizing currency risks in conditions of stress and uncertainty caused by the war. The main elements of the NBU's regulatory easing policy on the currency market of Ukraine in wartime conditions are outlined. One of the first steps taken by the National Bank of Ukraine in times of macroeconomic and military-political instability were the measures of strict currency regulation aimed at minimizing currency risks. In order to maintain financial stability, the NBU had to introduce strict currency restrictions and fix the exchange rate of the hryvnia to the US dollar. Such administrative intervention helped to balance the foreign exchange market in conditions where it would have been impossible to do so by market methods. The temporary fixation of the exchange rate, strict restrictions on currency transactions, restrictions on withdrawals from currency accounts and other measures became a reliable basis for stabilizing both the currency market and the financial system of Ukraine. Of course, administrative restrictions smooth out temporary distortions in the foreign exchange market, but over time they can lead to the accumulation of imbalances, since the market mechanism of balancing the demand and supply of currency in search of exchange rate equilibrium ceases to operate, which sooner or later can lead to or to sudden major crises, or to endless stagnation. Therefore, long-term regulation of the foreign exchange market by strict administrative measures can have negative consequences. This prompted the NBU, in accordance with the new strategy of gradually abandoning the fixed exchange rate of the hryvnia, to switch to the strategy of easing currency restrictions and returning to flexible exchange rate formation and targeting. This strategy is one of the structural beacons of the memorandum with the IMF, which will determine the sequence of steps to liberalize currency restrictions and return to a more flexible exchange rate regime. If such mitigations are not made even in the conditions of a brutal war, the consequences for the country's financial system and the functioning of business can be negative.

INTERACTION OF MACRO-MANAGEMENT POLICIES TO REDUCE LENDING GROWTH

This paper examines whether capital flow management (CFM) and monetary policies effectively reduce lending growth in emerging market economies (EMEs) in the presence of conventional and unconventional monetary policy actions undertaken by advanced economies. We apply a dynamic panel model with fixed effects to a sample of 24 emerging market economies for 2000–2021 using quarterly data and more continuous variables than in other studies rather than limiting the variability using proxies. Capital controls and macroprudential regulation, as CFM policy tools, moderate lending growth. This effect is particularly shown in countries with tighter monetary conditions. Our main findings highlight the useful role of coordinating CFM and monetary policies. This role stands for both fixed and flexible exchange rate regimes. Lastly, we find capital flow management and monetary policies manage to control lending in normal periods, but their coordination is less effective during crises and high volatility periods.

Capital flow management and monetary policy to control credit growth

AbstractThis paper examines whether capital flow management and monetary policies effectively reduce credit growth in emerging market economies in the presence of both conventional and unconventional monetary policy actions undertaken by advanced economies. We apply a dynamic panel model with fixed effects to a sample of 21 emerging market economies from 2000 to 2020 using quarterly data and more continuous variables than in other studies rather than limiting the variability using proxies. We find that capital controls and macroprudential regulation, as tools of capital flow management policy, moderate credit growth. This effect is particularly shown in countries with tighter monetary conditions. Our main findings highlight the useful role of coordinating capital flow management and monetary policies. This role stands for both fixed and flexible exchange rate regimes. Lastly, we find capital flow management and monetary policies manage to control credit in normal periods, but their coordination is less effective during crises and high volatility periods. Robustness checks suggest that these findings are stable across alternative proxies used in the literature, thus providing additional support for the validity of our results.

Assessing the impact of the COVID-19 pandemic on the performance of the Vietnam stock exchange: An empirical analysis

The emergence of COVID-19 in Wuhan, China, in December 2019 led to a global crisis with profound implications for public health and the global economy. This study investigates the ramifications of the pandemic on the Vietnam Stock Exchange, recognizing its interconnectedness with global financial markets. Despite the considerable speculation surrounding the pandemic's influence on economic and financial systems worldwide, limited empirical research has been conducted on its specific impact on the Vietnam Stock Exchange. Employing historical data spanning from January 30, 2020, to April 27, 2022, sourced from a secondary dataset, this research empirically explores the performance of the Vietnam Stock Exchange during the COVID-19 pandemic period compared to a normal period. The findings reveal a significant decline in stock returns and heightened volatility during the pandemic, signaling adverse effects on the exchange's performance. Furthermore, the study applies Quadratic GARCH (QGARCH) and Exponential GARCH (EGARCH) models, incorporating a dummy variable, to scrutinize stock returns. The results corroborate the pandemic's negative impact on stock returns in Vietnam. This research underscores the importance of implementing strategic political and economic policies, including maintaining a stable political environment, promoting indigenous enterprises, diversifying the economy, and adopting a flexible exchange rate regime. These measures are recommended to enhance the resilience of the financial market and attract new investors to the Ho Chi Minh Stock Exchange.

Improving Macroeconomic Management: Experiences and Lessons

The relationship between growth and macroeconomic stability is a wellestablished phenomenon. Long-term growth requires a higher level of investment and a stable economic environment contributes in promoting saving and investment. Good macroeconomic policies help attract foreign saving. Sound fiscal and monetary policies create a conducive climate for private investment and economic growth. So, the policymakers need to redress the problems of domestic and external financial imbalances by designing and implementing an appropriate mix of policies for achieving higher growth, lower price uncertainty, reduced external imbalances, and other macroeconomic vulnerabilities. So, the important issues facing the policymakers are designing sound exchange rate arrangement, making current account sustainable, and promoting financial and macroeconomic stability. In order to promote sound macroeconomic environment for attaining sustained economic growth, there is a need to pursue more flexible exchange rate regime and make progress toward adopting inflation targeting in addition to improving the financial sector soundness, strength and stability.

The “real” exchange rate regime in China since 2015′s exchange rate reform

Moving away from a fixed exchange rate in 2005, China has gradually enlarged the band of fluctuations of Renminbi (RMB) and implemented various reforms on its central parity to have a more flexible exchange rate regime. This paper studies the nature of the exchange rate regime in China since the exchange regime reform of August 2015. Relying on the self-exciting threshold autoregressive (SETAR) model, it identifies endogenously the band of inaction beyond which the People's bank of China (China's central bank) starts to intervene in the foreign exchange market to restrict further fluctuations. Based on the comparison of the estimated threshold with the official band, this paper shows that the RMB/USD exchange rate followed an intermediate regime similar to the crawling band but with only one single threshold of intervention which is much lower than the upper boundary of the announced band.

Weather shocks and exchange rate flexibility

AbstractThis paper assesses the stabilization properties of fixed versus flexible exchange rate regimes and aims to answer this research question: Does greater exchange rate flexibility help an economy's adjustment to weather shocks? To address this question, the impact of weather shocks on real per capita GDP growth is quantified under the two alternative exchange rate regimes. We find that although weather shocks are generally detrimental to per capita income growth, the impact is less severe under flexible exchange rate regimes. Moreover, the medium‐term adverse growth impact of a 1°C increase in temperature under a pegged regime is about −1.4 percentage points on average, while under a flexible regime, the impact is less than one half that amount (−0.6 percentage point). This finding bolsters the idea that exchange rate flexibility not only helps mitigate the initial impact of the shock but also promotes a faster recovery. Importantly, there is evidence of nonlinear effects, whereby greater exchange rate flexibility can be more beneficial for EMDCs with hotter climates. In terms of mechanisms, our findings suggest that the depreciation of the nominal exchange rate under a flexible regime supports real export growth. In contrast to standard theoretical predictions, we find that countercyclical fiscal policy may not be effective under pegged regimes amid high debt, highlighting the importance of the policy mix and precautionary (fiscal) buffers.

Exchange rate pass-through and inflation targeting regime under energy price shocks

The global surge in energy costs poses a significant obstacle for the attainment of price stability by the central banks across the world. This obstacle is further magnified for the economies that adopt an inflation-targeting framework and a flexible exchange rate regime. To overcome this challenge, our study attempts to answer whether inflation targeting can achieve price stability if an exchange rate pass-through exists, especially in the presence of energy price shocks. The study uses secondary data from twenty-one inflation-targeting economies for the period 1997-2020 and applies the non-linear autoregressive distributive lag (NARDL) model to test the hypotheses empirically, considering the possible asymmetries. The results confirm that exchange rate depreciation increases domestic price levels, while exchange rate appreciation reduces them in the long run. The study also finds that rising energy prices contribute to higher inflation in inflation-targeting economies. These findings suggest that inflation-targeting economies face a serious challenge in maintaining their core price stability goal due to exchange rate pass-through especially during energy price shocks. The results invite authorities of IT economies to re-evaluate their policy framework that conveniently ignores exchange rate pass-through by requiring a mandatory floating exchange rate regime.

Do sovereign credit rating events affect the foreign exchange market? Evidence from a treatment effect analysis

AbstractWe estimate the effect of sovereign credit rating events on the foreign exchange market. Using entropy balancing—a treatment effect methodology that properly addresses the possible self‐selection and endogeneity biases related to rating events—we find robust evidence that a positive (negative) sovereign credit rating event significantly increases (decreases) on average exchange rates, with a larger magnitude for negative events. This effect remains significant under flexible (but not under fixed) exchange rate regimes, and displays asymmetries related to the size of the rating event: in particular, only negative large (i.e., above one notch) rating events trigger a significant response of exchange rates. Lastly, we unveil important nonlinearities related to the initial value of the rating, suggesting a possible amplification mechanism: the impact of positive (negative) rating events is stronger in absolute value if ratings are initially high (low).

The trade-off between inflation and unemployment in an ‘MMT world’: an open-economy perspective

This paper is focused on modern monetary theory’s (MMT) treatment of inflation from an open-economy perspective. It analyses how the inflation process is explained within the MMT framework and provides empirical evidence in support of this vision. However, it also makes use of a stock–flow consistent open-economy model to underline some limits of the theory when it is applied in the context of a non-US (relatively) open economy with a flexible exchange-rate regime. The model challenges the contention made by MMT-ers that measures such as the job guarantee programme can achieve full employment without facing an inflation–unemployment trade-off.

Price efficiency of the foreign exchange rates of BRICS countries: A comparative analysis

In this paper, we analyze BRICS countries’ long-term exchange rate market efficiency. Our analysis, using multifractal detrended fluctuation analysis (MFDFA) for the 2009–2021 period, shows considerable differences in the exchange rate efficiency of BRICS countries, with South Africa the most efficient and China the least efficient. Based on daily exchange rates, our analysis shows that after a country shifts to a flexible exchange rate regime, the price efficiency of its currency improves, but not immediately. All the BRICS countries show improvements in market efficiency over the 13-year period of our study. The adaptive market hypothesis supports our finding of efficiency improvements over time more than the efficient market hypothesis does.

Analysis of the possibility of moving to a new stage in the process of flexibilization of the exchange rate regime in Morocco

Given the profound structural changes in the national economy and its increasingly increased openness to the outside world, the transition to a more flexible exchange rate regime constitutes a fundamental reform in order to strengthen the competitiveness of the economy. its resilience to exogenous shocks and the level of its potential growth. However, the transition to more flexibility is not without risk, it would be accompanied by massive inflows of foreign capital motivated mainly by expectations of appreciation of the national currency and the interest rate differential, which will result in excess bank liquidity and excessive growth of reserves causing greater inflationary pressures and aggravation of financial fragilities and exchange rate risk. The objective of this article is therefore to question the capacity of the Moroccan economy through its macroeconomic fundamentals, its financial markets and its institutions, to support the transition to a new stage in the process of flexibilization of the exchange rate regime. The results show that this transition still has to wait, the ground needs to be further prepared.