Flexible Exchange Rate Regime Research Articles

Effects of monetary policy shocks on exchange rate in emerging countries

AbstractThis study empirically investigates the effects of monetary policy shocks on the exchange rate in six emerging countries (Korea, Thailand, the Philippines, Mexico, Brazil and Colombia). VAR models are used, wherein sign restrictions on impulse responses are imposed to identify monetary policy shocks. The empirical model reflects the small open emerging economy features. The estimation period is the recent period in which these countries adopted inflation‐targeting and more flexible exchange rate regimes based on the experience of advanced countries. The main findings are as follows: first, various puzzles such as the ‘exchange rate puzzle’, ‘delayed overshooting puzzle’ and ‘forward discount bias puzzle’ are frequently found in these countries; and second, more severe puzzles are found in these emerging countries than in small open advanced countries.

ADAPTATION TO EXTERNAL SHOCKS WITHIN THE CURRENCY BOARD SYSTEM ON THE EXAMPLE OF THE BALTIC COUNTRIES AND BOSNIA AND HERZEGOVINA

One of the most important economic policy issues, especially in the post-transition countries, is exchange rate regime (ERR), i.e. the question of optimal exchange rate regime that would stimulate economic growth and propagate macroeconomic stability. For small and EU-oriented countries like Bosnia and Herzegovina (B&H), the EU accession processes and character of countries' economic cycle phase are usually highlighted among many factors. The choice of the appropriate exchange rate system is determinated by the specific characteristics of individual countries, time moment and the characteristics of the external shock occurrence. It is generally accepted that monetary instabilities are treated by fixation and real economic shocks by exchange rate fluctuations. An important criterion for assessing the adequacy of the current exchange rate regime is its response to external shocks, such as the Great Recession in 2008. While flexible exchange rate regime is used as an automatic stabilizer, fixed exchange rates place certain restrictions. The process of macroeconomic adjustment in the Baltic States is an example of how large macroeconomic imbalances can be reduced without adjusting the nominal exchange rate and how the currency board can be successfully used as a stage in the euro introduction process. The aim of this paper is to give a comparative overview of the currency board introduction in Bosnia and Herzegovina and the Baltic countries, results achieved and reactions to external shocks (Great Recession in 2008) within this exchange rate arrangement, so conclusions that could be valuable in post-COVID 19 recovery can be drawn. Key words: exchange rates, currency board, external shocks

The effectiveness of macro-prudential policies in the face of global uncertainty –the role of exchange-rate regimes

The paper analyses the effects of world uncertainty on the level of domestic credit growth rate and the role of macro-prudential policies (Mapps) in mitigating these effects in a panel of 33 countries under different exchange rate regimes. A higher level of world uncertainty decreases the level of domestic credit under both fixed- and flexible-exchange rate regimes, but these spill-over effects are higher for countries with fixed-exchange rate regimes. The Mapps have a significant impact on financial conditions and help to achieve long-term financial stability, but only for countries under the flexible-exchange regime. It remains completely ineffective for the fixed-exchange economies.

EXTERNAL ADJUSTMENT AND FLEXIBILITY OF THE EXCHANGE RATE REGIME: THE CASE OF TRANSITION COUNTRIES

Milton Friedman’s traditional claim is that flexible exchange rates facilitate external adjustment by means of their cor- rective movements before the balance of payments crisis occurs. In order to test this hypothesis, we employ the first order autoregression based on the panel data on exchange rate regime and external balance expressed as the share of balance of goods and services in GDP. The sample covers 16 Central and Eastern European (CEE) and 12 Common- wealth of Independent States (CIS) transition countries over the period 2000-2019. The results, which are based on the sample of all transition countries, failed to prove that more flexible exchange rate regimes facilitate external adjust- ment. When the analysis was performed on two groups of countries separately, the results showed that the deficit of balance of goods and services in CIS countries has a higher persistence compared to CEE countries. However, a more flexible exchange rate regime does not facilitate external ad- justment. On the other hand, in CEE countries, the relation- ship between exchange rate regime flexibility and the rate of balance of goods and services reversion exists, proving that Friedman’s hypothesis does hold.

Determining The Real Exchange Rate Equilibrium for Pakistan

The achievement of macroeconomic stability and sustained economic growth are the main targets of macroeconomic agents and policymakers. High volatility in Real Effective Exchange Rate (REER) is noticed while moving towards flexible Exchange rate regime. Three assessment methodologies are followed in the paper i.e., PPP approach, PPP approach adjusted for Penn effect and reduced form equation approach to gauge REER misalignment. VAR modelling suggest that, PPP holds for Pakistan and Penn effect is witnessed in the country for FY1980-FY2018. The determinants of REER, like “openness to GDP ratio, Govt consumption to GDP ratio, Long term Investment to GDP ratio, relative productivity and terms of trade” are responsible for depreciation in REER. While, worker remittances and FDI leads towards the REER appreciation in. It is indispensable to opt for the devaluation of PKR to gain export competitiveness, which may result in shrinkage of current account deficit. To increase the productivity of tradable items and to reduce the GOVT consumption of imported items are few steps to push REER towards equilibrium level. As per the state of art model the range of misalignment in REER is from -3.9% to 4.2% in Pakistan

In search of lost time: Examining the duration of growth-reducing sudden stops

This paper investigates the duration of sub-par growth spells associated with sudden stops in private capital flows. Our key finding is that countries featuring floating exchange rate regimes experience shorter growth-reducing sudden stops than countries with more rigid regimes. The estimated effect is large: countries with flexible exchange rate regimes are at least 50 percent more likely to exit a growth-reducing sudden stop. Our results withstand a number of robustness checks, including: controlling for banking crises and initial levels of debt, and introducing unobserved heterogeneity. The paper revisits the heated policy debate of the 1990s on fixed vs. flexible exchange rate regimes from a different angle and uncovers another important shock absorber role of flexible exchange rates.

A Historical Perspective on Prudential Regulation, Currency Mismatches and Exchange Rates in Latin America and the Caribbean

This paper runs a survey across seventeen countries from Latin American and the Caribbean about the use, implementation characteristics and policy motivations of limits and requirements on FX positions, as well as the exchange rate regimes of these economies over 1992-2012. Among other novel stylized facts, we show that when referring to policy motivations, national authorities linked their regulatory measures mostly to currency mismatches and fluctuations of the exchange rate, and this pattern was clearer for the more flexible exchange rate regimes adopted in the aftermath of the currency crisis of the 1990s and early 2000s. Thus, we use the survey and the synthetic control method to show that changes in limits and requirements on FX positions affected fluctuations of the exchange rate.

Can Lebanon's Economy Be Saved? A Plan for Revival

AbstractThe recent financial and economic meltdown in Lebanon is the result of 30 years of social, economic, financial, and fiscal mismanagement, amplified by the Covid‐19 pandemic and further exacerbated by the Beirut port explosion. Lebanese citizens’ trust, as well as the international community's trust in the government, have unfortunately been destroyed. Consequently, Lebanon's sole option is to rebuild confidence in the government and public institutions by implementing economic reforms and to seek an IMF program to pave the way for additional financing from other international sources. The most important confidence‐building step is a clear financial and economic plan that has the support of all key stakeholders. This article presents a road map for a reforms‐driven, export‐led growth strategy for Lebanon. Ultimately, the goal is to jump‐start the economy and put it on a path of sustainable, inclusive, and equitable economic growth. Such growth should be grounded in a small, open‐economy model and driven by low tariffs, a flexible exchange rate regime, and a dynamic export sector built on competitive and comparative advantages. This plan partially builds on proposals and recommendations provided by previous economic plans and policy notes.

Exchange rate flexibility, the real exchange rate, and adjustment to terms‐of‐trade shocks

AbstractWe study the impact of exogenous terms‐of‐trade shocks in a large sample of small open economies. Using a panel vector autoregression, we estimate the response of domestic variables including the exchange rate, output, exports, imports, and domestic demand, allowing impulse responses to vary according to the de facto exchange rate regime. We find strong evidence that flexible exchange rate regimes play a shock‐absorbing role by reducing the response of output to terms‐of‐trade shocks. Results show that flexible regimes see a stronger response of the real exchange rate and faster external adjustment, suggestive of a mechanism that switches expenditure from imported to domestically‐produced goods.

Cyclical drivers of fiscal policy in sub-Saharan Africa: New insights from the time-varying heterogeneity approach

We extend the topical literature on the cyclical behavior of fiscal policy in developing countries subject to terms of trade cycles by applying the interactive fixed effects model that allow for unobserved time-varying heterogeneity in the impact of fundamentals. Based on a sample of 20 sub-Saharan African (SSA) countries from 1985 to 2017, our results support existing evidence about developing countries that fiscal policy is pro-cyclical in SSA countries. Whereas this pro-cyclicality is valid for government spending and fiscal balance, government revenue is slightly counter-cyclical. We also find that the pro-cyclicality of government expenditure and fiscal balance escalates during episodes of terms of trade booms. Our results make a strong case for the support of the pivotal role of Sovereign Wealth Funds, access to international financial markets, and flexible exchange rate regimes in reversing the pro-cyclical behavior of fiscal policy.

¿Afectan los regímenes de tipos de cambio a la prima de riesgo cambiario? Evidencias internacionales

Este artículo analiza el impacto de la prima de riesgo en los rendimientos cambiarios y la relación entre la prima de riesgo y los regímenes de tipos de cambio flexibles. Utilizamos el estimador GMM propuesto por Arellano y Bond (1991) en una muestra de 21 países entre enero de 1997 y diciembre de 2015. Nuestros resultados muestran que la prima de cambio variable en el tiempo se concentra en los mercados emergentes y genera una depreciación que oscila entre el 1,8% y el 2,7% mensual. En los mercados desarrollados, hay una prima de riesgo de cambio constante que promueve una apreciación de sus monedas frente al dólar estadounidense. Estos resultados revelan que la UIP y la CIP no se cumplen, aunque su sesgo es menor en los países emergentes. La flexibilidad del intercambio tiene efectos diferentes entre países desarrollados y emergentes. Estos resultados tienen importantes consecuencias para los encargados de formular políticas y los inversores.

Food Price Shocks and Household Consumption in Developing Countries: The Role of Fiscal Policy

This paper studies whether fiscal policy plays a stabilizing role in the context of import food price shocks. More precisely, the paper assesses whether fiscal policy dampens the adverse effect of import food price shocks on household consumption. Based on a panel of 70 low and middle-income countries over the period 1980-2012, the paper finds that import price shocks negatively and significantly affect household consumption, but this effect appears to be mitigated by discretionary government consumption, notably through government subsidies and transfers. The results are particularly robust for African countries and countries with less flexible exchange rate regimes.

Macroeconomic determinants of the demand for international reserves in Bangladesh

Recent financial crises have heightened the demand from emerging markets' and developing countries’ central banks for international reserves that can meet their emergency foreign currency liquidity needs at times of halts in capital flow. The necessity of reserves for weathering external shocks is well documented in the literature. Likewise, macroeconomic factors to determine the level of reserves have been central to many empirical studies. Motivated by Bangladesh’s stance in regard to reserve accumulation, we aim to investigate the macroeconomic determinants of the demand for international reserves in the country using quarterly data ranging from 1994Q2 to 2016Q4. We also examine the role of disequilibrium in the national money market in reserve movements during the same period. In addition, we check for a structural break associated with the exchange rate regime change in the reserves demand function. The Johansen cointegration test of reserve demand function reveals that the current account vulnerability and exchange rate flexibility play a crucial role in Bangladesh’s long-term reserve demand policies. However, reserves appear to be insensitive to economic size and opportunity cost. A single equation error correction estimate suggests that the monetary disequilibrium does not play a significant role in the short-term reserve movements. More importantly, a dynamic ordinary least-squares estimate suggests that switching to the flexible exchange rate regime in 2003 contributes to a structural change in the long-term reserve demand policies of Bangladesh. Since the empirical results suggest that Bangladesh’s reserve holding behavior is primarily driven by the precautionary motive, we propose that the country should continue to focus on increasing its reserve stock in relation to the current account vulnerability.

Food Price Shocks and Household Consumption in Developing Countries: The Role of Fiscal Policy

This paper studies whether fiscal policy plays a stabilizing role in the context of import food price shocks. More precisely, the paper assesses whether fiscal policy dampens the adverse effect of import food price shocks on household consumption. Based on a panel of 70 low and middle-income countries over the period 1980-2012, the paper finds that import price shocks negatively and significantly affect household consumption, but this effect appears to be mitigated by discretionary government consumption, notably through government subsidies and transfers. The results are particularly robust for African countries and countries with less flexible exchange rate regimes.

Exchange rate fluctuations and economic growth nexus: An empirical evidence from Nigeria

This research study examined the effect of exchange rate on economic growth from 1986 to 2019 using secondary data sourced from Central Bank of Nigeria Statistical Bulletin of various issues. From 1986 being the year the monetary authority shifted from fixed exchange rate regime to flexible exchange rate regime to 2019. The regression analysis using ordinary least square was used to analyze the data. The result revealed that exchange rate has insignificant positive effect on economic growth while interest rate and inflation rate have significant negative effect on economic growth. Therefore, in order to maintain a surplus balance of trade, it is recommended that government should encourage export promotion strategies and also provision of conducive environment, adequate security, effective fiscal and monetary, as well as infrastructural facilities should be available in order to attract foreign investors to invest in Nigeria.

The sudden stops of debt‐led capital inflows, credit crunch, and exchange rate regimes

AbstractBased on the data of 70 developing countries during 1970–2015, we empirically study the relationship between international capital flows and domestic credit. We find that the sudden stop of debt‐led net capital inflows is significantly associated with a domestic credit crunch in developing countries. Moreover, we use the method of event analysis to discover that a flexible exchange rate regime offsets the severity of the credit crunch. These empirical findings are robust to different measures of sudden stops and endogeneity tests.

Reserves and currency crises: the role of the exchange rate regime

ABSTRACT Although it is widely accepted that more reserves are required to support a peg relative to a more flexible currency, there is lack of empirical evidence motivating this phenomenon. This paper shows evidence that international reserves help countries decrease the probability of a currency crisis. However, the alleviating effect of reserves on the likelihood of currency crises is lower under pegged exchange rate regimes. This result implies that countries with pegged regimes need to accumulate more reserves to avoid currency crises, relative to their peers with more flexible exchange rate regimes.

The Main Determinants of Capital Inflows in Emerging Market Economies: Does the Exchange Rate Regime Matter?

There is a bulk of literature in analyzing the impacts of exchange rate regimes (ERRs) on capital flows into emerging market economies. However, these studies mainly do not take into account integration and cointegration properties of variables. This paper aims to tackle this important issue by investigating whether ERRs matter for the impacts of the main push (global financial conditions, GFC) and pull (real GDP) factors on capital inflows into emerging market economies. We find that worsening GFC decreases all types of capital inflow except foreign direct investments in case of floating ERR. This impact is statistically significant only for portfolio inflows in case of managed ERR. The pull factor is often positive and statistically significant in determining capital inflows in the long-run only under floating ERRs. These results suggest that the long-run impacts of the main pull and push factors on capital inflows are often magnified under more flexible ERRs.

Caught in the Crosswinds

A case study approach is used to assess the multi-pronged policy response of seven small financially open economies with flexible exchange rate regimes to external shocks following the global financial crisis. FX intervention was frequently used— including during outflow episodes to prevent disorderly depreciation and preserve financial stability. Monetary policy often considered both financial and external stability. Capital flow management measures were sometimes calibrated symmetrically over the cycle while macroprudential measures were mostly deployed during inflow episodes. Assessment of the macroeconomic conditions paints an inconclusive picture on the benefits or costs of such policies, suggesting the need for further analysis.

Real exchange rate management and economic growth: export performance in Kazakhstan, 2009–2019

ABSTRACT This study contributes to the literature on the evaluation of the effects of the stable and competitive real exchange rate management (SCRER) on economic growth by studying the exporting performance of the tradable sector in Kazakhstan between 2009 and 2019. We also aim to capture the impact of a significant change in the behavior of the exchange rate in August of 2015, following the introduction of inflation targeting monetary policy and switching to the flexible exchange rate regime of domestic currency – tenge. Our results show that a 10% undervaluation of the RER leads to a 0.05 percentage points increase in the growth rate of manufacturing exports. At the same time, a one percent increase in RER leads to a 0.08 percentage points growth in primary products industries, while a depreciation of the RER by one percent leads to a rise of 0.14 percentage points in the growth rate of high-tech manufacturing industries. We also find that a highly volatile exchange rate regime of the exchange rate is not favorable to the development of capital-intensive sectors. Overall, the results suggest that a macroeconomic policy targeting a stable and competitive real exchange rate can be beneficial for the advancement of higher technologically intensive sectors, increased price competitiveness for Kazakhstan’s manufacturing goods and high-skill tradable services, and the process of rapid capital accumulation.