Floating Exchange Rate Period Research Articles

An Analysis of Exchange Rate Pass-Through to Domestic Prices: Evidence from Turkey

Assessing the impact of exchange rate shocks on domestic prices (Exchange Rate Pass-through) has a crucial role, particularly for the inflation targeting countries. This paper aims to clarify some aspects of ERPT to domestic prices in Turkey, an emerging country. Specifically, this study investigates if ERPT in Turkey is complete and how the behavior of ERPT has changed after the adoption of a flexible exchange rate regime in 2001. A Vector Auto Regression (VAR) framework is used to analyze the impact of exchange rate shocks on CPI Inflation. This study provides empirical evidence on the incompleteness and the pattern of ERPT on Turkey’s CPI inflation based on the VAR Model. The findings demonstrate that ERPT is not only incomplete but also has a different pattern during the floating exchange rate period. The pass-through has decreased from 2001 to 2017, and it has increased dramatically after 2017 to a large extent because of very high inflation and high exchange rate volatility in this period.

The response of exchange rates to economic policy uncertainty: Evidence from Russia

The Russian economy has encountered substantial exchange rate volatility due to many endogenous and exogenous shocks, including the adoption of different exchange rate systems, the global financial crisis, sanctions, and the COVID pandemic. The economy has long experience with a managed floating exchange rate system, which motivates us to investigate the exchange rate response to domestic economic policy uncertainty, incorporating oil prices and the trade volume under different economic circumstances. We apply quantile-based time-series approaches to deal with extreme values. Our empirical investigation demonstrates that the local currency appreciates in response to increased Russian economic policy uncertainty under different quantiles of the managed floating exchange rate, but it depreciates under most quantiles in a floating exchange rate period. Our findings confirm that the Russian currency appreciates with the rise in international oil prices and trade as Russia is an oil-exporting country. Moreover, the findings are robust under the quantile-on-quantile approach.

Purchasing power parity as a long-term memory process

Purpose – The purpose of this paper is to focus on whether the deviations from the cointegrating relationship possess long memory and the fractional cointegration analyses may capture a wider range of mean-reversion behaviour than standard cointegration analyses. Design/methodology/approach – This paper uses a fractional cointegration technique to test the purchasing power parity (PPP). Findings – The authors found that PPP held, but very weakly, in the long run between the Argentine, Brazil, Chile, Colombia, Indonesia, Korea, Mexico, Thailand and Venezuela and US exchange rate during our floating exchange rate period but that the deviations from it did not follow a stationary process. Nevertheless, it is also found that the deviations from PPP exists and can be characterized by a fractionally integrated process in nine out of 13 countries studied. Originality/value – The findings are consistent with the consensus of the empirical literature, reviewed earlier in this paper, on PPP between Argentine, Brazil, Chile, Colombia, Indonesia, Korea, Mexico, Thailand and Venezuela and the USA.

Nonlinear stationarity of real interest rates in the EMU countries

PurposeThis paper aims to examine two hypotheses that have not been well investigated in the existing literature. One hypothesis is that the real interest rates of industrial countries tend to be mean‐reverting during the current floating exchange rate period. Another hypothesis is that the real interest rates of the countries involved in forming the Euro area are more likely to behave as nonlinear stationary series than those of other industrial countries.Design/methodology/approachThe study applies the conventional linear unit root tests and recently developed nonlinear unit root tests, as well as the tests of specifying nonlinearity in time series, to the short‐term real interest rates of 16 industrial countries.FindingsThe results of the study provide support for both hypotheses.Practical implicationsThe results imply that, having adopted target‐zone type stabilization policies for years, the central banks of European Monetary Union (EMU) countries were likely to have exercised monetary policies in a nonlinear way, especially in the process of meeting the requirements of joining EMU.Originality/valueThe study provides stronger evidence than previous studies for the theory that real interest rates of industrial countries tend to have mean‐reverting behavior. The study suggests that more active monetary policies for inflation control in the floating exchange rate period may have enhanced mean reversion in real interest rates.

Nonlinearity and stationarity of inflation rates: evidence from the euro-zone countries

Earlier studies hardly reject the hypothesis of a unit root in inflation. Few studies have examined the possibility of nonlinearity in inflation and tested nonlinear stationarity of the inflation rates. This study thus intends to fill the gap. This study utilizes the tests for nonlinearity along with the unit root tests that allow for nonlinearity in the variables to examine the stationarity of inflation rates of 12 European countries that formed the Euro Zone (EZ) later in the sample period. The results suggest that the majority of these countries’ inflation rates can be characterized by mean reversion during the floating exchange rate period. Many of them appear to be nonlinear stationary. This finding is essential in conducting applied economic studies for these countries, when constructing models whose validity relies on whether or not inflation is stationary. The results of this study also imply that shocks to inflation have a transitory effect on inflation in the euro area. Therefore, it would be less costly in exercising the policies of disinflation for the monetary authorities of the euro area than for those of the countries with nonstationary inflation.

The sustainability of Australia's current account deficits—A reappraisal after the global financial crisis

The heated debate over the sustainability of Australia's high current account deficit that raged over most of the fixed and floating exchange period was due to the failure of policymakers to shift from the Keynesian Mundell Fleming (KMF) paradigm which has been rendered obsolete by the floating of the Australian in 1983q4 to the Intertemporal Optimization (ITO) paradigm which was more appropriate under the floating exchange rate as advocated by a number of Australian economists in the Pitchford thesis. The Pitchford thesis contended that after the floating of the exchange rate the current account deficit was the residual outcome of rational optimizing decisions of private agents and if there was fiscal balance then the policy of targeting the reduction of the current account deficit based on the KMF paradigm was misconceived. Empirical tests based on the application of the net present value criterion using vector autoregressions, unit root and cointegration econometrics reveals that Australia's current account deficit revealed that the current account deficits were unsustainable during the fixed exchange period and over the whole study period 1960q3–2007q4, but not during the floating exchange rate period post-1983q4. Therefore the empirical results gave credibility to the Pitchford thesis but Australian policymakers continued to target the reduction of the current account deficit because their failure to make the paradigm shift from KMF to ITO to be consistent with the regime shift from a fixed to a floating exchange rate. However, in 2004 after more than two decades feuding Australian policymakers accepted the Pitchford thesis and abandon the policy of targeting the reduction of the current account deficit. But the global financial crisis and global recession has delivered a death blow to the Pitchford thesis by undermining the key assumptions of fiscal balance and rationality that underpins it. The fiscal stimulus package that has been implemented to combat the fall in aggregate demand and restore consumer confidence due to the global recession has resulted in massive fiscal imbalance and the credit crunch has undermined rational behavior and consumer confidence. Therefore, the Pitchford thesis no longer rules the policy roost after the global financial crisis. In this study we draw on the conflicting policy perspectives on the unsustainability of high US current account deficits that tender a malign prognosis based on Salvatore's twin deficit hypothesis and a benign prognosis based on Bernanke's global savings glut hypothesis to identify some key policy challenges that confront Australian policymakers to navigate the Australian economy out of the global financial crisis and recession into a robust recovery phase in the near future.

Purchasing Power Parity Under the Current Float

Purchasing power parity (PPP) is an important benchmark model in international finance. Recent literature emphasizes that panel unit root tests have higher power than univariate unit root tests. The results from the ADF unit root test also support the recent literature. Using four panel data unit root tests for the 1990:1 - 2006:3 period, we re-examine the PPP both for developed countries and emerging market economies during the floating exchange rate period. Our empirical results fail to support long-run PPP for both developed countries and emerging market economies.

Real exchange rates may have nonlinear trends

AbstractThe unit root null is tested against possible nonlinear‐trend stationarity for 13 US and German bilateral real exchange rates over the floating exchange rate period. Eight tests specified with nonlinear trends are applied. Simulations are used to determine individual and joint significance levels and to help interpret the results. Unit roots can be rejected for a number of the exchange rates, and nonlinear‐trend stationarity appears more plausible than mean or linear‐trend stationarity as the alternative. In several cases, estimates of the trends support the nonlinear‐trend conclusion with statistical and economic significance. Thus, purchasing power parity is probably violated, but real exchange rates have meaningful long‐run equilibrium values. Copyright © 2007 John Wiley & Sons, Ltd.

A portfolio balance approach to the Canadian–U.S. exchange rate

An empirical portfolio balance model based on Branson and Henderson [Branson, W. H., & Henderson, D. W. (1985). The specification and influence of assets markets. In: Jones R. W., Kenen, P. B. (Eds.), Handbook of International Economics, Volume 2, Elsevier, Amsterdam] is specified for the Canadian–U.S. exchange rate over the floating exchange rate period. Empirical implementation reveals two cointegrating vectors that closely, although not perfectly, match the home and foreign asset demands of the theoretical model. Furthermore, the exchange rate is important in the error correction process. Finally, although the significance is quantitatively and statistically modest, a simplified version of the empirical model resulting from general-to-specific procedures is able to beat a random walk at some out-of-sample forecast horizons.

The Panel Purchasing Power Parity Puzzle

Does long-run purchasing power parity (PPP) hold over the post-1973 floating exchange rate period? Panel unit root tests provide evidence of PPP that increases with the number of observations. The strengthening of the evidence, however, is highly cyclical. When the dollar appreciates at the end of the sample, the evidence of PPP strengthens and, when it depreciates, the evidence weakens. While these patterns cannot be explained by the specifications that are normally used to model real exchange rates, the strengthening, but not the cyclical pattern, can be explained by a specifi- cation that incorporates PPP restricted structural change.

A re-examination of international inflation convergence over the modern float

Crowder [Crowder, W.J., 1996. The international convergence of inflation rates during fixed and floating exchange rate regimes. Journal of International Money and Finance 15, 551–576] provided evidence that inflation rates among the seven largest industrialized economies shared one common stochastic trend in the post-war era, over both the fixed and floating exchange rate regimes. The convergence of inflation rates over the floating exchange rate period implies less insulation for the domestic economy from idiosyncratic shocks in the rest of the world, thereby reducing the attractiveness of flexible exchange rates. Several subsequent studies have found much less convergence than suggested in Crowder's original results, suggesting a higher degree of insulation of flexible exchange rates. In this study, we revisit the question of the degree of inflation convergence among the G-7 nations over the modern float. Employing a host of diagnostic methods, we conclude that there is in fact one common trend underlying the inflation rates of the G-7 nations. Consistent with Crowder [Crowder, W.J., 1996. The international convergence of inflation rates during fixed and floating exchange rate regimes. Journal of International Money and Finance 15, 551–576], we cannot attribute the source of the underlying common trend to any one particular country.

Testing for long-run PPP in a system context: Evidence for the US, Germany and Japan

This paper extends the current literature on PPP by re-examining the validity of the PPP hypothesis for the three key currencies of the recent floating exchange rate period, in a multilateral framework. We argue that PPP testing is more adequate in a system context, which takes into account the dynamic interactions of exchange rates and prices of more than two economies, simultaneously. In the system analysis framework, some form of causality among the variables under consideration is also assessed empirically with the aid of weak exogeneity tests. The results illustrate the importance of the multilateral testing. Positive evidence for PPP is found: long-run PPP is supported for the US and Germany but also for the US and Japan, in contrast to evidence of earlier empirical studies. In addition, causality is found running from the US prices to the exchange rates and German and Japanese prices.

Purchasing Power Parity Across States and Goods Within Australia*

Panel unit root tests show that intranational purchasing power parity cannot be rejected across major Australian cities from 1972:3 to 1999:1. The persistence of deviations in response to shocks is low, as measured by the estimated exact half‐life of between five and ten quarters. This is much lower than results for similar tests done on US cities, and for international purchasing power parity tests. The food CPI is largely responsible for the fast convergent results for city CPIs. Intranational purchasing power parity was rejected for the floating exchange rate period from 1984 to 1991 when inflation was high and not specifically targeted by the central bank.

Testing for Long-Run PPP in a System Context: Evidence for the Us, Germany and Japan

The present paper tests for the validity of long-run purchasing power parity (PPP) for the three key currencies of the recent floating exchange rate period, the US dollar, the German mark and the Japanese yen. The novelty of the paper is that the validity of the PPP conditions relating the economies of the US, Germany and Japan is tested in a system framework, which allows for possible interactions in the determination of the exchange rates and the prices of the three economies. Some form of causality among the variables of the system is also assessed empirically with the aid of weak exogeneity tests. The results illustrate the importance of the multilateral testing. Positive evidence for PPP is found: long-run PPP is supported for the US and Germany but also for the US and Japan, in contrast to evidence of earlier empirical studies. In addition, causality is found running from the US prices to the exchange rates and German and Japanese prices.

Long-horizon regression tests of the theory of purchasing power parity

In this article we test the purchasing power parity (PPP) hypothesis during the recent floating exchange rate period, using quarterly data for 21 OECD countries. In doing so, we use the long-horizon regression approach developed by Fisher and Seater [American Economic Review 83 (1993) 402] and consider 60 bilateral intercountry relations. We investigate the power of the long-horizon regression tests, using the inverse power function of Andrews [Econometrica 57 (1989) 1059], and provide weak evidence in favor of PPP.

Real and monetary shocks to the Canadian dollar: Do Canada and the United States form an optimal currency area?

There is widespread agreement that during the floating exchange rate period from 1970 to the present, Canada’s nominal and real exchange rates with respect to the United States have shown considerable volatility. It has been suggested that the volatility of the real exchange rate would be substantially reduced if the nominal exchange rate with the U.S. dollar were fixed, either through a permanent fixed exchange rate mechanism or the adoption of a common North American currency. In all discussions of the fixed versus floating exchange rate question, it is important to understand why real exchange rates are volatile. The sources of real exchange rate volatility are the focus of this paper. Our findings are that substantial asymmetric real shocks have occurred and were an important determinant of the real exchange rate but there is no evidence of real exchange rate effects of monetary shocks. Since our results indicate that the sources of exchange rate volatility are real, not monetary, they are unfavorable to the adoption by Canada of a common currency with the United States.

The Long-Run Relationship between Real Exchange Rates and Real Interest Rate Differentials: A Panel Study

This paper empirically examines the long-run relationship between real exchange rates and real interest rate differentials over the recent floating exchange rate period, using a panel cointegration method, with data for a set of industrialized countries. The paper finds evidence of statistically significant long-run relationships and plausible point estimates, which contrasts with much existing evidence. The failure of others to establish such relationships may reflect the estimation method they use rather than any inherent deficiency of the fundamentals-based models.

The relationship between the monetary regime and output volatility: a multivariate GARCH-M model of the Japanese experience, 1919–1996

In this paper we tried to determine whether or not adherence to a floating exchange rate regime helped the Japanese economy to absorb shocks which originated from domestic and foreign sources based on the Japanese experience from the interwar to the post Bretton Woods floating exchange rate period. Using a multivariate GARCH-M model, we analyzed the relation of exchange rate volatility and output volatility directly. The results imply that the floating exchange rate regime has helped the Japanese economy to insulate itself from foreign shocks. The estimated coefficient which represents the response to the foreign shocks decreases and the decrease is significant in the floating exchange rate regime.

Long-run purchasing power parity with short-run data: evidence with a null hypothesis of stationarity

We investigate long-run Purchasing Power Parity with data from the current floating exchange rate period by using tests where stationarity and cointegration are the null, rather than the alternative, hypotheses. In most cases, we cannot reject either the null hypothesis of stationarity of the real exchange rate or the null of cointegration between the nominal exchange rate and the domestic and foreign price levels. This constitutes evidence of long-run Purchasing Power Parity because, using the same tests, we can reject the null of stationarity for the nominal exchange rate. Confirmation of the results is provided by a Monte Carlo study.

Price level trend-stationarity and the instruments and targets of monetary policy: An empirical note

The application of a stationarity test to floating exchange rate period data indicates a trend reverting price level in Switzerland with a base money targeting central bank whereas for the countries with interest rate oriented monetary policy (Germany, Japan, UK, USA) the data suggest a difference stationary or trend break behavior of the price level.