Floating Exchange Rate Research Articles

Harry Johnson's “Case for flexible exchange rates”—50 years later

AbstractFifty years ago, Harry G. Johnson published “The Case for Flexible Exchange Rates, 1969”, its title echoing Milton Friedman's classic essay of the early 1950s. Though somewhat overlooked today, Johnson's reprise was an important element in the late 1960s debate over the future of the international monetary system. The present paper has three objectives. The first is to lay out the historical context in which Johnson's “Case” was written and read. The second is to examine Johnson's main points and see how they stand up to nearly five decades of experience with floating exchange rates since the end of the Bretton Woods system. The third is to review the most recent academic critiques of exchange‐rate flexibility and ask how fatal they are to Johnson's basic argument. I conclude that the essential case for exchange‐rate flexibility still stands strong.

Macroprudential policy and the probability of a banking crisis

The ultimate purpose of macroprudential policy is to avoid financial instability, such as banking crises, which have a long-lasting and devastating effect on the economy. Although a growing number of studies have examined the effects of macroprudential policy on credit growth, few empirical studies have analyzed its effect on the probability of a banking crisis. Does macroprudential policy actually affect the probability of a banking crisis? Do other macroeconomic policies matter for the effectiveness of macroprudential policy? To answer these questions, this paper empirically investigates the effect of macroprudential policy on the probability of a banking crisis and its relationship with other macroeconomic policies. Specifically, using data on 65 countries from 2000 to 2016, we employ a probit model to analyze the effect of changes in the loan-to-value (LTV) ratio on crisis probability. Our results show that macroprudential policy is effective in changing the probability of a banking crisis via a credit channel and that its effectiveness depends on other macroeconomic policies. Changes in the LTV ratio are found to be effective in influencing the probability of a banking crisis in countries that have inflation targeting frameworks, floating exchange rate regimes, and/or no capital controls. Our results underscore the importance of policy coordination among different government bodies to design an appropriate macroprudential policy, especially in the current context of the Covid-19 crisis.

Модель реального обменного курса рубля с марковскими переключениями режимов (Model of the Real Exchange Rate of the Ruble With Markov Mode Switches)

Russian Abstract: В работе анализируется взаимосвязь реального обменного курса рубля и реальных цен на нефть на основе модели коррекции ошибок с марковскими переключениями режимов, позволяющей учесть изменения политики курсообразования. Показано, что в период 1999-2018 гг. хорошо разделяются два режима динамики реального курса: с быстрым и медленным приспособлением к долгосрочному равновесию в ответ на шоки цены нефти. При этом не отвергается гипотеза о том, что долгосрочная взаимосвязь между реальным обменным курсом и ценой на нефть инвариантна к изменению режима. Также показано, что, несмотря на переход к плавающему обменному курсу, в последние годы периодически идентифицируется режим негибкого курсообразования, что может быть связано с новым бюджетным правилом, согласно которому с февраля 2017 г. Минфин России ежемесячно покупал иностранную валюту в объеме превышения фактических поступлений нефтегазовых доходов над уровнем нефтегазовых доходов федерального бюджета, сформированного при цене на нефть марки “Юралс” 40 долларов США за баррель. English Abstract: The paper analyzes the relationship between the real Russian ruble exchange rate and real oil prices using the error correction model with Markov regime switching, which allows for changes in exchange rate policy. It is found that during the period 1999-2018 real exchange rate dynamics was characterized by two clearly distinguishable regimes, one with fast and the other with slow adjustment to long-term equilibrium in response to oil price shocks. Further model testing shows that long-term relationship between real exchange rate and oil price is invariant to regime change. It is also found that, despite adoption of a floating exchange rate policy in 2014, inflexible real exchange rate regime has been periodically identified in recent years. This could be due to the new budget rule, according to which Russian Ministry of Finance in February 2017 started purchasing foreign currencies in amount of excess oil and gas earnings of the federal budget.

Estimated Policy Rules for Capital Controls

This paper borrows the tradition of estimating policy reaction functions from monetary policy literature to ask whether capital controls respond to macroprudential or mercantilist motivations. I explore this question using a novel, weekly dataset on capital control actions in 21 emerging economies from 2001 to 2015. I introduce a new proxy for mercantilist motivations: the weighted appreciation of an emerging-market currency against its top five trade competitors. This proxy Granger causes future net initiations of non-tariff barriers in most countries. Emerging markets systematically respond to both mercantilist and macroprudential motivations. Policymakers respond to trade competitiveness concerns by using both instruments—inflow tightening and outflow easing. They use only inflow tightening in response to macroprudential concerns. Policy is acyclical to foreign debt; however, high levels of this debt reduces countercyclicality to mercantilist concerns. Higher exchange rate pass-through to export prices, and having an inflation targeting regime with non-freely floating exchange rates, increase responsiveness to mercantilist concerns.

Macroeconomic policies in Brazil before and after the 2008 global financial crisis: Brazilian policy-makers still trapped in the New Macroeconomic Consensus guidelines

Abstract Even though the New Macroeconomic Consensus (NMC) guidelines have been under review by mainstream economists from developed countries since the 2008 global financial crisis, Brazilian policy-makers are still following these old recommendations. The NMC was adapted in Brazil in 1999 as a policy arrangement known as the macroeconomic tripod: a combination of inflation targeting, floating exchange rates and targets for the primary fiscal surplus. The theoretical basis of this policy arrangement is thus closely aligned to that of the NMC: a reduced (if any) role for fiscal policy and an exclusive focus on price stability for monetary policy. Particularly with respect to the experience of inflation targeting in Brazil, by implementing a vector autoregression model for the period 2000–17, we show that (i) inflation dynamics are mostly cost-push rather than demand-pull; (ii) inflation rates show low sensitivity to changes in interest rates; and (iii) the main variables negatively affected by an increase in the Brazilian policy rate are the nominal exchange rate (i.e. the Brazilian real tends to appreciate) and output growth. It follows that the macroeconomic tripod is unsuitable to the Brazilian economy, especially considering that, as it is also shown in this article, such arrangement has contributed to perpetuating trends of high real interest rates, domestic currency overvaluation and low economic growth in Brazil in the last two decades. The article ends calling for a new macroeconomic arrangement to reverse these adverse long-term trends.

U.S. Monetary Policy and the Global Financial Cycle

Abstract U.S. monetary policy shocks induce comovements in the international financial variables that characterize the “Global Financial Cycle.” A single global factor that explains an important share of the variation of risky asset prices around the world decreases significantly after a U.S. monetary tightening. Monetary contractions in the US lead to significant deleveraging of global financial intermediaries, a decline in the provision of domestic credit globally, strong retrenchments of international credit flows, and tightening of foreign financial conditions. Countries with floating exchange rate regimes are subject to similar financial spillovers.

Determinants of Real Exchange Rate Evidence: from Egypt

In November 2016, the Central Bank of Egypt (CBE) had announced the adoption of a floating exchange rate regime. Determining the equilibrium exchange rate is a chronic problem in the Egyptian economy, this means that the exchange rate is determined according to several variables. So, this research comes to examine the determinants of the exchange rate dealing with money supply, trade openness, and foreign exchange reserves. This research uses time-series data from 1990 to 2018 and depends on the method of co-integration (Autoregressive Distributed Lag Model, ARDL) through which the relationship is estimated in the long run, and depends on the Error Correction Mechanism (ECM) method to estimate the relationship in the short run, and the model is applied through the statistical program EViews. Besides using the descriptive method to view and analyze the exchange rate problem, the variables, and interpretation of the results. This study revealed that foreign exchange reserves and broad money have a significant and positive impact on the real exchange rate in the long-run, as well as trade openness and foreign exchange reserves have a significant impact and positively related to the real exchange rate in the short-run. The study also found, If the real exchange rate is deformed, it will need about 21 months to return to equilibrium.

VOLATILITAS INDEKS KOMPOSIT PASAR MODAL ASEAN-3

Rapid integration between domestic and world economy in the last decade has been a major issue. For Indonesia, the situation has been accelerated by the adoption of floating exchange rate regime in 1997, also with the development of Indonesia stock exchange. One notable financial variable that often exposed to external shocks is stock market index. This research will analyzed the behavior of 3 major stock market indices in ASEAN, those are Jakarta Composite Index (JCI), Kuala Lumpur stock index (KLSE), and Singapore stock index (STI). The employment of volatility model is chosen to figured the behavior of those 3 indices, and to analyze the aggregate investment in each stock market. Observation will be based upon monthly basis, from 2010 until 2015.The findings in this research are (i) similarity in the movement behavior of ASEAN-3 stock market indices, (ii) Indonesia stock market shows the highest aggregate investment return relative to Malaysia and Singapore, (iii) Singapore stock market shows the lowest aggregate investment risk relative to Indonesia and Malaysia, as the representation of more developed stock market.

Contribution of International Trade and Capital Accumulation to Economic Growth of Thailand during the last half of the 20th century

The present paper examines the links between international trade, capital and economic growth in Thailand from 1950 to 2000 in an applied growth model including exchange rate as a control variable. Prior to 1980 the elasticity of per capita income with respect to trade was -0.2% switching to 0.07% in 1980 in line with the change from resource exports and import substitution to manufactured exports. The exchange rateelasticity of per capita income prior to 1980 was 0.4% switching to -0.2% consistent with the move to a floating exchange rate. Results confirm the overriding theoretical importance of investment to economic growth

РОЗБАЛАНСОВАНІСТЬ ДЕРЖАВНИХ ФІНАНСІВ ЯК ЧИННИК КУРСОВОЇ ТА ЦІНОВОЇ НЕСТАБІЛЬНОСТІ

У статті розглядаються умови ефективної реалізації інфляційного таргетування, серед яких основними є плаваючий режим валютного курсу та збалансованість державних фінансів. Аналізуються чинники, що впливають на волатильність курсу гривні та причини розбалансування державного бюджету. Наголошується на тому, що дефіцит держбюджету в країні на сучасному етапі економічного розвитку є великим, а одне з основних джерел його погашення – випуск державних цінних паперів несе в собі курсові та цінові ризики. Проведена оцінка обсягів державного боргу України і показано, що він перевищує рівень гранично допустимого. Для збалансування державного бюджету запропоновано дотримуватися фіскальних правил.

Volatility connectedness in global foreign exchange markets

We statically and dynamically measure total and directional volatility connectedness in global foreign exchange (forex) markets. We use the volatility spillover index and LASSO-VAR approaches in the variance decomposition framework to construct high-dimensional volatility connectedness network linking 65 major currencies. Empirical results indicate that the US dollar (USD) and Euro are major volatility transmitters while other currencies including Japanese yen and British pound are basically net volatility receivers. In volatility connectedness network, currencies tend to be clustered according to geographical distributions. Dynamically, total volatility connectedness reacts sensitively to changes in international economic fundamentals and increases during crisis periods. Directional volatility connectedness of Renminbi has decreased significantly since the reforms of the Chinese exchange rate regime (which shifts from a USD-pegged exchange rate regime to a regulated, managed floating exchange rate regime). Generally, oil exports, forex regimes and monetary policies are major factors driving volatility transmission across global forex markets.

Exploring the Output Effect of Fiscal Policy Shocks in Low Income Countries

What do we know about the output effects of fiscal policy in low income countries (LICs)? There are very few empirical studies on the subject. This paper fills this gap by estimating the output effects of government spending shocks in LICs. Our analysis—based on the local projection method—finds that the output effects in LICs are markedly lower than those in AEs and marginally smaller than those in EMs. We also find that in LICs, the output effects are larger (i) during recessions; (ii) under a fixed exchange rate regime; and/or (iii) with higher quality of institutions. Our analysis could not confirm any statistically significant output effect under floating exchange rate regimes. For the estimation of the output effects of fiscal spending shocks, it is thus important to consider the state of the economy and the country’s structural characteristics. Our results imply that the output costs of fiscal adjustment in LICs may not be as large as previously thought, especially if adopted outside of a recession, based on cutting public consumption, and accompanied by reform to enhance institutions.

Development of Inflation Expectations in Serbia and a Comparative Analysis

Abstract Inflation expectations are very important when it comes to monetary policy and its decisions. In countries which are applying inflation targeting, inflation expectations reflect prediction of economic agents of movement of inflation rate in mid and long term. Anchored inflation expectations and their movements within target tolerance band are pointing to effectiveness of the inflation targeting strategy. Consistent with the best international practice, after introducing the inflation targeting regime in January 2009, the National Bank of Serbia began monitoring and analysing inflation expectations of economic agents (financial sector, corporate sector, trade unions, and households). The aim of this paper is to analyse inflation expectations in Serbia, but also to give a comparative analysis of inflation expectation of other countries which are using inflation targeting and floating exchange rate, as is the case of the National Bank of Serbia.

Harry Johnson's "case for flexible exchange rates"—50 years later

Fifty years ago, Harry G. Johnson published “The Case for Flexible Exchange Rates, 1969,” its title echoing Milton Friedman’s classic essay of 1953. Though somewhat overlooked today, Johnson’s reprise was an important element in the late 1960s debate over the future of the international monetary system. The present paper has three objectives. The first is to lay out the historical context in which Johnson’s “Case” was written and read. The second is to examine Johnson’s main points and see how they stand up to nearly five decades of experience with floating exchange rates since the end of the Bretton Woods system. The third is to review the most recent academic critiques of exchange rate flexibility and ask how fatal they are to Johnson’s basic argument. I conclude that the essential case for exchange rate flexibility still stands strong.

Оценка эффективности политики бюджетных расходов

The article discusses opportunities for improving fiscal policy in order to ensure macroeconomic stability and sustainable growth of the Russian economy. Budget expenditures have several key macroeconomic goals, the quality of which determines the effectiveness of budget spending policies. The authors developed a methodology that allows evaluating changes in the efficiency of budget expenditures based on a set of indicators. The estimates are based on the Russian Federation as the example, with special attention paid to the implementation of a balanced budget policy over the past decade. In Russia, significant progress has been made in ensuring macroeconomic stability through the introduction of flexible mechanisms for macroeconomic regulation (budget rules and floating exchange rates). However, when planning budget expenditures, additional attention should be paid to ensuring long-term economic growth and inclusive development, the structure of expenditures adjusted in accordance with these priorities. In the final part of the article, we consider changes in budget policy that have become a response to the crisis situation caused by the coronavirus pandemic. It is concluded that an increase in public debt may be appropriate in the current economic conditions in the event of a qualitative improvement in the budget spending policy.

Commodity Price Volatility, External Debt and Exchange Rate Regimes

This study explores the impact of commodity price volatility on external debt accumulation under fixed, managed, and floating regimes. We estimate dynamic panel data models for 97 countries from 1993 to 2016. Our empirical findings show that commodity price volatility increases external debt accumulation for commodity-exporting countries. This impact is three-times higher for countries with fixed exchange rate regimes compared to managed floating exchange rate regimes. Under floating exchange regimes, the effect of commodity price volatility on external debt is statistically insignificant. Our results suggest that the adoption of a floating exchange rate regime by commodity-exporting countries is critical to mitigate the effects of commodity price volatility on external debt accumulation.

Monetary Policy Transmission Mechanisms in the Central and Eastern European Countries

Objective: The aim of this study is to examine monetary policy transmission mechanisms in four Central and Eastern European countries (the Czech Republic, Hungary, Poland and Romania), in the presence of fiscal and exchange rate effects. Research Design & Methods: We implement a structural vector autoregression (SVAR) approach for modelling the interdependencies between monetary and fiscal policies, output gap and consumer price inflation (CPI). In our six-variable model, which includes the budget balance, the output gap, CPI, the central bank reference rate, the lending rate and the real exchange rate (RER), short-run restrictions on the contemporaneous structural parameters imply that the budget balance responds to changes in the output gap and lending rate, while the central bank reference rate is a function of output and inflationary shocks. Findings: The results of our research show that the effects of an increase in the central bank’s short-run interest rate on inflation, output gap and the RER are quite heterogeneous across the CEE countries. As the monetary policy response to inflation seems to be significant and rather uniform across countries, though with a different time pattern, there is no evidence of its reaction to the output gap (except for Romania in the long run). Among other results, budget surplus has a strong anti-inflationary impact in all countries but at the expense of a short-lived output slowdown (except for Hungary). The RER undervaluation is likely to stimulate output (Romania) or depress it (Poland), with a neutral stance in the two other countries. As expected, an increase in the lending rate is followed by a fall in output on impact, while there is no significant effect on inflation. Implications/Recommendations: Our study argues in favour of a much stronger response of the central bank reference rate to the output gap in the CEE countries. As suggested by the experience of Poland, an immediate response of the central bank to inflation could explain the lack of the price puzzle when an increase in the reference rate is associated with a sustained increase in consumer prices. An anti-inflationary monetary policy stance should be strengthened by fiscal tightening, while in a recession a higher budget deficit is likely to boost output and prevent a deflationary spiral. Contribution: The article presents the application of the extended IS-MP-IA model to the modelling of monetary policies by the central banks of the CEE countries that practice a floating exchange rate regime.

Government Expenditures and Economic Growth: A Cointegration Analysis for Thailand under the Floating Exchange Rate Regime

Contributing to the controversial issue on the impact of government spending on economic growth, this paper shows that government spending has long-run impact in stimulating aggregate output in Thailand during the floating exchange rate regime. The results reveal that the long-run relationship between aggregate output, government expenditures and private consumption is stable. Based on quarterly dataset during 1997Q3 to 2019Q4, the results suggest that expansionary fiscal policy is effective under the floating exchange rate regime. Furthermore, the traditional version of the Wagner’s law is supported since an expansion in aggregate output causes government expenditure to increase. Therefore, the findings in this paper support both Keynesian hypothesis and the Wagner’s law.

Innovation Mechanism in Monetary Policy Forecasting: Unification of all Macroeconomic Puzzles in SVAR Model

The article is devoted to developing a forecasting mechanism unifying all macroeconomic puzzles, which violate fundamental macroeconomic relationships among variables of the monetary transmission mechanism in Ukraine. The violations mentioned above caused by breaking one-law price (PPP puzzle), uncovered interest rates rule (UIP puzzle), plausible emergence of new sophisticated financial instruments, and causality of international risk-sharing conditions under the financial capital spillover. The authors calculated the residuals in the VAR model of monetary transmission mechanism (MTM) to analyze the correlations between shocks and disturbances in these variables. Furtherly these correlations were put in constructing the restriction matrix for building a structural vector autoregressive model. The correlations between shocks and disturbances were employed for estimating the impulse response functions used for determining the duration of half-life shocks for the real exchange rate. The obtained results allowed noticing that relationships between macroeconomic variables in the monetary transmission mechanism were not similar if considering the established foreign exchange arrangement. In particular, during 2007-2020, relationships among MTM variables were violated. Besides, the half-life duration of the real exchange rate was far longer. While in cases for Ukraine before switching to floating exchange rate regime and after it became less explicit and half-lives were shorter. The findings allowed confirming the impact of the currency arrangement switching on violation of traditional linkages between the variables of foreign exchange rate channel of MTM. Thus, it showed that during the fixed arrangement, absolutely all reactions were violated. Although after the introduction of a flexible exchange rate, the sign of REER correlation with foreign trade terms has changed to positive and more strengthened. Therefore, it has demonstrated a positive impact on the dynamics of real GDP and lower inflation. The findings of the current study could be used to improve existed methodical approaches for establishing structural constraints on variables responses to the shock of the exchange rate. The algorithm for designing optimal monetary policy strategies could take place in empirical data and forecasting exchange rate volatility. Keywords: PPP puzzle, UIP puzzle, MTM, financial innovations, REER, SVAR.

Does Monetary Policy Impact International Market Co-Movements?

We show that FED policy announcements lead to a significant increase in international comovements in the cross-section of equity and in particular sovereign CDS markets. The relaxation of unconventionary monetary policies is felt strongly by emerging markets, and by countries that are open to the trading of goods and flows, even in the presence of floating exchange rates. It also impacts closed economies whose currencies are pegged to the dollar. This evidence is consistent with recent theories of a global financial cycle and the pricing of a FED's put. In contrast, ECB announcements hardly affect comovements, even in the Eurozone.