Floating Exchange Rate Research Articles

Does Exchange Rate Undervaluation Have a Symmetric or Asymme-tric Effect on Economic Growth?

This paper investigates the asymmetric pass-through of real exchange rate undervaluation (Underval) on economic growth. The study using the autoregressive distributed lagged (ARDL) and non-linear autoregressive distributed lagged (NARDL) models reveals the complex and asymmetric effects of Underval on economic growth across different economies for the period 1984-2022. In developing countries, particularly those with floating exchange rate regimes, undervaluation can enhance economic performance by boosting exports and attracting foreign investment. However, in developing countries with fixed exchange rate regimes, undervaluation poses significant challenges and can lead to negative economic outcomes due to the rigidity and financial burdens associated with maintaining a fixed exchange rate. Conversely, developed countries and emerging markets exhibit a more muted response to underval, reflecting their greater economic stability and resilience. These findings highlight the importance of tailoring exchange rate policies to each country's specific economic context and exchange rate regime to optimize their impact on economic growth.

Parallel Currencies under Free Floating Exchange Rates: A Model Setting Out the Conditions for Stable Currency Competition

We use a theoretical model to set up the conditions for a country to attain monetary stability by allowing for two freely tradable currencies to circulate in parallel. For this parallel system to function properly, confidence in the good behavior of the monetary authorities in charge of the two currencies is key. Our model shows how a floating exchange rate between the two can keep the issuers of the local currency in check. The results from our model show the conditions under which a parallel currency system disciplines the issuers of the currencies and thus maintains their purchasing power. In non-volatile economies, it also discourages governments (or private issuers) from inflating one of the currencies as a means to raise seigniorage, as this policy results in the displacement of the currency from the market. When foreign payments shortfall—such as in Greece and Cyprus during the ‘euro crisis’ in the mid-2010s, or intractable hyperinflation—leave the country without a medium of exchange, our model shows how currency choice can restore monetary circulation and offer a path to achieving and maintaining monetary stability.

The Evolution of the International Monetary System: Impacts on Multinational Firms and Global Trade

The International Monetary System is a global system that regulates money transfers between different nations. It includes currency exchange rates, regulation of international payments, legislations on capital movements, and worldwide financial organizations, including the IMF. The paper analyses how the change over time of the International Monetary System (IMS) affects the international trade and MNCs. Thus, from the Bretton Woods new exchange regime established in 1944–1971 to the current floating exchange rate system, it has been analyzed in regard to the IMS's historical development. Because of the increasing volatility in the currency rate, this has consequently had an impact on the stability of international transactions and trade volumes. The IMS study investigates exchange rate systems, capital flow regulations, and the role of international financial organizations, including the IMF. For its methodology, the study resorted to a mixed-method approach, combining numbers analysis-that includes regression models and time- series data on exchange rates, amounts of international trade, and MNC performance-with analysis of the historical record and inspection of IMF policy documents. The study shows that trade goes down during big financial troubles, like the Asian Financial Crisis in 1997 and the Global Financial Crisis in 2008. It also shows that changes in exchange rates make global trade smaller, especially during these crises. Also, while IMF help, such as structural adjustment programs, often causes short-term problems for multinational companies (MNCs), like less foreign direct investment (FDI), these policies usually help stabilize economies and lead to recovery in the long run. The outcomes indicate how the IMS, international trade, and multinational corporations are intertwined. Acquainting oneself with the fluctuating money system is very crucial because it enables a person to make informed decisions about the world economy. Keywords: International Monetary System (IMS), Exchange Rate Volatility, Multinational Corporations (MNCs), International Trade, International Monetary Fund (IMF)

Does official development assistance (ODA) cause the Dutch disease in developing countries

PurposeThis paper aims to investigate whether official development assistance (ODA) inflows to developing countries (lower-middle and low income) can cause the symptoms of Dutch disease or not.Design/methodology/approachThis study applies the methodology of dynamic panel data estimation with a one-step system generalized methods of moment (GMM) for the sample of 59 developing countries from 2001 to 2019.FindingsThe results indicate that ODA (as a percentage of gross domestic product (GDP)) rises by 1%, the real effective exchange rate (REER) appreciates by 0.252%. This finding reveals that these selected developing countries have faced the symptoms of Dutch disease. The countries with the higher ODA ratio have a higher effect of the Dutch disease, and the managed floating exchange rate regime is the lowest impacted, when compared to the fixed and flexible exchange rate.Practical implicationsThe selected countries are recommended to use ODA inflows right and efficiently. These ODA inflows should be invested in productive sectors or support for production rather than in consumption. The managed float exchange rate regime is applied to reduce the symptom of Dutch disease for the selected countries. The good cooperation of monetary and fiscal policies is important to absorb the huge ODA inflow and sterilize the adverse effects of the disease.Originality/valueThe paper contributes to the literature and empirical of the Dutch disease. An adverse effect of the huge ODA inflow to the developing countries appreciated of the real exchange rate and caused the symptom of the dutch disease.Peer reviewThe peer review history for this article is available at: https://publons.com/publon/10.1108/IJSE-12-2022-0777

Exchange rate flexibilization and macroeconomic determinants: Evidence from MENA region

Many emerging economies have significantly changed their economic policies by adopting floating exchange rate regimes. This article aims to investigate the relationship between exchange rate variations and key macroeconomic indicators in the MENA region, focusing specifically on Egypt, Tunisia, and Turkey. The study employs regression analysis to explore how macroeconomic factors such as inflation, interest rates, trade balances, foreign exchange reserves, etc. influence exchange rate movements in these economies. By conducting a comprehensive regression model, we aim to provide insights into the complex dynamics of exchange rate fluctuations and their implications for economic stability and policymaking in the MENA region.

Capital controls in China: A necessity for macroeconomic stability

This paper investigates the crucial role of capital controls in maintaining macroeconomic stability in China. We develop an open macroeconomic model integrating capital controls within a managed floating exchange rate system. Our model shows that capital controls enhance the effectiveness of foreign exchange interventions by restricting capital outflows and providing a broader array of policy options, though they may also create discrepancies between domestic and foreign asset holdings. Simulations using quarterly time-series data reveal that capital controls are essential for the success of both sterilized and non-sterilized interventions. These results indicate that the combined use of capital controls and foreign exchange interventions can reduce macroeconomic volatility in China. Moreover, our analysis of fixed versus floating exchange rate regimes suggests that an inappropriate regime choice can increase volatility in capital flows. Therefore, China should adopt a balanced financial approach within its managed floating system to stabilize the macroeconomy.

Impact of Exchange Rate Regime Change on Bangladesh RMG Exports to the USA and the EU

Abstract Bangladesh adopted floating exchange rate system in May 2003. After that regime change, the country has faced a relatively higher volatility of nominal exchange rate than previous regime. Economic theories on volatility suggests that trade flow is adversely affected in response of fluctuation of the exchange rate. Bangladesh is the second largest readymade garments (RMG) exporter in the world and it is the main export product of the country. In this research, Difference in Difference (DID) model introduced by Card and Krueger (1994) is used for the yearly data of 1983 to 2022 to discern this impact of volatility on the RMG exports of Bangladesh. The result shows that RMG exports is negatively affected due to the exchange rate volatility and the estimated figure shows that on Bangladesh‘s average RMG exports has been lessened to the USA and EU regions by US$1.04 billion and 1.02 billion, respectively, owing to the volatility incurred by the regime change. Therefore, as volatility obviously has hindered RMG exports, the central bank of Bangladesh should stay alert to avoid high volatility of the nominal exchange rate to keep the RMG exports flow uninterrupted.

EXCHANGE RATES AND STOCK MARKET DYNAMICS: ISLAMIC VERSUS CONVENTIONAL FINANCIAL SYSTEMS

This study investigates the changes and persistence in dynamic connectedness between stock market performance and exchange rate fluctuations, comparing conventional and Islamic financial systems. With an eye on a global financial landscape characterized by the integration of capital markets and the adoption of floating exchange rate regimes, it examines the effects of exchange rate variations on the dynamics of the stock market in nine different countries - the United Kingdom, Australia, Japan, Singapore, Canada, China, India, Korea, and South Africa. The study employs daily data spanning from November 2015 to July 2023 and uses a comprehensive analysis of three-step methodology, including nonparametric causality-in-quantiles tests, asymmetric slope Conditional Autoregressive Valueat-Risk (CAViaR), and Time-Varying Parameter Vector Autoregressive (TVP-VAR) Connectedness measure. Our results underline the asymmetric impact of exchange rate fluctuations on stock markets and highlights the distinctive characteristics of Islamic financial markets. Comparing Islamic and conventional stock markets in the context of exchange rate fluctuations, this study not only serves to fill a gap in the existing literature but also emphasizes the significance of currency exchange rate swings for global investors, policymakers, and practitioners trying to understand the intricacies of global financial markets.

Editorial for the Special Issue of Comparative Economic Studies: 50 Years After the End of Bretton Woods—The Experiences of Small Open Economies

AbstractThis special issue of Comparative Economic Studies, commemorating fifty years since the end of the Bretton Woods system, examines the adjustment of small open economies to floating exchange rates and new monetary policy frameworks. Based on a workshop held at the KOF Swiss Economic Institute in June 2023, six papers analyse dimensions such as the evolution of monetary policy regimes, the impact of economic crises and the use of unconventional monetary policies in Canada, Israel, Norway, Sweden and Switzerland. The findings highlight the benefits and limitations of inflation targeting, the challenges of global financial integration and the strategic responses of central banks to maintain stability and independence, providing policymakers with valuable insights into the complex dynamics of monetary policy in the post-Bretton Woods era.

The Relationship Between Current Account Deficit and CBRT Policy Rates After the 2008 Crisis: ARDL and NARDL Bounds Test Approach

The current account deficit has continued as a constant problem due to the structural problems of the Turkish economy and the impact of the tightening monetary policy decisions taken after the 2008 global crisis. For this reason, measures regarding the current account deficit are among the priority agenda items of the CBRT. The aim of this study is to examine the relationship between the current account deficit and the policy interest rate in the inflation targeting and floating exchange rate system using the ARDL bounds test method in the period 2011:Q1-2023:Q1. Cointegration results confirm the existence of a long-term relationship between the variables. Long and short term coefficients show that the policy rate does not have a significant effect on the current account deficit.The findings indicate that the expected impact of policy rate adjustments on the current account deficit is limited. It is thought that this situation arises from the fact that the reaction of the exchange rate to the policy interest is more decisive in inflation targeting than the reaction of the current account deficit. Therefore, keeping the current account deficit at a sustainable level will depend on exchange rate stability.

Why does uncovered interest parity fail empirically?

The Uncovered Interest Parity theory, predicated on perfect capital mobility and a floating exchange rate regime, faces challenges in real-world contexts marked by capital restrictions and diverse exchange rate regimes. This research investigates the validity of the UIP hypothesis in selected OECD countries, considering the role of capital control and de facto exchange rate regimes. By analyzing annual and monthly data, including immediate rates, short-term borrowing rates, and 10-year government bond rate differentials, several panel estimation techniques and alternative empirical models are employed. The results are robust to sub-sample analyses, alternative specifications of the empirical model, and different estimation methods. The study provides evidence supporting the UIP, particularly for immediate and short-term interest rates. The empirical examination underscores the necessity of accounting for the de facto floating exchange rate regime and capital flow restrictions when testing the UIP model. Consequently, the UIP hypothesis moves beyond being a theoretical fallacy and emerges as empirically verifiable, holding significant implications for policymakers and advancing the understanding of international finance.

UKRAINE’S MONETARY POLICY UNDER MARTIAL LAW

The relevance of the research is due to the change in the monetary policy regime of the National Bank of Ukraine (NBU), which consists in the transition from inflation targeting with a floating exchange rate to a fixed exchange rate as the nominal anchor of monetary policy under martial law. Such a plan to change the monetary policy regime was carefully calculated and outlined in the NBU's Monetary Policy Guidelines for the Duration of Martial Law. The timeliness and effectiveness of the NBU's monetary policy decisions enabled it to mitigate the impact of the military shock on the macro-financial stability of the national economy. The purpose of the article is to consider the theoretical and practical aspects of the NBU's monetary policy under martial law. Methodology. The study uses a systematic method of cognition to determine the sequence of application of monetary policy instruments to smooth out monetary shocks of the wartime period; an abstract-logical method to understand the future monetary policy strategy based on the abandonment of the fixed exchange rate regime and a gradual return to inflation targeting; and a statistical method to analyse the dynamics of monetary indicators of the national economy. Results. The paper presents the main principles of the NBU's monetary policy under martial law. The first shock from the war led to changes in the conduct of monetary policy and a shift to unconventional instruments of its regulation. The gradual adaptation of the economy to the new conditions determined the NBU's further steps to ease monetary policy and move to greater exchange rate flexibility. Practical implications. The practical significance of the research results is to assess the conditions for the transition from the key policy rate-based inflation targeting regime as the main monetary policy instrument to the use of foreign exchange interventions as the main operation in the foreign exchange market under martial law. Value / Originality. The originality of the article is due to the need to identify the prerequisites for the transition to a new monetary policy strategy in a wartime economy. Conclusions. The NBU's timely response to the negative phenomena associated with deteriorating inflation expectations, multiple exchange rates and pressure on international reserves helped prevent the development of a currency and financial crisis in Ukraine. Despite the active hostilities, the NBU is trying to find options that will allow it to conduct an effective monetary policy in the face of a full-scale invasion and unprecedented internal and external shocks. Internationally, Ukraine has exceeded expectations and the NBU has shown a high degree of responsibility, professionalism and creativity in the conduct of monetary policy. Increased confidence in the central bank is a valuable resource in times of martial law.

Monetary policy independence in an era of financial globalization: what theory suggests and the data in Oceania say

ABSTRACT This paper shows that under a floating exchange rate and integrated financial markets an optimizing central bank concerned about price and output stability partly accommodates a change in monetary policy abroad. A positive co-movement between the domestic policy rate and the foreign interest rate does not indicate lack of monetary policy independence but is an outcome of optimal policymaking in an open economy deeply embedded in the global financial architecture. Empirical evidence on overnight interest rate changes in Oceania (New Zealand, Australia) and US federal funds rate changes is consistent with this view.

Exchange rate, external reserves and current account balance nexus in oil-dependent countries: A Toda-Yamomoto-based Panel Vector Autoregressive (PVAR) approach

The international monetary authorities have been consistently advising oil-dependent countries to change their exchange rate policy from a fixed to a floating exchange rate regime. While some of these countries including Nigeria have announced their adoption of a free-floating exchange rate system, evidence shows that the majority are suffering from “fear of floating”, hence operating an abridged exchange rate system. This study employs the Toda-Yamomoto-based Panel Vector Autoregressive (PVAR) model to use the causality approach to determine the exchange rate system that best explains the de facto exchange rate policy system operating in these countries. This is explained by the dynamic causality between exchange rates and foreign reserves. The dynamic causality between the exchange rate and current account balance also explains the potential effect of devaluation to improve the external trade balance, which implies the J-curve and Marshall Lerner condition. The results show that there is no significant causality from foreign reserves and trade balance to the exchange rate, suggesting that oil-dependent countries are more aligned to a fixed exchange rate regime than a floating exchange rate regime. We also find significant negative causality from the exchange rate to foreign reserves, while foreign reserves have a positive causal effect on the current account balance. This implies that the expected devaluation gains that may be prompting oil-dependent countries to stick to fixed exchange rate regimes are not there, as currency devaluation tends to worsen trade performance and foreign reserves rather than improve them. While oil-dependent countries are not benefiting much from a fixed exchange rate system, it is recommended that appropriate policy to boost private sector generation of foreign exchange should be put in place before the adoption of a full-fledged floating exchange rate system.

A study of the dynamic relationship between the RMB exchange rate, foreign exchange reserves and monetary policy

In today's globalized economic environment, the relationship between China's RMB exchange rate, foreign exchange reserves and monetary policy has become more and more complex, and is crucial to the stability and sustainable development of the economy. The interactions among these three have a direct impact on China's macroeconomic situation, so it has become a very urgent task to study this relationship in depth. This study combines theoretical and empirical research to deeply analyze the dynamic relationship among these three, aiming to provide practical guidance for the formulation of China's monetary policy.This paper selects the time series data of RMB exchange rate, foreign exchange reserves and money supply from 2003 to 2023 to study the relationship between RMB exchange rate, foreign exchange reserves and monetary policy. This paper will deeply explore the impact of the government's market intervention on the RMB exchange rate under different exchange rate regimes, especially under the fixed exchange rate regime and the floating exchange rate regime. This paper will delve into the transmission mechanism of monetary policy, especially the flexibility and adaptability of monetary policy under the volatility of global financial markets and changes in economic cycles. In terms of empirical research, this paper will use the VAR model and the GARCH model for time series analysis to verify the applicability of the theoretical mechanism in practical situations and provide lessons for the formulation of future monetary policy.

Spillover effects of multidimensional information in Fed statements on China's bond market

This paper shows significant information spillover effects of Fed statements on China's bond market. Regarding Fed monetary policy statements as external shocks, we extract both monetary policy information and narrative sentiment information from the statements, with the sentiment data measured using the text analysis method. Furthermore, it investigates spillover effects of the multidimensional Fed information on investors' trading behaviors in China's bond market, using the event study method. Our study emphasizes three key findings. First, both monetary policy and textual sentiment within Fed statements influence trading decisions of China's bond investors, generating international spillover effects. Importantly, the role of textual sentiments as an additional spillover channel of Fed statements has been overlooked in existing literature. Second, the US monetary policy information influences investors' expectations of China's short-term interest rates and their perceptions of risks associated with holding China's long-term bonds, while the Fed's negative and uncertain sentiments primarily impact investors' short-term rate expectations. Moreover, the spillover effects of Fed sentiments on China's yield curve cannot be blocked by China's managed floating exchange rate regime. Third, the heterogeneity test reveals that spillover effects of multidimensional information in Fed conventional monetary policy statements on China's bond market are stronger than those of Fed unconventional monetary policy statements. These findings suggest that Fed narrative sentiments should be incorporated into the research framework of international spillover effect of monetary policy, especially amidst the current period characterized by growing anticipation of federal funds rate cuts and enduring monetary policy uncertainty, providing valuable insights for trading decisions of China's bond market investors.

Three aspects of the critical analysis of the bank of Russia’s activities

The article analyzes the policy of the Central Bank of Russia in three aspects: setting the key rate, the low level of monetization of Russia’s GDP and determining the causes of inflation. The transition of the Bank of Russia from a liberal to an ultra-liberal policy is proved, expressed in the policy of targeting inflation, the floating exchange rate of the ruble and the liberalization of cross-border capital flows. The logical error of the Central Bank in determining the consequences of raising the key rate is shown. It rises to stop the inflation of demand, and thus causes the inflation of production costs. As a result, the opposite effect is achieved – an increase in inflation. The same process is facilitated by maintaining a low level of GDP monetization and incorrectly determining the causes of inflation in Russia, which is non-monetary in nature in the country. The author concludes that in its policy of expensive money, the Central Bank relies more on political factors than economic ones.

The Importance of Sound Monetary Policy: Some Lessons for Today from Canada’s Experience with Floating Exchange Rates Since 1950

The Importance of Sound Monetary Policy: Some Lessons for Today from Canada’s Experience with Floating Exchange Rates Since 1950

The Role of Macro‐Economic Policy in Explaining China's Current Account Surplus

AbstractI assess how much of China's current account surplus can be explained by government policy of capital controls and foreign reserve accumulation during a period of rapid productivity growth. My model can generate an increase in China's current account surplus and foreign reserve holdings. I find that half of the peak in China's current account surplus can be explained by its capital control policies and half by its foreign reserve accumulation policies. Under an open capital account and floating exchange rate, China would have run a current account deficit of 6.5% of GDP.

Currency Exchange Rate Formation in Ukraine: Problems and Ways of Optimization

The conducted analysis proved the presence of quite diverse trends in the foreign exchange market of Ukraine: the national currency is undervalued, the exchange rate is unstable, a significant burden on the financial system as a whole due to the growth of public debt, a high level of dollarization of the economy. That is, on the one hand, there are destructive processes, including those of a chronic nature. On the other hand, the national currency market quickly and easily picks up new opportunities that come to all spheres of economic life, related to digitization and electronic means of trade.
 It was revealed that of the key macroeconomic variables that determine the exchange rate: gross domestic product, government debt, gold and foreign exchange reserves, balance of payments, inflation, it is inflation that has the greatest influence on the exchange rate.
 Key macroeconomic parameters determining the state of the foreign exchange market can have a destabilizing effect on the foreign exchange market both at a fixed and at a floating exchange rate. It has been proven that the use of any of these regimes in their "pure" form is particularly risky for the economy. An algorithm for making a decision on softening/increasing course flexibility was proposed.