Foreign Currency Holdings Research Articles

Donald Edward Moggridge (1943–2021)

Donald Edward Moggridge (1943–2021)

Policies for Transactional De-Dollarization: A Laboratory Study

Partial currency substitution occurs typically in small economies amid economic crises when the local currency loses some of its essential functions, and foreign currency, usually the US Dollar, is widely adopted. Interestingly, the coexistence of two currencies often persists after macroeconomic stability has returned, which imposes challenges to the conduct of monetary policy. Central banks have responded by applying de-dollarization policies. This paper studies the effectiveness of three of them: (1) taxes on transactions in foreign currency among domestic agents, (2) storage costs on foreign currency holdings, and (3) information on the acceptance rate of the foreign currency among local agents. We extend the model in Matsuyama et al. (1993) to study the effects of these policies, both theoretically and experimentally. We contribute to the theory literature by characterizing a new circulation regime where agents use the foreign currency solely for international trade and settle domestic transactions exclusively in local currency. Our experimental evidence suggests that both taxes and storage costs reduce the overall acceptability of foreign currency in international and domestic transactions (around 40 percent in both cases). Information treatment does not have a significant impact relative to baseline.

Are Regulatory Measures Influencing Bank Performances: The Ethiopian Case

The study has explored the impact of selected regulatory variables on performances applying a panel regression on 18 commercial banks in Ethiopia for the period 1999-2015. The variables used in the model are directly derived from the extant regulatory approach used by the Central Bank to regulate the banking business. The literature review also shows that most of them are enacted in other countries with few exceptions and mainly related to bill purchase requirements. The model constructed, therefore, has established and finds a statistically significant relationship in some of the regulatory variables with performance measures. The most important findings of this study relate to the negative affect of some of the recent policy directions from the regulator on performances. For instance, branch growth and bill purchases have a statistically significant negative relationship with bank performances. This should be one of the areas requiring policy flexing from the regulatory side in the future. Nevertheless, other policy direction such as capital growth requirement remains a positive contributor to performances. More specifically, the study finds that exchange rate has a positive and statistically significant relationship with the profit models. Despite the benefit of a depreciating local currency and a stable foreign currency type to shield them from currency fluctuation, it allowed banks to earn a policy profit. The depreciation of Birr permitted banks to enjoy a profit from their foreign currency holdings in the form of daily asset revaluations. Nevertheless, many of the variables (prudential regulatory variables) used in this study (interest rate, reserve rate, number of new entrant banks, and level of entry capital) are not statistically significant to influence on bank performances.

FINANCIAL AND CREDIT IMPERATIVES OF ALTERGLOBALIZATION THE EMERGING MARKETS

The article analyzes the financial and credit imperatives of alterglobalization the emerging markets. In the study, it is researched the theory of financial globalization and there are established advantages, benefits and disadvantages of financial globalization for emerging markets. There are defined the main conditions and risks of global financial stability and there are analyzed the capital flows to emerging market economies. In the article, it is researched that the combination of declining global trade and growth would increase corporate vulnerability. It is concluded the distribution of government debt breakdown of emerging market economies in foreign currency and nonresident holdings of local currency. In the research, it is established a correlation between emerging market economy and advanced economy volatilities. In the study, it is proved that disadvantages of financial globalization include availability of crises, shocks, risks, external risks and nonliquidity. In the article, it is developed the financial-credit imperatives of alterglobalization the emerging markets and it is argued the transition of emerging markets to an alternative global model of economic development.

An Analysis of the Relationship between Inflation and Gold Prices: Evidence from Pakistan

In this study, we formulate a new inflation equation to capture the potential effects of gold and stock prices on inflation in Pakistan. We aim to assess the inflation-hedging properties of gold compared to other assets such as real estate, stock exchange securities, and foreign currency holdings. Applying time-series econometric techniques (cointegration and vector error correction models) to data for 1960–2010, we find that gold is a potential determinant of inflation in Pakistan. On the other hand, it also provides a complete hedge against unexpected inflation. Real estate assets are more than a complete hedge against expected inflation, although stock exchange securities outperform gold and real estate as a hedge against unexpected inflation. Foreign currency proves to be an insignificant hedge against inflation. Given the dual nature of the relationship between gold and inflation, it is increasingly important for the government to monitor and regulate the gold market in Pakistan. Moreover, stock market investment should be encouraged by the government given that asset price inflation does not pose a critical problem for Pakistan as yet.

Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle

A major puzzle in international finance is that high interest rate currencies tend to appreciate (forward discount puzzle). Motivated by the fact that only a small fraction of foreign currency holdings is actively managed, we calibrate a two-country model in which agents make infrequent portfolio decisions. We show that the model can account for the forward discount puzzle. It can also account for several related empirical phenomena, including that of “delayed overshooting.” We also show that making infrequent portfolio decisions is optimal as the welfare gain from active currency management is smaller than the corresponding fees. (JEL F31, G11, G15)

Special Economic Zones as Survival Strategy of North Korea

IntroductionNorth Korea has recently begun to develop two new projects: the Gaeseong Industrial project (hereafter Gaeseong SEZ) and the Mt. Kumgang tourism project (hereafter Mt. Kumgang SEZ). In terms of their levels of cooperation, partners and functions, these new projects were distinguished from the two earlier SEZs. The Rajin-Sunbong SEZ is a trade-oriented center that includes China, Russia and Japan. The Sinuiju SEZ has focused on the trade-oriented function in order to cooperate with countries in the Yellow Sea rim area including China. In contrast, Gaeseong is envisaged as a production-centered SEZ to attract small and medium-sized South Korean businesses. The Mt. Kumgang SEZ is also cooperating with the Hyundai Asan Corporation of South Korea in the development of an international tourism course.These two new projects were apparently an advanced step toward economic cooperation when compared with the previous level and form of interaction between the two Koreas. The projects have not only contributed to economic exchange, but also have demonstrated the possibility of advancing the two Koreas' political relations. South-North Korean economic cooperation is important in aiding the recovery of cultural and emotional homogeneity as well as promoting reciprocal economic development, development of infrastructure and building a harmonized structure between the two Koreas. Furthermore, such changes in the economic sector could lead to the political stability of North Korea, which, in turn, would contribute to the political and military stability of the entire Korean peninsula.Table 1 summarizes the economical and political effects of two new North Korean SEZs on both North and South Koreas. The effects of the success or failure of the North Korean SEZs will not be confined to the North Korean government; the result will affect the economic and political atmosphere of the entire Korean peninsula and all Northeast Asian countries.Therefore, this paper will address possible routes to success for the North Korean SEZs. The first section provides an analysis of the complicated features of North Korean SEZs. The second section offers an examination of a short-term and longterm development strategy of North Korean SEZs. The concluding section contains a discussion of the most appropriate way to achieve success for the SEZs through close economic cooperation between the two Koreas, with consideration of the eventual establishment of a future commonwealth.The Concept, Developmental Logic, and Type of a North Korean SEZThe Concept of the SEZ in North KoreaAccording to the Dictionary of Economics of North Korea, the Special Economic Zone (Open Zone for Foreigners) is defined as follows (p. 116):China, in 1979, announced some parts of four cities as the special economic zone. The purpose of establishing special economic zones was inducing foreign capital, technology, and management skills as well as increasing foreign trade and foreign currency holdings, accelerating economic development. The Chinese special economic zone is different from the industrial district in capitalist countries. While capitalist countries develop capitalist economies by inducing foreign capital in the industrial district, in the Chinese special economic zone, various economic systems coexist on condition that a socialist economy predominates. Foreign capitalists have the right to possess the means of production, a part of or whole rights of management, the right to employ and discharge workers, and particular privileges and special favors regulated by the Chinese government. However, foreign capitalists have to undertake economic activity in the special economic zone under the supervision and direction of the socialist country.In the same Dictionary of Economics, the so-called industrial district in capitalist countries is defined as follows (p. 176):The origin of the industrial district was the Manchester Industrial District in Britain in the late 19th century and this model has been diffused all around the world after World War I. …

Incomplete Information Processing: A Solution to the Forward Discount Puzzle

The uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle implies that excess returns on foreign currency investments are predictable. Motivated by the fact that even today only a tiny fraction of foreign currency holdings are actively managed, we investigate to what extent incomplete information processing can explain this puzzle. Two types of incompleteness are considered: infrequent and partial information processing. We calibrate a two-country general equilibrium model to the data and show that incomplete information processing can fully match the empirical evidence. It can also account for several related empirical phenomena, including that of “delayed overshooting”. We also show that incomplete information processing is optimal. Predictability is largely overshadowed by uncertainty about future exchange rates, so that the welfare gain from actively managing foreign exchange positions is small and easily outweighed by a small cost of active portfolio management.

Introduction—The EU and Its “Constitution”: Public Opinion, Political Elites, and Their International Context

The European Union is going about its regular business. It is putting forth proposals to keep the Doha Round alive, continuing to negotiate a major trade agreement with Mercosur in South America, keeping peace-keeping troops in Bosnia and Herzegovina, spending development aid in numerous poor countries, financially supporting the Palestine Authority while giving Israel preferential access to the EU market, investigating Microsoft's business practices, and battling over the reach and scope of an ambitious new legislative attempt to regulate the chemical industry. The EU Greenhouse Trading Scheme, the largest greenhouse emissions trading scheme in the world, is up and running. The European Central Bank is making monetary policy decisions while the euro makes up almost 20% of central banks' foreign currency holdings. The European Medicines Agency (EMEA) has called for suspending the sale of the children's vaccine Hexavac. The European Court of Justice, for its part, has recently declared illegal a high profile Italian law designed to prevent foreign takeover of Italian energy companies. And the commissioner for Health and Consumer Protection is playing a leading role in the EU's response to the threat of a pandemic of avian bird flu.

Evolutionary dynamics of currency substitution

This paper examines the issues related to the competition between two currencies in an agent-based computational economic model. The economic environment is a two-country overlapping generations economy with no restrictions on foreign currency holdings. Governments of both countries finance their deficits via seignorage. Agents make decisions about their savings and portfolio decisions. They use the genetic algorithm to update their decision rules. The results presented in the paper show that the currency of the country that finances larger of the two deficits becomes valueless. The adjustment process is characterized by a flight away from the currency used to finance the larger of the two deficits. The economy converges to a stationary equilibrium that corresponds to a single-currency economy.

Can foreign currency deposits prop up a collapsing exchange-rate regime?

The Flood and Garber [Flood, R.P., Garber, P.M., 1984. Collapsing exchange-rate regimes: some linear examples. Journal of International Economics 17, 1–13] speculative attack model is extended to consider whether the authorities could forestall an exchange rate collapse by encouraging foreign currency holdings by domestic residents. Deposits of foreign currency could be held at home or abroad, although domestic residents have a home country preference other things equal. The paper considers the consequences of a required reserves policy on domestically located deposits, which the authorities use to supplement official reserves to defend the exchange rate. Despite initial findings that suggest the life of the regime can be lengthened in this way the paper shows that such a policy does not postpone a collapse but actually hastens it.

Currency Substitution and the Moneyness of Monetary Assets

The previous literature on dollarization processes has two basic problems. First is the poor empirical methods of measurement, and second is the lack of a clear definition of the phenomenon under study. Several methodological problems have not been successfully addressed. Foreign currency holdings cannot be measured directly, and the dollarization ratios are very imprecise as they do not take into account institutional considerations. We present a simple model in which monetary assets are held for two motives: transactions and a store of wealth. Based on the Divisia literature, the model emphasizes the difference in liquidity properties in different monetary assets. In a dollarized economy, this notion is particularly important as we can distinguish two separate phenomena: currency substitution and asset substitution. The first one is measured as the share of total liquidity obtained from dollar- denominated assets. The second one is not related to transactions and, therefore, is just the share of total financial assets that is held in dollar-denominated assets. The model predicts a close relationship between asset substitution and the interest rate differential and between currency substitution and the inflation rate differential. Using the Peruvian dollarization experience (1978-1996), we found significant evidence supporting these hypotheses. Furthermore, we reject the presence of hysteresis as the corrected currency substitution ratios are cointegrated with the inflation differential rate.

The behavior of foreign currency holdings during currency crises: Causes and consequences

This paper evaluates the current literature on dollarization and finds it to be disappointing in its ability to explain many of the prevailling features of the dollarizations experiences in Latin America, Eastern Europe and the Former Soviet Union. The paper takes a different approach to the standard empirical studies, which usually extend a demand for money function to include international variables, by analyzing foreign currency holding behaviors in response to the sustainability and credibility of the exchange rate regime. The results are very promising and explain some of the previously unexplained phenomena which arise from dollarization.

Russian Labor Market in Transition

Declining growth rates in industrial and agricultural output as well as the technological backwardness of Soviet industry fueled Mikhail Gorbachev's 5-year struggle to restructure the socialist centrally planned economy.' Under the auspices of perestroika, new forms of ownership emerged, the state monopoly over foreign trade and hard currency holdings was abolished, Council for Mutual Economic Assistance (CMEA) countries switched to hard currency transactions, enterprises were instructed to become self-financing, state orders replaced plan targets, ministries were reorganized and reduced in number, a growing number of prices were decontrolled, and centrally administered prices more than doubled. Gorbachev not only initiated a unilateral reduction in defense spending and the production of defense-related goods but also granted the Baltic republics independence. Perestroika contributed to the dramatic decline in output-more than 17% in 1991 alone-and to rampant inflation in both the state and nonstate sectors of the economy.2 Unemployment, inevitable as a consequence of declining state orders and military downsizing, was officially recognized for the first time since 1930. The 1991 Law on Employment established job placement and training centers, as well as an unemployment compensation program. With the dissolution of the Soviet Union in 1991 and the adoption in January 1992 of more radical policies to initiate the transition to a market economy, budget deficits, inflation, and unemployment rose to unprecedented magnitudes.3 The consequences are nowhere more dramatically illustrated than in estimates of the number of people living in poverty conditions: perhaps one-third to one-half of the population.4 This article uses official statistics and survey data to analyze the nature and scope of change in the Russian labor market over the last decade. Characteristic features of the Soviet labor market-such as relatively low centrally administered wages, which were differentiated

Dollarization in Transition Economies: Evidence and Policy Implications

After most restrictions on foreign currency holdings were relaxed in the early 1990s, foreign currency deposits in transition economies have been increasing rapidly. This paper takes a first look at the evidence on dollarization for 15 transition economies, and then discusses some key conceptual and policy implications. Depending on the institutional constraints, foreign currency deposits as a proportion of broad money reached a peak of between 30 and 60 percent in 1992-93. Unlike what has been observed in Latin America, however, dollarization has fallen substantially in the aftermath of successful stabilization plans in Estonia, Lithuania, Mongolia, and Poland. Since foreign currency deposits reflect mainly a portfolio choice, the fall in dollarization can be primarily attributed to higher real returns on domestic-currency assets, as a result of lower inflation and more market-determined interest rates.

Dollarization in Transition Economies: Evidence and Policy Implications

After most restrictions on foreign currency holdings were relaxed in the early 1990s, foreign currency deposits in transition economies have been increasing rapidly. This paper takes a first look at the evidence on dollarization for 15 transition economies, and then discusses some key conceptual and policy implications. Depending on the institutional constraints, foreign currency deposits as a proportion of broad money reached a peak of between 30 and 60 percent in 1992-93. Unlike what has been observed in Latin America, however, dollarization has fallen substantially in the aftermath of successful stabilization plans in Estonia, Lithuania, Mongolia, and Poland. Since foreign currency deposits reflect mainly a portfolio choice, the fall in dollarization can be primarily attributed to higher real returns on domestic-currency assets, as a result of lower inflation and more market-determined interest rates.

Exchange Rate Movements, Inflation Expectations, and Currency Substitution in Turkey

This paper contains an empirical analysis of currency substitution in Turkey: a simple relationship between the share of foreign currency holdings in M2X on one side and movements in the exchange rate or inflation on the other is derived from a two-stage portfolio choice model. This relationship is estimated by band spectrum regression which allows to remove from the data the short-term cyclical components. The results show that the relationship between currency substitution depends mainly on long-term movements in the exchange rate, while the effect of inflation on currency substitution is not statistically significant.

Exchange Rate Movements, Inflation Expectations, and Currency Substitution in Turkey

This paper contains an empirical analysis of currency substitution in Turkey: a simple relationship between the share of foreign currency holdings in M2X on one side and movements in the exchange rate or inflation on the other is derived from a two-stage portfolio choice model. This relationship is estimated by band spectrum regression which allows to remove from the data the short-term cyclical components. The results show that the relationship between currency substitution depends mainly on long-term movements in the exchange rate, while the effect of inflation on currency substitution is not statistically significant.

What has foreign exchange market intervention since the Plaza Agreement accomplished?

We review the conduct and scale of official intervention by monetary authorities in the U.S.A., Japan, and West Germany since the Plaza Agreement. Relative to trading volume and the stock of internatonally traded assets denominated in foreign currencies, intervention is small-scale and sporadic, hence at best limited to transitory effects. It does not appear to reduce volatility of daily exchange rates. Monetary authorities gamble that they will not suffer losses on their foreign currency holdings. Evidence in favor of sterilized foreign exchange market intervention as a way of conveying information to the private sector is far from convincing. Since changes in relative monetary growth rates are sufficient to alter bilateral exchange rates, monetary authorities can achieve their exchange rate preferences with domestic monetary policy, but at the cost of possible distortionary effects on monetary growth rates, domestic interest rates, and international capital flows.

Immunizing Foreign Exchange Contracts Against Swap Rate and Volatility Risks

AbstractSwap rate risk, also called the problem of' “maturity gaps,” originates from foreign currency holdings whenever the involved contracts have differing maturities. Such differing maturities give rise to a sensitivity of the portfolio values with respect to the “swap rate,” or differential between the relative interest rates in two countries. Volatility risk, which typically affects only currency contracts having asymmetric payoffs (such as currency options), gives rise to a sensitivity of portfolio values with respect to changes in the exchange rate volatility. In this article we show how currency portfolios may be immunized, or made insensitive, to both swap rate risk and volatility risk, in the sense of Macaulay's (1938) classical treatment of interest rate risk. The European currency option contract is the primary subject of our discussion, since we show that both ordinary forward contracts and other complicated currency contracts are equivalent to suitable combinations of European currency options.