Free Floating Exchange Rate Research Articles

Statistical mechanics of a time-homogeneous system of money and antimoney

Financial crises appear throughout human history. While there are many schools of thought on what the actual causes of such crises are, it has been suggested that the creation of credit money might be a source of financial instability. We discuss how the credit mechanism in a system of fractional reserve banking leads to non-local transfers of purchasing power that also affect non-involved agents. To overcome this issue, we impose the local symmetry of time homogeneity on the monetary system. A bi-currency system of non-bank assets (money) and bank assets (antimoney) is considered. A payment is either made by passing on money or by receiving antimoney. As a result, a free floating exchange rate between non-bank assets and bank assets is established. Credit creation is replaced by the simultaneous transfer of money and antimoney at a negotiated exchange rate. This is in contrast to traditional discussions of full reserve banking, which stalls creditary lending. With money and antimoney, the problem of credit crunches is mitigated while a full time symmetry of the monetary system is maintained. As a test environment for such a monetary system, we discuss an economy of random transfers. Random transfers are a strong criterion to probe the stability of monetary systems. The analysis using statistical physics provides analytical solutions and confirms that a money–antimoney system could be functional. Equally important to the probing of the stability of such a monetary system is the question of how to implement the credit default dynamics. This issue remains open.

Implications of New Keynesian Theory for Research Design: Differences Induced by Cross-Country Variations in Exchange Rate Regimes

Relative to free floating exchange rate regimes, I find the adoption of a hybrid exchange rate regime induces alternate research questions within the context of new Keynesian theory. Specifically, while exchange rates are measures of differences in monetary equilibria within a cross-section of countries that run free floating exchange rate regimes, it is balance of payments situations that constitute measures of differences in monetary equilibria within a cross-section of countries that run hybrid exchange rate regimes. Also, while relations between deposit or lending interest rates and inflows of Foreign Direct Investment (FDI) into countries with hybrid exchange rate regimes yield insights into the extent to which inflows of foreign capital induce distortionary effects on price equilibriums, these relations do not yield similar insights within a cross-section of countries that run free floating exchange rate regimes. An important implication of these empirical results is that inflation is not a measure of differences in price equilibriums within a cross-section of countries that operate hybrid exchange rate regimes. These findings, generated within the context of new Keynesian theory, identify theoretically appropriate differences in research questions and research design or methodology conditional on differences in exchange rate regimes.

The Response of the Johannesburg Stock Exchange to Changes in Exchange Rate Regimes

This paper used Granger Causality test and descriptive statistics analysis to examine the response of the South African stock market to different exchange rate regimes from 1978 to 2008. The analysis of the history of the exchange rate regimes in South Africa showed that the flexibility was introduced in 1979 but the exchange rate shocks of great magnitude appeared during the period of the free-floating exchange rate system (1995-2008). Results reported in this paper revealed that the response of Johannesburg Stock Exchange to changes in the exchange rate was not consistent throughout different exchange rate regimes. A significant correlation between the variables during the sub-periods characterised by capital controls was observed. Granger causality test revealed that the direction of causality changed with exchange rate regimes. This paper concluded that changes in exchange rate regimes have a significant impact on the relationship between the stock market index and the exchange rate. DOI: 10.5901/mjss.2013.v4n6p413

Current Account and Real Exchange Rate Dynamics in Indonesia

We analyze the role of both permanent and temporary factors in affecting the Indonesian current account and real exchange dynamics before and after 2000. Adopting Lee and Chinn (1998, 2006) approach as well as Chinn et al (2007), two results stand out. First, we confirm that the behavior of the real exchange rate has altered since 2000. Identifications show that permanent shocks are the primary causes for the movement of the real exchange rate after 2000, while in the period before 2000, the Indonesian real exchange rate changes are characterized by greater dominance of temporary shocks. The apparent change in the real exchange rate behavior may be strongly justified by the implementation of free-floating exchange rate system since August 1997. Second, the shift of the real exchange rate behavior after 2000 does not necessarily affect the current account dynamics. Empirical evidence confirms that the variance of current account post 2000 remains largely due to temporary shocks. Albeit having increasing influence, permanent shocks have insignificant effect in explaining fluctuations of the current account. In this sense, the current account surplus after 2000 is attributed largely to nominal variables such as price increase, while the impact of productivity improvement is still limited.

Fear of floating or monetary policy as usual? A structural analysis of Mexico's monetary policy

This paper uses Bayesian methods to estimate a small open economy dynamic stochastic general equilibrium (DSGE) model for the period in Mexico after the 1994 crisis. I consider a Taylor rule as the expression of the evolution of monetary policy to gauge its response to the exchange rate in the post-crisis period. The estimation results favor a consistent response of the nominal interest rate to the short-run nominal exchange rate after 1994. Although fear of floating is present, Mexico's monetary policy has taken steps toward a credible free-floating exchange rate that targets inflation.

Taylor rules and exchange rate predictability in emerging economies

This study demonstrates the relationship between exchange rate determination and an endogenous monetary policy represented by Taylor rules. We fill a gap in the literature by focusing on a group of fifteen emerging economies that adopted free-floating exchange rates and inflation targeting beginning in the mid-1990s. Because of the limited span of the time series, which is a common obstacle to studying emerging economies, we employ panel data regressions to produce more efficient estimates. Following the recent literature, we use a robust set of out-of-sample statistics, incorporating bootstrapped and asymptotic distributions for the Diebold-Mariano statistic, the Clark and West statistic and Theil's U ratio. By evaluating different specifications for the Taylor rule exchange rate model based on their out-of-sample performances, we find that a present-value forward-looking specification shows strong evidence of exchange rate predictability.

Fenomena Fear of Floating Nilai Tukar di Indonesia Periode 1998-2007: Identifkasi, Alasan Ekonomi, dan Implikasinya terhadap Kebijakan Moneter

The stable fluctuation of Rp against the US$ during the free floating exchange rate regime in 2002-2007 raises the existence of fear of floating exchange rate phenomenon in Indonesia. The GARCH method is use to verify this phenomenon. Moreover, Time Varying Parameter and Error Correction Mechanism method shows the economic reason behind the Monetary Authoritys response in stabilizing rupiah. Depreciation and increasing volatility of Rupiah raises ination and bank Non-Performing Loans, while appreciation and increasing volatility of Rupiah, reduce the net export. Furthermore, Vector Autoregressive confirms the Monetary Authority respond to exchange rate shock through the interest rate policy for four months and through the foreign reserves policy for two months.

EXCHANGE RATE PASS-THROUGH, IMPORT PRICES AND INFLATION UNDER STRUCTURAL BREAKS

This research estimates the exchange rate pass-through (ERPT) into import prices by applying an extension of the basic model of ERPT on Indonesia. It estimates models of cointegration and error-correction mechanism (ECM), with and without structural breaks. It uses the techniques of Zivot-Andrews and of Gregory-Hansen to test for structural breaks and cointegration with the structural breaks, respectively. The results show that with the control variables, inflation affects import prices and lower the pass-through for short term, in a condition of free floating exchange rate. In the short term, with the inclusion of structural breaks, significant inflation affects import prices and lowers the ERPT coefficient. Keywords: Exchange rate pass-through, inflation, structural breaks, cointegration, error-correction mechanism JEL classification numbers: C22, C32, E31, F41

Exchange Rate Policy in Serbia

In August 2006, Serbia adopted an inflation targeting regime as its monetary regime. The initial period of implementation of this regime was characterized by an extremely high capital inflow and appreciation of the exchange rate of the dinar. Under such conditions, the selected monetary policy regime functioned well. However, at the end of 2008, when the global financial crisis caused the outflow of foreign capital, deterioration of foreign borrowing conditions and an increase in inflationary expectations, the dinar lost about 25 per cent of its value within a relatively short period, despite the interventions of the National Bank of Serbia in the foreign exchange market. Therefore, the authors of this paper raise a dilemma whether Serbia conducts an adequate policy of the exchange rate of the dinar. The authors point out that, at the moment, the policy of a free floating exchange rate is not adequate for Serbia. As an alternative, a two nominal-anchor regime—inflation and the exchange rate—is proposed.

통화론적 접근방법에 근거한 외환위기 전후 원/달러 환율결정에 대한 비교분석

Korea experienced a financial crisis in 1997. Since then Korea economy has undergone severe change such as exchange rate regime from the market average exchange rate system to the free floating exchange rate system in 1997, and the currency rate fluctuation has been widening. We empirically analyze the determination of the Won/Dollar exchange rate based on the monetary approach. We employ Lucas (1982), Bilson (1978) and Frankel (1979) models and consider some mixed models. We make use of monthly data of money supply, income, interest rate, capital balance, terms of trade, and the yen/dollar exchange rate over the period 1990-2009. We compare the empirical results of cointegration tests and the vector error correction model(VECM) from the two regimes, the pre and post korean financial crisis. The won/dollar exchange rate has long-run relationship with the variables in the monetarist models in the two regimes. For the post crisis regime, the Bilson model is the best and the long run variables also affect the short run dynamics of the won/dollar exchange rate.

Exchange Rate Regimes and Economic Stability

The Bank of Russia intends to introduce inflation targeting policy and exchange rate free floating regime in three years. Exogenous shocks absorption which stabilizes the real sector of economy is usually considered to be one of the advantages of free floating exchange rate policy. However, our research based on the analysis of 25 world largest economies exchange rates and industrial production during the crisis of 2008-2009 does not confirm this hypothesis. The article also analyzes additional risks associated with free floating exchange rate regime in Russia and presents some arguments in favor of managed floating exchange rate regime.

Bivariate cointegration of major exchange rates, cross-market efficiency and the introduction of the Euro

The aim of this paper is to investigate whether the Euro–US dollar exchange rate cointegrates with other major exchange rates since the introduction of the Euro. In order to evaluate whether the introduction of a new currency, which has commonly replaced more and less established currencies, has generated common stochastic trends which are possibly linked to cross-inefficient markets, the results are compared with those of a cointegration analysis of the pre-Euro era. We can show that after the introduction of the Euro two cointegration relationships arise among the Euro–US dollar and the four most important exchange rates, whereas the no-arbitrage condition is satisfied. Here, we discovered a new result: free floating exchange rates are cointegrated after the introduction of the Euro. The Euro–US dollar exchange rate cointegrates with the Australian dollar–US dollar and with the British pound–US dollar. In both cases the Euro–US dollar is weakly exogenous. The results coincide with comovements of important fundamentals which imply cross-market efficiency.

Inflation Targeting and Exchange Rate Regimes: Evidence from the Financial Markets*

Inflation targeting is gaining popularity as a framework for conducting monetary policy. At the same time many countries employ some sort of foreign exchange intervention policy assuming that these two policies can coexist. This paper attempts to show that both policies are not sustainable. Israel is a classic test case. We test our hypothesis using information from the financial markets. The results support the hypothesis that both policies cannot be sustained in the long run. The conclusion is that a credible monetary policy aimed at inflation targets should be conducted in a free floating exchange rate regime.

The Volatility and Asymmetry of Won/Dollar Exchange Rate

The study on volatility and asymmetry of the exchange rate by applied to the daily Won/Dollar exchange rate shows that past volatility of the exchange rate still has strong persistency at present and asymmetry effect and the leverage effect, which explain that volatility shock has an effect on the uncertainty of the exchange rate, are also existent after the free floating exchange rate system was adopted.

An Empirical Examination of East Asia´ s Pre-Crisis Pegged Exchange Rates

I. Introduction According to conventional wisdom, the rigidity of pre-1997 pegged exchange rate regimes in East Asia was one of the main causes of the currency crisis. (1) The basis for assuming that East Asia's pre-crisis exchange rates were rigid is the declarations of central banks about exchange rate policies. In practice, however, the declared exchange rate regime itself may not indicate rigidities--a tightly controlled managed float regime may be more rigid than a pegged regime with a wide band, ceteris paribus. As Ghosh et al. (1995) and Reinhart (2000) point out, declared exchange rate regimes may differ from the actual characteristics of exchange rates. Therefore, it is worthwhile to pursue a statistical examination of East Asia's pre-crisis exchange rates in order to identify their distinctive characteristics. We also investigate the issue of whether systematic relationships existed among East Asia's bilateral exchange rates vis-a-vis the U.S. dollar in the pre-crisis period. For example, was there a systematic relationship between the Malaysian ringgit-U.S, dollar exchange rates and the Thai baht-U.S, dollar exchange rate? The existence of such systematic relationships in the pre-crisis period would lend further support to the contagious nature of the Asian currency crisis. At the same time, the pre-crisis existence of relationships raises the interesting question of how the peg regimes were able to last so long in light of their vulnerability to external shocks. Evidence shows that intra-day, daily, or weekly exchange rates are approximated by martingales, and the returns exhibit conditional volatility, fat-tail distribution, skewness, and excess kurtosis. Autoregressive conditional heteroscedasticity (ARCH) models have been used successfully to describe foreign exchange rate data. More recently, Engle and Gau (1997) examine the conditional volatility of the exchange rates under the target zone regime of the European Monetary System (EMS). They find that exchange rates within the EMS show the same characteristics as free-floating exchange rates except for strong negative autocorrelations. Conditional volatility in exchange rates has been attributed to the irregular arrival of new information in the market. Engle, Ito, and Lin (1990) interpret volatility persistence in foreign exchange markets to either the time it takes market traders to act on new information or the autocorrelation of news across countries arising from potential policy coordination. They employ Ito and Roley's (1987) decomposition of the intra-day yen-U.S, dollar exchange rates based on the operating times of different markets to show volatility spillover across markets. On the other hand, Baillie and Bollerslev (1990) examine systematic relationships in the conditional returns or variances of the hourly bilateral exchange rates of the United Kingdom, Germany, Switzerland, and Japan vis-a-vis the U.S. dollar. They use the robust inference procedures of Wooldridge (1990) and Bollerslev and Wooldridge (1992) in order to handle the skewness and excessive kurtosis in the data. The results fail to show systematic relationships among the four major exchange rates. Our paper investigates the behaviour of the precrisis daily bilateral exchange rates of four Newly Industrializing Countries (NICs) of Hong Kong, South Korea, Singapore, and Taiwan, and four members of the Association of Southeast Asian Nations (ASEAN-4), Indonesia, Malaysia, Philippines, and Thailand, vis-a-vis the U.S. dollar. We perform preliminary analyses and robust misspecification tests to explore the distinctive characteristics of East Asian exchange rates. We also look for empirical evidence of systematic relationships among the region's precrisis bilateral exchange rates vis-a-vis the U.S. dollar. Although our paper is essentially a study of the behaviour of exchange rate rather than exchange rate policy or regime, we do attempt to draw some policy implications from our results. …

Target Zone Exchange Rate Option Pricing

This paper provides a short introduction to the topic of target zone exchange rate option pricing. Models covered include: Black-Scholes equation with derivation, European Call on a stock option, Garman-Kohlhagen model for an option on a free-floating exchange rate, Dumas Jennergren and Naslund model for an exchange rate option within a fully credible target zone and a discussion of the relationship between empirical option pricing data and partial target zone credibility.

Economic Fundamentals and Exchange Rates Under Different Exchange Rate Regimes: Korean Experience

Korea provides a unique opportunity to study the different behaviors or roles, if any, of limited flexibility and free floating exchange rate regimes. Korea shifted from a limited flexibility to a free floating exchange rate regime after the 1997 economic crisis. It is well documented that the exchange rate is very difficult to predict using any theoretical models for exchange rate determination. Based on a simple monetary model, we find that the impact of economic fundamentals on the exchange rate is very similar under both exchange rate regimes according to OLS estimates, but the difference is statistically significant with GARCH(1,1) results. We also find that the size of the exchange rate shock is much bigger under the free floating regime than under the limited flexibility regime. VAR results show that the exchange rate shock impact on inflation is not statistically different under the two regimes. These findings are generally in line with Baxter and Stockman (1989) for regime neutrality.

Political elections and foreign investor trading in South Korea's financial markets

This article investigates the relationship between foreign investors’ trading behaviour and political election events in South Korea and the effect of the relationship on the financial markets via a bivariate GARCH (1,1) model analysis. The empirical results show that the KOSPI 200 index return (total trading volumes of spot) and the derivatives volume have a negative (positive) relationship for foreign investors. South Korea shifted to a free floating exchange rate system, however, it did not have an effect on foreign investors’ trading behaviour. In particular, foreign investors showed significant decrease in trading options contracts during the parliamentary election periods and the parliamentary elections stabilized derivatives trading volatility. It is evident from the results that the presidential elections create far more financial uncertainty in comparison to parliamentary elections.

Stabilitas Permintaan Uang di Indonesia Sebelum dan Sesudah Perubahan Sistem Nilai Tukar

The objective of this study is to analyze the stability of money demand in Indonesia before and after the change of exchange rate system, from managed floating exchange rate to free floating exchange rate in the middle of 1997. And also to analyze the role of exchange rate on the money demand in Indonesia. The result shows that there are no change in stability of money demand for M1 and any change in stability for M2. The role of exchange rate is very significant in money de¬mand in Indonesia not only for M1 but also for M2. Because of right now, the exchange rate system is free floating exchange rate, where no government intervening, so that the govern¬ment should to maintain the exchange rate market more efficient. Keywords: Money Demand, Managed floating exchange rate, free floating exchange rate, stability of money demand

Genetic learning as an explanation of stylized facts of foreign exchange markets

This paper revisits the Kareken–Wallace model of exchange rate formation in a two-country overlapping generations world. Following the seminal paper by Arifovic [Journal of Political Economy 104 (1996) 510] we investigate a dynamic version of the model in which agents’ decision rules are updated using genetic algorithms. Our main interest is in whether the equilibrium dynamics resulting from this learning process helps to explain the main stylized facts of free-floating exchange rates (unit roots in levels together with fat tails in returns and volatility clustering). Our time series analysis of simulated data indicates that for particular parameterizations, the characteristics of the exchange rate dynamics are, in fact, very similar to those of empirical data. The similarity appears to be quite insensitive with respect to some of the ingredients of the genetic algorithm (i.e. utility-based versus rank-based or tournament selection, binary or real coding). However, appearance or not of realistic time series characteristics depends crucially on the mutation probability (which should be low) and the number of agents (not more than about 1000). With a larger population, this collective learning dynamics looses its realistic appearance and instead exhibits regular periodic oscillations of the agents’ choice variables.