Net Foreign Assets Research Articles

Currency Misalignments and Exchange Rate Regimes in Emerging and Developing Countries*

AbstractPegged exchange rates are often pointed out as more prone to risk of overvaluation, because their real exchange rates have a tendency to appreciate. We check this assumption empirically over a large sample of emerging and developing countries, by using two databases for de facto classifications by Levy‐Yeyati and Sturzenegger (2003) and by Reinhart and Rogoff (2004). We assess currency misalignments by estimating real equilibrium exchange rates taking into account a Balassa effect and the impact of net foreign assets. Pegged currencies are shown to be more overvalued than floating ones.

Real Exchange Rate Misalignment: An Application of Behavioral Equilibrium Exchange Rate (BEER) to Nigeria

Abstract This paper seeks to estimate the long run behavioral equilibrium exchange rate in Nigeria. The empirical analysis builds on quarterly data from 1986Q1 to 2006Q4 and derives a Behavioral Equilibrium Exchange Rate (BEER) and a Permanent Equilibrium Exchange Rate (PEER). The econometric analysis starts by analyzing the stochastic properties of the data and found all the variables stationary at first level of differencing. Accordingly, the paper proceeds by estimating vector-error correction models. Regression results show that most of the long-run behavior of the real exchange rate could be explained by real net foreign assets, terms of trade, index of crude oil volatility, index of monetary policy performance and government fiscal stance. On the basis of these fundamentals, four episodes each of overvaluation and undervaluation were identified and the antecedents characterizing the episodes were equally traced to the archive of exchange rate management in the country within the review period. Among others for instance, large inflow of oil revenues into the country and stable macroeconomic performance were discovered to account for undervaluation of the real exchange rate between 2001Q1 and 2006Q4 in Nigeria. The results further suggest that deviations from the equilibrium path are eliminated within one to two years. The paper recommends the pursuance of sound monetary policy as an instrument for achieving real exchange rate cum macroeconomic stability in Nigeria.

Oil shocks and external balances

We provide estimates of the effects of demand and supply shocks in the global crude oil market on several measures of oil exporters' and oil importers' external balances, including the oil trade balance, the non-oil trade balance, the current account, capital gains, and changes in net foreign assets (NFA). First, we show that the effect of oil demand and supply shocks on the merchandise trade balance and the current account, which depending on the source of the shock can be large, depends critically on the response of the non-oil trade balance. Our results provide evidence of an intermediate degree of international financial integration. Second, we document the presence of large and systematic valuation effects in response to these shocks. Valuation effects overall tend to cushion the effect of oil demand and supply shocks on the NFA positions of oil exporters and oil importers. Third, we quantify the overall importance of global business cycle demand shocks as well as oil-market specific demand and supply shocks for external balances.

Real Exchange Rate Misalignment in Azerbaijan

By using quarterly data from 2001-2007 and applying various approaches, we estimate real equilibrium exchange rate misalignment for Azerbaijani Manat (AZN) and find that AZN is slightly overvalued. Purchasing power parity approach does not explain the equilibrium exchange rate. However using behavioral and permanent equilibrium exchange rate approaches, we find that the relative productivity, terms of trade, trade openness, net foreign assets, government expenditures and oil prices are the main determinants of misalignment.

A Tractable Model of Precautionary Reserves, Net Foreign Assets, or Sovereign Wealth Funds

We model the motives for residents of a country to hold foreign assets, including the precautionary motive that has been omitted from much previous literature as intractable. Our model captures many of the principal insights from the existing specialized literature on the precautionary motive, deriving a convenient formula for the economy's target value of assets. The target is the level of assets that balances impatience, prudence, risk, intertemporal substitution, and the rate of return. We use the model to shed light on two topical questions: The 'upstream' flows of capital from developing countries to advanced countries, and the long-run impact of resorbing global financial imbalances.

International Currency Portfolios

This paper develops a theory of international currency portfolios that holds in general equilibrium, and that is therefore not subject to the criticisms directed at the portfolio balance literature of the 1980s. It shows that, under plausible assumptions about fiscal policy, the relationship between the rates of return of different currency bonds is not correctly described by an arbitrage relationship but instead also depends on outstanding bond stocks. Other findings are: (1) There is a monotonically increasing relationship between domestic interest rates and the portfolio share of domestic currency denominated assets. This relationship is steep at low levels of government debt, and almost flat at high levels of government debt. (2) Optimal private sector foreign currency positions are negative, and their size is decreasing in exchange rate volatility. Under volatile exchange rates large negative aggregate net foreign asset positions can only be rationalized by assuming large public sector borrowing from foreign governments. (3) For a baseline economy with zero net foreign assets, open market sales of domestic government debt lead to valuation gains (losses) when the country as a whole has a short (long) position in foreign currency. (4) A fiscal theory of exchange rate determination is compatible with general equilibrium in a two-country world. (5) Equilibria are determinate when both fiscal and monetary policy are passive.

External Balance in Low Income Countries

This paper offers a coherent empirical analysis of the determinants of the real exchange rate, the current account, and the net foreign assets position in low income countries. The paper focuses on indicators specific to low income countries, such as the quality of policies and institutions, the special access to official external financing, and the role of shocks. In addition to more standard factors, we find that domestic financial liberalization is associated with higher current account balances and net foreign asset positions, while capital account liberalization is associated with lower current account balances and net foreign asset positions and with more appreciated real exchange rates. Negative exogenous shocks tend to raise (reduce) the current account in countries with closed (opened) capital accounts. Finally, foreign aid is progressively absorbed over time through net imports, and is associated with a more depreciated real exchange rate in the long-run.

The Valuation Channel of External Adjustment

International financial integration has greatly increased the scope for changes in a country's net foreign asset position through the valuation channel, namely capital gains and losses on external assets and liabilities. We examine this valuation channel in a dynamic equilibrium portfolio model with international trade in equity. By separating asset prices and quantities, we can characterize the first-order dynamics of valuation effects and the current account in macroeconomic dynamics. Specifically, we disentangle the roles of excess returns, capital gains, and portfolio adjustment for consumption risk sharing when financial markets are incomplete.

Global Imbalances: The Role of Emerging Asia

This paper investigates the role played by emerging Asia in the emergence and evolution of the global trade imbalances. Based on simulations in a general equilibrium model of the world economy, we find that a productivity slowdown in the non-tradable sector of these economies in the second half of the 1990s fits regional macroeconomic developments relatively well, but has limited spillover effect to the United States trade balance. In contrast, an increase in the desired level of emerging Asia net foreign assets starting in 2001 not only fits regional developments relatively well, but also has a significant spillover effect to the United States.

Current account dynamics and optimal monetary policy in a small-open economy

This paper studies a small open economy with two sectors. In a perfect foresight, rational expectation general equilibrium model, with sticky prices in the non-traded goods sector, the current account responses to monetary shocks depend on the elasticity of substitution between consumption and risk aversion, the country's initial net foreign asset position, and the degree of monopolistic competition. The current account reacts quite efficiently to technological shocks in a small open economy. The welfare gain for households from adopting optimal monetary policy in contrast to constant money growth rule is quantitatively small.

Global Imbalances: The Role of Emerging Asia

This paper investigates the role played by emerging Asia in the emergence and evolution of the global trade imbalances. Based on simulations in a general equilibrium model of the world economy, we find that a productivity slowdown in the non-tradable sector of these economies in the second half of the 1990s fits regional macroeconomic developments relatively well, but has limited spillover effect to the United States trade balance. In contrast, an increase in the desired level of emerging Asia net foreign assets starting in 2001 not only fits regional developments relatively well, but also has a significant spillover effect to the United States.

External Balance in Low Income Countries

This paper offers a coherent empirical analysis of the determinants of the real exchange rate, the current account, and the net foreign assets position in low income countries. The paper focuses on indicators specific to low income countries, such as the quality of policies and institutions, the special access to official external financing, and the role of shocks. In addition to more standard factors, we find that domestic financial liberalization is associated with higher current account balances and net foreign asset positions, while capital account liberalization is associated with lower current account balances and net foreign asset positions and with more appreciated real exchange rates. Negative exogenous shocks tend to raise (reduce) the current account in countries with closed (opened) capital accounts. Finally, foreign aid is progressively absorbed over time through net imports, and is associated with a more depreciated real exchange rate in the long-run.

Yuan Real Exchange Rate Undervaluation, 1997-2006: How Much, How Often? Not Much, Not Often

Yuan real effective exchange rate misalignment is estimated in a behavioral equilibrium exchange rate (BEER) model for the period 1997 to third quarter 2007. Using the Beveridge-Nelson decomposition a vector error correction model (VECM) of the exchange rate as a function of macroeconomic fundamentals, including government expenditures, economic openness, the balance of trade surplus, and net foreign assets, is estimated. We find that the Chinese Yuan has been fluctuating moderately around its long run equilibrium value with undervaluation up to 4% and overvaluation up to 6% at various points in time since 1997. This result is consistent with findings of many of the most recent studies employing alternative econometric methodologies to determine the equilibrium exchange rate. While the Yuan real effective exchange rate has deviated from equilibrium, and it is sticky, taking over five years to correct 50% of the short run misalignment, it does not appear to have been consistently undervalued as has been widely argued.

Valuation Effects with Transitory and Trend Output Shocks

This paper investigates the role of valuation efiects on a country’s net foreign asset position. It shows that following transitory output shocks, valuation efiects are stabilizing; they counteract current account movements and mitigate the impact of the current account on a country’s net foreign assets. Following trend shocks, valuation effects are amplifying; they move in the same direction as the current account and reinforce the impact of the current account on net foreign assets. The results are illustrated by the external imbalances between the U.S. and other industrialized countries since the 1990s.

The International Dimension of U.S. Expansions: A Structural VAR Analysis

This paper investigates the international dimension of productivity and demand shocks in the US using sign restrictions based on standard theory predictions. Identifying shocks to US manufacturing — our measure of tradables — we nd that productivity gains have substantial aggregate demand e¤ects, boosting US consumption and investment, relative to the rest of the world, thus raising real imports; net exports and US net foreign assets correspondingly decrease. At the same time, however, these shocks appreciate the US real exchange rate, improve the terms of trade and raise stock prices. Shocks to the demand for US manufacturing appear to have less pronounced aggregate e¤ects, with little impact on trade and capital accounts; they lead to a (delayed) dollar appreciation, however. Our ndings provide novel evidence on key channels of the international transmission of shocks, pointing to a low degree of consumption risk sharing as an essential feature of the transmission mechanism, and suggesting that strong wealth e¤ects play an important role in generating aggregate demand ‡uctuations across countries. JEL classi cation: F32, F41, F42

Quo Vadis Real? Estimating the Brazilian Real Exchange Rate Misalignment in Vector Error Correction Model with Structural Change

This paper aims to estimate the equilibrium real exchange rate for the Brazilian economy. The equilibrium exchange rate is defined as the level of exchange rate that guarantees the stability of the net foreign asset position over time. An econometric model is estimated using a Vector Error Correction Model with structural breaks. The main conclusion of the paper is that the Brazilian exchange rate is below its long run values. The model also suggests that the improvement in fundamentals observed in the recent past is about to end. The level of misalignment is estimated at 18% in third quarter of 2009.

Net foreign asset positions and consumption dynamics in the international economy

We examine the effect of non-zero, steady-state foreign assets on consumption dynamics in response to productivity shocks in a two-country, dynamic, general equilibrium model. The model generates non-zero steady-state net foreign assets by allowing for different discount factors across countries. As a consequence of discounting differences, individual steady-state consumption profiles are tilted upward or downward. Worldwide shocks to long-run productivity levels lead to dynamics that are absent in standard, symmetric models with equal discount factors. We then compare the model results to those of a VAR in common trend representation for the U.S. versus the rest of the G7. In the data, we find that permanent worldwide productivity shocks lead to net foreign asset and consumption dynamics that are broadly consistent with interpreting the U.S. as the relatively impatient model economy and are not consistent with symmetric models with equal discount factors.

Equilibrium Exchange Rates in New EU Members: External Imbalances versus Real Convergence

AbstractIn new EU members, the accumulation of net foreign liabilities has gone hand‐in‐hand with real exchange rate appreciations, contrary to intuition. This may be due to the induced effect that capital inflows on productivity and competitiveness (Balassa‐Samuelson effect). An extended empirical model comprising relative productivity and net foreign assets is well‐suited to capture this indirect, opposite effect of liabilities accumulation on the equilibrium exchange rates for the three largest economies: Poland, Hungary and Czech Republic. The model makes it possible to estimate equilibrium exchange rates and misalignments. Going forward, sustaining high productivity growth will be essential to ensure a smooth transition towards euro membership.

The growing current account surpluses in East Asia: the effect of dark matter assets

In a series of papers we have developed the notion that net foreign assets could be better approximated by capitalizing the net investment income line of the balance of payments statistics. Hidden assets or changes in financial costs may change the net return of net foreign assets even when the valuation of assets remains unchanged. By capitalizing the net investment income a more realistic picture emerges on the true burden or return of net foreign assets. This paper estimates external positions for East Asian economies using this methodology and compares the results with that of official accounts. We find that, until the late 1990s, net investment income increased relatively little, signaling that net foreign assets had not grown as suggested by the large current account surpluses of these countries. This is consistent with the fact that the region had attracted large amounts of foreign direct investment, for which the transfer of technology and knowledge are not accurately captured by the valuation of the foreign asset position. Since 2002, however, the trend has reversed, indicating much larger surpluses than officially registered. We discuss individual country cases.

Assessing the Equilibrium Exchange Rate of the Malaysian Ringgit: A Comparison of Alternative Approaches

Drawing on the behavioral equilibrium exchange rate and the fundamental equilibrium exchange rate approaches, this paper assesses the equilibrium value of the real effective exchange rate of the Malaysian ringgit over the past 25 years. For 2005, when the Malaysian authorities exited from the peg with the US dollar, both models determine a slight undervaluation of the currency. Openness and real GDP per capita have been the main drivers of real exchange rate movements in the past, although non‐tradable productivity, government consumption, and net foreign assets have also had a sizable impact. The paper also highlights the limitations of applying the two approaches in the context of emerging countries.