Nominal Exchange Rate Adjustment Research Articles

Monetary policy transparency and real exchange rate adjustment

AbstractWe study the effect of different attributes of monetary policy transparency on real exchange rate adjustment by estimating the half‐life of the real exchange rate. After controlling for sample‐selection bias, results from the panel error‐correction model suggest that the economic aspect of transparency facilitates real exchange rate adjustment in non‐industrial countries. The driving force behind this finding is that economic transparency enhances nominal exchange rate adjustment. However, none of the different attributes of monetary policy transparency significantly affect real exchange rate adjustment in industrial countries. Failure to control for sample‐selection bias over‐rejects the null hypothesis.

Gains from monetary policy cooperation under asymmetric currency pricing

In most international trade transactions, the U.S. dollar is used. Hence, this study considers optimal monetary policy in a two-country model under asymmetric currency pricing (ACP) in which U.S. (Home) firms use producer currency pricing (PCP) while firms in the rest of the world (Foreign) use local currency pricing (LCP). In the ACP model, there is an additional inefficiency, namely, the internal relative price distortion compared with the LCP model and the distortion arising from deviations from the law of one price compared with the PCP model. Consequently, welfare gains from monetary policy cooperation in the ACP model are substantially greater compared with the LCP and PCP models. Moreover, the noncooperative Foreign policymakers in the ACP model can manipulate not only the internal relative price but also deviations from the law of one price in favor of their own welfare through nominal exchange rate adjustment, whereas the noncooperative Home policymakers can control neither. This result rationalizes the fact that the U.S. designates currency manipulators to protect its welfare. Therefore, gains from cooperation in Home are larger than in Foreign. Furthermore, I find that there are substantial gains from cooperation in the ACP model even under the conditions that remove gains from cooperation in the LCP and PCP models.

Real Exchange Rate Misalignments in Tanzania

The study uses a real exchange rate equilibrium (REER) technique to examine real exchange rate misalignments in Tanzania, through the cointegration technique. The empirical findings reveal that the real exchange rate misalignment has decreased significantly over recent years, and the real effective exchange rate has been evolving close to the long-term equilibrium. The findings strongly suggest that the underlying monetary and exchange rate policies were crucial in bringing the real exchange rate back to equilibrium in line with medium-term fundamentals recently. As a result, it is suggested that the existing monetary and exchange rate policies be maintained. While the monetary policy will contribute to real exchange rate stability through low inflation, flexible exchange rate policy will contribute to real exchange rate stability through nominal exchange rate adjustment.

Current Account Imbalances, Real Exchange Rates, and Nominal Exchange Rate Variability

AbstractThis paper globally analyzes the bivariate relation between large current account imbalances and the real exchange rate over different degrees of nominal exchange rate variability. Employing both linear and nonlinear panel estimation procedures, we typically find an inverse long-run link between large imbalances and the real exchange rate at lower nominal exchange rate rigidity levels. This is in contrast to the often non-existent or positive comovement that materializes under lower nominal exchange rate variation. Our results thus suggest that greater nominal exchange rate adjustment can induce a stabilizing “current account”-“real exchange rate” relation. Meanwhile, current account adjustment speeds up with more flexible nominal exchange rates. Along the cross-section, the most salient findings are i) the striking positive relation between current account persistence and real exchange rate persistence based on country-specific estimates and ii) the inverse correlation between persistence in either the current account or real exchange rate and nominal exchange rate volatility.

Post-COVID-19 EMU: Economic Distancing by Parallel Currencies

The coronavirus crisis has caused new distress in the European Economic and Monetary Union (EMU), as the southern part of the EMU has been hit stronger than the northern part. The common currency prevents nominal exchange rate adjustment in response to the asymmetric shock. Policymakers have therefore taken recourse to large-scale financial transfers. Based on the lessons from the German monetary union, this article proposes instead the introduction of parallel currencies to facilitate relative price changes. Parallel currencies in the south would allow an increase in competitiveness of the south via real depreciation. The introduction of a parallel currency in Germany would lead to capital inflows and a real appreciation of the new German mark. The pre-EMU pressure for structural adjustments and productivity gains would be restored.

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Stabilisation and Rebalancing with Fiscal or Monetary Devaluation: A Model-Based Comparison

The paper uses a small open economy general equilibrium model to compare fiscal and nominal exchange rate devaluation with respect to their impact on economic activity and the current account. In particular, it investigates to which extent fiscal devaluation mimics nominal exchange rate adjustment and mitigates the output loss associated with demand rebalancing and external adjustment. The results suggest that internal or external devaluation can support external adjustment and mitigate its impact on economic activity, without leading to lasting adjustment themselves. The quantitative contribution of a tax shift from labour to consumption as standard example of fiscal devaluation remains moderate, however.

Macroeconomic impacts of Chinese currency appreciation on China and the Rest of World: A global CGE analysis

This paper analyzes the ex-ante short-term impacts of the Chinese RMB appreciation on the Chinese and world economy, using a novel approach of modeling nominal exchange rate adjustment in the GTAP, a global CGE model. Scenario results show that Chinese economy will be affected negatively, with lower real GDP, lower employment rates, and a decline in the trade surplus. Chinese currency appreciation has positive impact on the GDP of the major countries and regions, although by a small margin. With higher Chinese exchange rate, trade balance for other trading partner countries improves with the exception of the U.S.

Hong Kong Consumer Prices are Flexible

It is generally believed that prices in Hong Kong are flexible. If this received wisdom is correct then the Currency Board system, which precludes a nominal exchange rate adjustment in response to macroeconomic shocks, may have little macroeconomic cost. However, this belief in price flexibility is based on very little empirical evidence. In this paper, we seek to rectify this in a study the behaviour of sub-indices of the Hong Kong Consumer Price Index. We compare estimated moments in the data against the predictions of models based on flexible prices, capacity constraints, rational inattention, and menu costs. We find evidence in favour of flexible prices.

A revisit on dissecting the PPP puzzle: Evidence from a nonlinear approach

The purpose of this paper is to re-investigate issues in purchasing power parity (PPP) convergence using a threshold vector error-correction model with deutschmark-based exchange rates. We find that the half-life of real exchange rates is less than two and a half years, that PPP convergence is attributed to nominal exchange rate adjustment for most countries, and that the half-life of nominal exchange rates is close to that of real rates and is longer than that of prices in general. Our findings are consistent with those of Cheung et al. [Cheung et al. 2004, Journal of International Economics 64, 135–150] except that our estimated half lives of real and nominal exchange rates are much shorter than theirs. These findings are important since they explain the PPP puzzle and indicate the significance of a nonlinear model in examining the engine of PPP convergence.

DO AFRICAN COUNTRIES MOVE ASYMMETRICALLY TOWARDS PURCHASING POWER PARITY?

This paper investigates the possibility that the adjustment towards long-run relative purchasing power parity (PPP) is dependent upon the nature of deviations from PPP that are experienced. While existing studies involving developed and less developed countries often find against PPP having employed linear tests of non-stationarity or non-cointegration, we employ a new cointegration test, recently advocated by Enders and Siklos and Enders and Dibooglu, that tests for an asymmetric adjustment towards parity with respect to positive and negative deviations of the real exchange rate from its equilibrium value. Using a sample often African economies with data taken from the post-Bretton Woods floating exchange rate era, long-run PPP holds in eight of these cases if an explicit distinction is made between positive and negative deviations. Across the sample, we find variation in the type of asymmetry experienced and the roles played by price and nominal exchange rate adjustment.

Dissecting the PPP puzzle: the unconventional roles of nominal exchange rate and price adjustments

The conventional view, as expounded by sticky-price models, is that price adjustment determines the PPP reversion rate. This study examines the mechanism by which PPP deviations are corrected. Nominal exchange rate adjustment, not price adjustment, is shown to be the key engine governing the speed of PPP convergence. Moreover, nominal exchange rates are found to converge much more slowly than prices. With the reversion being driven primarily by nominal exchange rates, real exchange rates also revert at a slower rate than prices, as identified by the PPP puzzle [J. Econ. Lit. 34 (1996) 647].

Capital Inflows and the Real Exchange Rate: A Comparative Study of Asia and Latin America

The nexus of real exchange rate (RER) and capital inflows is examined through a comparative analysis of the experiences of emerging market economies in Asian and Latin America during the period 1985‐2000. It is found that the degree of appreciation in RER associated with capital inflow is uniformly much higher in Latin American countries compared to their Asian counterparts, despite the fact that the latter experienced far greater foreign capital inflows relative to the size of the economy. The econometric evidence suggests that both the composition of capital flows and differences in the degree of response of RER to capital flows matter in explaining these contrasting experiences. While RER appreciation is a phenomenon predominantly associated with other (non‐FDI) forms of capital inflows (OCFW), a given level of OCFW brings about a far greater degree of appreciation of the real exchange rate in Latin America where the importance of these flows in total capital inflow is also far greater. On the policy front, Asian countries seem to have used fiscal contraction and nominal exchange rate adjustment more effectively to cushion the RER against the appreciation pressure of capital inflows. There is, however, no evidence to suggest that sterilised intervention can generate a lasting impact on the real exchange rate.

Dissecting the PPP Puzzle: The Unconventional Roles of Nominal Exchange Rate and Price Adjustments

The conventional view, as expounded by sticky-price models, is that price adjustment determines the PPP reversion rate. This study examines the mechanism by which PPP deviations are corrected. Nominal exchange rate adjustment, not price adjustment, is shown to be the key engine governing the speed of PPP convergence. Moreover, nominal exchange rates are found to converge much more slowly than prices. With the reversion being driven primarily by nominal exchange rates, real exchange rates also revert at a slower rate than prices, as identified by the PPP puzzle (Rogoff, 1996).

The Real Exchange Rate Always Floats

This paper makes two main points. First, irrespective of nominal exchange rate arrangements, the real exchange rate always floats — if not through nominal exchange rate adjustment, then through price change. Further, because prices and wages tend to be sticky, the adjustment of real exchange rates towards long–run equilibrium takes time, as witnessed by long–lasting currency misalignments around the world. In second place, real exchange rates are rather likely to fluctuate on their way towards long–run equilibrium because of the dynamic interaction between real exchange rates and the current account or, put differently, because the structure of lags with which exchange rates impact the volume of exports and imports may give rise to oscillatory behaviour.

Long-Run Purchasing Power Parity with Asymmetric Adjustment

1. Introduction Despite its intuitive appeal, there is inconclusive evidence supporting purchasing power parity (PPP) between countries with low inflation rates during the post-Bretton Woods period. For example, Enders (1988), Taylor (1988), and MacDonald (1993) use various forms of cointegration tests-called stage-three tests-and find that real exchange rates exhibit large fluctuations with slow rates of decay toward a long-run mean. Froot and Rogoff's (1995) literature review presents a consensus estimate that deviations from long-run PPP have a half-life of about three years. This is somewhat disappointing since stage-three tests seem to be well suited to the task-they require no assumptions concerning exogeneity and they imply a sensible dynamic relationship among price levels and the exchange rate. The vast literature on PPP is indicative of the importance of the issue and the ambiguity of the findings. It is well recognized that standard cointegration tests have low power to reject the null hypothesis of no cointegration. This observation is especially relevant for PPP since any mean reversion in real rates is very gradual and the length of the post-Bretton Woods period sample period is relatively short. Efforts to increase the power of unit-root and stage-three tests have had mixed success. For example, Lothian and Taylor (1996) and Mark (1990) have tried to circumvent the low power of stage-three tests by using long spans of time-series data. Unfortunately, the use of long time spans raises the possibility of structural changes occurring during the period being examined. Panel unit-root tests are generally more supportive of PPP than are bilateral tests of real exchange rate behavior. For example, Oh (1996), Wei and Parsley (1995), and Wu (1996) have used panel data in order to enhance the power of standard unit-root tests. Although these particular articles are supportive of PPP, panel studies must deal with the thorny issues of cross-sectional correlation and the choice of the nations to include in the panel. Papell (1997) finds that allowing for serial correlation substantially weakens the evidence in favor of long-run PPP. O'Connell (1998) applies generalized least squares to panel data to eliminate any contemporaneous correlation in the error structure and finds no evidence supporting PPP The second problem with the standard unit-root and cointegration tests is that they implicitly assume symmetric adjustment. However, official intervention in the foreign exchange market means that nominal exchange rate adjustment may be asymmetric. Under a managed float, for example, one of the monetary authorities might be more willing to tolerate currency appreciation than depreciation. Similarly, a currency band mitigates exchange rate movements until the level of the band is altered. Furthermore, the slow adjustment of real exchange rates is often explained by the stickiness of national price levels. For example, in the well-known Dornbusch (1976) overshooting model, prices and the exchange rate move in the same proportion as the money supply in the very long run. However, in the short run, prices are sticky and monetary shocks cause PPP deviations since the exchange rate moves proportionately more than prices. Rhee and Rich (1995) and Madsen and Yang (1998) provide empirical evidence corroborating the implications of the asymmetric price adjustment models. The key point to note is that, if prices are primarily sticky in the downward direction, there is no reason to presuppose that real exchange rate adjustment is symmetric. In spite of the evidence supportive of asymmetric exchange rate and price adjustments, there are only a few nonlinear tests of PPP Although they do not explicitly test for PPP, Michael, Nobay, and Peel (1997) and Taylor and Sarno (1998) estimate real exchange rates as smooth-- transition threshold adjustment processes. Enders and Falk (1998) formally apply various nonlinear unit-root tests to real exchange rates and find little evidence of PPP. …

Aid Flows and “Dutch Disease” in a General Equilibrium Framework for Pakistan

The impact of development aid has been mainly studied through one-sector and or partial equilibrium models, such as the two-gap framework, “Dutch disease” models, and fiscal response models. These approaches tend to capture inadequately the general equilibrium effects of aid inflows, resulting from income and relative price responses, as well as from the effects on the financial constraints on investment by public and private sector agents in the economy. This article applies a multisectoral general equilibrium framework with a full specification of financial sector relations to Pakistan, overcoming the indicated shortcomings. The model tries to capture the Pakistan economy characterized by commodity and financial market imperfections and structural differences in savings and investment behavior of institutional agents. Model simulations suggest aid inflows tend to generate fairly strong Dutch disease effects in the case of Pakistan. However, more use of aid inflows to alleviate financing constraints on investment of household firms, which are mainly active in traded goods production, could mitigate the Dutch disease effects, whereas nominal exchange rate adjustment appears counterproductive. Comparative country analysis applying similar CGE models for Mexico, the Philippines, and Thailand indicates that the findings for Pakistan are not easily generalizable and depend strongly on the existing economic structure, investment and savings behavior of institutional agents, and the allocation additional capital inflows among public and private sector agents