Changes In Nominal Exchange Rate Research Articles

Effects of monetary policy on the twin deficits

This study uses a three-equation dynamic linear system to show the positive relationship between federal budget deficits and the 5-year Treasury bond rate and between the twin deficits in the U.S. during 1975:01 through 2004:12. An optimal efficient rule equation suggests that a one percentage point increase in bond rate explains a 22% budget deficit variations. A one index point change in nominal exchange rate correlates to a 78% variation in budget deficits. When real exchange rate is adopted in the system, the corresponding percentages become 14 and 86, respectively, showing the fading influence of T-bond rate and the increasing strength of exchange rate.

Estimating time-varying conditional correlations between stock and foreign exchange markets

This study explores the dynamic interaction between stock market returns and changes in nominal exchange rates. Many financial variables are known to exhibit fat tails and autoregressive variance structure. It is well-known that unconditional covariance and correlation coefficients also vary significantly over time and multivariate generalized autoregressive model (MGARCH) is able to capture the time-varying variance-covariance matrix for stock market returns and changes in exchange rates. The model is applied to daily Euro-Dollar exchange rates and two stock market indexes from the US economy: Dow-Jones Industrial Average Index and S&P500 Index. The news impact surfaces are also drawn based on the model estimates to see the effects of idiosyncratic shocks in respective markets.

THE PURCHASING POWER PARITY THEORY AND RICARDO'S THEORY OF VALUE

In this paper the Purchasing Power Parity (PPP) theory and its criticisms are analysed. The majority of studies show that in most cases, the PPP indicator is not a good predictor for nominal exchange rate changes, nor a good indicator of relative competitiveness between countries. Instead, orthodox and non-orthodox economists use relative labour costs to represent real exchange rates. This has interesting implications for the currently accepted price determination theory. In turn, this also allows us to use a Ricardian model as developed by Pasinetti to calculate the ratio of real, vertically integrated unit labour costs between countries as a real exchange rate determination theory and as a sectoral relative competitiveness indicator as well. Copyright 2004, Oxford University Press.

Inflation in India: An Analysis Using Post-Liberalisation Data

Using the post liberalization data on monetary aggregates and nominal effective exchange rates this paper tries to see if there still exists causality between these variables. With an unrestricted Vector Auto Regression framework we check for the granger causality existing among these variables. An attempt is also made to see which one of the three monetary aggregate, among reserve money, narrow money and broad money, explain the inflation in a better way. The granger causality tests and the analysis of unrestricted VAR models suggests strong linkage between both growth in all the three monetary aggregates and changes in nominal exchange rate on inflation in India. Even though no clear evidence is found as to which of the monetary aggregates best explains inflation, from the VAR model there is sufficient reason to believe that the broad money measure (M3) is better. It has also been observed that the explanatory power of these variables in explaining inflation is not high any more.

The Exchange Rate and Inflation in the UK

AbstractThe United Kingdom is a highly open economy, and has a monetary policy strategy of targeting inflation in consumer prices. In this paper, we look at the evidence from the UK on inflation behaviour, and examine the propositions from several theoretical models about inflation dynamics in an open economy, focusing in particular on the hypothesized connections between the exchange rate and consumer price inflation. Theoretical open‐economy macroeconomic models ‘cover the waterfront’ on this issue, ranging from ‘exchange rate disconnect’ to a rigid link between nominal exchange rate changes and inflation. We estimate on UK data the open‐economy Phillips curves implied by the alternative explanations. We argue that, of the alternatives considered, only a model where imports are modelled as an intermediate good, as in McCallum and Nelson (1999), provides a reasonable match with the data. Unlike the standard model, in which imports are treated as a final consumer good, the intermediate‐goods specification provides support for a policy of CPI inflation targeting.

Sudden Stops in Capital Inflows and the Design of Exchange Rate Regimes

A two sector small open economy model developed by Corden (1991, 2002) is used to analyse the impact of sudden stops in capital inflows on an internal and external equilibrium and to explore the merits of disposing of the nominal exchange rate as policy tool in rectifying real exchange rate misalignments. It is shown how the economy's sectoral demand properties determine the extent of recession associated with real exchange rate adjustment that is neither engineered by nominal exchange rate changes nor brought about by a decline in nontraded goods prices. The conclusion is drawn that, when deciding on the design of exchange rate regimes, the structural characteristics of the economy ought to be considered so as to appropriately strengthen its capacity to cope with shocks in the form of negative swings in capital inflows.

Mehanizam uticaja promene deviznog kursa na inflaciju

The implementation of an adequate exchange rate policy inevitably leads us to the pass-through of exchange rate changes on export prices and inflation. During the last decade of 20th century, there was a lot of research done on the pass-through of exchange rate changes from the microeconomic aspect. This approach, known as New Open Economy Macroeconomics, is theoretically grounded mainly on producers' ability to price discriminate in markets for export goods. Consistent with the established theoretical framework, the focus of this research has been directed towards studying the pass-through of exchange rate changes to export prices. Relatively few research papers, also based on theoretical grounds of basically macroeconomic character, have dealt with the pass-through of exchange rate changes to inflation. This paper observes the pass-through of exchange rate changes to inflation from the macroeconomic aspect. The starting point of our theoretical consideration of the pass-through of exchange rate changes to inflation is the well-known Dornbusch's overshooting model. The observation of the pass-through of exchange rate changes to inflation within the overshooting model allows us to observe two dimensions through which changes in the exchange rate pass through to inflation. The first dimension observes the pass-through of nominal exchange rate changes to inflation, whereas the second one observes the deviations of the nominal exchange rate from the equilibrium nominal exchange rate, having simultaneous internal and external equilibrium. The final pass-through of exchange rate changes to inflation will depend on the joint influence of both dimensions. Also, the pass-through of exchange rate changes to inflation will be observed in the countries with a fixed exchange rate system, which so far has not been a common situation in practice. We believe that exchange rate changes pass through to inflation even in a fixed exchange rate system, when a change in the exchange rate is equal to zero, which is manifested in deviations of the nominal exchange rate from the equilibrium exchange rate.

A Currency Union for the Caribbean

The experiences of Caribbean Economic Community countries show that exchange rate depreciation in these countries is inflationary, and that, while changes in the relative prices of tradables may affect exports, tourism, and imports, nominal exchange rate changes have no predictable effect on those relative prices. Under these circumstances, economic literature indicates that a fixed exchange rate regime is optimal, and Caribbean countries with (quasi-) currency boards have been successful in maintaining durable exchange rate pegs. Commitment to a currency board is a potentially vital step in achieving a currency union for the Caribbean.

Exploring real exchange rate effects on trade balances in Thailand

This study investigates the impact of real exchange rates on the trade balances between Thailand and its major trading partners. Previous empirical evidence gave mixed results of the impact of real exchange rates on trade balances. In this study, Augmented Dicky‐Fuller and Phillips‐Perron tests for stationarity followed by the cointegration tests are implemented. All variables in the model are nonstationary but cointegrated. In cointegrating regressions, biases are introduced by simultaneity and serial correlation in the error. The specification that deals with these problems is the non‐linear specification of Stock and Watson (1989). By using this non‐linear model as modified by Reinhart (1995), the results show that the impact of real exchange rates (Thai baht/foreign currency) on trade balances is significant in most cases. Therefore, the generalized Marshall‐Lerner condition seems to hold. Furthermore, the results show that the real exchange rates play a more important role in the determination of the bilateral trade balances than other factors. Since the real exchange rate variable plays a major role in this study, the policy recommendation is to prevent exchange rate misalignment. A policy that can neutralize the changes in nominal exchange rates and relative prices should be introduced to prevent further deterioration of the trade balance.

India’s trade balance: the role of income and exchange rates

This study estimates the balance of trade model on Indian data from 1960 to 1995 using a reduced-form specification similar to Rose [J. Int. Economics, 30 (1991) 301]. The results show that the real exchange rate (trade weighted) and domestic income play a significant, while the world income plays an insignificant or a less significant role in affecting the balance of trade in India. The trade effects of real exchange rate are different from those of nominal exchange rate. The study suggests the need to monitor the real rather than nominal exchange rate, and in this major focus is required on weighted and more specifically the trade weighted real effective exchange rate. Besides, the devaluation-based adjustment policies need to be supplemented by stabilisation policies to ensure domestic price stability and achieve the desired effects of nominal exchange rate changes (devaluation) on the balance of trade.

Local-currency pricing and the choice of exchange-rate regime

Feldstein (1992, The Economist 19–22; 1997, Journal of Economic Perspectives 11, 23–42) invokes Friedman's (1953, Essays in Positive Economics. Chicago University Press, Chicago, pp. 157–203) classic case for flexible exchange rates to argue that the single currency of the European Monetary Union will hinder adjustments that might have occurred through real exchange rate movements under a more flexible exchange rate system. The extent of local-currency pricing among European countries undermines this view. The prices that consumers pay for imported goods are not much influenced by changes in nominal exchange rates in the short run. The channels for adjustment through relative price changes are considerably narrowed when local-currency pricing predominates. New evidence is presented that reaffirms the predominance of local-currency pricing for consumer prices in Europe. The optimum currency area analysis is reexamined in a Mundell–Fleming framework with local-currency pricing.

International foreign exchange agreements and nominal exchange rate volatility: a GARCH application

For eight major national currencies, this study estimates, and tests several hypotheses with, a t-distribution GARCH model of daily spot nominal exchange rate changes. The sample period covered is June 1, 1982 through September 30, 1992. By using likelihood ratio and parameter stability tests, it finds that for most of the currencies considered, both the conditional means and variances of unexpected exchange rate changes experienced statistically significant structural breaks across the five subperiods that are associated with four episodes of international foreign-exchange policy coordination. The study also finds that the orderings of the GARCH-estimated unconditional standard deviations roughly match the orderings of the sample standard deviations across the five subperiods. An explanation is provided for what underlying factors contributed to these structural shifts.

Exchange rate pass-through and the J-curve: An analysis of the Korean case

By using Rubinstein's bargaining model, it is shown that the degree of pass-through from the nominal exchange rate to export price, which is measured by the foreign currency, can be different whether the home currency depreciates or appreciates. These asymmetric movements of export prices can yield different dynamic paths for effects of changes in nominal exchange rate upon the trade balance. By using Korean data, these findings are empirically tested through the generalized Marshall-Lerner condition.

Haircuts or hysteresis? Sources of movements in real exchange rates

We empirically assess the importance of two sources of real exchange rate movements. In models where PPP holds only among traded goods, real exchange rate variation results from relative price movements within countries. An alternative explanation relies on hysteretic price-setting and nominal exchange rate changes. Using disaggregated price data from 11 OECD nations, we find some support for the non-traded goods models. For example, prices of haircuts in Canada and the United States are unrelated in the long run. We find stronger evidence to support models that emphasize sticky prices, transportation costs, or other impediments to frictionless trade.

Purchasing power parity in the major EMS countries: The role of price and exchange rate adjustment

In this paper we address the issue of whether the European Monetary System has contributed to real exchange rate stability between France, Germany, and Italy. We first ask whether bilateral PPP holds between any pair of these countries and between each of them and the United States. We find that PPP never holds before the EMS was created, and that it does among EMS countries, but not relative to the U.S. since. Next we assess the role of relative prices and exchange rates in the adjustment process toward PPP. We find that PPP between France and Germany is solely due to exchange rate dynamics. However, both nominal exchange rate and domestic inflation rate changes are responsible for the emergence of a PPP relationship between Italy and Germany, though price movements contribute less than nominal exchange rates to the adjustment process.

Real and Nominal Exchange Rates in the Long Run

This paper decomposes longer-run movements in (major) dollar real exchange rates into components associated with changes in nominal exchange rates and price levels, and their comovements. Though the decompositions suggest some permanent movements, they imply that there are large transitory components in real exchange rates. These transitory components in real exchange rates are found to be closely associated with those in nominal exchange rates. A stochastic version of Dornbusch’s overshooting model—configured with representative parameter values for the United States and subjected to permanent nominal shocks—can rationalize these transitory comovements of nominal and real exchange rates as well as several other features of the decompositions.

Real and Nominal Exchange Rates in the Long Run

This paper decomposes longer-run movements in (major) dollar real exchange rates into components associated with changes in nominal exchange rates and price levels, and their comovements. Though the decompositions suggest some permanent movements, they imply that there are large transitory components in real exchange rates. These transitory components in real exchange rates are found to be closely associated with those in nominal exchange rates. A stochastic version of Dornbusch`s overshooting model--configured with representative parameter values for the United States and subjected to permanent nominal shocks--can rationalize these transitory comovements of nominal and real exchange rates as well as several other features of the decompositions.

The Determinants of Export Supply and Export Demand in Two Developing Countries: Greece and Korea

This paper indicates the responsiveness of export supply and export demand to changes in relative prices in Greece and Korea. At the same time, estimates made for Korea indicate that exporters respond more strongly to changes in the nominal exchange rate, adjusted for export incentives, than to changes in the prices of export and non-export goods. The paper further provides estimates of the effects of domestic capacity on export supply and the effects of foreign incomes on export demand. [420]

Exchange Rate Movements and International Interdependence of Stock Markets

This paper investigates linkages between stock markets in seven industrialized countries since 1974. Empirical evidence shows that both nominal and real stock prices (and returns) are strongly positively correlated across countries, and that nominal exchange rate changes do not have systematic effects on nominal stock prices. A two-country theoretical model is developed and an attempt is made to reconcile the empirical findings with the properties of this model. Independent evidence on the main sources of shocks is used to argue that the time-varying correlation in the data can be reconciled with the predictions of the theory.

Expectations of Exchange Rates and Differential Inflation Rates: Further Evidence on Purchasing Power Parity in Efficient Markets

ABSTRACTThe paper tests the null hypothesis of ex ante purchasing power parity. The empirical evidence obtained is inconsistent with the null for major industrialized countries over the current floating exchange rate regime. Expected nominal exchange rate changes appear to deviate systematically from expected inflation rate differentials over the same holding period even though real exchange rate changes appear to be serially uncorrelated. This supports the presence of time‐varying risk premia in foreign exchange markets and real determinants of exchange rate movements as suggested by equilibrium theories of international asset markets.