Rigid Exchange Rate Regimes Research Articles

Exchange rate regimes as thresholds: The main determinants of capital inflows in emerging market economies

We investigate whether the impacts of the main push (global financial conditions, GFC) and pull (growth) factors on capital inflows are invariant to endogenously estimated thresholds for exchange rate regimes (ERRs) in emerging market economies. The impact of GFC is higher under more flexible ERRs for aggregate capital and portfolio inflows. FDI inflows are determined by growth. The sensitivity of aggregate and other investment inflows to growth is higher under more rigid ERRs. Our results also suggest that managed ERRs encourage capital inflows by allowing countries to import the monetary policy credibility of the anchored country and to provide an exchange rate guarantee.

MONETARY CHALLENGES OF EMERGING EUROPEAN ECONOMIES TOWARDS THE EURO ZONE

The paper aims to highlight the main difficulties on the monetary path towards the euro zone experienced by Emerging Europe. Emerging European Economies (EEEs), EU members, adopted either double shift or smooth transition monetary approach towards the euro zone. Double shift assumes changes from floating exchange rate regimes (ERRs) to the ERM II target zone and, finally, monetary union as a rigid ERR. The smooth transition is practiced by economies with mainly rigid ERRs before the ERM II entrance and, at the end, again rigid ERR of a monetary union. Despite chosen monetary path towards the euro zone, crucial difficulties or aggravating factors could be identified in the form of real exchange rate appreciation due to productivity growth or capital inflows. A reconciliation of inflation and exchange rate target zone is extremely complex, at the same time striving not to jeopardize the real convergence. What is stressed here is the vicious cycle between real and nominal convergence as the reason why the ERM II target should be regarded as a “waiting room“ not as a “training room“ in the pre-EMU phase.

Exchange Rates and Insulation in Emerging Markets

The insulating properties of flexible exchange rates have long been a highly contentious issue in emerging markets—not least in Asian emerging markets. A number of recent theoretical and empirical studies question whether a trade-off exists between rigid exchange rate regimes and insulation from foreign shocks when the degree of international capital mobility is high. On the other hand, Obstfeld et al. (2017) find that countries with flexible exchange rate regimes experience less real and financial instability in the face of global financial volatility. We contribute to this empirical debate by significantly extending their analysis. Overall, our findings are broadly consistent with their results, suggesting that flexible exchange rate regimes are better at insulating emerging markets from external shocks. There are, however, a few subtle differences. In particular, we find somewhat less robust evidence that limited flexibility is enough to insulate emerging markets from shocks.

Exchange Rates and Insulation in Emerging Markets

The insulating properties of flexible exchange rates have long been a highly contentious issue in emerging markets—not least in Asian emerging markets. A number of recent theoretical and empirical studies question whether a trade-off exists between rigid exchange rate regimes and insulation from foreign shocks when the degree of international capital mobility is high. On the other hand, Obstfeld, Ostry, and Qureshi (2017) find that countries with flexible exchange rate regimes experience less real and financial instability in the face of global financial volatility. We contribute to this empirical debate by significantly extending their analysis. Overall, our findings are broadly consistent with their results, suggesting that flexible exchange rate regimes are better at insulating emerging markets from external shocks. There are, however, a few subtle differences. In particular, we find somewhat less robust evidence that limited flexibility is enough to insulate emerging markets from shocks.

Disinflationary Spillovers from The Euro Area into the Countries of Southeastern Europe

AbstractWe analyse the determinants of the inflation trends in ten Southeast European (SEE) countries. Global cost-related factors and euro area inflation developments play an important role in explaining inflation dynamics in SEE countries. Changes in world food and energy prices, together with related changes in administered prices, similarly contribute to these trends. In general, we show that disinflationary spillovers from the euro area have been an important factor for fixed exchange rate regime countries, especially those with more trade exchange with countries in the euro area. Furthermore, our heterogeneity analysis shows that countries with less rigid exchange rate regimes but with relatively high exposure of trade exchange to the euro area (EA) market appear to be susceptible to inflation spillovers from the euro area. Moreover, nominal effective exchange rate plays an important role in inflation process in SEE countries, particularly in floating regime countries. In line with several recent findings about flattening of the Phillips curve in many economies across the world, cyclical unemployment does not appear to be significant in our sample. We conclude with some policy implications of our results.

Monetarne faze i okviri emergentnih zemalja Evropske unije

The paper reviews the monetary stages and frameworks towards the eurozone (EZ) for emerging EU members. At the first pre-EU stage, three monetary frameworks were identified, whereas at the second pre-EZ stage, the emerging EU members combined ER targeting with the rigid/fixed exchange rate regimes (ERRs), on the one hand, and inflation targeting (IT) with the ERM II, on the other. The last stage of monetary convergence assumes monetary nonautonomy within the monetary union as a rigid ERR, where the ER and monetary policies are sacrificed as countercyclical instruments. Countries with rigid ERRs are more prone to macroeconomic overheating, performing worse under a crisis impact compared to the floaters. The difficulties to maintain stability under a rigid ER environment, such as the monetary union, as well as the inherent vulnerabilities of the EZ, are crucial for the delayed entry of some EU members into the ERM II.

Gross Capital Flows, Common Factors, and the Global Financial Cycle

This paper assesses the international comovement of gross capital inflows and outflows using a two-level factor model. Among advanced and emerging countries, capital flows exhibit strong commonality: common (global and country group-specific) factors account, on average, for close to half of their variance. There is a contrast across groups: common factors dominate advanced-country capital flows, while idiosyncratic factors dominate emerging- country flows and, especially, developing-country flows. The reason is the much larger role of global factors among advanced countries. Importantly, these findings apply to both inflows and outflows: their respective common factors are very similar -- although global factors play a bigger role for outflows than for inflows. The commonality of flows reflects a global cycle, summarized by a small set of variables (the VIX, the U.S. real interest rate and real exchange rate, U.S. GDP growth, and world commodity prices) that explain much of the variance of the estimated factors -- especially the global factors. Over time, the quantitative role of the common factors exhibits aglobalizationstage up to 2007, during which they acquire growing importance, followed by a phase ofdeglobalizationpost-crisis. Greater financial openness, deeper financial systems, and more rigid exchange rate regimes amplify countries'exposure to the global financial cycle.

Exchange rate flexibility and credit during capital inflow reversals: Purgatory … not paradise

We identify periods of capital inflows reversals—looking at both gross and net capital flows—and document the behavior of macro and credit variables in economies with different degrees of exchange rate flexibility. We find that more exchange rate flexibility moderates credit swings during capital flow cycles, mainly because it is associated with milder credit growth during the boom. Flexibility, however, cannot completely shield the economy from a credit reversal. We observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress potential complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surcharges and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

The transmission of foreign shocks to South Eastern European economies

This paper investigates the transmission of foreign shocks to economic activity and macroeconomic policies in three South Eastern European (SEE) economies: Croatia, Macedonia and Bulgaria. Specifically, we provide empirical evidence on the influence of several policy and non-policy shocks (euro-zone output gap, money market rate and inflation) on economic activity as well as monetary and fiscal policies in the three countries. The main motivation behind our empirical investigation is the fact that all of these economies are small open economies with rigid exchange rate regimes and different degree of integration within the European Union (EU). As for the methodological issues, we employ recursive vector autoregressions to identify the exogenous shocks in the euro-area. Generally, the estimated results imply that euro-zone economic activity has significant and relatively strong influence on these economies where foreign output shocks are transmitted relatively quickly. The results also suggest that the effects of foreign shocks are of larger magnitude in the countries that are more integrated with the EU. An additional finding is that positive foreign interest rate shocks trigger a contractionary response of domestic monetary policy notwithstanding the fact that domestic money market rates are not linked with euro-zone interest rates. Finally, euro-zone inflation is instantly transmitted to domestic inflation. We can explain these effects by several factors, such as: the fixed exchange rates, the relatively high trade integration of SEE economies within the euro-zone as well as the dependence of SEE banks on foreign financing.

Current account sustainability in Sub-Saharan Africa: Does the exchange rate regime matter?

This paper aims at studying the sustainability of current accounts in Sub-Saharan Africa and determining whether this sustainability depends on the exchange rate regime. Relying on a formal theoretical framework and recent panel cointegration techniques, our findings show that current accounts have been globally sustainable in Sub-Saharan Africa countries over the 1980–2011 period. However, this sustainability has been lower for countries operating a fixed exchange rate regime or belonging to a monetary union. We also find that the difference in the level of sustainability could be explained by a higher persistence in the current account adjustment of countries operating under rigid exchange rate regimes.

Exchange Rate Flexibility and Credit during Capital Inflow Reversals: Purgatory…not Paradise

We document the behavior of macro and credit variables during episodes of capital inflows reversals in economies with different degrees of exchange rate flexibility. We find that exchange rate flexibility is associated with milder credit growth during the boom but, even though smaller than in more rigid regimes, it cannot shield the economy from a credit reversal. Furthermore, we observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress the complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surchages and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

Exchange Rate Flexibility and Credit During Capital Inflow Reversals: Purgatory…Not Paradise

We document the behavior of macro and credit variables during episodes of capital inflows reversals in economies with different degrees of exchange rate flexibility. We find that exchange rate flexibility is associated with milder credit growth during the boom but, even though smaller than in more rigid regimes, it cannot shield the economy from a credit reversal. Furthermore, we observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress the complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surchages and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

Are Non-Euro Area EU Countries Importing Low Inflation from the Euro Area?

The synchronized disinflation across Europe since end-2011 raises the question of whether non-euro area EU countries are affected by the undershooting of the euro area inflation target. To shed light on this issue, we estimate an open-economy, New Keynsian Phillips curve, in which we control for imported inflation. Regression results suggest that falling food and energy prices have been the main disinflationary driver. But low core inflation in the euro area has also had a clear and significant impact. Countries with more rigid exchange-rate regimes and higher share of foreign value added in domestic demand have been more affected. The scope for monetary response to low inflation in non-euro area EU countries depends on concerns about financial stability and unanchoring of inflationary expectations, as well as on exchange rate regime and capital flows dynamics.

Are Non-Euro Area EU Countries Importing Low Inflation from the Euro Area?

The synchronized disinflation across Europe since end-2011 raises the question of whether non-euro area EU countries are affected by the undershooting of the euro area inflation target. To shed light on this issue, we estimate an open-economy, New Keynsian Phillips curve, in which we control for imported inflation. Regression results suggest that falling food and energy prices have been the main disinflationary driver. But low core inflation in the euro area has also had a clear and significant impact. Countries with more rigid exchange-rate regimes and higher share of foreign value added in domestic demand have been more affected. The scope for monetary response to low inflation in non-euro area EU countries depends on concerns about financial stability and unanchoring of inflationary expectations, as well as on exchange rate regime and capital flows dynamics.

Interest rate pass-through in South East Europe: An empirical analysis

This paper investigates the effectiveness of the interest rate channel in three small open economies with rigid exchange rate regimes in South East Europe – Bulgaria, Croatia and Macedonia – during the period 2000–2010. Specifically, we examine the size and speed of adjustment of bank lending rates to the changes in money market rates by employing various cointegration methods. In addition, we assess the stability of interest rate passthrough during the transition period, including the recent economic crisis. The results reveal the existence of a cointegrating relationship among some of the interest rates. We find that the long-run pass-through is far from complete with the exception of Macedonia. The shortrun adjustment of lending rates is also low and sluggish, implying that the domestic monetary policy may have a limited impact on the interest rate channel. Finally, the econometric investigation provides mixed evidence on the stability of the interest rate pass-through. Therefore, the overall findings of the paper support the view that in small open economies with rigid exchange rates the effectiveness of domestic monetary policy through the interest rate channel is quite limited.

Flexible exchange rates as shock absorbers

In this paper we analyze empirically the effect of terms of trade shocks on economic performance under alternative exchange rate regimes. We are particularly interested in investigating whether terms of trade disturbances have a smaller effect on growth in countries with a flexible exchange rate arrangement. We also analyze whether negative and positive terms of trade shocks have asymmetric effects on growth, and whether the magnitude of these asymmetries depends on the exchange rate regime. We find evidence suggesting that terms of trade shocks get amplified in countries that have more rigid exchange rate regimes. We also find evidence of an asymmetric response to terms of trade shocks: the output response is larger for negative than for positive shocks. Finally, we find evidence supporting the view that, after controlling for other factors, countries with more flexible exchange rate regimes grow faster than countries with fixed exchange rates.

Financial Openness, Sudden Stops, and Current-Account Reversals

In this paper I use a panel data set to investigate the mechanics of sudden stops of capital inflows and current account reversals. I am particularly interested in four questions: (a) What is the relationship between sudden stops and current account reversals? (b) To what extent does financial openness affect the probability of a country being subject to a current account reversal? In other words, do restrictions on capital mobility reduce the probability of such occurrences? (C) Does openness -- both trade openness and financial openness -- play a role in determining the effect of current account reversals on economic performance (i.e. GDP growth)? And, (d) does the exchange rate regime affect the intensity with which reversals affect real activity? The empirical analysis shows that sudden stops and current account reversals have been closely related. The econometric analysis suggests that restricting capital mobility does not reduce the probability of experiencing a reversal. Current account reversals, in turn, have had a negative effect on real growth that goes beyond their direct effect on investment. The regression analysis indicates that the negative effects of current account reversals on growth will depend on the country's degree of trade openness: More open countries will suffer less in terms of lower growth relative to trend than countries with a lower degree of trade openness. On the other hand, the degree of financial openness does not appear to be related to the intensity with which reversals affect real economic performance. The empirical analysis also suggests that countries with more flexible exchange rate regimes are able to accommodate better shocks stemming from a reversal than countries with more rigid exchange rate regimes.

Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops

In this paper I analyze the anatomy of current account adjustments in the world economy during the past three decades. The main findings may be summarized as follows: (i) Major reversals in current account deficits have tended to be associated with “sudden stops” of capital inflows. (ii) The probability of a country experiencing a reversal is captured by a small number of variables that include the (lagged) current account to GDP ratio, the external debt to GDP ratio, the level of international reserves, domestic credit creation, and debt services. (iii) Current account reversals have had a negative effect on real growth that goes beyond their direct effect on investments. (iv) There is persuasive evidence indicating that the negative effect of current account reversals on growth will depend on the country's degree of openness. More open countries will suffer less-in terms of lower growth-than countries with a lower degree of openness. (v) I was unable to find evidence supporting the hypothesis that countries with a higher degree of dollarization are more severely affected by current account reversals than countries with a lower degree of dollarization. And (vi) the empirical analysis suggests that countries with more flexible exchange rate regimes are able to accommodate the shocks stemming from a reversal better than countries with more rigid exchange rate regimes.