Role Of Exchange Rate Regime Research Articles

A state-dependent international CAPM for partially integrated markets: Using local and US risk factors

This study investigates the impact of emerging economies' trade levels with the US and exchange rate systems on their interdependency with the US market. We employ a comprehensive approach, analyzing both local factors (such as illiquidity and dividend yield) and US risk factors (including the S&P500 Index, US effective exchange rate, and term spread) to discern various market phases and capture equity returns. Utilizing a State-dependent International CAPM framework, we reveal a common trend among market returns: the reduced informativeness of both US and local variables during transitions from low to high volatility states. Notably, the majority of emerging markets respond to signals from the US equity market during bullish periods. We also highlight the critical role of exchange rate regimes in explaining the sensitivity of emerging markets to US risk factors. While the illiquidity ratio emerges as a significant local risk factor, its informativeness wanes during bear markets. These findings offer valuable insights for asset allocation, diversification, and risk management strategies tailored to the dynamic nature of emerging markets.

International reserves, economic crisis and monetary autonomy in Asia: a panel data analysis

ABSTRACT A country cannot simultaneously have an independent monetary policy, fixed exchange rate and freely mobile capital. This paper uses data from 10 Asian economies in recent years to investigate the macroeconomic trilemma. It makes special reference to the role of exchange rate regimes, capital controls, economic crisis, and international reserve holdings to analyse how interest rate changes in the centre country affect peripheral countries’ interest rates. The main findings support the existence of a macroeconomic trilemma. Moreover, we find that international reserves help to provide monetary autonomy with a buffer even under a fixed exchange rate and free capital mobility regime.

Exchange rate policy and heterogeneity in small open economies

This paper studies the role of exchange rate regimes in shaping the distributional effects of external monetary shocks. I model a small open economy where agents differ in wealth and in exposure to international trade, producing either tradable or non-tradable goods. The central bank responds to a foreign interest rate hike by a monetary tightening to stabilize the exchange rate or lets the currency depreciate, keeping the interest rate low. I find that exchange rate flexibility distributes consumption gains to the poorer agents. The monetary tightening required to stabilize the currency disproportionately affects their disposable income through interest payments on loans and falling wages. Attempts to fix the exchange rate increase consumption inequality. Flexibility also benefits the non-tradable sector because conditions in this sector are more sensitive to domestic demand and sharply deteriorate when domestic interest rates rise.

Does the Volatility of Oil Price Affect the Structure of Employment? The Role of Exchange Rate Regime and Energy Import Dependency

The volatility of oil price as a key energy resource for modern economies has a significant impact on the macroeconomic situation. In addition to affecting aggregated production, consumption, employment and inflation, oil shocks can affect the economy in a more nuanced way. One consequence of the turmoil in the oil market may be a shift in the employment structure between the tradable and non-tradable sectors, which we investigate in this paper. The aim of this study is to test how oil price volatility affects the structure of employment in Central and Eastern European countries. Our main hypothesis is that oil price volatility causes a temporal employment reallocation between tradable and non-tradable sectors. To verify this assumption, we created Interacted Panel VAR (IPVAR), which showed that the shocks of oil price volatility affect the employment structure and this impact is conditioned by the level of dependence on energy imports and the exchange rate regime. The constructed impulse response functions showed that, in general, oil price volatility causes a temporal fall in relative employment in the manufacturing (tradable) sector. For periods of an above-average import of energy, the exchange rate regime does not matter for the response of the structure of employment. Inversely, when countries are less dependent on imports of energy, the exchange rate regime matters for shock absorption—for floats, oil price shocks cause a temporal fall in relative employment in manufacturing, whereas for pegs, there is a slight relative increase in employment in manufacturing.

International Spillover of US Policy Uncertainty Shock and the Role of Exchange Rate Regime

International Spillover of US Policy Uncertainty Shock and the Role of Exchange Rate Regime

The effectiveness of macro-prudential policies in the face of global uncertainty –the role of exchange-rate regimes

The paper analyses the effects of world uncertainty on the level of domestic credit growth rate and the role of macro-prudential policies (Mapps) in mitigating these effects in a panel of 33 countries under different exchange rate regimes. A higher level of world uncertainty decreases the level of domestic credit under both fixed- and flexible-exchange rate regimes, but these spill-over effects are higher for countries with fixed-exchange rate regimes. The Mapps have a significant impact on financial conditions and help to achieve long-term financial stability, but only for countries under the flexible-exchange regime. It remains completely ineffective for the fixed-exchange economies.

Impact of commodity price volatility on external debt: the role of exchange rate regimes

ABSTRACT This study explores the impact of commodity price volatility on external debt accumulation under fixed, managed, and floating exchange rate regimes. We estimate dynamic panel data models for 97 countries from 1993 to 2016. Our empirical findings show that commodity price volatility increases external debt accumulation for commodity-exporting countries. This impact is three-times higher for countries with fixed exchange rate regimes compared to managed floating exchange rate regimes. Under floating exchange regimes, the effect of commodity price volatility on external debt is statistically insignificant. Our results suggest that the adoption of a floating exchange rate regime by commodity-exporting countries is critical to mitigate the effects of commodity price volatility on external debt accumulation.

Exchange Rate Policy and Heterogeneity in Small Open Economies

I study the role of exchange rate regimes in shaping the distributional effects of external monetary shocks in a small open economy with two types of heterogeneity: in wealth and exposure to international trade. Under capital mobility, foreign tightening induces a combination of domestic tightening and currency depreciation, affecting consumption through the interest rate and income channels. Exchange rate policy determines their relative strength. Raising the interest rate under peg causes a recession and exacerbates inequality because the collapse in wages disproportionately affects the poor. The non-tradable sector is hit harder, being more sensitive to domestic demand. The consumption gap between tradable and non-tradable sectors opens wider in the left tail since it is driven by the divergence in wages. Letting the currency float boosts incomes through expenditure switching, while better interest rate insulation protects domestic demand, so the impact is more even across sectors and inequality decreases.

Dynamics of monetary policy spillover: The role of exchange rate regimes

In a time-varying framework, our study investigates the role of exchange rate regimes in explaining monetary policy spillover across a set of AEs and EMEs. We also investigate the channels contributing to the dynamism in the degree of such spillover. We find that the flexible exchange rate regime in the AEs insulates them against the spillover to a relatively larger extent as compared to the managed float regime in the EMEs. We also find that the spillover is strongly time-varying, being influenced by macroeconomic conditions in the centre economy. Risk-taking, portfolio rebalancing, and signaling channels are found to be significant in explaining the rise in spillover in the EMEs, but not in the AEs. The rise in the connectedness of interest rates in the AEs occurred only during the global financial crisis (2008–12), owing to their higher policy coordination with the US. This should not be misconstrued as monetary policy spillover.

Governance and economic growth: The role of the exchange rate regime

In this paper, we revisit the relationship between governance and economic growth focusing on the role of exchange rate regime. The conventional theoretical view is that increased quality of governance stimulates economic growth, while recent years show that some countries with weak governance are experiencing more economic growth. We show that the effect of governance on economic growth is influenced by several factors such as the potential costs associated with choice of the exchange rate regime. We carried out GMM regressions on panel data to overcome heteroscedasticity, autocorrelation and homogeneity problems. Our panel covers the period 1996-2012 and comprises 50 countries, among which 21 are developed and 29 are emerging. We found that governance is not highly significant to explain economic growth while exchange rate flexibility significantly destabilizes emerging markets and accelerates economic growth in developed countries. Likewise, we found that good governance encourages the choice of flexible exchange rate regime and that exchange rate flexibility requires the improvement of governance to stimulate economic growth in emerging countries. Concerning developed countries, good governance accelerates economic growth if the exchange rate regime is not too flexible and exchange rate flexibility increases economic activity if the governance is not of high quality. Thus, our estimates show that the nature of the exchange rate regime plays a crucial role in the decision to improve the quality of governance. Similarly, the quality of governance determines the optimal exchange rate regime. The interaction term between the overall governance index and the degree of exchange flexibility is statistically significant at the conventional threshold, confirming the importance of the theoretical and empirical foundations raised in this research.

Exchange rate regimes and the international transmission of business cycles: Capital account openness matters

We investigate the role of exchange rate regimes in the international transmission of business cycles during the global financial crisis. We find that exchange rate regimes alone did not account for differences in the international transmission of business cycles during the crisis. However, analysis considering capital account openness and countries with currencies pegged to the U.S. dollar indicates that exchange rate regimes play an important role in shaping business cycle co-movement: adopting a fixed regime with high capital account openness (additionally) increased business cycle co-movement with the United States during the crisis, whereas U.S. dollar peggers with relatively restrictive capital accounts during the crisis were not found to affect business cycle transmission.

Exchange Rate Regimes and the International Transmission of Business Cycles: Capital Account Openness Matters

We investigate the role of exchange rate regimes in the international transmission of business cycles during the global financial crisis. We find that exchange rate regimes alone did not account for differences in the international transmission of business cycles during the crisis. However, analysis considering capital account openness and countries with currencies pegged to the U.S. dollar indicates that exchange rate regimes play an important role in shaping business cycle co-movement: adopting a fixed regime with high capital account openness (additionally) increased business cycle co-movement with the United States during the crisis, whereas U.S. dollar peggers with relatively restrictive capital accounts during the crisis were not found to affect business cycle transmission.

Time-inconsistency and expansionary business cycle theories: What does matter for the central bank independence–inflation relationship?

Since the seminal paper of Kydland and Prescott (1977), a central bank’s independence (CBI) has been considered an important institutional condition for achieving lower inflation. Recently, however, this long-held belief has been challenged. This paper investigates the relationship between CBI and inflation for a large sample (91 countries) covering the period from 1990 to 2014. We follow the previous literature by considering differences across national monetary regimes in explaining this relationship. Our approach also traces the sources of the inflationary phenomenon. Using panel data and the turnover indicator as a proxy for CBI, we offer two main findings. First, we identify the role of exchange rate regimes in the dynamic between inflation and CBI. Second, our results show that only intermediate and flexible exchange rate regimes are appropriate in this relationship. This finding is explained by the level of CBI, which is very low for countries with a fixed exchange rate policy and low income levels. For policymakers, our results highlight the importance of the choice of monetary regime in controlling inflation in the presence of CBI. For public agents, our results provide guidelines for formulating expectations.

Coordination of Wage Bargaining, Exchange Rate Stability and External Adjustment

The literature on the determinants of the rate of current account reversion has been limited to examining the role of exchange rate regimes. We propose that the degree of coordination of wage bargaining affects the speed of current account adjustment. Our point estimates are economically and statistically significant, suggesting that fragmented firm-level wage bargaining facilitates external adjustment. We also find a strong negative interaction between the effects of coordination of wage bargaining and exchange rate stability on the rate of current account reversion.

Current Account and Real Effective Exchange Rate Misalignments in Central Eastern EU Countries: An Update Using the Macroeconomic Balance Approach

Using the IMF Consultative Group on Exchange Rate Issues methodology, we make an assessment of the current account and price competitiveness of the Central Eastern European Countries that joined the EU between 2004 and 2014. We present results for the “Macroeconomic Balance” approach, which provides a measure of current account equilibrium based on its determinants together with misalignments in real effective exchange rates. We believe that a more refined analysis of the misalignments may useful for the Macroeconomic Imbalance Procedure. This is especially the case for these countries, which have gone through a transition phase and boom/bust periods since their independence. Because such a history may have influenced a country’s performance, any evaluation must take account of each country’s particular characteristics. We use a panel setup of 11 EU new member states (incl. Croatia) for the period 1994-2012 in static and dynamic frameworks, also controlling for the presence of cross-sectional dependence and checking specifically for the role of exchange rate regimes, capital flows and global factors.We find that the estimated coefficients of the determinants meet with expectations. Moreover, the foreign capital flows, the oil balance, and relative output growth seem to play a crucial role in explaining the current account balance. Some global factors such as shocks in oil prices or supply might have played a role in worsening the current account balances. Having a pegged exchange rate regime (or being part of the euro zone) affects the current account positively. The real effective exchange rates behave in accord with the current account gaps, which clearly display cyclical behaviour. The current accounts and real effective exchange rates come close to equilibria in 2012 in most of the countries and the rebalancing is completed for some countries that were less misaligned in the past, such as Poland and Czech Republic, but also for Lithuania. When foreign direct investments are introduced as a determinant for these countries, the misalignments are larger in the boom periods (positive misalignments) whereas the negative misalignments are smaller in magnitude.

Current Account and Reer Misalignments in Central Eastern EU Countries: An Update Using the Macroeconomic Balance Approach

Following the IMF CGER methodology, we conduct an assessment of the current account and competitiveness of the EU new member states (here defined as Central Eastern European Countries, CEECs, which joined the EU between 2004 and 2014). We present results for a method called the “Macroeconomic Balance (MB) approach” which provides a measure of current account equilibrium based on its determinants together with misalignments in the real effective exchange rates. We use a panel setup of 11 EU new member states (Croatia is included) over the period 1994-2012 in static and dynamic frameworks, also controlling for the presence of cross-sectional dependence, checking specifically for the role of exchange rate regimes, capital flows and global factors. We find that the estimated coefficients for the determinants are in line with the expectations. Moreover, the foreign capital flows, the oil balance and relative output growth seem to play a crucial role in explaining the current account. Some global factors like shocks in oil prices or supply might have played a role in worsening, the current account balance of the CEECs. Having a pegged exchange rate regime (or being part of the euro zone) affects the current account positively, but the resulting misalignments for the current account and the real effective exchange rates are bigger. The real effective exchange rates behave in line with the current account gaps, which experience a clear cyclical behaviour. When the Foreign Direct Investments (FDIs) are introduced as a determinant for these countries, the misalignments are larger in the boom periods (positive misalignments); while the negative misalignments are smaller in magnitude.

Current Account and Reer Misalignments in Central Eastern EU Countries: An Update Using the Macroeconomic Balance Approach

Following the IMF CGER methodology, we conduct an assessment of the current account and price competitiveness of the Central Eastern European Countries, CEECs, which joined the EU between 2004 and 2014. We present results for a method called the “Macroeconomic Balance (MB) approach” which provides a measure of current account equilibrium based on its determinants together with misalignments in the real effective exchange rates. We believe that a more refined analysis of the misalignments may be of some use for the Macroeconomic Imbalance Procedure (MIP). This is especially useful for these countries which went through a transition phase and boom/bust periods since their independence. This can have influenced their performances and a judgement based on their own characteristics may be needed. We use a panel setup of 11 EU new member states (Croatia is included) over the period 1994-2012 in static and dynamic frameworks, also controlling for the presence of cross-sectional dependence, checking specifically for the role of exchange rate regimes, capital flows and global factors. We find that the estimated coefficients for the determinants are in line with the expectations. Moreover, the foreign capital flows, the oil balance and relative output growth seem to play a crucial role in explaining the current account. Some global factors like shocks in oil prices or supply might have played a role in worsening, the current account balance of the CEECs. Having a pegged exchange rate regime (or being part of the euro zone) affects the current account positively. The real effective exchange rates behave in line with the current account gaps, which experience a clear cyclical behaviour. The CAs and REERs are getting close to equilibria in 2012 in most of the countries. The rebalancing is completed for some countries less misaligned in the past like Poland and Czech Republic, but also in the case of Lithuania. When the Foreign Direct Investments (FDIs) are introduced as a determinant for these countries, the misalignments are larger in the boom periods (positive misalignments); while the negative misalignments are smaller in magnitude.

Foreign interest rate shocks and exchange rate regimes in East Asia

Using a theoretical dynamic stochastic general equilibrium model and an empirical panel vector autoregression, we assess the transmission of foreign real interest rate shocks on the volatility of various key macroeconomic variables in nine small open economies in East Asia taking into account the role of exchange rate regimes. Both the theoretical and empirical findings confirm the hypothesis that flexible exchange rate may work as a shock absorber when the economy is hit by foreign real interest rate shocks. The findings suggest a clear trade-off between the volatility of real exchange rate and real output to foreign interest rate shocks, both the US and G7 real interest rates, where the responses of real output are mitigated in countries that have more flexible exchange rate regime.

CURRENT ACCOUNT ADJUSTMENT IN DEVELOPING COUNTRIES: THE ROLE OF EXCHANGE RATE REGIMES

This article employs hazard models to investigate the role of exchange rate regimes in the timing of current account adjustment in developing countries. We identify high current account deficit spells and find that fixed exchange rate regimes increase the duration of high deficit spells and thus delay current account adjustment. The result is robust to a variety of model specifications and alternative classifications of exchange rate regimes. When distinguishing between hard pegs and soft pegs, we notice that the delay in the current account adjustment is primarily driven by hard pegs rather than soft pegs. (JEL F3, F4)

Exchange rate regimes and national price levels

This paper explores the role of exchange rate regimes in explaining deviations from the classic theory of purchasing power parity. Examining a broad panel of countries, I find that developing countries with fixed exchange rate regimes have national price levels that are 20 percent higher than those with flexible regimes. For industrial countries, the relation between regimes and price levels is qualitatively similar but weaker. I investigate several explanations for this pattern, and find that exchange-rate overshooting in floats, inflation inertia in pegs and expansionary policies can explain only 5 percentage points of the observed differences. I also show that even though the observed pattern could be the outcome of a class of open economy models pioneered by Obstfeld and Rogoff, the data provides limited empirical support for the predictions of this model.