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on Central Banking |
| By: | Michael B. Devereux (University of British Columbia); Charles Engel (University of Wisconsin) |
| Abstract: | Both empirical evidence and theoretical discussion has long emphasized the impact of ¡¥news¡¦ on exchange rates. In most exchange rate models, the exchange rate acts as an asset price, and as such responds to news about future returns on assets. But the exchange rate also plays a role in determining the relative price of non-durable goods. In this paper we argue that these two roles may conflict with one another when nominal goods prices are sticky. If news about future asset returns causes movements in current exchange rates, then when nominal prices are slow to adjust, this may cause changes in current relative goods prices that have no efficiency rationale. In this sense, anticipations of future shocks to fundamentals can cause current exchange rate misalignments. We outline a series of models in which an optimal policy eliminates news shocks on exchange rates. |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:062007&r=cba |
| By: | Michael, Kumhof; Ricardo, Nunes; Irina, Yakadina |
| Abstract: | This paper asks whether an aggressive monetary policy response to inflation is feasible in countries that suffer from fiscal dominance, as long as monetary policy also responds to fiscal variables. We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. But following such rules results in extremely volatile inflation. This leads to very frequent violations of the zero lower bound on nominal interest rates that make such rules infeasible. Even within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance. |
| Keywords: | Optimal simple policy rules; fiscal dominance |
| JEL: | E40 |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:4462&r=cba |
| By: | Cedric Tille (Federal Reserve Bank of New York); Eric van Wincoop (University of Virginia, NBER) |
| Abstract: | The sharp increase in both gross and net capital flows over the past two decades has led to a renewed interest in their determinants. Most existing theories of international capital flows are in the context of models with only one asset, which only have implications for net capital flows, not gross flows. Moreover, there is no role for capital flows as a result of changing expected returns and risk-characteristics of assets as there is no portfolio choice. In this paper we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. We show why standard first- and secondorder solution methods no longer work in the presence of portfolio choice, and extend them giving special treatment to the optimality conditions for portfolio choice. We apply the solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach highlights time-varying portfolio shares, resulting from time-varying expected returns and risk characteristics of the assets, as a potential key source of international capital flows. |
| Keywords: | international capital flows, portfolio allocation, home bias. |
| JEL: | F32 F36 F41 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:122007&r=cba |
| By: | Spiros Bougheas (University of Nottingham); Paul Mizen (University of Nottingham); Cihan Yalcin (University of Nottingham) |
| Abstract: | This paper provides a theoretical model of an open economy credit channel including currency mismatch and financial fragility where exporting firms have access to international credit but non-exporting firms do not. It considers the post-crisis outcome which is predicted to be dramatically different for exporters/ non-exporters. We examine firms¡¦ access to external finance in four Asian economies after 1997 using a large panel of balance sheet data. Our paper demonstrates that firm heterogeneity is critical to understanding the open economy credit channel effects post-crisis since smaller and less profitable firms are indeed less likely to obtain credit than larger, export-oriented firms. |
| Keywords: | Credit Channel, External Finance, Asian Crisis |
| JEL: | E32 E44 E51 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:082007&r=cba |
| By: | Pierre L. Siklos (Wilfrid Laurier University); Diana N. Weymark (Vanderbilt University) |
| Abstract: | This paper applies a new measure of the effectiveness of sterilized interventions to data for 16 economies. The measure is defined as the difference between ex ante(xaEMP) and ex post exchange market pressure(xpEMP). xaEMP is calculated on the basis of a counterfactual that no intervention takes place and this is the rationally expected policy. xpEMP is the degree of exchange market pressure that remains based on the actual intervention policy in place. Based on a sample of 12 emerging markets, and Hong Kong, Korea, Japan, and Singapore, we conclude that sterilized interventions have persistent exchange rate effects. However, we also show empirically that this success also took place during a period of substantial growth in foreign exchange reserves. |
| Keywords: | exchange market pressure, foreign exchange intervention, emerging markets |
| JEL: | F31 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:142007&r=cba |
| By: | L. Randall Wray |
| Abstract: | This paper addresses three issues surrounding monetary policy formation: policy independence, choice of operating targets, and rules versus discretion. According to the New Monetary Consensus, the central bank needs policy independence to build credibility; the operating target is the overnight interbank lending rate, and the ultimate goal is price stability. This paper provides an alternative view, arguing that an effective central bank cannot be independent as conventionally defined, where effectiveness is indicated by ability to hit an overnight nominal interest rate target. Discretionary policy is rejected, as are conventional views of the central bank's ability to achieve traditional goals such as robust growth, low inflation, and high employment. Thus, the paper returns to Keynes's call for low interest rates and euthanasia of the rentier. |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_510&r=cba |
| By: | James K. Galbraith; Olivier Giovannoni; Ann J. Russo |
| Abstract: | Using a VAR model of the American economy from 1984 to 2003, we find that, contrary to official claims, the Federal Reserve does not target inflation or react to "inflation signals." Rather, the Fed reacts to the very "real" signal sent by unemployment, in a way that suggests that a baseless fear of full employment is a principal force behind monetary policy. Tests of variations in the workings of a Taylor Rule, using dummy variable regressions, on data going back to 1969 suggest that after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell "too low." Further, we find that monetary policy (measured by the yield curve) has significant causal impact on pay inequality-a domain where the Fed refuses responsibility. Finally, we test whether Federal Reserve policy has exhibited a pattern of partisan bias in presidential election years, with results that suggest the presence of such bias, after controlling for the effects of inflation and unemployment. |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_511&r=cba |
| By: | Yin-wong Cheung (University of California, Santa Cruz); Menzie D. Chinn (University of Wisconsin, Madison and NBER); Eiji Fujii (University of Tsukuba) |
| Abstract: | We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables. |
| Keywords: | absolute purchasing power parity, exchange rates, real income, capital controls, currency misalignment. |
| JEL: | F31 F41 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:112007&r=cba |
| By: | Szilárd Benk (Magyar Nemzeti Bank); Max Gillman (Cardiff Business School); Michal Kejak (CERGE-EI) |
| Abstract: | The paper sets the neoclassical monetary business cycle model within endogenous growth, adds exchange credit shocks, and finds that money and credit shocks explain much of the velocity variation. The role of the shocks varies across sub-periods in an intuitive fashion. Endogenous growth is key to the construction of the money and credit shocks since these have similar effects on velocity, but opposite effects upon growth. The model matches the data's average velocity and simulates well velocity volatility. Its Cagan-like money demand means that money and credit shocks cause greater velocity variation the higher is the nominal interest rate. |
| Keywords: | Velocity, business cycle, credit shocks, endogenous growth. |
| JEL: | E13 E32 E44 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:mnb:wpaper:2007/5&r=cba |
| By: | Yin-wong Cheung (University of California, Santa Cruz); Kon S. Lai (California State University, Los Angeles) |
| Abstract: | This study investigates whether greater nominal exchange rate flexibility aids real exchange rate adjustment based on data from dual exchange rates in developing countries. Specifically, we analyze whether the more flexible parallel market rate produces faster real exchange rate adjustment than the less flexible official rate does. Half-life estimates of adjustment speeds are obtained from fractional time series analysis. We find no systematic evidence that greater exchange rate flexibility tends to produce either faster or slower real exchange rate adjustment, albeit there is substantial cross-country heterogeneity in speed estimates. With official rates pegged to the dollar, many developing countries use parallel exchange markets as a back-door channel to facilitate real exchange rate adjustment. The evidence suggests, however, that these parallel markets often fail to speed up real rate adjustment. |
| Keywords: | Real exchange rate; Fractional time series; Half life; Adjustment speed |
| JEL: | C22 F31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:092007&r=cba |
| By: | Miguel Fuentes (Instituto de Economía. Pontificia Universidad Católica de Chile.) |
| Abstract: | In this paper I study the pass-through of nominal exchange rate changes to the price of imported goods in four developing countries. The results indicate that 75% of changes in the exchange rate are passed-through to the domestic currency price of imported goods within one quarter. Complete pass-through is attained within one year. There is no evidence that exchange rate pass-through to the price of imported goods has declined over time even in those countries that have managed to reduce inflation significantly and open their economies to foreign competition. |
| Keywords: | Exchange Rate Pass-Through, Local Currency Pricing, Macroeconomics of Developing Countries |
| JEL: | F31 F41 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:ioe:doctra:320&r=cba |
| By: | Felix Hammermann; Mark Flanagan |
| Abstract: | Panel estimates based on 19 transition economies suggests that some central banks may aim at comparatively high inflation rates mainly to make up for, and to perhaps exploit, lagging internal and external liberalization in their economies. Out-of-sample forecasts, based on expected developments in the underlying structure of these economies, and assuming no changes in institutions, suggest that incentives may be diminishing, but not to the point where inflation levels below 5 percent could credibly be announced as targets. Greater economic liberalization would help reduce incentives for higher inflation, and enhancements to central bank independence could help shield these central banks from pressures. |
| Keywords: | inflation, transition economies, panel data |
| JEL: | E58 P24 |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1373&r=cba |
| By: | Tony Latter (Hong Kong Institute for Monetary Research) |
| Abstract: | This paper examines the way in which Hong Kong¡¦s currency board has operated since its re-introduction in 1983. It discusses currency board design and the extent to which Hong Kong has conformed to particular principles. The core of the paper is an assessment of the rules-versus-discretion question. From 1983 to 1988 the currency board convertibility obligation applied, in effect, to physical cash only. Arbitrage could not be relied upon to ensure that the market rate converged to 7.80, so intervention ¡V mostly in the foreign exchange market ¡V played a significant role. In 1988 the authorities acquired the means to apply currency board principles also to the reserve balance of the banking system, but over the next ten years they did not exploit that to full advantage in the currency board context. They gave no convertibility promise for the reserve balance and seldom allowed foreign exchange transactions to trigger currency-board-type adjustment. They concentrated instead on managing bank liquidity or interest rates, very often via money market intervention, albeit subject to the overriding goal of a stable exchange rate. But the range which defined that stability was never revealed. Although this exercise of discretion and the departures from strict currency board principles were not obviously damaging, they may have complicated official procedures unnecessarily, and may have raised doubts as to the authorities¡¦ longterm commitment to 7.80. In other words, rather than helping to settle markets, the tactics may at times have disturbed them. Reforms in 1998 included a weak-side convertibility undertaking for banks¡¦ reserve money at 7.80 (after transition), but left strong-side intervention to the discretion of the Monetary Authority. It was only in 2005 that a firm strong-side undertaking was introduced at 7.75, with the weak side bound being moved to 7.85 in order to provide symmetry. Now, only one minor element of discretion ¡V for intrazone intervention ¡V remains. Whereas discretionary interventions were probably very necessary in the early years after 1983, the authorities could have moved more quickly after 1988 to reach the almost completely rule-based status of today. But the stability of the exchange rate over the entire period speaks for itself, and it is not obvious that stricter adherence to currency board principles would have delivered a materially different outcome. |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:022007&r=cba |