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on International Finance |
| By: | Madhavi Bokil (Clark University) |
| Abstract: | This paper explores the idea that “Fear of Floating” and accompanying pro-cyclical interest rate policies observed in the case of some emerging market economies may be justified as an optimal discretionary monetary policy response to shocks. The paper also examines how the differences in monetary policies may lead to different degrees of this fear. These questions are addressed with a small open economy, new- Keynesian model with endogenous capital accumulation and sticky prices. The economy consists of two sectors- traded and non-traded. International credit markets are assumed to be imperfect, so that only the traded sector enjoys the ability to borrow internationally in foreign currency. The firms in the traded sector could potentially hold a large proportion of their debt in foreign currency, while the liabilities of the non-traded sector firms are entirely denominated in the domestic currency. Domestic exchange rate volatility adversely affects the balance sheets of the traded sector firms, while interest rate volatility creates problems for the firms in the non-traded sector. In such a situation, the monetary authorities face a dilemma when reacting to shocks. The numerical solution of the model indicates that the central bank’s reaction to shocks depends not only on the net effect of exchange rate movements on output gap and inflation, but also on the relative weight the central bank allocates to stabilizing output in the traded sector as against the non-traded sector. A central bank that assigns relatively higher importance to output stability in the traded goods sector also displays greater aversion for exchange rate volatility. |
| Keywords: | fear of floating, exchange rates, exchnage rate volatility, monetary policy, emerging countries |
| JEL: | F3 F4 |
| Date: | 2005–10–04 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpif:0510002&r=ifn |
| By: | Joshua Aizenman; Reuven Glick |
| Abstract: | This paper studies the empirical and theoretical association between the duration of a pegged exchange rate and the cost experienced upon exiting the regime. We confirm empirically that exits from pegged exchange rate regimes during the past two decades have often been accompanied by crises, the cost of which increases with the duration of the peg before the crisis. We explain these observations in a framework in which the exchange rate peg is used as a commitment mechanism to achieve inflation stability, but multiple equilibria are possible. We show that there are ex ante large gains from choosing a more conservative not only in order to mitigate the inflation bias from the well-known time inconsistency problem, but also to steer the economy away from the high inflation equilibria. These gains, however, come at a cost in the form of the monetary authority’s lesser responsiveness to output shocks. In these circumstances, using a pegged exchange rate as an anti-inflation commitment device can create a “trap” whereby the regime initially confers gains in anti-inflation credibility, but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy. We also show that the more conservative is the regime in place and the larger is the cost of regime change, the longer will be the average spell of the fixed exchange rate regime, and the greater the output contraction at the time of a regime change. |
| JEL: | F15 F31 F43 |
| Date: | 2005–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11652&r=ifn |
| By: | Viv B. Hall |
| Abstract: | Arguments for and against abandoning independent national currencies and monetary policies have varied considerably over time and by country. For New Zealand, it can be argued that a key driving force behind recent debates has been the conduct of monetary policy and the need for improved overall economic performance in the longer term, rather than major dissatisfaction with its floating exchange rate system. In that context, this paper initially considers some issues considered important by other countries, and factors specific to New Zealand. It then utilises deterministic and stochastic simulation results from the RBNZ's core FPS model, to illustrate what New Zealand's inflation, output and trade outcomes might have been, had it faced US or Australian interest rate and exchange rate movements of the 1990s. The paper concludes with some implications for future research, and some ways forward for New Zealand policy. |
| JEL: | E58 F36 E31 E37 E17 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:pas:camaaa:2005-21&r=ifn |
| By: | Juan F. Castro (Universidad del Pacífico); Eduardo Morón (Universidad del Pacífico) |
| Abstract: | Based on the significance of a Minimum Variance Portfolio (MVP) for the understanding of dollarization equilibria, a significant strand of the debate concerned with the driving forces behind this phenomenon has focused on analyzing the determinants of the relative volatility of inflation vis-à-vis real depreciation. This analysis contributes in the identification of those factors by extending the basic CAPM formulation via the introduction of credit risk that is directly linked to the shock that determines real returns for dollar denominated assets: unanticipated shifts in the real exchange rate. We show this ingredient can end up altering the perceived relative volatility of peso and dollar assets in a way that fuels financial dollarization (by increasing the relative hedging opportunities offered by the latter). We calibrate our model using Peruvian data for the period 1998-2004, and its predictions show a better fit with observed financial dollarization ratios than those of the basic CAPM model. |
| Keywords: | Financial dollarization, Minimum Variance Portfolio, Peru |
| JEL: | E44 E58 C34 |
| Date: | 2005–09–30 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0509027&r=ifn |
| By: | Zeljko Bogetic (The World Bank) |
| Abstract: | As more nations in the Western Hemisphere consider adopting the U.S. dollar as their own major currency, this IMF economist separates fact from fiction concerning dollarization. How will the dollarized nations react to U.S. monetary policy over which they will have no say? |
| Keywords: | dollarization seigniorage spreads Latin America |
| JEL: | F3 E O P |
| Date: | 2005–10–05 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpif:0510007&r=ifn |