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on International Finance |
| By: | Jean-Christian Lambelet; Alexander Mihailov |
| Abstract: | Scientists and epistemologists generally agree that a scientific law must be (a) relatively simple and (b) not contradicted by the available evidence. In this paper we propose and test one such law pertaining to international economics, the triple-parity law. It integrates three well-known equilibrium conditions, which are shown to prevail in the long run, on average and ex post: (i) uncovered nominal interest rate parity (UIP); (ii) relative purchasing power parity (PPP); (iii) real interest rate parity (RIP). Using a cross-section of annual mean values or trend growth rates for 18 OECD countries in the post-Bretton-Woods/pre-EMU floating rate period (1976-1998) and employing a variety of single-equation and system estimation methods, we present robust evidence that the triple-parity law ultimately holds for large and diversified economies. For a few, mostly small and specialized countries, its working is however affected by some significant financial or real comparative (dis)advantages, for which estimates are provided. The law says nothing about short-term dynamics, but it can provide useful benchmarks in this context too, insofar as measures of the speed of convergence to long-run equilibrium are estimated. The triple-parity law, finally, illustrates another, rather fundamental point: if we look beyond short-term fluctuations and vagaries, economic laws do exist in the long run, just as economists used to think in the days of Marshall, Fisher, Walras and Pareto. |
| Date: | 2005–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:604&r=ifn |
| By: | Carlo Altavilla; Paul De Grauwe |
| Abstract: | This paper investigates the relationship between the euro-dollar exchange rate and its underlying fundamentals. First, we develop a simple theoretical model in which chartists and fundamentalists interact. This model predicts the existence of different regimes, and thus non-linearities in the link between the exchange rate and its fundamentals. Second, we account for non-linearity in the exchange rate process by adopting a Markov-switching vector error correction model (MSVECM). Finally, the paper investigates the out-of-sample forecast performance of three competing models of exchange rate determination. The results suggest the presence of nonlinear mean reversion in the nominal exchange rate process. The implications are that different sets of macroeconomic fundamentals act as driving forces of the exchange rates during different time periods. More interestingly, the nonlinear specification significantly improves the forecast accuracy during periods when the deviation between exchange rate and fundamentals is large. Conversely, when the exchange rate is close to its equilibrium value it tends to be better approximated by a naïve random walk. |
| Keywords: | non-linearity, Markov-switching model, fundamentals |
| JEL: | C32 F31 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1561&r=ifn |
| By: | Campa, José Manuel; Goldberg, Linda S; González Mìnguez, Jose Manuel |
| Abstract: | This paper presents an empirical analysis of transmission rates from exchange rate movements to import prices, across countries and product categories, in the euro area over the last fifteen years. Our results show that the transmission of exchange rate changes to import prices in the short run is high, although incomplete, and that it differs across industries and countries; in the long run, exchange rate pass-through is higher and close to one. We find no strong statistical evidence that the introduction of the euro caused a structural change in this transmission. Although estimated point elasticities seem to have declined since the introduction of the euro, we find little evidence of a structural break in the transmission of exchange rate movements except in the case of some manufacturing industries. And since the euro was introduced, industries producing differentiated goods have been more likely to experience reduced rates of exchange rate pass-through to import prices. Exchange rate changes continue to lead to large changes in import prices across euro-area countries. |
| Keywords: | Currency invoicing; exchange rate; local currency pricing; pass-through; producer currency pricing |
| JEL: | F3 F4 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5347&r=ifn |
| By: | Bacchetta, Philippe; van Wincoop, Eric |
| Abstract: | The uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle is one of the most extensively researched areas in international finance. It implies that excess returns on foreign currency investments are predictable. In this paper we propose a new explanation for this puzzle based on rational inattention. We develop a model where investors face a cost of collecting and processing information. Investors with low information processing costs trade actively, while other investors are inattentive and trade infrequently. We calibrate the model to the data and show that (i) inattention can account for most of the observed predictability of excess returns in the foreign exchange market, (ii) the benefit from frequent trading is relatively small so that few investors choose to be attentive, (iii) average expectational errors about future exchange rates are predictable in a way consistent with survey data for market participants, and (iv) the model can account for the puzzle of delayed overshooting of the exchange rate in response to interest rate shocks. |
| Keywords: | excess return predictability; forward discount puzzle; rational inattention |
| JEL: | E44 F31 G1 |
| Date: | 2005–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5261&r=ifn |
| By: | Seung Hyun Hong (Dept. of Economics, Concordia University); Peter C. B. Phillips (Cowles Foundation, Yale University; University of Auckland & University of York) |
| Abstract: | This paper develops a linearity test that can be applied to cointegrating relations. We consider the widely used RESET specification test and show that when this test is applied to nonstationary time series its asymptotic distribution involves a mixture of noncentral chi^2 distributions, which leads to severe size distortions in conventional testing based on the central chi^2. Nonstationarity is shown to introduce two bias terms in the limit distribution, which are the source of the size distortion in testing. Appropriate corrections for this asymptotic bias leads to a modified version of the RESET test which has a central chi^2 limit distribution under linearity. The modified test has power not only against nonlinear cointegration but also against the absence of cointegration. Simulation results reveal that the modified test has good size infinite samples and reasonable power against many nonlinear models as well as models with no cointegration, confirming the analytic results. In an empirical illustration, the linear purchasing power parity (PPP) specification is tested using US, Japan, and Canada monthly data after Bretton Woods. While commonly used ADF and PP cointegration tests give mixed results on the presence of linear cointegration in the series, the modified test rejects the null of linear PPP cointegration. |
| Keywords: | Nonlinear cointegration, Specification test, RESET test, Noncentral chi^2 distribution |
| JEL: | C12 C22 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1541&r=ifn |
| By: | Anella Munro; (Reserve Bank of New Zealand) |
| Abstract: | This paper looks at reduced form descriptions of changes in the USD/NZD exchange rate, with emphasis on the interest rate-exchange rate relationship. In the estimated reduced form equations, high domestic short term interest rates relative to foreign interest rates are associated with continued upward pressure on the New Zealand dollar. This effect is most pronounced for the 6-month forward interest differential, and is reinforced by some "inertia" but moderated by deviations from equilibrium as "over or under-valuation" erodes expected returns. Changes in commodity export prices are estimated to have short term effects. Some aspects of the estimated equations are consistent with forward-looking rational expectations, a standard feature of open economy models. Other aspects of the estimated equations suggest random walk exchange rate expectations consistent with Meese and Rogoff (1983). The cross correlation between interest differentials and the exchange rate may be difficult to reconcile with rational expectations. The forecasting performance of a reduced form equation is also assessed. |
| JEL: | E52 E58 F31 F32 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2005/05&r=ifn |
| By: | Isabel Ruiz (Western Michigan University) |
| Abstract: | This paper re-examines the role of exchange rates as determinant of FDI. It extends the analysis to include the issue of how exchange rates determine the decision of invest in one country depending on whether the firm is deciding to invest on the country to service the local market or to invest on the country in order to re-export. This paper offers a broad literature review of the state of the empirical research in order to draw conclusions of the real importance of the exchange rate as a determinant of FDI. Details of FDI current behavior in Latin American are described and I propose a model of FDI to be applied for these countries. Data sources are given. |
| Keywords: | FDI, Exchange Rates, Exchange Rates Volatility |
| JEL: | F1 F2 |
| Date: | 2005–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpit:0511016&r=ifn |
| By: | Burstein, Ariel Thomas; Eichenbaum, Martin; Rebelo, Sérgio |
| Abstract: | Changes in the price of nontradable goods relative to tradable goods account for roughly 50% of the cyclical movements in real exchange rates. |
| Keywords: | nominal exchange rates; nontradeable goods; prices; tradeable goods |
| JEL: | F31 |
| Date: | 2005–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5306&r=ifn |
| By: | Freyan Panthaki |
| Abstract: | This paper studies the impact of Swiss National Bank interventions, and news about these interventions, on the intraday volatility of the Swiss franc -U.S. dollar exchange rate. It extends the existing literature by characterising the the impact of different aspects of central bank interventions, like direction, size, frequency and time of intervention, on exchange rate volatility. Briefly, the paper finds that the effect of intervention on volatility varies depending on how volatility is defined. Interventions decrease volatility contemporaneously but this effect is reversed in the two hours afterwards. This relationship is symmetric with respect to the direction of the intervention, whether they be buy and sell interventions or with-the-wind and against-the-wind interventions. Analysis of the volatility and intervention size relationship finds that as we move from small to large interventions, the larger interventions tend to increase volatility relative to small interventions. The frequency of interventions has a small but positive impact on volatility, and this is underscored when the analysis is done by splitting the sample into low, average and high frequency interventions. The interaction between intervention size and intervention frequency results in a small positive effect on volatility for the squared return measure and the absolute return measure and a negative effect for both the realised volatility measures this effect is negative. As before the effect of the timing of the intervention varies with the volatility measure. The relationship is different for interventions at different times of the day. For the two realised volatility measures 9am interventions reduce volatility while for the other two measures the significant coeffcients have an overall positive effect increasing volatility. 2pm interventions decrease volatility for both the squared return measures but increase volatility for both the absolute return measures. Reuters reports of sell interventions have a significant and lagged negative effect on volatility for the squared return measure and both the absolute return measures. |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp550&r=ifn |
| By: | Isabel Ruiz (Western Michigan University) |
| Abstract: | This paper re-examines the effects of inflation and exchange rate uncertainty on real economic activity. The existent literature has treated both issues as separate subject matters. It has emphasized either the issue of inflation uncertainty or exchange rate uncertainty on economic growth or on different measures of economic activity. This paper attempts dealing with both issues by analyzing the magnitudes and direction of the effect of both: inflation and exchange rate uncertainty on real economic activity. By introducing dummy variables, we control for monetary policy change (the change to inflation targeting and flexible exchange rate). By using a generalized autoregressive conditional variance (GARCH) model of inflation and exchange rates, the conditional variances of the model’s forecast errors were extracted as measures of uncertainty. The results suggest that higher levels of inflation Granger cause more uncertainty and vice versa for the Colombian economy. Also, only inflation uncertainty matters for output by exerting a negative influence. |
| Keywords: | Inflation Targeting, Inflation Uncertainty, Exchange Rate, Uncertainty, GARCH models, Granger causality |
| JEL: | F3 F4 |
| Date: | 2005–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpif:0511006&r=ifn |
| By: | Caroline Freund; Frank Warnock |
| Abstract: | There are a number of worrisome features of the U.S. current account deficit. In particular, its size and persistence, the extent to which it is financing consumption as opposed to investment, and the reliance on debt inflows raise concerns about the likelihood of a sharp adjustment. We examine episodes of current account adjustment in industrial countries to assess the validity of these concerns. Our main findings are (i) larger deficits take longer to adjust and are associated with significantly slower income growth (relative to trend) during the current account recovery than smaller deficits, (ii) consumption-driven current account deficits involve significantly larger depreciations than deficits financing investment, and (iii) there is little evidence that deficits in economies that run persistent deficits, have large net foreign debt positions, experience greater short-term capital flows, or are less open are accommodated by more extensive exchange rate adjustment or slower growth. Our findings are consistent with earlier work showing that, in general, current account adjustment tends to be associated with slow income growth and a real depreciation. Overall, our results support claims that the size of the current account deficit and the extent to which it is financing consumption matter for adjustment. |
| JEL: | F3 F4 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11823&r=ifn |
| By: | Forsman, Mats-Ola (Department of Economics, School of Economics and Commercial Law, Göteborg University) |
| Abstract: | This paper analyzes the relationship between economic fundamentals and balance-ofpayments crises for the three Nordic countries, Norway, Sweden, and Finland, during 1971-1992. To identify periods of balance-of-payments crisis a method first introduced by Eichengreen, Rose, and Wyplosz (1996) was used. They did not report specific results for the three Nordic countries, but compared a group of ERM countries with a control-group of non- ERM countries (including Norway, Sweden and Finland) during 1967-1992. The results here verify theirs more generally, in that the three Nordic non-ERM countries in particular also followed the so-called first-generation of balance-of-payments-crisis models (Paul Krugman,1979). A second finding was that balance-of-payments crises for the three Nordic countries mainly took place during recessions, typically when governments tried to stimulate their way out by holding government spending constant in spite of decreased tax revenues, which led to budget deficits and speculative attacks. This result is consistent with Krugman’s firstgeneration model, based on constant revenue and increased spending, which led to the same result. <p> |
| Keywords: | Balance of Payments Crisis; Nordic; Exchange rates; Speculative Attacks |
| JEL: | F31 F32 |
| Date: | 2005–08–27 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0186&r=ifn |
| By: | Wagner, Martin (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria) |
| Abstract: | Based on two detailed Balassa-Samuelson (BS) studies, Wagner and Hlouskova (2004) for eight Central Eastern European countries (CEECs) and Wagner and Doytchinov (2004) for ten Western European countries (WECs), this study assesses the differences and similarities of the BS effect between these two country groups. The econometric results show that the BS effect may have been overestimated in previous studies due to application of inappropriate first generation panel cointegration methods. When appropriately quantified, the BS effect itself explains RER movements respectively inflation differentials only to a small extent. However, extended BS relationships that include additional variables allow for an adequate modelling of inflation. Based on the comparative analysis we draw some conclusions for monetary policy in the future enlarged Euro Area. |
| Keywords: | Balassa-Samuelson effect, Central and Eastern Europe, Western Europe, Non-stationary panels, Inflation simulations |
| JEL: | F02 O40 P21 P27 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:ihs:ihsesp:180&r=ifn |
| By: | Lionel Artige; Rosella Nicolini |
| Abstract: | This study aims at analyzing the determinants of FDI (foreign direct investment) inflows for a group of European regions. The originality of this approach lies in the use of disaggregated regional data. First, we develop a qualitative description of our database and discuss the importance of the macroeconomic determinants in attracting FDI. Then, we provide an econometric exercise to identify the potential determinants of FDI. In spite of choosing regions presenting economic similarities, we show that regional FDI inflows rely on a combination of factors that differs from one region to another. |
| Keywords: | Foreign Direct Investment, Productivity, Regions |
| JEL: | F20 O47 R10 |
| Date: | 2005–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:aub:autbar:655.05&r=ifn |
| By: | L Angeles |
| Abstract: | This paper presents a model where opening the capital account of an economy causes more bankruptcies to take place in the non tradables sector. Non tradable firms must forecast the future state of the economy when investing since the demand for their goods depends on this. In our model the interest rate is a powerful signal that non tradable firms use when the capital account is closed, but its informational content decreases once the capital account opens up and international (as well as domestic) shocks affect it. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:65&r=ifn |