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on International Finance |
| By: | jair Ojeda Joya |
| Abstract: | This paper provides evidence of long run purchasing power parity by performing a recently developed method to test for unit roots in the presence of structural breaks. Data consist of real exchange rate series for 20 countries including developed and developing economies. Structural breaks are detected in 18 countries and real exchange rates are found to be stationary in all countries except Japan. Estimated linear trends are the result of cross-country total factor productivity differentials between tradable and nontradable sectors. Estimated breaks correspond to large and permanent total factor productivity shocks associated with historical events like wars, structural reforms or deep economic recessions. An exercise with total factor productivity data shows that the Balassa-Samuelson effect explains the estimated long run trends in most countries. |
| Date: | 2009–05–13 |
| URL: | http://d.repec.org/n?u=RePEc:col:000094:005521&r=ifn |
| By: | Hevia, Constantino; Nicolini, Juan Pablo |
| Abstract: | According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the currency lowers the relative price of non-tradable goods, and this reduces the necessary adjustment in output relative to the case in which the exchange rate remains constant. This paper uses a simple small open economy model with sticky prices to characterize optimal fiscal and monetary policy in response to productivity and terms of trade shocks. Contrary to the conventional wisdom, in this framework optimal exchange rate policy cannot be characterized just by the cyclical properties of output. The source of the shock matters: while recessions induced by a drop in the price of exportable goods call for a devaluation of the currency, those induced by a drop in productivity in the non-tradable sector require a revaluation. |
| Keywords: | Economic Theory&Research,Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Stabilization |
| Date: | 2009–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:4926&r=ifn |
| By: | Bacchetta, Philippe; van Wincoop, Eric |
| Abstract: | It is well known from anecdotal, survey and econometric evidence that the relationship between the exchange rate and macro fundamentals is highly unstable. This could be explained when structural parameters are known and very volatile, neither of which seems plausible. Instead we argue that large and frequent variations in the relationship between the exchange rate and macro fundamentals naturally develop when structural parameters in the economy are unknown and change very slowly. We show that the reduced form relationship between exchange rates and fundamentals is driven not by the structural parameters themselves, but rather by expectations of these parameters. These expectations can be highly unstable as a result of perfectly rational "scapegoat" effects. This happens when parameters can potentially change much more in the long run than the short run. This generates substantial uncertainty about the level of parameters, even though monthly or annual changes are small. This mechanism can also be relevant in other contexts of forward looking variables and could explain the widespread evidence of parameter instability found in macroeconomic and financial data. Finally, we show that parameter instability has remarkably little effect on the volatility of exchange rates, the in-sample explanatory power of macro fundamentals and the ability to forecast out of sample. |
| Keywords: | Exchange rate; Time-varying coefficients |
| JEL: | F31 F37 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7309&r=ifn |