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Expectations and Exchange Rate Dynamics
... Harold Vásquez 1 Resumen* El objetivo de este estudio es determinar la relación entre el tipo de cambio y los fundamentos monetarios de la economía dominicana, en el período 2008-2019. Partiendo de un modelo monetario tradicional (Dornbusch, 1976;Frankel, 1979;Mussa, 1976), se encuentra que un aumento relativo en la cantidad de dinero y de 100 puntos básicos en el diferencial de tasas de interés inciden en una depreciación cambiaria de 0.71 % (significativo al 0.1 %) y de 0.67 % (significativo al 5 %), respectivamente. Al extender el modelo base considerando la teoría de paridad descubierta, se encuentra que un aumento de 1 % en las expectativas devaluatorias a 12 meses causan un aumento del tipo de cambio de 0.83 % (significativo al 0.1 %). ...
... Abstract* This study aims to determine the relationship between the exchange rate and the monetary fundamentals of the Dominican economy in the period 2008-2019. Starting from a traditional monetary model (Dornbusch, 1976;Frankel, 1979;Mussa, 1976), we find that a relative increase in the quantity of money and a 100 basis points increase in the spread of short-term interest rates lead to an exchange rate depreciation of 0.71 % (significant at 0.1 %) and 0.67 % (significant at 5 %), respectively. Extending the base model and considering the uncovered parity theory, we find that a 1 % increase in 12-month expectations of devaluation causes an increase in the nominal exchange rate of 0.83 % (significant at 0.1 %). ...
... Sin embargo, en la práctica, la mayoría de los países en desarrollo -especialmente en Latinoamérica-han adoptado un sistema mixto de EMI con tipo de cambio flotante y diferentes grados o esquemas de intervención en el mercado de divisas. Esto así, aun cuando los modelos macroeconómicos tradicionales indican que las intervenciones cambiarias no deberían impactar el tipo de cambio, especialmente cuando se analizan sus efectos en economías abiertas con libre movilidad de capitales (Fleming, 1962;Mundell, 1963;Dornbusch, 1976;Obstfeld, 1996). ...
... (2) Equation (2) displays the exchange rate determined in terms of comparative income, comparative money supply, and comparative money velocity. We get equation (3) after using the logarithms in each side of equation (2). ...
... Since Bangladesh's comparative higher interest rate as well as inflation will cause depreciation in the Bangladesh Taka, and coefficients are both anticipated to show positive signs. The sticky price model developed by Dornbusch (1976) predicted that = 0. Error-correction modeling and cointegration approaches would be a suitable approach to investigate the overshooting hypothesis because it is a short-dated phenomenon. Unit root tests were applied at the beginning stage of the analysis, and the outcomes are shown in Table 1. ...
... The outcomes of the financial shock on the BDT/USD exchange rate are positive in the second month and dampen after that, showing that the BDT/USD exchange rate overturns to depreciate and overshoot in the short date. This study's outcomes justify the overshooting hypothesis of currency depreciation as portrayed earlier in the sticky-price framework by Dornbusch (1976). Although this overshooting hypothesis occurs after one month. ...
... In detecting the real exchange volatility sources in Egypt, this paper estimates a threeequation open macro model proposed by Clarida and Gali (1994) based on earlier studies of Dornbusch (1976), Obstfeld (1985) and Blanchard and Quah (1989). The following model presents a standard three-variable vector autoregressive (VAR), employing a long-run identification scheme ...
... In the short run, our results may not be consistent with some empirical support for disequilibrium models of the exchange rate (e.g. Dornbusch, 1976) that attribute short-run volatility in nominal and real exchange rates to nominal shocks. Our result, however, is consistent with the results of Clarida and Gali (1994) and Thomas (1997) for developed countries and with those of Wang (2004) and Sfia (2006) for developing countries. ...
Purpose-This paper aims to empirically investigate the sources of real exchange rate fluctuations in Egypt using structural vector autoregression (SVAR). The data covers the period between 1980 and 2016, where exchange regime has been changed more than once. Design/methodology/approach-This paper investigates the source of real exchange rate fluctuations for the period between 1980 and 2016 using the SVAR method. The SVAR method will incorporate real gross domestic product (GDP), real effective exchange rate (REER) and price level in a multidimensional equations system. However, impulse response function (IRF) and error variance decompositions (EVDC) will be generated by the system to have a behavioral insight of real exchange rate in response to economic shocks. Findings-The IRF and EVDC results indicate a significant impact of demand shocks over the real exchange rate relative to supply shocks and monetary shocks in the period between 1980 and 2016. On the other hand, monetary shocks will have a negligible effect on the real exchange rate in the short run and converging to its previous level in the covering period of the study. Originality/value-In the best of the authors' knowledge, the topic of the source of the real exchange rate fluctuations in Egypt has not been discussed in a wide range due to the lack of time series data. However, this study provides constructed data for REER for Egypt with the published method in the International Monetary Fund (IMF). Furthermore, the study involves theoretical and econometric modeling to ensure the reliability of the economic results.
... Our study is based on Dornbusch's overshooting model [6]. However, in contrast to the original model, we shift our focus to examining the impact of the expectation type utilised in the model from the overshooting. ...
... In our study, we investigated the effect of the types of expectations used in the literature on a specific model, the Dornbusch overshooting model (Dornbusch 1976). We focused on defining the steady state equilibrium, investigating its stability properties and the global solution with given parameters, exogenous variables and initial value. ...
The article applies the famous Dornbusch "overshooting" model to investigate the impact of different types of expectations on economic model stability. We tested the well-known Dornbusch model with discrete variables. Initially, we established a foundational model, employing simulations to illustrate the impact of each parameter within the model on the overall solution, starting from an initial value. Subsequently, we explored the influence of different expectation types on the stability of the steady state vector, considering simple, static, adaptive, and rational expectations (Muth-type rational expectation and perfect foresight). It was observed that static expectations and perfect foresight did not contribute to stability. In the case of simple, adaptive, and rational expectations, the stability conditions (parameter combinations) are the same as the stability conditions for the steady state vector of the baseline model. This condition is restricted to four parameters: two related to the interest rate, one to the foreign-domestic price level and one to the adjustment speed. We also run a simulation to show how the inclusion of each type of expectation leads to a change in the global solution of the model for a given initial value.
... Conversely, Mankiw (1985) contends that even small menu costs can have significant impacts on the economy. Furthermore, Dornbusch (1976) posits that incomplete pass-through arises due to firms operating in markets with imperfect conditions who adjust their mark-up in response to exchange rate shocks. Dornbusch (1976) highlights the role of less competitive markets in explaining the behavior of prices in response to exchange rate effects. ...
... Furthermore, Dornbusch (1976) posits that incomplete pass-through arises due to firms operating in markets with imperfect conditions who adjust their mark-up in response to exchange rate shocks. Dornbusch (1976) highlights the role of less competitive markets in explaining the behavior of prices in response to exchange rate effects. Burstein et al. (2002) emphasize the importance of non-tradable inputs in the supply chain of tradable goods. ...
The current study estimates the exchange rate pass-through on domestic prices from January 2013 to December 2018, using a recursive vector autoregressive model (VAR). Applying Cholesky decomposition to the model, six variables were ordered as follows: oil prices, output gap, exchange rate, import prices, overall inflation and Treasury bill rate with an assumption that the identified shocks contemporaneously impact variables which are ordered after the shock without any contemporaneous feedback. We find evidence of incomplete exchange rate pass-through to domestic prices. Thus, domestic price changes by 9.6 percent in the first three months following an exchange rate shock and the shock dies out after a year with a total pass-through effect of 10.7 percent. We also find that, exchange rate effect is more pronounced for the imported prices than the overall inflation, suggesting some moderation of pass-through effect in domestic price dynamics.
... Formuła oczekiwań (11) może być zgodna z formułą przewidywania doskonałego, o ile poprawnie przyjmie się wartość parametru y (por. [6]). ...
... Stąd parytet PPP występuje w modelu jako zależność długookresowa z możliwymi odchyleniami kursu nominalnego od parytetu w krótkim okresie (por. [6]). ...
This paper presents a two-sector model of prices and exchange rate, belonging to the mainstream of mathematical economics. The model operates under floating exchange rate regime. The model is given in the system form of two first order differential equations with respect to prices of tradables and non-tradables. Using the model we show the main transmission channels of economic policy – monetary, fiscal and wage – on prices and real exchange rate in terms of production divided into tradables and non-tradables goods.
... In retrospect, it may seem surprising that the role of expectations played a small role in the early post-Bretton Woods debates. Even though many earlier contributions had identified the importance of expectations and their impact on the exchange rate, the theory had not been worked out satisfactorily until Dornbusch (1976) built upon the nascent theory of rational expectations (Sargent and Wallace 1975;Lucas 1976). The improved understanding of the role of expectations led to several further innovations. ...
After centuries of metallic monies, for a long time, our understanding of fiat money had remained rudimentary and often controversial. Successive regimes eventually failed. The end of the Bretton Woods system marked the moment when the link between fiat money and gold was severed and when the possibility of letting exchange rates float became possible. The small open economies adopted various arrangements. Informed by these experiments, the understanding of monetary policy substantially progressed, leading to the widespread adoption of the expected inflation-targeting strategy with similar inflation targets. As a result, exchange rate variability has declined. The US dollar dominance was maintained and even increased. Yet, new challenges have emerged. The long period of interest rates stuck at the effective bound effectively suspended the use of the strategy. Then, during the post-pandemic surge in inflation rates, inflation forecasts became highly imprecise.
... c. Exchange Rate Channel: -The exchange rate channel, discussed in detail by Dornbusch (1976), suggests that monetary policy impacts the exchange rate, which in turn affects the competitiveness of exports and imports. A depreciation of the euro, induced by accommodative ECB policies, makes Euro-denominated commodities cheaper for foreign buyers, potentially increasing demand and prices. ...
This paper investigates the impact of the European Central Bank's (ECB) monetary policy on commodities markets within the Euro area, focusing on the period post-2020. By utilizing advanced econometric models and empirical data, the study explores the intricate relationships between central bank policy shifts and commodity price dynamics. The analysis provides insights into how recent monetary interventions, particularly in response to economic disruptions caused by global events, have influenced commodity markets, offering policy recommendations for enhancing market stability and economic resilience.
... Those papers studied the transmission of monetary shocks between nations and markets. The Mundell-Fleming (MF) model, when evident, can be assessed through its transmission effects of monetary policy on the value of currency, dynamics of trade, and asset prices in the long run (Dornbusch 1976). The research was extended by (Vissing-Jorgensen and Krishnamurthy 2011). ...
This study advances the understanding of the Preferred Habitat Model’s capacity to shed light on the inter-market transfer of mean returns and the diffusion of price volatility in Pakistani investment markets. It examines the extent to which returns in one market exert a systematic influence on returns across others under the potential sway of interest rate policy shifts, USD exchange rate volatility, and domestic inflation trends. Employing a methodological arsenal that includes the GARCH process, enhanced by Dynamic Conditional Correlations (DCC), as well as the Markov Switching Model, this research assesses the propagation of mean returns and volatility across markets. The analysis uncovers significant linkages between monetary policy and stock market indices, underscoring the profound impact of monetary policy on cross-market performance transmission. These insights are pivotal for regulators overseeing the nuanced interaction between monetary policy and market performance. They are crucial for local and international investors interested in developing economies, especially in Pakistan’s markets.
... Despite the weaknesses, Oates model provided a good foundation for future investigations into the possible linkages between income and exchange rates and their impact on inflation as well as associated macroeconomic policy directions. On a good note, most of the shortfalls of Oates (1966) were addressed a decade later, by Pentti Kouri, a Finnish economist and Professor, who developed a simplified model, mainly based on the works of Rudiger Dornbusch (Dornbusch 1973;Dornbusch 1976). ...
This dissertation investigates the linkages between oil price, crude production, nominal exchange rate and inflation in Nigeria (a typical mono-product resource-rich developing country) with the main objective to determine whether the existing inflationary condition in the country was caused by the presence of cointegration, causality, significance and volatility linkages or resulted from their absence because of an undiversified and unbalanced economy which projects the significance of imports in the model (curse).
Working with clear theoretical postulates and data from 1995 to 2016, the study employed a robust mix of econometric tools which include stationarity, cointegration (TEGSECT) and causality (WTCR) tests, ECM regressions, GARCH (1,1) model and residual testing to evaluate different aspects of the possible linkages.
Empirical results obtained confirmed both cointegration of the study variables and causality from exchange rate, money supply, interest and their respective lags to CPI; as well as from crude production output, oil price, and their respective lags jointly and aggregate import and their lags to exchange rate in both the short-term and long-term. The ECM regression confirmed that EXCHR and its returns is negatively correlated with oil price, production volume, and their returns; while CPI and its returns is positively correlated to oil price, production volume, exchange rate and their respective returns.
Whereas the ECM regression and WTCR tests showed that oil price and production volume movements are insignificant in the determination of CPI, the GARCH (1,1) results confirmed that large shocks to them and aggregate import will trigger large and protracted future volatility in the CPI. The GARCH (1,1) also revealed that large shocks to aggregate import and oil production volume will trigger large and protracted future in the exchange rate.
Overall, the results showed the findings can be applied to the population and support both the cause and curse linkages while the structural model was well-fitted with strong predictive efficiency.
Based on the results, relevant policy implications have been identified and followed by policy measure propositions. Possible future research areas have also been suggested.
... Short-term nominal interest rates comprise information about the future economic conditions and the state of investment opportunities. Dornbusch (1976) has already explained the role of monetary variables on exchange rate volatility in the short run and long run. More recently, Ganguly and Breuer (2010) provide evidence that nominal interest rate changes, have a stabilizing effect on the residual volatilities of the real and nominal exchange rates in developing countries. ...
Plain Language Summary
The paper investigates the dynamics of exchange rate volatility of Turkish Lira in a complementary perspective by employing both Generalized autoregressive conditional heteroskedasticity (GARCH) method and Lyapunov exponents over the period from March 1, 2019 to November 11, 2021. Firstly, decomposing the impact of domestic and global financial variables, the results of the GARCH model indicate that the exchange rate volatility is affected by Volatility index (VIX) and Credit default swaps (CDS).
The importance of the subject: The exchange rate dynamics are known to influence financial stability, which has been targeted as a policy implication simultaneous to macroeconomic stability. Moreover, the exchange rate volatility stands out as the main source of financial vulnerability and the loss of macroprudential stability. Especially in emerging markets, the exchange rate movements affect sustainability of many other macroeconomic parameters, such as interest rates, trade balance, output and asset prices.
Contribution: Domestic and global financial causes for exchange rate volatility are identified. Volatility dynamics were decomposed by GARCH (1,1) method and global effects were identified. Chaotic dynamics are shown in Turkish foreign exchange rate markets, violating Efficient market hypothesis.
Methods: Stochastic time series analysis methods are applied. First, GARCH (1,1) is used. Second, we reconstruct phase space in order to observe multiple equilibria embedded in financial time series. We obtain multidimensional embedded space and then we compute the Lyapunov exponents (LE) of the associated dynamical system. The Tisean Package introduced by Hegger et al. and R programme is used for computations.
This result suggests that the exchange rate shocks experienced are mainly caused by global fact.
... In the Brazilian literature, a consensus seems to exist that a restrictive monetary policy shock decreases the output level with a certain lag, losing intensity in the long run. There are occurrences of a price puzzle 4 in some studies, as well as mixed results regarding the impact on the exchange rate, going against the traditional theory that expects appreciation of the exchange rate 5 (Dornbusch 1976). ...
This article analyzes the Brazilian business cycle from Jan 2000 to February 2020 using a structural vector autoregression (SVAR) model. In Brazilian literature, articles aiming to obtain stylized facts using SVAR models adopt controversial identification hypotheses. The identification via heteroskedasticity emerges as an alternative, eliminating the need for such restrictions. Despite the limited sample size of Brazilian data, we exogenously select regimes with sufficient changes in the variance of the residuals over time. This allows us to identify a SVAR model via heteroskedasticity, as proposed by Brunnermeier et al. (Am Econ Rev 111(6):1845–79, 2021), using a different set of macro variables. The results from this approach are similar to those of a model identified via sign restrictions, providing support for the economic theory used by the latter to identify the shocks. The agnostic approach of identification via heteroskedasticity has enabled the identification of a new shock. We interpret it as a “pessimism” shock, particularly related to future expectations about economic activity.
... What Friedman used was the term "final position" of an exchange rate. 20 This argument is clearly an anticipation of Dornbusch's (1976) overshooting model. Thus, both Friedman and Johnson argued that exchange rates under a floating regime would be determined by the economic fundamentals. ...
... Studies such as Frenkel (1976Frenkel ( , 1979, Mussa (1976) and Bilson (1978aBilson ( , 1978b. Dornbusch (1976), Frankel (1979). Sarantis (1994); Cushman (2000) ; and Engel and West (2005) have studied this relationship using the monetary model. ...
... • Véase: Dornbusch (1976) ;Frenkcl y Mussa (1985); Kouri (1976). ciones para la teoría del tipo de cambio de una especificación diferente de los fundamentos microeconómicos de la demanda de dinero y de las demandas de otros activos financieros que pagan interés5. ...
... In my opinion, there is one weak point of using rational expectations in the model: the time horizon. In the case of the long run in economic terms, the concept of perfect foresight is the most appropriate one for rational expectations (in line with Dornbusch's claim that perfect foresight is the deterministic equivalent of rational expectations (Dornbusch, 1976). In this sense, perfect foresight is actually a special case where economic agents are aware of the long-term equilibrium value of the variable under consideration. ...
The study focuses on the problem of introducing expectations, as a subjective factor, into economic theoretical models. The basis of the model presented here is the well-known conventional Keynesian IS-LM model. It also follows that the concept of the IS-LM model can be approached as a problem or task in several ways. Also used was a discretized model encompassing three distinct categories of expectations, namely, simple, adaptive, and rational. It can be concluded that the type of expectation affects the number of stable cases in the model. The inclusion of the adaptive expectation results in the highest number of stable cases within the range of economically relevant values of the parameters studied. Numerical examples illustrate the results.
... It followed that the expected effect on the Bid-Ask spread could be measurable for our system under scrutiny. Additional support for the effect of money disturbances and price shifting under informality pressure on FX rates and their Bid-Ask spread can be recognized by considering the dynamic FX model, for example, the Dornbusch overshooting model [21]. To highlight the idea, this model can be simplified in the following form: ...
The assessment of the effect of the informal use of a foreign currency on the corresponding FX rates toward the national currency is a very difficult task, requiring direct calculation and modeling. It comes mostly because of the unknown quantity of foreign money used in the informal sector, but also because of the lack of quantitative calculation models. To overcome this gap and to realize a qualitative description of this effect in a concrete economic environment, we propose herein a comparative analysis between the behavior of two typical FX rate series recorded in the Albanian currency market, the Euro-ALL and USD-ALL, providing that the Euro is used commonly as a national currency substitute in the informal economy and the USD is not. So, we have evidenced that the un-stationarity degree of the Bid and Ask spread distribution for the Euro-ALL FX series is higher than for the corresponding USD-ALL case, but with a lower variance. Those features occurring simultaneously can be explained by assuming that informal use of the Euro acts as an additional perturbation on the FX system, imposing high nonstationary, but at the same time it provides reservoir or source features for the money disbalances, reducing the average fluctuations. Next, the depth of the market measured by the average Bid-Ask Spread has resulted in a smaller price for the Euro currency, indicating a lower cost of the transactions and reinforcing the assumption regarding the distribution’s in-stationarity features. Based on those indicatory findings, we propose to realize indirect evidence for our assumptions by comparing the reproduction of the corresponding distribution using autoregressive models. In this case, we have evidenced that the distribution of the FX Euro-ALL spread can be reproduced better if we include in standard ARCHX (m, n, p) models a term that mimics the informality measure. When applying the same procedure for the USD-ALL spread, the resulting distribution has not matched equally well with the original ones. Those findings have been discussed in the framework of an alternative description of the effect of the informal use of foreign currency in a small economy with a sizeable informal sector, which convene our current system under analysis, but we believe that they can be applicable for similar economic environments. Doi: 10.28991/HEF-2024-05-01-02 Full Text: PDF
... Precios flexibles se considera como enfoque de largo plazo, ya que se espera un signo positivo en el diferencial de tasas de interés en el largo plazo (Frenkel, 1976). Precios rígidos se considera como enfoque de corto plazo, ya que indica la existencia de un signo negativo esperado en dicho diferencial de tasas en el corto plazo (Dornbusch, 1976). ...
This research aims to determine the effect of the global COVID-19 pandemic on the exchange rate, where the microstructure approach will be used, which uses long and short positions in the futures market. Weekly data will be available during the period 2010-2023. A negative relationship has been found between the exchange rate and the net positions, as well as a positive relationship between the exchange rate and the interest rate differential between Mexico and the United States, as indicates the existing literature. The main finding has been the presence of structural change in the relationship due to the COVID-19 pandemic. Therefore, it is concluded that the microstructure approach is an adequate model to explain exchange rate fluctuations in the short-term, where the relationship has suffered a structural change due to the pandemic.
... Frenkel (1976) proposed a monetary exchange rate theory that links exchange rates to money supply and other monetary variables. Dornbusch (1976) expanded the theory of exchange rate by accounting for the full capital mobility and slow commodity market adjustment relative to capital markets. Subsequent in-depth studies of exchange rate-related theories by Taylor (1995), Sager and Taylor (2006) have provided detailed and up-to-date descriptions of the microstructure of the foreign exchange market and the behavior of participant groups. ...
Changes in the degree of trade freedom influence economic development and foreign investment, which in turn, affect currency values and exchange rate movements. Therefore, this study examined the direct and indirect impacts of trade freedom on exchange rate movement in emerging, developing, and developed economies. Empirical tests conducted using panel data from 75 countries revealed that trade freedom has a nonlinear U-shaped relationship with exchange rate movement, which is positively moderated by high-technology trade and foreign direct investment. Additionally, the results of heterogeneity analysis showed that trade freedom has a linear positive impact on the exchange rate movement of developed economies but a U-shaped impact on emerging and developing economies, with a stronger impact on emerging economies. The findings of this study provide valuable insights for governments to strike a balance between promoting trade freedom and maintaining currency exchange rate stability.
... 141-142) state that from the mid-1970s "… it became increasingly clear that continuous PPP could not hold as nominal exchange rates were patently far more volatile than relative national price levels". Dornbusch's (1976) "… the estimated persistence in real exchange rates is too high even in those cases in which mean reversion apparently holds." Further, the generally accepted rationale for the high degree of real exchange rate persistence based on aggregate data is that the price indices used tend to include a large proportion of non-traded goods. 1 However, the evidence on this classical dichotomy for persistence in real exchange rates is "limited and decidedly mixed" Crucini and Shintani (2008, p. 630). ...
A growing body of research suggests that the literature applying unit root, stationarity and cointegration tests of long run purchasing power parity (PPP) and the law of one price (LOP) with price index data test relative PPP/LOP and not absolute PPP/LOP. We argue that such tests cannot determine when long run relative PPP/LOP is rejected and therefore are not tests of relative PPP/LOP. These are not tests of strong absolute PPP/LOP either. We contend that they are tests of weaker forms of absolute PPP/LOP and that determining which form of absolute PPP/LOP is useful in terms of, for example, establishing the form of long run flexible-price monetary exchange rate model that it implies. Keywords: absolute purchasing power parity, relative purchasing power parity, the law of one price, price indices, unit root tests, cointegration tests, flexible-price monetary exchange rate models. JEL codes: C32; C43; F31 Acknowledgements: The paper has benefitted from comments made by Michela Vecchi on an earlier version. Chris Stewart is responsible for all errors.
... The monetary model was developed by several authors, i.e., the flexible price model developed by Frenkel,(1976) ,Bilson, (1978, sticky-price model developed by Dornbusch, (1976), real interest rate deferential model developed by Frankel,(1979), and equilibrium exchange rate model by Hooper, (1982). The flexible price model emphasizes that monetary policy directly affects the exchange rate determination, and the monetary expansion leads to the exchange rate depreciation. ...
This paper explores the monetary model for the prediction of exchange rates using the neural network. This paper aims to understand the effectiveness of prediction using the monetary model of determination of BRICS nations i.e. USD/BRL, USD/RUB, USD/INR, USD/CNY and USD/ZAR, by employing the Artificial Neural Network (ANN) model. We have used measures of accuracy such as Mean Absolute Error, Root Mean Absolute Error, Mean Absolute Percentage Error, and symmetric Mean Absolute Percentage Error to understand the effectiveness of the exchange rate using the monetary model. The monetary model can predict the USD/CNY because the scaled dependent error and percentage error are low compared to other exchange rates. The evidence suggests that the monetary model cannot be used to predict the exchange rate. The beneficiaries of this study are policymakers, investors, and international organizations.
This study examines the existing relationships among exchange rate volatility, trade openness and Nigerian economy from 1981 to 2021, using Autoregressive Distributed Lag (ARDL) bound and Pairwise Granger causality technique to achieve the stated objectives. The findings revealed a long-run relationship among the research variables. It was discovered that external reserve had positive significant short-run and long-run effects on Nigerian economy, while exchange rate volatility had negative short-run significant effect on economic growth. Unidirectional causal relationship was established between exchange rate volatility and economic growth as well as between trade openness and economic growth. A bidirectional causality was established between total tax on goods and economic growth in Nigeria. It is therefore recommended that government should come with policies to regulate exchange rate for naira to regain more strength against foreign currencies and as a result, promoting trade openness. Also, government should encourage more export through infant industrial promotion and economic diversification to support trade openness in the process of attaining economic growth in the country.
This study aims to investigate the impact of trade and investment risks on the real effective exchange rate from the first quarter of 2014 to the fourth quarter of 2021 using the Structural Vector Autoregression (SVAR) method. Gross Domestic Product (GDP) per capita, inflation rate, and Globalization Index are controlled variables. Results indicate that trade and investment risks have a significant positive effect on the real effective exchange rate throughout the study period, leading to an increase in Iran's real effective exchange rate in the long run. Additionally, the variance decomposition reveals that 23.37% of the variation in the real effective exchange rate in the tenth quarter is attributable to trade and investment risks. Moreover, inflation rate, GDP per capita, and globalization also positively influence Iran's real effective exchange rate.
This paper presents an alternative foundation to the standard quadratic loss function characterizing central bank inflation policy. The alternative treats high employment as a social benefit. In recognition of the inherent asymmetry of the output gap, two self-imposed constraints provide guardrails that rule out excess unemployment and opportunistic reflation. The loss function includes a novel reverse discounting mechanism that penalizes the bank for more sustained inflation gaps that could undermine confidence in the central bank’s target. In the absence of anchoring, the central bank is obliged to use economic slack to accomplish a disinflation but the presence of anchoring creates greater policy flexibility, freeing it from the tyranny of the sacrifice ratio. The central bank’s optimal policy differs dramatically from the standard Taylor Rule recommendation in choosing policy plans with higher employment, in its willingness to overshoot inflation targets, and in avoiding excess unemployment, all while observing the discipline needed for successful inflation targeting.
Exchange rate modeling has always fascinated researchers because of its complex macroeconomic dynamics. This study documents the exchange rate dynamics of major emerging economies after accounting for their macroeconomic cycles and explores the Bayesian Vector Error Correction Model (VECM) Markov Regime switching model, which uses time-varying transition probabilities. The main objective is to study the exchange rate dynamics of Brazil, Russia, India, China, and South Africa (BRICS) vis-à-vis the US dollar. The Bayesian setup uses two hierarchal shrinkage priors, the normal-gamma (NG) prior and the Litterman prior, for parameters' estimation. These shrinkage priors allow for a more comprehensive assessment of the regime-specific coefficients. The model performed well in differentiating between the two regimes for all currencies. The Russian ruble was identified to be the most depreciated currency, whereas the African Rand was the most appreciated. The evaluation of model features revealed that many regime-specific coefficients differed significantly from their common mean. A forecasting exercise was then performed for the out-of-sample period to assess the model's performance. A significant improvement was observed over the basic random walk (RW) model and the linear Bayesian vector autoregression (BVAR) model.
Through this study, we attempt to understand the dynamics of Indian Rupee fluctuations against US Dollar that have been caused by the fluctuations in the Fed Rate. We tried to understand how the Fed Rate influence the Indian rupee - US Dollar exchange rate movements. After research work done via secondary method, we have observed that factors like differential interest rate, differential inflation rate, differential money supply in both the markets, differential output growth rate of both the countries, among others, are important factors which impact the fluctuation in the fed rate that accounts for approximately 91% variance of the Dollar-Rupee exchange rates and explain the exchange rate dynamics to a large extent. A few factors that were earlier considered to be important are not as significant as expected.
Revealing the precise thresholds at which fluctuations in oil prices start to affect gross domestic product and its various components (consumption, investment, expenditure and exports) holds significant implications for policymakers in both oil-importing and oil-exporting countries. Existing studies assessing the effects of oil prices on economic activity typically assume constant or stable threshold values. However, recent evidence suggests that this restrictive assumption may not accurately capture the dynamic nature of these relationships. We address this issue by adopting a more realistic framework that allows for the possibility that oil prices will have a time-varying effect on economic activity. We also employ the innovative time-varying threshold regression kink model of Yang and Su (2018). Our analysis focuses on a sample of 20 top oil-importing and oil-exporting countries during the period 1995Q1 to 2023Q2. The findings of our investigation provide compelling evidence to support the existence of time-varying threshold levels in the relationship between oil prices and macroeconomic activity for most countries in our sample. Notably, our research unveils a substantial heterogeneity in the oil price thresholds across the investigated countries, thereby challenging the notion of a universal threshold applicable to all.
In this paper I analyze the work on exchange rates and external imbalances by University of Chicago faculty members during the university’s first 100 years, 1892 to 1992. Many people associate Chicago’s views with Milton Friedman’s advocacy for flexible exchange rates. But, of course, there was much more than that, including the work of J. Laurence Laughlin on bimetallism, Jacob Viner on the balance of payments, Lloyd Metzler on transfers, Harry Johnson on trade and currencies, Lloyd Mints on exchange rate regimes, Robert Mundell on optimal currency areas, and Arnold Harberger on shadow exchange rates, among others. The analysis shows that, although different scholars emphasized different issues, there was a common thread in this research, anchored on the role of relative prices’ changes during the adjustment process.
Après une intégration à l’Union européenne en 2013, puis une adhésion au mécanisme de change européen (MCE) II en juillet 2022, la Croatie est devenue le 20ème État membre de la zone euro en janvier dernier. Cet article se propose, à partir du compte courant et du compte financier de ce pays, d’exposer comment ce dernier a réussi à rejoindre la zone euro. Nous présenterons, dans un premier temps, les conditions financières internationales de l’insertion de la Croatie, en analysant sa politique de taux de change et ses choix de spécialisation. Nous étudierons ensuite l’évolution de son niveau de vie et la soutenabilité des stratégies adoptées. Classification JEL : F14, F21, F32, F36, O11
An alternative to the Taylor Rule for monetary policy.
The information base of the study is the time series of the daily exchange rate of the currency pair USD/JPY, the US 10-year Treasury bond (TB 10), the Japanese government bond 10-year (JGB 10), the volatility index (VIX) of the Chicago Board Options Exchange (CBOE), which calculated by Bloomberg. Study period: December 1, 2015 (the date the Federal Reserve raised interest rates, which initiated a new regime-began easing its ZIRP zero interest rate policy) to December 29, 2023. The relationship between monetary policy and the currency pair USD/JPY is evaluated using 3 approaches: 1) a rally dynamic system based on the standard theory of nonlinear differential equations aimed at eliminating psychological noise (1/f noise, pink noise, trend noise with spectrum capacity); 2) regression of instrumental variables with heteroskedasticity aimed at managing unobservable sources of variability; 3) an event tracking method to measure anomalous asset price response, analyzing the daily price action of USD/JPY to detect market-related fluctuations in the exchange rate and separate the impact of general market trends from related differences in interest rates. The study found that the US Federal Reserve's (Fed's) monetary policy only occasionally affects the USD/JPY exchange rate, and it changes mainly when monetary policy deviates from expected future trajectories. Within the studied period, this happened only 3 times: growth on December 16, 2015; emergency rate reduction due to COVID-19 on March 15, 2020; and the first increase of 75 basis points on June 15, 2022 (the article estimates the impact of each of these episodes on the exchange rate). Statements by the Fed on monetary policy affect the price dynamics of the USD/JPY pair in the short term (since short-term psychological expectations play a decisive role in shaping the dynamics of the currency market), but not often (if the statement on monetary policy is consistent with market forecasts, it is practically will not affect exchange rates). The Fed's adoption of tools such as "forward guidance" and official statements to inform the future course of monetary policy indirectly affects the price dynamics of USD/JPY. The price action of USD/JPY was driven by the fundamentals of the difference in interest rates between the US and Japanese bonds, which are influenced by the monetary policy of the US Federal Reserve and the Bank of Japan (BoJ). In 2023, it could be hard to attempt to challenge FX intervention except to curb "excess volatility and disorderly movements in exchange rates" like the Minister of Finance's (MoF) 2022 intervention.
This study investigates the dynamic relationship between external debt, inflation rate, and the exchange rate of the Lao Kip (LAK) against the US dollar over the period of 2000 to 2021. Utilizing time series data and the Autoregressive Distributed Lag (ARDL) Model, we analyze the impacts of these economic variables in both the short and long run. Our estimation results reveal a significant long-term positive relationship between external debt and the inflation rate with the exchange rate. Inflation rate and external debt have a significantly positive impact on exchange rate in the long run, while short-term analysis indicate a negative relationship between external debt and the inflation rate with the exchange rate. economic shocks or short-term fluctuations may disrupt the exchange rate, the system has a strong tendency to return to its long-term equilibrium point at a brisk pace. The policy implications are discussed. Therefore, policymakers must maintain a stable and controlled inflation environment. Inflation targeting and other monetary policy measures can be utilized to ensure that inflation remains within a manageable range. Keeping inflation under control can help stabilize the exchange rate and safeguard the country's economic stability.
Purpose
The purpose of this paper is to test the overshooting effects of monetary expansion on prices of agricultural products at farm production, processing and circulation stages in China, and to investigate the heterogeneity of the overshooting mechanisms in these three links.
Design/methodology/approach
Empirical results are obtained through the vector error correction model and the overshooting framework proposed by Saghaian et al . (2002b). Specifically, we first apply the Dickey–Fuller generalized least squares (DF-GLS) method to test the stationarity of the key variables, and then use the Johansen’s (1991) method to conduct the cointegration test. Finally, the vector error correction model is employed to examine the overshooting hypotheses in the three stages of China’s agricultural sector.
Findings
Empirical results indicate that overshooting of prices relative to monetary expansion in China’s agricultural sector is a common phenomenon, but with significant heterogeneity. Firstly, at the stage of agricultural production, the overshooting degree and restoration rate of material price are greater than those of agricultural products price. Secondly, at the processing stage of agricultural products, both the purchase price of agricultural products and industrial producer price have an overshooting effect, but the overshooting effect of the former is more significant than the latter. Thirdly, at the circulation stage of agricultural products, the overshooting coefficient of the wholesale price index of agricultural products is the most significant, while that of the retail and purchase price of agricultural products is not significant.
Originality/value
The paper contributes to proposing a comprehensive framework on testing the overshooting effects for three main stages of agricultural sector in China and empirically investigating the heterogeneity of the overshooting mechanisms in different stages with time series methods.
Outline for a second course in macroeconomics for graduate students of the Department of Economics, University of the Philippines Los Baños. Note: This is the latest version of the course outline.
Purpose
This study empirically examines the impact of some domestic as well as global factors such as trade openness (TO), money supply (MS), exchange rate, global oil prices (GOPs) and interest rate (IR) on inflation.
Design/methodology/approach
This study deploys a quantitative method considering 30 years of data (1991–2020) from four South Asian countries, namely, Sri Lanka, Pakistan, Bangladesh and India. To determine the potential impact of different factors on inflation, this study applies the panel analysis of the system generalized method of moments (SGMM).
Findings
This study empirically finds that TO, MS, exchange rate and GOPs have a positive impact on inflation, while IR and the structural adjustment program (SAP) have a negative impact on inflation. Out of the various determinants considered in this study, TO, exchange rate and the SAP are insignificant, while the rest of the variables are significant and consistent with previous studies.
Practical implications
This study informs policymakers about maintaining price stability and fostering economic growth in South Asian nations. It breaks new ground as the first empirical examination of the International Monetary Fund (IMF)’s SAP impact on inflation in the region.
Originality/value
This study tries to find out whether the SAP of the IMF is responsible for inflation in South Asian countries. It gives renewed attention to the causality of inflation from the perspective of countries receiving loans from donors, especially the IMF.
This paper raises doubts about the proposition that monetary policy is effective, under flexible exchange rates, in stabilizing domestic output. It is argued that if the price elasticities of the demands for exports and imports are affected by the transition to flexible rates, and capital flows are assumed to be dependent on the exchange rate, the efficacy of monetary policy under flexible rates will not necessarily follow.
This paper develops three perspectives on the determination of exchange rates and their interaction with macroeconomic equilibrium and aggregate policies. A long- run view characterizes exchange rate determination in terms of monetary and real factors where the real aspects include an explicit consideration of relative price structures. A short-run or “liquidity” view of the exchange rate emphasizes the role of asset market equilibrium and expectations. A policy view, finally, analyses the effectiveness of aggregate policies and points out that in the short-run nominal disturbances will tend to be transmitted internationally. The paper concludes with an analysis of dual exchange rate systems as a stabilizing policy in the presence of speculative disturbances.