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Essays on flexible exchange rates.
Abstract
Thesis. 1977. Ph.D.--Massachusetts Institute of Technology. Dept. of Economics. MICROFICHE COPY AVAILABLE IN ARCHIVES AND DEWEY. Vita. Includes bibliographies. Ph.D.
We exploit a rich but rather neglected source of data, The Commercial and Financial Chronicle, to shed light on the behaviour of daily and weekly exchange rates throughout several interwar hyperinflation episodes, paying special attention to the case of Germany. The purpose of our analysis is fourfold: First, we investigate the consistency of exchange rate data by comparing the rates available from The Commercial and Financial Chronicle at daily frequency with those provided by Einzig (1937). Although Einzig is a widely used source, the daily rates of the currencies of countries that witnessed episodes of hyperinflation during the interwar period, reported in The Chronicle, have not been examined previously. Second, we scrutinize the commentaries offered by The Chronicle to shed light on the impact of news on the behaviour of the German mark–U.S. dollar exchange rate over the interwar German hyperinflation and to check whether the narrative analysis provided therein is consistent with formal econometric analyses in dating when the probability of monetary reform became salient. This is crucial for the interpretation of the findings reported by previous studies of the German hyperinflation. Third, we focus on the commentaries that provide evidence on the volume of trade in German marks and on whether the quotations of the exchange rate of the mark against the U.S. dollar were purely notional in the final stages of the hyperinflation. Fourth, for the first time, we examine the behaviour of the real exchange rate of the German mark after the 1923 stabilization episode using data at weekly frequency.
This chapter presents a critical survey and an interpretation of recent exchange rate research. It focuses on empirical results for exchange rates among major industrialized countries. The expectations of future exchange rate changes are a key determinant of asset demands, and therefore of the current exchange rate. The expectations variable is relatively straightforward in the conventional monetary models; in theoretical terms , it is determined by the rational expectations assumption, while in empirical terms, it is typically measured by the forward discount or interest differential. The standard empirical implementation of rational expectations methodology infers ex ante expectations of investors from ex post changes in the exchange rate. Unexpected changes in monetary policy frequently cause movements in the exchange rate in the direction hypothesized by the sticky-price monetary model. The chapter presents a survey of the work on exchange rate determination in floating rate regimes. It considers evidence across exchange rate regimes and examines the issue of speculative bubbles. It also reviews some relatively new directions in exchange rate research that focus on the micro-structure of foreign exchange markets.
This chapter reviews the international aspects of monetary policy and presents the classical model of the open economy. The operation of the gold standard, the price–specie flow mechanism, purchasing power parity, and the monetary approach to the balance of payments are illustrated in the chapter. The Mundell–Fleming model that is an open economy version of the investment—saving/liquidity preference—money supply (IS–LM) model of monetary policy under conditions of short-run wage–price stickiness and capital mobility are discussed in the chapter. The distinction between fixed and flexible exchange rates is described in the chapter. The macroeconomic model is described in the chapter by drawing out the evidence on two central questions: the extent to which wages and prices are sticky and the international linkages among asset markets. Both issues are of central importance for the channels of transmission and the effectiveness of monetary policy. Classical monetary economics deals with the linkages among money, spending, and prices in the open economy. It is best represented by David Hume's price–specie flow mechanism. The simple model assumes full price flexibility and focuses on a money–goods economy with no nonmonetary assets.
In this paper we study the predictability of exchange rate return of India using macro variables such as money supply growth, stock price returns, inflation rate, foreign investment, trade balance, foreign exchange reserve etc., which have been found to be relevant in similar studies concerning other, mostly developed, economies and / or which are considered to be important in theoretical studies on exchange rate. The full set of macro variables used, to begin with, comprises 24 variables. Inferences on predictive ability of each of these variables are based on recently developed out-of-sample tests of predictive ability due to West (1996), Clark and McCracken (2001) and McCracken (2004). In this selection procedure, specific-to-general as well as general-to-specific approaches of model selection are used, and we also check our results using a data-mining-robust bootstrap procedure. Thereafter, we use the macro variables which are thus found to have significant predictive ability and obtain a model for exchange rate return of India in linear dynamic regression framework, and then carry out all relevant diagnostic tests on the residuals of this model.
The foreign exchange risk premium in a cash-in-advance model is investigated. Some weaknesses of the definition of the risk premium generally used are discussed. It is shown that the primary ultimate source of foreign exchange risk is the covariance of monetary shocks with real output shocks. Several studies have assumed this covariance is zero, and hence assumed away the major source of risk in the model. Finally, the risk premium generated from standard versions of this model is argued to be very small, because it is the same order of magnitudeas covariances of money and output growth rates.
This paper uses a model calibrated to suit a small open Asian economy to present a series of counterfactual policy experiments aimed at comparing conventional optimal inflation targeting (IT) under commitment and discretion and variations of simple fixed monetary policy rules (MPRs). Two significant points of departure between the model presented here and previous ones for industrial countries are the incorporation of the real exchange rate and consideration of possible contractionary depreciation/devaluation. This represents a realistic scenario for some Asian economies after the crisis. In assessing the impact of different policy types it is essential to find parameters for model calibration that suitably represent the small and open Asian economies that have recently implemented inflation targeting arrangements. We have used estimates from Thailand over a recent period (1993-2003) to assist in selecting these parameters.
The continuing depreciation of the dollar stands out as one of the big policy issues. It has started to impinge on U.S. monetary policy; it influences the chances for international commercial diplomacy, and it is enhancing the move toward European monetary integration. Above all it leaves most observers with a puzzle as to the causes of the ongoing depreciation. This paper will, of course, not resolve the puzzle. ft rather attempts to layout the basic analytical framework that has been developed for the analysis of exchange-rate questions and to relate it to the question of monetary policy. Part I concentrates on the development of the relevant theoretical framework. The main points to be made here are: (i) exchange rates are primarily deter-mined in asset markets with expectations playing a dominant role; (ii) the sharpest formulation of exchange-rate theory is the "monetary approach, "Chicago's quantity theory of the open economy; (iii) purchasing power parity is a precarious reed on which to hang short-term exchange-rate theory; (iv) the current account has just made it back as a determinant of exchange rates
The paper is concerned with time series modelling of foreign exchange rate of an important emerging economy, viz., India, with due consideration to possible sources of misspecification of the conditional mean like serial correlation, parameter instability, omitted time series variables and nonlinear dependences. Since structural change is pervasive in economic time series relationships, the paper first studies this aspect of the exchange rate series in detail and finds the existence of four structural breaks. Accordingly, the entire sample period is divided into five sub-periods of stable parameters each, and then the appropriate mean specification for each of these sub-periods is determined by incorporating functions of recursive residuals. Thereafter, the GARCH and EGARCH models are considered to capture the volatility contained in the data. The estimated models thus obtained suggest that return on Indian exchange rate series is marked by instabilities and that the appropriate volatility model is EGARCH. Further, out-of-sample forecasting performance of the model has been studied by standard forecasting criteria, and then compared with that of an AR model only to find that the findings are quite favorable for the former. Copyright Springer Science+Business Media, LLC 2006
This paper investigates optimum North-South tariffs by taking into consideration the fact that tariffs serve mainly as trade policy in the North, but serve as revenue policy as well as trade policy in the South. A statically and endogenously determined conjectural variation is devised to approach the problem. We show that, among other things, there are many possibilities for the North optimally to choose the zero tariff other than only in the case where the elasticity of the South's supply of export is infinite.
This paper tests for the absence of expected red profits from forward market speculation. It contrasts with the literature that has considered opportunities for expected tmrnitd prolit from speculation - that is. protits denominated in one of the currencies. These studies assume money illusion on the part of market participants, but this paper does not. Empirical results (ail to tind evidence of unexploited real protit opportunities.
This paper examines the empirical validity of a simple monetary model of exchange rate determination. The model stresses that the exchange rate, which is the relative price of two monies, is determined by the relative supplies of, and demands for, the two monies, rather than by the condition for flow equilibrium in the balance of payments. It follows from this approach that the exchange rate is determined by the relative money supplies, the levels of real income, and the nominal interest rates in the two countries under consideration. The monetary model provides a useful tool for exchange rate analysis because it (a) clearly defines the role of speculation among the determinants of the exchange rate; (b) provides a workable definition of the equilibrium exchange rate; and (c) directly relates the equilibrium rate to the underlying instruments of monetary policy. The model is tested using data on the deutsche mark/pound rate during the current floating rate period. This particular rate was chosen because of the large variance in the variable stressed by the monetary approach. The empirical tests broadly support this approach, although the need for a more complete empirical model is evident. /// Cette étude examine la validité empirique d'un modèle monétaire simple de la détermination du taux de change. Ce modèle fait ressortir que le taux de change, qui est le prix relatif de deux monnaies, est déterminé par l'offre et la demande relatives des deux monnaies, plus que par la condition d'équilibre des flux dans la balance des paiements. Il découle de cette théorie que le taux de change est déterminé par l'offre de monnaie relative, le niveau du revenu réel et le taux d'intérêt nominal dans chacun des deux pays considérés. Le modèle monétaire constitue un instrument utile pour l'analyse des taux de change en ce qu'il a) définit clairement le rôle de la spéculation parmi les facteurs qui déterminent le taux de change, b) donne une définition exploitable du taux de change d'équilibre, enfin c) établit une relation directe entre le taux d'équilibre et les instruments de politique monétaire sous-jacents. L'auteur teste le modèle pour les données sur le cours du deutsche mark par rapport à la livre pendant la période de flottement actuelle. Ce taux particulier a été choisi en raison de la variance élevée de la variable mise en avant par la théorie monétaire. Les essais empiriques corroborent largement cette théorie; il est néanmoins évident qu'un modèle empirique plus complet est nécessaire. /// En este trabajo se examina la validez empÃrica de un modelo monetario sencillo de determinación del tipo de cambio. El modelo subraya que el tipo de cambio, que es el precio relativo de dos monedas, está determinado por la oferta y la demanda relativas de ambas, y no por el equilibrio de flujos de la balanza de pagos. De este enfoque se deduce que el tipo de cambio está determinado por las ofertas monetarias relativas, los niveles de ingreso real y los tipos de interés nominales de los dos paÃses analizados. El modelo monetario constituye un instrumento útil para el análisis del tipo de cambio porque: a) define claramente el papel de la especulación entre los determinantes del tipo de cambio; b) proporciona una definición operativa del tipo de cambio de equilibrio, y c) relaciona directamente el tipo de equilibrio con los instrumentos fundamentales de la polÃtica monetaria. En la verificación del modelo se utilizan datos sobre el tipo marco alemán/libra esterlina durante el actual perÃodo de tipos flotantes. Este tipo se eligió en razón de la amplia varianza de la variable subrayada por el enfoque monetario. Las pruebas empÃricas respaldan en general este enfoque, aunque es evidente que se necesita un modelo empÃrico más completo.
Thesis--University of Chicago. Microfilm copy of typescript.
Using the result that under the null hypothesis of no misspecification an asymptotically efficient estimator must have zero asymptotic covariance with its difference from a consistent but asymptotically inefficient estimator, specification tests are devised for a number of model specifications in econometrics. Local power is calculated for small departures from the null hypothesis. An instrumental variable test as well as tests for a time series cross section model and the simultaneous equation model are presented. An empirical model provides evidence that unobserved individual factors are present which are not orthogonal to the included right-hand-side variable in a common econometric specification of an individual wage equation.
The requirements of asset-market equilibrium play a crucial role in determining the exchange rate. Changes in relative asset supplies and in the terms at which the public is willing to hold them—and these terms depend crucially on expectations—are therefore to be focused on in any analysis of exchange- rate variations in both the short and long run.
The asymptotic distributions of cointegration tests are approximated using the Gamma distribution. The tests considered are for the I(1), the conditional I(1), as well as the I(2) model. Formulae for the parameters of the Gamma distributions are derived from response surfaces. The resulting approximation is flexible, easy to implement and more accurate than the standard tables previously published.
“[The] central contention of … [Mussa’s] … paper [is] that the basic theoretical framework of the monetary approach to the balance of payments remains applicable” (see above, page 97) to the world of controlled floating which has existed since 1971. The paper itself is informal and the discussion general but, there is also a more formal appendix. This comment summarizes and evaluates both the paper and the appendix.
This paper considers the extension of the fundamental principles of the monetary approach to balance of payments analysis to a regime of floating exchange rates, with active intervention by the authorities to control rate movements. It makes four main points. First, the exchange rate is the relative price of different national monies, rather than national outputs, and is determined primarily by the demands and supplies of stocks of different national monies. Second, exchange rates are strongly influenced by asset holder’s expectations of future exchange rates and these expectations are influenced by beliefs concerning the future course of monetary policy. Third, “real” factors, as well as monetary factors, are important in determining the behavior of exchange rates. Fourth, the problems of policy conflict which exist under a system of fixed rates are reduced, but not eliminated, under a regime of controlled floating. A brief appendix develops some of the implications of “rational expectations” for the theory of exchange rates.
As many papers in this conference, Frenkel’s deals with the determinants of the exchange rate and uses the analytical framework provided by the monetarist approach to the balance of payments. The paper is divided in two main sections. In the first one Frenkel shows, with appropriate quotations, that the new monetarist approach has deep roots in economic doctrine. In the second part, Frenkel aims at an empirical verification of the monetarist approach, and in order to do so he chooses a period in which we may say without doubt that monetary disturbances dominated over real, and domestic over foreign ones. His case is the German hyperinflation during the years 1920–23.
This paper deals with the determinants of the exchange rate and develops a monetary view (or more generally, an asset view) of exchange rate determination. The first part traces some of the doctrinal origins of approaches to the analysis of equilibrium exchange rates. The second part examines some of the empirical hypotheses of the monetary approach as well as some features of the efficiency of the foreign exchange markets. Special emphasis is given to the role of expectations in exchange rate determination and a direct observable measure of expectations is proposed. The direct measure of expectations builds on the information that is contained in data from the forward market for foreign exchange. The empirical results are shown to be consistent with the hypotheses of the monetary approach.
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