Imports under a foreign exchange constraint

The traditional model of import behavior -- which looks only at the gross domestic product (GDP) and real import prices as explanatory variables -- failed to predict or explain the developing countries'import slumps in the early 1980's. This paper expands on a more useful model, the Hemphill, which incorporates the traditional variables (relative prices and domestic income) with the variables introduced by Hemphill (foreign exchange receipts and international reserves). Section 2 of this paper discusses the theoretical models in the present study. The traditional model, used here as a benchmark, is presented first, and is later extended to include foreign exchange constraints. Section 3 presents the empirical estimates of the general import models that include foreign constraints, and two special cases, the Hemphill and benchmark models, using pooled, cross-section time series. Section 4 concludes that policy makers must look at the policies that affect GDP and prices and the availability of foreign exchange when trying to estimate import behavior in developing countries.Economic Theory&Research,Environmental Economics&Policies,Economic Stabilization,Inequality,Geographical Information Systems

Volatility reversal from interest rates to the real exchange rate : financial liberalization in Chile, 1975-82

The authors analyze the dynamic adjustment of the real exchange rate, the domestic interest rate, and foreign borrowing under conditions of perfect and imperfect capital mobility during financial liberalization. Making use of a two-sector model with current and capital accounts interacting, they show that the domestic interest rate is more volatile under imperfect mobility and the real exchange rate more volatile under perfect mobility. So liberalizing the capital accounts does not eliminate variations in the domestic interest rate but shifts them to the real exchange rate. Studying data for Chile during the period of financial liberalization from 1975 to 1982, they found that the domestic interest rate became less volatile and less responsive to domestic variables - and more dependent on the covered international interest rate, while the real exchange rate became more responsive to domestic wealth. Foreign reserve holdings and net exports followed a similar pattern: the covered international rate had stronger effects on reserve changes while real wealth became more important for determining net exports.Economic Theory&Research,Macroeconomic Management,Economic Stabilization,Environmental Economics&Policies,Banks&Banking Reform

Intertemporal adjustment and fiscal policy under a fixed exchange rate regime

The paper presents a dynamic model for small to medium open economies operating under a fixed exchange rate regime. The model provides a partial explanation of the channels through which fiscal and monetary policy affects the real exchange rate. An empirical investigation is conducted for the case of Argentina during the currency board period of 1991-2001. Empirical estimates show that fiscal policy may indeed be an efficient instrument for promoting macroeconomic stability insofar as it encourages convergence toward long-run equilibrium and alters the long-term balance between exports and consumption, both private and public. The simulation applied to Argentina shows that if the share of public spending in the economy is higher than the share of imports, an increase in the tax rate will stimulate capital stock slightly, at least in the short term, anddepreciate the real effective exchange rate. In the long run, the fiscal policy affects the value of the real exchange rate and consequently external competitiveness.Currencies and Exchange Rates,Economic Stabilization,Debt Markets,Economic Theory&Research,Emerging Markets

A Two-Country NATREX Model for the Euro/Dollar

This paper develops a NATREX (NATural Real EXchange rate) model for two large economies, the Eurozone and the United States. The NATREX approach has already been adopted to explain the medium-long term dynamics of the real exchange rate in a number of industrial countries. So far, however, it has been applied to a one-country framework where the "rest of the world" is treated as given. In this paper, we build a NATREX model where the two economies are fully specified and allowed to interact. Our theoretical model offers the basis for empirical estimation of the euro/dollar equilibrium exchange rate that will be carried out in future research. JEL classification: F31; F36; F47Key words: NATREX; equilibrium exchange rate; euro/dollar; structural approach

A Two-Country NATREX Model for the Euro/Dollar

This paper develops a NATREX (NATural Real EXchange rate) model for two large economies, the Eurozone and the United States, which are fully specified and allowed to interact. After description of the theoretical framework grounding on dynamic disequilibrium modelling approach in continuous time, we implement empirical analysis. First, we estimate the model in its structural form as a simultaneous nonlinear differential equation system for the 1975-2003 period. Second, we simulate the Euro/USD NATREX series in- and out-of-sample by using parameters estimates. The simulated equilibrium real exchange rate enables us to determine a benchmark against which the dynamics of the actual real exchange rate can be measured.NATREX, equilibrium exchange rate, Euro/USD, structural approach, continuous time econometrics, misalignment

Optimal currency shares in international reserves: the impact of the euro and the prospects for the dollar

Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important. JEL Classification: F02, F30, G11, G15Currency optimizer, euro, Foreign reserves, international currencies

Does monetary policy generate recessions?

The issue of uncovering the effects of monetary policy is far short of resolution. In the identified VAR literature, restrictions have been imposed to identify the effects of unpredictable monetary policy disturbances. We offer critical views on the unreasonable assumptions in the existing work and argue for careful economic argument about identifying assumptions. We display a structural stochastic equilibrium model in which our VAR identification would produce correct results while drawing attention to the serious lack of time series fit in most of the DSGE literature.Monetary policy

An Evaluation of Foreign Exchange Intervention and Monetary Aggregates in Nigeria (1986- 2003)

The paper investigates the impact of foreign exchange intervention in the Nigerian foreign exchange market using an Autoregressive Distributed Lag (ARDL) modeling approach. Quarterly time series data spanning 1986:1 to 2003:4 are used and a number of statistical tools are employed to verify this hypothesis. The study examines stochastic characteristics of each time series by testing their stationarity using Phillip Perron (PP) test. This is followed by performing cointegration test using Johansen technique. The existence of co-integration motivates us to estimate the error correction model for broad money, M2. The overall finding from all the techniques employed is that foreign exchange intervention in Nigeria is sterilized because the cumulative aid, which constitute part of foreign exchange inflows, and net foreign assets variables, which are proxies for intervention, are not significant. Thus, paper concludes by recommending, among others, that the use of stock of external reserves to support the exchange rate through increased funding of the foreign exchange market should be encouraged.Nigeria; Foreign Exchange Intervention; Co-integration and Auto-regressive Distributed Lag

The Dynamics Of The Current Account Behavior In The ASEAN-5 Countries

The current account is an endogenous variable that contains information about the behaviors of the economics agents. Thus, it is important for economic policymaking as it gives a broad reflection of the stance of macroeconomics policies. This dissertation empirically analyzed the anatomy of the dynamic current account behavior for the ASEAN-5 countries using three closely related elements. These includes evaluating the dynamic current account behavior using the present value model, the sustainability of current account imbalances and the interconnection between twin deficits phenomenon in the ASEAN-5 economies. Several important results are summarized from this study. First, the statistical estimation from the present value model suggests that the agents behave as the forward-looking rational agents in the face of the shocks in the three out of five economies. This implies that the current account acts as a buffer to smooth the consumption in the presence of shock and optimally smoothing its consumption path for these countries. Second, the sustainability analysis clearly indicates that for all countries, (except Malaysia and Singapore), current account deficits were not on the long-run steady state in the pre-crisis (1961-1997) era. An important lesson from this result is that the large and persistent external imbalances can trigger a financial crisis. The policy action to correct the widening of current account deficits should have taken place prior to 1997 when the external imbalances were on the unsustainable path. In other words, the external imbalances may be used as an indicator (or early warning signal) for a forthcoming crisis. Third, we found two channel of causal relationship between budget and current account deficits which (i) directly transmitted between budget and current account deficit and (ii) budget deficit is the driving force for interest rate, exchange rate and current account. Solving and managing the current account problem had been the center of international economic policymaking in many countries around the globe. As such, the issues presented in this study would serve as important guidelines for the understanding of the co-movements of the current account behavior and provide a platform for debate on the experiences of developing countries in promoting macroeconomic stability and sustainability in their countries

Theoretical Developments in the Light of Macroeconomic Policy and Empirical Research

The paper surveys the macroeconomic literature of the last decade with emphasis on the implications of the New Classical and Rational Expectations critiques for the Keynesian paradigm and the role of macro policies. This is done on the background of the main macro developments of the l970'a and 1980's as well as the specific lessons of recent high (chronic) inflation processes. The paper takes an eclectic view emphasizing a synthesis that is emerging in which the basic Keynesian view of the existence of market and price co-ordination failures as well as room for Pareto improving policy intervention are maintained. At the same time the theoretical underpinnings are undergoing substantial change mainly due to a 'rational expectations' (rather than 'new classical') reformulation. The new Theory of Economic Policy is also discussed and illustrated in terms of recent stabilization experience.