Nonlinear Adjustment, Purchasing Power Parity and the Role of Nominal Exchange Rates and Prices

Although the literature on purchasing power parity (PPP) is rich in controversy, the relative contribution of prices and nominal exchange rates to real exchange rate movements which restore PPP disequilibria has rarely been put under any close scrutiny. Using monthly data from 1973:01 to 2009:12 from the USA, UK, Germany, France and Japan, this paper as a fi rst step applies a cointegrated VAR framework to test for stationary real exchange rates and linear adjustments in prices and nominal exchange rates. As a second step, ESTR error correction models are fi tted to test whether nonlinear error correctional behaviour characterizes the data. The results clearly indicate that the nominal exchange rate is responsible for the nonlinear mean reverting behaviour in real exchange rates and also mainly drives overall adjustment. Applying dynamic stochastic simulations based on the estimated models, this study also confi rms recent results that the half-life times of real exchange rate shocks are signifi cantly smaller than the consensus benchmark of three to fi ve years.Purchasing power parity; cointegration; nonlinear vector error correction

Cross-section Dependence and the Monetary Exchange Rate Mode – A Panel Analysis

This paper tackles the issue of cross-section dependence for the monetary exchange rate model in the presence of unobserved common factors using panel data from 1973 until 2007 for 19 OECD countries. Applying a principal component analysis we distinguish between common factors and idiosyncratic components and determine whether non-stationarity stems from international or national stochastic trends. We find evidence for a cross-section cointegration relationship between the exchange rates and fundamentals which is driven by those common international trends. In addition, the estimated coefficients of income and money are in line with the suggestions of the monetary model.Monetary exchange rate model; common factors; panel data; cointegration; vector error-correction models

Global Integration of Central and Eastern European Financial Markets: The Role of Economic Sentiments

This paper examines the importance of different economic sentiments, e.g. consumer moods, for the Central and Eastern European countries (CEECs) during the transition process. We first analyze the importance of economic confidence with respect to the CEEC's financial markets. Since the integration of formerly strongly regulated markets into global markets can also lead to an increase of the dependence of the CEECs' domestic market performance from global sentiments, we also investigate the relationship between global economic sentiments and domestic income and share prices. Finally, we test whether the impact of global sentiments and stock prices on domestic variables increases proportionally with the degree of integration. For these purposes, we apply a structural cointegrating VAR (CVAR) framework based upon a restricted autoregressive model which allows us to distinguish between the long-run and the short-run dynamics. For the long run we find evidence supporting relationships between sentiments, income and share prices in case of the Czech Republic. Our results for the short run suggest that economic sentiments in general are strongly influenced by share prices and income but also offer some predictive power with respect to the latter. What is more, global sentiments play an important role in particular for the CEECs' share prices and income. The significance of this link increases with economic integration.Cointegration, European integration, financial markets, restricted autoregressive model, sentiments

Global Integration of Central and Eastern European Financial Markets – The Role of Economic Sentiments

This paper examines the importance of diff erent economic sentiments, e.g. consumer moods, for the Central and Eastern European countries (CEECs) during the transition process. We fi rst analyze the importance of economic confi dence with respect to the CEECs’ fi nancial markets. Since the integration of formerly strongly-regulated markets into global markets can also lead to an increase in the dependence of the CEECs’ domestic market performance on global sentiments, we also investigate the relationship between global economic sentiments and domestic income and share prices. Finally, we test whether the impact of global sentiments and stock prices on domestic variables increases proportionally with the degree of integration. We also account for eff ects stemming from global income. For these purposes, we apply a restricted cointegrating VAR (CVAR) framework based upon a restricted autoregressive model which allows us to distinguish between the long-run and the short-run dynamics. For the long run we fi nd evidence supporting relationships between sentiments, income and share prices in the case of the Czech Republic. Our results for the short run suggest that economic sentiments in general are infl uenced by share prices but also off er some predictive power with respect to the latter. What is more, European sentiments play an important role in particular for the CEECs’ share prices and income. The signifi cance of this link increases with economic integration.Cointegration; European integration; fi nancial markets; restricted autoregressive model; sentiments

Cross-Section Dependence and the Monetary Exchange Rate Model: A Panel Analysis

This paper tackles the issue of cross-section dependence for the monetary exchange rate model in the presence of unobserved common factors using panel data from 1973 until 2007 for 19 OECD countries. Applying a principal component analysis we distinguish between common factors and idiosyncratic components and determine whether non-stationarity stems from international or national stochastic trends. We find evidence for a cross-section cointegration relationship between the exchange rates and fundamentals which is driven by those common international trends. In addition, the estimated coefficients of income and money are in line with the suggestions of the monetary model.Monetary exchange rate model, common factors, panel data, cointegration, vector error-correction models

How Stable Are Monetary Models of the Dollar-Euro Exchange Rate? - A Time-varying Coefficient Approach

This paper examines the significance of different fundamental regimes by applying various monetary models of the exchange rate to one of the politically most important exchange rates, the exchange rate of the US dollar vis-à-vis the euro (the DM). We use monthly data from 1975:01 to 2007:12. Applying a novel time-varying coefficient estimation approach, we come up with interesting properties of our empirical models. First, there is no stable long-run equilibrium relationship among fundamentals and exchange rates since the breakdown of BrettonWoods. Second, there are no recurring regimes, i.e. across different regimes either the coefficient values for the same fundamentals differ or the significance differs. Third, there is no regime in which no fundamentals enter. Fourth, the deviations resulting from the stepwise cointegrating relationship act as a significant error-correction mechanism. In other words, we are able to show that fundamentals play an important role in determining the exchange rate although their impact differs significantly across different subperiods.Structural exchange rate models, cointegration, structural breaks, switching regression, time-varying coefficient approach

The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule. CEPS Working Document No. 403, February 2015

Deviations of policy interest rates from the levels implied by the Taylor rule have been persistent before the financial crisis and increased especially after the turn of the century. Compared to the Taylor benchmark, policy rates were often too low. This paper provides evidence that both international spillovers, for instance international dependencies in the interest rate-setting of central banks, and nonlinear reaction patterns can offer a more realistic specification of the Taylor rule in the main industrial countries. The inclusion of international spillovers and, even more, nonlinear dynamics improves the explanatory power of standard Taylor reaction functions. Deviations from Taylor rates tend to be smaller and their negative trend can be eliminated

Effective exchange rates, current accounts and global imbalances

This study analyzes the dynamics between real e ective exchange rates and current account patterns from a novel perspective. We start by dissecting long-run and time-varying short-run dynamics between both variables. Following this, we extend our framework by including interest rates into our analysis. Finally, we examine common exchange rate and current account dynamics based on common factors derived from a principal components analysis. Our results show that a real appreciation is positively related to a worsening of the current account in most cases. The adjustment pattern is time-varying but suggests that the causality mainly runs from e ective exchange rates to current accounts and occurs through valuation e ects. However, an extension of our framework based on monthly data shows that trade balance adjustment is observed less frequently. From a global point of view, cross-country trends which drive exchange rates and current accounts also share similar dynamics over the long-run

The impact of uncertainty on professional exchange rate forecasts

This paper analyzes the role of uncertainty on both exchange rate expectations and forecast errors of professionals for four major currencies based on survey data provided by FX4casts. We consider economic policy, macroeconomic, and financial uncertainty as well as disagreement among CPI inflation forecasters to account for different dimensions of uncertainty. Based on a Bayesian VAR approach, we observe that effects on forecast errors of professionals turn out to be more significant compared to the adjustment of exchange rate expectations. Our findings are robust to different forecasting horizons and point to an unpredictable link between exchange rates and fundamentals. Furthermore, we illustrate the importance of considering common unpredictable components for a large number of variables. We also focus on the post-crisis period and the relationship between uncertainty and disagreement among exchange rate forecasters and identify a strong relationship between them.Dieser Beitrag analysiert die Bedeutung von Unsicherheit für professionelle Wechselkurserwartungen und die resultierenden Prognosefehler für vier große Währungen auf Basis von Umfragedaten von FX4casts. Wir betrachten politische, makroökonomische und finanzielle Unsicherheit sowie die Inflationsunsicherheit als unterschiedliche Dimensionen von Unsicherheit. Basierend auf einem Bayesianischen VAR-Modell finden wir, dass eine Steigerung von Unsicherheit oftmals den Prognosefehler erhöht. Die Auswirkungen auf die Prognosefehler sind im Vergleich zu der Anpassung der Wechselkurserwartungen wesentlich bedeutsamer. Die Ergebnisse sind robust über unterschiedliche Prognosehorizonte und bestätigen einen nicht prognostizierbaren Zusammenhang zwischen Wechselkursen und Fundamentaldaten. Erwartungsunsicherheit ist zudem insbesondere nach der Finanzkrise stark mit den Unsicherheitsmaßen korreliert

Exchange rate expectations since the financial crisis: Performance evaluation and the role of monetary policy and safe haven

We analyze and evaluate novel data on exchange rate expectations after the collapse of Lehman Brothers for more than 60 economies over different horizons. We find that monetary policy effects on expectations are time-varying and identify substantial international spillovers over the recent period. Our results also show that markets have been surprised by monetary policy effects on the exchange rates and point to an unexpected safe haven status of the US dollar after 2009