Twin Fallacies About Exchange Rate Policy in Emerging Markets

Two assertions about exchange rate regimes circulate with some frequency in policy circles. The first, the hypothesis of the excluded middle, holds that authorities must either choose perfectly floating exchange rates (preferably anchored by an inflation target for the central bank) or a hard (preferably irrevocable) peg. The second, seemingly unrelated, argues that the inability of emerging market economies to exercise monetary independence owes to the severe mistrust that they are perceived with by global investors because of the economic failures of prior governments. This paper argues that the theories of the excluded middle and original sin are twin and related fallacies that are contrary to theory and evidence. This paper will provide a model in which the government can choose policies consistent with either a pure float anchored by a constant money stock or a pure peg but, under certain circumstances, fail to find exchange rate stability at either corner. The problem is that the potential for regime change implies that the current government's successors may behave less admirably, which will weigh on investors' current behavior. The difficulties imparted by this expectation channel in an otherwise standard model of optimizing agents endowed with rational expectations shows both why looking back to explain credibility problems is looking the wrong way and why the excluded middle is, in fact, so crowded.

When the North Last Headed South: Revisiting the 1930s

macroeconomics, recession, financial crisis, historical economics

What Hurts Most? G-3 Exchange Rate or Interest Rate Volatility

With many emerging market currencies tied to the U.S. dollar either implicitly or explicitly, movements in the exchange values of the currencies of major countries have the potential to influence the competitive position of many developing countries. According to some analysts, establishing target bands to reduce the variability of the G-3 currencies would limit those destabilizing shocks emanating from abroad. This paper examines the argument for such a target zone strictly from an emerging market perspective. Given that sterilized intervention by industrial economies tends to be ineffective and that policy makers show no appetite to return to the controls on international capital flows that helped keep exchange rates stable over the Bretton Woods era, a commitment to damping G-3 exchange rate fluctuations requires a willingness on the part of G-3 authorities to use domestic monetary policy to that end. Under a system of target zones, then, relative prices for emerging market economies may become more stable, but debt-servicing costs may become less predictable. We use a simple trade model to show that the resulting consequences for welfare are ambiguous. Our empirical work supplements the traditional literature on North-South links by examining the importance of the volatilities of G-3 exchange-rates, and U.S. interest rate and consumption on capital flows and economic growth in developing countries over the past thirty years.

Securing the Peace after a Truce in the War on Inflation

Central bankers in the major industrial economies have come close to securing the peace, or in some cases, have secured it in the battle against inflation, hostilities that lasted almost as long as the Cold War. It is important to remember that this battle has been a good fight: both the theory and the empirics reviewed in this paper support the central tenet of central banking that lower inflation supports faster economic growth. However, the observation that low inflation is associated with a macroeconomic benefit does not imply that disinflation should be pursued without limit. A particularly compelling argument in the body of work on the optimal inflation rate is the view that price deflation, or even very low inflation, may pose unacceptable macroeconomic risks given the lower bound of nominal interest rates of zero. Empirical work in this paper suggests that the zero bound is not an artifact of theoreticians but a palpable reality. That said, the perils of the zero bound to nominal interest rates may be seen as less threatening if a central bank is willing to be both aggressive in providing policy accommodation when the economy may be nearing the zero bound and flexible in using the available tools of policy.

Temporary controls on capital inflows

During the past decade a number of countries imposed capital controls that had two distinguishing features: they were asymmetric, in that they were designed principally to discourage capital inflows, and they were temporary. This paper studies formally the consequences of these policies, calibrates their potential effectiveness, and assesses their welfare implications in an environment in which the level of capital inflows can be suboptimal. In addition, motivated by the fact that these types of controls have often been left in place after the dissipation of the shock that lead to the controls being implemented, the paper evaluates the welfare cost of procrastination in removing these types of controls.capital flows controls international interest rates inflation reserve requirements

Too much of a good thing: The macroeconomic effects of taxing capital inflows

In addition to altering fiscal, monetary, and exchange rate policies in response to the surge in international capital inflows in the early 1990s,policy makers in many countries in ASIa, Eastern Europe, and Latin America have resorted to measures to control capital inflows.We provide a preliminary assessment of the effects of some of the macroeconomic effects of these policies.capital controls capital inflows reserve requirements taxes

Continuation-conjugate gradient methods for the least squares solution of nonlinear boundary value problems

We discuss in this paper a new combination of methods for solving nonlinear boundary value problems containing a parameter. Methods of the continuation type are combined with least squares formulations, preconditioned conjugate gradient algorithms and finite element approximations. We can compute branches of solutions with limit points, bifurcation points, etc. Several numerical tests illustrate the possibilities of the methods discussed in the present paper; these include the Bratu problem in one and two dimensions, one-dimensional bifurcation and perturbed bifurcation problems, the driven cavity problem for the Navier–Stokes equations

When in Peril, Retrench: Testing the Portfolio Channel of Contagion

One plausible mechanism through which financial market shocks may propagate across countries is through the effect of past gains and losses on investors' risk aversion. The paper first presents a simple model examining how heterogeneous changes in investors' risk aversion affects portfolio decisions and stock prices. Second, the paper shows empirically that, when funds' returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were "overweight", increasing their exposure to countries in which they were "underweight." Based on this insight, the paper discusses a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. Comparing this measure to indices of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.

Penggunaan Metode Compromise Programming untuk Menentukan Sumber Air Baku Optimal di Kota Bengkayang

Kota Bengkayang merupakan ibukota dari KabupatenBengkayang. Saat ini di wilayah Kota Bengkayang sudah ada fasilitas sarana danprasarana penyediaan air bersih yang dikelola PDAM yang sumber air bakunyaadalah Riam Madi dengan kapasitas produksi 100 lt/det yang telah diolah untukmenghasilkan pasokan aliran air bersih yang beroperasi selama 8 -10 jam. Namunpelayanan air bersih PDAM masih belum merata atau dapat dikatakan belum optimalkarena sampai saat ini baru dapat melayani sekitar 30-35% dari kebutuhan airmasyarakat kota Bengkayang. Saat ini pemerintah daerah berupaya untuk mencarialternatif sumber air baku yang dapat dikembangkan menjadi sumber air bersihbagi masyarakt Kota Bengkayang. Adapun alternatif yang menjadi prioritaspengembangan pemerintah Kabupaten Bengkayang adalah sumber air baku Riam Marun,Sungai Bekuan, Sungai Karangan, Riam Madi dan Riam Bide. Oleh karena itu makaperlu dilakukan penelitian yang mengkaji sumber air baku mana dari kelimasumber air baku tersebut yang sangat potensial untuk dikembangkan gunakepetingan masyarakat Kota Bengkayan

Capital Flow Bonanzas: An Encompassing View of the Past and Present

A considerable literature has examined the causes, consequences, and policy responses to surges in international capital flows. A related strand of papers has attempted to catalog current account reversals and capital account "sudden stops." This paper offers an encompassing approach with an algorithm cataloging capital inflow bonanzas in both advanced and emerging economies during 1980-2007 for 181 countries and 1960-2007 for a subset of 66 economies from all regions. In line with earlier studies, global factors, such as commodity prices, international interest rates, and growth in the world's largest economies, have a systematic effect on the global capital flow cycle. Bonanzas are no blessing for advanced or emerging market economies. In the case of the latter, capital inflow bonanzas are associated with a higher likelihood of economic crises (debt defaults, banking, inflation and currency crashes). Bonanzas in developing countries are associated with procyclical fiscal policies and attempts to curb or avoid an exchange rate appreciation -- very likely contributing to economic vulnerability. For the advanced economies, the results are not as stark, but bonanzas are associated with more volatile macroeconomic outcomes for GDP growth, inflation, and the external accounts. Slower economic growth and sustained declines in equity and housing prices follow at the end of the inflow episode.