Money and the Open Economy Business Cycle: A Flexible Price Model

This paper develops an open-economy model of the business cycle. The nominal prices in the model are flexible and monetary nonneutrality is developed using information confusion about the sources of disturbances to demand coupled with differential persistence of demand shocks. Firms use inventories to smooth their production, and consumers follow a stochastic permanent income expenditure function. The major implication of the model is that unperceived monetary disturbances improve the terms of trade and increase real output in contrast to sticky price models in which the terms of trade deteriorates. This implication of the model is examined empirically.

Asset Price Volatility, Bubbles, and Process Switching

Evidence of excess volatilities of asset prices compared with those of market fundamentals is often attributed to speculative bubbles. This study examines the sense in which speculative bubbles could in theory lead to excess volatility, hut it demonstrates that some of the variance hounds evidence reported to date precludes bubbles as a reason why asset prices might violate such hounds. The findings must represent some other model misspecffication or market inefficiency. One important misspecification occurs when there searcher incorrectly specifies the time series properties of market fundamentals. A bubble-free example economy characterized by a potential switch in government policies produces paths of asset prices that would appear, to an unwary researcher, to contain bubbles.

Financial Integration: A New Methodology and an Illustration

This paper develops a simple new methodology to test for asset integration and applies it within and between American stock markets. Our technique is tightly based on a general intertemporal asset-pricing model, and relies on estimating and comparing expected risk-free rates across assets. Expected risk-free rates are allowed to vary freely over time, constrained only by the fact that they are equal across (risk-adjusted) assets. Assets are allowed to have general risk characteristics, and are constrained only by a factor model of covariances over short time periods. The technique is undemanding in terms of both data and estimation. We find that expected risk-free rates vary dramatically over time, unlike short interest rates. Further, the S&P 500 market seems to be well integrated, and the NASDAQ is generally (but not always) integrated. However, the NASDAQ is poorly integrated with the S&P 500.

Uncovered Interest Parity in Crisis

This paper tests for uncovered interest parity (UIP) using daily data for 23 developing and developed countries during the crisis-strewn 1990s. We find that UIP works better on average in the 1990s than in previous eras in the sense that the slope coefficient from a regression of exchange rate changes on interest differentials yields a positive coefficient (which is sometimes insignificantly different from unity). UIP works systematically worse for fixed and flexible exchange rate countries than for crisis countries, but we find no significant differences between rich and poor countries. Copyright 2002, International Monetary Fund

Fixes: Of The Forward Discount Puzzle

Regressions of ex post changes in floating exchange rates on appropriate interest differentials typically imply that the high- interest rate currency tends to appreciate, the `forward discount puzzle.' Using data from the European Monetary System, we find that a large part of the forward discount puzzle vanishes for regimes of fixed exchange rates. That is, deviations from uncovered interest parity appear to vary in a way which is dependent upon the exchange rate regime. By using the many EMS realignments, we are also able to quantify the `peso problem.'

A Systematic Banking Collapse in a Perfect Foresight World

In this paper we present a model in which a systematic banking collapse is possible in a perfect foresight, general equilibrium context. Our aim is to determine con3itions under which a collapse will eventually occur and the timing of such a collapse. The collapse can occur endogenously, driven by market fundamentals. Alternatively, it can be caused by a mass hysteria which generates itself in reality. Vie also compare the assumptions and implications of our model to the observable phenomena of the 1930's.