Capital controls and foreign exchange policy

The empirical analysis of the paper suggests that an FX policy objective and concerns about an overheating of the domestic economy have been the two main motives for the (re-)introduction and persistence of capital controls over the past decade. Capital controls are strongly associated with countries having significantly undervalued exchange rates. Capital controls also appear to be less motivated by worries about financial market volatility or fickle capital flows per se, but rather by concerns about capital inflows triggering an overheating of the economy – in the form of high credit growth, rising inflation and output volatility. Moreover, countries with a high level of capital controls, and those actively implementing controls, tend to be those that have fixed exchange rate regimes, a non-IT monetary policy regime and shallow financial markets. This evidence is consistent with capital controls being used, at least in part, to compensate for the absence of autonomous macroeconomic and prudential policies and effective adjustment mechanisms for dealing with capital flows. JEL Classification: F30, F31.Capital controls, capital flows, exchange rates, financial stability, economic policy, G20.

Financial market integration in Europe: on the effects of EMU on stock markets

This paper analyzes the integration process of European equity markets since the 1980s. Its central focus is on the role that EMU, and specifically, changes in exchange rate volatility, has played in this process of financial integration. Building on an uncovered interest rate parity condition to measure financial integration, a trivariate GARCH model with time-varying coefficients yields three key results: first, European equity markets have become highly integrated only since 1996. Second, the Euro area market has gained considerably in importance in world financial markets and has taken over from the US as the dominant market in Europe. And third, the integration of European equity markets is in large part explained by the drive towards EMU, and in particular the elimination of exchange rate volatility and uncertainty in the process of monetary unification JEL Classification: C32, F3, G15

US shocks and global exchange rate configurations

The paper analyses the heterogeneity in the link between macroeconomic fundamentals and exchange rates. For a set of important US-specific economic shocks, it shows that such shocks have exerted a remarkably heterogeneous effect on global exchange rate configurations over the past 25 years. Despite a significant decline over time, this heterogeneity remains high as primarily currencies of a few industrialized countries provide the largest contribution to the adjustment of the effective US dollar exchange rate. The paper finds that this heterogeneity is not only due to policy choices of inflexible exchange rate regimes, but to an important extent due to market forces, in particular business cycle synchronization and the degree of financial integration – foremost in portfolio investment – but not to trade. The findings have implications for a potential unwinding of global imbalances and future exchange rate adjustment, as well as for monetary policy choices in emerging market economies. JEL Classification: F31, F4, G1cross-rates, exchange rate, global distribution, heterogeneity, shocks, transmission channels, US dollar

What explains global exchange rate movements during the financial crisis?

A striking and unexpected feature of the financial crisis has been the sharp appreciation of the US dollar against virtually all currencies globally. The paper finds that negative US-specific macroeconomic shocks during the crisis have triggered a significant strengthening of the US dollar, rather than a weakening. Macroeconomic fundamentals and financial exposure of individual countries are found to have played a key role in the transmission process of US shocks: in particular countries with low FX reserves, weak current account positions and high direct financial exposure vis-à-vis the United States have experienced substantially larger currency depreciations during the crisis overall, and to US shocks in particular. JEL Classification: F31, F4, G1Exchange Rates, financial crisis, global imbalances, shocks, transmission channels, United States, US dollar

Communication and exchange rate policy

This paper deals with the very short-term influence of "oral interventions" on the exchange rate of major currencies. The paper finds that official communication, as reported by wire services, are effective in influencing the US dollar-euro and yen-US dollar exchange rates in the desired direction on intervention days. Oral interventions are found to be substantially more effective if they deviate from the prevalent policy "mantra". They also tend to reduce market volatility whereas actual interventions raise volatility. A key result of the paper is that oral interventions are effective independently from the stance and direction of monetary policy as well as the occurrence of actual interventions. This suggests that oral interventions might constitute, on a short-term basis, an effective and largely autonomous policy tool. JEL Classification: E61, E58, F31communication, euro area, exchange rate, intervention, policy, United States

Capital flows, push versus pull factors and the global financial crisis

The causes of the 2008 collapse and subsequent surge in global capital flows remain an open and highly controversial issue. Employing a factor model coupled with a dataset of high-frequency portfolio capital flows to 50 economies, the paper finds that common shocks – key crisis events as well as changes to global liquidity and risk – have exerted a large effect on capital flows both in the crisis and in the recovery. However, these effects have been highly heterogeneous across countries, with a large part of this heterogeneity being explained by differences in the quality of domestic institutions, country risk and the strength of domestic macroeconomic fundamentals. Comparing and quantifying these effects shows that common factors (“push” factors) were overall the main drivers of capital flows during the crisis, while country-specific determinants (“pull” factors) have been dominant in accounting for the dynamics of global capital flows in 2009 and 2010, in particular for emerging markets. JEL Classification: F3, F21, G11Capital flows, common shocks, factor model, liquidity, push factors, risk

On currency crises and contagion

This paper analyzes the role of contagion in the currency crises in emerging markets during the 1990s. It employs a non-linear Markov-switching model to conduct a systematic comparison and evaluation of three distinct causes of currency crises: contagion, weak economic fundamentals, and sunspots, i.e. unobservable shifts in agents' beliefs. Testing this model empirically through Markov-switching and panel data models reveals that contagion, i.e. a high degree of real integration and financial interdependence among countries, is a core explanation for recent emerging market crises. The model has a remarkably good predictive power for the 1997-98 Asian crisis. The findings suggest that in particular the degree of financial interdependence and also real integration among emerging markets are crucial not only in explaining past crises but also in predicting the transmission of future financial crises. JEL Classification: F30, E60, E65, E44

The Euro bloc, the Dollar bloc and the Yen bloc: how much monetary policy independence can exchange rate flexibility buy in an interdependent world?

The paper analyses the trade-off between exchange rate flexibility and monetary policy autonomy. It tests empirically the 'Possible Duality' hypothesis, i.e. whether countries with more flexible currency regimes are indeed able to exert more monetary policy autonomy than those with less flexible ones, and whether moving towards exchange rate flexibility allows countries to gain monetary independence. The results for a set of open emerging markets and ERM countries show no systematic link between exchange rate flexibility and monetary independence. It is also found that the Fed is still the dominant force in world capital markets, although the importance of EU monetary policy decisions has been increasing and a Euro bloc has formed in Europe. JEL Classification: F41, F31, E50error correction model, exchange rate regime, GARCH, international transmission, monetary policy

Equal size, equal role? : interest rate interdependence between the Euro area and the United States

This paper investigates whether the degree and the nature of economic and monetary policy interdependence between the United States and the euro area have changed with the advent of EMU. Using real-time data, it addresses this issue from the perspective of financial markets by analysing the effects of monetary policy announcements and macroeconomic news on daily interest rates in the United States and the euro area. First, the paper finds that the interdependence of money markets has increased strongly around EMU. Although spillover effects from the United States to the euro area remain stronger than in the opposite direction, we present evidence that US markets have started reacting also to euro area developments since the onset of EMU. Second, beyond these general linkages, the paper finds that certain macroeconomic news about the US economy have a large and significant effect on euro area money markets, and that these effects have become stronger in recent years. Finally, we show that US macroeconomic news have become good leading indicators for economic developments in the euro area. This indicates that the higher money market interdependence between the United States and the euro area is at least partly explained by the increased real integration of the two economies in recent years

Purdah: on the rationale for central bank silence around policy meetings

Despite substantial differences in monetary policy and communication strategies, many central banks share the practice of purdah, a self-imposed guideline of abstaining from communication around policy meetings or other important events. This practice is remarkable, as it seems to contradict the virtue of transparency by requiring central banks to withhold information precisely when it is sought after intensely. However, imposing such a limit to communication has often been justified on grounds that such communication may create excessive market volatility and unnecessary speculation. This short paper assesses the purdah for the Federal Reserve. The empirical results confirm the conjecture that financial markets are substantially more sensitive to central bank communication around policy meetings. Short-term interest rates react three to four times more strongly to statements in the purdah before FOMC meetings than during other times, and market volatility increases (compared to a volatility reduction induced by statements otherwise). The findings thus offer relevant insights about the limits to central bank transparency. JEL Classification: E58, E52, E43communication, effectiveness, Federal Reserve, Interest Rates, monetary policy, purdah, transparency