Policy modeling of foreign exchange rates

This paper is neither a complete survey of empirical work on exchange rate determination, nor a review of the ballooning volume of theoretical models. It is instead an attempt to classify the main alternative approaches to modeling exchange rates. I shall concentrate on approaches that can be used to assess the effects of alternative policies. There will be four further sections in the paper. The first three sections will each deal withthe structure, empirical support, and policy consequences of three main types of model: purchasing power parity models emphasizing the close and immediate relation of goods markets; interest rate parity models emphasizing the close and immediate international linkage of markets for financial assets; and structural balance-of-payments models that do not assume either of the above linkages to be so strong and immediate as to eliminate the other, and that hence require separate (but interdependent) modeling of trade and capital linkages in the determination of exchange rates. Each of these main categories has many rather distinct models within it, and some models are not easily classified into one of the three categories; I hope that the three-way split will nevertheless serve to make some distinctions that are important for policy modeling.In the final section I shall try to summarize the available model results that pertain to national and international policy choices under a system of more flexible exchange rates, and then to suggest where more or better model building might usefully increase the amount of information available to guide policy decisions.     

Rent seeking and the North-South terms of trade

In this paper results are reported for a series of counterfactual experiments with an eight- region numerical general equilibrium model of world trade, production, and welfare. In these analyses trade restrictions in the developing world are modeled as quantity constrained import licensing, which generates competitive rent-seeking behavior. Model experiments concentrate on the implications of differential factor endowment growth for the North-South terms of trade, and the effects of alternative trade policy changes in developing countries.     

A model of the Canadian global exchange rate: A test of the 1970s

A review of the literature indicates that no single exchange rate model has been able to track successfully the movements of the Canadian dollar for both the 1970–1976 period and the period thereafter. The purchasing power parity model, irrespective of whether based on relative wholesale prices, unit labor costs, GNP deflators, or export prices performs very poorly; the monetarist models collapse because of their strict adherence to the purchasing power parity and interest rate parity assumptions; the portfolio demand models require a significant adjustment for the post-1976 period. This paper presents a medium-term eclectic model of the global exchange rate of the Canadian dollar and examines a spectrum of broad issues that reflect on the efficiency of the foreign exchange market of Canada. These issues are basically related to the interest parity assumption, the role of speculation, and the test of rational expectations. The global exchange rate is defined as the value of the Canadian dollar measured in terms of a unit of basket of currencies comprising currencies of France, West Germany, Japan, the U.K., and the USA. The model belongs to the same genre of balance of payments structural models that explain the exchange rates by balancing demand and supply of foreign currencies. The model simultaneously explains both spot and forward rates, and it has been estimated and tested by using the quarterly data for 1971–1981.     

A model of the Canadian global exchange rate: A test of the 1970s

This comment points out some methodological weaknesses in the Canadian global exchange rate model and the associated efficiency tests of Marwah and Bodkin. The model is found to be inadequate for policy analysis.     

New technology and unemployment: A simulation of macroeconomic impacts and responses in Canada

This paper addresses macroeconomic issues of the debate over high technology and unemployment. A macroeconometric simulation model with a number of special features is used to examine alternative scenarios of enhanced productivity performance in Canada over the next decade. Responses of wages, prices, and the monetary authorities are shown to be quantitatively important in determining the impact on employment. The type of productivity change and aggregate fiscal-policy response are shown to be less importance.     

The linkage effects of raw material processing in economic development: A survey of modeling and other approaches

Processing of primary raw materials has become an important and widely recommended strategy for economic development. Yet, even as the councils of many LDCs call for primary commodity producers to gain greater participation in downstream activities, there remain doubts on fundamental questions:What comparative advantage and what disadvantages do processing activities have in the LDCs?What linkages do processing activities offer?What is the potential contribution of processing to economic goal attainment in the LDCs?In this article we survey the material on processing, particularly with respect to modeling direct and indirect linkages between processing and the LDC economies. The article examines the following topics: (1) the literature on processing in economic development; (2) modeling processing linkages; and (3) outstanding questions regarding processing linkages.We focus on quantifiable linkages between the processing industry and the rest of the economy. There is also the possibility of other linkages, such as the development of entrepreneurship and management talent and technology, that are more difficult to quantify. It is important to distinguish between micro linkages, which refer to the direct impact on supplier and user sectors, and macro linkages, which include indirect general economic effects transmitted through government revenue and expenditures, the money supply, and foreign exchange availabilities.     

An evaluation of the Tokyo Round trade agreement using general equilibrium computational methods

An empirically based general equilibrium model involving the United States, Japan, the (nine-member) EEC, and a residual rest of the world is used to evaluate the Tokyo Round trade agreement negotiated under the GATT. Equilibria for post-Agreement policy regimes are computed and compared to a pre-Agreement equilibrium. Results indicate small aggregate welfare impacts but more significant terms of trade effects. Losses seem likely for Third World countries due to an adverse terms of trade change. Under some assumptions the changes in NTB codes produce more significant effects than the tariff cuts in the Agreement.     

Trade liberalization and factor prices: An application to the U.S. manufacturing sector

The effects of a trade policy on the prices of productive factors have important policy implications, particularly with regard to trade liberalization and protection. This paper examines the empirical evidence of the Stolper-Samuelson theorem for 16 major U.S. manufacturing industries. The theorem asserts that international trade reduces the prices of scarce productive factors and hence decreases their shares of income. The elasticities of prices of finished goods with respect to factor prices are estimated and then rearranged in the form of the row stochastic P-matrix in accordance with the proposition of Uekawa. The inverse of this matrix seems to confirm the weak version of the Stolper-Samuelson theorem.     

Economic evaluation of an agricultural sector investment program: A case study for Peru

An evaluation of a sector-wide investment program differs in important respects from an evaluation of an individual project. First, the program as a whole is likely to have more than a marginal effect on production and trade levels and other variables, and so the returns to any one project depend on which other projects are included in the program. Therefore the evaluation of all projects in the program must be carried out jointly. Second in many cases Policy makers may judge alternative program designs according to a multiplicity of criteria, explicitly or implicity. Hence the project identification stage of work is more useful if it takes into account the multiple criteria. This paper reports an experience in constructing and applying a model for the design and evaluation of a sector-wide agricultural investment program. Emphasis is placed on the ways in which such a model may be used. In the course of the applications discussed here, policy makers' preference weights among alternative goals were elicited, but even without such information a model-based exercise can be helpful in the design of a sector investment program.     

Consistent price determination of income and production: A singular equation system applied to the MPS model

In this article we present a general methodology that can be used to estimate a singular equation system of relative prices for a large disaggregated macroeconometric model (MPS). The accounts consistency requirements and the necessity to utilize distributed lag restrictions and to impose a serial correlation structure on the estimated model make these sum constraints rather cumbersome. Estimates of the MPS model and multiplier analysis illustrate the use of these constraints on a large forecasting model as well as the feasibility of the technique.     

The impact of a Tax-Based Incomes Policy on U.S. macroeconomic performance: An optimal control study

This study attempts to estimate the potential impact of a Tax-Based Incomes Policy (TIP) on macroeconomic performance by applying an optimal control algorithm to the Wharton Quarterly Econometric Model. A TIP is any tax incentive that would induce firms and/or workers to reduce wage increases. Our study is applicable to any version of TIP. To isolate TIP's potential impact, we compare the optimal path of the economy without TIP to the optimal path of the economy with TIP. Our conclusion is that a TIP may be able to significantly improve the path of inflation, unemployment, and real GNP simultaneously.     

Partial vs. general equilibrium analysis and choice of functional form: Implications for policy modeling

In formulating empirically tractable, economywide models, researchers are often forced to employ “convenient” functional forms. These forms embody restrictive maintained hypotheses. Alternatively, flexible functional forms may be utilized in a partial equilibrium setting. Estimation and incorporation of flexible functions into computable general equilibrium models is considerably more demanding of research resources. Assuming that shortcuts will continue to be necessary for researchers attempting to respond to current policy problems, this paper compares these two alternatives. Specifically, a general equilibrium model for New York State is employed to evaluate the relative performances of flexible partial equilibrium models and their more restrictive, general equilibrium counterpart. In the particular application considered, the former approach is found to dominate the latter.     

From oil shortage to oil glut: Simulation of growth prospects in the Nigerian economy

During the 1970s, the economy of Nigeria provided one of the most interesting cases of development financed through oil revenue. Between 1970 and 1980, the country's GNP grew at an outstanding rate—after the transition from oil shortage to oil glut, the economy of Nigeria ran into dramatic financial difficulties, which are now placing major constraints to its development. To investigate the transition from an oil-based economy to a stage characterized by greater diversification of exports and more balanced sectoral growth, a model has been built by the University of Ibadan in Nigeria. The model was developed in association with Project LINK staffing for the future inclusion in the Project. According to the finding presented in the study, the annual growth rate of GDP of Nigeria between 1980 and 1988 will be around 2.5 percent. To compensate the drop of the foreign exchange earnings caused by the contraction of oil prices and demand, a vigorous export drive of agricultural products is simulated.     

United States trade and possible restrictions in high-technology products

This paper assesses the changing U.S. competitive position in high-technology products, and examines reasons for changes. It then inquires into the potential value of restrictive trade policies for promoting the U.S. interest in this sector, including mutual restrictions between the U.S., the EC, and Japan. The paper shows that the U.S. market share in most high-technology products, while still high, is declining. While industrial policy in other countries may have been a facilitating factor in this adverse development, the main explanation appears to lie in changing factor endowments, particularly the marked increase in the human capital/labor endowment ratios of Japan and Germany relative to that of the United States. When considering all the criteria relevant to trade policy, the differences between the high-technology industries bring into question the validity of lumping them into one sector for the purpose of strategic trade policy. Each industry needs to be treated separately. Their main common characteristic is intensity in human capital input. When they are viewed as one sector, a move to redress the declining U.S. lead calls for a domestic rather than a trade policy: massive U.S. investment in human capital and in research and development of the post-sputnik variety.     

A simulation model of infant feeding and family economics in developing countries

Malnutrition is one of the major problems in the Third World. Rooted in mass poverty. It has implications that seriously hamper the ability of poor countries to reach higher standards of living Malnutrition affects the biological development of human beings, which limits intellectual growth and therefore hampers social and economic betterment. At the same time the cultural fabric in many countries has been badly torn, with an increasingly large share of population moving into grossly underemployed and gravely underpriviledged communities within urban areas. This change has altered most traditional life styles: one of its major consequences has been the marked decline in the breast-feeding of infants. The nutrition and welfare of the family affected by new infant feeding practices, not only interact with the household economy, but affect and are affected by social forces and external conditions.This paper presents a model to address these issues and measure the extent by which the above mentioned interaction threatens economic growth and standards of living encouraging a vicious circle of worsening quality of life and declining economic potential. The model is applied to the economy of Malaysia on the basis of statistical information generated by random sampling techniques. The model is designed to provide a simulation mechanism which although bared on expectations and known input conditions takes into consideration random determination events within predetermined probable patterns. The basis of the procedure is a profile of areas occuring within a single family over a span of 10 years.     

Toward integrated global models: From economic engineering to social science modeling

It is argued that political and military variables are so crucial in decision making that they ought to be included in world models. Three projects, including our own, are described in brief to give a sense of the theories and data that have been employed in some existing global modeling efforts based on this assumption. The project entitled Computer Simulations for Decision Making in International Affairs utilizes an adaptive macromodel of global political, military, and economic processes into which a host of empirically based minimodules are introduced. The Nations in Conflict studies have focused thus far on an econometric model comprised of three primary components: domestic growth and external expansions, competition for foreign resources, market, allies, and strategic advantage, and the dynamics of crisis behavior. The Alker simulation studies have utilized artificial intelligence techniques to study the structuring and restructuring of international systems of social interaction.The theoretical and empirical materials developed in these projects are highly relevant to the enterprise of integrated global modeling. The earliest efforts were begun to build models of the political and military components of international processes. Subsequent world modelers of the Forrester-Meadows inspired genre focused on the economic aspects of the globe, including its demography. It is argued that the convergence of these two traditions be accomplished in a synthetic fashion in ongoing as well as future work.     

Optimal control of large nonlinear models: An efficient method of policy search applied to the Dutch economy

A modification of optimal control for an economy under uncertainty, by splitting the technique into a simulation phase and a control phase, makes policy optimization feasible for large-scale nonlinear models. The advantages of this approach in a policy search are clearly illustrated by an application to Dutch economic planning. A historical analysis shows that it is important to treat unemployment and the balance of payments as the key targets. That dual target strategy, worked out for the current planning period, leads to economic expansion and employment creation rather than retreachment.     

Simulation of a debtor country: The example of Colombia

A dynamic model, illustrated on Colombian data, simulates the functioning of an open economy under specified parametric conditions and selected policy scenarios. Unlike the usual two-sector models, the rate of growth of GDP is generated endogenously. Whereas related models perform sensitivity analysis for variations in parameters our procedure makes n possible to simulate policy alternatives under balance-of-payments pressure. The simulations explore the implications of policy options when debt services on inherited and new foreign indebtedness act as constraints on the debtor's growth, especially when new external borrowing is limited.     

Poverty, inequality, and development: A distributional approach

Economists have concentrated on aggregate economic growth to measure countries' development progress and in recent years have also considered income distribution performance. This paper reverses the conventional emphasis by placing income distribution at the forefront. I examine what is known about the distributions of income and poverty in the developing countries of the world and probe the correlations between poverty, inequality, and development. I explore the main sources of inequality and the extent to which individual countries have managed to alleviate poverty and reduce inequality in the course of economic growth. Employing evidence from case studies of six developing nations. I suggest some explanations for differing patterns of development and call for development planning founded on a firm commitment to helping the poor.     

The bureaucratic response to economic fluctuation: An econometric investigation of Hungarian investment policies

This paper develops bureaucratic response functions within a “deviation from trend” econometric model to determine those factors that were related to fluctuations in aggregate investment finding and in the sectoral distribution of that aggretate during 1960–1975. Investment in buildings and investment in machinery are analyzed separately. On the national level, investment funding is found to respond to indicators of well-being, plan targets, bottlenecks, and foreign trade variables. Sectoral investment funding is based mainly on priority considerations.