Portfolio stock adjustment and the real exchange rate: The Dollar-Mark (DM) and Mark-Sterling

The advent of “freely floating” exchange rates in the 1970's coincided with the emergence of what is known as “monetary” or “asset” models of exchange rate behavior where exchange ratesmove to equilibrate demand for stocks of monies. The fundamental monetary model assumes purchasing power parity holds in the long-run, and therefore exchange rates are determined by the same factors that determine relative prices, to wit, money stocks, real incomes, and nominal interest rates. Though early proponents of the monetary view clearly emphasized its long-run nature, empirical testing has by and large neglected this caveat. Thus a model developed for long-run equilibrium exchange rates has instead been tested many times over on short-run equilibrium rates. The latter require a distinct model of their own. This paper develops a short-run equilibrium exchange rate model based on deviations of the short-run exchange rate from its long-run equilibrium. The model differs in that all variables are cast in real terms. It also differs in that the monetary and current account exchange rate versions are shown to be subsets of the more general wealth/portfolio framework used here. The present model considers, in addition to stocks of monies, stocks of foreign assets, and stocks of domestic wealth.     

Macroeconomic impacts of Chinese currency appreciation on China and the Rest of World: A global CGE analysis

This paper analyzes the ex-ante short-term impacts of the Chinese RMB appreciation on the Chinese and world economy, using a novel approach of modeling nominal exchange rate adjustment in the GTAP, a global CGE model. Scenario results show that Chinese economy will be affected negatively, with lower real GDP, lower employment rates, and a decline in the trade surplus. Chinese currency appreciation has positive impact on the GDP of the major countries and regions, although by a small margin. With higher Chinese exchange rate, trade balance for other trading partner countries improves with the exception of the U.S.     

Asymmetric price rigidity and the optimal interest rate defense of the exchange rate: Some evidence for the US

This paper analyses the optimal monetary policy under incomplete exchange rate pass-through and asymmetric price rigidity. In a general equilibrium sticky price model of an open economy we find that the optimal interest rate rule is to respond to all types of shocks in an economy: real exchange rate shocks, supply shocks and demand shocks. We concentrate our analysis on the interest rate defense of the currency. We claim that the extent of the optimal response of the interest rate to exchange rate shocks depends positively on the degree of pass-through and negatively on price rigidity. Therefore, in the presence of asymmetric price rigidity, the optimal monetary policy should be non-linear, and the interest rate should be adjusted more in case of depreciation of the domestic currency than in case of its appreciation by the same magnitude due to higher downward price rigidity and lower downward pass-through, which are observed empirically. We test this prediction for the US economy and find that the US monetary policy is asymmetric indeed with higher reaction of the interest rate to depreciations of US dollar than to appreciations of the same size.     

The impact of the term spread in US monetary policy from 1870 to 2013

In this paper, we apply a novel econometric approach joint with an exhaustive revision of the main events in the history of US monetary policy in order to check the effectiveness of monetary policy focused on interest rates. Unlike the traditional cointegration approach, this new methodology allows us to break with the rigidity of traditional approaches in favour of letting the series be cointegrated, and the spread is able to follow a long-memory process; i.e., it does not necessarily need to be I(0) and also rejects the assumption that interest rates could follow the dichotomy I(0)/I(1). To the best of our knowledge, this is one of the first applications of the Fractionally Cointegrated Vector Autoregressive (FCVAR) model (Johansen and Nielsen (2012) and Nielsen and Popiel (2016)). Aiming to achieve this goal, we use two databases, i.e., the Jordà-Schularick-Taylor Macrohistory Database and Shiller’s database. Our results cannot reject the Expectations Hypothesis of Term Structure in this time period, and more importantly, we also find that the long-term rate drives the long-run relationship, contributing to the total proportion to the common trend; the persistence of the spread shows us effective control power over interest rates by the Fed.     

The effectiveness of monetary policy in small open economies

This paper examines the relative effectiveness of the use of direct and indirect monetary policy instruments in Barbados, Jamaica and Trinidad and Tobago, by estimating a restricted Vector Autoregressive model with Exogenous Variables (VARX). The model captures the dynamic interaction of the key sectors in the economy and it accounts for the fact that the banking system in those countries is characterized by high levels of excess reserves. Also, the study assumes that the central bank conducts monetary policy using a Taylor-type rule, and it evaluates the effects of a reserve requirement policy. The results show that although a positive shock to the policy interest rate has a direct effect on commercial banks’ interest rates, there is a weak transmission to the real variables. Furthermore, an increase in the required reserve ratio is successful in reducing private sector credit and excess reserves, while at the same time alleviating pressures on the exchange rate. The findings therefore indicate that central banks in small open economies should consider using reserve requirements as a complement to interest rate policy, to achieve their macroeconomic objectives.     

Capital mobility among advanced countries

Mobility of capital has been studied by examining savings–investment correlations, real interest rates differentials, covered and uncovered interest parity, and equity home bias. All these examine the capital mobility question indirectly. This paper directly tests the return/total flow specification of the Mundell–Fleming model. It finds that while portfolio equity and debt flows are, direct investment is not; and in every case, the inclusion of direct investment makes the aggregative-capital variable unresponsive to interest rates. Asset-based exchange rate models may benefit by looking at the composition of cross-border assets, countries can have independent monetary policies with full capital mobility, and macroeconomic policy trilemma for open economies disappears.     

Money demand stability: A case study of Nigeria

Monetary policy in Nigeria aims is to achieve price and monetary stability. During the 1980s and 1990s, monetary targeting was the dominant monetary policy framework in Nigeria. However, in 2006 the Central Bank of Nigeria (CBN) adopted the new monetary policy framework through which short-term interest rates are adjusted to achieve stability in the value of the domestic currency. This paper has presented an empirical investigation into the demand for Nigerian real narrow money (M1) over the period 1960–2008 in an attempt to identify whether the CBN were right to adopt the new monetary policy framework. In doing so, we estimate alternative (canonical and extended) specifications of M1 demand using structural change methods. Our results suggest that the canonical specification is well-determined. Although the money demand relationship went through a regime shift in 1986, it is largely stable. These findings favour the use of supply of money as an instrument of monetary policy, thus lending limited support for the new monetary policy framework.     

An Analysis of the Determinants of the Changes in China’s Foreign Exchange Reserves’ Nominal and Real Rates of Return

We use decomposition and regression to examine the reasons for the changes in nominal and real rates of return of China’s foreign exchange reserves between 2002 and 2009. The results show that the US financial market risk premium is the most important determinant of changes in the nominal rate of return, while the US dollar exchange rate and the bulk commodity price are the two key determinants of changes in the real rate of return. From empirically based research, one may conclude that the loose monetary policy of the US Federal Reserve increases China’s foreign exchange reserves’ nominal rate of return but decreases the real rate of return and that the European debt crisis has an uncertain impact on China’s foreign exchange reserves’ nominal rate of return but may well raise the real rate of return.     

An Analysis of the Determinants of the Changes in China＇s Foreign Exchange Reserves＇ Nominal and Real Rates of Return

采用分解和回归方法,考察2002-2009年间中国外汇储备名义收益率与真实收益率变动的原因,可以发现：美国金融市场风险溢价是影响中国外汇储备名义收益率变动的最重要因素,美元汇率和大宗商品价格是影响中国外汇储备真实收益率的最重要因素。基于实证的研究还可以推断：美联储宽松货币政策会提高中国外汇储备名义收益率,但降低了真实收益率;欧洲债务危机对中国外汇储备名义收益率的影响不确定,但很可能提高了真实收益率。     

Does the twin deficit hypothesis hold in the OECD countries under different real interest rate regimes?

This paper explores the validity of the twin deficit hypothesis in selected 25 OECD countries with annual data for 2005–2016 by considering different real interest rate regimes. A non-dynamic panel threshold model, introduced by Hansen (1999), is employed. The novelty of the empirical findings from the present study is that there exists a non-linear relationship between the budget deficit and the trade balance, which is driven by a critical threshold level in the real interest rates. The findings suggest that twin deficit hypothesis holds only under the low real interest rate regime, that is, rises in budget deficits lead to deteriorations in the trade balance when the real interest rate is below the threshold level. When the high real interest rate (i.e. above-the-threshold) regime is concerned, increasing budget deficits give rise to improvements in the trade balance, a finding consistent with the twin divergence hypothesis. Thus, the effect on the trade balance of an expansionary fiscal policy that worsens the budget balance reverses substantially depending on the threshold level of the real interest rates. The major policy implication of this paper is that the policy makers in the selected OECD countries should pay a greater attention to fiscal discipline in order to prevent the trade balance from worsening, because the majority of the countries fall into the low real interest rate regime over the recent years of the sample period (i.e. between 2010 and 2016).     

A new challenge to economic science: Global model simulation

The FUGI (Futures of Global Interdependence) global modeling system has been developed as a scientific policy modeling and future simulation tool of providing global information to the human society and finding out possibilities of policy co-ordination among countries in order to achieve sustainable development of the global economy co-existing on the planet Earth in the ever changing universe. The FUGI global model M200 classifies the world into 200 countries/regions where each national/regional model is globally interdependent. Each national/regional model has nine subsystems as population, foods, energy, environment, economic development, peace and security, human right, healthcare and quality of life (IT revolution). This is a super complex dynamic system model using integrated multidisciplinary systems analysis where number of structural equations is over 170,000. Economic model as a core includes major economic variables such as production of GDP, employment, expenditures of GDP, income distribution, prices, money, interest rates and financial assets, government finance, international balance of payments, international finance, foreign exchange rates and development indicators.The purpose of this article is twofold, namely to provide information on a new frontier science of economics: global model simulation as well as appropriate policy exercise for sustainable development of the interdependent global economy. The world economy is facing “green” energy revolution to change from fossil to create alternative energy and energy saving technology against sky rocketing higher oil prices. Japan takes a lead in this field of technology innovation. Under such circumstances, Japan should take an initiative to create a new peaceful world through not only harmonized adjustments of Japanese economic policy but also wise cosmic mind to promote human solidarity with the ever changing nature will be desirable to adjust orbit of the fluctuated global economy. Japan should challenge for a new strategy to accelerate economic growth rates by “CO₂ reducing environment investment” based on technology innovations.     

A comment on ‘the extraordinary claim of praxeology’ by Professor Gutiérrez

Ludvig von Mises and the Austrian School of Praxeological Economics do make a claim that can only be considered extraordinary, considering the type of methodology that now pervades our social science Establishment. And the claim is that there is economic knowledge that can be both known with apodictic certainty, and be of great usefulness in understanding the world in which we live. Prof. Gutiérrez, defending the accepted view that knowledge can either be known with apodictic certainty, or have usefulness for understanding the real world, but not both, attacks praxeological allegations to the contrary, and is in turn, criticized by the author. Under contention are the status of the a priori nature of the category of human action, the basic premise of praxeology, as well as several other claims:

1. Human action can only be undertaken by individual actors
2. Action necessarily requires a desired end and a technological plan
3. Human action necessarily aims at improving the future
4. Human action necessarily involves a choice among competing ends
5. All means are necessarily scarce
6. The actor must rank his alternative ends
7. Choices continually change, both because of changed ends as well as means
8. Labor power and nature logically predate, and were used to form, capital
9. Technological knowledge is a factor of production

This exchange involves not so much specific disagreements between Gutiérrez and the author as it does the different world views of two competing philosophies of social science. To put it in its historical perspective, what we have here can be characterized as evolving from the debates concerning the possibility of synthetic a priori statements, first raised by Immanuel Kant and David Hume, but applied to the conceptual foundations of modern economics.     

The determinants of the benchmark interest rates in China

This paper empirically investigates the determinants of the two key benchmark interest rates in China using an array of constrained ordered probit models for quarterly frequency data from 1987 to 2013. Specifically, we estimate the behavioral equation of the People's Bank of China that models its decision-making process for revisions of the benchmark deposit rate and the lending rate. Our findings imply that the PBC's policy decisions are better understood as responses to changes in inflation and money growth, while output gaps and the exchange rate play negligible roles. We also implement in-sample fit analyses and out-of-sample forecast exercises. Our empirical findings show robust and reasonably good performances of our models in understanding dynamics of these benchmark interest rates.     

Interest rate determination in India: domestic and external factors

This paper examines the determinants of interest rates in India in the post-reform period in the context of a model that takes into account both domestic and external factors. The short- and long-run behavior of interest rates (commercial paper rate, 3-month Treasury bill rate, 12-month Treasury bill rate) is studied. The empirical results are robust across interest rates and indicate the existence of a cointegrating relationship between real interest rates, real government expenditure, real money supply, foreign interest rates and the forward premium. The estimations also show that movements in interest rates are Granger caused by both domestic and external factors.     

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.     

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.     

On Primary Commodity Prices: The Impact of Macroeconomic/Monetary Shocks

The hypothesis of a long-run quantifiable relationship between non-oil primary commodity prices and macroeconomic/monetary variables—focusing industrial production and effective exchange rate of the US dollar—is tested by cointegration technique using quarterly data for 1970q2–93q3. This confirmed equilibrium adjustment explains the origin of the observed coincidence of commodity price variations with the fluctuations of macroeconomic/monetary variables. An error correction specification, including interest rate, is therefore applied to estimate the observed disequilibrium prices of commodities in the context of steady-state solutions. This instantaneous adjustment explains why commodity prices have fluctuated more strongly over the last 2 decades than before.     

Preferences of the Central Bank of Brazil under the inflation targeting regime: Estimation using a DSGE model for a small open economy

The main objective of this paper is to estimate the preferences of the Central Bank of Brazil after the inflation targeting regime (January 2000 to December 2013), using a DSGE model with microeconomic foundations for a small open economy, based especially on the work of Kam et al. (2009). The model used in this study considers that the Central Bank minimizes a loss function, taking into account the deviation of inflation from its target, output stabilization, the interest rate smoothing and, unlike the previous works, the exchange rate. The results show that the major concern of the monetary authority in the period was the stabilization of inflation, followed by interest rate smoothing, exchange stabilization and, finally, output stabilization. The large value for the exchange rate smoothing parameter suggests the presence of fear of floating in the Brazilian case. An improved inflation targeting strategy should allow for less Central Bank intervention in the exchange rate market.     

Entry rates and the risks of misalignment in the EU8

New member states will join the EMU in the coming years. Setting the central parity at which they will join has been and will be a challenging task, as there is a considerable amount of uncertainty, both from a theoretical and an empirical perspective, surrounding the determination of the optimal exchange rate. Given the probable difficulty in evaluating the equilibrium rate it is thus advisable to focus on the effects of a misalignment of the entry rate for the economy, as it has implications for countries’ real and nominal convergence. An overvalued exchange rate would have an adverse impact on a country's competitiveness and its growth, while an undervalued currency would contribute to an overheating of the economy and an excessive inflation. The objective of this paper is to better understand the role of the entry rates for short run inflation and GDP developments and their implications for the inflation criterion and the real convergence process. Having estimated equilibrium exchange rates for eight out of ten countries that entered the EU in May 2004: Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia we conduct simulations showing what their adjustments to equilibrium would be if their entry rates deviated from the optimal ones.     

Monetary policy and its transmission mechanisms in Eritrea

The main purpose of this study is to identify the best practices of monetary policy implementation in the Eritrean economy. As such, the paper examines what kind of monetary policy and transmission mechanisms are relevant to the Eritrean economy. It also addresses which channels are effective and which are not and why. Vector Autoregressive modelling is employed over the study period 1996Q1–2008Q4. This paper addresses the argument that the bank lending is the sole functioning channel in low income economies. We find that interest rate and official exchange rate channels are inoperative. However, effective exchange rate and credit channels exist through the black foreign exchange market and credit issued to the government sector. The main policy implication of this study is that the Bank of Eritrea might be able to control inflation through manipulating the reserve requirement ratio.