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Exchange Rate Pass-through, Exchange Rate Volatility, and Exchange Rate Disconnect

Exchange Rate Pass-through, Exchange Rate Volatility, and Exchange Rate Disconnect
Author: Michael B. Devereux
Publisher:
Total Pages: 60
Release: 2002
Genre: Economics
ISBN:
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This paper explores the hypothesis that high volatility of real and nominal exchange rates may be due to the fact that local currency pricing eliminates the pass-through from changes in exchange rates to consumer prices. Exchange rates may be highly volatile because in a sense they have little effect on macroeconomic variables. The paper shows the ingredients necessary to construct such an explanation for exchange rate volatility. In addition to the presence of local currency pricing, we need a) incomplete international financial markets, b) a structure of international pricing and product distribution such that wealth effects of exchange rate changes are minimized, and c) stochastic deviations from uncovered interest rate parity. Together, it is shown that these elements can produce exchange rate volatility that is much higher than shocks to economic fundamentals, and `disconnected' from the rest of the economy in the sense that the volatility of all other macroeconomic aggregates are of the same order as that of fundamentals.

The Consequences of Policy Uncertainty

The Consequences of Policy Uncertainty
Author: Sandile Hlatshwayo
Publisher: International Monetary Fund
Total Pages: 30
Release: 2016-06-09
Genre: Business & Economics
ISBN: 1484383494
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In recent years, the link between the real effective exchange rate (REER) and exports in South Africa has weakened. While exports still rise in response to REER depreciations, the REER-export elasticity is below historical estimates. The literature has put forward a number of possible explanations, from multi-national supply-chains to muted exchange rate pass-through. This research explores the role of policy uncertainty in reducing the responsiveness of exports to relative price changes. We construct a novel “news chatter” measure of policy uncertainty and examine how it, paired with other supply-side constraints, can improve our understanding of export performance. We find that increased policy uncertainty diminishes the responsiveness of exports to the REER and has short and long-run level effects on export performance. Finally, we show that a measure of competitiveness that adjusts for uncertainty and supply-side constraints greatly outperforms the REER in tracking exports performance.

Home Bias, Exchange Rate Disconnect, and Optimal Exchange Rate Policy

Home Bias, Exchange Rate Disconnect, and Optimal Exchange Rate Policy
Author: Jian Wang
Publisher:
Total Pages: 44
Release: 2015
Genre:
ISBN:
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This paper examines how much the central bank should adjust the interest rate in response to real exchange rate fluctuations. The paper first demonstrates in a two-country Dynamic Stochastic General Equilibrium (DSGE) model, that the home bias in consumption is important to duplicate the exchange rate volatility and exchange rate disconnect documented in the data. When home bias is high, the shock to Uncovered Interest-rate Parity (UIP) can substantially drive up exchange rate volatility while leaving the volatility of real macroeconomic variables, such as GDP, almost untouched. The model predicts the volatility of the real exchange rate relative to that of GDP increases with the extent of home bias. This relation is strongly supported by the data. Then a second-order accurate solution method is employed to solve the model and compare the conditional welfare under different policy regimes. The results suggest that the monetary authority should not seek to vigorously stabilize exchange rate fluctuations. In particular, when the central bank does not take a strong stance against the inflation rate, exchange rate stabilization may induce substantial welfare loss. The model also suggests no welfare gain from the international monetary cooperation, which extends Obstfeld and Rogoff's (2002) findings to a DSGE model.

Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies

Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies
Author: Enrique G. Mendoza
Publisher: International Monetary Fund
Total Pages: 40
Release: 2006-03
Genre: Business & Economics
ISBN:
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The dominant view in the empirical literature on exchange rates is that the high variability of real exchange rates is due to movements in exchange-rate-adjusted prices of tradable goods. This paper shows that this dominant view does not hold in Mexican data for the periods in which the country had managed exchange rate regimes. Variance analysis of a 30-year sample of monthly data shows that movements in the price of nontradables relative to tradables account for up to 70 percent of the variability of the real exchange rate during these periods. The paper proposes a model in which this stylized fact, and the Sudden Stops that accompanied the collapse of Mexico's managed exchange rates, could result from an endogenous amplification mechanism operating via nontradables prices in economies with dollarized liabilities and credit constraints. The key feature of this mechanism is Irving Fisher's debt-deflation process. Numerical evaluation suggests that the Fisherian deflation effects on consumption, the current account, and relative prices dwarf those induced by the standard balance sheet effect typical of the Sudden Stops literature.

A Gravity View of Exchange Rate Disconnect

A Gravity View of Exchange Rate Disconnect
Author: Doireann Fitzgerald
Publisher:
Total Pages: 0
Release: 2004
Genre:
ISBN:
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The empirical "gravity" equation is extremely successful in explaining bilateral trade. This paper shows how a multi-country model of specialization and costly trade (i.e. a microfounded gravity model) can be applied to explain empirical exchange rate puzzles. One such puzzle is the fact that nominal exchange rates are enormously volatile, but that this volatility does not appear to affect inflation. The gravity model is very successful in explaining this puzzle. In a sample of 25 OECD countries in the post-Bretton Woods period, the gravity prediction of inflation substantially outperforms the purchasing power parity prediction. The gravity prediction matches the volatility of actual inflation, and tracks its path closely. The superior performance of the gravity prediction is explained primarily by the fact that it takes account of the interaction of specialization with home bias. The stability of inflation in very open economies is explained in addition by the fact that the size of bilateral trade is negatively correlated with bilateral exchange rate volatility.

The Effect of Exchange Rates on Chinese Trade

The Effect of Exchange Rates on Chinese Trade
Author: Bin Qiu
Publisher:
Total Pages:
Release: 2018
Genre:
ISBN:
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"Previous studies investigating the effect of exchange rate changes on a country's exports have found little evidence that exchange rates matter. This "Exchange Rate Disconnect Puzzle" may stem from the fact that studies have mostly focused on aggregate data. Using HS6 digit product-level data for exports from China, we analyze the effect of real exchange rate as well as the volatility of real exchange rate of the Chinese RMB. By decomposing China's exports into its "extensive" and "intensive" margins, we find that real exchange rate volatility has a significantly impact on overall Chinese exports that operate via both the extensive and the intensive margins of trade. Real exchange rate volatility increases the uncertainty and deters small and new firms from entering the market or force them to exit the market via the extensive margin. As less firms operate in the export market, the export share of the existing firms increase via the intensive margin. The overall effect of this volatility is slightly positive. We find that these effects are dominant for the sub sample of countries that are the minor trading partners of China compared to its major trading partners. We find weak evidence that real exchange rate depreciation affects China's exports via the extensive margin. Keywords: Chinese Trade, Extensive Margin & Intensive Margin, Real Exchange Rate, Volatility"--Page [ii].