Exchange rates

Woo Jin Choi, Alan Taylor, 22 May 2017

Widening global imbalances, driven by reserve accumulation, can help us investigate how real exchange rates are determined. Standard theory would predict real exchange rate appreciation when there is an increase in net foreign assets. This column uses recent data from 75 countries to argue that, in practice, there is the opposite correlation in the particular case of reserve accumulation, notably in countries with higher capital controls and in developing countries.

Kris Mitchener, Gonçalo Pina, 04 May 2017

Fixed exchange-rate regimes reduce uncertainty, which may increase trade and encourage investment and capital flows. This column identifies and tests one reason why markets expect countries to abandon pegs and devalue their currencies – shocks to the value of their output. During the classical gold standard era, commodity price fluctuations determined expected devaluation by investors, as measured by currency risk. These results highlight how trade shocks in an integrated world may undermine fixed exchange rate regimes under limited fiscal adjustments.

Yin-Wong Cheung, Menzie Chinn, Antonio Garcia Pascual, Yi Zhang, 27 April 2017

Previous assessments of nominal exchange rate determination have focused on a narrow set of models. Using data for six currencies, this column examines the performance of an expanded set of models at various forecast horizons. No model consistently outperforms a random walk benchmark, although the purchasing power parity model does fairly well. Overall, combinations of model, specification, and currency that work in one period will not necessarily work well in another.

Willem Buiter, 22 March 2017

A border tax adjustment from origin-based taxation to destination-based taxation is under consideration for corporate profit tax in the US. This column investigates the implications of such an adjustment for the nominal exchange rate, assuming the real equilibrium of the economy is unchanged. While conventional wisdom is that the currency of the country implementing the adjustment will appreciate by a percentage equal to the VAT or corporate profit tax rate, a depreciation of the same magnitude is just as likely. 

Yan Carrière-Swallow, Bertrand Gruss, Nicolas Magud, Fabian Valencia, 13 March 2017

The rate at which consumer prices rise following a depreciation of the currency, known as the exchange rate pass-through, has been declining. The column uses a decomposition of exchange rate pass-through into the component that can be attributed to pricing of imported goods at the dock, and the second-round effects on domestically produced goods and services, to show that reductions in second-round effects are largely responsible for the decline in pass-through. Enhanced monetary policy credibility is strongly associated with this reduction. 

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