Creator: Kareken, John H. and Wallace, Neil Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 153 Abstract:
In this paper we consider a particular international economic policy regime: the laissez-faire regime, the distinguishing features of which are unrestricted portfolio choice and floating exchange rates. And as we show, that regime, although favored by many economists, is not economically feasible. It does not have a determinate equilibrium. That is an implication of an over-lapping-generations model. But as we argue in the paper, that is no reason for doubting the indeterminacy of the laissez-faire regime equilibrium.
Stichwort: Overlapping generations, International economic policy, Foreign exchange rate, and Laissez-faire regime Fach: F31 - Foreign Exchange and D53 - General Equilibrium and Disequilibrium: Financial Markets
Creator: King, Robert G. (Robert Graham), Wallace, Neil, and Weber, Warren E. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 307 Abstract:
This paper shows that there can be equilibria in which exchange rates display randomness unrelated to fundamentals. This is demonstrated in the context of a two currency, one good model, with three agent types and cash-in-advance constraints. A crucial feature is that the type i agents, for i=l, 2, must satisfy a cash—in-advance constraint by holding currency i, while type 3 agents can satisfy it by holding either currency. It is shown that real allocations vary across the multiple equilibria if markets for hedging exchange risk do not exist and that the randomness is innocuous if complete markets exist.
Stichwort: Foreign exchange rates, Currencies, and Macroeconomics Fach: F31 - Foreign Exchange and E00 - Macroeconomics and Monetary Economics: General
Creator: Backus, David and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 359 Abstract:
We show that some classes of sterilized interventions have no effect on equilibrium prices or quantities. The proof does not depend on complete markets, infinitely-lived agents, Ricardian equivalence, monetary neutrality, or the law of one price. Moreover, regressions of exchange rates or interest differentials on variables measuring the currency composition of the debt may contain no information, in our theoretical economy, about the effectiveness of such interventions. Another class of interventions requires simultaneous changes in monetary and fiscal policy; their effects depend, generally, on the influence of tax distortions, government spending, and money supplies on economic behavior. We suggest that in applying the portfolio balance approach to the study of intervention, lack 01 explicit modeling of these features is a serious flaw.
Stichwort: Debts, external and Foreign exchange law and legislation Fach: F31 - Foreign Exchange, H30 - Fiscal Policies and Behavior of Economic Agents: General, and F41 - Open Economy Macroeconomics
Creator: Kiyotaki, Nobuhiro, Matsui, Akihiko, and Matsuyama, Kiminori Series: Monetary theory and financial intermediation Abstract:
Our goal is to provide a theoretical framework in which both positive and normative aspects of international currency can be addressed in a systematic way. To this end, we use the framework of random matching games and develop a two country model of the world economy, in which two national fiat currencies compete and may be circulated as media of exchange. There are multiple equilibria, which differ in the areas of circulation of the two currencies. In one equilibrium, the two national currencies are circulated only locally. In another, one of the national currencies is circulated as an international currency. There is also an equilibrium in which both currencies are accepted internationally. We also find an equilibrium in which the two currencies are directly exchanged. The existence conditions of these equilibria are characterized, using the relative country size and the degree of economic integration as the key parameters. In order to generate sharper predictions in the presence of multiple equilibria, we discuss an evolutionary approach to equilibrium selection, which is used to explain the evolution of the international currency as the two economies become more integrated. Some welfare implications are also discussed. For example, a country can improve its national welfare by letting its own currency circulated internationally, provided the domestic circulation is controlled for. When the total supply is fixed, however, a resulting currency shortage may reduce the national welfare.
Stichwort: Money as a medium of exchange, Random matching games, Multiple currencies, Best response dynamics, and Evolution of international currency Fach: F31 - Foreign Exchange, D51 - Exchange and Production Economies, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, and C78 - Bargaining Theory; Matching Theory
Creator: Miller, Preston J. and Todd, Richard M. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 481 Abstract:
This paper investigates the effects of changes in a country's monetary policies on its economy and the welfare of its citizens and those of other countries. Each country is populated by two-period lived overlapping agents who reside in either a home service sector or a world-traded good sector. Policy effects are transmitted through changes in the real interest rate, relative prices, and price levels. Welfare effects are sometimes dominated by relative price movements and can thus be opposite of those found in one-good models. Simulation of dynamic paths also reveals that welfare effects for some types of agents reverse between those born in immediate post-shock periods and those born later.
Stichwort: Exchange rates, Real interest rates, Monetary policy, Prices, and Relative prices Fach: E31 - Price Level; Inflation; Deflation, F31 - Foreign Exchange, and E52 - Monetary Policy
Creator: Hevia, Constantino and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 726 Abstract:
We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
Stichwort: Inflation targeting, Foreign exchange intervention, and Dutch disease Fach: F31 - Foreign Exchange and F41 - Open Economy Macroeconomics
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 627 Abstract:
Time-varying risk is the primary force driving nominal interest rate differentials on currency-denominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation—can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit of asset market participation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.
Stichwort: Forward premium anomaly, Pricing kernel, Asset pricing-puzzle, Time-varying conditional variances, Segmented markets, and Fama puzzle Fach: E43 - Interest Rates: Determination, Term Structure, and Effects, F30 - International Finance: General, G15 - International Financial Markets, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, F31 - Foreign Exchange, and F41 - Open Economy Macroeconomics
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 589 Abstract:
We show that the desirability of fiscal constraints in monetary unions depends critically on the extent of commitment of the monetary authority. If the monetary authority can commit to its policies, fiscal constraints can only impose costs. If the monetary authority cannot commit, there is a free-rider problem in fiscal policy, and fiscal constraints may be desirable.
Stichwort: Free riding problem, Growth and stability pact, International cooperation, and Time inconsistency Fach: E58 - Central Banks and Their Policies, F33 - International Monetary Arrangements and Institutions, E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems, F31 - Foreign Exchange, and F36 - Financial Aspects of Economic Integration
Creator: Ayres, João, Hevia, Constantino, and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 743 Abstract:
In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ﬁnal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
Stichwort: Real exchange rate disconnect puzzle and Primary commodity prices Fach: F31 - Foreign Exchange and F41 - Open Economy Macroeconomics
Creator: Drozd, Lucasz and Nosal, Jaromir B. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 411 Abstract:
This paper develops a theory of pricing-to-market driven by marketing and bargaining frictions. Our key innovation is a capital theoretic model of marketing in which relations with customers are valuable. In our model, producers search and form long-lasting relations with their customers, and marketing helps overcome the search frictions involved in forming such matches. In the context of international business cycle patterns, the model accounts for observations that are puzzles for a large class of theories: (i) pricing-to-market, (ii) positive correlation of aggregate real export and import prices, (iii) excess volatility of the real exchange rate over the terms of trade, and (iv) low short-run and high long-run price elasticity of international trade flows. The behavior of quantities is shown to be on par with standard international business cycle theories that, in contrast to our model, assume low intrinsic elasticity of substitution between domestic and foreign goods.
Stichwort: Price volatility, Foreign exchange rates, Real exchange rates , Market share, Marketing, Price elasticity, Market prices, Import prices, and Retail stores Fach: F31 - Foreign Exchange, F14 - Empirical Studies of Trade, E13 - General Aggregative Models: Neoclassical, M31 - Marketing, F44 - International Business Cycles, and F41 - Open Economy Macroeconomics
Creator: Atkeson, Andrew and Burstein, Ariel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 404 Abstract:
International relative prices across industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in a quantitative model of international trade. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the US, it can reproduce deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
Stichwort: Terms of trade, Real exchange rate, Purchasing power parity, Exchange-rate pass-through, and Pricing-to-market Fach: F31 - Foreign Exchange, F14 - Empirical Studies of Trade, and F12 - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
Creator: Amador, Manuel, Bianchi, Javier, Bocola, Luigi, and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 528 Abstract:
In January 2015, in the face of sustained capital inflows, the Swiss National Bank abandoned the floor for the Swiss Franc against the Euro, a decision which led to the appreciation of the Swiss Franc. The objective of this paper is to present a simple framework that helps to better understand the timing of this episode, which we label a “reverse speculative attack". We model a central bank which wishes to maintain a peg, and responds to increases in demand for domestic currency by expanding its balance sheet. In contrast to the classic speculative attacks, which are triggered by the depletion of foreign assets, reverse attacks are triggered by the concern of future balance sheet losses. Our key result is that the interaction between the desire to maintain the peg and the concern about future losses, can lead the central bank to first accumulate a large amount of reserves, and then to abandon the peg, just as we have observed in the Swiss case.
Stichwort: Fixed exchange rates, Balance sheet concerns, and Currency crises Fach: F31 - Foreign Exchange and F32 - Current Account Adjustment; Short-term Capital Movements
Creator: Kocherlakota, Narayana Rao, 1963- and Pistaferri, Luigi Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 372 Abstract:
Typical incomplete markets models in international economics make two assumptions. First, households are not able to fully insure themselves against country-specific shocks. Second, there is a representative household within each country, so that households are fully insured against idiosyncratic shocks. We assume instead that cross-household risk-sharing is limited within countries, but cross-country risk-sharing is complete. We consider two types of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. We show that the models imply distinct restrictions between the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the United States and the United Kingdom. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The analogous restrictions implied by the representative agent model and the DI model are rejected at conventional levels of significance.
Stichwort: Precautionary savings, Real exchange rate, Market incompleteness, and Pareto optimality Fach: E21 - Macroeconomics: Consumption; Saving; Wealth, F31 - Foreign Exchange, and D63 - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 278 Abstract:
This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.
Stichwort: Volatile real exchange rates, Baumol-Tobin model, Liquidity effects, Term structure of interest rates, and Fixed costs Fach: E52 - Monetary Policy, F31 - Foreign Exchange, E43 - Interest Rates: Determination, Term Structure, and Effects, E40 - Money and Interest Rates: General, and F41 - Open Economy Macroeconomics
Creator: Atkeson, Andrew and Ríos-Rull, José-Víctor Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 212 Abstract:
In this paper we develop a model in which a country faces a balance of payments crisis if constraints on its international borrowing bind. We use the model to describe the dynamics of the trade balance, capital account, and balance of payments of a country that borrows to finance consumption following sweeping macroeconomic and structural reforms and then hits constraints on its international borrowing. We compare the predictions of this theoretical example with events in Mexico from 1987 through 1995.
Stichwort: Balance of payments, International borrowing, Speculative attacks, and Exchange rate crises Fach: F31 - Foreign Exchange and F34 - International Lending and Debt Problems
Creator: Ayres, João, Hevia, Constantino, and Nicolini, Juan Pablo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 584 Abstract:
In this paper, we show that there is substantial comovement between prices of primary commodities such as oil, aluminum, maize, or copper and real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar. We therefore explicitly consider the production of commodities in a two-country model of trade with productivity shocks and shocks to the supplies of commodities. We calibrate the model so as to reproduce the volatility and persistence of primary commodity prices and show that it delivers equilibrium real exchange rates that are as volatile and persistent as in the data. The model rationalizes an empirical strategy to identify the fraction of the variance of real exchange rates that can be accounted for by the underlying shocks, even if those are not observable. We use this strategy to argue that shocks that move primary commodity prices account for a large fraction of the volatility of real exchange rates in the data. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated final goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
Stichwort: Real exchange rate disconnect puzzle and Primary commodity prices Fach: F31 - Foreign Exchange and F41 - Open Economy Macroeconomics
Creator: Amador, Manuel, Bianchi, Javier, Bocola, Luigi, and Perri, Fabrizio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 740 Abstract:
Recently, several economies with interest rates close to zero have received large capital inflows while their central banks accumulated large foreign reserves. Concurrently, significant deviations from covered interest parity have appeared. We show that, with limited international arbitrage, a central bank's pursuit of an exchange rate policy at the ZLB can explain these facts. We provide a measure of the costs associated with this policy and show they can be sizable. Changes in external conditions that increase capital inflows are detrimental, even when they are beneficial away from the ZLB. Negative nominal rates and capital controls can reduce the costs.
Stichwort: Negative interest rates, Currency pegs, CIP deviations, International reserves, Capital flows, and Foreign exchange interventions Fach: F32 - Current Account Adjustment; Short-term Capital Movements, F31 - Foreign Exchange, and F41 - Open Economy Macroeconomics
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 371 Abstract:
Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in time-varying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation.
Stichwort: Pricing Kernel, Segmented Markets, Asset Pricing-Puzzle, Time-Varying Conditional Variances, Fama Puzzle, and Forward Premium Anomaly Fach: F30 - International Finance: General, F31 - Foreign Exchange, E43 - Interest Rates: Determination, Term Structure, and Effects, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, G15 - International Financial Markets, and F41 - Open Economy Macroeconomics