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1. Dismantling the License Raj: The Long Road to India’s 1991 Trade Reforms

Author:
Douglas A. Irwin
Publication Date:
01-2025
Content Type:
Working Paper
Institution:
Peterson Institute for International Economics (PIIE)
Abstract:
In July 1991, India began to dismantle its long-standing, highly restrictive import control regime and move toward a more open economy. How were policymakers able to dislodge and replace an entrenched system with powerful vested interests behind it? Standard explanations for policy change—pressure from domestic producer interests, shifts in political power, or conditionality by international financial institutions—do not explain the dramatic transformation that took place. Instead, reform-minded technocrats persuaded political leaders to reject what had been a standard response to balance of payments pressure (import repression to avoid a devaluation) and embrace a new approach (exchange rate adjustment and a reduction of import restrictions). This paper explores the economic and political context behind the country’s dramatic policy transformation. India’s experience highlights the crucial link between exchange rate policy and trade policy
Topic:
Foreign Exchange, Reform, Tariffs, Trade, Imports, and Exchange Rates
Political Geography:
South Asia and India

2. The Industrial Cost of Fixed Exchange Rate Regimes

Author:
Blaise Gnimassoun, Carl Grekou, and Valérie Mignon
Publication Date:
06-2024
Content Type:
Working Paper
Institution:
Centre d'Etudes Prospectives et d'Informations Internationales (CEPII)
Abstract:
Premature deindustrialization in most emerging and developing economies is one of the most striking stylized facts of the recent decades. In this paper, we provide solid empirical evidence supporting that the choice of a fixed exchange rate regime accelerates this phenomenon. Relying on a panel of 146 developed, emerging, and developing countries over the 1974-2019 period, we show that fixed exchange rate regimes have had a negative, significant, and robust effect on the size of the manufacturing sector —developing countries being the most affected by the industrial cost of such a regime. Additional gravity model regressions show that the impact of fixed regimes passes through the trade channel. In particular, this regime has kept countries with low relative productivity in a state of structural dependence on imports of manufactured products to the detriment of the emergence of a strong local manufacturing sector.
Topic:
Developing World, Manufacturing, Industrialization, Deindustrialization, Exchange Rates, and Emerging Economies
Political Geography:
Global Focus

3. Is “High Inflation” Always and Everywhere an Exchange Rate Phenomenon?

Author:
Tural Yusifzada, Hasan Cömert, and Kagan Parmaksiz
Publication Date:
10-2024
Content Type:
Working Paper
Institution:
Political Economy Research Institute (PERI), University of Massachusetts Amherst
Abstract:
After decades of stable and low levels of inflation throughout the world, the recent global upsurge in inflation has once again triggered extensive debate among economists about the underlying reasons for the rising trend in inflation. This study aims to contribute to this ongoing discussion by exploring a potential channel that could be fundamental to our understanding of the high inflation levels common across a large number of countries. Drawing upon a rich historical dataset spanning from 1961 to 2023 and employing a random effects panel probit model, our research reveals that the nominal exchange rate depreciation emerges as a strong predictor of “high inflation” episodes across different economies and time periods. Notably, this predictive capability extends to countries with varying income levels, with high-income, upper-middle-income, and lower-middle-income nations exhibiting success rates of 70%, 77%, and 63%, respectively, in forecasting “high inflation” based solely on exchange rate depreciation. Furthermore, food and energy prices also emerge as other important contributors to inflation. These findings have important implications for recognizing exchange rate depreciation as a vital early warning signal for high inflation not only facilitates more timely and effective policy interventions but also emphasizes the critical role of historical exchange rate dynamics and supplyside factors in comprehending the complexities of “high inflation.”
Topic:
Economy, Inflation, Exchange Rates, Early Warning, and Panel Probit Model
Political Geography:
Global Focus

4. Estimation of Nonlinear Exchange Rate Dynamics in Evolving Regimes

Author:
Jeffrey Frankel, Yao Hou, and Danxia Xie
Publication Date:
03-2023
Content Type:
Working Paper
Institution:
The John F. Kennedy School of Government at Harvard University
Abstract:
This paper develops a new econometric framework to estimate and classify exchange rate regimes. They are classified into four distinct categories: fixed exchange rates, BBC (band, basket and crawl), managed floating, and freely floating. The procedure captures the patterns of exchange rate dynamics and the interventions by authorities under each of the regimes. We pay particular attention to the BBC and offer a new approach to parameter estimation by utilizing a three-regime Threshold Auto Regressive (TAR) model to reveal the nonlinear nature of exchange rate dynamics. We further extend our benchmark framework to allow the evolution of exchange rate regimes over time by adopting the minimum description length (MDL) principle, to overcome the challenge of simultaneous two-dimensional inference of nonlinearity in the state dimension and structural breaks in the time dimension. We apply our framework to 26 countries. The results suggest that exchange rate dynamics under different regimes are well captured by our new framework.
Topic:
Economy, Econometrics, and Exchange Rates
Political Geography:
Global Focus

5. Gold in Ghana: A Story of Unbalanced Exchange

Author:
Léonce Ndikumana and William Godfred Cantah
Publication Date:
09-2023
Content Type:
Working Paper
Institution:
Political Economy Research Institute (PERI), University of Massachusetts Amherst
Abstract:
his paper presents the historical and institutional context of the development of the gold sector in Ghana, which sets the stage for examining the contribution of the sector to the economy and its exposure to capital flight. The analysis sheds light on the important role that the regulatory framework and the fiscal regime that govern the gold sector have played in perpetuating a system of unequal distribution of gains from gold exploitation in terms of tax revenue and foreign exchange earnings in favour of foreign gold companies. The statistical analysis of gold export statistics reveals substantial discrepancies between Ghana’s gold exports and the recorded value of imports by its trading partners. These differences point to export underinvoicing as a conduit of capital flight, while also exhibiting a systematic lack of transparency and inconsistencies vis-a-vis established international conventions governing the recording of trade transactions, especially in the case of gold destined for South Africa which does not show up in the latter’s import statistics. Overall, the analysis suggests that the gains from the gold sector remain much below potential, but that at the same time there may be room for reforms that can improve the benefits from gold exploitation for the country.
Topic:
Development, Regulation, Capital Flight, Exchange Rates, and Gold
Political Geography:
Africa, South Africa, and Ghana

6. Signaling Virtue or Vulnerability? The Changing Impact of Exchange Rate Regimes on Government Bond Yields

Author:
Z. Barta, Lucio Baccaro, and A. Johnston
Publication Date:
01-2022
Content Type:
Working Paper
Institution:
Max Planck Institute for the Study of Societies
Abstract:
Do exchange rate regimes affect the conditions under which developed countries borrow? This paper argues that they do, but their impact on yields depends on the prevailing macroeconomic context. When investors regard inflation as the most relevant risk to bond holdings, monetary union has a distinct advantage over floating and fixed exchange rates because of its credible in-built mechanism to control inflation. However, once default is seen as the most relevant risk, exchange rate rigidity becomes a liability due to its constraining effect on governments’ ability to respond to adverse shocks. We test our argument with a moving window panel analysis for twenty-three OECD countries from 1980 to 2017. We find that before the late 2000s, inflation was penalized under floating and (to a lesser extent) fixed exchange rate regimes, but not in countries in monetary union. Since the 2010s, inflation carries no penalty under any exchange rate regime. Variables linked to default risk (debt and entitlement spending) did not affect yields under any exchange rate arrangements until the mid-2000s. Afterwards, countries in monetary union (and to a lesser extent in fixed exchange rate regimes) were significantly penalized for public debt and entitlement spending, whereas countries with floating regimes were not. Our results speak to the literatures on governments’ institutional commitments and “room to move.”
Topic:
Financial Markets, Bonds, Exchange Rates, and Euro
Political Geography:
Global Focus

7. Exchange Rate Predictability Based on Market Sentiments

Author:
Hyo Sang Kim, Eunjung Kang, Yuri Kim, Seongman Moon, and Huisu Jang
Publication Date:
09-2022
Content Type:
Policy Brief
Institution:
Korea Institute for International Economic Policy (KIEP)
Abstract:
It is well-known that exchange rates are difficult to forecast using observed macro-fundamental variables. This discrepancy between economic theory and empirical results is called the Meese and Rogoff puzzle. The purpose of this study is to address this puzzle from a new approach. Rather than pursuing a linkage between macro-fundamentals and exchange rates, we focus on the market sentiment index as a factor that could possibly enhance exchange rate predictability. The analysis folds into three phases. First, we conducted an assessment of the traditional exchange rate predictability model, as well as the augmented traditional model incorporating the market sentiment index. Second, we predicted the exchange rate by applying the market sentiment index, based on the contrarian opinion investment strategy commonly used by foreign exchange dealers. Finally, we analyzed if the machine learning model incorporating both economic fundamentals and market sentiment index could enhance the predictability of the exchange rate.
Topic:
Economics, Markets, and Exchange Rates
Political Geography:
Global Focus

8. Leaning-against-the-wind intervention and the “carry-trade” view of the cost of reserves

Author:
Eduardo Levy-Yeyati and Juan Francisco Gómez
Publication Date:
10-2022
Content Type:
Working Paper
Institution:
The John F. Kennedy School of Government at Harvard University
Abstract:
For a sample of emerging economies, we estimate the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabilization motive (appreciating the exchange rate as a nominal anchor) but are rather small when interventions follow a countercyclical, leaning-against-the-wind (LAW) pattern to contain exchange rate volatility. We document that under LAW, central banks outperform a constant size carry trade, as they additionally benefit from buying against cyclical deviations, and that the cost of reserves under the carry-trade view is generally lower than the one obtained from the credit-risk view (which equals the marginal cost to the country´s sovereign spread).
Topic:
Foreign Exchange, Economy, International Reserves, Trade, and Exchange Rates
Political Geography:
Global Focus

9. Signaling Virtue or Vulnerability? The Changing Impact of Exchange Rate Regimes on Government Bond Yields

Author:
Zsófia Barta, Lucio Baccaro, and Alison Johnston
Publication Date:
09-2022
Content Type:
Working Paper
Institution:
Max Planck Sciences Po Center on Coping with Instability in Market Societies (MaxPo)
Abstract:
Do exchange rate regimes affect the conditions under which developed countries borrow? This paper argues that they do, but their impact on yields depends on the prevailing macroeconomic context. When investors regard inflation as the most relevant risk to bond holdings, monetary union has a distinct advantage over floating and fixed exchange rates because of its credible in-built mechanism to control inflation. However, once default is seen as the most relevant risk, exchange rate rigidity becomes a liability due to its constraining effect on governments’ ability to respond to adverse shocks. We test our argument with a moving window panel analysis for twenty-three OECD countries from 1980 to 2017. We find that before the late 2000s, inflation was penalized under floating and (to a lesser extent) fixed exchange rate regimes, but not in countries in monetary union. Since the 2010s, inflation carries no penalty under any exchange rate regime. Variables linked to default risk (debt and entitlement spending) did not affect yields under any exchange rate arrangements until the mid-2000s. Afterwards, countries in monetary union (and to a lesser extent in fixed exchange rate regimes) were significantly penalized for public debt and entitlement spending, whereas countries with floating regimes were not. Our results speak to the literatures on governments’ institutional commitments and “room to move.”
Topic:
International Political Economy, Financial Markets, Bonds, Exchange Rates, and Euro
Political Geography:
Global Focus

10. Timely measurement of real effective exchange rates

Author:
Zsolt Darvas
Publication Date:
12-2021
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
We demonstrate that short-run real exchange effective rate changes are dominated by nominal effective exchange rate changes, while inflation rates are sticky and contribute little to short-run real exchange rate changes. These observations allow a rather accurate real-time approximation of the real effective exchange rate using actual nominal exchange rate data and forecast inflation data. We measure the approximation error and find it is minor for most countries and sizeable only for a few countries experiencing high and volatile inflation. For a set of countries, the revision in our estimates using real-time data is slightly lower than the revision in World Bank estimates and much lower than International Monetary Fund estimates. By considering two widely studied economic issues, unit root testing in real exchange rates and nominal exchange rate forecasting with the real exchange rate, we find that using a version of real exchange rates based on approximated monthly price level data instead of actual price level data hardly changes the conclusions on unit roots and forecasting. By combining alternative data sources for exchange rates and consumer prices, we calculate up-to-date monthly real effective exchange rates for 177 countries and the euro area. Our dataset, which is frequently updated, includes more than twice as many observations as the second most comprehensive dataset.
Topic:
Economy, Inflation, and Exchange Rates
Political Geography:
Global Focus