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Keywords: threshold cointegration, nominal exchange rate pass-through, oil price shocks, oil-exporting countries, optimal exchange rate regimes, monetary policy.
This dissertation revisits the literature on the role of exchange rate flexibility in smoothing the adjustments of the economy to different disturbances. Recently, the role of flexible exchange rates in stabilizing the economy against real shocks has been challenged by the new open economy models, which build on some empirical regularities, such as the low pass-through from nominal exchange rates to import prices. We take three approaches in an attempt to enrich this literature. Firstly, we incorporate factors of production into welfare analyses of fully-specified general equilibrium models. We find flexible exchange rate regimes reduce terms of trade and consumption volatility for primary commodity economies, particularly oil-exporting. Secondly, in an empirical investigation, using a panel Vector Autoregressive Regression of nine of the OECD's major oil-importing countries and the Reinhart and Rogoff's de facto classification of exchange rate regimes, we find support for the hypothesis that flexible exchange regimes better absorb oil-price shocks. We also document feedback from the real effective exchange rate and inflation rate to the domestic-currency real oil price shocks, supporting the growing notion that oil price shocks are not purely exogenous to developed economies. Thirdly, in a micro-level empirical investigation, we find a significant improvement in estimating the degree of nominal exchange rate pass-through to import prices when the adjustment costs and the equilibrium degree of pass-through assumptions are considered. More specifically, using a vector threshold cointegration model, we find increases in both the initial reaction and the long-run equilibrium response of import prices to nominal exchange rate changes for five industries in 16 OECD countries, especially for the manufacturing industry.
Contains essays on the impact of exchange-rate variability on trade policy and trade flows
Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments” of exogenous changes in bilateral exchange rate regimes.
Theoretical models on the relationship between prices and exchange rates predict that the magnitude of expenditure switching affects the optimal choice of exchange rate regime. Focusing on the transmission of terms-of-trade shocks to domestic real variables we document that the magnitude of the expenditure switching effect is positively associated to the degree of exchange rate flexibility. Moreover, results show that flexible exchange rates allow for significant adjustment in relative prices, which in turn lowers the burden of adjustment on demand for domestic goods and, in some cases, facilitates a faster and more durable external adjustment process. These results, which are robust to accounting for possible non-linearities due to balance sheet effects or currency mismatches, shed new light on the shock absorbing properties of flexible exchange rates.
This book collects together the basic documents of an approach to the theory and policy of the balance of payments developed in the 1970s. The approach marked a return to the historical traditions of international monetary theory after some thirty years of departure from them – a departure occasioned by the international collapse of the 1930s, the Keynesian Revolution and a long period of war and post-war reconstruction in which the international monetary system was fragmented by exchange controls, currency inconvertibility and controls over international trade and capital movements.
Written form 1957 through 1978 by one of the foremost authorities in the field of international economics, this collection of Peter Kenen's previously published essays deals with issues in the pure theory of international trade, international monetary theory, and international monetary reform. The essays in Part I, "Trade, Tariffs, and Welfare," concern the roles of tangible and human capital in the determination of trade patterns, the joint determination of demand conditions and trade patterns, the gains from international trade, and the effects of migration on economic welfare. Part II, "International Monetary Theory and Policy," contains essays on the theory of gold-exchange standard, the determination of forward exchange rates, the demand for international reserves, economic integration and the delineation of currency areas, and the process of balance of payments adjustment under pegged and floating exchange rates. The essays in Part III, "Monetary Reform and the Dollar," are arranged in chonological order, from 1963 through 1977, and focus on the problems and progress of international monetary reform and on the functioning of the present international monetary system. Peter B. Kenen is Walker Professor of Economics and International Finance at Princeton University. The Princeton Sereies of Collected Essays provides facsimile reprints, in paperback and in cloth, of important articles by leading scholars. Originally published in 1981. The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.
Motivated by the existence of time-varying volatility in exchange rates, the paper investigates the effects of exchange rate volatility shocks on a small open economy. First, we use a high-frequency dataset to generate a volatility measure for the period, instead of the traditional moving average standard deviation of exchange rates. The structural VAR impulse responses utilizing the volatility measure yield more significant and robust reactions of real variables to a volatility shock. Consumption, ouput, investment and net export exhibit non-trivial decrease upon impact of the shock. On the contrary, an exchange rate level shock and the traditional volatility measure fail to generate robust impulse responses under different Cholseky orderings. Second, we develop a theoretical model based on a standard New Keynesian small open economy, which can replicate the effects of a volatility shock observed in the VAR result. We solve the model up to a third order approximation so that the solution includes an explicit time-varying volatility term. The model impulse responses exhibit that real variables respond to a volatility shock and they are qualitatively consistent with the VAR result. The underlying mechanism is precautionary saving. The result is sensitive to various parameters such as the openness parameter and the elasticity of inter-temporal substitution. Finally, we make a welfare analysis regarding the optimal monetary policy. Two types of welfare measures are used: the unconditional mean of utility and the conditional welfare. The conditional welfare suggests that policy makers should raise the interest rate when volatility increases. The seemingly counter-intuitive result is due to the fact that the conditional welfare measure reflects dynamic response of the agent throughout her life-cycle. Under the optimal policy suggested by the conditional welfare, the initial consumption adjustment is severe but agents work less and eventually enjoy a higher level of consumption from savings carried over from earlier periods.