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Regime-switching in exchange rate policy and balance sheet effects

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  • Fiess, Norbert
  • Shankar, Rashmi

Abstract

The authors apply regime-switching methods to a monetarist model of exchange rates and identify well-defined intervention policy cycles. The policy response indices include a standard exchange market pressure-based index and a model-based volatility ratio that is endogenized relative to Japan, assumed to be a"benchmark"floater. The authors find strong evidence that balance sheet effects, proxied by the stock ratio of external liabilities to assets, and economic performance, as measured by GDP and stock market indices, determine the cost of the regime shift. They use a panel of quarterly data from 1985 to 2004 for a sample of 15 countries, mostly in East Asia and Latin America.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3653.

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Date of creation: 01 Jul 2005
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Handle: RePEc:wbk:wbrwps:3653

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Keywords: Economic Theory&Research; Economic Stabilization; Macroeconomic Management; Fiscal&Monetary Policy; Banks&Banking Reform;

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References

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  1. Michael Owyang & Garey Ramey, 2003. "Regime switching and monetary policy measurement," Working Papers 2001-002, Federal Reserve Bank of St. Louis.
  2. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-72, January.
  3. Carmen M. Reinhart, 2000. "Mirage of Floating Exchange Rates," American Economic Review, American Economic Association, vol. 90(2), pages 65-70, May.
  4. Kraay, Aart & Loayza, Norman & Serven, Luis & Ventura, Jaume, 2004. "Country Portfolios," Policy Research Working Paper Series 3320, The World Bank.
  5. Sweder van Wijnbergen, 1987. "Fiscal Deficits, Exchange Rate Crises and Inflation," NBER Working Papers 2130, National Bureau of Economic Research, Inc.
  6. Mendoza, Enrique G, 2001. "The Benefits of Dollarization When Stabilization Policy Lacks Credibility and Financial Markets Are Imperfect," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 440-74, May.
  7. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Vegh, 2004. "When it Rains, it Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Working Papers 10780, National Bureau of Economic Research, Inc.
  8. Reinhart, Carmen, 2000. "The mirage of floating exchange rates," MPRA Paper 13736, University Library of Munich, Germany.
  9. Frenkel, Jacob A. & Aizenman, Joshua, 1982. "Aspects of the optimal management of exchange rates," Journal of International Economics, Elsevier, vol. 13(3-4), pages 231-256, November.
  10. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
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  12. Andres Velasco & Roberto Chang, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," NBER Working Papers 10827, National Bureau of Economic Research, Inc.
  13. Charles Engel, 1991. "Can the Markov switching model forecast exchange rates?," Research Working Paper 91-04, Federal Reserve Bank of Kansas City.
  14. repec:rus:hseeco:124089 is not listed on IDEAS
  15. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  16. Reinhart, Carmen & Calvo, Guillermo, 1999. "Capital Flow Reversals,the Exchange Rate Debate,and Dollarization," MPRA Paper 8951, University Library of Munich, Germany.
  17. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
  18. Axel Schimmelpfennig & Nouriel Roubini & Paolo Manasse, 2003. "Predicting Sovereign Debt Crises," IMF Working Papers 03/221, International Monetary Fund.
  19. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  20. Chang-Jin Kim & Charles R. Nelson, 1999. "Has The U.S. Economy Become More Stable? A Bayesian Approach Based On A Markov-Switching Model Of The Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 608-616, November.
  21. Bazdresch, Santiago & Werner, Alejandro, 2005. "Regime switching models for the Mexican peso," Journal of International Economics, Elsevier, vol. 65(1), pages 185-201, January.
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Cited by:
  1. Walter, Stefanie, 2008. "A New Approach for Determining Exchange-Rate Level Preferences," International Organization, Cambridge University Press, vol. 62(03), pages 405-438, July.

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