exchange rate volatility at the emu periphery
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May 2008 Gunther Schnabl, Leipzig University & CESIfo 1
Exchange Rate Stabilization and Growth in Small Open Economies at the EMU
Periphery
Gunther SchnablLeipzig University & CESifo
University of Münster
Münster, 29 May 2008
May 2008 Gunther Schnabl, Leipzig University & CESIfo 2
Exchange Rate Volatility at the EMU Periphery
May 2008 Gunther Schnabl, Leipzig University & CESIfo 3
Exchange Rate Volatility at the EMU Peripheryand East Asia
May 2008 Gunther Schnabl, Leipzig University & CESIfo 4
Exchange Rate Volatility at the EMU PeripherySub-Samples
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
perc
ent
euro
dollar
EMU Periphery
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
perc
ent
euro
dollar
Emerging Europe
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
perc
ent
euro
dollar
Non-EMU Developed Europe
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08
perc
ent
euro
dollar
CIS
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08
perc
ent
euro
dollar
Mediterranean Countries
0,0%
0,5%
1,0%
1,5%
2,0%
2,5%
3,0%
3,5%
4,0%
4,5%
5,0%
Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
perc
ent
euro
dollar
East Asia
May 2008 Gunther Schnabl, Leipzig University & CESIfo 5
Table of Content
1. Exchange Rate Regime and Growth2. Balassa-Samuelson and Exchange Rate
Regime3. Adjustment on the Nominal Appreciation Path4. Empirical Evidence5. Outlook
May 2008 Gunther Schnabl, Leipzig University & CESIfo 6
1. Exchange Rate Regime and Growth
Mixed empirical evidence• Ghosh, Gulde and Wolf (2003): weak evidence that exchange
rate stability affects growth in a positive or negative way (large sample).
• Edwards and Levy-Yeyati (2003): countries with more flexible exchange rates grow faster (large sample).
• Eichengreen and Leblang (2003): strong negative relationship between exchange rate stability and growth for 12 countries over a period of 120 years.
• Aghion et al. (2006): Positive impact of the exchange rate stability and growth for countries with underdeveloped financial sectors.
• De Grauwe and Schnabl (2005): Positive impact of the exchange rate stability on growth for the EU new member states.
Alternative approach (EMU periphery sample)• Countries in the economic catch-up process (underdeveloped
financial sectors)• with (mostly) open capital accounts.
May 2008 Gunther Schnabl, Leipzig University & CESIfo 7
2. Balassa-Samuelson and Exchange Rate Regime
ii iiii LKAY 1)()( with 0 < i < 1 and i = T, NT (1)
i
i
i
ii
P
W
L
Y )1(
WWW NTT
T
NT
NT
T
P
P
Q
Qc
(perfect markets and profit maximization)
(perfect labor mobility)
(relative productivity gains imply relative increase of non-traded goods prices)
May 2008 Gunther Schnabl, Leipzig University & CESIfo 8
Policy OptionsPurchasing power parity
Pegging the exchange rate and higher inflation
Inflation close to the EMU level and nominal appreciation
T
NT
EATE
NT
NT
T
P
P
EP
P
Q
Qc
/*
EATE
NT
NT
T
EP
P
Q
Qc
/*
TEEA
TA PEP */ (real appreciation)
„pathological appreciation pressure“
May 2008 Gunther Schnabl, Leipzig University & CESIfo 9
3. Adjustment on the Nominal Appreciation Path
Trade and capital flows as (standard) transmission channels
• both micro- and macroeconomic dimensions
Sustained appreciation expectations affect• adjustment of labour markets• adjustment of asset markets• monetary policy decision making
Kinds of uncertainty• exchange rate risk (trade and capital flows)• labour and capital market adjustment
– wage bargaining– international asset market equilibrium
• macroeconomic stabilization – stop-and-go in monetary policies– fiscal policies and structural reforms
May 2008 Gunther Schnabl, Leipzig University & CESIfo 10
Adjustment of Labour MarketsLindbeck (1979) model of wage adjustment• with fixed rates workers bargain for productivity
gains• starting in the tradable sector (extending to non-
tradables)• uncertainty is less if exchange rates are fixed
Equilibrium in labor markets • constant productivity and prices in the anchor
country• • with fixed exchange rate (ê=0, =0)• with flexible exchange rates (ê < 0, < 0)
Stylized adjustment pattern under a free float • in addition to predictions of productivity growth (and
inflation)• exchange rate appreciation has be predicted (ê < 0)• enterprises are less eager to increase real wages• in average real wage increases will be less
)ˆ()ˆ(ˆ eEqEw)ˆ(ˆ qEw)ˆ(ˆ qEw
May 2008 Gunther Schnabl, Leipzig University & CESIfo 11
Japan: Wage Growth and Inflation Differential with US
-10%
-5%
0%
5%
10%
15%
20%
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
perc
ent
-20
60
140
220
300
380
yen/
doll
ar
wage growth differential
inflation differential
yen/dollar
May 2008 Gunther Schnabl, Leipzig University & CESIfo 12
Adjustment of Asset MarketsForward-looking asset markets • sustained appreciation expectation affect interest rates• exchange rate volatility implies a positive risk premium
()
Augmented equilibrium in international assets markets
• i = i€ + ê + • i = i€ with fixed exchange rates (ê = 0, = 0)• i < > i€ with flexible exchange rates (ê<> 0, > 0)
“Stylized” adjustment pattern of monetary policy• domestic monetary policy tar gets (inflation targets)• exchange rate appreciation (ê < 0)• slow-down of economic growth • (partially) unsterilized intervention or interest rate cuts• stop-and-go in monetary policy making• increasing uncertainty (risk premium)
May 2008 Gunther Schnabl, Leipzig University & CESIfo 13
Short-Term Interest Rates in Bulgaria and Poland
PLBU pp ˆˆ
May 2008 Gunther Schnabl, Leipzig University & CESIfo 14
Short-Term Risk Premia in the New Member States
(1999-2007)
May 2008 Gunther Schnabl, Leipzig University & CESIfo 15
4. Empirical EvidenceTheoretical and empirical evidence has
remained mixed
Sample and Observation Period• Fragmented cross-country panel for 41 EMU
periphery countries– 17 central, eastern and southeastern countries (€)– 6 non-euro area industrialized European countries (€)– 9 CIS countries ($, €)– 9 Mediterranean countries ($, €)
• Observation period– 1994-2005
Volatility Measures• volatility around a constant level (standard
deviation σ)• the trend of the exchange rate path (mean μ)• Z-score (Ghosh, Gulde and Wolf 2003) as a
measure of both• year-over-year percent changes ()• against the dollar, euro and both (min)
May 2008 Gunther Schnabl, Leipzig University & CESIfo 16
Model Specification
Growth is explained by• exchange rate volatility measures (, , z, )• transmission channels
– interest rates (short-term)– exports (percent changes)– macroeconomic stability (inflation)
• dummies– inflation targeting– crisis (1998, 2001)
• capital controls (financial account + errors & omissions)
Estimation model and method• .• GLS / GMM
itiitiit vw '
May 2008 Gunther Schnabl, Leipzig University & CESIfo 17
EMU Periphery Sample 1994-2005 (min) (GMM)
(1) (2) (3) (4) (5) (6)
Growth (-1) 0.085*** (0.017)
0.114*** (0.015)
0.063** (0.029)
0.074** (0.033)
0.305*** (0.015)
0.296*** (0.015)
Standard deviation -0.255*** (0.034)
-0.198*** (0.021)
-0.029 (0.023)
Yearly change 0.013*** (0.003)
0.004* (0.002)
-0.022*** (0.001)
Z-score -0.144*** (0.016)
-0.147*** (0.017)
-0.201*** (0.015)
Interest rate -0.156*** (0.009)
-0.127*** (0.003)
-0.126*** (0.008)
-0.115*** (0.007)
Export growth 0.017*** (0.002)
0.013*** (0.001)
0.011*** (0.001)
0.009*** (0.001)
0.018*** (0.002)
0.023*** (0.001)
Inflation -0.002 (0.003)
-0.002*** (0.001)
-0.016*** (0.001)
-0.015*** (0.001)
Inflation target -0.012*** (0.004)
-0.015*** (0.005)
-0.009*** (0.004)
-0.006 (0.004)
-0.021*** (0.006)
-0.023*** (0.007)
Crisis -0.000 (0.000)
-0.000 (0.000)
-0.000 (0.001)
0.001 (0.001)
0.002*** (0.000)
0.002** (0.001)
Constant -0.000** (0.000)
-0.000 (0.000)
0.000 (0.000)
0.000 (0.000)
0.001*** (0.000)
0.001*** (0.000)
Observations 349 349 360 360 387 387 Number of id 40 40 41 41 40 40 Sargan test Chi² 32.71 35.64 33.64 35.33 36.84 33.56 Prob > Chi² 1.000 1.000 1.000 1.000 1.000 1.000
May 2008 Gunther Schnabl, Leipzig University & CESIfo 18
Emerging Europe 1994-2005 (Min) (GMM) (1) (2) (3) (4) (5) (6)
Growth -0.114 (0.15)
0.049 (0.015)
-0.025 (0.096)
0.038 (0.080)
-0.048 (0.226)
0.254* (0.149)
Standard deviation -0.407 (0.649)
-0.903*** (0.116)
-0.019 (0.639)
Yearly change 0.004 (0.030)
0.033*** (0.010)
-0.029* (0.011)
Z-score -0.373 (0.274)
-0.605*** (0.017)
-1.059*** (0.365)
Interest rate -0.084 (0.071)
-0.098*** (0.037)
-0.189*** (0.039)
-0.106*** (0.027)
Export growth 0.046*** (0.016)
0.088*** (0.021)
0.059*** (0.007)
0.045*** (0.009)
0.089*** (0.018)
0.083*** (0.016)
Inflation -0.019 (0.036)
-0.052*** (0.017)
-0.075** (0.039)
-0.007 (0.021)
Inflation target -0.006 (0.009)
-0.003 (0.006)
0.000 (0.008)
-0.003 (0.006)
-0.002 (0.007)
0.004 (0.007)
Crisis 0.000 (0.000)
-0.001 (0.002)
-0.003 (0.003)
-0.001 (0.003)
-0.001 (0.003)
-0.005 (0.003)
Constant 0.000 (0.000)
-0.002 (0.001)
-0.002* (0.001)
-0.002 (0.001)
-0.000 (0.001)
-0.001 (0.001)
Observations 153 153 153 153 164 164 Number of id 17 17 17 17 17 17 Sargan test Chi² 8.66 10.23 13.82 13.71 10.07 11.08 Prob > Chi² 1.000 1.000 1.000 1.000 1.000 1.000
May 2008 Gunther Schnabl, Leipzig University & CESIfo 19
Non-EMU Industrialized Europe 1994-2005 (Min) (GLS)
(1) (2) (3) (4) (5) (6)
Standard deviation -0.415 (0.518)
-0.509 (0.499)
-0.214 (0.560)
Yearly change -0.014 (0.035)
-0.017 (0.037)
-0.002 (0.038)
Z-score -0.361 (0.462)
-0.530 (0.433)
-0.113 (0.497)
Interest rate -0.042 (0.131)
-0.132 (0.143)
0.033 (0.141)
0.033 (0.142)
Export growth 0.044 (0.018)
0.043 (0.018)
0.030 (0.019)
0.029 (0.019)
Inflation -0.348 (0.247)
-0.364 (0.244)
-0.401 (0.268)
-0.409 (0.265)
Inflation target 0.000 (0.005)
0.000 (0.005)
-0.002 (0.005)
-0.002 (0.005)
-0.007 (0.005)
-0.007 (0.005)
Crisis 0.011*** (0.004)
0.011*** (0.003)
0.010*** (0.003)
0.010*** (0.003)
0.009** (0.004)
0.009** (0.004)
Capital flows 0.161*** (0.048)
0.159*** (0.048)
0.141*** (0.043)
0.143** (0.042)
Constant 0.031*** (0.007)
0.037*** (0.006)
0.034*** (0.005)
0.034*** (0.005)
0.033*** (0.006)
0.033*** (0.006)
Observations 68 68 72 72 68 68 Number of id 6 6 6 6 6 6 R² within 0.399 0.396 0.276 0.278 0.273 0.271 R² between 0.189 0.208 0.260 0.247 0.266 0.261 R² overall 0.341 0.343 0.250 0.246 0.094 0.099
May 2008 Gunther Schnabl, Leipzig University & CESIfo 20
CIS 1994-2005 (Min) (GLS) (1) (2) (3) (4) (5) (6)
Standard deviation -0.590* (0.314)
-0.672*** (0.238)
-0.764*** (0.251)
Yearly change 0.068* (0.038)
0.009 (0.012)
0.084** (0.032)
Z-score -0.049 (0.089)
-0.421*** (0.102)
-0.139 (0.088)
Interest rate -0.194*** (0.035)
-0.213*** (0.034)
-0.175*** (0.034)
-0.189*** (0.035)
Export growth 0.045** (0.021)
0.031 (0.019)
0.048** (0.019)
0.033* (0.019)
Inflation -0.026* (0.013)
-0.012 (0.011)
-0.019 (0.012)
0.013*** (0.004)
Crisis -0.007 (0.008)
-0.003 (0.008)
0.004 (0.015)
0.005 (0.015)
-0.009 (0.008)
-0.002 (0.008)
Capital flows -0.074 (0.061)
-0.057 (0.061)
-0.049 (0.115)
-0.037 (0.114)
Constant 0.099*** (0.009)
0.097*** (0.009)
0.059*** (0.012)
0.056*** (0.011)
0.093*** (0.008)
0.088*** (0.008)
Observations 78 78 98 98 81 81 Number of id 9 9 9 9 9 9 R² within 0.595 0.574 0.188 0.174 0.617 0.577 R² between 0.081 0.081 0.009 0.003 0.327 0.254 R² overall 0.471 0.463 0.161 0.144 0.562 0.515
May 2008 Gunther Schnabl, Leipzig University & CESIfo 21
Mediterranean Countries 1994-2005 (Min) (GLS)
(1) (2) (3) (4) (5) (6)
Standard deviation 0.062 (0.337)
0.069 (0.279)
0.254 (0.279)
Yearly change -0.004 (0.086)
-0.023 (0.073)
-0.066 (0.062)
Z-score 0.043 (0.134)
-0.014 (0.109)
-0.016 (0.114)
Interest rate -0.106 (0.217)
-0.104 (0.204)
-0.175 (0.148)
-0.158 (0.148)
Export growth -0.005* (0.008)
-0.005 (0.008)
-0.005 (0.007)
-0.006 (0.007)
Inflation 0.072 (0.149)
0.071 (0.147)
0.096 (0.108)
0.044 (0.096)
Inflation target -0.036 (0.025)
-0.036 (0.025)
-0.036* (0.020)
-0.035** (0.020)
-0.043** (0.021)
-0.045** (0.021)
Crisis 0.006 (0.008)
0.006 (0.008)
0.003 (0.007)
0.003 (0.007)
0.004 (0.007)
0.002 (0.007)
Capital flows 0.126 (0.109)
0.127 (0.106)
0.125 (0.084)
0.128 (0.083)
Constant 0.049*** (0.015)
0.049*** (0.014)
0.041*** (0.005)
0.042*** (0.005)
0.053*** (0.009)
0.056*** (0.009)
Observations 73 73 88 88 86 86 Number of id 7 7 8 8 9 9 R² within 0.106 0.105 0.082 0.081 0.098 0.083 R² between 0.105 0.109 0.003 0.004 0.000 0.003 R² overall 0.071 0.071 0.043 0.043 0.044 0.031
May 2008 Gunther Schnabl, Leipzig University & CESIfo 22
East Asia 1980-2005 ($) (GLS) (1) (2) (3) (4) (5) (6)
Standard deviation -0.486*** (0.122)
-0.658*** (0.104)
-0.627*** (0.116)
Yearly change 0.074*** (0.017)
0.074*** (0.019)
0.071*** (0.017)
Z-score -0.156 (0.104)
-0.400*** (0.089)
-0.323*** (0.098)
Interest rate 0.039 (0.079)
-0.000 (0.083)
0.126* (0.074)
0.099 (0.076)
Export growth 0.139*** (0.017)
0.137*** (0.018)
0.154*** (0.016)
0.152*** (0.172)
Inflation -0.093* (0.052)
-0.133** (0.055)
-0.091* (0.049)
-0.124** (0.051)
Inflation target 0.002 (0.008)
-0.009 (0.008)
-0.000 (0.007)
-0.007 (0.007)
0.003 (0.008)
-0.007 (0.008)
Crisis -0.032*** (0.009)
-0.029*** (0.010)
-0.036*** (0.010)
-0.031*** (0.011)
-0.027*** (0.008)
-0.025*** (0.008)
Capital flows 0.135*** (0.035)
0.147*** (0.037)
0.120*** (0.039)
0.122*** (0.041)
Constant 0.049*** (0.006)
0.055*** (0.007)
0.067*** (0.003)
0.069*** (0.003)
0.044*** (0.006)
0.049*** (0.006)
Observations 177 177 187 187 210 210 Number of id 8 8 8 8 9 9 R² within 0.598 0.548 0.390 0.327 0.534 0.487 R² between 0.420 0.482 0.029 0.085 0.313 0.526 R² overall 0.540 0.530 0.311 0.278 0.481 0.478
May 2008 Gunther Schnabl, Leipzig University & CESIfo 23
5. Conclusion• The panel estimations for the EMU periphery
provide strong evidence in favour of a negative impact of exchange rate volatility on growth.
• This result is independent from the anchor currency. • Trade, capital flows and macroeconomic stability
are important transmission channels from exchange rate stability to growth.
• The effects are most pronounced for Emerging Europe which has widely dismantled capital controls.
• For the industrialized European countries exchange rate stability seem to matter less.
• The effect is less pronounced for the Mediterranean countries where financial repression and capital controls prevail.
• Introducing East Asia into the sample strengthens the evidence in favour of a positive impact of exchange rate stability on growth.
May 2008 Gunther Schnabl, Leipzig University & CESIfo 24
Thank you for your attention!
Münster, May 29 2008
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