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Fear of Floating in Reverse: Exchange Rate Policy in the 2000s Eduardo Levy Yeyati The World Bank & Universidad Torcuato Di Tella Federico Sturzenegger Kennedy School, Harvard Univ. & Universidad Torcuato Di Tella May, 2007 1 Storyboard LYS updated: Regimes in the 2000s Fear of floating or fear of appreciation? Fear of floating in reverse: reviving exchange rate policy Economic impact Final remarks: Brainstorming Exchange rate regimes in the 2000s: Classification • Key criterion: ER variability relative to forex intervention • The intervention dimension is key to characterized exchange rate policy (as opposed to the evolution of exchange rates) and its consequences Regime in the 2000s: Nothing changed? 100% Float 80% Int 60% 40% Fix 20% 0% 1974 1978 Source: LYS (2006) 1982 1986 1990 1994 1998 2002 Fear of flying: A characterization • Fear of floating’s underlying fears: – Contractionary devaluations (due to BS effects) and currency and debt crisis propensity – Dollar pricing, pass-through & inflation • Fear of flying: Leaning against the appreciation wind – Intervention to strenthen the demand for the foreign currency, to avoid/mitigate appreciation pressures • Not to be mistaken with fear of sudden stops in the aftermath of a crisis Fear of floating? (non-floats) Source: LYS (2006) The comeback of exchange rate policy? Mercantilist interventions as a substitute for protection Less specific than subsidies Less prone to mismanagement & corruption Fear of floating in reverse (FoFiR) Invertion of the ER anchor problem: sustaining an undervalued currency Instead of amplified recessions due to price rigidities… …inflationary expansions fueled by positive real shocks. Does it work? How? FoFiR: leaning against the appreciation wind Dlog (Real bilateral exchange rate) (t) (t, t+1) (t, t+2) (3-y avg, t+1) int1 (t) 0.036* 0.109** (0.022) (0.055) int1 (t, t+1) 0.072** (0.029) int1 (t, t+2) 0.090** (0.040) R-squared 0.989 0.99 0.991 0.99 Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows. …at the cost of inflation pressures ∆%Inflation ∆%Deflator ∆%Deflator - ∆%Inflation (t) (t) (t) int1 (t) 0.192 1.542** 0.803** (0.602) (0.720) (0.364) int1 (t-1) -0.65 -2.170*** -0.026 (0.502) -0.654 (0.367) R-squared 0.65 0.64 0.119 Additional controls: country and time FE, dlog(M2), dlog(GDP), dl(RER), lagged dep. var. Intervention & growth dlog(GDP) dlog(GDP per worker) (3y avg; t+1) (3y avg; t+1) int1 (t-1, t-3) 2.789*** 1.728*** (0.459) -0.578 int1 (t) 1.352** 0.791 (0.661) -0.808 R-squared 0.446 0.464 0.306 0.363 Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged HP cycle, lagged GDP, lagged dep. var. Intervention & long-term growth? BK trend HP trend BK cycle HP cycle int1 (t-1, t-3) 1.781*** 0.009*** (0.305) (0.002) int1 (t) 0.599*** 0.011*** (0.222) (0.003) R-squared 0.469 0.627 0.415 0.312 Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged HP cycle, lagged GDP, lagged dep. var. Savings & investment int1(t) int1 (t-1, t-3) R-squared Savings (% GDP) (t+1) 1.044** (0.474) 1.154 (0.738) 0.805 Real Inv. (% GDP) (t+1) (3Y avg; t+1) 1.784*** 4.142*** -0.304 -1.224 0.692* -0.375 0.829 0.656 Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged dlog(GDP), savings High dollar, low wages? int1 (t) int1 (t-1) ∆%GDP (t) R-squared Labor/Capital Compensation Unemp (%) -3.041* -0.439** (1.787) (0.20) -5.872** 0.244 (2.885) (0.19) -0.036* (0.02) 0.787 0.783 0.925 Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, lagged dlog(product), dlog(pop) Example exports consumption 100 100 2006.IV 250 2005.IV 150 2004.IV 400 2003.IV 200 2002.IV 550 2001.IV 250 Example IPC exports consumption 100 100 2006.IV 250 2005.IV 150 2004.IV 400 2003.IV 200 2002.IV 550 2001.IV 250 Example IPC exports GDP consumption 100 100 2006.IV 250 2005.IV 150 2004.IV 400 2003.IV 200 2002.IV 550 2001.IV 250 Example IPC Precio implicito del PBI real w age 100 0 2006.IV 50 2005.IV 150 2004.IV 100 2003.IV 200 2002.IV 150 2001.IV 250 Example IPC Precio implicito del PBI real w age real w age (formal) 100 0 2006.IV 50 2005.IV 150 2004.IV 100 2003.IV 200 2002.IV 150 2001.IV 250 Example GDP by production factor 100% Other 80% Labor compensation 60% 40% Capital benefits 20% 0% 2001 2002 2003 2004 2005* Taking stock Distribution of regimes little changed in the 00s But the composition of non-floats have changed Reversed fear of floating is an increasingly popular contender Positive on Long-run & productivity growth Saving & investment Not so much on exports Is it merely low real wages? Thank you Fear of Floating in Reverse: Exchange Rate Policy in the 2000s Eduardo Levy Yeyati The World Bank & Universidad Torcuato Di Tella Federico Sturzenegger Kennedy School, Harvard Univ. & Universidad Torcuato Di Tella May, 2007 22 De facto regimes over the years: Classification Exchange rate volatility (e): average of the absolute value of monthly changes in the exchange rate Volatility of exchange rate changes (De ): standard deviation of monthly changes in the exchange rate Volatility of reserves (R): average of the absolute value of monthly changes in international reserves relative to the monetary base of the previous month (both denominated in US dollars) De facto regimes over the years: Classification Regime e De R Float Low Low High Intermediate Med Med Med Fix High Low Low