Download Fiscal policy in candidate transition countries

Exchange rate regimes
and shocks
Fabrizio Coricelli
Budapest, November 28, 2002
Outline
 CEECs are characterized by high
volatility
 Volatility of shocks, volatility of policy
 Exchange rate regime: shock absorber
or source of shocks
 Real and financial shocks
 Real: structural change and productivity
shocks (Balassa-Samuelson)
 Financial: emerging market features
 Conclusons: Skepticism on flexibility
Volatility
GDP Terms of
trade**
CEECs*
Real
effective
exchange
rate**
Real
Gov’t
interest revenue/G
rate**
DP
Latin America
4,10
3,74
4,40
8,70
12,66
18,00
6,34
13,18
2,31
2,19
Emerging Asia
4,11
5,92
8,65
2,52
1,82
Advanced
countries
2,09
3,73
5,90
2,07
1,02
*1993-2001
**Only Czech republic, Hungary, Poland and Romania
Evolution of shocks
 Initially: price liberalization and
structural change
 Over time: trade opening and
integration with EU
 Over time: opening to capital flows
(financial shocks)
Trend effects and dynamics
 Trend real appreciation (Balassa-
Samuelson): productivity shocks
 Cyclical co-movements
 External shocks: contagion
Accounting for REA
log(PT/PN)i,t = αoi - α1log(aT – aN)i,t - α2sharei,t - α3govreali,t + α4labi,t + εi,t
1,5
1
0,5
govreal
0
share
T=1
T=2
T=3
T=4
T=5
T=6
T=7
T=8
lab
prod
-0,5
Actual RER
Fitted Values
-1
-1,5
-2
Balassa-Samuelson: Slovenia
140
120
100
80
60
40
20
0
1992
1993
Labor (IND/SER)
1994
Productivity diff.
1995
1996
Poli. (Labor (IND/SER))
1997
1998
Poli. (Productivity diff.)
-5.0%
-10.0%
Sep-02
Jun-02
Mar-02
Dec-01
Sep-01
Jun-01
Mar-01
Dec-00
Sep-00
Jun-00
Mar-00
Dec-99
Sep-99
Jun-99
Mar-99
Dec-98
Sep-98
hungary
Jun-98
Mar-98
Dec-97
Sep-97
Jun-97
eu
Mar-97
Dec-96
Sep-96
Jun-96
Mar-96
Dec-95
Sep-95
Jun-95
Mar-95
Dec-94
Sep-94
Cyclical co-movements
Industrial production annual changes
3month moving average
25.0%
8.0%
Poland
20.0%
6.0%
15.0%
4.0%
10.0%
2.0%
5.0%
0.0%
0.0%
-2.0%
-4.0%
Trade openness
Figure 1: Degree of Openness in the EU and the CEECs
(exports plus imports of goods and services as percent of GDP in 2000)
%
300
EU
250
CEECs
200
150
100
50
* 1999
Source: IMF: International Financial Statistics
ITALY
FRANCE
GREECE
UK
POLAND*
SPAIN
GERMANY
ROMANIA
PORTUGAL
FINLAND
DENMARK
SWEDEN
LITHUANIA
AUSTRIA
LATVIA
SLOVENIA
BULGARIA
HUNGARY
NETHERLANDS
CZECH REP.
SLOVAK REP.
BELGIUM
IRELAND
ESTONIA
LUXEMBOURG
0
Poland: Flexible exchange rates
Risk premium: Poland
1600
EMBI+
EMBI+ Poland
400
1400
350
1200
300
1000
250
800
200
600
150
400
100
200
50
0
1/30/1998 10/30/1998
0
7/30/1999
4/30/2000
1/30/2001 10/30/2001
7/30/2002
Risk premium: Poland 2
 After adoption of flexible rates (in
2000) risk premium jumps up
 Before and after high correlation
with EMBI+
Evolution of regimes
Fix
Stabilisation phase Czech Rep.
1990-1994
Estonia
Hungary
Latvia
Lithuania
Malta
Poland
Slovakia
Transition phase
1995-2000
Bulgaria
Estonia
Latvia
Lithuania
Malta
Preparatory phase Bulgaria
2001 - ERMII
Estonia
Latvia
Lithuania
Malta
Intermediate
Float
Cyprus
Bulgaria
Slovenia
Romania
Czech Rep.
Cyprus
Hungary
Poland
Slovakia
Slovenia
Romania
Cyprus
Hungary
Czech Rep.
Poland
Slovakia
Slovenia
Romania
De jure classification according to the IMF. Fix: currency board, conventional peg, narrow band;
Intermediate : tightly managed, broad band; Float : managed float, free float
Heterogeneity
 Movement towards extremes
 Euro is the end-point:is the
movement towards more flexibility
reasonable?
 It depends on the ability of flexible
rates to absorb shocks and
insulate from currency and
financial crises
Exchange rate shock absorber?
 Response of exchange rate to external
shocks
 Response of interest rates
 Habib (2002): high sensitivity to
external shocks (change in risik
premium). Poland and Czech Republic:
Exchange rate follows EMBI+ shocks.
Hungary and Slovenia: interest rate
reacts.
 In both cases either real exchange rates
and/or real interest rates move in
response to international shocks
600
2
400
1
200
0
0
Forint one-year ex ante real rate
Euro one-year zero-coupon yield
Jan-02
3
Jul-01
800
Jan-01
4
Jul-00
1000
Jan-00
5
Jul-99
1200
Jan-99
6
Jul-98
1400
Jan-98
7
Jul-97
1600
Jan-97
8
basis points
%
Contagion and interest rates:
Hungary
EMBI+ (right-hand scale)
Poland: interest rate spreads
12
2001
2002
 Short term
spreads vs. euro
still large
10
8
 Long-term
6
expectation of
entry in the
eurozone
4
2
0
3m
6m
1y
2y
3y
4y
5y
10y
External constraint
 External constraint not to be
underestimated
 Exposure to swings in foreign financing
 Low liability “euroization”? Need to be
qualified (example of Hungary)
 These elements should be factored in
when advising flexibility of exchange
rates
External position,
External
debt/GDP
External
debt/Exports
2000-01
Current
Account/
GDP
FDI
/GDP
Bulgaria
Czech
Estonia
Hungary
Latvia
Lithuania
Poland
Romania
Slovakia
Slovenia
86.4
42.8
61.4
67.3
65.9
42.9
42.9
27.0
56.3
34.3
148.3
56.2
64.6
97.3
144.0
95.1
214.5
81.7
76.5
58.1
8.3
9.1
6.4
2.6
5.6
3.3
5.9
2.7
10.7
0.2
5.9
4.8
6.8
3.9
6.8
6.0
6.3
3.7
3.7
3.3
avg.
CEECs
52.7
103.6
5.5
5.1
Exchange rate and inflation 1
 Pass-through: eg. Darvas (2001);
Coricelli et al. 2002
 High pass-through, especially in
Slovenia and Hungary
 Problem with inflation targeting
Exchange rate and inflation 2
 Difficulties in bringing down
inflation at low rates
 Exchange rate flexibility may in
fact make it worse
 Implicit real exchange rate targets
internalized in the price
setting………….
Slovenia
30
25
20
ip
ner
rer
cpi
15
10
5
0
-5
-10
-15
-20
dic-93
feb-95
apr-96
giu-97
ago-98
ott-99
dic-00
feb-02
Czech Republic
25
20
ip
ner
rer
cpi
15
10
5
0
-5
-10
-15
mar-94 mag-95
lug-96
set-97
nov-98
gen-00 mar-01 mag-02
Hungary
ip
rer
35
ner
cpi
25
15
5
-5
-15
apr-94
ago-95
dic-96
apr-98
ago-99
dic-00
apr-02
Poland
35
ip
ner
rer
cpi
25
15
5
-5
-15
-25
mar-94
mag-95
lug-96
set-97
nov-98
gen-00
mar-01
mag-02
Advantages of flexibility
not obvious
 True: with inflationary inertia in the non
tradable sector fixing the exchange rate
may cause a temporary drop in output
in non-tradables
 However, there would be gains in
welfare associated to the reduction of
losses due to monopolistic behavior in
non tradable sectors (Calvo et al.
(2002)
Adoption of the euro
 Would avoid real appreciation induced
by nominal appreciation arising from
capital inflows
 Would allow immediate convergence in
interest rates
 Would reduce inefficiency of monopoly
power in non-tradable sectors
 Thus, nominal convergence may be less
costly with euro than with flexibility of
exchange rates