Download Tight Monetary Policy During Currency Crises: A Focus on Emerging

Currency Crises and Monetary Policy:
A Study on Advanced and Emerging
Economies
Sylvester Eijffinger and Bilge Karatas
Tilburg University
CIGI, VERC and University of Tasmania Conference
October 04, 2011
Outline

Introduction



Empirical Analysis




Theoretical Models in Currency Crises
Monetary Policy Response to Currency
Methodology and Data
Pooled OLS Results
System GMM Results
Conclusion
Introduction: Currency Crisis


“...an episode in which the exchange rate
depreciates substantially during a short period of
time” (Burnside et al., 2007)
Theoretical Models in Crisis Explanation:



First Generation Models Balance Sheet Imbalances of
the Government (Krugman, 1979)
Second Generation Models Self-fulfilling
Expectations (Obstfeld, 1994)
Third Generation Models
Balance Sheet Imbalances
of the Private Sector (Krugman, 1999 & Chang and
Velasco, 1998)
Introduction: Monetary Policy Response


Conventional Wisdom: The behavior of exchange rate is explained
with asset market conditions. Tighter monetary policy followed today
leads to a stronger currency today: IS THAT THE CASE DURING
CRISIS TIMES?
Empirical Studies:



Goldfajn & Gupta (2003): Tight monetary policy facilitates the reversal of
the real exchange rate. In contrast, in periods of twin crises the
effectiveness of tight monetary policy decreases.
Kraay (2003): There is little evidence that monetary policy has any positive
or negative effect on exchange rate.
Eijffinger & Goderis (2008): Focusing on the third generation
vulnerabilities the study concludes that tight monetary policy depreciates
the exchange rates following currency crisis.
Introduction: Research Question and
Motivation

Research Question: “Do Emerging and Advanced
Economies Need Different Monetary Policies Following a
Currency Crisis?”

Various economic vulnerabilities preceding and
following the currency crisis in emerging and
advanced economies motivated a separate analysis
for these groups of economies.
Empirical Analysis:
Methodology and Data



Years: 1986 – 2009
24 Economies – 9 Advanced and 15 Emerging.
Crisis Period Identification (Eijffinger and Goderis,
2008): 35 crisis periods


Starting month of the currency crisis is the month with the large
depreciation of the nominal exchange rates following the period of
moderately stable exchange rates.
Ending month of the currency crisis is the first month after the
start in which speculative pressures have substantially diminished
compared to earlier peaks.
Empirical Analysis: Crisis Periods
Emerging Economies
Country
Period
Argentina
2002:01 - 2002:10
Brazil
1999:01 - 1999:05
Brazil
2002:10 - 2003:12
Brazil
2008:09 - 2009:05
Chile
2008:10 - 2009-03
China
1994:01 - 1994:11
Colombia
2008:10 - 2009:05
India
1991:07 - 1991:12
Indonesia
1986:09 - 1989:02
Indonesia
1997:08 - 1999:06
Indonesia
2008:11 - 2009:04
Korea
1997:11 - 1998:07
Korea
2008:10 - 2009:04
Malaysia
1997:12 - 1998:09
Mexico
1994:12 - 1996:08
Mexico
1998:09 - 1999:04
Mexico
2008:10 - 2009:05
Philippines
1997:09 - 1997:12
Russia
1998:09 - 1998:11
Russia
2009:01 - 2009:04
Thailand
1997:07 - 1998:07
Turkey
2001:02 - 2001:06
Turkey
2008:10 - 2009:01
Venezuela
1995:12 - 1996:06
Venezuela
2002:02 - 2003:07
Episode
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Advanced Economies
Country
Period
Episode
Australia
2008:08 - 2009:03
26
Canada
2008:10 - 2009:04
27
Euro Area
2008:10 - 2009:05
28
Germany
1991:04 - 1994:09
29
Japan
1991:03 - 1993:09
30
New Zealand 2008:08 - 2009:02
31
Sweden
1991:03 - 1991:06
32
Switzerland
1991:07 - 1994:03
33
United Kingdom 1992:10 - 1992:12
34
United Kingdom 2008:08 - 2009:01
35
Empirical Analysis :
Methodology and Data
Yi ,t   0  1 X i ,t 1   2 Z i ,t k   3 X i',t 1Z i ,t k   i ,t

Yi ,t
: Change in the Nominal Exchange Rates

X i ,t 1
: Change in Monetary Policy: Money Market Interest Rates

Z i ,t  k
: Episode-Specific Fundamentals

X i',t 1Zi ,t k :Interaction terms : Monetary Policy X Fundamentals
Empirical Analysis: Episode Specific
Fundamentals

From Eijffinger and
Goderis (2008)





Deviation of the Real PerCapita GDP
Real Exchange Rate
Overvaluation
Corporate Short-term Debt
to Total Assets
Institutional Quality
Capital Account Openness

From Kaminsky (2006)





Fiscal Position
Stock Prices
Short-term External Debt
Current Account Position
Central Bank Transparency
Empirical Analysis:
Pooled OLS Results
Monetary Policy
GDP
Current Account
Exchange Rate Overveluation
Debt to Total Assets
Institutional Quality
Capital Account Openness
Fiscal Position
Stock Prices
Central Bank Transparency
Initial Level of Spread
MP X GDP
MP X Current Account
MP X Exchange Rate Overvaluation
MP X Debt to Total Assets
MP X Institutional Quality
MP X Short Term External Debt
MP X Capital Account Openness
MP X Stock Prices
MP X Central Bank Transparency
R2
Number of Observations
0.192
134
0.202
(0.278)
0.073**
(0.031)
1.796
(1.213)
-1.432*
(0.743)
-0.045*
(0.022)
0.344
72
-0.047*
(0.025)
-0.002
(0.069)
0.445
(0.243)
0.188
(0.214)
0.070
(0.083)
1.559*
(0.911)
-0.825*
(0.386)
0.516
(0.242)
0.201**
(0.050)
0.172
(0.356)
0.791**
(0.215)
-0.285*
(0.119)
1.739
(1.465)
Emerging Economies
Monetary Policy: Ambiguous
Overvaluation
Low Inst. Quality
Fall in Stock Prices
Low CB Transparency
MP X Debt to Assets
MP X KA Openness
MP X Fiscal Deficit
MP X Stock Prices
MP X CB Transparency
Advanced Economies
-0.364
(0.407)
-0.068**
(0.022)
-4.165*
(1.498)
-0.008
(0.061)
0.438
83
0.222
72
Monetary Policy: Ambiguous
CA Deficit
MP X CA Deficit
MP X Fiscal Deficit
MP X Stock Prices
Depreciation
MP X Fiscal Position
5.682***
(1.561)
0.517*
(0.279)
1.466**
(0.501)
-0.213**
(0.093)
0.071**
(0.025)
-1.568**
(0.606)
-0.322
(0.208)
Advanced
3
4
1.242
-0.139***
(1.093)
(0.021)
-0.281
-0.122
(0.213)
(0.066)
-0.173***
-0.118
(0.025)
(0.356)
-0.078
-0.432
(0.910)
(0.325)
0.215
-0.149
(0.169)
(0.158)
-0.355
(0.283)
Depreciation
Short Term External Debt
Emerging
1
2
-1.147**
0.334***
(0.404)
(0.090)
0.018
0.510*
(0.096)
(0.244)
-0.318
-0.453
(0.215)
(0.390)
-0.490
-2.494***
(0.517)
(0.241)
-0.198
0.006
(0.154)
(0.289)
-0.173
-1.120***
(0.242)
(0.233)
-0.008
-0.112
(0.035)
(0.092)
-0.003
-0.092***
(0.014)
(0.024)
-0.168
0.349**
(0.217)
(0.137)
-0.150
-0.245**
(0.087)
(0.083)
-0.013***
(0.004)
0.039
-0.043
(0.034)
(0.080)
0.547**
1.521
(0.227)
(1.663)
Empirical Analysis :
System GMM Estimation Results
Lagged Dependent Variable
Monetary Policy
GDP
Current Account
Debt to Total Assets
Institutional Quality
Short Term External Debt
Capital Account Openness
Fiscal Position
Stock Prices
Central Bank Transparency
Initial Level of Spread
MP X GDP
MP X Current Account
MP X Exchange Rate Overvaluation
MP X Debt to Total Assets
MP X Short Term External Debt
MP X Capital Account Openness
MP X Fiscal Position
MP X Stock Prices
MP X Central Bank Transparency
Number of Observations
Number of Instruments
Sarga Test P-Value
AR (1)
AR (2)
134
41
0.910
-1.33
0.07
1.024
(1.077)
0.013
(0.066)
5.488
(4.715)
-0.931*
(0.483)
-0.135*
(0.078)
72
36
0.566
-1.29
0.74
-0.033
(0.036)
0.002
(0.079)
0.565
(0.409)
-0.034
(0.249)
0.011
(0.043)
1.470**
(0.636)
-0.238
(0.588)
0.649***
(0.196)
0.143*
(0.078)
-0.102
(0.119)
0.678***
(0.123)
-0.499***
(0.163)
1.969*
(1.018)
-0.062
(0.237)
-0.064**
(0.027)
-4.511***
(0.927)
0.048
(0.043)
83
30
0.129
-1.85*
-0.58
72
31
0.791
-1.34
-1.26
Emerging Economies
Monetary Policy: Ambiguous
Fall in Stock Prices
MP X Debt to Assets
MP X Stock Prices
MP X CB Trans.
Advanced Economies
Monetary Policy: Ambiguous
Deviation GDP Growth
CA Deficit
Overvaluation
Low Inst. Quality
MP X CA Deficit
MP X Fiscal Deficit
MP X Stock Prices
Depreciation
MP X Institutional Quality
4.849
(3.280)
1.032***
(0.326)
0.715
(1.013)
-0.126
(0.196)
0.077
(0.052)
-0.851
(1.533)
-0.018
(0.178)
Advanced
3
4
0.354***
0.351***
(0.116)
(0.037)
0.270
-0.106***
(0.663)
(0.013)
-0.478
-0.118***
(0.297)
(0.016)
-0.178**
0.004
(0.081)
(0.216)
-1.245
-0.876***
(1.049)
(0.110)
0.673*
-0.179**
(0.347)
(0.076)
-0.264***
(0.074)
Depreciation
Exchange Rate Overveluation
Emerging
1
2
0.263***
0.407**
(0.059)
(0.176)
-0.795
0.714*
(0.779)
(0.363)
0.194
1.657
(0.340)
(1.302)
-0.118
-0.094
(0.398)
(2.520)
-1.489
-4.159
(1.343)
(2.553)
-0.388
0.572
(0.392)
(0.621)
0.135
-1.436
(0.668)
(0.990)
0.118
-0.240
(0.168)
(0.191)
-0.103***
-0.168
(0.033)
(0.103)
1.236*
1.453
(0.678)
(1.219)
-0.135
-0.642**
(0.089)
(0.255)
-0.015
(0.038)
0.034
0.016
(0.050)
(0.085)
-0.190
2.326
(0.547)
(2.746)
Conclusions

Tight monetary policy’s ineffectiveness in exchange
rate stabilization is an emerging economy problem:
Financial and corporate sector problems + Tight policy =
Depreciation of exchange rates.


Transparency of central banking has a crucial role
in policy implementation.
Advanced Economies: Excluding 2008 financial
crisis, tight policy stabilizes exchange rates.
Discussion