The real effects of fixed versus floating exchange rate regimes

The real effects of fixed versus floating exchange rate regimes

by Emi Nakamura and Jon Steinsson

There remains limited empirical evidence on the real consequences of fixed versus floating exchange rate regimes, despite the importance of the question, both in terms of developing open economy macroeconomics models, and in determining appropriate macroeconomic policies. A benchmark reference in this literature is Baxter and Stockman (1989), who conclude that the exchange rate arrangement doesn’t matter. This evidence is deeply unsatisfying. The main empirical exercise is to compare pre-1973 (fixed exchange rate) to 1973-1986 output volatility for a set of countries. However, many other factors changed between the pre and post period aside from the exchange rate regime, making it difficult to know whether the exchange rate regime was the cause of any difference between the two periods.
A more recent and more convincing reference is Broda (2006), who studies the effect of “terms of trade” shocks for countries with fixed versus floating exchange rates. A basic challenge here is that the terms of trade depend mechanically on the exchange rate. Broda focuses on small countries for whom he argues the terms of trade are exogenous. We can show, however, using our identification approach (more on this below) that the assumption of an exogenous terms of trade is violated. Rose (2011) concludes his recent survey on this topic by stating that “similar countries choose radically different exchange rate regimes without substantive consequences for macroeconomic outcomes like output growth and inflation.”
We believe these issues are ripe for re-investigation, given the limitations of the empirical methods that have been used in previous research. propose a new identification approach to study these issues below and present some preliminary results.

Exchange rates, capital flows and the financial cycle: the origins of the BIS view

Exchange rates, capital flows and the financial cycle: the origins of the BIS view

by Barry Eichengreen

There is no official Bank for International Settlements view of feasible and desirable exchange rate and international monetary arrangements, so far as can be gleaned from documents and publications of the institution.  Butit is possible to discern the outlines of an unofficial, unstated institutional consensus.  Its most prominent elements are the proposition that lax credit conditions create incentives for risk taking that can threaten systemic stability; that the instruments and institutions that convey capital flows across borders are important for understanding financial-stability risks; and that there is a role for macro-prudential policy in restraining the excesses that heighten these risks.

In this project I will trace the events, personalities and institutional dynamics responsible for the development of this view.  I will do so through the lens of the Bank’s Annual Reports, which provide a distillation of the thinking of staff and management.  I will see characterize the evolution of those analyses, focusing on the post-Bretton Woods period that saw the emergence of the modern BIS and is most directly relevant to today.  I plan on supplementing my discussion with material from the BIS archives and secondary sources.

Does geographic expansion of banks increase, decrease or have no impact on their funding cost?

Does geographic expansion of banks increase, decrease or have no impact on their funding cost?

by Ross Levine

 

It is crucial to understand the impact of the geographic diversification of a bank’s assets on its funding costs because (1) the costs to banks of raising capital, issuing other securities, and attracting deposits affect the allocation and pricing of bank credit, which are central to economic growth and the distribution of income and (2) banks expand geographically for many reasons, raising questions about the impact of such expansions on funding costs and bank lending. Existing research, however, offers differing perspectives on whether the geographic diversification of bank branches and subsidiaries increases, decreases, or has no effect on the costs to banks of raising deposits and issuing securities. This research will provide the first empirical evaluation of the impact of geographic expansion on the costs of a bank’s interest-bearing liabilities, which account for about 90 percent of bank liabilities. A crucial methodological contribution is the development of an empirical strategy to identify the impact of an exogenous source of variation in the geographic expansion of a bank on its funding costs.

Financial Intermediation in International Macroeconomics

Financial Intermediation in International Macroeconomics

by Emily Eisner

This project aims to understand the role of value-at-risk (VaR) constraints and bank risk-taking behavior in determining entry and exit into global asset markets. The model informs the aggregate risk of the global financial markets and informs macroeconomic dynamics that depend on financial frictions in intermediation. The project develops an open economy model of financial markets based on the closed economy model in Coimbra and Rey (2017). In the extended model, financial intermediaries, which are heterogeneous in their VaR constraint as in Coimbra and Rey (2017), have an opportunity to invest in foreign assets. The model predicts the risk-taking composition and international asset composition of financial intermediaries under different interest rate environments.

Topics

Initiatives

How Islamic are Islamic Banks

How Islamic are Islamic Banks

by James Wilcox

More than a dozen countries have both sizable conventional banks and Islamic banks. Instead of paying fixed deposit interest rates, which are prohibited by sharia law, Islamic banks offer profit and loss sharing (PLS) accounts. Payments to PLS accounts should vary with banks’ earnings. To the extent that they do, PLS accounts may be more equity-like than deposits at conventional banks. However, widespread consensus holds that Islamic banks’ payments to depositors are nearly indistinguishable from the interest rates paid by conventional banks. We estimate how much Islamic banks pass through their PLS-related earnings to PLS-related accounts and how much their responses to various factors differ from those of conventional banks. We also analyze how much Islamic banks’ profit and loss sharing has been obscured by previous data difficulties and by their smoothing over time the payments to PLS accounts. The results may shed light on the prospects for PLS loans and deposits as a source of more-equity-like financing from banks for smaller businesses, which often obtain few conventional loans from banks.

 

Topics

Capital flows

Initiatives

Financial Globalization