I spent the last week attending many presentations on macroeconomics and international finance. Among these, some are particularly interesting:
Pablo Cuba Borda, Board of Directors of the Federal Reserve
Martin Bodenstein, Federal Reserve Board
Nils Gornemann, Federal Reserve Board
Ignacio Presno, member of the Federal Reserve Board of Directors
We propose a model with costly international financial intermediation that links exchange rate movements to changes in the demand for domestically produced goods relative to the demand for imported goods (trade rebalancing). Our model is consistent with stylized facts of exchange rate dynamics, including those related to the trade balance, which is generally neglected in the literature on exchange rate determination. In a quantitative assessment, trade rebalancing explains almost 50% of exchange rate fluctuations over the business cycle, while exogenous deviations from uncovered interest rate parity—the main source of exchange rate fluctuations in the literature—account for slightly more than 20%. The use of trade flow or trade balance data is essential to correctly identify the determinants of the exchange rate. Thus, our model overcomes the strong dichotomy between the real exchange rate and the macroeconomy embedded in other models of exchange rate determination.
Speaker:
Federica Romei, University of Oxford
In that first post, I noted that while the paper tried to explain Fama’s result (forward premium rates do not correctly predict exchange rate depreciation), it is not a constant. BCCF (IMF) ER (2022).
Figure 1: Annualized ex post 3-month depreciation of the euro/dollar (vertical axis) relative to the 3-month offshore US-euro interest rate differential (horizontal axis), for 1999M01-2005M04 (top figure), 2005M05-2017M04 (middle figure) and 2017M05-2021M06 (bottom figure). The samples are for interest rate data, so the 1999M01-2005M04 sample includes a 3-month ex post depreciation up to 2005M07.
Tarek Alexander Hassan, Boston University and NBER
Thomas Mertens, Federal Reserve Bank of San Francisco
Jingye Wang, Renmin University of China
Canonical long-run risk and habit models reconcile high risk premia with smooth risk-free rates by inducing an inverse functional relationship between the variance and mean of the stochastic discount factor. We show that this highly successful resolution of closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies with complete markets: it requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns differ because interest rates differ substantially across currencies. We show that the exchange risk premia arising from canonical long-run risk and habit preferences cannot accommodate this fact. We argue that this tension between canonical asset pricing and international macroeconomic models is one of the main reasons why researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. The lack of such a unifying model is a major obstacle to understanding the effect of risk premia on international markets.
Speaker:
Hanno Lustig, Stanford University and NBER
Seunghoon Na, Purdue University
Yinxi Xie, Bank of Canada
This paper studies exchange rate dynamics and forecast errors by incorporating bounded rationality into a small open economy neo-Keynesian model. Policymakers have limited foresight, and are only able to plan up to a finite distance into the future. This leads to dynamic overshooting of real exchange rate forecast errors over different time horizons. It also distinguishes between short-term and long-term expectation formations, where the law of iterated expectations is broken. This framework provides a micro-basis for understanding time and forecast horizon variability in uncovered interest parity (UIP) puzzles. Our model predictions about these UIP violations align both qualitatively and quantitatively with empirical estimates.
Speaker:
Rosen Valchev, Boston College and NBER
I found this article particularly interesting because, with Guy Meredith, I found a consistent relationship with this model. Chinn and Meredith (1998).
Figure 2: Panel beta coefficients at different horizons. Notes: Up to 12 months, panel estimates for 6 currencies against the US dollar, euro deposit rates, 1980Q1-2000Q4; 3-year results are zero coupon yields, 1976Q1-1999Q2; 5 and 10 years, constant yields to maturity, 1980Q1-2000Q4 and 1983Q1-2000Q4 (last observation is exchange rate data). Source: Chinn (2006).
Some updated results are in this Publication 2022.
