The role of monetary policy in managing the euro dollar exchange rate

Transcription

1 The role of moneary polcy n managng he euro dollar exchange rae Nkolaos Mylonds a, and Ioanna Samopoulou a a Deparmen of Economcs, Unversy of Ioannna, 45 0 Ioannna, Greece. Absrac The US Federal Reserve s new relaxed moneary polcy (he so-called quanave easng) has rggered conroversy among economss and polcy makers abou s effecveness. Ths paper nvesgaes he role of moneary polcy n managng he euro dollar exchange rae va alernave conegraon ess and mpulse response funcons. I s found ha moneary fundamenals have neher long- nor shor-run mpac on he exchange rae. Ths mples ha he Fed s quanave easng schemes are unlkely o have any sgnfcan mpac on he euro dollar rae. Keywords: Exchange raes; Moneary model; Conegraon; Impulse response funcons JEL classfcaon: F3; E52 Correspondng auhor. Tel: ; fax: E-mal address: nmylond@uo.gr

2 The role of moneary polcy n managng he euro dollar exchange rae. Inroducon The euro dollar exchange rae s of grea mporance gven he leadng nernaonal saus of boh currences. Euro deprecaed snce s nroducon (on January 4, 999) seadly and whou any major nerrupon unl February Then began o rse agans dollar almos smoohly and reached a hegh of o US$ on July 5, Wh he ouburs of he global fnancal crss, euro nally deprecaed agans he dollar, bu almos reganed s value by November 2009 ( 0.665/US$). Snce hen, he value of he euro frs deprecaed and hen pcked-up agan (see Fgure ). Ths paper aemps o examne he behavour of he euro dollar exchange rae by ulsng he moneary approach o exchange rae (MAER) deermnaon. The MAER emerged as he domnan exchange rae model a he ouse of he recen floa n he early 970s and remans an mporan exchange rae paradgm. Despe s quesonable forecasng ably (as frs suggesed by Meese and Rogoff 983), hs approach reans s appeal as provdes he heorecal framework for nvesgang he role of moneary polcy n managng exchange raes. Ths s a opcal ssue snce he alk of a currency war s sll makng headlnes as varous economes aemp o fnd ways o weaken her currences, and hus make her expors more compeve n he sruggle for economc recovery. There s a wdespread vew, for example, ha he US Federal Reserve s polcy of quanave easng (.e., prnng money o buy bonds) n he pos-2009 perod has reduced he value of he dollar relave o oher currences (such as he euro), whose volume remans consan or rses more slowly. 2 Alhough hs may be rue n he very shor-erm, vsual nspecon of Fgure suggess ha he nfluence of he Fed s quanave easng schemes of he las wo years on he euro dollar exchange rae s less han clear cu for longer horzons. [Fgure ] Our major concern n hs paper s o emprcally esmae he all-ou dynamc of he euro dollar exchange rae n relaon o s fundamenals by dscernng he long-run effecs of moneary polcy on he exchange rae from s shorrun mpacs. In hs regard, we employ boh conegraon echnques and mpulse response funcons (IRFs) o analyse he long- and shor-erm dynamc model for he euro dollar rae. Ths paper possesses wo man noveles. Frs, nvesgaes no only he long-run relaonshp beween he For a revew of he recen leraure on he emprcal valdy of he MAER see Beckmann e al. (200). 2 The Fed launched s quanave easng programme n January The European Cenral Bank offcally denes embarkng on quanave easng. 2

3 euro dollar rae and s fundamenals, bu also he shor-run dynamcs as raced by he me-profle and response rajecores of he exchange rae o he shocks o he nnovaons of varables under consderaon. Ths s parcularly mporan snce he Fed has only recenly adoped quanave easng schemes whose mpac on he euro dollar exchange rae has no been ye formally esed. Second, he paper uses exclusvely pos-999 daa. A number of arcles ha ulse he MAER approach use eher euro synhec daa (van Aarle e al. 2000; Frenkel and Koske 2004; Alavlla 2008), or Deuschmark daa (Beckmann e al. 200) for he perod before he nroducon of he common currency. Accordng o our opnon, hs sraegy masks he fac ha he euro area counres dd no necessarly pursue a common moneary polcy pror o 999. The exclusve use of acual euro marke daa overcomes he problem of dversfed moneary polces, and hus allows us o accuraely examne he (possble) lnkages beween he euro dollar exchange rae and s fundamenals. The res of he paper s srucured as follows: The MAER and he mehodologes employed are skeched n Secon 2. The daa se s descrbed and he emprcal resuls are dscussed n Secon 3. Secon 4 concludes. 2. Mehodologcal consderaons The MAER was developed afer he collapse of he fxed exchange rae sysem n he 970s. Several versons have been pu forward ha can be broadly classfed no wo man ypes of models: (a) he flexble-prce moneary model (Frenkel, 976; Blson, 978), and (b) he scky-prce moneary model (Dornbusch, 976) and he real neres rae dfferenal model (Frankel, 979). Whchever model ha one adheres o, he clear mplcaon s ha moneary polcy s he mos effecve means of managng he exchange rae. The MAER can be expressed hrough he followng reduced form: e e ( m ) ( ) ( ) ( ) - m + γ y - y + γ - + γ ϖ - ϖ ε s = c + γ () where s s he spo exchange rae (prce quoaon), (foregn) money supply, y ( ) s he domesc (foregn) neres rae, m ( ) m s he domesc y s he domesc (foregn) real ncome, e ϖ ( ) e ( ) ϖ s he domesc (foregn) expeced nflaon rae, c s a consan and ε s a whe nose error. Table summarzes he drecon n whch he explanaory varables are expeced o nfluence he exchange rae wh respec o he aforemenoned versons of he MAER. [Table ] Equaon oulnes he long-run relaonshp among he varables under consderaon. To examne he long-run valdy of he MAER, we mplemen 3

4 hree alernave conegraon echnques. The frs echnque, developed by Johansen and Juselus (990) and Johansen (99), apples maxmum lkelhood o a vecor auoregressve (VAR) model assumng ha he errors e e are Gaussan. Defnng X [ s, ( m - m ), ( y - y ), ( - ), ( ϖ - ϖ )] = as he vecor of endogenous varables, he error-correcon form of he VAR can be wren as: k- X = Γ X + ΠX + ε (2) = - - The rank of marx Π (whch shows he number of conegrang vecors) s deermned by means of wo lkelhood rao ess: he race sasc and he maxmum egenvalue sasc. The second echnque, known as he Auoregressve Dsrbued Lag (ARDL) bounds approach o conegraon, was nroduced by Pesaran e al. (200). The advanage of hs approach s ha does no requre any un roo preesng of he varables and can be appled wheher he varables under consderaon are negraed of order one or zero or even fraconally conegraed. To mplemen he bounds es le a vecor ( ) ξ = s, Z where s s he exchange rae and Z s he vecor of regressors. The error correcon represenaon of he ARDL specfcaon model s gven by: p ' s = α + λ s + λ Z + θ s + φ Z + ε (3) - 5 =2 - - = j= 0 q where λ and λ are long-run mulplers, α s he consan, and ε are whe nose errors. The es for he absence of a long-run relaonshp beween s and Z enals he followng null hypohess: H 0 : λ = 0, λ = 0 for =2,, 5 Pesaran e al. (200) provde he crcal values for hs F-es. If he compued F-sasc s above (below) he upper (lower) bound crcal value he null hypohess of no conegraon s rejeced (acceped). If he F-sasc falls whn he lower and upper bounds, he resuls are nconclusve. A major shorcomng of boh echnques s ha hey do no accoun for srucural changes n he conegrang vecor. Thus, we also use he Gregory and Hansen (996) approach ha ess for conegraon wh a one shf n he conegrang vecor a some unknown dae. Here we consder a level shf model (model 2 n Gregory and Hansen) whch (followng he former noaon) akes he form: j - j 4

5 4 µ φ a Z u (4) = s = µ + where φ = 0 f [nτ] and φ = oherwse, τ s an unknown parameer denong he mng of he change pon and [ ] denoes he neger par. In equaon (4), µ s he nercep before he shf and µ 2 s he change n he nercep due o he shf. Gregory and Hansen provde hree ess whch are modfed versons of he Za and Z (Phllps, 987) and he ADF sascs. I should be noed here ha he underlyng movaon of Gregory and Hansen s mehodology s no he esmaon of he break dae per se; nsead he focus s on mprovng he power of convenonal conegraon ess by allowng for a srucural change. Informaon regardng he exsence of conegraon s crucal f one wans o accuraely esmae he shor-run dynamc relaonshps beween he euro dollar rae and s fundamenals. The mos convenen way o characerse hese relaonshps s o smulae her responses o unancpaed shocks n each of he varables (mpulse response funcons - IRFs). IRFs capure dynamc behavour as hey race he effec of an exogenous shock o a varable on curren and fuure values of anoher varable. IRFs are calculaed from he movng average represenaon of he VAR model: X = A ε (5) =0 - where X s he vecor of he jonly deermned dependen varables and he coeffcen marces A are recursvely calculaed usng he followng expresson: A = φ A- + φ2 A φ ρα -ρ, =, 2,, wh A 0 = I X and A = 0 for <0. Followng Pesaran and Shn (998), he scaled generalzed IRF (GIRF) of varable X wh respec o a sandard error shock n he j h equaon can be defned as: GIRF ( X X, h) Ah e j, j =, h = 0,, 2, σ jj where σ jj s jj h elemen n he varance covarance marx and e j s m vecor wh uny a s j h row and zeros elsewhere. GIRFs are unque and do no requre he pror orhogonalsaon of he shocks. In conras, he 5

6 wdely used orhogonalsed IRFs are dependen on he choce of he a pror orderng for he varables n he Cholesk decomposon. GIRFs can be derved from wo ypes of VAR models. One s a sandard VAR n levels (f all varables are saonary), or n frs dfferences (f all varables are non-saonary bu no conegraed). The oher s a vecor error-correcon model (VECM) ha explcly models non-saonary varables and conegrang relaonshps ha are presen n he daa. 3. Emprcal fndngs The daa orgnae from he IMF s Inernaonal Fnancal Sascs (IFS) daabase. The daa are of monhly frequency spannng from 999M0 o 200M. Exchange raes are monhly averages n erms of euro/us$. The chosen moneary aggregaes are narrow money sock (M). Indusral producon ndces are used as proxes for real ncome. Ineres raes are monhly averages of shor-erm marke raes. Precedng welve monhs growh n consumer prce ndces s used as a measure of he unobservable expeced nflaon rae. All varables, excep for neres raes and expeced nflaon raes, are expressed n naural logarhms. Table 2 repors he oucome of he Augmened Dckey Fuller (ADF) ess (Dckey and Fuller, 979). The ess are carred ou n models wh and whou a (lnear) rend, n addon o he nercep erm. The rend appears o be boh numercally and sascally nsgnfcan n almos all nsances. Therefore, we confne our aenon o he nercep only case. The es resuls show ha all, bu one, varables are saonary n frs dfferences (.e. I()). The expeced nflaon dfferenal s he only varable ha exhbs srong saonary n levels (I(0)). 3 [Table 2] Nex, we es for conegraon usng Johansen and Juselus (990) procedure (Table 3 Panel A). Boh he race and he maxmum egenvalue sascs ndcae he exsence of a mos one conegrang equlbrum relaonshp beween he euro dollar exchange rae and s fundamenals a he 0% sgnfcance level. Neverheless, we suspec ha hs sngle conegrang vecor s spanned by he saonary of he expeced nflaon dfferenal. Formal esng of hs hypohess verfes our a pror conjecure (χ 2 = 3.044, p- value = 0.550). In essence, hs fndng ndcaes ha here s no long-run relaonshp among he varables under consderaon. The ARDL approach o conegraon furher suppors hs oucome (Table 3 Panel B). The compued F-sasc (=2.582) s less han he correspondng lower bound 3 We also performed Ello e al. (996) DF-GLS ess wh correced mean. The es resuls verfy he oucome of he repored ADF ess. For brevy he resuls are no repored bu hey are avalable upon reques. 6

7 crcal value (=2.86). Therefore, we accep he null of no long-run relaonshp. However, hs concluson mgh be msleadng f he conegrang relaonshp has shfed over me due o a srucural change. To hs end, we employ he procedure proposed by Gregory and Hansen. The alernave es resuls are repored n Table 3 Panel C. Agan, all ess fal o rejec he null of no conegraon. 4,5 Conclusvely, he alernave conegraon es resuls unformly sugges ha here s no long-run equlbrum relaonshp beween he euro dollar exchange rae and s fundamenals n he pos-999 perod. [Table 3] In he fnal sage of our analyss, we race he shor-run mpac of a one me shock o he macroeconomc fundamenals on he euro dollar exchange rae. For, we proceed by esmang he correspondng GIRFs. Gven he absence of conegraon, GIRFs are derved from he resduals of a sable VAR(2) model where all varables (excep expeced nflaon dfferenal) appear n frs-dfference form. 6 Fgure 2 shows he response of he euro dollar exchange rae (along wh her respecve boosrapped 95% confdence nervals) o nnovaons of one sandard devaon n he fundamenals. A 20- monh horzon s consdered. The upper lef graph n Fgure 2 llusraes he GIRF of he exchange rae subjec o a shock n he relave money supply. I s evden ha he effec s nally negave (.e. euro apprecaes agans he US$) bu becomes posve from he hrd monh onwards. Neverheless, hs exchange rae response s sascally nsgnfcan snce les whn he confdence nervals whch unformly evolve around he zero axs. Smlarly, he responses of he exchange rae o a shock o relave ncome, neres rae dfferenal and expeced nflaon dfferenal are que small and nonsgnfcan n almos all cases. These fndngs sugges he absence of any sgnfcan shor-run effecs of shocks n macroeconomc fundamenals o he euro dollar exchange rae. 4. Concludng remarks [Fgure 2] Ths paper uses he MAER o nvesgae he role of moneary polcy n managng he euro dollar exchange rae durng he recen pas. Conrary o 4 We also esed for conegraon usng Gregory and Hansen s Models 3 (level shf wh rend) and 4 (regme shf). Agan, all ess ndcae no conegraon. 5 Beckmann e al. (200) use he Ba and Perron (998, 2003) sequenal procedure and fnd one srucural break n he 2000s (2004:). The ADF es of he Gregory and Hansen (996) procedure (Table 3 Panel C) denfes one srucural break n 2005:04. Neverheless, accounng for hs break does no seem o aler he evdence of no-conegraon. 6 The esmaed VAR(2) does no suffer from seral correlaon and sasfes he sably condon snce all nverse roos of he characersc AR polynomal have modulus less han one. 7

8 prevous sudes, we also consder shor-run dynamcs ogeher wh he (more convenonal) long-run relaonshp beween he exchange rae and s underlyng moneary/macroeconomc fundamenals. The conegraon es resuls do no provde any suppor for he long-run properes of he moneary approach. Smlarly, he generalzed mpulse response funcons show ha he exchange rae response o moneary shocks s small and nsgnfcan. Thus, he Fed s new relaxed moneary polcy s unlkely o have any sgnfcan mpac on he euro dollar rae. Overall, he oucome of our analyss corroboraes he so-called exchange rae dsconnec puzzle. Therefore, furher research s needed n order o explore he way ha expecaons of exchange raes are formed. Alernavely, modellng he euro dollar exchange raes n a lnear fashon may be nadequae. In hs sense he resuls from hs sudy se he sage for fuure research. References van Aarle B., Boss M. and Hlouskova J. (2000). Forecasng he Euro exchange rae usng vecor error correcon models, Revew of World Economcs, 36, Alavlla, C. (2008) The (UN-) sable relaonshp beween he exchange rae and s fundamenals, Appled Economcs Leers, 5, Ba, J. and Perron, P. (998) Esmang and esng lnear models wh mulple srucural changes, Economerca, 66, Ba, J. and Perron, P. (2003) Compuaon and analyss of mulple srucural change models, Journal of Appled Economercs, 8, 22. Beckmann, J., Belke A. and Kühl, M. (200) The dollar-euro exchange rae and macroeconomc fundamenals: a me-varyng coeffcen approach, Revew of World Economcs (forhcomng). Blson, J. F. O. (978) Raonal expecaons and he exchange rae, n The Economcs of Exchange Raes (Eds) J. A. Frankel and H. G. Johnson, Addson- Wesley, Readng MA, pp Dckey, D. and Fuller, W. (979) Dsrbuon of he esmaes for auoregressve me seres wh a un roo, Journal of he Amercan Sascal Assocaon, 74, Dornbusch, R. (976) Expecaons and exchange rae dynamcs, Journal of Polcal Economy, 84, Ello, G., Rohenber, T. J. and Sock, J. H. (996) Effcen ess for an auoregressve un roo, Economerca, 64, Frankel, J. (979) On he Mark: A Theory of Floang Exchange Raes Based on Real Ineres Rae Dfferenals, Amercan Economc Revew, 69, Frenkel, J. A. (976) A moneary approach o he exchange rae: docrnal aspecs and emprcal evdence, n Exchange Rae Economcs Volume I (Eds) R. MacDonald and M. P. Taylor, Cambrdge Unversy Press, Cambrdge, pp

9 Frenkel, M. and Koske, I. (2004) How well can moneary facors explan he exchange rae of he euro?, Alanc Economc Journal, Inernaonal Alanc Economc Socey, 32, Gregory, A. W. and Hansen, B. E (996) Resdual-based ess for conegraon n models wh regme shfs, Journal of Economercs, 70, Johansen, S., Juselus, K. (990) Maxmum Lkelhood Esmaon and Inference on Conegraon-wh Applcaons o he Demand for Money. Oxford Bullen of Economcs and Sascs, 52, Johansen, S. (99) Esmaon and Hypohess Tesng of Conegraon Vecors n Gaussan Vecor Auoregressve Models, Economerca, 52, Meese, R. and Rogoff, K. (983) Emprcal Exchange Rae Models of he Sevenes: Do hey f Ou of Sample?, Journal of Inernaonal Economcs, 4, Pesaran, M. and Shn, Y. (998) Generalzed mpulse response analyss n lnear mulvarae models, Economcs Leers, 58, Pesaran, M. H., Shn, Y. and Smh R. J. (200) Bounds esng approaches o he analyss of level relaonshps, Journal of Appled Economercs, 6, Phllps, P. C.B. (987) Tme seres regresson wh a un roo, Economerca, 55,

10 Table. Alernave hypoheses on he coeffcens of he MAER (m-m) (y-y) (-) (ϖ e -ϖ e ) Coeffcens γ γ 2 γ 3 γ 4 Frenkel Blson Dornbusch Frankel Table 2. ADF es resuls I. Levels Inercep Inercep and rend -ADF -ADF Trend s х0-5 [0.0] ( m - m ) х0-5 [0.6] ( y - y ) х0-6 [0.43] ( - ) ( ) х0-6 [0.56] ϖ - ϖ х0-6 [0.3] II. Frs dfferences Inercep -ADF s ( ) m - m y - y ( ) ( ) Noes: The ADF ess are based on parsmonous ADF models ha were derved by mnmsng he SIC, sarng from a generous lag lengh of 3. Panel I: Columns 2 and 3 repor he -ADF values wh nercep and nercep & rend, respecvely. Column 4 presens he esmaed coeffcens of he (lnear) rend and he assocaed p-values (n brackes). Rejecon of he null a he 5% level. 0

11 Table 3. Conegraon es resuls Panel A: Johansen and Juselus procedure λ LM() H 0: [0, 0, 0, 0, ] λ race max r= (0.059) (0.068) (0.308) (0.550) r<= (0.387) (0.625) Panel B: ARDL approach F[s (m-m),(y-y),(-),(ϖ e -ϖ e )] LM() (0.373) ADF Panel C: Gregory and Hansen procedure (Model 2) Z Z a [2005M04] [2002M08] [2002M07] Noes: The fgures n parenheses denoe p-values. All compuaons are carred ou n EVews 5.0. Panel A: The race and max. egenvalue sascs are based on an unresrced VAR(2). We allow for he presence of an nercep, bu no me rend, n he conegrang equaons. LM() ess for seral correlaon of s order n he unresrced VAR. H 0 ess for he saonary of he expeced nflaon dfferenal and s dsrbued as χ 2 (4). Panel B: The number of lags n eq. (3) s se equal o. LM() ess for seral correlaon of s order. The 5% crcal values (Case III: unresrced nercep and no rend) for k=4 are 2.86 (lower bound) and 4.0 (upper bound). Panel C: The 5% crcal values for m=4 are -5.56, and for ADF, Z a and Z, respecvely. The numbers n brackes are he esmaed srucural break daes [year/mm].

12 Fgure. The euro dollar exchange rae: 999M0 200M Noes: The shaded area represens he perod of he Fed s embarkng on quanave easng. Fgure 2. Generalsed Impulse Response Funcons Response of euro/us$ o nnovaons of one s.d. n relave money supply Response of euro/us$ o nnovaons of one s.d. n relave ncome Response of euro/us$ o nnovaons of one s.d. n neres rae dfferenal Response of euro/us$ o nnovaons of one s.d. n expeced nflaon dfferenal Noes: The doed lnes represen he 95% confdence nervals. Mone Carlo smulaons usng,000 draws are performed o compue he error confdence bands. 2