floating exchange rate

The coefficient for broad money is not significant for both general and food inflation which is a very surprising result. One possible explanation in this case is that the transmission mechanism is indirect and involves the role of interest rate. This may also explain the neutrality of money growth on inflation for the entire sample period. The broad money may also have negative impact on inflation as demonstrated by the famous Price Puzzle 3 observed in the US. This insignificant result does not accord well with the findings of Grauwe & Magdalena (2005), Nisar & Tufail (2013) and Khan & Islam (2013) who found a statistically significant positive association between money growth and inflation. However, they have different estimation approaches like some studies use the wholesale prices instead of consumer prices. Particularly, Khan & Islam (2013) who used a sample of yearly data of Bangladesh for the period 1974-2010, thus containing both fixed (1974- July, 2003) and floating exchange rate regimes (after July, 2003) while our sample is entirely after the adoption of the floating exchange rate regime. The choice of both the fixed and floating exchange rate regime in their sample period may also lead to these results which could be biased as suggested by Ball, Lopez & Reyes (2013).

that countries under flexible regimes do not enjoy full monetary policy autonomy. However, these countries follow the monetary policy of those key currency countries from which they import the largest part of their goods and services and in which currency most of the cross border assets are denominated. My argumentation builds on work of Plümper and Troeger (2006a,b) who examine how the foundation of the European Monetary Union impacts monetary policy flexibility of countries which did not join the Union. The theoretical argument is partly based on McKinnon's (1963) argument that small open economies with flexible exchange rate arrangements have only limited monetary flexibility due to the fact that interest rate differentials to the relevant key currency area have real exchange-rate effects. Accordingly, cutting back the interest rate for achieving domestic goals would lead to a devaluation of the domestic currency and accordingly to imported inflation. I will show that this effect is the larger the more goods and services are imported from the key currency area and the more domestic cross border assets are denominated in the key currency. The trade argument builds upon the Optimal Currency Area (OCA) theory (see Alesina and Barro 2001 and 2002, Mundell 1961, Frankel and Rose 1997, Rogoff 2001, Alesina/ Barro and Tenreyro 2002, McKinnon 2004) stating that a common currency reduces hedging and exchange rate risks. In accordance, countries with a joint currency benefit largely from intensified trade. In some contrast to the OCA literature and the “fear of floating” literature I develop a model explaining monetary policy choices of governments who are constraint by efforts to satisfy domestic voters on the one hand and international consequences of domestic policy choices on the other hand. The formal model developed in this section generates predictions about the factors defining the level of monetary policy autonomy in open economies under floating exchange rate regimes.

governance. Both are currently regional financial centers with relatively developed financial sectors and top- rated public services. Domestic prices and wages are almost flexible with little rigidity (Ding Lu, 1999). Both governments have enjoyed a benign budget surplus during the non-economic-crises times and have accumulated large official foreign reserves. Both Singapore and Hong Kong play more and more active roles in the Sovereign Wealth Fund Market than other similar-sized economies. Because of their limited natural resources, exports in both economies depend mainly on raw materials and on imported parts. However, both economies have fairly different money system and exchange rate regime. Hong Kong has a currency board system (CBS) under which the Hong Kong dollar is pegged to the US dollar at a fixed exchange rate since 1983(Shu-ki Tsang, 1999). In contrast, Singapore has gradually switched from the traditional sterling-based CBS into a managed float monitoring band regime under which the value of the Singapore dollar is managed floating within an undisclosed band based upon a trade-weighted basket of foreign currencies from 1970’s (Yip, S. L, 2003). This paper considers the implications of the managed floating exchange rate system on the interest rate behavior of Singapore. We examine the Singapore - U.S. interest differential under the managed floating exchange rate system. We also study whether there is any change in the correlation between the Singapore and U.S. interest rates differential due to the financial crisis by using a GARCH model. Consider Hong Kong’ s economic situation in the past years, linked exchange rate regime survived severe attacks on the Hong Kong dollar by those international hedge funds during the Asian Financial Crisis. It is, however, not optimal for Hong Kong to insist on its currency board-type exchange rate regime in the future, especially given that Hong Kong had lost much more on the Mini bond issue than Singapore under this global financial crisis. In this aspect, Singapore’s experience of a currency regime that has evolved from a classical CBS offers an alternative for Hong Kong’s government.

The experience of Bangladesh under the floating exchange rate system is only three years plus which is yet very short to reach any significant conclusion. However, it is possible to draw an overview about the performance of the key economic indicators which will be helpful in drawing some policy recommendations. Though Bangladesh adopted the floating regime one month before the end of the fiscal year 2002-03 that is in May,2003, comparisons of the economic indicators are made over three post-regime fiscal years (July,03-June,06) with that of the previous three fiscal years(July,00- June,03) because of uniformity and computational advantage. In order to discern regime-specific behavior, the exchange rate characteristics of Bangladesh are compared between pre exit and post exit period. A similar exercise is carried out for interest rates, reserves, import, export, inflation etc.

Interestingly, the monetary autonomy represent both a negative characteristic for countries which chose fixed exchange rates in order to escape from inflation and a positive feature for countries which intend to have more control over their national economies. Consequently, it results that the key of success, both for the fixed exchange rate regime and for floating exchange rate regime depends on prudent monetary and fiscal policies. The option of fixed rates enables the countries to accelerate a more prudent monetary policy while the choosing of floating rates represent a blessing for those countries which have already implemented a prudent monetary policy.

On the other hand, the negative accumulated response of exchange rate after the export shock is not uniform to the standard findings but not unique as well. While studying the effect of different shocks on foreign trade in Finland's economy, for example, Sariola (2009) finds this sort of relationship. As the result suggests, in Bangladesh the immediate cumulative effect of export shock is negative before it moves up a bit in 3rd month and becomes stationary to -0.2% on average from fourth month and so on. Again, this pattern of exchange rate does make sense in the Bangladesh context. This is consistent with the relentless endeavour of the GoB 8 to maintain the export growth by managing the exchange rate through central bank when it requires. For example, after entering the managed-floating exchange rate regime in 2003, the central bank of Bangladesh kept the exchange rate almost in the same level (undervalued) during the period 2005-2010 with the target of not hurting exporter.

The IFR shows how the variables used in future study respond to the exchange rate shock. The IRFs analysis in this section tracked the impact of exchange rate shocks (LS) on the variables of import price (LP) and national income (LY). The IFRS analysis was conducted to innovation by increasing the value of exchange rate variable of one standard deviation at the beginning of the period resulting in quarterly changes over a period of ten quarters or 2½ years. The selection of ten quarter was expected to be relatively precise to observe the changes in the variables of price (LP) and national income (LY) to the shock innovation of exchange rate. The figure of impulse response shows the response of a variable due to the shock of the other variables for some periods after the shock. When the images of impulse response show the movement which is getting closer to balance (convergence) or returns to the previous equilibrium, it means thatthe response of a variable due to the shock does not leave permanent effect on the variables. Figure 1 shows that the observation of the effects of responses received by import prices due to the shock of exchange rate over ten quarters. At the beginning of the period, the price response due to the shock of exchange rate was very small. Then, the price response increased until the second quarter. However, after the second quarter, the price response to exchange rate change was relatively constant, but do not indicate the nature of convergence. It shows that the shock of exchange rate to exchange rate is relatively permanent.

targeting, to 1 when seignorage has a high weight in the policy maker’s objective function. As shown in Table 4, in about 83 percent of the cases the index of exchange rate flexibility is below that of Australia--for Japan and the United States the share of cases below these two benchmarks is 95 and 90, respectively. When we disaggregate the advanced economies from the emerging market countries, no obvious differences emerge on the proportion of cases that lie below and above the three benchmarks. Separating the two groups does shed light on the “causes” behind the high readings. For the advanced economies, there is no obvious link between a high flexibility index reading and high inflation or rising inflation, as is usually the case following a currency crisis. For emerging markets, however, between 66 and 93 percent of the cases (depending on

Second, high assets and currency substitutability under a floating exchange rate regime make a change in the exchange rate, in reponse to a change in monetary policy, more excessive than[r]

absence of real or nominal shocks in these economies--indeed, relative to the United States and Japan most of these countries are subject to larger and more frequent shocks to their terms of trade, hardly surprising, given the high primary commodity content of their exports in many cases. Second, the low relative exchange rate variability is the deliberate result of policy actions to stabilize the exchange rate. Reserve volatility (contrary to what we should expect in the context of a floating exchange rate or relative to what we observe in the more committed floaters) is very high. Third, interest rate volatility (both real and nominal) is significantly higher--and in a different league altogether--from that of the “true(r)” floaters. The high volatility in both real and nominal interest rates appears to have had two main explanations. It suggests that countries are not relying exclusively on foreign exchange market intervention to smooth fluctuations in the exchange rates--interest rate defenses are commonplace. The high variability of interest rates also suggests that there are chronic credibility problems. Lastly, since countries that are classified as having a managed float mostly resemble noncredible pegs--the so- called Αdemise of fixed exchange rates≅ is a myth. Instead, the fear of floating is pervasive, even

In monetary policy transmission, the Rupiah’s exchange rate is one of explanatories on the change of price rate in a period beyond the growth of money supply. The exchange rate dynamics will affect aggregate supply and demand which eventually affects the output and the price. The magnitude of the impact from exchange rate movement on the price rate is primarily determined by the exchange rate regime in a country. In a managed floating exchange rate system, an expansive monetary policy by the central bank drives the depreciation of domestic currency and increases the price of imported goods that subsequently drives the increase in price of domestic goods; even without expansion on the aggregate demand. This is commonly termed as the direct impact of exchange rate movement (direct pass-through) while the impact of exchange rate through aggregate demand changes is indirect (indirect pass-through).

Results indicate that there are differences depending on who the originator of the shock is, i.e. the EU or US, and whether the country has a floating or fixed exchange rate regime. Following the EU shock, floating exchange rate countries mostly experience contractions. Interest rates are the only transmission mechanism, and it appears that countries who have more reliance on international capital flows are the ones either increasing their interest rates in response to the foreign shock, thus keeping capital from flowing out but sacrificing real economic growth, or failing to raise rates and experiencing contractions nonetheless. Countries with lower reliance on international capital flows use countercyclical interest rate policy in an attempt to offset the shock, though unsuccessfully as some third factor is driving their results. Fixed exchange rate countries following the EU shock experience more mixed real economy results in earlier periods, becoming more expansionary in the medium and long term. Both interest rates and trade act as transmission mechanisms for these countries. The economies that experience expansions see increased trade from a lowering of prices and/or are able to use capital controls to maintain the peg and lower interest rates. Those economies experiencing contractions see increases in prices from the lowering of interest rates, resulting in decreased trade that dominates other effects.

In Nigeria, exchange rate policies are implemented by the Central Bank of Nigeria (CBN) and consistently targeted at avoiding substantial misalignments as well as achieving a realistic Naira exchange rate that is capable of addressing the basic problems of the country’s external sector. These ranged from a fixed exchange rate regime prior to 1986 to various forms of floating exchange rate system, following the liberalization of the foreign exchange market in 1986. Consequent upon the adoption of Social Adjustment Programme (SAP) in 1986, the Second-tier Foreign Exchange Market (SFEM) was introduced as a market-driven mechanism for foreign exchange allocation. Currently, foreign exchange transactions are guided by the Wholesale Dutch Auction System (WDAS), which was introduced on the 20th of February, 2006. Historically, many currencies of the world have suffered crashes. These include the Bretton Woods system collapse of 1971-73, the British pound crisis of 1976, the European Exchange Rate Mechanism (EERM) mayhem of 1992-93, the Mexican peso crisis of 1994-95 and the Russian rubble crisis of 1998, amongst others. In fact, Hutchison and Noy (2002) noted that more than 51 currency crises episodes occurred in emerging-market economies between 1976 and 2001. The pervasive socio-economic costs of such crises have also been widely documented in countries of diverse economic structures and monetary policy frameworks. For instance, Hutchison and Noy (2002) found a 5-8 per cent currency-crises-caused output reduction in emerging market economies while Bordo et al. (2001) estimated currency crisis cost amounting to 5-10 per cent of GDP. There is also evidence that currency crises can result to banking crises (i.e. the twin crises), especially when the banking sector holds substantial unhedged foreign liabilities during periods of sharp exchange rate depreciation (Glick and Hutchison, 2001). In this regard, the balance sheets of banks are negatively affected as the domestic currency value of their foreign liabilities become bloated. These historical perspectives as well as the experiences of the 2008- 09 financial crisis underscores the pervasiveness as well as the spread of currency crises via contagion.

In view of the above findings, it can be concluded that in the long run, exchange rate regimes do matter for trade. When comparing the freely floating exchange rate regime (year 2000 to current), to the fixed exchange rate regime, the dual exchange rate regime and the managed floating exchange rate regime, it was found that South African trade performed better under a fixed or managed exchange rate regime than the freely floating exchange rate regime. This study’s findings are consistent with economic theory and empirical studies that developing countries perform better under a more managed or fixed exchange rate regime. However, caution should be taken when considering the adoption of a fixed exchange rate regime as it can be costly to maintain and may not be sustainable in the long run. It is therefore recommended that South Africa adopts a managed floating exchange rate regime until its markets and the economy are developed to deal with exchange rate fluctuations associated with a freely floating exchange rate regime. The objective of the South African Reserve Bank is to maintain price stability through the inflation rate-targeting framework. However, the adoption of a freely floating exchange rate implies that import and export prices also fluctuate, defeating the objective of monetary policy. A study by Gupta (2012) revealed that South Africa’s inflation rate was more volatile since the year 2000, when the South African Reserve Bank discarded exchange rate targeting and adopted an inflation rate-targeting framework. As a result, it is recommended that the Reserve Bank should consider reverting to an exchange rate targeting framework.

hand corner, would be like a ‘slow motion train crash’: policy-makers would hang onto the peg far too long before the inevitable occurred, and in the meantime interest rates would inflict increasing damage to the economy. Note that, in this case, a speculative attack might advert the delay by achieving an early devaluation anyway! (Policy-makers expecting a costly transition will tend to ‘devalue later’, see Row 2 Column 1: here too, this delay might be foreshortened by a ‘self-fulfilling crisis’.) Now assume that only a chaotic transition to floating exchange rate is possible so that devaluation should effectively be ruled out as a policy tool. In these circumstances, following the Fenix plan with a relatively ‘early devaluation’ would be a disaster. (The plan would also seem ill-advised in the case of costly transition.) This last column presumably captures the view of Mr. Cavallo 3 who vowed never to devalue or default.

While there is no significant nominal rigidities or price rigidities, the choice of the exchange rate regime is largely insignificant. Note that only nominal rigidities matter. A country may be constrained by real rigidities (real wage rigidities, non-flexible relative price, non-wage labour costs high, stagnant productivity of factors of production immobility) and its actual economic performance will be mediocre, without this having implications for the choice of the exchange rate regime. Unless these realities can be effectively addressed through changes in the nominal exchange rate, this country's performance will be equally poor with a credible fixed exchange rate, a floating exchange rate, or a universal bilateral barter system. The severity and persistence of nominal rigidities therefore become a key political and empirical issue. Unfortunately, the empirical results available are extremely opaque and difficult to interpret. Even if information is available, on the rigidity of nominal wage contracts and prices, and on the extent to which they are synchronised, this interpretation is obviously subject to Lucas' criticism. These contractual practices are not statements of fact, but the results of deliberate choices. Changes in the economic environment conditioning these choices will change practices.

In a two-country macroeconomic model where the consumer demand behaviors, the money, the nominal exchange rate and the balance of payment are explicitly introduced, we reexamine the PPP under the floating exchange rate regime in considering different trade, policy and macroeconomic conditions. The existence of differences in value-added tax rates in the two countries, import taxes or export subsidies (even with the same rates), transport costs, constraint of full employment, export or import quotas, self-limiting export quota can all, if not always, imply a violation of the law of one price and the absolute PPP. Particular attention is paid to the role of the ratio between nominal wage rate and aggregate demand. When there are transport costs, the role of the ratio of the nominal unitary transport costs to the aggregate demand is considered. Here it is assumed that the nominal wages are rigid, but this is not a sufficient condition to invalidate the two PPP. In contrast, both PPP can be well verified under nominal wage rigidities. The restrictive conditions under which both absolute and relative PPP are verified are discussed. From the results of this paper, question can be raised about whether the PPP in its actual form can effectively play, in a non Walrasian world, the role mentioned by Dornbusch.

The monetary approach to the balance of payments has received considerable attention. However, most of the empirical studies are based on a small country with fixed exchange rates [1] [2]. Therefore, its application is greatly restricted. To solve this problem, Lance Girton and Don Roper (1977) designed the mone- tary model of exchange market pressure. The so-called “exchange market pres- sure”, according to Lance Girton and Don Roper’s definition [3], is the pressure on foreign exchange reserves and exchange rate when there exists an excess of domestic money supply over money demand in a managed floating exchange rate regime. The basic theoretical proposition is that any such excess supply of money can be relieved by foreign exchange depreciation, a loss in foreign re- serves, or, in the context of a managed float, by some combination of them [4].

Even though, the flexible exchange rate policy enhances the stock market development in the long run; the estimated model for the short run dynamics provides an inverse relationship between floating exchange rate and stock market development. The estimated coefficient for the exchange rate policy variable by the dynamic model is negative and highly statistically significant. The Central Bank of Sri Lanka introduced the floating exchange rate in 23 rd of January 2001. However, the economic indicators of Sri Lanka turned in to worse during the first two years after introducing the flexible exchange rate. Especially, the economic growth rate dropped down to lowest in the history and recorded a negative value of -1.5. Similarly, the exchange rate depreciated due to the lack of supply of foreign reserves. Under these critical economic structures in the economy happened in the short run, both local and international investors lost their credibility about the Sri Lanka economy. Hence, the stock market activities restricted and underperformed. However, the floating exchange rate was successful as a policy variable in the Sri Lanka economy few year after its arrival. Especially, the flexible exchange rate reasoned to increase the effectiveness of the monetary and fiscal policy under semi-liberalized capital account of Sri Lanka and it also caused to absorb the more foreign investments as well. Thus, the exchange rate policy variable negatively affected to the stock market development in the short run despite positively in the long run.

Prior to adopting floating exchange rate regime, Islam (2003) concludes that the economic and institutional prerequisites of a floating exchange rate regime are not met in Bangladesh. Some recent studies have tried to explain the behaviour of nominal exchange rates of Bangladesh after its transition to the floating rate regime. By doing a correlation analysis, Rahman and Barua (2006) explore the possible explanation of the exchange rate movement. They found that there is a strong correlation (-0.40) between depreciation and export-import gap as a share of reserves, L/C openings for imports also have a positive correlation (0.45) with volatility of the exchange rate which implies that the higher the L/C openings the more volatile is the exchange rate. They conclude that high seasonal demand for foreign currency because of increased import bills, systematic withdrawal of excess liquidity by Bangladesh Bank, relatively faster expansion of credit and higher interest rates on various national savings instruments are the reasons behind the interest rate hike in the money market and depreciation of the nominal exchange rate.