contagion macroeconomic models with multiple equilibria abstract several concepts of contagion are distinguished it is argued that models that allow only a single equilibrium conditional on the macroeconomic fundamentals are not adequate to capture all forms of contagion hence it is useful to formulate macro models that admit multiple equilibria and self fulfilling expectations a simple balance of payments model is presented to illustrate that phenomenon and some back of the envelope calculations assess its relevance to the coincidence of emerging market crises in 1994 95 and in 1997

u s money demand structural shifts or heterogeneous agents this paper examines whether observed structural shifts in the money demand function could be the result of agent heterogeneity due to different household income levels following the methodology of stoker 1986 income distribution variables are found to be significant determinants of money demand and once changes in the distribution of income are accounted for there is no evidence of parameter instability a money demand function incorporating income distribution effects is shown to perform as well or better than several standard alternatives on the basis of diagnostic tests non nested hypothesis tests within sample prediction errors and out of sample forecasting

can learning affect exchange rate behavior the case of the dollar in the early 1980 s this paper demonstrates that a change in parameters of the money market that is not immediately understood will affect the behavior of exchange rate forecast errors while the market is learning the analysis is applied to the behavior of u s dollar german mark forecast errors during the early 1980 s when the market appeared to systematically underpredict the strength of the dollar consistent with this observation empirical estimates of implied forecast errors based upon bayesian learning suggest that forecast errors would have been on average negative during the period as the market came to realize the increase in u s money demand

investment and financing activity following calls of convertible bonds abstract the staged financing hypothesis of mayers mayers d 1998 why firms issue convertible bonds the matching of financial and real investment options journal of financial economics 47 83 102 predicts that investment and financing activity will increase following in the money convertible bond calls the prediction for out of the money convertible calls is different no increase is expected we study the rate of both corporate investment and external financing around forced conversions using benchmarks that are analogous to those recommended by barber and lyon barber b lyon j 1996 detecting abnormal operating performance the empirical power and specification of test statistics journal of financial economics 41 359 400 we also examine the cross section of changes in investment and financing activity conversion forcing firms exhibit an increase in both capital expenditures and debt financing around the year of the convertible bond call however the same result holds for the sample firms that conducted out of the money convertible calls further there is no relation between changes in investment activity and changes in debt issuance at the firm level the evidence is inconsistent with the notion that forced conversions serve as a catalyst for staged financing and investment

interpreting an error correction model partial adjustment forward looking behaviour and dynamic international money demand an error correction model is derived from a stochastic dynamic programming problem incorporating rational expectations a parametric restriction is derived that allows a test for the theoretical proposition that the optimal strategy behind the error correction from entails the failure to asymptotically close the gap between the choice variable and the growing target this is accomplished by nesting a partial adjustment model with forward looking expectations within the error correction paradigm the counterintuitive behaviour embodied in the error correction model is not supported by the data in the context of a cross country comparison of cash balances relationships

modelling money demand in open economies over the modern floating rate period the role of open economy factors in influencing domestic money demand in major industrial countries over the modern floating rate period is examined the theoretial model for the empirical analysis is derived from a general two country portfolio balance framework that determines the demand for domestic and foreign monetary and non monetary assets in each country the ecm estimates indicate that capital mobility plays an important role in the money demand function in all seven counteries considered currency substitution in contrast is not an important phenomenon

fixed exchange rates credibility flexibility and multiplicity abstract this paper surveys recent work on the sustainability of fixed exchange rates it considers a dynamic version the barro gordon framework in which the level of a state variable in this case debt determines the pay offs available to the government at each point in time multiple equilibria and self fulfilling runs are possible but only at certain levels of debt a surprise devaluation can either increase or decrease future expected devaluation relative to a no devaluation situation

instability of the u s money demand function this paper surveys the two major episodes of instability of the u s money demand function known respectively as the mystery of missing money and the great velocity decline it also assesses the recent literature on open economy money demand models and their usefulness in explaining the puzzling behavior of money demand manifested shortly after the transition to floating exchange rates copyright 1991 by blackwell publishers ltd

collusion and overlending i introduction for a long time have korean companies been engaged in unbridled expansionism financed through loans inefficient octopus style management and over and duplicate investment thus expediting the structural failure of the economy this failure to concentrate on profits consolidation and efficiency provided the fuse to the bankruptcy bombs that triggered the foreign exchange and economic crises the collusion between the conglomerates financial sector and politicians made this financial monopoly possible chosun ilbo december 26 1997 collusion and overlending in the korean financial sector may be best illustrated by the above editorial highlight of chosun ilbo the most read newspaper in korea its 1997 financial crisis is primarily triggered by continual bankruptcies of chaebols conglomerates which with assistance from politicians had borrowed heavily from financial institutions in financing their investment projects 1 unlike some other asian countries experiencing problems in their financial sector due to shifts in investment projects toward real estates such as japan hong kong and thailand chaebols in korea concentrated mostly on manufacturing activities 2 in this study we establish a tractable model of overlending with three key players namely chaebols financial institutions and politicians as highlighted in chosun ilbo the model is designed to achieve two primary goals that are crucial for matching some key observations during the korean turmoil first we illustrate how overlending can be an equilibrium outcome with collusion between chaebols and politicians when the economic environment is favorable this occurs despite that such a collusion distorts normal borrowing lending operation by causing a discernible shift in loan composition from more to less productive investment projects second we show that as the economic environment gradually deteriorates there can be a shift from a collusion to a no collusion equilibrium the combination of deterioration in fundamentals and expectations of an equilibrium shift can trigger economy wide financial crisis more specifically we construct a simple principal supervisor agent model of corruption and overlending the principal is the formal authority of loan decision making of a financial institution or in short the financial institution the supervisor is a politician who serves as the informational intermediary in the borrowing lending arrangement via his her connections and networking 3 the agent is a chaebol of an unknown type which seeks for external financing of a set of risky projects a politician s favorable signal about the borrowing chaebol s overall performance would grant the approval of the loan to finance an array of risky projects whose returns depend on idiosyncratic shocks that cannot be washed out in aggregation within the chaebol as an outside alternative to making the loan the financial institution can invest in the world capital market where a fixed rate of return is guaranteed this portfolio decision depends on a comparison of the expected average returns on the given set of risky projects with the safe returns on investments in the world capital market while both the chaebol s type and the state of nature are unobservable to the financial institution we for simplicity assume that politician s connections and networking can fully uncover the true type of the chaebol this valuable information possessed by the politician is one that the financial institution has an incentive to purchase but a low type chaebol has an incentive to conceal whether the politician ends up revealing truthfully this information depends on how much to obtain from the lender in terms of general support versus how much to gain from the borrower in terms of bribes or side payments when a low type chaebol has the politician on its side information is distorted and a collusion equilibrium arises

strategic interactions and contagion effects under monetary unions this paper applies game theory and a cost benefit analysis to study voluntary exits and contagion effects in countries joined to a monetary union the paper looks at two non core or periphery countries of a large union and examines the role of structural asymmetries and strategic interactions as determinants of equilibrium outcomes following both country specific and common shocks the paper finds that under almost symmetry between countries country specific shocks are never associated with multiple equilibria and if large enough can spread to other countries leading to contagion by contrast common shocks are seen to sustain multiple equilibria if almost symmetric countries are considered and to have implications similar to those found in the country specific case if large structural asymmetries are admitted

devaluation without common knowledge in an economy with a fixed exchange rate regime that suffers a random adverse shock we study the strategies of imperfectly and sequentially informed speculators that may trigger an endogenous devaluation before it occurs exogenously the game played by the speculators has a unique symmetric nash equilibrium which is a strongly rational expectation equilibrium in the set of all strategies with delay uncertainty about the extent to which the central bank is ready to defend the peg extends the ex ante mean delay between the exogenous shock and the devaluation we determine endogenously the rate of devaluation

the short run demand for money a reconsideration the partial adjustment approach to the specification of the short run demand for money has dominated the literature for more than a decade there are three basic problems with this approach first the same lag structure is imposed on all variables and each independent variable enters only as a current value in contrast a rational individual would respond to different variables income interest rates prices with quite different lags second when the general price levelis subject to gradual adjustment hut can move quickly in response to supply shocks the influence of these supply shocks should enter with a negative sign third the estimated equation for real balances may not be a money demand equation at all but rather its coefficients may represent a shifting mixture of demand and supply responses the empirical work examines several alternative dynamic specifications including a generalized partial adjustment framework and the error correction model both of the latter specifications exhibit greater structural stability after 1973 than the standard partial adjustment specification and the generalized partial adjustment model also yields relatively small errors in post sample dynamic simulations shifts in coefficients as the sample period is extended after 1973 are consistent with the interpretation that the real balance equation no longer traces out structural demand parameters hut rather a mixture of demand and supply responses this abstract was borrowed from another version of this item

models of currency crises with self fulfilling features the discomfort a government suffers from speculation against its currency determines the strategic incentives of speculators and the scope for multiple currency market equilibria after describing an illustrative model in which high unemployment may cause an exchange rate crisis with self fulfilling features the paper reviews some other self reinforcing mechanisms recent econometric evidence seems consistent with the practical importance of these mechanisms

the instability of fixed exchange rate systems when raising the nominal interest rate is costly abstract this paper points to a vicious circle which may arise when a government tries to defend its currency by raising the nominal interest rate in a fixed exchange rate system we present a stylised model in which raising the nominal interest rate helps to maintain the parity but is costly for the government the speculators are aware that this cost gives incentives for the government to stop defending the parity which in turn reinforces the speculation against the currency we show that this mechanism can generate self fulfilling currency crises the outcome of which depends on the level of sacrifice that the government is ready to endure and the evolution of domestic economic conditions we provide some informal evidence showing that this model explains some features of the 1992 93 ems crisis

credibility of policies versus credibility of policymakers standard models of policy credibility defined as the expectation that an announced policy will be carried out emphasize the preferences of the policymaker and the role of tough policies in signaling toughness and raising credibility whether a policy is carried out however will also reflect the state of the economy we present a model in which a policymaker maintains a fixed parity in good times but devalues if the unemployment rate gets too high our main conclusion is that if there is persistence in unemployment observing a tough policy in a given period may lower rather than raise the credibility of a no devaluation pledge in subsequent periods we test this implication on ems interest rates and find support for our hypothesis

coordination cooperation contagion and currency crises we analyze the effect of trade competition international coordination and cooperation on currency crises to do this we present a micro founded model where governments have an incentive to devalue to increase the national market share in a monopolistically competitive sector currency crises generated by self fulfilling expectations are possible because private agents demand high wages when they expect a devaluation this decreases the competitiveness and profits of national firms and induces the government to devalue we show that the more important trade competition the more likely self fulfilling speculative crises are and the larger the set of multiple equilibria coordination decreases the possibility of simultaneous self fulfilling speculative crises in the region and reduces the set of multiple equilibria however regional coordination even though welfare improving makes countries more dependent on other countries fundamentals so that it may induce more contagion cooperation further reduces the set of multiple equilibria with currency crises

the politics of speculative attacks in industrial democracies recent models of speculative currency crises contend that market expectations of policy behavior can trigger a speculative attack we argue that political processes and partisan objectives inform expectations about the government s commitment to the exchange rate first market actors anticipate periods when the partisan identity of a government may change through an election or a cabinet collapse second party labels provide information to currency traders about the policy objectives of a potential government consequently we contend that the probability of a speculative attack will be higher when markets expect the cabinet to end and when the cabinet dissolution is likely to produce a leftward shift in policy a discrete timesurvival model is used to estimate the probability that a cabinet will dissolve in any given month for sixteen parliamentary democracies from 1970 to 1995 the predicted values are then used as a proxy for market expectations in a model of speculative currency crises

economic fundamentals and self fulfilling crises further evidence from mexico abstract this paper considers a model of debt stabilization under a fixed exchange rate in which a currency crisis can develop as the result of self fulfilling speculation following a bifurcation in the behavior of economic fundamentals based on this theoretical framework and by exploiting the test developed by jeanne 1997 this paper provides evidence that self fulfilling speculation was at work in the 1994 mexican crisis in terms of fundamentals we show that the critical variables in generating the mexican crisis were the fast rise in us denominated public debt tesebonos the appreciated real exchange rate and the small rises in unemployment and primary deficit

the ems and the dollar the ems and the dollar francesco giavazzi and alberto giovannini this paper examines the behaviour of exchange rates prior to and since the inception of the european monetary system ems movements in bilateral european exchange rates tend to be associated with fluctuations in the dollar in particular the mark tends to appreciate against other european currencies when the dollar depreciates further most realignments of currencies in the ems have generally occurred after sharp movements in the dollar conventional explanations relying on portfolio diversification by investors do not seem to explain the facts fully a more satisfactory explanation is provided by the existence of capital controls these limit the mobility of assets and ensure an asymmetric response by european currencies to movements in the dollar these capital controls are in the absence of coordinated monetary policy essential to the smooth working of the ems however at the same time they limit the scope for the further integration of european capital markets thus the ems is not a step on the road to greater financial integration indeed it is a cul de sac

currency crises sunspots and markov switching regimes abstract this paper investigates the theoretical properties of a class of escape clause models of currency crises as well as their applicability to empirical work we show that under some conditions these models give rise to an arbitrarily large number of equilibria as well as cyclic or chaotic dynamics for the devaluation expectations we then propose an econometric technique based on the markov switching regimes framework by which these models can be brought to the data we illustrate this empirical approach by studying the experience of the french franc between 1987 and 1993 and find that the model performs significantly better when it allows the devaluation expectations to be influenced by sunspots

modelling money demand in open economies the case of selected asian countries while early work on money demand estimation focused primarily on the importance of domestic variables many studies in later years have suggested that foreign variables also influence the domestic demand for money in an open economy with the rapid financial market liberalization in some of the asian economies in the last couple of decades open economy factors have become very important in the determination of money demand therefore this paper aims to ascertain the degree to which foreign opportunity cost variables influence money demand in the philippines singapore and south korea cointegration analysis is performed and an error correction model estimated using quarterly time series data the empirical results support the inclusion of foreign opportunity cost variables in the money demand function

assessing target zone credibility mean reversion and devaluation expectations in the erm 1979 1992 abstract the paper presents estimates of devaluation expectations for six erm currencies relative to the deutsche mark for the period march 1979 april 1992 both the simplest test and the drift adjustment method are used the simplest test adjusts interest rate differentials for the maximum and minimum expected rate of depreciation within the exchange rate band the drift adjustment method adjusts interest rate differentials by the estimated expected rate of depreciation within the band the latter method gives more precise estimates especially for short horizons and allows statistical inference and hypothesis testing expected rates of devaluation have generally fallen during the period still some devaluation expectations relative to the deutsche mark remain in 1992 except for the belgian luxembourg franc and the netherlands guilder expected rates of devaluation have fluctuated more than interest rate differentials

a theory of ambiguity credibility and inflation under discretion and asymmetric information this paper develops a positive theory of credibility ambiguity and inflation under discretion and asymmetric information the monetary policymaker maximizes his own politically motivated objective function that is positively related to economic stimulation through monetary surprises and negatively related to monetary growth the relative importance he assigns to each target shifts stochastically through time his current preference trade off is known to him but not to the public when choosing the state contingent path of money growth for the present and the future the policymaker compares the benefits from current stimulation with the costs associated with higher future inflation expectations current monetary growth conveys information to the public about future money growth because there is persistence in the policymaker s objectives although expectations are rational information is imperfect because monetary control procedures are imprecise as a result the public cannot correctly distinguish persistent changes of emphasis on different policy objectives from transitory monetary control errors the public becomes aware of changes gradually by observing past monetary growth credibility is defined in terms of the speed with which the public recognizes changes in the objectives of the policymaker credibility is lower the noisier monetary control and the more stable the objectives of the policymaker looser monetary control and a higher degree of time preference on the part of the policymaker induce him to produce higher and more variable monetary growth when the policymaker is free to determine the accuracy of monetary control he does not always choose the most effective control available in spite of the fact that monetary surprises always have an expected value of zero the reason is that ambiguous control procedures enable the policymaker to generate positive surprises when he cares more than on average about economic stimulation he leaves the inevitable negative surprises for periods in which he cares more about inflation prevention this result provides an explanation for the fed s preference for ambiguity recently documented by goodfriend 1986 the policymaker is more likely to pick more ambiguous control procedures the more uncertain his objectives and the higher his time preference the paper also provides a theoretical underpinning for the well documented crosscountry positive correlation between the level and the variability of inflation

modeling the demand for narrow money in the united kingdom and the united states abstract despite the importance of well specified empirical money demand functions for inference forecasting and policy problems in modeling have arisen concerning the economic theories of money demand the data institutional frameworks financial innovation and econometric implementation by developing constant data coherent m 1 demand equations for the u k and the u s we investigate these issues and explain such puzzles as missing money the great velocity decline and the recent explosion in m 1 the endogeneity of money the lucas critique and the non invertibility of our m 1 models are also discussed

the role of non transparency in a currency crisis model abstract this paper extends the work by morris and shin am econom rev 88 1998 587 597 where multiple equilibria in the self fulfilling currency attack models can be reduced to a unique equilibrium when agents observe fundamentals privately with small errors we find that under a more general specification with realistic parameters noisy private observations are generally insufficient to prevent the multiplicity of equilibria the pivotal role played by the transparency of fundamentals policies in currency crisis is also examined surprisingly transparency may trigger rather than eliminate currency crises when fundamentals are relatively healthy our results may be relevant to research in other coordination problems

buying and selling attacks on fixed exchange rate systems abstract in this paper we show how rational expectations models of speculative attacks on fixed exchange rate systems can be extended to take into account the possibility that the central bank could be forced to either devalue or revalue essential to the analysis are the concepts of buying attack and selling attack by means of which we were able to describe how expectations about the future exchange rate are formed we also provide a discussion on the problem of uniqueness of the equilibrium that may arise in this kind of speculative attack models

destabilizing effects of exchange rate escape clauses abstract this paper studies policy rules with escape clauses analyzing as an example fixed exchange rate systems that allow member countries the freedom to realign in periods of stress while well designed escape clause rules can raise society s welfare in principle limited credibility makes it difficult to implement such rules in practice an ems type institution that imposes political costs on policymakers who realign may raise welfare but can also produce equilibria far inferior to an irrevocably fixed exchange rate switches between multiple equilibria may have the character of sudden speculative attacks

illiquidity contagion and liquidity crashes liquidity providers often learn information about an asset from prices of other assets we show that this generates a self reinforcing positive relationship between price informativeness and liquidity this relationship causes liquidity spillovers and is a source of fragility a small drop in the liquidity of one asset can through a feedback loop result in a very large drop in market liquidity and price informativeness a liquidity crash this feedback loop provides a new explanation for comovements in liquidity and liquidity dry ups it also generates multiple equilibria

the demand for money a rational expectations approach the authors derive a model of money demand for an optimizing consumer with rational expectations in a discrete time infinte hortizon framework under uncertainty mone y demand responds to unanticipated changes in income one period expe ctations of future bond and money interest rates unanticipated curre nt interest rates and past anticipations of current rates the deriv ed consumption function mirrors money demand behavior joint estimati on of the consumption and money demand equations by weighted nonlinea r least squares corroborates the predicted effects particularly inco me neutrality this money demand model substantially outperforms a co nventional specification in post sample simulation over 1975 85 copyright 1988 by mit press

speculation and the decision to abandon a fixed exchange rate regime this paper investigates the extent to which it is possible for speculative attacks to be predictable given information on economic fundamentals a standard model of predictable attacks is extended to incorporate an optimizing monetary authority it is shown that while incorporating a forward looking monetary authority improves our understanding of many observed phenomena it also implies that the branch of the literature that places emphasis on predictable movements in fundamentals cannot generate predictable speculative attacks in addition the model provides useful insights into the viability of temporary nominal anchor policies and a theoretical foundation for an important empirical methodology

the mirage of fixed exchange rates this paper discusses the profound difficulties of maintaining fixed exchange rates in a world of expanding global capital markets contrary to popular wisdom industrialized country monetary authorities easily have the resources to defend exchange parities against virtually any private speculative attack but if their commitment to use those resources lacks credibility with markets the costs to the broader economy of defending an exchange rate peg can be very high the dynamic interplay between credibility and commitment is illustrated by the 1992 swedish and british crises and the 1994 95 mexican collapse we also discuss the small number of successful fixers

are currency crises self fulfilling abstract this paper studies the respective roles of the fundamentals and self fulfilling speculation in currency crises we first present a model of a fixed exchange rate system in which self fulfilling speculation can arise following a bifurcation in the fundamentals we then estimate the model in the case of the 1992 3 crisis of the french franc and find some evidence that self fulfilling speculation was at work

mexico s balance of payments crisis a chronicle of a death foretold this paper claims that the roots of mexico s balance of payments crisis are found in the prevailing high degree of capital mobility and financial globalization under these circumstances shifts in foreign capital flows and anticipation of a banking system bailout may produce large imbalances between stocks of financial assets and foreign reserves threatening the sustainability of currency pegs econometric analysis suggests that half of mexico s reserve losses could be accounted for by these phenomena large financial imbalances are also fertile ground for self fulfilling prophesy crises which lead devaluations to produce deep recessions these difficulties can be partly remedied by appropriate policies

was the great depression a low level equilibrium abstract if the great depression indeed was a bad equilibrium then there was another better equilibrium that the economy might have been in but wasn t this is the multiple equilibrium explanation but another explanation is that equilibrium was unique and that there were especially bad real shocks that caused output and employment to fall so much the data tentatively support the second story the depression can not be blamed on a massive coordination failure this conclusion hinges however on the assumption that the money supply did not act as an equilibrium selection device but since in the u s at least money is not the best leading indicator there are more natural variables that could have played this role and we find this assumption reasonable if this is correct our results offer little if any support to the view that the depression was the result of a coordination failure

portfolio preferences of foreign institutional investors the authors examine the relationship between foreign investment and the attributes of emerging market countries and firms in which investment is made their findings indicate that countries with higher levels of economic development and floating exchange rate regimes tend to have greater ability to obtain foreign capital after controlling for the country s level of economic development they find that firms in countries with stronger shareholder rights and legal framework attract more foreign capital the authors also find that foreign institutions allocate more of their assets to firms with better corporate governance after controlling for other country and firm attributes the main firm level measures of corporate governance are derived from accounting quality variables their results imply that steps can be taken both at the country and the firm level to create an environment conducive to foreign portfolio investment the analysis is based on a unique dataset consisting of equity positions of u s mutual funds in emerging markets

financial instability under a flexible exchange rate many governments in developing countries contemplate the possibility of increasing the flexibility of their exchange rates despite having accumulated substantial dollar denominated debt using a model of corporate dollar debt in which the future exchange rate is uncertain this paper studies the financial risks that might arise as a consequence of increased exchange rate flexibility since a firm may default on its debt either because its dollar income is too low or because investors refuse to roll over its debt the measure of the overall risk of default should take into account both factors as well as their interaction solving the model for the no default rational expectations equilibrium we find that a small risk of insolvency may bring about a substantial risk of illiquidity

an alternative approach to the american demand for money with a decade of evidence behind it the profession seems to have agreed on the fact that a structural break shifted the american demand for money shortly after 1973 it is difficult to pinpoint the source of the trouble precisely let alone to explain the event with an econometric model in their survey judd and scadding 1982 tentatively concluded that financial innovation is the source of the problem while this conclusion has not been universally accepted the instability of the money demand function is largely taken as a given stylized fact the primary goal of this article is to provide an alternative solution to the case of the missing money using the methods of hendry 1979 it should be stressed at the outset that as this paper deals with a problem in the applied literature it is unabashedly empirical in nature the paper attempts to explain an empirical difficulty without presenting a new theoretical model of money demand rather in the context of the standard transactions demand theory for narrow money a number of questions are analyzed with an atypical econometric model was there actually a shift or a series of shifts in the demand for money if not why have other investigators concluded that there was in fact a shift most importantly what function seems to be the most reasonable approximation to the data generation process during the period in question

the search for a stable money demand function a survey of the post 1973 literature phe question of whether the demnand function for money is stable is one of the most important recurring issues in the theory and application of macroeconomic policy what is being sought in a stable demand function is a set of necessary conditions for money to exert a predictable influence on the economy so that the central bank s control of the money supply can be a useful instrument of economic policy as such the notion of a stable demand function appears to involve three key elements e g john t boorman 1976 p 317 and david e w laidler 1977 pp 34 35 first the demand for money relation should be highly predictable in a statistical sense as measured by the usual goodness of fit statistics precision of estimated coefficients and presumably its ability to forecast accurately out of sample second a stable demand function for money has relatively few arguments a relationship that requires knowledge about a large number of variables in order to pin it down is in effect not predictable finally the variables that appear as arguments in the function should represent significant links to spending and economic activity in the real sector in sum a stable demand function for money means that the quantity of money is predictably related to a small set of key variables linking money to the real sector of the economy the importance of a stable money demand function for monetary policy can be illustrated with the standard is lm model in which interest rates and gnp are the endogenous variables in this context a stable demand function for money translates into a well defined relationship between money interest rates and gnp

gaining and losing erm credibility the case of the united kingdom the model of this paper highlights two aspects of credibility signaling the type of government which is assumed not to be known and for any type the likelihood that if circumstances are sufficiently unfavorable a devaluation will be impossible to avoid since not to do so would go against the government s interests these two factors have opposite implications for the link between unemployment and interest differentials high unemployment signals a tough government but also makes it less likely that even a tough government will maintain an existing parity copyright 1995 by royal economic society

purchasing power parity in the long run a test of the dollar pound exchange rate 1890 1978 this paper tests the purchasing power parity ppp hypothesis by analyzing t he long run tendency of the dollar pound exchange rate using data sin ce 1890 two different models are considered 1 a na ive model and 2 a modified monetary model the conditions of propor tionality and symmetry cannot be rejected when using the naive model the final results using the monetary model however indicate that t he existence of permanent deviations from ppp cannot be ruled out copyright 1987 by ohio state university press

the causal direction between money and prices abstract causality is viewed as a matter of control controllability is captured in simon s analysis of causality as an asymmetrical relation of recursion between variables in the unobservable data generating process tests of the stability of marginal and conditional distributions for these variables can provide evidence of causal ordering the causal direction between prices and money in the united states 1950 1985 is assessed the balance of evidence supports the view that money does not cause prices and that prices do cause money

learning large deviations and recurrent currency crises this article studies a version of obstfeld s journal of international economics 43 1997 61 77 escape clause model the model is calibrated to produce three rational expectations equilibria two of these equilibria are e stable and one is unstable dynamics are introduced by assuming that agents must learn about the government s decision rule it is assumed they do this using a stochastic approximation algorithm it turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small the algorithm converges to a small noise diffusion process the dynamics of exchange rate changes are then characterized using large deviation techniques from freidlin and wentzell random perturbations of dynamical systems second edition berlin springer verlag 1998 these methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two state markov switching process where the two states correspond to the two e stable equilibria the model is calibrated to the exchange rate histories of argentina brazil and mexico currency crises in these countries resemble the predicted escape routes of the model a key feature of these escape routes is that expectations of a devaluation erupt suddenly without large contemporaneous shocks this is consistent with evidence showing that crises are often poorly anticipated by financial markets

money demand the effects of inflation and alternative adjustment mechanisms the paper first reconciles a variety of specification tests for partial adjustment money demand models and points out a fundamental identification problem which makes it impossible to distinguish between the real and nominal partial adjustment models if inflation has an independent effect on the long run demand for money the paper also finds that empirical estimates of simple partial adjustment models have some undesirable properties and then considers the shortand long run effects of inflation in a more general distributed lag model

relative risk aversion and the transmission of financial crises we study how investor behavior affects the transmission of financial crises if investors exhibit decreasing relative risk aversion then negative wealth shocks increase the risk premium required to hold risky assets we integrate this into a second generation model of currency crises which allows for contagion through changes in fundamentals investor behavior can be a transmission channel of financial crises as changes in risk premia increase the coverage ratio and makes the defense of a peg less attractive for the policy maker the feedback effect of the risk premia on the probability of devaluation also makes multiple equilibria more likely the possible stabilization effects of capital controls and a tobin tax on the international transmission of financial crises are also studied

changing beliefs and systematic rational forecast errors with evidence from foreign exchange this paper addresses a new interpretation to the appearance in the early 1980s of systematic errors in forecasting the dollar exchange rate following a change in the process of a fundamental variable market participants revise their beliefs about the process using bayes rule since the market does not immediately recognize the change forecast errors are on average wrong during a period when the market is rationally learning for conservative parameter values the learning behavior of the dollar exchange rate in the early 1980s appears consistent with about half of the dollar s underprediction implied by the forward market copyright 1989 by american economic association

regional vulnerability the case of east asia in a case study of six east asian economies we use dynamic factor analysis to estimate a regional component of the exchange market pressure index empi as a measure of regional financial stress the extent to which this indicator is explained by regional economic and financial factors is interpreted as regional vulnerability to crisis we find that regional external liabilities and exuberance in domestic stock and credit markets as well as the us high yield spread were positively correlated with regional vulnerability individual country empis are also explained by regional factors with country specific factors and trade linkages playing little role

empirical evidence on nominal wage and price flexibility this paper tests a necessary condition for the neutrality of money in a framework that imposes only weak restrictions on the money supply process it extends bernanke s 1986 work by weakening the set of just identifying restrictions and by providing a statistical test of the overidentifying restrictions instead of specifying a structural model to identify primitive shocks i deduce the impact effects of structural money shocks under the neutrality hypothesis and then test whether the system maintains neutrality as it propagates these impact effects the tests reject neutrality for both the m1 and the monetary base

fixed exchange rates as a means to price stability what have we learned abstract the paper discusses what we have learned from last year s currency crises in erm and the nordic countries about fixed exchange rates as a means to achieve price stability after discussing the explanations for the crises the paper concludes that fixed exchange rates are not a shortcut to price stability monetary stability and credibility have to be built at home and cannot easily be imported from abroad fixed exchange rates are more fragile and difficult to maintain than previously thought they may even be in conflict with price stability by inducing a procyclical destabilizing monetary policy and by inducing an inflation bias building monetary credibility is even more important with flexible exchange rates

company sector liquid asset holdings a systems approach liquid asset holdings of the u k company sector are modeled using a money in the utility function theoretical approach symmetry homogeneity and negativity but not homotheticity restrictions are found to hold in a dynamic model using quarterly data the authors examine the usefulness of cointegration techniques in a systems framework the preferred dynamic equations are estimated using the engle granger two step procedure and have coefficients that are satisfactory on a priori grounds and are stable copyright 1992 by ohio state university press

gold monetization and gold discipline gold and its price have emerged as frequent topics of both academic and government debate 2 public attention focused on the gold market since gold s price began fluctuating violently in 1980 and 1981 has turned to gold as a possible means of removing some discretion inherent in the current fiat money system since lack of adherence to monetary rules can lead to problems of dynamic policy inconsistency academic economists have begun seriously to reconsider monetary standards based either on gold or on some other commodity as politically feasible methods of establishing rules 3

on the reinterpretation of money demand regressions a stylized fact concerning estimated money demand relationships is that lagged dependent variables have high explanatory power and large estimated coefficients which is hard to explain at a theoretical level marvin s goodfriend 1985 suggests that this may be due to the presence of serially correlated measurement errors in the independent variables the author demonstrates how consistent estimates of the short run demand function can be obtained even if the goodfriend hypothesis is accepted and also how the hypothesis might be tested application of the suggested test using the goldfeld 1973 data set leads to decisive rejection of the hypothesis copyright 1994 by ohio state university press

the mexican peso crisis sudden death or death foretold abstract we argue that allowing for the possibility of a self fulfilling panic helps to understand several features of the recent mexican crisis self fulfilling expectations became decisive in generating a panic only after the government ran down gross reserves and ran up short term dollar debt we present a simple model to explain how and why multiple equilibria can occur for some levels of reserves or debt but not for others lastly we argue that the imperfect credibility of mexican exchange rate policy made it advisable to follow more contractionary fiscal and monetary policies in 1994 our model formalizes the reasons why this is so

multiple equilibria and currency crisis evidence for korea abstract this paper estimates a non linear model that allows for multiple equilibria using data on korea during the currency crisis in 1997 results suggest that korea may have been vulnerable to self fulfilling speculation as early as january 1997 an extended phase of multiple equilibria started in october 1997 the fundamentals for korea remained in this crisis zone until march 1998 korea briefly entered a multiple equilibria zone again in may and june 1998 before stabilizing in july 1998 results are supportive of roles for weakness in fundamentals and for self fulfilling beliefs in explaining currency crises

money demand instability expectations and policy regimes a note on the case of italy 1964 1986 abstract this paper compares the stability performance of feedback and feedforward specifications of the demand for m2 in italy over the period 1962 1986 a clear change in the monetary policy regime occurred in 1969 1970 together with marked breaks in the processes generating several relevant variables in the mid 70s making this period particularly appropriate for the investigation of the potential role of expectations our main results show that the feedback specification suffers from instability at both relevant dates whereas the feedforward specification is remarkably stable during the policy regime change but displays signs of instability during the mid 70s

stochastic devaluation risk and the empirical fit of target zone models in the model of this paper an exchange rate fluctuates between given boundaries for random lengths of time and jumps discretely when devaluation occur we provide explicit solutions for the stochastic processes followed by the exchange rate and by the expected rate of depreciation when the likelihood and the size of devaluations vary stochastically over time the model produces realistic patterns of covariation between exchange rates and interest rate differentials and provides interesting interpretations of available empirical evidence we also specify how to infer devaluation risk from target zone data

a primer on financial contagion abstract this paper presents a theoretical framework to highlight possible channels for the international transmission of financial shocks we first review the different definitions and measures of contagion adopted by the literature we then use a simple multi country asset pricing model to classify the main elements of the current debate on contagion and provide a stylized account of how a crisis in one country can spread to the world economy in particular the model shows how crises can be transmitted across countries without assuming ad hoc portfolio management rules or market imperfections finally tracking our classification we survey the results of the empirical literature on contagion

self fulfilling risk predictions an application to speculative attacks abstract we show that changing market beliefs about currency risk can generate a self fulfilling speculative attack on a fixed exchange rate the attack does not require a later change in policies to make it profitable we illustrate this point by introducing an endogenous risk premium into a first generation model of a speculative attack the model is further modified to take account of sterilization debt financed fiscal deficits and anticipatory price setting behavior we use the model to interpret the 1994 mexican peso crisis

default on sustainable public debt illiquidity suspect convicted abstract according to a well established economic principle any public debt that does not exceed the discounted stream of future primary surpluses should find buyers this paper argues why this principle may not hold if the government has only imperfect control over its net income flow a small risk of unsustainability appears to be at the origin of a much larger risk of illiquidity solving the model for the rational expectations equilibrium we find that the maximum debt level that investors are willing to hold may be much lower than the commonly used sustainable level

partial adjustment in the demand for money theory and empirics central to the notion of money as the medium of exchange is the concept that all transactions are conducted using money balances this notion expounded most explicitly by robert clower 1967 1970 has led to the development over the past decade of interesting models of the transactions and precautionary demand for money these have examined optimal behavior of the economic agent in steady state although there has been much gained by examining money balance behavior in this way money demand models so far have ignored the behavior of money during periods of disequilibrium an adequate understanding of total money balances is possible only by incorporating both equilibrium and disequilibrium behavior into an overall view in this regard michael darby 1972 is exceptional in explicitly treating disequilibrium money demand behavior darby s paper is mainly empirical but it contains an interesting intuitive discussion of money s role as a shock absorber during periods of disequilibrium in the present study we address both the theoretical foundation and empirical importance of the shock absorber effect we construct a model of optimal behavior by the economic agent showing the necessary conditions for the existence of partial adjustment and indicating how the intensity of adjustment behaves over time and in response to changes in economic variables this appears to be the first such attempt in the money demand literature although there is related work in the investment literature on the flexible accelerator we test the model on u s quarterly data to estimate the existence and magnitude of partial adjustment we find a significant but small effect for both ml and m2 furthermore the effect dies out within one and two quarters for the respective definitions of money the results thus support but disagree in magnitude with those of darby 1972 who found a larger and longer lasting partial adjustment effect our finding of so short an effect is especially important in light of robert barro s 1978 paper which relies on darby s long lasting effect to explain price behavior

rational and self fulfilling balance of payments crises speculative attacks on a pegged exchange rate must sometimes occur ifasset price paths are to be free of abnormal profit opportunities suchattacks are fully rational as they reflect the market s response to aregime breakdown that is inevitable the authors shows that under someexpectations about policy balance of payments crises can also be purely self fulfilling events in such cases even a permanently viableregime may collapse and the economy will possess multiple equilibriacorresponding to different subjective assessments of the probability ofa crisis the behavior of the domestic interest rate will naturally reflect the possibility of a speculative attack copyright 1986 by american economic association

two cases for sand in the wheels of international finance the incompatibility of pegged exchange rates international capital mobility and national monetary autonomy is a basic postulate of open economy macroeconomies in the present environment of high capital mobility and political uncertainty even the possibility that governments may utilize their policy autonomy can defeat efforts to peg the exchange rate this leaves two possibilities one is to fix the exchange rate irrevocably through monetary unification the other is to live with floating rates either way a case can be made for throwing sand in the wheels of international finance where monetary unification is not an option this is a may to make distinct national currencies tolerable and international money and capital markets compatible with modest national autonomy in monetary and macroeconomic policy for eu counties striving to create a monetary union it is the only politically and economically feasible way of completing the transition to stage iii of the maastricht process

currency crises with the threat of an interest rate defence while virtually all currency crisis models recognise that the decision to abandon a peg depends on how tenaciously policy makers defend it this is seldom modelled explicitly we add the threat of an interest rate defence to the global game model of morris and shin american economic review 88 1998 with an endogenous defence actions of speculators may become strategic substitutes instead of the usual complements nevertheless our generalised model remains tractable and has a unique threshold equilibrium it provides additional insights for instance the threat of an interest rate defence makes speculation riskier and this may be sufficient to keep speculators out when fundamentals are still relatively strong

leading indicators of fiscal distress evidence from extreme bounds analysis early warning systems ewss are widely used to assess a country s vulnerability to fiscal distress a fiscal distress episode is identified as a period when government experiences extreme funding

the international monetary system forty years after bretton woods review essay in may 1984 a distinguished group of central bankers and economists gathered for a conference at bretton woods to consider the evolution of the world monetary system that was born at that location forty years earlier this volume contains nine essays with accompanying discussion on issues of performance and reform of current international monetary arrangements these papers deal with problems facing the industrialized and the lessdeveloped countries and assess the institutions that have been set up to accommodate these problems the major accomplishments of the original bretton woods conference were of course the establishment of the system of payments based on fixed exchange rates and the organization of the world bank and the international monetary fund as the order developed in the late 40 s and early 50 s each central bank saw it as its duty to intervene in foreign exchange markets to ensure an essentially fixed parity of their currency with respect to the dollar the role of the u s was to guarantee the dollar price of gold at 35 an ounce the system has been called a dollar standard because the dollar played the role of a reserve currency one of the paradoxes of the system as robert triffin pointed out in the early 60 s is that in order to produce a continuing and rapid enough expansion of world reserves the u s had to run balance of payments deficits yet continued deficits by the u s threatened the convertibility of the dollar into gold as it happened the system of fixed parities broke down in the early 70 s not because of a lack of reserves but because a glut of dollars made the bretton woods dollar exchange rates untenable the system eventually evolved into one in which most of the industrialized countries currencies more or less are determined by the market while the currencies of most second and third world countries are pegged to a major currency the floating period has been

the dollar pound exchange rate in the 1920s an empirical investigation much of the empirical support for the monetary approach to exchange rate determination has been obtained with data from the 1920s for example clements and frenkel 4 frenkel 8 9 frenkel and clements 11 and huang 18 all obtained favorable empirical evidence estimating different versions of the monetary model the empirical results with data from the 1970s however are mixed bilson 1 2 3 edwards 7 hoffman and schlagenhauf 16 and woo 25 obtained favorable empirical evidence while dornbusch 6 hartley 14 huang 17 meese and rogoff 20 and shafer and loopesko 24 obtained contrary empirical evidence this mixed performance of the monetary exchange rate model in the 1970s has been attributed by dornbusch 6 and frenkel 10 to the failure of purchasing power parity ppp to hold in the short run and by meese and rogoff 21 to the instability of the u s money demand function we re examine the empirical evidence on the dollar pound exchange rate in the 1920s using the simple monetary exchange rate model popularized by bilson 1 2 and frenkel 8 9 thus it is not the purpose of this paper to suggest new empirical monetary exchange rate models nevertheless there are several important reasons why we re examine the simple monetary exchange rate model first several important implications of the monetary exchange rate model in our opinion are not adequately tested in existing work second there is a presumption that the failure of the monetary exchange rate model in the 1970s and the 1980s is due to special events such as real shocks that affected ppp and the instability of the u s money demand function by using the data from the 1920s we hope to avoid the problem of the instability of the u s money demand equation in the 1970s moreover frenkel 10 found that ppp held up reasonably well in this period thus the period of the 1920s provides a favorable setting to test the monetary approach finally we choose the dollar pound exchange rate based on data availability our empirical methodology differs from most previous empirical studies in that we estimate the reduced form equation of the exchange rate within a system of three equations in addition to the reduced form equation of the exchange rate there are also two equations describing monetary equilibrium one for the domestic economy and one for the foreign economy the estimation

exchange market mayhem the antecedents and aftermath of speculative attacks exchange market mayhem the antecedents and aftermath of speculative attacks this paper evaluates the causes and consequences of episodes of turbulence in foreign exchange markets using data from 1959 through 1993 for twenty oecd countries we consider the antecedents and aftermath of devaluations and revaluations flotations fixings and speculative attacks which may not be successful we find that realignments of fixed exchange rates are alike devaluations are preceded by political instability budget and current account deficits and fast growth of money and prices revaluations are mirror images of devaluations speculative attacks resemble devaluations but money growth and inflation are more endemic and there is no last minute attempt to tighten monetary policy in contrast few consistent correlations link regime transitions like flotations or fixings to macroeconomic or political variables transitions between exchange rate regimes are largely idiosyncratic and are neither consistently provoked ex ante by systematic imbalances nor typically justified ex post by subsequent changes in policy we conclude that there are no clear early warning signals of many speculative attacks and no easy solutions for policy makers barry eichengreen andrew k rose and charles wyplosz

collapsing exchange rate regimes some linear examples abstract we construct a pair of linear examples to study the collapse time of a fixed exchange rate regime the first example is a perfect foresight continuous time model which allows calculation of the exact collapse time and the tracking of reserves the second example is a discrete time stochastic model which yields an endogenous probability distribution over the collapse time and produces a forward discount of the exchange rate

investment incentives debt and warrants abstract this paper models and characterizes investment incentive problems associated with debt financing the decision problem of residual claimants is explicity formulated and their investment policies are characterized the paper also analyzes the use of conversion features and warrants to control distortionary incentives these claims reverse the convex shape of levered equity over the upper range of the firm s earnings and this mitigates the incentive to take risk it is shown that under certain conditions such claims can be constructed to restore net present value maximizing incentives and simultaneously meet the financing requirements of the firm

self fulfilling currency crises and central bank independence we develop a model of a fixed exchange rate peg arrangement derived from the barro gordon model of rules versus discretion it is shown that the fixed peg is vulnerable to self fulfilling currency crises in which the unemployment rate increases the credibility of the rule decreases but paradoxically the reputation of the policy maker improves delegating monetary policy to an independent central banker does not prevent this type of crisis from arising and can even make it more costly

a cardan s discriminant approach to predicting currency crashes abstract this paper models large swings in exchange rates by introducing nonlinearity via the generalized normal gen distribution lye j n martin v l 1993 robust estimation nonnormalities and generalized exponential distributions journal of the american statistical association 88 261 267 as the distribution allows for bimodality a switch between modes may give rise to currency crashes a statistic known as cardan s discriminant based on the shape parameters of the gen is used to detect bimodality the cardan s discriminant is found to reliably predict currency crashes for eight emerging countries and generate relatively low false signals for stable currencies

an experimental exploration of self fulfilling banking panics their occurrence persistence and prevention this article tests the possibility and the degree of persistence of self fulfilling banking panics through an experimental protocol panics are proved to be persistent phenomena that are difficult to prevent however it seems possible to curb them through a learning effect caused by a temporary but sufficient suspension of the deposit availability combined with a narrow banking solution which makes banks more liquid additionally panic prevention requires a full deposit coverage to be effective this suggests that the moral hazard issue should not be tackled through a lower deposit coverage especially in emerging countries banking systems where depositors are likely to lose confidence

speculative attacks with unpredictable or unknown foreign exchange reserves during a currency crisis speculators usually do not know the value of a central bank s foreign exchange reserves in this paper i show that modelling speculators as having imperfect knowledge of reserves enriches the predictions of the classical model of specula tive attacks with realistic lags in reserve reporting and costs to unsuccessful speculation successful speculative attacks will involve a jump depreciation unsuccessful attacks may occur attacks may occur when fundamentals are improving attacks may not be preceded by large increases in interest rates and fixed exchange rates may be abandoned with no attack and no decline in the money supply jel classification f3 1 attaques speculatives quand les reserves de devises etrangeres sont soit imprevisibles soit inconnues au cours d une crise monetaire les speculateurs ne connaissent pas normalement la valeur des reserves de devises etrangeres que la banque centrale a en main ce memoire montre qu une modelisation des speculateurs en postulant qu ils ont une connaissance imparfaite des reserves permet d enrichir les predictions du modele classique des attaques speculatives a partir d une evaluation realiste des delais dans les rapports sur la quantite de reserves et des couits d une speculation ratee on deter mine que les attaques speculatives reussies vont impliquer que se produise une deprecia tion discontinue que des attaques speculatives ratees puissent se produire que des attaques peuvent se produire quand les donnees fondamentales s ameliorent que des at taques ne peuvent pas etre precedees par de fortes augmentations des taux d interet et que des taux de change fixes peuvent etre abandonnes sans attaques et sans chute dans

investor protection and convertible debt design abstract an important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio maturity date and call period following lewis et al lewis m rogalski r seward j 2003 industry conditions growth opportunities and market reactions to convertible debt financing decisions journal of banking and finance 27 153 181 we employ a single measure that simultaneously considers all of these features the expected probability measured at issue date that the convertible will be converted to equity at maturity we find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity the positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs specifically in countries with stronger shareholder rights firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion furthermore we find that large non management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights in contrast firms in countries with stronger creditor rights issue convertibles with lower probability of conversion we also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights