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1982
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University
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300 N. ZEEB RD.. ANN ARBOR. Ml 48106
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University
Microfilms
International mX.ZeebRoad.AnnAitwr.MI48106
PH.D. 1982
Economics
Approved:
Signature was redacted for privacy.
In Cha^^ of Maj
Work
ii
TABLE OF CONTENTS
Page
CHAPTER 1. INTRODUCTION
3
6
EMPIRICAL ESTIMATION
The Model
Empirical Results
Anticipated and Unanticipated Money Supplies and
the Exchange Rate Level
Identification
Estimation and Diagnostic Checking
Autocorrelation check
Cumulative periodogram check
Exchange Rate Volatility
CHAPTER 5.
9
19
24
24
31
34
53
56
59
65
78
81
113
115
119
123
133
136
146
148
151
152
153
165
168
iii
REFERENCES
173
ACKNOWLEDGMENTS
176
APPENDIX 1. DATA
177
177
177
178
178
179
180
186
188
iv
LIST OF FIGURES
Page
Figure 1. The time path of the exchange rate when
a transitory change in the money supply
is unanticipated
Figure 2.
62
68
73
75
Figure 5.
77
84
92
93
97
98
vi
LIST OF TABLES
Page
Calculated exchange rate levels in
response to anticipated open market
operations
95
100
111
113
125
unre
OLS estimates for Ln(S) DM/ restrictedmixed samule and prior information
125
OLS estimates for Ln(S) DM/ restrictedmixed sample and prior information
127
127
130
131
137
142
143
145
vii
Table 14.
155
Table 15.
164
166
167
Table 16.
Table 17.
CHAPTER 1. INTRODUCTION
Recently, increased attention has been focused on
the asset market approach to exchange rate determination.
The asset market approach to exchange rates views an
exchange rate as the relative price of national monies.
And it is viewed as one of the prices that equilibrates
the international markets for various financial assets.
Hence, the supplies of and demand for stocks of various
monies and other financial assets are the important
elements under this approach.
In contrast, the traditional theory of exchange
rate determination is based solely on the current account.
It focuses on the demand for and the supply of foreign
exchange and the price elasticities of import demands
and export supplies.
In
Previous studies
Exchange
Under
An addition
Secondly, in this
In this
In Chapter 2,
In
In the second
CHAPTER 2.
LITERATURE REVIEW
Their fluctuations
10
11
However,
Consequently,
12
Since
of funds do occur to correct the existing market disequilibria, but are not considered as the basic determinant
of equilibrium.
Recently, asset market models have, therefore, been
developed to replace the traditional approach models. These
asset market models differ in many respects, but the main
emphasis is on the requirement that available stocks of
national monies and other financial assets must equal
stock demands for these assets as a necessary condition
13
for equilibrium.
An alternative group of
It is therefore
14
15
will have the same effects as an open-market operation bydomestic monetary authorities.
16
17
18
19
Over periods of
Bilson
20
21
22
The
More consideration
It is
be etnp "1-3 #
tnoneta Nr^;g? -Cof the
Dombu ; ^ <#'. 4'
(1976)
The Di I V
empiri
-:
polici
analys
repere <'^^-^-2.
are ig ^ e of th ^13?-
:i'
countr
emoiri
?SSS35P5
1
count: \
L
[ggsgTiss- - -
!==
3,
23
24
In Section 1, the
25
is fixed.
P = SP*
It is also assumed
26
27
or stable.
i = r* + X
(3)
^ = 8(r* +
X,
Y)U
(4)
6(r* + X, Y)
1 - 0(r* + X, Y)
(5)
and hence
L(Y, r* + x)
> 0,
< 0
(6)
28
An increase
Equilibrium in
An increase in real
29
^ - Y + A - E(Y + A, p +
(7)
g = AY^e-^(^* +
(r*)-^
(8)
- Y y +
\r* +(tinCr*) 4- xx - p*
(9)
(10)
30
A fall
An
31
As Tumovsky and
And for
Xt = Et^t+1
3%)
(11)
32
Substituting Equation 11
yields
(12)
expectations, we obtain
(13)
+ AEt+i(St+2) - P*t+i]
Note that
^t^"t+l^t+2^^ = Et(St+2)
^t^t+2^
also
'^^*t+2
(14)
33
the expression
(15)
~^
Substituting Equation 15
^t = ITr^t - at -
- *t+j
j=l
(16)
yyt+j +
An increase
34
of future exchange rates based solely on interest-rateparity conditions can be highly inaccurate, because
expected future exchange rates are influenced by expected
monetary and fiscal policies as well.
Explanation for Exchange Rate Volatility
In the past years, exchange rates have exhibited
wider fluctuations than had been expected, and some
attention has been devoted to explaining the causes of
this short-run volatility. Perspectives on volatility
are provided by Schafer (1976), Dombusch (1976), Kouri
(1976) and Branson (1976).
Exchange rate volatility may be attributed to the
fact that expectations about future exchange rates are
imprecise. Insights into why expectations are imprecise
and thus, into why observed exchange rates have been so
volatile can be obtained from the model developed in
35
this section.
venience,
- m
- t+j - ^^c+j +
Consequently,
36
In
37
If A^
Note that
38
xPt+1 - (1 + x)p^ =
(17)
Pt -
Solving
in Equation 17 we obtain
- ^t+i +
(18)
a + 1)
Note that this solution is the same as in Equation 16.
If
- Y + A - E(Y + A, ^
= H(Y,A,|,r*)
> 0,
< 0
< 0. V 0
P
An independent increase in real output raises real expendi
tures, but assuming a marginal propensity to consume of
less than unity, part of the increased real output leads
to foreign asset accumulation.
An increase in A above
39
An independent increase
dB_
dA.
32^ - 0, but 32^ - -1.
40
- P^]
or
^t+l + *t+l -
- Zt+1:
bo = (1 - S)'
da^
for i f 0
-1
for i = 0
Hence, if
is recognized as endogenous,
Xpt^l - (1 + %)pt -
" ~1 ~ t
- ^t+1
(19)
(20)
41
=2^t+2 + "l^t+1 +
= [eo-(l-bo)ei] + (bo-g^^t-^t+l'^t+l
or
=2^t+2 + ""l^t+l + Soft =-(Go + gl> + ^8(t - *t+l)
+ (1 + X)Zt+i - XZt+2
Pt =
00
00
+ Yina^+ir^ + zOTt+i'' + ^3
o
o
o
Y4ZZt+l+iG
"^5^1^
^62^
(21)
and
00
Gt = *o + *l^t+i""''
o
CO
$2t+i^''
o
00
^s^^t+l+i^""
o
OO
+ *4^^t4-l4-i^^
o
*51
*6
1^
= 0 where
= -(1 + X + Xb^)
Oq = (1 + %)bo - g
(22)
42
and
(1 - b^)e^ "
1+g - b
y _ r(bQ - g) - 1
1
D
bp - g
(1 + X)bQ - g
-r
D
^3
Y _ r
1
4 - D - CI + X)b^ - g
2
-1 /Xoi - 4*^02)
=
z;;
%=
gei + e,
*0 - 1 + g - b
1 =
- 'I +
43
*2 = (1 + x^i
-Z-g - *1
3 = Y3(' - % +
_
1+ X
^^4 - (1 + x)b^ - g - *3
and
l(Mt+i - M*)k^
o
exists, and we assume converges. Where k = max[|r|, |s|]
and suppose r > 1 > s > 0. Let
O O
XP^_P2 - (1 + %)?% -
(23)
44
^t+1 -
- ^t+1 +
(24)
ft = To + YlSVc+iri +
o
+ YgZZc+i+iri
o
+ YsZ^t+l+i^ ^758^1 +
^t = *0 +
+ *2:Vc+iS^ + fszZt+l+i?^
0
0
"
i
t
+ 'J>4^^t+H-i ^ *58 1
o
where in Equation 25,
To = **
(25)
t
"i'6 2
(26)
(l-bo)e^ - e^
i + g - bo
45
If
satisfied.
From the two roots of the quadratic equation
2
1
"2
2 + a2^ + a^r = 0, we have r + s = and rs = .
This implies that if r > 1 > s > 0, then
= (1 + %)bQ - g > 0
> 0
or g = 1 - b > 2 + X'
Since
46
-*5?
0^^ - (1 + A)
(1 + x)r - X
da.Q =~d.Z^ =
"h
00
^2^ )dV ^
^4^ )dZ
00
CO
=r
+-r
^\r _-\]d4s
U +
X
D
O M 8
-o-
""ii
HM8
eW
ti
8-
O M
-e-
+
o M 8
-eM
MH
rt
I
6-
w
n
+
-e-
K>
CO
Ui
.
t.
O M 8
Ow
H
-e4>
e4>
&(b
CO
e-
oNi
CO
H-
V-/
N3
CO
rt
I
p.
S-
<!
rt
+
O"
to
CO
H-
+
o M 8
/-s
-e-
w
H
1
a>
rt
p.
5p.
S-
p>
rt
nn>
I
p.
N
O
o
rt
rt M 8
M
oM
H
H-
+
eN)
CO
H-
<5<!
(D
O M
1
CD
rt
M
0 M V
M
M
H-
H*
-eN>
CO
rt M 8
ew
+
eN>
CO
H'
s_x
p.
<
n>
rt
it
+
oM8
-e-
OCO
CL
CS)
(D
(O
pu
N
(D
+
O M Y
,
CO
H'
p.
N
(D
H
-e<jO
H
H
+
H"
O"
CO
H
g(D
H
H
+
oho
CO
H-
-
Ln
+
eM
M
H'
+
-eN>
CO
H*
P;
n>
v-y
l
+
O M 8
O%
CO
s*
n>
+
rt
M
p.
O M 8
-o-
/-s
a
rt
M
H*
-e-
-eM
M
H-
-e-
p.
N
O
a>
rt
H
+
o M8
C*3
M
e-
-e-
4>
CO
CO
Sn>
5n>
48
Therefore,
da^ =
E (f^r^ +
o
t-1
s
.
+ I (o^r + <i)^s )dz
+ *2S^) -
+ [E{(*3ri +
+ 4,2S^'''^)}dV^^_^j.
- 8t\(*3rt+^ + <{.45^"^^)
da^ = -dz^e 2 - G
t-1
.
E ($3%^
o
.
4)48 )dz 2+^]
o^^2
"
^
i ^3 r^
z[*4s
t ^ 3
+1-9 i(^(^nr^
^^^z
49
da^ =
E (*1%^ + <j,2S^)dv^
o
t-1
.
+ Z (Ogr +
o
i
e
)dz
+ I[*2sl(l o
+ eSdy
l^TS
Note that
dy^ =
+ (jr^ +
+ r{(^jr^ + 2s'-)<ivj
50
r
C-1
.
i
l+[ ^ (+1? + *2"
t-1
i
i. e
Z (*3? +<j>4S )dz i+il[(i+^)r -
+(z[(4irt+i + 'J'2S^'^^)dv^^^
o
+ zECyi?^ + Y2S^)dv^t+i
o
and hence
rdz
dPj = dy^ +
t-1
+
Z (*3r
t-1
.
.
- %] 1 +([ I (*1^ + +2=
-
re^i
"
-i
-
+ ziYiri + Tzsi) +
" ,]
^^r^ ^
^^r()
,+((!+,)/_ ,)s^)]dv\+.
,
.
4'or^'^^
i|),r(S.)^
+ z[(Y3r + Y4S ) +((i+x)r _ % + ((l4-x)r - :\^^^^^%+l+i
51
rdz
= dY. + t(l+l)r -
t-1
.
1 + [ I (If + *2:
+ Y(+3ri +
,]
*ir
i
<l>2^()^
+ :[((l+x)r - X + Yl) r + ("^2 + (i+A)r -
"
^3^"
i
4"/^()
.
+ :[((l+x)r - X + Y3)r + (^4 + (l+x)r - x^
Note that
.-[Xm^l
and ^
[ ail^,
and hence,
Cl + X )r - X +
- 0
and
*3%
(1+ X )r - X
+ ^3
= 0
_
t+i
t+l+i
52
Thus:
rdz
dP^ = dm* + 8 i[(i+%)r _
4-
I (*3?
t-1
+[ Z (41?! + *28
e
"
4>2^(f")^
i
+ ^^(^2 + (l+x)r - 7?^
<i>4r()^
i
+ (^4 + (l+x)r - x)^
e
t+i
g
t+l+i
(26b
)dz i+in(i+x)r -
In particular,
53
= 8(Y, r*)(g +
(27)
#9? = Y - E(Y, g + e) = 0
(28)
54
9-1
-Ew
-E
r*
dA
Consequently,
a policy of pure monetary expansion leads to an equiproportionate increase in the price level in the long run (and
short run).
55
-E (d(p)) w
1.
dA +
2:*
dr* - 0
and hence
d(f)
'
6-1
-Ew
-Ew
r(0A
dA
_
r*
) dr*
dr*
56
d($)
dr*
E^p0r*/r*
-E.
w
(0-1) +
= W8^* <
and
E A
dA
- V'f*
^(s-1)
= (^ - W9 ^ ) r * > 0
Y*
An independent increase in the foreign interest rate reduces
the equilibrium real money stock both because it lowers the
preferred share of real balances in wealth and because it
reduces the level of real wealth. With real balances
comprising a smaller fraction (and hence with realTassets
comorising a larger fraction) of wealth, we tnust have
an increase in the equilibrium price level and thus a
depreciation of the exchange rate.
Short Run Analysis
In this model, it is possible to introduce a distinc
tion between anticipated changes in exogenous variables
based on previously available information, and unanticipated
changes in exogenous variables due to the receipt of new
information. The analysis of the anticipated changes is
57
This operation
58
dm^
of monetary disturbance.
(b) Unanticipated Permanent Disturbance: represented
ds.
PU
^3g
PA
59
dM +
dA = 0
60
dA
-r* dM
"
TT
IT - -p- T
-dM . M r*
P X
dA
-dM f e .
-W
and hence,
diut - da^ =
dSt TU
cno " XrFxTTireT
61
After the
Figure 1.
t+1
time
63
dst TU
dm^ KE
Since
^
^
In
64
To take these
We can
65
Hence,
" ITT-
Hence
66
Therefore
ds^ PU
me
of accumulation.
This is the
67
for all i.
= ^o
d^t
dm^
PU
= 1
ME
+ .1^
3--'dst
dm^
PU
. 1
1
omo T'l+ + ^<Tr)l
- da^+j)(i^)^]
hence
68
Fifure 2 .
time
69
Consequently, larger
The present
70
equation
= Y + A - E(Y + A, ^ + 1^)
- J
71
PU
omo
l^i+x )r -
= ^
(iZe)
^^o
a
omo
A exog.
ITe
^+A
dP
a;;;;; ^
1
+
^-
Ki+x)r --
Jt-rrl
conclude that
72
3omo
FEE
A Exog
da. = - 0^,dz^
t
1 o
if r > 1, then the time path of a^ approaches
steady state level, from below.
, the
This continues
73
r<-1
r>1
time
Figure 3.
74
Under
that real wealth has fallen), the trade surplus decreases due
to rising wealth. This continues with A rising until the
current account is back in balance. At that point the rate of
accumulation of net foreign assets is back to zero, so that
the system is back in steady state equilibrium. Throughout
the adjustment process there is a surplus in the current
75
76
77
A<
t=0
Figure 5.
time
78
Therefore
79
depreciation occurs.
If
The
80
Throughout the
81
dm_ - da = 0
,
o
o
= dm(Y^) ,
t + i<
t + i^T
dPt iTx
dm^_j.^ - da^^.^ f 0
when t + i ^ x
or for i > T - t
1T-t
Therefore at t = 0, the impact effect of the change in
expectations is given by dS^ = (Y^)
82
The results
suggest that the longer the time lag between the time
of the announcement and the time the change actually occurs,
the smaller is the initial depreciation of the exchange
rate. From Equation 29 above, it is clear that the effects
of the anticipated increase in the money stock on the
exchange rate are greatest in the period in which the
change occurs and are proportional to that change in
earlier periods, with the weights declining geometrically.
It is plausible to have the increase in the exchange rate
level in all earlier periods since the information on which
individual's expectations are based changes with the
announcement of the monetary policy.
At t =
T ,
Jo
83
This
is illustrated in Figure 6.
Comparing the impact effect of unanticipated open
market operation with anticipated open market operation
impact effect, we realize that
3
omo
anticipated
X y
I+T' omo
unanticipated
dS.
omo
dSo
> J ''
unanticipated
omo
T >
anticipated
means that
84
fft
dm^
1
1-e
1.0
Full
Neutrality
1
t=7
Figure 6.
time
85
dZ = 0
o
dm^ = dm*, t ^ x
= 0
, t < T
, i^T
and also
dZ^ = 0 ,
dz^ = dz =
i f T
dm
. Hence,
daT=
E ((}>-!+
<j)2S^)]dm
- dz[-^
X ^_Q
J.
z.
r + -^(^)^]
s r
= 9^1J-[ z (6nr^
J. + 6)S^)dm
^
- *5*2^
+ 4/s'^"^)dz]
4
86
where
T-1
5 =[
If
> 0, and
and as t
00,
This
87
t,
-r
would cause an
88
But when
As t approaches T, we accumulate
1
T -1
= ^ + (l+x)r - X
If (j>5 < 0, it implies that
89
< 0, and
dPt - dm - (i+x)r As t
0 and dp^
and at t >
it
90
^^t =
re^,
- ^(l+x>r T -t
t-1
<t)2^(|-)^
'iio
.
*2=
^
,S\t
Hence, when t = 0
T-1
(t>2^
dpj - dm - ^^[y2 + (1+,)^ -
= dm -
+ j- [r(i+^),>]s^'^dz
Hence, at t = 0, when expectations are revised, a^ is ixnchanged; the imnediate response is a depreciation of the ex
change rate. The anticipated increase in the money stock
causes an anticipated and therefore an actual depreciation of
the domestic currency.
91
accumulated.
At t = x
92
dm
Full
Nutrality
t=0
Fifture 7a.
t=T
time
93
t=0
Fipure 7b.
time
94
Using
= 5;
95
Preannouncement
0.0000
0.0000
t = 0
0.0002
0.00023
0.0012
0.0008
t = 2
0.0025
0.0047
t = 3
0.0170
0.0281
t = 4
0.0280
0.1684
t = 5
0.9762
1.0100
t = 6
0.9854
1.0100
0.9910
1.0100
t = 8
0.9945
1.0100
t =9
0.9966
1.0100
t = 10
0.9979
1.0100
P^
1I
dS^/dm^
Partial rational
expectations
II
Time
dS^/dm^
Full rational
expectations
II
rt
Table la.
1.0000
96
97
Full
Neutrality
Figure 8a.
98
i=
FiRure 8b.
t=T
time
99
= 0.8;
= 5;
= 0.2;
= 0.5; m* = 100;
= 96;
= -0.02; yg = 0.81;
= 0.022; ^2 ~ 0.033;
Let us
100
Partial rational
expectations
Preannouncement
0.0000
0.0000
0.0002
0.0003
t= 1
0.0018
0.0015
t = 2
0.0063
0.0093
t = 3
0.0410
0.0555
t= 4
0.0515
0.3333
t= 5
1.8670
2.0000
t= 6
1.5320
2.0000
t = 7
1.3263
2.0000
1.2002
2.0000
t= 9
1.1228
2.0000
t = 10
1.0753
2.0000
II
rt
t
II
Full rational
expectations
rt
Time
oo
Table lb.
^ 1.0000
101
permanently.
dm^ = 0;
t+ i < T
= dm;
t + i-^ T
For t T, we have
dm^_^j^
when t + i ^ t
or when i ^
- t
102
dPo = (l^)^dm
Hence, the longer the time lag between the time of the
announcement and the time the change actually occurs,
the smaller is the initial depreciation of the exchange
rate. For t < %, the exchange rate depreciates exponentially,
and the system reaches full neutrality at t = %.
Comparing the impact effect of the unanticipated
pure monetary expansion with the anticipated pure
monetary expansion effect, we obtain
dME
anticipated
dME
unanticipated
103
and hence
< as.
anticipated
dIE
since
unanticipated
< 1
dSo
Tomo
~
1 \/ ,X \T 'dS^
_ /_1
o
antlctpated"
'3
anticipated
I+x
means that
dZj = 0
for all j
104
dm^ = dm*,
t ^ T
= 0,
<
i < T
= 0,
i^T
for t = 0,
dao = 0
t = T
t,
105
da_ = 8f
Z (Onri + (j)si)dni]
^
^1=0-^
^
and as t + , da^
= dm -
T-t
* 2 ^
s dm
= dm - : ^[bo-g +
o
o
As noted in an earlier discussion, there will be an
immediate depreciation of the exchange rate at the time of
the announcement of the future increase in the money stock.
From then on, the exchange rate will continue to depreciate,
and the anticipation of depreciation will lower real
balances, real wealth and real expenditures and hence will
give rise to current account surplus. The subsequent time
paths of the price level under full rational expectations
is as follows:
(ii) when t
< T
106
re^,
t-1
i-O 1
s
'
aPt = dm - [(i+^)r - %][.Eo(*ir + *2=
T-t
" iio
(iii) when t =
i
dm
(1+A)r t
re"^dp, = dm - '(l+Or -
T-1
.
+ *2 )dm]
1u
Hence no overshooting at t = t.
T -1
dPt dn -
as t ^ , dp^
)dm]
107
t=0
t=T
time
108
dm
Full
Neutrality
t=0
Figure 10.
t=T
time
109
expectations.
At t =
T,
T.
110
This is
Under partial
The
Ill
Table 2.
Time
dS^/dm^
Full rational
expectations
Partial rational
expectations
Preannouncement
0.00
0.00000
t = 0
0.00012
0.00013
t = 1
0.00121
0.00077
t = 2
0.00250
0.00463
t = 3
0.01700
0.02778
t =4
0.02750
0.16667
t = 5
0.96720
1.00000
t = 6
0.97990
1.00000
t = 7
0.98766
1.00000
t = 8
0.99243
1.00000
t = 9
0.99536
1.00000
t = 10
0.99715
1.00000
t; - oo
P^
1.00000
112
This is
113
Table 3.
< T
t =
> T
approaching
approaching
= 1.0
= 1.0
= 1.0
= 1.0
r
omo antic.
< 1
increasing
c^E antic.
< 1
increasing
omo unantic.
do
3 unantic.
< 1
approaching
1.
114
(i) dS,
TA
omo
(ii) dSt
dME
dS.
TU
omo
TA
dS^
TU
The results suggest that the larger the time lag between
the time of the announcement and the time the change
actually occurs, the smaller is the initial depreciation
in the current exchange rate.
115
The pumose is to
Each country
We also assume
(30)
Equilibrium in
(31)
E = E(Y, W)
(32)
E* = E*(Y*,W*)
(33)
where
116
It is assumed
Let us also
(34)
(35)
r* + P*/P*
117
hence
(36)
(37)
Thus,
118
M _
F"
L(r* + IT, Y)
< 0, L2 > 0
(38)
(39)
and
M* _ re*(r* + IT*, Y*)
- 11 _ 8*(r* + IT*,
p - ^ L(r* + IT, Y)
(40)
(41)
E + E* = Y + Y*
(42)
119
_ PA.L(r* +
Y)
p*A*.L*(r* 4- TT*, Y*)
y*
and \ = x* we
shall have
^ ~ S(^)(^) e
(45)
120
(46)
denotes the
Similarly, an increase in
121
power parity.
St = TTT
122
123
CHAPTER 4.
EMPIRICAL ESTIMATION
Y[Ln(S)
- Ln(S_^)] where
denotes
124
+ K^t
is a constant and
equation becomes
Ln(S) =
Bq
(47)
where
Bq
~ *^0' 1 ~
65 = yn; 6g =
^2 ~
yK^;
By = 1 -
^3 ~ YE;
~ -yn;
y-
Table 4.
Ln(S)
unrestricted
gq
Ln(M^)
Ln(M*^) (i-i*)
Ln(Y^)
Ln(Y*^) t
Ln(S-l)
-1.15
0.46
0.04
-0.03
-0.18
0.71
0.34
-0.01
Table 5.
Ln(S)
= 0.9832
p = 0.2087
DW = 1.954
gg
Ln(M^)
Ln(M*^) (i-i*)
Ln(Y^)
Ln(Y*^) t
Ln(S-l)
-0.25
0.19
-0.18
-0.17
0.19
0.81
0.26
-0.001
= 0.9807
P = 0.2496
DH = 1.9707
126
The consistency
equal to
Since there
Table 6.
Ln(S)
OLS estimates for Ln(S) DM/ restricted-mixed sample and prior informa
tion
Po
Ln(M^)
Ln(M'V^) (i-i*)
Ln(Y^)
Ln(Y>^^.)
-1.328
1.003
-0.985
-0.901
1.018
-0.005
(3.341)
(3.623)
(3.247)
1.385
Table 7.
^o
Ln(S)
^'T'^ N
Ln(M)
Ln(M*)
Ln(Y/Y*)
(i-i*)
-4.297
0.415
1.050
-0.044
0.188
0.363
(1.396
(0.099)
(0.1821)
(0.143)
(0.066)
(0.350)
= 0.96
SI = 0.015
DW = 1.55
0.88
128
Results are
shown in Table 7.
The figures in parentheses are the standard errors
of the estimated coefficients. The coefficient of relative
prices turned out with the predicted sign and highly
significant. The elasticity of the exchange rate with
respect to the domestic money supply is consistent
with the homogeneity postulate, that a given change in
the supply of money results in an equiproportionate
change in the exchange rate.
129
Their
130
Table 8.
S -9.43
Mlu
FPg
FPu
-0.103
0.143
0.249
-0.289
RHO
R2
0.826
0.41
-0.057 0.089
0.456
-0.293 0.864
0.938 1.33
Table 9.
Bo
RHO
R2
DW
0.994
0.87
(la)
MBg
-0.736
(4.6)
1.074
(72.9)
80.140
(1.3)
(lb)
MBg
-0.785
(-1.8)
1.080
(26.8)
-67.053
(-1.5)
0.731
(6.3)
0.997
1.508
(Ic)
Mlg
0.959
(0.2)
1.372
(3.5)
-67.944
(-0.6)
0.917
(13.6)
0.989
1.719
RHO
.R2
DW
0.338
(2.1)
0.780
1.629
FGg
11944
(2.8)
FGg-1
e($/DM
0.631
(4.7)
188.673
(2.8)
Exchange rate
(3)
"^o
Mlg
Mlu
FPg
Fpu
RHO
R^
DW
151.58
(1.5)
-0.02
(-0.4)
0.0145
(0.3)
0.338
(0.7)
-0.247
(-0.8)
0.814
(8.4)
0.771
1.118
^T-Jhere MB and HB are central bank money and target central bank money,
respectively.
132
rate equation.
133
Incorporation of additional
The
134
(48)
(49)
j^d
(50)
p*A*Y*^e"^
_ PAY^e"^^^*"*"^^
^T
P**Y^vnF^^hry
fc..
Hence, S provides an
135
. _ dLn(M^/M*^) _
'
ar
.
3T
S =
- g^T + U
(S^_^^-S^)/S^],
In
136
parameters.
137
Variable
Parameter/
Estimate
T-ratio
Intercept
-0.713
-0.502
0.616
0.149
0.685
0.494
M*
0.262
0.792
0.429
-0.435
-1.611
0.110
Y*
0.025
0.107
0.914
0.167
2.490
0.014
A*
0.211
4.594
0.001
FP
0.438
0.511
0.611
-0.013
-6.192
0.001
= 0.9167
S.E = 0.003
p = 0.748
DW = 0.48
The
138
Aliber (1973)
139
Serial
all t.
!P |
<
S -0
for s f 0
140
One of the
-P
-p
-p
-p
T =
(52)
+ ""t-l
(53)
141
%t-l
(54)
and hence
\ = pYc_i +
- pXt_i)3 +
(55)
After correcting
and foreign real bond holdings turned out with the signs
predicted by the model, but are not statistically different
from zero. The parameter estimate for the forward
142
T-ratio
0.636
0.363
0.717
0.226
1.800
0.074
M*
-0.087
-0.436
0.663
0.036
0.177
0.859
Y*
-0.088
-0.333
0.740
-0.037
-0.577
0.565
A*
0.078
1.158
0.249
FP
-0.767
-0.988
0.325
-0.007
-3.009
0.003
Variable
Intercept
M
?? = 0.638
S.E = 0.001
143
Table 12.
Variable
Parameter
estimate
Intercept
1.564
11.562
0.0001
(M - M*)
0.600
2.845
0.0054
(Y* - Y)
-0.421
-1.964
0.0523
(A* - A)
0.062
1.858
0.0661
FP
0.580
0.706
0.4820
-01006
-13.251
0.0001
ET = 0.898
T ratio
S.E = 0.003
144
be attributed to the reduction of the problem of multicollinearity, by imposing the parameter restrictions.
145
in Table 13 below.
Table 13.
Variable
T ratio
Prob >|
|
T
Intercept
1.912
14.319
0.0001
(m - M*)
0.840
4,793
0.0001
(Y* - YN)
0.222
1.475
0,1434
(A* - AN)
0.059
3,794
0.0003
FPN
0.759
1.234
0.2199
-0.006
-16,231
0.0001
T
= 0.911
where
S.E = 0.002
146
147
In this study,
Hence, Ln(M^)
148
In this step a
In this step
149
***$********$******$**$*
*************#***#******
**********$****$*******
*******$***$**$*$*****
********$*********?***
***********?****$***
********$*******$****
**$$*#**$***********
*************$******
***********#****$**
****************$**
************?*****
******#***#****#**
***********$****
*#$************$
***************
4;4c***********
**************
*************
************
******$****
***********
**********
********
******* *
******* *
*******
******
*****
**** *
****
***
***
**
**
*
*
Figure 11.
150
-1.0
0.0
1.0
+
************$*****#*****
******
****
**
*
*
*
*
***
**
***
***
*
*
*
*
**
**
*
**
*
*
**
$*
*
**
*
**
*
*
I
I
*
*
Figure 12.
151
To
where
= Ln(M^) and
Model 2:
(56)
- 2^C-2 + H
(57)
152
Autocorrelation check
Outputs pertaining to the residuals from the fitted
model are useful for diagnostic checking.
An effective
If it does account
153
Such problems
Standard Error
S = y
154
where
frequency i/n.
cumulative periodogram
c(f.) =
j
2
z I(fi)/nS^
i-1
155
Table 14.
No. of parameters
0.9964
0.6654
(40.27)
(7.11)
^1
0.3329
*2
(3.57)
6
Box-Pierce
0.018
(20 D.F.)
0.0083
19.412
15.384
Significant autocorrelations
in residuals
Lag 1
Lag 2
Standard Error
0.0036
0.0032
0.936
0.944
**********
***
*
*
*
*
*
*
*
**
*
*
***
***
*
*
*
**
*
*
*
*
*
*
Figure 13.
*******
**
*
*
*
*
*
<-*
*
**
**
** *
*
*
*
**
*
*
*
*
*
**
Figure 14.
158
An addition of a
The standard
159
Figure 15.
160
Figure 16.
Figure 17.
162
Figure 18.
163
(58)
(6.06)
= 0.948
DW = 1.91
164
Table 15.
Variable
Parameter
estimate
T-ratio
Intercept
3.661
2.804
0.006
0.163
0.800
0.426
0.269
1.981
0.050
M*
-0.624
-2.561
0.012
Y* - Y
-0.328
-1.434
0.155
A* - A
0.174
2.038
0.044
FP
-0.136
-0.147
0.884
-0.002
-1.484
0.141
R^ = 0.889
S.E = 0.004
165
is
ZN^ = 0.0007 +
i + 0.4893Et_i
^t
(89.4467) (5.2187)
An R
obtained.
Exchange Rate Volatility
The purpose of this section is to test the hypothesis
of positive correlation between observed exchange rates
166
Table 16.
Variable
Parameter
estimate
T-ratio
Intercept
0.483
0.453
0.651
ZN
0.404
5.501
0.001
RN
0.445
5.513
0.001
M*
-0.139
-0.783
0.435
Y* - YN
0.048
1.142
0.256
A* - AN
0.061
3.577
0.005
FPN
0.973
1.489
0.139
-0.007
-5.599
0.001
T
= 0.911
S.E = 0.002
167
RN
0.031
(0.754)
SN
0.0101
(0.918)
168
CHAPTER 5.
If a country is running
169
= T
must be higher
170
171
172
173
REFERENCES
Aliber, R. Z. "The Interest Rate Parity Theorem: A
Reinterpretation." Journal of Political Economy
81 (December 1973): 1451-1459.
Barro, R. J. "Unanticipated money growth and unemployment
in the United States." American Economic Review
67 (March 1977): 101-115.
Barro, R. J. "Unanticipated money, Output and the Price
Level in the United States." Journal of Political
Economy 86 (August 1978): 549-580.
Bilson, I. F. 0. "The Monetary Approach to the Exchange
Rate--Some Empirical Evidence." Staff Papers,
International Monetary Fund 25 (March 1978): 48-75.
Bowerman, B. L. and O'Connell, R. T. Forecasting and
Time Series. North Scituate, Mass.: Duxbury Press
(1979).
Branson, W. H. "The Dual Roles of the Government Budget
and the Balance of Payments in the Movement from
Short Run to Long Run Equilibrium." Quarterly
Journal of Economics 90 (1976): 345-367.
Branson, W. H., Halttunnen, H. and Masson, P. "Exchange
Rates in the Short Run. The Dollar-Deutschemark
Rate." European Economic Review 10 (1977): 303-324.
Brock, W. A. "A Simple Perfect Foresight Model." Journal
of Monetary Economics 1 (April 1975): 133-150.
Clements, K. W. and Frenkel, J. A. "Exchange Rates,
Money, and Relative Prices: The Dollar-pound in the
1920s." Journal of International Economics 10
(1980): 249-262.
Dombusch, R. "Expectations and Exchange Rate Dynamics."
Journal of Political Economy 84 (December 1976):
1161-1176.
Dombusch, R. and Fischer, S. "Exchange Rates and the
Current Account." American Economic Review 70
(December 1980): 960-971,
174
175
176
ACKNOWLEDGMENTS
In preparing this dissertation, I have benefited
a great deal from the supervision of my committee chairman.
Dr. Harvey Lapan. I owe special thanks to him for his
detailed suggestions and constant inspiration and advice.
This experience has deepened my understanding of economics
considerably. I acknowledge a very special debt to Dr.
Walter Enders for his careful reading and many useful
comments. I am grateful to the other members of my
graduate committee. Oris. James Stephenson, Dennis Starleaf,
Wallace Huffman, and Roy Hickman for their invaluable
services.
I am personally grateful to Napoleon for the extreme
patience and understanding during the period when this
dissertation was in preparation. I am also happy to thank
B. 7. Thorbs and A. Tegene for their service which was a
necessary condition for the completion of this dissertation.
177
APPENDIX 1. DATA
Time Period Under Study
The time period undertaken by this study is from
January 1972 to December 1980.
MN
Y*
178
YN
A*
AN
FP
FPN
Derived variables
Z
ZN
RN
Data Sources
Monthly data on all variables are obtained from the
International Financial Statistics, published by the
International Monetary Fund.
179
APPENDIX 2.
AS
~S"
Using the Taylor series
Hence
= Ln[l + ^] +|(^)^ -
AS
= Ln[l 4- -^]
= Lnt-g^]
= Ln[!l]
^t
Hence,
= Ln(S^^^) - Ln(S^)
180
t+l -
%Pt+2 "
+ [bQ(l+X)-g]p^
= (bQ-g)V^ -
or
^a^+2 "
+ [b^(l4-X)-g]a^
= -^gVf+i + gXV_ -
= 0.
(60)
181
Hence,
P* = tn* +
!
g
and define
a2 ~ ^
= -(1 +
X + XBGI)
ao = (1 + x)bo - g
Hence,
O + 1 + 02 = bo - g - 1
q
s =
2
-2 ~ /(a 2 "
182
Pt = Yo +
+ Yse^i
Define
^1
^2 = ^^t+2+i^''
o
^^t+3+i^'
o
^2
^^t+3+i^
o
Hence
1
'^'t+2+i^^ = 't+2 + W +
o
and
-^t+l+io
^t+1
- \+i +
and
= Vt + W +
O
\ + 't+i'^ +
183
^2*
02[
Yq
+ 72^2
"^3%
y^2^
+ Y4SM2 + (YI+Y2)\+I
+ (y3 + yfy>^t+2^
+ Y2S^^2
^3^^1
= i\ -
Rearranging terms:
'''o^"0'^"l''"'2^
2
1^ + 0^ )
Yl^^(*2
+
Y2^^(G2
"'l^
o ^ S ^ )
+ OgS^)
''4'^t+l
- (bg-l)(e2^-ha^)+(e^-gm*)
184
Therefore,
= (bo-g)V^ -
We know that r = -
a-i
+ D
0 ^=0
S = .^ ^
o
= r -^
o
and
= 2r +
o
0
" 2
bo - S
185
(b) a^(Y2+Y2) +
+ Y2S] = -1
+ ajv^r +
- Yi)(r - i)l = -1
a,
a-.
a, b - g
^(bi - g) + o[n<2r + ^)- (r + ^)(-^)] - -1
0
0
0
1
o[Yi(2r +
b - g
- r(-2_
)] = -1
"o
Y2^ - rCbg - g) = -1
rCb^ - g) - 1
Yl
and
bo - g
^2 =
- ^1
(Y3 + Y4) = ^
o
"o
186
+ y^S) = 0
^3 = if
and
1 . r
Y4 - - ^+ D
o
We can use the same procedure to derive the coefficients
in Equation 26.
Derivation of the Homogenous Solution
At t = 0 Equation 22 becomes
Hence,
0
0 0
0 0
,0
0 0
"i" ^4^^1+i^ ]
o
187
= -dZ^
+ (i)^S''~^)dZ]
^5
X0^ - iL-i-X)
188
- (l+x)p^ ~ t ~ ~^t ~
- ^t+1 +
- 5^*)
1+X
^t+1
e^ + m*
1
X
^t+1
Pt
+
g
bo
^t
- Zt+1 +
g^t
Let
Pt
^5
^t
*5
hence
Pt+1
't+1
y,
X*,
- gm*
189
Therefore
-,
X.5
- (4^)
-1 Y5
=
+ X^
- s
-^0 *5
e^+m*
- \
gV^
- Z^-^i+e^-gm*
1+X
X - b
and hence.
li)(X - b^) - I
(X -
XX
=0
- (xb^ + X + 1)X + (1
02^ - a^X + Oq
Where 02
x)b^ - g
= 0
^ 1
=0
~ r
^ 2
~ 2
190
and 4^ is given by
(61 - ^)
1
-X
Y5
-g
1 - ^0
<^5
and hence
75(81 -
-0
(62)
(63)
< 0 and if
< 0, hence if
> 0 it implies
Therefore,
= 5*5
- "o
> 0, that is if
191
+ *28^)6111 -
+ *4S^"l)dZ > 0
then
5
^5 - xei- (1 +X) ^ 0
And secondly, if
< 0 that is if
+ 4vS^"l)dZ < 0
^