Consumption Risk and International Asset Returns: Some Empirical Evidence

The paper examines if real stock returns in four countries are consistent with consumption-based models of international asset pricing. The paper finds that ex-ante real stock returns exhibit statistically significant fluctuations over time and that these fluctuations cannot be explained by consumption-based models when the conditional covariances between real stock returns and the rate of change of consumption are assumed to be constant over time. These conditional covariances are then modeled and the paper finds that they too exhibit statistically significant fluctuations over time. However, even when conditional covariances are allowed to change over time, the paper finds that the consumption-based models do not fully explain real stock returns.

Is it Risk? Explaining Deviations from Uncovered Interest Parity

This paper analyzes ex-ante returns to forward speculation and asks if these returns can be explained by models of a foreign exchange risk premium. After presenting evidence that both nominal and real expected speculative profits are non-zero, the paper examines if real returns to forward speculation are consistent with consumption-based models of risk premia. Estimates of the conditional covariance between real speculative returns and real consumption growth are presented and, like ex-ante returns to forward speculation, they exhibit statistically significant fluctuations over time and often change sign.

Forecasting Exchange Rates and Relative Prices with the Hamburger Standard: Is What You Want What You Get With McParity?

A decade ago the Economist began an annual survey of Big Mac prices as a guide to whether currencies are trading at the right exchange rates. This paper asks how well the hamburger standard has performed. Although average deviations from absolute Big Mac parity are large for several currencies, once estimates of these average deviations are removed from the data, the evidence suggests that convergence to relative Big Mac parity is quite rapid. The half-life of deviations from Big Mac parity appear to be about 1 year, which is considerably shorter than estimates of the half-life of deviations from purchasing power parity (4-5 years) that are reported in the literature. In addition, deviations from relative Big Mac parity appear to provide useful information for forecasting exchange rates. After accounting for currency-specific constants, a 10 percent undervaluation according to the hamburger standard in one year is associated with a 3.5 percent appreciation over the following year. Finally, deviations from relative Big Mac parity seem to be helpful in forecasting relative local currency prices. When the U.S. dollar price of Big Macs is high in a country, the relative local currency price of Big Macs in that country is likely to fall during the following year.

International Interest-Rate and Price-Level Linkages Under Flexible Exchange Rates: A Review of Recent Evidence

In an open economy, the scope for activist stabilization policy depends on the nature of the lincages between domestic and international markets for goods and assets. Tgo

Finanial Policy and Speculative Runs with a Crawling Peg: Argentina 1979-1981

In this paper we present a model of a balance-of-payments crisis and use it to examine the Argentine experiment with a crawling peg between December 1978 and February 1981. The approach taken allows us to examine the evolution of a crisis when the collapse is not a perfectly-foreseen event. The implementation of the model yields plausible values of the one-month ahead probabilities of a collapse of the crawling peg. The probabilities exhibit a sharp increase in the middle of 1980 and indicate a significant loss of credibility throughout the remainder of the year. The results suggest that viability of an exchange rate regime depends strongly on the domestic credit policy followed by the authorities. If this policy is not consistent with the exchange rate policy pursued by the authorities, confidence in the exchange rate policy is undermined.

Monetary aggregates and liquidity in a neo-Wicksellian framework

Woodford (2003) describes a popular class of neo-Wicksellian models in which monetary policy is characterized by an interest-rate rule, and the money market and financial institutions are typically not even modeled. Critics contend that these models are incomplete and unsuitable for monetary-policy evaluation. Our Banks and Bonds model starts with a standard neo-Wicksellian model and then adds banks and a role for bonds in the liquidity management of households and banks. The Banks and Bonds model gives a more complete description of the economy, but the neo-Wicksellian model has the virtue of simplicity. Our purpose here is to see if the neo-Wicksellian model gives a reasonably accurate account of macroeconomic behavior in the more complete Banks and Bonds model. We do this by comparing the models’ second moments, variance decompositions and impulse response functions. We also study the role of monetary aggregates and velocity in predicting inflation in the two models.

The Need for International Policy Coordination: What's Old, What's New, What's Yet to Come?

Fifty years ago, the Chicago School argued that flexible exchange rates would insulate employment from foreign economic disturbances: there is no need for policy coordination; flexible exchange rates suffice. Twenty five years later, the Bretton Woods system was gone, and the first generation of policy coordination models was introduced. Chicago School arguments not withstanding, these Old-Keynesian models provided a theoretical rational for policy coordination. Now, a new generation of policy coordination models is emerging. These New-Keynesian models incorporate optimizing households, monopolistic competition and nominal inertia. Here, we examine macroeconomic interdependence and the scope for policy coordination in a tractable second generation model that has received much recent attention. We relate our discussion to the old Chicago School arguments, to earlier analyses of first generation models, to recent empirical work on productivity, and to recent theoretical work on closed economy models. We conclude that second generation models may have more scope for policy coordination than did the first, and we identify the empirical work that is needed to give a serious answer to the question.