1

Eduardo Levy YeyatiEduardo Levy Yeyati

The World Bank & Universidad Torcuato Di TellaThe World Bank & Universidad Torcuato Di Tella

Federico SturzeneggerFederico Sturzenegger

Kennedy School, Harvard Univ. & Kennedy School, Harvard Univ. & Universidad Torcuato Di TellaUniversidad Torcuato Di Tella

May, 2007

Fear of Floating in Reverse:Fear of Floating in Reverse:

Exchange Rate Policy in the 2000sExchange Rate Policy in the 2000s

StoryboardStoryboard

LYS updated: Regimes in the 2000s Fear of floating or fear of appreciation? Fear of floating in reverse: reviving exchange

rate policy Economic impact

Final remarks: Brainstorming

• Key criterion: ER variability relative to forex intervention

• The intervention dimension is key to characterized exchange rate policy (as opposed to the evolution of exchange rates) and its consequences

Exchange rate regimes in the 2000s: Exchange rate regimes in the 2000s: Classification

Regime in the 2000s: Nothing changed?Regime in the 2000s: Nothing changed?

Source: LYS (2006)

0%

20%

40%

60%

80%

100%

1974 1978 1982 1986 1990 1994 1998 2002

Fix

Int

Float

• Fear of floating’s underlying fears:– Contractionary devaluations (due to BS effects)

and currency and debt crisis propensity– Dollar pricing, pass-through & inflation

• Fear of flying: Leaning against the appreciation wind– Intervention to strenthen the demand for the

foreign currency, to avoid/mitigate appreciation pressures

• Not to be mistaken with fear of sudden stops in the aftermath of a crisis

Fear of flying: A characterizationFear of flying: A characterization

Fear of floating? (non-floats)Fear of floating? (non-floats)

Source: LYS (2006)

The comeback of exchange rate policy?The comeback of exchange rate policy?

Mercantilist interventions as a substitute for protection Less specific than subsidies Less prone to mismanagement & corruption

Fear of floating in reverse (FoFiR) Invertion of the ER anchor problem: sustaining

an undervalued currency Instead of amplified recessions due to price rigidities… …inflationary expansions fueled by positive real

shocks.

Does it work? How?

(t) (t, t+1) (t, t+2) (3-y avg, t+1)int1 (t) 0.036* 0.109**

(0.022) (0.055)int1 (t, t+1) 0.072**

(0.029)int1 (t, t+2) 0.090**

(0.040)R-squared 0.989 0.99 0.991 0.99

Dlog (Real bilateral exchange rate)

FoFiR: leaning against the appreciation FoFiR: leaning against the appreciation windwind

Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows.

∆%Inflation ∆%Deflator ∆%Deflator - ∆%Inflation( t ) ( t ) ( t )

int1 (t) 0.192 1.542** 0.803**(0.602) (0.720) (0.364)

int1 (t-1) -0.65 -2.170*** -0.026(0.502) -0.654 (0.367)

R-squared 0.65 0.64 0.119

……at the cost of inflation pressuresat the cost of inflation pressures

Additional controls: country and time FE, dlog(M2), dlog(GDP), dl(RER), lagged dep. var.

(3y avg; t+1) (3y avg; t+1)int1 (t-1, t-3) 2.789*** 1.728***

(0.459) -0.578int1 (t) 1.352** 0.791

(0.661) -0.808R-squared 0.446 0.464 0.306 0.363

dlog(GDP) dlog(GDP per worker)

Intervention & growthIntervention & growth

Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged HP cycle, lagged GDP, lagged dep. var.

BK trend HP trend BK cycle HP cycle int1 (t-1, t-3) 1.781*** 0.009***

(0.305) (0.002)int1 (t) 0.599*** 0.011***

(0.222) (0.003)R-squared 0.469 0.627 0.415 0.312

Intervention & long-term growth?Intervention & long-term growth?

Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged HP cycle, lagged GDP, lagged dep. var.

Savings (% GDP)(t+1) (t+1) (3Y avg; t+1)

int1(t) 1.044** 1.784*** 4.142***(0.474) -0.304 -1.224

int1 (t-1, t-3) 1.154 0.692*(0.738) -0.375

R-squared 0.805 0.829 0.656

Real Inv. (% GDP)

Savings & investmentSavings & investment

Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, dlog(pop), lagged dlog(GDP), savings

Unemp (%)int1 (t) -3.041* -0.439**

(1.787) (0.20)int1 (t-1) -5.872** 0.244

(2.885) (0.19)∆%GDP (t) -0.036*

(0.02)R-squared 0.787 0.783 0.925

Labor/ Capital Compensation

High dollar, low wages?High dollar, low wages?

Additional controls: country and time FE, terms of trade, GDP of trade partners, net inflows, lagged dlog(product), dlog(pop)

100

150

200

250

2001

.IV

2002

.IV

2003

.IV

2004

.IV

2005

.IV

2006

.IV

100

250

400

550

exports consumption

ExampleExample

100

150

200

250

2001

.IV

2002

.IV

2003

.IV

2004

.IV

2005

.IV

2006

.IV

100

250

400

550

IPC exports consumption

ExampleExample

100

150

200

250

2001

.IV

2002

.IV

2003

.IV

2004

.IV

2005

.IV

2006

.IV

100

250

400

550

IPC exports GDP consumption

ExampleExample

100

150

200

250

2001

.IV

2002

.IV

2003

.IV

2004

.IV

2005

.IV

2006

.IV

0

50

100

150

IPC Precio implicito del PBI real w age

ExampleExample

100

150

200

250

2001

.IV

2002

.IV

2003

.IV

2004

.IV

2005

.IV

2006

.IV

0

50

100

150

IPC Precio implicito del PBI real w age real w age (formal)

ExampleExample

GDP by production factor

Capital benefits

Labor compensation

Other

0%

20%

40%

60%

80%

100%

2001 2002 2003 2004 2005*

ExampleExample

Taking stockTaking stock

Distribution of regimes little changed in the 00sBut the composition of non-floats have changed

Reversed fear of floating is an increasingly popular contenderPositive on

Long-run & productivity growth Saving & investment Not so much on exports

Is it merely low real wages?

Thank youThank you

22

Eduardo Levy YeyatiEduardo Levy Yeyati

The World Bank & Universidad Torcuato Di TellaThe World Bank & Universidad Torcuato Di Tella

Federico SturzeneggerFederico Sturzenegger

Kennedy School, Harvard Univ. & Kennedy School, Harvard Univ. & Universidad Torcuato Di TellaUniversidad Torcuato Di Tella

May, 2007

Fear of Floating in Reverse:Fear of Floating in Reverse:

Exchange Rate Policy in the 2000sExchange Rate Policy in the 2000s

Exchange rate volatility (e): average of the

absolute value of monthly changes in the exchange rate

Volatility of exchange rate changes (De ):

standard deviation of monthly changes in the exchange rate

Volatility of reserves (R): average of the absolute

value of monthly changes in international reserves relative to the monetary base of the previous month (both denominated in US dollars)

De facto regimes over the years: De facto regimes over the years: ClassificationClassification

De facto regimes over the years: Classification

Regime e De R

Float Low Low High

Intermediate Med Med Med

Fix High Low Low