Empirical Exchange Rate Issues

Ferraro, Domenico, Kenneth Rogoff, and Barbara Rossi. 2015. “Can Oil Prices Forecast Exchange Rates?” 54 (June): 116-141. JIMF Abstract

This paper investigates whether oil prices have a reliable and stable out-of-sample relationship with the Canadian/U.S dollar nominal exchange rate. Despite state-of-the-art methodologies, we find little systematic relation between oil prices and the exchange rate at the monthly and quarterly frequencies. In contrast, the main contribution is to show the existence of a very short-term relationship at the daily frequency, which is rather robust and holds no matter whether we use contemporaneous (realized) or lagged oil prices in our regression. However, in the latter case the predictive ability is ephemeral, mostly appearing after instabilities have been appropriately taken into account.

Reinhart, Carmen, Kenneth Rogoff, and Miguel Savastano. 2014. “Addicted to Dollars.” Annals of Economics and Finance 15 (1): 1-50. Read online
Chen, Yu-chin, Kenneth Rogoff, and Barbara Rossi. 2010. “Can Exchange Rates Forecast Commodity Prices?.” Quarterly Journal of Economics 125 (3): 1145–1194. Article at QJE. Abstract

We show that "commodity currency" exchange rates have remarkably robust power in predicting global commodity prices, both in-sample and out-of-sample, and against a variety of alternative benchmarks. This result is of particular interest to policymakers, given the lack of deep forward markets in many individual commodities, and broad aggregate commodity indices in particular. We also explore the reverse relationship (commodity prices forecasting exchange rates) but find it to be notably less robust. We offer a theoretical resolution, based on the fact that exchange rates are strongly forward looking, whereas commodity price fluctuations are typically more sensitive to short-term demand imbalances.

Paper Data and Programs
Acemoglu, Daron, Kenneth Rogoff, and Michael Woodford. 2008. “Exchange Rate Models Are Not as Bad as You Think: A comment.” NBER Macroeconomics Annual 2007, 443-452. Cambridge: MIT Press, 443-452. NBER volume; Paper
Husain, Aasim, Ashoka Mody, and Kenneth Rogoff. 2005. “Exchange Rate Regime Durability and Performance in Developing versus Advanced Economies.” Journal of Monetary Economics 52: 35-64.Abstract

Drawing on new data and advances in exchange rate regimes' classification, we find that countries appear to benefit by having increasingly flexible exchange rate systems as they become richer and more financially developed. For developing countries with little exposure to international capital markets, pegs are notable for their durability and relatively low inflation. In contrast, for advanced economies, floats are distinctly more durable and also appear to be associated with higher growth. For emerging markets, our results parallel the Baxter and Stockman classic exchange regime neutrality result, though pegs are the least durable and expose countries to higher risk of crisis.

Brooks, Robin J, Aasim M Husain, Ashoka Mody, Nienke Oomes, and Kenneth Rogoff. 2004. “Evolution and Performance of Exchange Rates Regimes.” International Monetary Fund Occasional Paper 229. IMF Working Paper WP03/243Abstract

Using recent advances in the classification of exchange rate regimes, this paper finds no support for the popular bipolar view that countries will tend over time to move to the polar extremes of free float or rigid peg. Rather, intermediate regimes have shown remarkable durability. The analysis suggests that as economies mature, the value of exchange rate flexibility rises. For countries at a relatively early stage of financial development and integration, fixed or relatively rigid regimes appear to offer some anti-inflation credibility gain without compromising growth objectives. As countries develop economically and institutionally, there appear to be considerable benefits to more flexible regimes. For developed countries that are not in a currency union, relatively flexible exchange rate regimes appear to offer higher growth without any cost in credibility.

Reinhart, Carmen M, and Kenneth S Rogoff. 2004. “The Modern History of Exchange Rate Arrangements: A Reinterpretation.” Quarterly Journal of Economics 119: 1-48. Working PaperAbstract

We develop a novel system of re-classifying historical exchange rate regimes. One difference between our study and previous classification efforts is that we employ an extensive data base on market-determined parallel exchange rates. Our 'natural' classification algorithm leads to a stark reassessment of the post-war history of exchange rate arrangements. When the official categorization is a form of peg, roughly half the time our classification reveals the true underlying monetary regime to be something radically different, often a variant of a float. Conversely, when official classification is floating, our scheme routinely suggests that the reality was a form of de facto peg. Our new classification scheme points to a complete rethinking of economic performance under alternative exchange rate regimes. Indeed, the breakup of Bretton Woods had a far less dramatic impact on most exchange rate regimes than is popularly believed. Also, contrary to an influential empirical literature, our evidence suggests that exchange rate arraignments may be quite important for growth, trade and inflation. Our newly compiled monthly data set on market-determined exchange rates goes back to 1946 for 153 countries.

Ilzetzki, Ethan O, Carmen M Reinhart, and Kenneth Rogoff. 2004. “Exchange Rate Arrangements into the 21st Century: Will the Anchor Currency Hold?.” Unpublished. DATA
Chen, Yu-chin, and Kenneth Rogoff. 2003. “Commodity Currencies.” Journal of International Economics 60: 133–160. Paper
Rogoff, Kenneth. 2001. “The Failure of Empirical Exchange Rate Models: No Longer New but Still True.” Economic Policy Web Essay 1 (1). Economic Policy Article
Rogoff, Kenneth, and Martin Feldstein. 1999. “Perspectives on Exchange Rate Volatility.” International Capital Flows, 441-453. Chicago: University of Chicago Press and NBER, 441-453. NBER volume, chapter 10; Chapter
Rogoff, Kenneth. 1999. “Monetary Models of Dollar/Yen/Euro Nominal Exchange Rates: Dead or UnDead?.” The Economic Journal 109: F655-F659. Article
Rogoff, Kenneth, and Alan Meltzer. 1998. “The Risks of Unilateral Exchange Rate Pegs.” The Implications of Globalization of World Financial Markets, 153-170. Seoul: Bank of Korea, 153-170. Chapter
Rogoff, Kenneth. 1996. “The Purchasing Power Parity Puzzle.” Journal of Economic Literature 34: 647-68. Article
Froot, Ken, and Kenneth Rogoff. 1995. “Perspectives on PPP and Long-Run Real Exchange Rates.” Handbook of International Economics, 3: 1647-88, 3, 1647-88.Abstract

This paper reviews the large and growing literature which tests PPP and other models of the long-run real exchange rate. We distinguish three different stages of PPP testing and focus on what has been learned from each. The most important overall lesson has been that the real exchange rate appears stationary over sufficiently long horizons. Simple, univariate random walk specifications can be rejected in favor of stationary alternatives. However, we argue that multivariate tests, which ask whether any linear combination of prices and exchange rates are stationary, have not necessarily provided meaningful rejections of nonstationarity. We also review a number of other theories of the long run real exchange rate -- including the Balassa-Samuelson hypothesis -- as well as the evidence supporting them. We argue that the persistence of real exchange rate movements can be generated by a number of sensible models and that Balassa- Samuelson effects seem important, but mainly for countries with widely disparate levels of income of growth. Finally, this paper presents new evidence testing the law of one price on 200 years of historical commodity price data for England and France, and uses a century of data from Argentina to test the possibility of sample-selection bias in tests of long-run PPP.

NBER Working Paper
Obstfeld, Maurice, and Kenneth Rogoff. 1995. “The Mirage of Fixed Exchange Rates.” Journal of Economic Perspectives 9: 73-96. Data Article
Rogoff, Kenneth. 1992. “Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Eschange Rate.” Monetary and and Economic Studies 10: 1-29. NBERAbstract

Conventional explanations of the near random walk behavior of real exchange rates rely on near random walk behavior in the underlying fundamentals (e.g.. tastes and technology). The present paper offers an alternative rationale, based on a fixed-factor neoclassical model with traded and non-traded goods. The basic idea is that with open capital markets, agents can smooth their consumption of tradeables in the face of transitory traded goods productivity shocks. Agents cannot smooth non-traded goods productivity shocks, but if these are relatively small (as is often argued to be the case) then traded goods consumption smoothing will lead to smoothing of the intra-temporal price of traded and non-traded goods. The (near) random walk implications of the model for the real exchange rate are in stark contrast to the empirical predictions of the classic Balassa-Samuelson model. The paper applies the model to the yen/dollar exchange rate over the floating rate period.

NBER Working Paper
Meese, Richard, and Kenneth Rogoff. 1988. “Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period.” Journal of Finance 43 (4): 933-948. Download from JSTORAbstract

In this paper, we explore the relationship between real exchange rates and real interest rate differentials in the United States, Germany, Japan, and the United Kingdom. Contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant, we find little evidence of a stable relationship between real interest rates and real exchange rates. We consider both in-sample and out-of-sample tests. One hypothesis that is consistent with our findings is that real disturbances (such as productivity shocks) may be a major source of exchange rate volatility.

Rogoff, Kenneth. 1984. “On the Effects of Sterilized Intervention: An Analysis of Weekly Data.” Journal of Monetary Economics 14: 133-150.Abstract

As the recent empirical studies surveyed here illustrate, it is very difficult to demonstrate that the exchange rate risk premium depends (through a portfolio balance channel) on the currency composition of outside assets. The existence of a 'portfolio balance effect' is a necessary condition for sterilized intervention to be a genuinely independent tool of monetary policy. This paper studies U.S./Canada data, and attempts to improve on earlier studies by using higher frequency (weekly) data and by implementing an appropriate instrumental variables technique (2S2SLS). However, we still fail to detect evidence of a portfolio balance effect.