Exchange Arrangements Entering the 21 st Century: Which Anchor Will Hold?

Transcription

1 Exchange Arrangements Entering the 21 st Century: Which Anchor Will Hold? Ethan Ilzetzki LSE Carmen M Reinhart Kenneth Rogoff Harvard University Bank of Israel, December 7, 2017

2 Overview Introduce new and updated classification of anchor currencies and exchange arrangements USD dominant anchor / benchmark currency World has not moved to greater ERA flexibility Bretton Woods II: Dooley et al (2003) Anchor currency classifications shed further light on new Triffin Dilemma. Farhi, Gourinchas & Rey (2011), Obstfeld (2013), Farhi & Maggiori (2016)

3 METHODOLOGY

4 Sketch of ERA Algorithm Use monthly absolute value of change in exchange rate. With respect to 10 candidate anchors/benchmark. Freely falling Peg Narrow band Managed float Freely floating Inflation > 40% for 12 months 0 variation for 4 months <2% variation over 2 year rolling window Within99% CI of variation among anchors

5 Sketch of Anchor Algorithm Freely falling/floating: no anchor Peg / Narrow band: anchor unambiguous Managed float: Single candidate anchor with smallest variation >50% of observations = anchor. If none: use non exchange rate criteria

6 Benchmark Currency Selection Process: Additional Criteria Benchmark Currency Index: Average of four measures: 1. Reserve denomination (% reserves in currency X) 2. Trade invoicing (% of X+M invoiced in X) 3. Denomination of (external public) debt (% denominated in currency X) 4. Previous anchor (1/y, where y is the number of years since anchored to currency X.)

7 Benchmark Currency Selection Process: Additional Criteria Country Years $ index index Benchmark Brazil % 4% USD Canada % 5% USD Chile % 9% USD Colombia % 0% USD Iceland % 19% Marginal India % 7% USD Israel % 12% USD Korea USD Latvia EUR Turkey % 25% USD Uruguay USD

8 Existing Classifications Exchange Arrangements: Reinhart and Rogoff (2004) Shambaugh (2004) Levi-Yeyati and Sturtzenegger (2005) IMF (annually) Anchor Currencies: Frankel and Wei (1994) for E. Asia First to integrate anchor classification formally with ERA classification.

9 MODERN HISTORY: ANCHOR CURRENCIES

10 Summary of Findings The dollar retains its dominant position as the world s reserve currency. By some metrics it is as dominant as it was at the time of the early Bretton Woods era. By other metrics, its global role has expanded: Collapse of the ruble zone Re-anchoring of freely falling Classification consistent with other measures of dollar dominance and provides summary measure of anchor currency based on revealed preference.

11 Post-World War II Major Anchor Currencies Share of countries, , excludes freely falling cases 100 Percent UK pound US dollar French franc and German DM ( ) and Euro ( ) M1 1956M1 1966M1 1976M1 1986M1 1996M1 2006M1

12 The Geography of Anchor Currencies, 2015

13 Stress Test: Whatever it takes, % -2% $ Anchor Borderline -4% -6% Non-$ Anchor -8% Appreciation vs. $: Smaller when classified as anchored -10% Jul-2012 Aug-2012 Sep-2012 Oct-2012 Nov-2012 Dec-2012 Jan-2013 /$

14 /$ Exchange Rate "Taper Tantrum" FRB Tightening signal "Whatever it takes"

15 Markers of an Anchor Currency

16 Markers of an Anchor Currency

17 MODERN HISTORY: EXCHANGE ARRANGEMENTS

18 Summary of Findings Oft cited global transition from fixed to floating exchange rates considerably overstates the reality. Based on ERA classification for 194 countries over IMF classification of all Eurozone member countries as having floating ER since 2007 contributes to the overstatement. Lower incidence of bi-polar or corner solutions (Stanley Fischer, 2001)

19 De Facto ERA Share of (independent) countries in each group Groups 1 and 2: Less flexibility, primarily nominal exchange rate anchors Percent Group 2: Gradualist adjustment (from crawling peg to narrow crawling bands) Group 1: Least flexible (from no separate legal tender to de facto pegs)

20 De Facto ERA Share of (independent) countries in each group Groups 3 and 4: Flexible, incl. most inflation target arrangements 100 Percent Group 4: Freely floating (few high-income cases) 30 Group 3: Broad bands and managed floating

21 De Facto ERA Share of (independent) countries in each group Groups 5 and 6: Freely falling & multiple ER Percent Group 6: Multiple, Dual, or parallel markets with limited or no data on the structure of exchange rates Group 5: Freeely falling, inflation > 40% or currency crash

22 The Geography of Exchange Rate Arrangements, 2015

23 TRIFFIN DILEMMA

24 Summary of Findings A modern Triffin Dilemma may be in the Making. Increasing dominance of USD anchor Continued inflexibility of ERAs Reserve accumulation substituting capital controls (per theoretical analysis of Korinek, 2013) But US declining share of global GDP

25 Exchange Rate Arrangements and Capital Mobility, Share of countries with less flexible exchange rate regimes Share of countries with dual/multiple/parallel exchange rates

26 World Reserves minus Gold (US dollars) % of US GDP Percent Reserves minus gold/ US GDP 100 The Bretton Woods system 80 World Emerging and Developing countries

27 Role of the Dollar and US Economy Share of countries US GDP as a share of world GDP (percent, right scale) Share of countries where the US dollar is the principal anchor currency (percent, left scale) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 Reinhart 10

28 Role of the Franc & DM , and Euro France and Germany GDP as a share of world GDP (percent, right scale) Share of countries where the euro (and previously the French franc and DM) are the principal anchor currency (percent, left scale) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 0

29 Role of the Pound and the UK Economy Share of countries where the UK pound is the principal anchor currency (percent, left scale) UK GDP as a share of world GDP (percent, right scale) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 2.0

30 Role of the Yen and Japanese Economy Japan GDP as a share of world GDP (percent, right scale) Share of countries where the yen is the principal anchor currency (percent, left scale) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 0

31 Chinese Economy China GDP as a share of world GDP (percent, right scale)

32 Conclusions USD as dominant as anchor today as ever. RMB is the wildcard. No substantial move to ER flexibility. Increase in intermediate de-facto regimes. New Triffin Dilemma may be on the horizon.

33 APPENDIX 1: HOW TO CLASSIFY EZ COUNTRIES?

34 Classifying the Eurozone Eurozone >10% of World GDP Poses classification challenge floating externally EZ countries no legal tender internally IMF classify all EZ countries freely floating We classify all as no legal tender

35 Classifying the Eurozone Unit of observation is sovereign country No EZ member has more than 4% voting share Trade: >60% of trade is internal Consistency in time series EZ has moved to less monetary autonomy

36 Classifying the Eurozone: Evidence

37 Estimating Taylor Rules

38 1.2 Taylor Rule Coefficients: Inflation Germany only country to satisfy Taylor principle Taylor principle violated for EZ as whole Whiskers: 95% confidence intervals

39 Taylor Rule Coefficients: Output Gap 1.5 But monetary policy has been countercyclical for most countries Whiskers: 95% confidence intervals

40 Calculating Taylor Rules

41 Taylor Rule vs. Policy Rate 12% 10% 8% 6% DM DM Regime Regime Rule 12% 10% 8% 6% DM DM Regime Regime Rule 4% 4% 2% 0% Policy 2% 0% Policy % 10% DM DM Regime Regime 8% 12% 10% DM DM Regime Regime 8% 6% 4% 2% 0% % -4% Rule Policy 6% 4% 2% 0% % Rule Policy

42 Germany 12% 10% DM DM Regime Regime 8% Rule 6% 4% 2% Policy 0%

43 France 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0%

44 Portugal 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0% -2% -4%

45 Eurozone 12% 10% DM DM Regime Regime 8% 6% Rule 4% 2% Policy 0% -2%

46 Summary No clear break in policy in 1999 ECB follows DM Taylor rule closely until 2008 Post crisis ECB playing stabilizing role for EZ, but little to suggest that doing so for for any individual member

47 APPENDIX 2: ARE INFLATION TARGETERS DIFFERENT?

48 Inflation Targeting One of the biggest developments in dejure monetary arrangements As we will show: IT not particularly informative Masks heterogeneity in exchange arrangements in practice.

49 Inflation Targeters Managed / Freely floating Or wide bands Crawling pegs

50 Monetary Practices of IT Central Banks

51 Augmented Taylor Rule Estimates Unbalanced Panel Regression Results w. Country Fixed Effects Dependent Variable = Nominal Interest Rate Inflation.68***.67***.74***.74***.73*** (.014) (.015) (.017) (.017) (.017) Log(Exchange Rate) 2.24*** 2.03*** 1.99*** 1.60*** (.144) (.147) (.150) (.150) Unemployment.10***.07*** (.017) (.017) Commodity Price Inflation 1.00 Inflation*"Fixed" (.628) Fixed IT: Less aggressive on inflation -.19*** -.19*** -.18*** (.026) (.026) (.026) Log(Exchange Rate)*"Fixed" Fixed IT: More aggressive on.34***.36***.34*** exchange rate (.053) (.053) (.054) Commodity Price Inflation*"Fixed".22 (.168) R n

52 Stress Testing ER Classification of IT Central Banks Consider two major shocks: 1. Lehman, September FRB signalling tightening cycle in June 2014

53 Lehman Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 NON-IT 1+2 IT 1+2 NON-IT 3+4 IT

54 102 Fed Tightening Announcement Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 NON-IT 1+2 IT 1+2 IT 3+4 NON-IT 3+4

55 14 Lehman 2008 Inflation May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec NON-IT 1+2 NON-IT 3+4 IT 1+2 IT 3+4

56 7 Fed Tightening Announcement 2014 Inflation Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 NON-IT CAT 1+2 NON-IT CAT 3+4 IT CAT 1+2 IT CAT 3+4

57 Summary IT masks heterogeneity in exchange rate practices Our ERA classification gives information that goes beyond the IT headline Pegged IT central banks less aggressive on inflation & more on exchange rate Similar exchange rate behaviorto non-it pegged currencies in face of major shocks. But inflation is lower in IT countries, even those with a dual mandate

58 APPENDIX 3: ANCHOR AND ERA ALGORITHMS

59 ER Arrangement Classification Algorithm Sequence and general scheme

60 ER Arrangement Classification Algorithm Statistical tests

61 Anchor Currency Selection Process

62 APPENDIX 4: CAPITAL CONTROLS

63 Summary of Findings Introduce an index of exchange restrictions As a minimal measure of capital controls. Global trend towards increased capital mobility. A fairly modern phenomenon for emerging and developing countries.

64 Index of Exchange Restrictions This index takes on the value 1 if any one or more of the following conditions hold and 0 otherwise. There is a de-jure dual market / multiple exchange rates OR There is a de-facto parallel market and the parallel premium >10% over 12-month moving average. Sources: IMF AEAER, Franz Pick. Index = 1 is sufficient but not necessary for capital controls.

65 Share of Independent Countries with Dual, Multiple, or Parallel Exchange Rates, January 1950-September 2016: 90 Advanced economies Share of countries(solid line) Share weighted by GDP (dashed line) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1

66 Share of Independent Countries with Dual, Multiple, or Parallel Exchange Rates, January 1950-September 2016: All independent countries Share of countries (solid line) Share weighted by GDP (dashed line) M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1