Narrow Results

The original objective of this paper is to study the impact of the exchange rate on the trade balance for Kazakhstan and Russia. Baseline empirical results indicate that an exchange rate depreciation actually decreases exports and deteriorates the trade balance for these countries; this is the opposite of the traditional theory of the J-curve and Marshall–Lerner condition. The paper then explores why these major oil exporters do not conform to the theory. It argues that it is the oil price that affects both the exchange rate and the trade balance, thereby masking the true impact of the exchange rate on the trade balance. More formally, the paper augments the traditional theory to take into account the behavior of oil prices in the export and trade balance equations. The augmented theory posits that a decrease in the oil price leads to a real exchange rate depreciation and a decline in exports, thereby creating the positive correlation seen in the baseline results. In accordance with the augmented theory, the regression results suffer from omitted variable bias; when the oil price is taken into account, the results again support the theory.

This paper attempts to shed light on the question: What motivates China to invest so heavily in U.S. Treasury securities, despite the fact that U.S. Treasuries provide real rates of return that are either close to zero or negative? Such an investment strategy can be perceived as economically irrational. A linkage can be presumed between China’s investment practices and the tactical decision to moderate the United States’ influence on economic, political, and military issues. We hypothesize, however, that China does not have a better investment option because holding an ever-increasing amount of U.S. dollar-based liquid assets gives China the ability to manage the value of the yuan in order to force its desired trade surpluses. In other words, China’s main mechanism to secure a positive trade balance and increase its foreign direct investment is by maintaining an undervalued currency, which requires an ever-increasing foreign-exchange reserve. From what we know, our study is the most comprehensive empirical examination of motivations for China’s heavy purchases of U.S. Treasury securities by analyzing nearly 25 years that begins in 1987 and covers the period over which China dramatically increased its holdings of these instruments.

The exchange rate pass-through for Nigeria imports is estimated by applying an econometric procedure to sectoral data which avoids the pit-falls in previous studies. We use the mark-up approach, which implies setting export prices as a mark-up on production costs. So, the price facing importers is the exchange rate adjusted production costs where mark-up depends on the competitive pressures in the import's market and the nominal exchange rate. Our results indicate incomplete pass-through at varying degrees across sectors, which implies that the foreign exporters passed on only part of the increase in their costs of production to import prices. Also, it reveals that the effort of the Nigerian government in encouraging companies to use local inputs where possible instead of relying on imported intermediate inputs is gradually yielding positive results. Important policy implications that follow from our results of incomplete pass-through to domestic prices could influence CBN forecasts of future path of inflation, a key element in the conduct of monetary policy. Indeed, the successful implementation of monetary policy presupposes that CBN has not only a good understanding of inflation dynamics but is also relatively successful at predicting the future path of inflation. Also, our results imply that the exchange rate policy may be a blunt instrument when used to restore external balance since relative price adjustments will be limited. Furthermore, the incomplete pass-through suggests that exchange rate changes are likely to lead to smaller real effects on the economy through lower changes in both the terms of trade and import volumes and finally, the extent of inflation (deflation) effects of exchange rate depreciation (appreciation) operating through changes in the prices of imported goods will be moderated.

Monetary authorities of many open economies have been regularly intervening in foreign exchange markets for years to limit volatility in exchange rates and/or push exchange rates back to some desired level. Such interventions have taken the form of actual and oral official interventions. Review of studies investigating the effectiveness of interventions reveals one major issue, related to the assumption that interventions are mostly sterilized. This assumption might lead to unreliable results when changes in interest rates and interventions are both used as explanatory variables for exchange rates.

One major consistent finding is that intervention has a significant but short-lasting effect on exchange rates. Studies have reached this conclusion by investigating whether intervention has been effective in turning around the exchange rate over the few days, weeks or months following intervention(s). Only a few studies have investigated and provided evidence that intervention has been effective in limiting long swings in exchange rates.

Studies testing for the effectiveness of interventions specifically through the signaling channel also provide evidence on the importance of macroeconomic variables for exchange rates. The significance of official intervention and official communication for exchange rate movements combined with the importance of macroeconomic variables for exchange rates provide a role for official intervention and parity announcement to influence exchange rate movements and limit the magnitude of exchange rate swings.