Alberto Giovannini

Exchange rates and traded goods prices

Abstract This paper presents a partial equilibrium model of the determination of domestic and export prices by a monopolistic competitive firm. The model stresses the role of exchange rate uncertainty and expectations. The most important result of the analysis is that the stochastic properties of deviations from the ‘law of one price’ are crucially affected by the currency of denomination of export prices. Using data on domestic and dollar export prices of Japanese goods, I find that deviations from the ‘law of one price’ are due to exchange rate surprises, but also to price staggering and ex ante price discrimination.

International evidence on tradables and nontradables inflation

Using 1970-1985 sectoral data for the OECD we find that inflation in nontradable goods is higher than in tradables, We identify a demand shift towards nontradables and faster growth of total factor productivity in the tradable goods sector as the prime causes of higher nontradables inflation. In addition. disinflation attempts and the exchange rate regime appear to have had significant influence on the relative inflation rate.

Limiting exchange rate flexibility : the European monetary system

Events of recent years have exacerbated the dissatisfaction with the performance of flexible exchange rates, and prompted a number of proposals to limit exchange rate fluctuations among industrialized countries. This book provides the first in depth analysis of the European Monetary System (EMS), the only lasting experiment of this kind.The books careful blend of theory and empirical analysis supports the view that, in Europe, nominal exchange rate targets have had significant real effects. Its detailed description of European economic institutions shows why exchange rate fluctuations are perceived as especially harmful.Giavazzi and Giovannini explain the institutional features of the EMS and describe how central banks run the system in practice. They offer an illuminating analysis of European capital controls and show how such regulations have guaranteed the survival of the EMS in a period characterized by unprecedented dollar fluctuations.The authors point out the lessons to be drawn from this experience with the EMS for the more general problem of reforming the international monetary system. Their forceful arguments are backed by analysis of such important issues as the determinants of international capital flows and international portfolio diversification, and the role of credibility and expectations in disinflation.Francesco Giavazzi is Professor of Economics at the University of Bologna. Alberto Giovannini is Associate Professor at the Columbia University Graduate School of Business.

Saving and the real interest rate in LDCs

Abstract This paper provides emperical evidence on the question of whether savings respond positively to changes in the real rate of interest in LDCs, exploiting some of the implications of the neoclassical theory of consumption. In the first section, it is shown that the emperical success of the high interest elasticity hypothesis can be traced down to the presence of cases of financial reforms in the sample. The second section offers evidence on the elasticity of intertemporal substitution in consumption. The results from both sections point to the presence of very low intertemporal substitution elasticity, as well as negligible responses of aggregate saving to the real rate interest.

Interest rates and risk premia in the stock market and in the foreign exchange market

Abstract This paper documents common empirical regularities in the foreign exchange market and in the US stock market. We find that increases in interest rates are associated with predictable increases in the volatility of returns in both markets, and that expected returns both in the stock market and in the foreign exchange market are negatively correlated with nominal interest rates. We show that not taking into account the time variation of second moments may seriously affect tests of asset pricing models. Using a numerical example based on the static capital asset pricing model, we are able to produce fluctuations in risk premia similar to those observed empirically. Finally we show that the overidentifying restrictions of the latent variable capital asset pricing model are not rejected when beats are assumed to be correlated with nominal interest rates.

International Evidenceon Tradables and Nontradables Inflation

Using 1970-85 sectoral data for the OECD we find that inflation in nontradable good exceeds inflation in tradables. We identify a demand shift towards nontradables and faster growth of total factor productivity in the tradable goods sector as the prime causes of the differential inflation. In addition, disinflation attempts and the exchange rate regime appear to have exerted significant influence on the relative inflation rate.

Models of the EMS: is Europe a Greater Deutschmark Area?

Regimes of fixed exchange rates or of limited exchange-rate flexibility, like the ideal ‘target zone’ proposal or the real European Monetary System (EMS), raise the question of symmetry. Who runs monetary policy and who sets exchange-rate parities? If exchange rates are determined exogenously by a mechanical rule, does — or should — only one country run monetary policy, or does this depend on all members of the system?

The EMS and the Dollar

The EMS and the Dollar Francesco Giavazzi and Alberto Giovannini This paper examines the behaviour of exchange rates prior to and since the inception of the European Monetary System (EMS). Movements in bilateral European exchange rates tend to be associated with fluctuations in the dollar. In particular the mark tends to appreciate against other European currencies when the dollar depreciates. Further, most realignments of currencies in the EMS have generally occurred after sharp movements in the dollar. Conventional explanations relying on portfolio diversification by investors do not seem to explain the facts fully. A more satisfactory explanation is provided by the existence of capital controls. These limit the mobility of assets and ensure an asymmetric response by European currencies to movements in the dollar. These capital controls are, in the absence of coordinated monetary policy, essential to the smooth working of the EMS. However at the same time they limit the scope for the further integration of European capital markets. Thus the EMS is not a step on the road to greater financial integration. Indeed it is a cul-de-sac.

The Determinants of Realignment Expectations Under the EMS - Some Empirical Regularities

The stability of the EMS depends crucially on realignment expectations of the market participants. In this paper we discuss how to measure such expectations and how to relate them to economic fundamentals, central bank reputation, and institutional arrangements of the EMS. We find the following empirical regularities for FF/DM and IL/DM exchange rates: (1) expected devaluations are positively related to the current exchange rate deviation from the central parity; (2) expected devaluations are negatively related to the length of time since last realignment in the short and medium run; (3) the Basle-Nyborg agreements seem to have a stabilizing effect for both currencies examined, albeit through different channels; (4) large revaluation expectations occur immediately after devaluations. (1) and (4) are not inconsistent with the hypothesis of over-speculation or market inefficiency.

Monetary policy in the open economy

Publisher Summary This chapter reviews the international aspects of monetary policy and presents the classical model of the open economy. The operation of the gold standard, the price–specie flow mechanism, purchasing power parity, and the monetary approach to the balance of payments are illustrated in the chapter. The Mundell–Fleming model that is an open economy version of the investment—saving/liquidity preference—money supply (IS–LM) model of monetary policy under conditions of short-run wage–price stickiness and capital mobility are discussed in the chapter. The distinction between fixed and flexible exchange rates is described in the chapter. The macroeconomic model is described in the chapter by drawing out the evidence on two central questions: the extent to which wages and prices are sticky and the international linkages among asset markets. Both issues are of central importance for the channels of transmission and the effectiveness of monetary policy. Classical monetary economics deals with the linkages among money, spending, and prices in the open economy. It is best represented by David Humes price–specie flow mechanism. The simple model assumes full price flexibility and focuses on a money–goods economy with no nonmonetary assets.