John Pippenger

Testing purchasing power parity: some evidence of the effects of transaction costs

Empirical tests of purchasing power parity often recognize the problems created by simultaneous equations, but seldom recognize the effects of measurement error or transaction costs. Presumably because most researchers believe that they are unimportant. We present evidence that shows that measurement error and transaction costs and create serious econometric problems for testing purchasing power parity. One effect of these problems is that conventional tests of purchasing power parity can accept PPP when predictive errors are relatively large and reject it when predictive errors are relatively small. Another effect is to bias test of cointegration toward accepting the null of no cointegration between exchange rates and relative price indexes. We also construct a simple model of the determination of exchange rates that shows how transaction costs lead to regression switiching.

Testing for absolute purchasing power parity

Abstract Purchasing power parity (PPP) is an equilibrium condition equating the nominal exchange rate between two countries with the relative price of an identical bundle of goods in each country. Previous time-series researchers use price indices to study PPP, so they test relative PPP. We use new data that measures price levels, so we test absolute PPP. Price levels provide a test of absolute PPP because, unlike price indices, price levels do not contain a base period in which the nominal exchange rate equals the price ratio by construction. We find support for absolute PPP.

Stabilization of the Canadian Dollar: 1975-1986

The authors extend their earlier work on Canadian intervention in the foreign-exchange market in three ways: (1) use daily data from 1975 to 1986 to see if results for the 1950s hold during the current float; (2) extend their original model to include both stock and flow versions of the foreign-exchange market; and (3) compare estimates using published Canadian holdings of U.S. dollars to estimates using actual intervention, which is confidential. Canadian authorities continue to lean against the wind, but their lagged response is longer and more variable. Published data effectively reflect intervention.

Commodity prices, exchange rates and their relative volatility

Abstract Exchange rates are move volatile than rates implied by PPP using conventional price indexes. This fact has led many to believe that exchange rates fluctuate more than is warranted by the variability in commodity prices and supports those who believe that fluctuations in exchange rates are excessive. We show that exchange rates are less volatile than commodity prices in auction markets and less volatile than rates implied by the law of one price using such prices. We also show that the behavior of exchange rates and the rates implied by these commodity prices is not consistent with the Dornbusch overshooting model.

Modeling foreign exchange intervention: stock versus stock adjustment

Abstract Intervention studies using stock models do not produce robust results across currencies and over time. Perhaps we should consider a different approach such as stock adjustment. Stock adjustment has several advantages over stock models. Stock adjustment explains profits from simple trading rules and why intervention can be effective when it is so small relative to the stock of financial assets. Stock adjustment solves the ‘secrecy puzzle’ and avoids the dubious signaling channel. Stock adjustment produces robust results across currencies and over time. Here, for the first time, I use two tests to discriminate between stock and stock adjustment. Both tests avoid simultaneity. One test uses the behavior of intervention when a central bank holds exchange rates constant. Those results favor stock adjustment over a stock approach. The other test analyzes changes in exchange rates under different types of intervention. Those results support stock adjustment and reject a stock approach.

UK Monetary Policy: The Challenge for the 1990s.

The development of UK monetary policy, 1949 to 1990 measures of money in the UK analyzing narrow money the counterparts approach to analyzing broad money funding policy problems with broad money European economic and monetary union the exchange rate as a monetary indicator - the experience of the 1980s UK membership of the European exchange rate mechanism bringing together the information on monetary conditions Bank of England operations in the money market.

The Term Structure of Interest Rates in the MIT-PENN-SSRC Model: Reality or Illusion?

THE IS-LM MODEL of income and expenditure, which is the conceptual foundation for large econometric models, contains only a single interest rate. Under standard interpretations of the model, however, investment expenditures depend on long-term rates of interest and the demand for money responds to short-term yields . Textbooks avoid the issue by adopting the fiction of a single rate of interest. Outside the classroom the question of the term structure of interestrates and ie link between monetary and expenditure sectors reappears. The problem is resolved in most large econometric models by an equation that expresses long-term interest rates as depending primarily on a long distibuted lag of current and past short-term yields .1 The justification for this approach rests primarily on work by Modigliani and Sutch [24, 25] and Modigliani and Shiller [23]. The Modigliani-Shiller model of the term structure is the primary channel irough which monetary policy in the MIT-PENN-SSRC model alters prices, income, and employment.2 There is, however, a large and growing body of empirical evidence indicating iat

In search of overshooting and bandwagons in exchange rates

Abstract There is a widespread misconception about the prevalence of destabilizing behavior such as overshooting and bandwagons in nominal exchange rates. In a recent article in this journal, Rotheli [J. Int. Financial Markets Inst. Money 12 (2002) 157] perpetuates this misconception. He interprets a combination of persistence and cointegration in his error correction model as evidence of bandwagons. However, his evidence for significant persistence is spurious and his conclusion regarding bandwagons is unwarranted. When the countries and periods he analyzes are estimated and interpreted correctly, there is no evidence of nominal overshooting or bandwagons in flexible exchange rates. Quite the opposite. The evidence suggests that something, probably intervention by central banks, is slightly reducing the short-run volatility of exchange rates.

Some evidence on the relationship between spot and forward exchange rates

Abstract A close relationship between changes in current spot and forward exchange rates has been used as evidence to support the asset approach to the determination of exchange rates. See for example Mussa (1979) and Frenkel (1981). The strongest empirical support for this relationship comes from Frenkel who uses monthly data during the 1970s for the dollar price of the British pound, French franc and German mark. This note extends the evidence in three ways. It looks at another currency, the Canadian dollar, investigates the dynamics of the relationship through spectral analysis, and uses daily data in order to concentrate on the strength of the short-run relationship. If one accepts the argument that a close relationship between contemporaneous changes in spot and forward rates support the asset approach, then these results provide strong support for that approach.

International capital movements: A synthesis of alternative models

Abstract The several alternative approches to international capital movements have not been compared theoretically. By showing that each represents a special case from a general simultaneous equation model, this note clarifies the theoretical relationships among the approaches, thus providing a convenient framework for their evaluation.