Scott W. Hegerty

Exchange rate volatility and trade flows: a review article

Purpose - Since the last review article by McKenzie, the literature has experienced a surge in the number of empirical articles. These new contributions, coupled with those that were overlooked by McKenzie, set the stage for this review. Many of the recent studies have been empirical in nature and these deserve specific attention. Thus, this paper aims to survey and review all of the studies by paying attention to the attributes outlined in the text. Design/methodology/approach - This paper examines the vast empirical literature, up to 2005, to assess the main trends in modeling and estimating these trade flows at the aggregate, bilateral, and sectoral levels. Findings - The increase in exchange-rate volatility since 1973 has had indeterminate effects on international export and import flows. Although it can be assumed that an increase in risk may lead to a reduction in economic activity, the theoretical literature provides justifications for positive or insignificant effects as well. Similar results have been found in empirical tests. While modeling techniques have evolved over time to incorporate new developments in econometric analysis, no single measure of exchange-rate volatility has dominated the literature. Originality/value - An argument put forward by the opponents of the floating exchange rates is that such rates introduce uncertainty into the foreign exchange market, which could deter trade flows. However, a theoretical argument is put forward by some to show that uncertainty could also boost trade flows if traders increase their trade volume to offset any decrease in future revenue due to exchange rate volatility. The empirical literature reviewed in this paper supports both views.

The J- and S-curves: a survey of the recent literature

Purpose - Since the introduction of the concepts of the J- and S-curves, many researchers have tried to verify their validity empirically. This paper aims to review the related papers and to offer direction for future research. Design/methodology/approach - This is a review paper. As such, no method is employed here. Rather, the methodologies used by others to test the J- and S-curves are explained and reviewed. Findings - No new findings are offered since this is a review paper. Practical implications - The J- and S-curves show whether currency depreciation worsens the trade balance first before improving it. Since the majority of studies are country-specific, policymakers could benefit by learning whether currency depreciation will be effective in improving the trade balance. Originality/value - This is a literature review paper and its originality is in terms of collecting the literature together and presenting it in one single paper.

PURCHASING POWER PARITY IN LESS‐DEVELOPED AND TRANSITION ECONOMIES: A REVIEW PAPER

The concept of purchasing power parity (PPP) has been the subject of numerous studies, many of which have been unable to prove conclusively this core principle of international finance. Although industrialized countries have received most of the attention, studies that focus on less-developed and transition economies have also attained mixed results. This study surveys trends in this branch of the literature, highlighting the econometric advances that have sought to solve this puzzle, while pointing out that more needs to be done to address the reasons that might cause PPP not to hold. Copyright

The J-curve and NAFTA: evidence from commodity trade between the US and Mexico

The North American Free Trade Agreement (NAFTA) was predicted to have a substantial impact on the US–Mexico trade, especially on specific importing and exporting industries. In this article, we use annual industry-level export and import data from 1962 to 2004 to discern both the short- and long-run effects of real exchange-rate depreciation on the Mexico–US trade balance, as well as the effects of NAFTA on this trade. We find that peso depreciation has a positive long-run effect on 24 of 102 Mexican industries and a negative short-run effect on 19 of 102 industries. Only a small fraction (7 of 102 industries) show any support for the J-curve hypothesis. NAFTA has had a significant effect on a significant number of the industries, however.

Brazil–US commodity trade and the J-Curve

Currency devaluation or depreciation is said to temporarily worsen a country’s trade balance and improve it later, an effect that is called the J-Curve. Previous research that tested the J-Curve for Brazil used the country’s aggregate trade flows with the rest of the world and did not find support for the phenomenon. In this article, we consider the trade flows between Brazil and a major trading partner, the United States, disaggregating their trade flows by commodity. We then test the empirical validity of the J-Curve for each of the 92 industries that trade between the two countries. We find support for the phenomenon in 31 industries. Therefore, disaggregation by industry seems to yield some support for the phenomenon.

Exchange-rate volatility and industry trade between Canada and Mexico

While it has long been assumed that exchange-rate volatility introduces a level of uncertainty that helps reduce trade flows, this need not be the case for particular country pairs or for specific products. This study examines the case of trade between Canada and Mexico—two members of the highly integrated North American market. Trade flows are examined for a number of specific products using the “bounds testing” cointegration approach over the period from 1973 to 2006. Relatively few industries see a long-run reduction in trade volumes due to volatility. This indicates that multinational producers in these integrated markets might be able to hedge against exchange-rate risk. Since major Mexican exports appear to see the largest reductions, Mexico might have a stronger incentive to reduce the volatility of the peso.

Trade Liberalisation, the Peso, and Mexico's Commodity Trade Flows with the United States

Abstract We assess the effects of real peso devaluations, as well as the effects of GATT and NAFTA, on Mexicos in-payments and out-payments with the United States for 102 industries. We find that relatively few trade flows are sensitive to changes in the real exchange rate, probably due to production-sharing and intra-industry trade, but devaluations affect Mexican imports more than exports. Trade liberalisation has had a larger impact, particularly on imports of intermediate goods and exports of certain manufactures. Many affected export industries are ones that have previously been shown to have economies of scale.

Exchange market pressure, commodity prices, and contagion in Latin America

Over the past two decades, Latin American currencies have faced not only pressure to devalue but also periods of uncomfortable appreciation. Domestic macroeconomic factors, as well as global events and contagion, might bear part of the responsibility. This study constructs a monthly index of exchange market pressure (EMP) for four Latin American countries before using vector autoregressive methods to test the influence of commodity prices, macroeconomic variables, and external factors on each countrys index. While inflation is an important determinant of EMP, we conclude that Chile and Peru are more likely than Mexico and Brazil to face pressure when commodity prices fall. This supports the idea that these two countries have “commodity currencies” and that their exchange markets are most vulnerable to international contagion.

Is exchange-market pressure contagious among transition economies?

The recent financial crisis led to such macroeconomic turmoil in transition economies that the ability of some countries to maintain their euro pegs was called into question. Others, such as Russia and Ukraine, were forced to devalue their currencies. How likely is it that one countrys crisis could spread to its neighbours? To answer this question, monthly indices of Exchange Market Pressure (EMP) are constructed for seven transition economies. Impulse–Response functions and other tests show that Russia is a less likely source of a contagious currency crisis than are smaller, more advanced euro candidates such as Hungary.

Exchange--rate volatility and US--Hong Kong industry trade: is there evidence of a 'third country' effect?

In an effort to better understand the determinants of trade flows worldwide, researchers have recently incorporated external volatility (in addition to that of the partners’ bilateral exchange rate) into their models. The so‐called ‘third country’ effect is present if adding this term changes the bilateral volatility estimates that are found when external volatility is omitted. This study examines US exports to Hong Kong for 143 industries, and imports from Hong Kong for 110 industries, and finds two key results. First, expected inflation due to Hong Kongs dollar peg leads to increased US exports in a large number of industries. Second, comparing our results with those of a previous study shows strong evidence of a ‘third country’ effect, especially for US imports. Nonparametric tests suggest that these effects differ by sector: for both exports and imports. Manufacturing industries that enjoy a large trade share are less likely to experience this effect once external volatility is incorporated into the analysis.