This paper offers empirical evidence that real exchange rate volatility can have a significant impact on long-term rate of productivity growth, but the effect depends critically on a country’s level of financial development. For countries with relatively low levels of financial development, exchange rate volatility generally reduces growth, whereas for financially advanced countries, there is no significant effect. Our empirical analysis is based on an 83 country data set spanning the years 1960-2000; our results appear robust to time window, alternative measures of financial development and exchange rate volatility, and outliers. We also offer a simple monetary growth model in which real exchange rate uncertainty exacerbates the negative investment effects of domestic credit market constraints. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.

This paper examines the bilateral composition of international bond portfolios for the euro area and the individual EMU member countries. I find considerable support for euroarea bias: EMU member countries disproportionately invest in one another relative to other country pairs. Another striking pattern is the positive connection between trade linkages and financial linkages in explaining asymmetries across EMU member countries in terms of their outward bond investments vis-à-vis external counterparties. My empirical results underline the impact of currency union on financial integration and support the notion that financial regionalization is the leading force underlying financial globalization.

Our goal in this project is to gain a better empirical understanding of the international financial implications of currency movements. To this end, we construct a database of international currency exposures for a large panel of countries over 1990–2004. We show that trade-weighted exchange rate indices are insufficient to understand the financial impact of currency movements. Further, we demonstrate that many developing countries hold short foreign currency positions, leaving them open to negative valuation effects when the domestic currency depreciates. However, we also show that many of these countries have substantially reduced their foreign currency exposure over the last decade. Last, we show that our currency measure has high explanatory power for the valuation term in net foreign asset dynamics: exchange rate valuation shocks are sizeable, not quickly reversed and may entail substantial wealth shocks. 1.

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper studies the role of an increase in foreign exchange reserves in reducing currency volatility for emerging market countries. The study employs a panel of 28 countries over the period 1986–2002. Several control variables are introduced in the regressions to account for other factors affecting exchange rate volatility (monetary and external indicators as well as conventional macroeconomic fundamentals). The paper controls for the endogeneity induced by the role of the exchange rate regime, since the regime can affect both the level of reserves and exchange rate volatility. The results provide ample support for the proposition that holding adequate reserves reduces exchange rate volatility. The effect is strong and robust; moreover, it is nonlinear and appears to operate through a signaling effect.

This paper argues that significant structural differences exist between industrial and emerging market economies. Cyclical fluctuations have been more extreme for the latter group and exacerbated by inappropriately procyclical macroeconomic policies. However, we argue that effective stabilization policies remain feasible for the emerging market economies, so long as these invest in developing a robust domestic institutional infrastructure.

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Abstract Recent experience suggests that the operation of monetary policy in emerging market economies is severely limited by the presence of financial constraints. This is seen in the tendency to follow contractionary monetary policy during crises, and the observation that these countries pursue much more stable exchange rates than do high income advanced economies, despite having a more volatile external environment. This paper analyzes the use of monetary policy in an open economy in which exchange rate sensitive collateral constraints may bind in some states of the world. The appeal of the model is that it allows for a complete analytical description of the effects of collateral constraints, and admits a full characterization of welfare-maximizing monetary policy rules. The model can explain the two empirical features of emerging market monetary policy described above -in particular, that optimal monetary policy may be pro-cyclical under binding collateral constraints, and an economy with large external shocks may favor a fixed exchange rate, even though flexible exchange rates are preferred when external shocks are smaller. *

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the authors and are published to elicit comments and to further debate. Oil funds have become increasingly popular in oil exporting countries during the recent surge in oil prices. However, the literature on the contribution is small, tends to focus narrowly on their fiscal benefits, and concludes that they are redundant of such funds—in other words, that well designed fiscal management and policy are adequate substitutes for oil funds. This paper argues that a broader focus is needed in judging the effectiveness of such funds. We test whether oil funds help reduce macroeconomic volatility. The econometric estimation results from a 30-year panel data set of 15 countries with and without oil funds suggest that oil funds are associated with reduced volatility of broad money and prices and lower inflation. However, there is a statistically weak negative association between the presence of an oil fund and volatility of the

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We construct a dynamic general equilibrium model of a small open economy where domestic entrepreneurs face borrowing constraints and finance their investment projects both in domestic and international capital markets. We parametrize the degree of financial exposure as the fraction of borrowing expressed in foreign units of denomination, and study its interaction with alternative exchange rate regimes. We find that a regime of flexible exchange rates greatly amplifies, relative to fixed rates, the response to domestic shocks. However, when financial exposure is high investment can fall and financial conditions can worsen in response to favorable productivity shocks, due to detrimental balance-sheets effects. Asset price volatility and overall financial instability are found to be monotonically increasing in financial exposure. In response to a rise in world interest rates, higher financial exposure greatly worsens the performance of flexible exchange rates (relative to the case with no exposure), so that the acclaimed insulating role of the latter (relative to fixed) barely applies to output and vanishes for financial variables. In general, the higher the degree of financial exposure, the closer the resemblance between flexible and fixed exchange rates, a result that provides a theoretical background for a fear-of-floating argument.