Re: Incomes and Exchange rates; part 3

[Basil Moore <bmoore@xxxxxxxxxxxx>]

Leigh
Thanks for the Oz data. Interest rate parity theory states that expected
REAL rates should be equalized. The period  from 83 to 91, when Oz rates
were very high, was presumably accompanied by high Oz inflation?? Since 91
the RBA has followed a cheap money policy. The rate differential has even
become negative in 97?? Does that imply the OZ inflation rate is now below
the US rate, ie. 3 percent??

Or is the RBA attempting to depreciate the exchange rate??   Basil
















At 11:28 PM 9/16/97 +1000, you wrote:
>Basil
>
>Thanks for your comments. You wrote that:
>
>> My obsevations were based in my stay in
>>South Africa, where the Reserve bank Is desperately attempting to raise
>>fereign exchange reserve cover; at present reserves are only about two
>>months imports.
>
>I saw similar pressure to raise foreign reserves on the Philippines from the
>IMF.  In August last year, they significantly raised foreign reserves. They
>appeared to have had a half hearted attempt at a fixing the exchange rate.
>Yet they kept interest rates high.  This initially appears to have attracted
>a great deal of foreign S/T capital.  However, when the Thai baht suffered
>serious devaluation, the Philippine currency had a massive outflow of
>capital that caused the CB to significantly devalue the currency and resume
>the float.
>
>>They are on a flexible exchange rate regime, and are keeping
>>Bank rate at 18 percent, in the attempt to attract foreign short term
>>capital , and also (mistakenly), to reduce the inflation rate. This in >the
>face of 35-40 percent unemployment.
>
>I agree it is a mistake.  The foreign capital enters only while interest
>rates are high.  While using those rates to gather foreign reserves does
>stimulate the economy with new money, the high exchange rate actually causes
>the country to import more and export less.
>
>Also, a high interest rate can kill investmen in long term projects.  The CB
>must maintain them to maintain the value of the currency.
>
>It would do better to forget about the floating exchange rate system,
>devalue the currency to increase exports and shift spending from imports to
>domestic products.  This would increase the multiplier and stimulate
>economic growth, thereby increasing employment.
>
>
>>So the size of foreign exchange reserves are absolutely critical to SA
>>monetary policy. That is primarily why I disagreed with your (conventional)
>>story that a flexible exchange rate regime permits the CB to act more
>>independently.
>
>I doubt if raising foreign reserves is critical to SA monetary policy.  The
>SA government may be just doing what the IMF is telling it to do.  I have
>found the IMF grossly incompetent.  It is neglecting its charter.  It more
>concerned about trying to force countries to implement neo-classical
>economic policies.  Keynes would turn in his grave if he could see what it
>was doing to economies around the world.
>
>>You say that In Oz the CB has tight control of the domestic short term
>>nominal interest rate. I doubt that very much.
>
>>Try to run a regression using  the nominal level of the domestic rate as
>>the dependent variable. Although I have not looked at OZ data, I feel
>>confident that the level of foreign rates
>>will be overwhelmingly the single most important variable. In an open
>>economy with capital mobility, the CB's reaction function refers to the
>>differential of the domestic rate over the foreign rate. (In SA the
>>domestic inflation rate is not even significant in the reserve bank's
>>reaction function on the nominal ST interest rate.
>
>
>Movements in domestic money market interest rates are closely linked to the
>CB's rate.  I cannot find the RBA's prime rates at the moment.
>
>However, if US and Oz rates were tightly linked, you would expect them to be
>similar but they have been varying.  The following compares the US Prime
>commercial paper rate (6 mth) with the Oz 180 day bank bill rate (June rates
>except for 1997 which is the May rate).
>
>	US	Oz	% Diff
>1983	9.03	13.57	50%
>1984	11.23	12.73	13%
>1985	7.38	16.46	123%
>1986	6.63	14.78	123%
>1987	7	13.36	91%
>1988	7.53	13.13	74%
>1989	8.8	18.28	108%
>1990	8.06	15.06	87%
>1991	6.16	10.48	70%
>1992	3.99	6.41	61%
>1993	3.38	5.25	55%
>1994	4.86	5.47	13%
>1995	5.79	7.57	31%
>1996	5.57	7.59	36%
>1997	5.78	5.63	-3%
>
>As you can see, one rate is not a good predictor of the other.
>
>While interest rates are important to the finance market, I do not see
>interest rates as being as important in the real economy as exchange rates
>and changes in the money supply (and what changes it).
>
>Regards
>
>
>Leigh
>
>
>
>______________________________________________________________________
>Leigh Harkness                                      leigh@xxxxxxxxxxx
>
>
>
>
>


Basil Moore, Department of Economics
Wesleyan University
685-2363