Economic Integration and the Exchange Rate Regime: How Damaging are Currency Crises?

Transcription

1 Economic Integration and the Exchange Rate Regime: How Damaging are Currency Crises? Axel A. Weber Cologne University, CFS, CEPR Guenter W. Beck Frankfurt University 11 December 2001 Abstract We use CPI data for 205 regions in 21 countries (industrialized and emerging market economies) to study deviations from the law-of-one-price before, during and after the major currency crises of the 1990s. We find that currency attacks had major disintegration effects. These effects seem to be quite persistent. Frankfurter Volkswirtschaftliches Kolloquium, WS 2001/2002, December,

2 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview

3 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background

4 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background 2. Data

5 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background 2. Data 3. Some Data Properties

6 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background 2. Data 3. Some Data Properties 4. Key Estimation Results

7 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background 2. Data 3. Some Data Properties 4. Key Estimation Results 5. Sensitivity Analysis

8 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 1 Overview 1. Motivation/Background 2. Data 3. Some Data Properties 4. Key Estimation Results 5. Sensitivity Analysis 6. Summary/Conclusions 1

9 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 2 Motivation/Background Two Key Developments of the 1990s Vanishing Intermediate Exchange Rate Regime, often triggered by crises (Frankel (1999) Globalization (integration of national economies), Knetter and Slaughter (2000) Mexico, December 1994 Asia, July 1997 Brazil, January in most cases, an existing intermediate pre-crisis regime was abandoned in favor of a free float NAFTA, January 1994 Mercosur, March 1991 EU Common Market while there is a consensus that financial markets have become more integrated, the evidence for goods and labor markets is less clear (Knetter/Slaughter, 2000) Look at links between regime choice and integration? 2

10 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on:

11 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data

12 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993),

13 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995),

14 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995), Wolf (2000),

15 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995), Wolf (2000), Rose (2000, 2001)

16 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995), Wolf (2000), Rose (2000, 2001) price data

17 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995), Wolf (2000), Rose (2000, 2001) price data our approach, see below

18 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 3 Motivation/Background Empirical literature on goods market integration based on: trade data Frankel and Wei (1993), McCallum (AER, 1995), Wolf (2000), Rose (2000, 2001) price data our approach, see below Theoretical background PPP/LOOP P = SP Q = 1 (1) 3

19 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background

20 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion

21 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000))

22 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996)

23 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001)

24 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001) Idea : ln(c) < ln(p j,t ) ln(p k,t ) < ln(c)

25 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001) Idea : ln(c) < ln(p j,t ) ln(p k,t ) < ln(c) at a later stage: examine time series behavior of real exchange rates

26 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001) Idea : ln(c) < ln(p j,t ) ln(p k,t ) < ln(c) at a later stage: examine time series behavior of real exchange rates Single equation unit root tests (Abuaf and Jorion (JoF, 1990), Lothian and Taylor (JPE, 1997))

27 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001) Idea : ln(c) < ln(p j,t ) ln(p k,t ) < ln(c) at a later stage: examine time series behavior of real exchange rates Single equation unit root tests (Abuaf and Jorion (JoF, 1990), Lothian and Taylor (JPE, 1997)) Nonlinear econometric models (Obstfeld and Taylor (1997, TAR), O Connell and Wei (1997, TAR), Michael, Nobay and Peel (1997, ESTAR))

28 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 4 Our research agenda is to...: Motivation/Background compare intra-country and inter-country price dispersion Engel and Rogers (AER (1996), JIE (2000)) Parsley and Wei (QJE, 1996) Beck and Weber (CFS Working Paper, 2001) Idea : ln(c) < ln(p j,t ) ln(p k,t ) < ln(c) at a later stage: examine time series behavior of real exchange rates Single equation unit root tests (Abuaf and Jorion (JoF, 1990), Lothian and Taylor (JPE, 1997)) Nonlinear econometric models (Obstfeld and Taylor (1997, TAR), O Connell and Wei (1997, TAR), Michael, Nobay and Peel (1997, ESTAR)) Panel unit root tests (Wu (JMCB,1996) Frankel and Rose (JIE, 1996), Goldberg and Verboven (NBER, 2001), Cecchetti, Mark and Sonora (1999) 4

29 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...:

30 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...: use the Engel-Rogers approach to examine the potential implications of currency crises on economic integration (previous paper: integration effects of EMU)

31 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...: use the Engel-Rogers approach to examine the potential implications of currency crises on economic integration (previous paper: integration effects of EMU) use relative price and real exchange rate data (instead of trade data) to identify potential optimal currency area blocs between emerking market economies (focus on U.S. Dollar bloc and the Asian/Yen bloc)

32 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...: use the Engel-Rogers approach to examine the potential implications of currency crises on economic integration (previous paper: integration effects of EMU) use relative price and real exchange rate data (instead of trade data) to identify potential optimal currency area blocs between emerking market economies (focus on U.S. Dollar bloc and the Asian/Yen bloc) compare price dispersion across countries and within countries under different exchange rate regimes

33 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...: use the Engel-Rogers approach to examine the potential implications of currency crises on economic integration (previous paper: integration effects of EMU) use relative price and real exchange rate data (instead of trade data) to identify potential optimal currency area blocs between emerking market economies (focus on U.S. Dollar bloc and the Asian/Yen bloc) compare price dispersion across countries and within countries under different exchange rate regimes... based on a completely new dataset the compilation of which was funded by the

34 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 5 Motivation/Background The objectives of this paper are to...: use the Engel-Rogers approach to examine the potential implications of currency crises on economic integration (previous paper: integration effects of EMU) use relative price and real exchange rate data (instead of trade data) to identify potential optimal currency area blocs between emerking market economies (focus on U.S. Dollar bloc and the Asian/Yen bloc) compare price dispersion across countries and within countries under different exchange rate regimes... based on a completely new dataset the compilation of which was funded by the 5

35 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 6 Data used in this paper Data: General Description

36 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 6 Data used in this paper Data: General Description 6

37 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data

38 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data monthly frequency, (some exceptions)

39 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data monthly frequency, (some exceptions) this paper: includes only CPI All Items to be able to include many countries, but...

40 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data monthly frequency, (some exceptions) this paper: includes only CPI All Items to be able to include many countries, but... traded and non-traded components?...

41 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data monthly frequency, (some exceptions) this paper: includes only CPI All Items to be able to include many countries, but... traded and non-traded components?... measurement bias (see e.g. Boskin report)?...

42 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 7 Data used in this paper Data: General Description consumer price index (CPI) data monthly frequency, (some exceptions) this paper: includes only CPI All Items to be able to include many countries, but... traded and non-traded components?... measurement bias (see e.g. Boskin report)?... at a later stage: include disaggregrated categories of goods, such as food, clothing, furniture,... 7

43 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data from 5 continents: Data: Location Listing

44 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data: Location Listing Data from 5 continents: North America USA (9), Canada (10), Mexico (15)

45 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data: Location Listing Data from 5 continents: North America USA (9), Canada (10), Mexico (15) South America Argentina (10), Bolivia (4), Brazil (11), Colombia (13)

46 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data from 5 continents: North America Data: Location Listing USA (9), Canada (10), Mexico (15) South America Argentina (10), Bolivia (4), Brazil (11), Colombia (13) Asia India (15), Indonesia (15), Korea (10), Malaysia (3), Philippines (10), Taiwan (7)

47 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data from 5 continents: North America Data: Location Listing USA (9), Canada (10), Mexico (15) South America Argentina (10), Bolivia (4), Brazil (11), Colombia (13) Asia India (15), Indonesia (15), Korea (10), Malaysia (3), Philippines (10), Taiwan (7) Europe Germany (10), Italy (10), Spain (10), Portugal (7)

48 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 8 Data from 5 continents: North America Data: Location Listing USA (9), Canada (10), Mexico (15) South America Argentina (10), Bolivia (4), Brazil (11), Colombia (13) Asia India (15), Indonesia (15), Korea (10), Malaysia (3), Philippines (10), Taiwan (7) Europe Germany (10), Italy (10), Spain (10), Portugal (7) Pacific Japan (12), Australia (8), New Zealand (10) 8

49 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 9 Data: Visual Illustration (1) North America A broad regional coverage of NAFTA! 9

50 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 10 Data: Visual Illustration (2) South America 10

51 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 11 Data: Visual Illustration (3) Europe 11

52 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 12 Data: Visual Illustration (4) Asia/Pacific A broad regional coverage of Asia! All crisis countries in the sample! 12

53 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 13 Data: Visual Illustration (5) Pacific 13

54 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 14 Data Properties: Intern. and Regional Inflation Dispersion Key: inflation levels: 0% p.a., 5% p.a., 10% p.a., 20% p.a. 14

55 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 15 Data Properties: Dispersion Measure

56 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 15 Data Properties: Dispersion Measure Two-month change in relative prices: construction: ln(q ij,t ) = (ln S tp t P t ln S t 1P t 1 Pt 1 )

57 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 15 Data Properties: Dispersion Measure Two-month change in relative prices: construction: ln(q ij,t ) = (ln S tp t P t ln S t 1P t 1 Pt 1 ) (2) measure 1: Standard Deviation of Changes for Each Relative Price Series

58 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 15 Data Properties: Dispersion Measure Two-month change in relative prices: construction: ln(q ij,t ) = (ln S tp t P t ln S t 1P t 1 Pt 1 ) (2) measure 1: Standard Deviation of Changes for Each Relative Price Series measure 2: Spread between the 10th and 90th Percentile

59 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 15 Data Properties: Dispersion Measure Two-month change in relative prices: construction: ln(q ij,t ) = (ln S tp t P t ln S t 1P t 1 Pt 1 ) (2) measure 1: Standard Deviation of Changes for Each Relative Price Series measure 2: Spread between the 10th and 90th Percentile Various other measures results are robust with respect to all different measures 15

60 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 16 Data Properties: Descriptive Statistics Table 1 a: Descr. Statistics, Relative Price Volatility, US Sample, Relative Locations, Indicated by Continent Names, Grouped by Continents Continent Pairs Mean Stdv Intranational lowest Within North America North vs. South America North America vs Asia North America vs. Pacific Within South America South America vs. Asia South America vs. Pacific Within Asia highest Asia vs. Pacific Intranational < Intracontinental < Intercontinental! Exception: Asia! 16

61 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 17 Data Properties: Volatility and Distance Dispersion Within Country Within North America (excluding Mexico) North-South America (including Mexico) North America-Asia Within South America South America-Asia Within-Asia Distance matters too! 17

62 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 18 Key Estimation Results: Basic Specification 18

63 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3

64 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular:

65 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability

66 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability dummy for NAFTA, ASEAN, ASEAN+,...

67 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability dummy for NAFTA, ASEAN, ASEAN+,... dummy for country pairs that switched from intermediate regime to free float

68 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability dummy for NAFTA, ASEAN, ASEAN+,... dummy for country pairs that switched from intermediate regime to free float dummy for country pairs that had free floating exchange rates throughout the 1990s

69 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability dummy for NAFTA, ASEAN, ASEAN+,... dummy for country pairs that switched from intermediate regime to free float dummy for country pairs that had free floating exchange rates throughout the 1990s also included: city dummies

70 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 19 Key Estimation Results: Basic Specification Estimation: Basic Equation σ qj,k = α 1 ln dist j,k + α 2 bord j,k + N α i x i + u j,k (3) i=3 x i stands for additional explanatory variables, in particular: exchange rate variability dummy for NAFTA, ASEAN, ASEAN+,... dummy for country pairs that switched from intermediate regime to free float dummy for country pairs that had free floating exchange rates throughout the 1990s also included: city dummies Results: see Table 3 19

71 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 20 Key Estimation Results: Basic Results Table 3: Estimation Using Log Distance, Border, Exchange Rate Volatility and Various Dummy Variables Overall Period (Jan 1991 June 2001), Measure 1 Specification (1) (2) (3) (4) (6) (7) (9) (10) (11) (12) Variable Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Log (Distance) Border Nom. Exrate Vol Landlocked Adjacency NAFTA ASEAN ASEAN + Korea ASEAN Indonesia YEN Bloc Swithching Exchange Arrangement Perm. Ind. Float R2 (adj) Volatility is significantly higher under regime transitions! 20

72 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4)

73 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs)

74 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs) further specifications: see above

75 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs) further specifications: see above estimate 105 individual border dummies

76 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs) further specifications: see above estimate 105 individual border dummies total period and subperiods

77 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs) further specifications: see above estimate 105 individual border dummies total period and subperiods detailed results: see Table 2 of the paper

78 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 21 Key Estimation Results: Individual Borders Estimation: Extended Equation σ qj,k = α 1 ln dist j,k + M+1 l=s α l bord j,k + N+M+1 i=m+2 α i x i + u j,k (4) bord j,k is an individual border dummy variable (M is the number of country pairs) further specifications: see above estimate 105 individual border dummies total period and subperiods detailed results: see Table 2 of the paper to analyze potential disintegration effects of crises: Figure 4 compares pre-crisis estimates (1991.I-1994.XII) to post-crisis estimates (1999.I-2001.VI) 21

79 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 22 Key Estimation Results: Individual Borders 100 Border Estimates: Pre-Mexican Crisis vs. Post-Asian Crisis Period Indonesia vs. Rest Korea vs. Rest mostly India vs. Rest Width of the border has increased! 22

80 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 23 Effects of Mexican Crisis on Within-Country Dispersion Mexico Brazil Mexican crisis has increased Mexican within-country volatility! 23

81 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 24 Effects of Asian Crisis on Within-Country Dispersion Indonesia Taiwan India Mexico Malaysia Asian crisis affected Indonesia strongly! 24

82 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 25 Sensitivity Analysis Dispersion of 12month changes: selected results Table 4: Estimation Using Log Distance, Border, Exchange Rate Volatility and Various Dummy Variables Overall Period (Jan 1991 June 2001), Measure 1 (12month changes) Specification (1) (2) (3) (4) (5) (6) (11) (12) Variable Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Log (Distance) Border Nom. Exrate Volatility Landlocked Adjacency NAFTA ASEAN Switching Exchange Arrangement Perm. Ind. Floating R2 (adj) Our basic findings are quite robust! 25

83 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 26 Summary/Conclusions 26

84 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 27 Summary/Conclusions The major currency crises of the 1990s

85 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 27 Summary/Conclusions The major currency crises of the 1990s...had both short- and medium-run effects on cross-country price dispersion (which today is still higher than before the crises)

86 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 27 Summary/Conclusions The major currency crises of the 1990s...had both short- and medium-run effects on cross-country price dispersion (which today is still higher than before the crises)...to a varying degree have also affected within country price dispersion

87 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 27 Summary/Conclusions The major currency crises of the 1990s...had both short- and medium-run effects on cross-country price dispersion (which today is still higher than before the crises)...to a varying degree have also affected within country price dispersion...according to our width-of-the-border metric have added to economic distance between markets. Our estimates confirm that global product markets are still very segmented and that segmentation has increased. 27

88 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 28 Policy Implications We find that the exchange rate regime choice plays a significant role in promoting economic integration. It is shown that intermediate regimes imply a larger relative price volatility than regimes with corner solutions.

89 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? 28 Policy Implications We find that the exchange rate regime choice plays a significant role in promoting economic integration. It is shown that intermediate regimes imply a larger relative price volatility than regimes with corner solutions. This suggests that a policy aimed at securing a stable global financial architecture and preventing currency crises is a key ingredient in fostering trade and in establishing globally integrated product markets. 28

90 ECONOMIC INTEGRATION AND THE EXCH. RATE REGIME: HOW DAMAGING ARE CURRENCY CRISES? End of Presentation 29