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Series:Research Paper  Bank:Federal Reserve Bank of New York 

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Are exchange rates excessively volatile? And what does \\"excessively volatile\\" mean, anyway?
Using data for the major currencies from 1973 to 1994, we apply recent tests of asset price volatility to reexamine whether exchange rates have been "excessively" volatile with respect to the predictions of the monetary model of the exchange rate and of standard extensions that allow for sticky prices, sluggish money adjustment, and time-varying risk premia. Consistent with previous evidence from regression-based tests, most of the models that we examine are rejected by our volatility-based tests. In general, however, we find that exchange rates have not been excessively volatile relative to movements of their determinants, with respect to the predictions of even the most restrictive version of the monetary model. Alternative measures of volatility, however, may disguise the cause of rejection as excessive exchange rate volatility.
AUTHORS: Bodnar, Gordon M.; Bartolini, Leonardo
DATE: 1996

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Exchange rate cointegration across central bank regime shifts
Foreign exchange rates are examined using cointegration tests over various time periods linked to regime shifts in central bank behavior. The number of cointegrating vectors seems to vary across these regime changes within the foreign exchange market. For example, cointegration is not generally found prior to the Plaza Agreement of September 22, 1985, but it is present after that date. The significance of these changes is evaluated using a likelihood ratio procedure proposed by Quintos (1993). The changing nature of the cointegrating relationships indicate that certain aspects of central bank activity do have long-term effects on exchange rates.
AUTHORS: Lopez, Jose A.
DATE: 1996

Report
Consumer payments over open computer networks
The increasing prospects for large volumes of commerce taking place over open computer networks has created considerable interest in the security and technology of open computer network commerce. In this paper, we explain how the basic encryption technology for sending secure messages works, and how this technology can be used to create electronic payment instruments, including cash, credit card, and check payments. We also review briefly the necessary elements required to support encryption technology: (1) a certification authority, (2) mathematical complexity of the encryption formulas, (3) system design. We conclude that security for making payments must be dynamic in nature as additional technological advances are likely to make electronic payment instruments vulnerable to more sophisticated attacks.
AUTHORS: Wenninger, John; Orlow, Daniel
DATE: 1996

Report
American employer salary surveys and labor economics research: issues and contributions
This paper reviews the uses of U.S. employer salary surveys for labor market research. Recent computational, theoretical, and econometric advances render these surveys ripe for exploitation. It summarize theories of employer wage effects and then describe salary surveys and their preparation for analysis. Then, the surveys and the methodological issues they raise are contrasted with household data. Finally, the paper summarizes the techniques used and contributions made in some salary survey-based studies.
AUTHORS: Groshen, Erica L.
DATE: 1996

Report
European integration and asymmetry in the EMS
The empirical literature offers conflicting views of German dominance in the European Monetary System. We examine the validity of the German dominance hypothesis (GDH) by analyzing the responses of the European central banks and the money markets to monetary innovations originating both in Europe (European asymmetry) and abroad (international asymmetry). Our results reconcile the conflicting views in the literature. The GDH is confirmed when the analysis is conducted with intervention rates before the German unification. Results support European asymmetry with short rates before 1990 but not international asymmetry. After 1990 the GDH is not supported by either set of rates.
AUTHORS: Uctum, Merih
DATE: 1996

Report
Has the cost of fighting inflation fallen?
During the 1980s, many OECD countries adopted labor-market policies designed to enhance wage flexibility and reduce unemployment. They also attempted to bolster the credibility of their anti-inflation measures through exchange rate and fiscal policies. These measures should have lowered the costs associated with fighting inflation. In this paper, we compare sacrifice ratio measures of the cost of disinflation in the most recent OECD recession with measures for the mid-seventies and early-eighties recessions. Surprisingly, in the overwhelming majority of OECD countries, the cost of reducing inflation has increased rather than declined. This conclusion stands, even if we take into account that it may be more expensive to fight inflation at lower inflation rates.
AUTHORS: Gabriel S.P. de Kock; Ghaleb, Tanya E.
DATE: 1996

Report
Capacity utilization-inflation linkages: a cross-country analysis
This paper analyzes whether capacity utilization in manufacturing is a reliable inflation indicator over and above economy-wide indicators of inflationary pressure and examines different theories on the propagation of inflation by testing their implications for the relationship between capacity utilization and inflation. Three mechanisms whereby shocks to manufacturing can impact on inflation are explored: First, direct pressure on producer prices in manufacturing arising from bottlenecks and a slowdown in productivity growth at high operating rates, second, spill-overs of manufacturing-sector wage increases into inflationary wage growth in the service sector, and finally, investment in manufacturing capacity that stimulates expansion, capacity pressures, and inflation on an economy-wide basis. We find that manufacturing capacity utilization has marginal predictive power for inflation in seven out of 15 major OECD economies and that the inflationary impact of an increase in manufacturing operating rates tends to be sizable. The links between capacity utilization and inflation that we uncover suggest that the mechanisms that propagate inflationary impulses differ widely among nations. In the U.S. there is strong evidence that changes in manufacturing activity impact on inflation through unit labor costs and finished goods producer prices. By contrast, wage contagion appears to be a crucial element of the inflation process in Japan. It also plays a role in Europe, particularly in Germany. Finally, only in Germany of the major capital-goods producing economies, does capital goods prices unambiguously play a role in transmitting manufacturing-sector shocks to economy-wide price indices.
AUTHORS: Gabriel S.P. de Kock; Nadal-Vicens, Tania
DATE: 1996

Report
Determinants and impacts of sovereign credit ratings
In this article, we present the first systematic analysis of the sovereign credit ratings of the two leading agencies, Moody's and Standard & Poor's (S&P). We find that the ordering of risks they imply is broadly consistent with macroeconomic fundamentals. While the agencies cite a large number of criteria in their assignment of sovereign ratings, a regression using only eight factors explains more than 90 percent of the cross-sectional variation in the ratings. In particular, a country's rating appears largely determined by its per capita income, external debt burden, inflation experience, default history and level of economic development. We do not, however, find any systematic relationship between ratings and either fiscal or current deficits, perhaps because of the endogeneity of fiscal policy and international capital flows. Sovereign ratings are also closely related to market-determined credit spreads, effectively summarizing and supplementing the information content of macroeconomic indicators in the pricing of sovereign risk. Cross-sectional results suggest that the rating agencies' opinions have independent effects on market spreads. Event study analysis broadly confirms this qualitative conclusion, for the reactions of bond yields to the announcements of changes in the agencies' sovereign risk opinions are statistically significant with respect to both their sign and magnitude.
AUTHORS: Packer, Frank; Cantor, Richard
DATE: 1996

Report
Predicting U.S. recessions: financial variables as leading indicators
This article examines the performance of various financial variables as predictors of U.S. recessions. Series such as interest rates and spreads, stock prices, currencies, and monetary aggregates are evaluated individually and in comparison with other financial and non-financial indicators. The analysis focuses on out-of-sample performance from 1 to 8 quarters ahead. Results show that stock prices are useful with 1-3 quarter horizons, as are some well-known macroeconomic indicators. Beyond 1 quarter, however, the slope of the yield curve emerges as the clear individual choice and typically performs better by itself out of sample than in conjunction with other variables.
AUTHORS: Estrella, Arturo; Mishkin, Frederic S.
DATE: 1996

Report
Capital flows & current account deficits in the 1990s: why did Latin America & East Asian countries respond differently?
The return of private capital to highly indebted less-developed countries (LDCs) in the late 1980s was accompanied by widening current account deficits in the recipient countries, which were primarily attributed to a consumption boom in Latin America and an investment surge in East Asia. Interpreting the return as an increase in the external debt ceiling, the maximum amount that can be borrowed, this paper analyzes and compares the different response of the two regions using the conceptual framework of a borrowing-constrained agent. According to it, an increase in the debt ceiling can reduce precautionary savings, and induce higher demand (and widening current account deficits) even when the borrowing constraint does not bind. Moreover, the increase in demand should be decreasing in the original ceiling. The results from a panel of fourteen Latin American and a panel of eight East Asian countries are consistent with the framework. They also indicate that the different response of the two regions can, to a large extent, be explained by Latin America's lower ceiling prior to the return. Further, the results identify several developments that have not received sufficient attention in the literature and, among other policy implications, suggest that controls on capital inflows may not be effective in preventing a current account deterioration.
AUTHORS: Antzoulatos, Angelos A.
DATE: 1996

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