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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : World Development, Volume 34, Issue 7, July 2006, Pages 1171–1181
The relationship between fiscal imbalances and other macroeconomic variables is complex and multifaceted. However, it remains important to understand it, not least in order to facilitate the design of appropriate policy. One central issue is whether the relationship varies across countries or groups of countries. If it does, an implication is that policy will also have to be differentiated. This paper empirically explores the relationship between fiscal imbalances and pressures in the foreign exchange (FX) market in Latin America & Caribbean (LAC) and East Asia & the Pacific (EAP) regions. Using panel data over 1970–2000, it finds that fiscal imbalances have a significant effect on FX pressures in LAC but not in EAP.
Two issues of central importance to developing and emerging economies relate to the macroeconomic effects of fiscal deficits and the choice of exchange rate regime. A key element in the Washington Consensus was that large fiscal deficits have severe deleterious effects and need to be reduced or eliminated, while another element of it focused on the need to avoid currency misalignment.1 In principle, these issues may be connected in as much as the monetary implications of fiscal deficits are inflationary and, in the context of pegged exchange rates, lead to a loss of competitiveness. Indeed the first generation currency crisis model built on this connection to show how fiscal deficits could cause current account balance of payments deficits, a loss of international reserves and financial crisis.2 At the same time, currency misalignment may have implications for the fiscal balance as, for example, the revenues from trade taxes are affected. Theoretical analysis suggests that the impact of fiscal deficits will vary according to a range of factors that are likely to differ across countries. It is therefore unsafe to assume that they will have any one particular set of effects. Empirical studies have tended to confirm this supposition (see, e.g., Easterly & Schmidt-Hebbel, 1994). Part of the difficulty in assessing the effects of fiscal deficits is that they can materialize in various ways; some direct and some indirect. Moreover, the diverse effects may be offsetting. This creates a daunting challenge for any study that seeks to estimate their detailed macroeconomic consequences. This paper has a much more modest objective. It concentrates on the relationship between fiscal deficits and pressures in the foreign exchange market. Do countries with larger fiscal deficits experience more foreign exchange market pressures? Furthermore, does the nature of the relationship differ across groups of countries? To test this, we commence with what has almost become a stylized fact; namely that fiscal deficits have constituted a more significant problem for Latin American than for Asian economies. This idea found succinct summary among those who criticized the IMF’s initial response to the economic crisis in East Asia in 1997–98. Here, critics claimed that the Fund adopted a conventional and fiscally contractionary approach to deal with foreign exchange crises that had little to do with fiscal excesses. Is the evidence consistent with the suggestion that Latin America and Asia differ when it comes to the association between fiscal deficits and foreign exchange markets?3 The paper is organized in the following way. Section 2 reviews descriptive statistics relating to fiscal imbalances in Latin America and Asia. These imply that the effects of fiscal deficits may indeed be expected to be different across the two regions. Section 3 explains the methodology used to estimate more formally the relationship between fiscal deficits and foreign exchange market pressures as well as to explore the relevance of the exchange rate regime as classified by Reinhart and Rogoff (2004). Our methodology has a number of advantages over that adopted in much of the existing literature on currency crises, since it allows us to map pressures in the foreign exchange market as a continuous variable. The least squares dummy variables method is used to estimate the panel. The section then goes on to present and interpret our findings. Section 4 briefly examines some of the broader policy implications of our results for the design of fiscal policy in the two regions. Section 5 offers a few concluding remarks and points to some of the limitations of the research reported in the paper.
نتیجه گیری انگلیسی
Nowadays, microstructure research in foreign exchange markets is seen by many as a promising avenue due to the “failure of the macro approach” (Flood and Taylor, 1996; Madhavan, 2000; Lyons, 2001). Our deeper understanding of the processes in foreign exchange is hampered, however, by the limited amount of data availability. In particular, profitability is a key source of information to understand the business, but useful profit figures are extremely rare. We contribute to the literature by analyzing a new data set which covers a much longer period than earlier studies. This allows us to apply new methods and to generate more reliable results. We find that our bank does make money in foreign exchange trading, but that speculation does not contribute much to this, if at all. Profits from speculation cannot be identified, either in an event study approach or by regressing potential determinants of profits. Moreover, analyzing spreads in non-speculative trading reveals revenues that fully explain overall profits. Thus, it is not speculation, but providing intermediation services to customers that seems to explain profits best. The issue of trading profitability is a core element of Friedman's (1953) proposition that profitable speculation would stabilize exchange rate movements. Although the conventional view now seems to be that profits are neither necessary nor sufficient for stabilizing speculation it is nevertheless very interesting to know whether banks’ foreign exchange speculation makes profits. Available evidence has not really been satisfying so far. There are several studies analyzing banks’ position taking, with lower frequency data, such as monthly data (Fieleke, 1981) or weekly data (Wei and Kim, 1997). We know, however, that banks square their large open positions at the end of the day, hence these kinds of studies miss the bulk of intra-day position taking (see Goodhart, 1988). Unfortunately, evidence from intra-day data is even rarer. According to our knowledge, only two studies analyzing profitability in foreign exchange exist, i.e., Lyons (1998) and Yao (1998). Their studies are limited since their data sets are based on one week and five weeks of trading respectively, a disadvantage in identifying a volatile phenomenon (Lyons, 1998). So at this stage, there is still an obvious need for better data which allow for the application of more reliable approaches, and thus, for drawing more general conclusions. Our data covers the complete tick-by-tick USD/EUR trading record of a bank in Germany over 87 days in 2001. This bank is a “regular” participant in foreign exchange markets as its activities show: first of all, the bank's trading volume in the market segment that we are analyzing is of about average size in comparison to the 33 foreign exchange trading banks in Deutsche Bundesbank's survey of the foreign exchange market in Germany (see details in the Appendix). Second, this bank offers the full range of products, i.e., spot as well as derivatives, it serves commercial as well as financial customers, it participates as a market maker and it conducts own-account trading. All this happens in several currencies. This bank is not as large as the banks covered by Lyons (1998) or Yao (1998) but it is not so tiny that it could be considered marginal, either. Moreover, the bank is not as specialized as Lyons’ dealer who trades in the interbank market only. In fact, this bank's customer share of trading volume is 38%, close to the average figure of 41% for the world-wide foreign exchange market (BIS, 2002, Table B.3). Finally, we identify considerable profits in our bank's foreign exchange trading, whereas Yao does not. Yao's results are somewhat surprising in light of the heavy trading and risk involved and may be due to non-representative circumstances. Beside the comparison above, there is further information suggesting that the evidence presented here is of potential interest beyond the single case. When analyzing the kind of trading behavior of this bank's USD/EUR dealer, we found that the characteristics are the same as those found in other studies (Osler et al. 2006, have examined this relation for other purposes). Moreover, foreign exchange markets seem to be so highly integrated that market-wide characteristics can be reproduced with our case data, such as the correlation between price changes and order flow in the sense of Evans and Lyons (2002). As a last check, we have compared the bank's profits at the four-month period covered here with a three-year period, finding that profits earned at the sample period are about 10% below average but not misleadingly low. We do find that our bank earns considerable revenues, i.e., gross profits. When we subtract transaction costs according to a standard approach, we find that this bank also makes (net) profits. We then turn to the core question of whether or not revenues are caused by speculation. Due to the data available we can extend and complement several methods of this literature: we follow Yao's (1998) definition of speculative trades and apply this also to incoming trades. The new application of an event study method shows that speculative positions fail to become systematically profitable over a period of 30 min. If we track these positions until they are closed we find profits, but these are partially caused by customer trades. Lyons’ (1998) suggestion that exchange rate volatility would foster speculative profits can be tested thanks to the comparatively long data period in a regression approach and his hypothesis is not confirmed by our case. Extending this approach by putting various suggested determinants of profitability into a multivariate regression, only customer business emerges as a significant profit source and not price volatility, nor position taking. Picking up ideas by Lyons (1998) and Yao (1998), we see that a spread analysis of interbank and customer business reveals that there is hardly any room left for residual revenues from speculation. Thus, the tentative finding in the literature that speculation may slightly contribute to foreign exchange trading profits (Lyons, 1998; Yao, 1998) is not confirmed by our examination of this case. Considering the competitive nature of this market, it seems reasonable to doubt that any participant could systematically make money by speculation. The paper proceeds as follows: Section 2 introduces the data used. Section 3 presents overall revenues and profits of the dealer's foreign exchange trading. Section 4 discusses approaches to help identify speculative trading activity. Section 5 focuses on identifying possible revenues from speculation. Section 6 concludes.