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‘Can exchange rate predictability be achieved without monetary convergence?—evidence from the EMS’ by Kenneth Rogoff
European Economic Review 28 (1985) 121-122. North-Holland
COMMENTS ‘Can Exchange Rate Predictability be Achieved without Monetary Convergence? - Evidence from the EMS’ by Kenneth Rogoff J.S. FLEMMING Bank of England, London ECZR 8AH, UK
This highly professional paper addresses a number of important issues. These can be broken down into two points. What as a matter of fact has happened to the predictability of nominal and real exchange rates since the implementation of the Exchange Rate Mechanism (ERM) (of which the U.K. is not a participant) of the European Monetary System (EMS) (of which it is) in March 1979? Given some identifiable apparent effect of the ERM on exchange predictability, what are the roles of different possible elements such as the required intervention, exchange controls, convergence (or coordination) of economic policy or convergence of, e.g., inflation performance? Despite the paper’s title more light is thrown on the first question than the second. This is because no operational definition of ‘monetary convergence’ is ever offered. Rather, Kenneth Rogoff examines movements in real interest differentials and finds the pattern incompatible with financial integration suggesting that exchange controls have continued to play a major role. This conclusion is plausible in the light of varying premia on ‘financial’ currencies and onshore/offshore interest rate divergences. I have only one comment beyond a welcoming of the careful analysis of conditional variances. Kenneth Rogoff documents the decline of intra-ERM nominal prediction variances and the rise of ERM/NERM variances (NERM referring to non-participating currencies). On pp. 105-107 he considers the hypothesis that since 1979 there has been a polarization of currencies around ERM and NERM centres with reduced intra group variances and increased between group variances. This possible description is rejected (on p. 105) ‘at least for’ the dollar, pound and yen cross rates considered in the paper. In footnote 15 the conditional variances of the three nominal cross rates between these currencies are reported to have increased by between about 50% and 75%. This is consistent with the results of a somewhat similar exercise undertaken in the Bank of England (‘Quarterly Bulletin’, September 0014-2921/85/$3.30 0 1985, Elsevier Science Publishers B.V. (North-Holland)
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J.S. Flemming, Comments on the Rogoff paper
1984). Nevertheless analysis of a larger group of 11 NERM currencies’ (with 55 cross rates) reveals no member of the group with a weighted variance of nominal cross rates with other members which has not fallen, and a typical fall of about 40%. In the case of real exchange rages the findings of the Bank of England exercise are closer to Rogoff’s with unambiguous falls of intraERM monthly variances and several exceptions to the general picture of reduced intra-NERM variances (three out of 11 weighted variances rose). Thus the ‘two camp’ hypothesis cannot lightly be rejected. If the emergence of two camps were due to the EMS/ERM the assessment of its impact on the overall predictability of exchange rates would be very complicated (an attempt is made in a forthcoming Bank of England Technical Discussion Paper).2 ‘Those of Australia, Austria, Canada, Finland, Japan, Norway, Spain, Sweden, Switzerland, U.K., U.S. ZPublished Nov. 1984 as paper no. 11, ‘Exchange rate variability: Evidence for the period 1973-1982’ by D. G. Barr, available from Bulletin Group, Economics Division, Bank of England, London, ECZR 8AA, England.
COMMENTS ‘Can Exchange Rate Predictability be Achieved without Monetary Convergence? - Evidence from the EMS’ by Kenneth Rogoff J.S. FLEMMING Bank of England, London ECZR 8AH, UK
This highly professional paper addresses a number of important issues. These can be broken down into two points. What as a matter of fact has happened to the predictability of nominal and real exchange rates since the implementation of the Exchange Rate Mechanism (ERM) (of which the U.K. is not a participant) of the European Monetary System (EMS) (of which it is) in March 1979? Given some identifiable apparent effect of the ERM on exchange predictability, what are the roles of different possible elements such as the required intervention, exchange controls, convergence (or coordination) of economic policy or convergence of, e.g., inflation performance? Despite the paper’s title more light is thrown on the first question than the second. This is because no operational definition of ‘monetary convergence’ is ever offered. Rather, Kenneth Rogoff examines movements in real interest differentials and finds the pattern incompatible with financial integration suggesting that exchange controls have continued to play a major role. This conclusion is plausible in the light of varying premia on ‘financial’ currencies and onshore/offshore interest rate divergences. I have only one comment beyond a welcoming of the careful analysis of conditional variances. Kenneth Rogoff documents the decline of intra-ERM nominal prediction variances and the rise of ERM/NERM variances (NERM referring to non-participating currencies). On pp. 105-107 he considers the hypothesis that since 1979 there has been a polarization of currencies around ERM and NERM centres with reduced intra group variances and increased between group variances. This possible description is rejected (on p. 105) ‘at least for’ the dollar, pound and yen cross rates considered in the paper. In footnote 15 the conditional variances of the three nominal cross rates between these currencies are reported to have increased by between about 50% and 75%. This is consistent with the results of a somewhat similar exercise undertaken in the Bank of England (‘Quarterly Bulletin’, September 0014-2921/85/$3.30 0 1985, Elsevier Science Publishers B.V. (North-Holland)
E.E.R.-
E
122
J.S. Flemming, Comments on the Rogoff paper
1984). Nevertheless analysis of a larger group of 11 NERM currencies’ (with 55 cross rates) reveals no member of the group with a weighted variance of nominal cross rates with other members which has not fallen, and a typical fall of about 40%. In the case of real exchange rages the findings of the Bank of England exercise are closer to Rogoff’s with unambiguous falls of intraERM monthly variances and several exceptions to the general picture of reduced intra-NERM variances (three out of 11 weighted variances rose). Thus the ‘two camp’ hypothesis cannot lightly be rejected. If the emergence of two camps were due to the EMS/ERM the assessment of its impact on the overall predictability of exchange rates would be very complicated (an attempt is made in a forthcoming Bank of England Technical Discussion Paper).2 ‘Those of Australia, Austria, Canada, Finland, Japan, Norway, Spain, Sweden, Switzerland, U.K., U.S. ZPublished Nov. 1984 as paper no. 11, ‘Exchange rate variability: Evidence for the period 1973-1982’ by D. G. Barr, available from Bulletin Group, Economics Division, Bank of England, London, ECZR 8AA, England.