Transcript A behavioural finance model of exchange rate expectations within a

A behavioural finance model of
exchange rate expectations
within a stock-flow consistent
framework
Gauthier Daigle
Marc Lavoie
Outline
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Prolegomena
Behavioural expectations
Baseline model, without expectations
Simulations with expectations
Conclusion
Recent developments in PK modelling, Université de Paris 13,
November 2009
Origins of the open-economy model:
Godley and Lavoie, 2007, chapter 12
Recent developments in PK modelling, Université de Paris 13,
November 2009
Main features of the model
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Stock-flow coherence
Two-country model
Integration of real and financial variables
Imperfect asset substitutability (in the tradition of Tobin, Branson
and Henderson, Blanchard et al. 2005)
• Therefore uncovered interest parity does not hold
• Many endogenous variables:
–
Import prices, export prices, domestic sales deflator, GDP deflator,
exchange rate
– Exports, imports, output, consumption, domestic sales, disposable income
– Taxes, interest payments, money stock, holdings of bills and money
(portfolios), wealth
– Trade balance, current account balance, capital account balance
Recent developments in PK modelling, Université de Paris 13,
November 2009
BEHAVIOURAL
EXPECTATIONS
Recent developments in PK modelling, Université de Paris 13,
November 2009
Exchange rate expectations
• In the original 2007 model, expectations about exchange rate
changes were set to zero (i.e., the probability of appreciation
and of depreciation are balanced).
• Here we reintroduce expectations, consistent with the claim by
several PK authors that exchange rate expectations of portfolio
holders play a key role in the determination of exchange rates
(Harvey 2003).
• We reject the mainstream introduction of expectations through
the interest parity theorem, which asserts that the forward
exchange rate represents the expectations of the market
regarding the future value of the spot rate.
• We support instead reversed causality: the forward exchange
rate is simply the spot rate plus the interest rate differential
(Coulbois/Prissert 1974, Lavoie 2000, Moosa 2004).
Recent developments in PK modelling, Université de Paris 13,
November 2009
Behavioural exchange rate
expectations
• Based on De Grauwe and Grimaldi (2006)
• Two types of investors/traders: fundamentalists and
chartists
• The fundamentalists stick to a given exchange rate
value. This value, in general, will not however be the
long-run « equilibrium » one.
• The chartists believe that the trend in the evolution of
the exchange rate will continue.
• If the exchange rate is moving upwards, but is still
below its « fundamental » value, both chartists and
fundamentalists will expect an increase in the
exchange rate.
Recent developments in PK modelling, Université de Paris 13,
November 2009
The portfolio equations
Recent developments in PK modelling, Université de Paris 13,
November 2009
Expectations equations
Recent developments in PK modelling, Université de Paris 13,
November 2009
BASELINE MODEL,
WITHOUT EXPECTATIONS
Recent developments in PK modelling, Université de Paris 13,
November 2009
Baseline simulation
• To study the role of expectations, we first run a
baseline simulation without expectations.
• We start off from a full equilibrium (the baseline
case), with the trade, current and capital accounts all
in balance.
• We then impose an increase in the propensity to
import of the US economy from the UK economy (US
imports rise)
Recent developments in PK modelling, Université de Paris 13,
November 2009
The UK trade balance (right axis) is initially in
surplus, then in deficit, and the UK exchange rate
keeps rising until it reaches a steady level (left axis)
1.35
1.2
1.30
1.0
1.25
0.8
1.20
0.6
1.15
0.4
1.10
0.2
1.05
0.0
1.00
-0.2
0.95
-0.4
1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
XR_UK
X_UK-IM_UK
Recent developments in PK modelling, Université de Paris 13,
November 2009
Why does the price of the UK currency
rise from a portfolio point of view?
• This can be explained by the large increase in the supply of US
bills to the UK.
• Higher US imports generate a slowdown in the US economy,
lower tax revenues and hence a US government deficit, and
thus an increase in the supply of US government bills.
• This larger supply cannot all be absorbed by the domestic US
market and must be unloaded on foreign financial markets, thus
generating the depreciation of the US currency and the
appreciation of the UK currency.
• The value of the UK currency moves from 1$ to 1.38$.
Recent developments in PK modelling, Université de Paris 13,
November 2009
SIMULATION WITH
EXPECTATIONS
Recent developments in PK modelling, Université de Paris 13,
November 2009
Simulation with stable results
• We assume the same increase in the propensity to
import of the US economy.
• Fundamentalist investors believe that the
« fundamental » value of the UK exchange rate
remains at its starting value, 1$.
• Thus they believe that changes are of a transitional
nature.
Recent developments in PK modelling, Université de Paris 13,
November 2009
With expectations, the UK exchange rate converges to a
different stationary value, 1.55$
The UK trade surplus is turned into a trade deficit
1.5
1.0
1.4
0.8
1.3
0.6
1.2
0.4
1.1
0.2
1.0
0.0
0.9
-0.2
0.8
1950
1975
XR_UK
2000
XRE_UK
2025
-0.4
2050
X_UK - IM_UK
Recent developments in PK modelling, Université de Paris 13,
November 2009
What happens if the « fundamental »
exchange rate value is modified?
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When the fundamental value of the exchange rate is being underestimated, the economy tends towards a steady-state value of the
exchange rate that is above its fundamental value without
expectations;
Reciprocally, when the fundamental value of the exchange rate is being
over-estimated, the economy converges towards a steady-state value
of the exchange rate that is below its fundamental value.
When the exchange rate expectations of the fundamentalists
correspond to the steady state value of the model without expectations,
this steady state value is realized in the model with expectations.
Thus, adaptative expectations of the « fundamental » exchange rate
value would drive the model towards the stationary state achieved
without expectations.
Recent developments in PK modelling, Université de Paris 13,
November 2009
What happens if chartists represent a greater
proportion of the exchange rate traders or investors?
The stabilizing effects of trade flows and asset
supplies are beaten by the destabilizing effects of
asset demands
1.20
1.0
1.16
0.8
1.12
0.6
1.08
0.4
1.04
0.2
1.00
0.0
0.96
1950
1955
XR_UK
1960
1965
XRE_UK
1970
-0.2
1975
X_UK - IM_UK
Recent developments in PK modelling, Université de Paris 13,
November 2009
Conclusion: Is there hysteresis with
expectations?
• When a shock is reversed, in the stable case, the
economy returns exactly at its starting point. There is
no path-dependence, even though there are
exchange rate expectations and chartists that act on
trends.
• But there is persistence. With exchange rate
expectations, the model takes twice as much time to
return to its stationary values compared to the model
without expectations.
• In the unstable case, reversing the shock will not do.
Recent developments in PK modelling, Université de Paris 13,
November 2009