Research
Publications
with Kristin Forbes and Tsvetelina Nenova, IMF Economic Review, Vol. 68, pp 721-763 (December 2020)
MIT Sloan Research Paper (2018)
BoE Discussion Paper (2017, extended version)
We analyse the economic conditions (the “shocks”) behind currency movements and show how that analysis can help address a range of questions, focussing on exchange rate pass-through to prices. We build on a methodology previously developed for the UK and adapt this framework so that it can be applied to a diverse sample of countries using widely available data. The paper provides three examples of how this enriched methodology can be used to provide insights into pass-through and other questions. First, it shows that exchange rate movements caused by monetary policy shocks consistently correspond to significantly higher pass-through than those caused by demand shocks in a cross-section of countries, confirming earlier results for the UK. Second, it shows that the underlying shocks (especially monetary policy shocks) are particularly important for understanding the time-series dimension of pass-through, while the standard structural variables highlighted in the previous literature are most important for the cross-section dimension. Finally, the paper explores how the methodology can be used to shed light on the effects of monetary policy and the debate on “currency wars”: it shows that the role of monetary policy shocks in driving the exchange rate has increased moderately since the global financial crisis in advanced economies.
with Kristin Forbes and Tsvetelina Nenova, Journal of International Economics, Vol. 114, pp 255-275 (September 2018)
A major challenge for monetary policy is predicting how exchange rate movements will impact inflation. We propose a new focus: directly incorporating the underlying shocks that cause exchange rate fluctuations when evaluating how these fluctuations “pass through” to import and consumer prices. A standard open-economy model shows that the relationship between exchange rates and prices depends on the shocks which cause the exchange rate to move. We build on this to develop a structural Vector Autoregression (SVAR) framework for a small open economy and apply it to the UK. We show that prices respond differently to exchange rate movements based on what caused the movements. For example, exchange rate pass-through is low in response to domestic demand shocks and relatively high in response to domestic monetary policy shocks. This framework can improve our ability to estimate how pass-through can change over short periods of time. For example, it can explain why sterling's post-crisis depreciation caused a sharper increase in prices than expected, while the effect of sterling's 2013–15 appreciation was more muted. We also apply this framework to forecast the extent of pass-through from sterling's sharp depreciation corresponding to the UK's vote to leave the European Union.
Click here for the Online Appendix.
See also our voxeu blog post "Using rule-of-thumbs for exchange rate pass-through could be misleading" here.
with Martin Weale and Tomasz Wieladek, Journal of International Money and Finance, Vol. 85, pp 93-123 (July 2018)
Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of financial regulation. In particular, financial liberalisation makes it more likely that the current account deteriorates following a monetary expansion. We test this theoretical prediction with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976Q1-2006Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit in countries with more liberalised financial markets.
with Kristin Forbes and Tsvetelina Nenova, Economic Journal, Vol. 127, No. 601, pp 571-623 (May 2017)
Large current account deficits, and the corresponding reliance on capital flows from abroad, can increase a country's vulnerability to periods of heightened risk. We develop a framework to evaluate such vulnerabilities and clarify which characteristics of a country's international investment portfolio determine whether a current account deficit is 'menacing' or 'mitigating'. Financial factors, namely international investment income and valuation changes on international investments, are critical. Our framework explores how domestic and global risk shocks affect these factors. An application to 10 OECD economies shows that a substantial degree of international risk sharing can occur through current accounts and international portfolios.
See also this article about our research.
Journal of International Economics, Vol. 102, pages 225-241 (September 2016)
This paper analyses optimal fiscal policy within a model of a monetary union in which agents cannot perfectly insure themselves against country-specific shocks. I show that in this model optimal cooperative policies consist in more than just stabilizing output gaps and inflation: policy makers can increase welfare by responding to sub-optimal intra-union imbalances arising in the face of shocks. Numerical analysis reveals that when the internationally traded goods are little substitutable, the optimal cooperative fiscal policies consist in setting government spending in each country such as to reduce intra-union imbalances at the expense of higher output gaps. Setting fiscal policy optimally reduces the welfare losses from business cycle fluctuations considerably.
Here is the Technical Appendix to Imbalances and Fiscal Policy in a Monetary Union.
Working Papers
The role of finance for export dynamics: Evidence from the UK
with Aydan Dogan
BoE Staff Working Paper (2024)
CEPR Discussion Paper (2024)
Through what channels do fluctuations in the financial costs of exporting affect exports, and how important are financial conditions for export dynamics over the business cycle? We first establish, using balance sheet data for UK manufacturing firms, that exporting firms have more short term liabilities than non-exporting firms. We find evidence consistent with exporting firms taking on these short term loans to (partly) cover labour costs. We then build a model with heterogeneous firms in which exporters need to access external finance to export, in line with the evidence, and parameterise it to UK data. We use rich firm level data to inform the calibration of the financial costs facing exporting firms, and estimate the shock processes in our model with Bayesian methods. Our estimations show that global shocks to the financial costs of exporting are the main driver of UK export dynamics over the business cycle, alongside shocks to productivity. These two shocks each contribute to around a third of UK export dynamics. Moreover, we find that global shocks to the financial costs of exporting played a crucial role in explaining the fall in UK exports in the early stages of the Global Trade Collapse, and slowed the recovery.
Understanding US Export Dynamics: Does Modelling the Extensive Margin of Exports Help?
with Aydan Dogan
BoE Staff Working Paper (2020)
This paper evaluates whether recent advances in modelling the extensive margin of exports contribute to our understanding of export fluctuations over the business cycle. Using US and euro‑area data, we estimate a general equilibrium model in which the extensive margin of exports varies over the business cycle. A comparison of its performance to two similar models that differ in their modelling of the extensive margin of exports shows that, while recent advances in modelling the extensive margin of trade help replicate exports dynamics, this is not the result of a good fit to the observed extensive margin of exports: the model‑implied extensive margin of exports varies considerably more than the data suggests.
Non-linearities, Asymmetries and Dollar Currency Pricing in Exchange Rate Pass-Through: Evidence from the Sectoral Level
with John Lewis
BoE Staff Working Paper (2020)
We investigate pass-through of exchange rate changes into UK import prices for 55 sectors using sector-specific exchange rate indices. Estimating a separate error correction model for each sector, we document substantial sectoral variation in pass-through, but find that compositional effects have not generated much variation in aggregate pass-through over time. Aggregating our sectoral results, we find that 74% of exchange rate changes are passed through to aggregate import prices in the long run. Pass-through is faster for larger exchange rate changes than smaller ones; and for movements driven by the US dollar than for broader based exchange rate changes. This greater sensitivity to the dollar exchange rate changes suggests the US dollar is used as a vehicle currency for invoicing some imports from non-US countries. We find no evidence of a comparable role for the euro nor for asymmetries in pass-through at the aggregate level.