Behaviour of the Norwegian exchange rate
Farooq Akram∗
October 14, 2003
∗ The
views and opinions expressed in this note and during the lecture are personal.
1
Exchange rate determination
• Supply of net foreign assets determined by:
• Risk premium: r = i − (i∗ + ∆ee)
• Current account surplus: D ≡ Tradesurplus (R, Y , Y f ,Commodity prices)
+ income from assets abroad + Transfers
+ − +
— R ≡ E×P f /P
• Shape of the demand curve depends on the exchange rate regime:
— Vertical when floating exchange rate regime
— Horisontal when fixed exchange rate regime
• The effect of r and D on E depends on the exchange rate regime
• What is the equilibrium level of the nominal exchange rate (E)?
— In a fixed regime: At what level should the govt. fix the exchange rate?
— In a floating regime: To which level will the nominal exch. rate revert
to?
• Purchasing Power Parity: E ∗ = P f /P
— R∗ = 1, which can imply D = 0, under some conditions.
— Assume that r converges to a value, say 0, at which the supply of net
foreign assets is at rest.
• Large shifts in the supply curve may lead to currency crises in a fixed
regime. May occur:
— When E 6= E ∗, i.e. when there is a misalignment. In which case R≷ R∗
and D ≷ 0 persistently
— If |D| becomes extremely large, due to jumps in commodity prices
— If r takes on extreme values, e.g. when ∆ee becomes large
• Govt. may shift to a floating exch. rate if the defence of the fixed exch.
rate becomes costly
— Command too high/low domestic interest rates to reverse the shift in
the supply curve
— Are likely to run out of foreign reserves (Fg ) if defend the exch. rate
Table 1: Norwegian exchange rate policy in the period 1972—2001
Exchange rate regimes
Period
Vis-a-vis
Fixed: Smithsonian Agreement
Fixed: European ”snake”
Fixed: European ”snake”
1971:12—73:3
1972:5—73:3
1973:3—78:12
US dollar
Euro. currencies
Euro. currencies
Fixed: Currency basket
Fixed: EMS
1978:12—90:10
1990:10—92:12
Trade weighted
ECU
Float (Managed)
Stable without bands
1992:12—94:5
1994:5—97:1
ECU
ECU
Stable without bands
1997:1—98:12
ECU
Stable without bands
1999:1—01:3
Euro
Major fluctuations
5% reval., 16 Nov., 1973
5% deval., 29 Aug., 1977
8% deval., 2 Feb., 1978
12% deval., 5 May, 1986
6% depr., 10 Dec., 1992;
temporary switch to float
7% appr., 1996:1—97:1;
defence abandoned on
10 January, 1997.
5% appr. 5 Feb., 1997.
6% depr. 24 Aug., 1998;
and defence abandoned.
14% depr. 28 Aug., 1998
.05
E
(RB - RB f)
1.1
1.0
0.00
.9
.8
1972
1975
1978
1.10
1981
1984
1987
1990
1993
1996
1999
E
(RB - RB f)
1.05
-.05
.01
1.00
0.00
.95
1991
2002
-.01
1993
1995
1997
1999
2001
2003
Figure 1: The interest rate difference and the nominal exchange rate during
fixed and floating periods. Stronger in the floating period: after 2001:1?
OILPRICE
Period: 1. January 1986--12 August 1998
110
32
115
38
ECU
26
105
20
100
14
95
8
90
85
0
288 576 864 1152 1440 1728 2016 2304 2592 2880 3168 3456 3744 4032 4320 4608
Figure 2: Daily observations of the oil prices in USD and the ECU index.
corr = -0.88
104.5
corr = -0.35
(10)
(12)
105
104
103.5
8
14
20
26
(10)
19
8
20
26
(12)
19
18
18
17
17
16
14
16
15
2600
2650
2700
2750
2800
2850
3200
3250
3300
3350
3400
3450
Figure 3: The correlation between oil prices and the exch. rate depends on
whether oil prices are falling or rising.
108
106
ECU × OILP RICE
No vemb er 1, 1990 - August 12, 1998
104
102
100
98
96
108
8
10
12
14
16
18
20
22
24
26
106
28
30
32
34
36
ECU × OILP RICE
January 1, 1993 - August 12, 1998
104
102
100
98
96
8
10
12
14
16
18
20
22
24
26
28
30
32
34
36
Figure 4: The correlation becomes weaker at higher level of oil prices.
1.20
E
P f/P
R = E× P f/P
1.15
1.10
1.05
1.00
0.95
0.90
0.85
0.80
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
Figure 5: Changes in E tend to coincide with changes in P f /P . R is relatively
stable over the period 1972:1—2003:2. PPP seems valid in the long run.
2
Variables
• x = ln(X); ∆x = 1. difference of x : relative change over a quarter
• [e − (cpi−cpi f )] : difference between the actual and the PPP value of the
nominal exchange rate (cpi − cpif ).
• RS = 3. Month market rate
• RB − RB f : Difference between Norwegian and foreign interest rates
• FLow (OILPt < 14.21) : When oil prices are below 14 USD; FF all (OILPt <
OILPt−1) : When oil prices are falling
• id97q1 : Dummy variable to capture unexplained appreciation in 1997:1
3
Econometric Model
∆ebt = − 0.09 [e − (cpi−cpi f )]t−1 + 0.17 ∆et−1 − 0.22 ∆cpi f t
(−3.46)
(2.34)
(−2.42)
− 0.21 ∆RS t − 0.26 ∆(RB t−1 − ∆cpi t−2) − 0.037 id97q1
(−2.62)
(−2.39)
(−4.39)
[− 0.14 ∆oilpt − 0.026 ∆oilpt−2] × FLow (OILPt < 14)
(−2.89)
(−5.52)
− 0.02 ∆oilpt−1× FF all (OILPt < OILPt−1)
(−2.15)
− 1.30 (RB−RB f )t | t >2001:1; Inflation Targeting
(−4.15)
Sample: 1972:2-2002:4 , T = 123, k = 10. Method: OLS
R2 = 0.53;
• Econometric model required to estimate the partial effects of the variables
• Convergence towards the PPP level
• Interest rate effects depends on the exchange rate regime. Stronger in the
floating period
• Oil price effects strong when oil prices are relatively low and are likely to
fall