International Financial Issues in the Pacific Rim Global Imbalances, Financial Liberalization, and Exchange Rate Policy
edited by Ito Takatoshi and Andrew K. Rose
University of Chicago Press, 2008
Cloth: 978-0-226-38682-9 | Electronic: 978-0-226-38708-6


The imbalanced, yet mutually beneficial, trading relationship between the United States and Asia has long been one of international finance’s most perplexing mysteries. Although the United States continues to post a substantial trade deficit—and China reaps the benefits of a surplus—the dollar has yet to sink in the face of ever-increasing account disparities.  International Financial Issues in the Pacific Rim explains why the United States enjoys a seemingly symbiotic relationship with its trading partners despite stark inequities in the trade balance, especially with Asia. This timely and well-informed study also debunks the assumed link between economic openness and low inflation in the region, identifies the serious gap between academic and private-sector researchers’ understanding of exchange rate volatility, and analyzes the liberalization of Asian capital accounts. International Financial Issues in the Pacific Rim will have broad implications for global trade and economic policy issues in Asia and beyond.


Takatoshi Ito is professor of economics at the University of Tokyo and a research associate of the NBER and the Tokyo Center for Economic Research.
Andrew K. Rose is the Bernard T. Rocca Jr. Professor of International Trade, director of the Clausen Center for International Business and Policy at the Haas School of Business, University of California, Berkeley, and a research associate of the NBER.



- Takatoshi Ito, Andrew K. Rose
DOI: 10.7208/chicago/9780226387086.003.0001
[East Asian Seminar in Economics, global imbalance, monetary policy, exchange rate policy, capital accounts]
This volume is a collection of papers that were presented at the 17th East Asian Seminar in Economics on June 22–24, 2006. The conference was organized around three inter-related research interests: global imbalances, monetary and exchange rate policy, and the liberalization of capital accounts. This introductory chapter presents an overview of these contributions. (pages 1 - 10)
This chapter is available at:
    University Press Scholarship Online


- Michael P. Dooley, David Folkerts-Landau, Peter Garber
DOI: 10.7208/chicago/9780226387086.003.0002
[China, Asia, capital markets, foreign exchange markets, Bretton Woods II system, financial markets, savings rates, United States, Euroland]
This chapter sets out in greater detail what the authors think about the dynamic forces emanating from the emergence of China and Asia as major players in world capital and foreign exchange markets. Conventional analyses have been based for several years on the assertion that the Bretton Woods II system cannot hold together for much longer. This may or may not turn out to be correct, but it does not offer any guidance if the system does survive for an extended time period. A framework is developed that also provides a guide to the dynamics of the system following a variety of changes in the economic environment. The analysis leans on four assumptions. (1) Asian financial markets are poorly integrated with the other two regions because of capital controls and the threat of sovereign interference with capital flows. (2) The United States and Euroland financial markets, in contrast, are very well integrated and their respective assets are very close substitutes. (3) The dominant change in the economic environment that is driving the main features of the world economy is the rapid growth of savings rates and the level of savings in Asia and their exportation to the rest of the world. (4) The United States and Euroland differ in their capacities to utilize Asian savings, with the United States having a much greater absorptive capacity. (pages 13 - 38)
This chapter is available at:
    University Press Scholarship Online

- Shin-ichi Fukuda, Yoshifumi Kon
DOI: 10.7208/chicago/9780226387086.003.0003
[capital flows, East Asia, currency crisis, macroeconomic variables, liquidity risk, foreign debt, debt maturity, East Asian economies]
This chapter explores some theoretical and empirical implications of the changed international capital flows in East Asian economies after the currency crisis. It shows that macroeconomic impacts will vary depending on which strategy developing countries take for self-protection. The first paper of the chapter investigates what impacts an increased aversion to liquidity risk can have on current accounts and the other macroeconomic variables in a simple open economy model. The second part provides some empirical evidence in East Asia that supports the theoretical implications. In particular, it focuses on the changes of foreign debt maturity structures and their implications in East Asian economies. (pages 39 - 64)
This chapter is available at:
    University Press Scholarship Online

- Jianhuai Shi
DOI: 10.7208/chicago/9780226387086.003.0004
[renminbi, real exchange rate, vector autoregression model, output, China, exchange rate shocks, capital controls, U.S. interest rates]
This chapter examines the relationship between the renminbi (RMB) real exchange rate and China's output by using the vector autoregression (VAR) model technique. The results show that RMB real appreciation has led to a decline in China's output, suggesting that currency appreciations have been contractionary in China, as traditional open economy macroeconomics forecasts. When the international finance linkage of the Chinese economy is accounted for, the effect of RMB real exchange rate shocks on China's output and the power of the shocks in explaining the change of China's output are relatively small, while the effect of U.S. interest rate shocks on China's output is relatively large. The intuition behind this finding may be that the effectiveness of China's capital controls has eroded over time and the scales of capital inflows and outflows have become large enough that external shocks through international finance channels have significant influence on the Chinese economy, exceeding the influence of external shocks through international trade channels. Shocks to domestic money supply and foreign demand also have important effects on China's output. However, government spending shocks have less power in explaining the change of China's output. (pages 71 - 101)
This chapter is available at:
    University Press Scholarship Online


- Chung-Shu Wu, Jin-Lung Lin
DOI: 10.7208/chicago/9780226387086.003.0005
[openness, inflation, newly industrialized economies, G7, VAR analysis, money supply, output]
Investigating a sample of 114 countries, Romer (1993) found a significant negative relationship between openness and inflation. This chapter investigates newly industrialized economies (NIEs) and the G7 to verify the robustness of Romer's findings. The empirical results show that openness and inflation do not have a regular relationship as stated by Romer (1993). The chapter is organized as follows. Section 4.2 describes the historical patterns of openness and inflation of NIEs and the G7. Section 4.3 investigates the relationship between openness and inflation using annual panel data. Section 4.4 presents the empirical results of a time series approach to the relationship for each individual country. Section 4.5 adopts a VAR analysis to examine the impacts of money supply on output in order to check the corollary of Romer's model (1993), and Section 4.6 concludes. (pages 109 - 138)
This chapter is available at:
    University Press Scholarship Online

- José Manuel Campa, Linda S. Goldberg
DOI: 10.7208/chicago/9780226387086.003.0006
[consumption prices, imported goods, exchange rates, food, energy, raw materials, manufactured goods, import prices, pass-through]
This chapter considers the evolution over the past decade in the predicted sensitivity of consumption prices of imported and domestically-produced goods with respect to exchange rates. It focuses on changes in distribution margins and imported inputs use, as well as on pass-through into import prices at the border for five broad categories of goods: manufactured, nonmanufactured, food, energy, and raw materials. One of the major findings of the study is that the degree of pass-through into import prices is more closely defined by industry than by country; the only exception is the United States. Pass-through into import prices is noisiest and least precisely measured with respect to energy imports. This may be due to regulatory changes in the energy sector in many countries. Pass-through effects are also very precisely estimated among manufactured goods and food in many countries. It is argued that growth in imported input use, especially in distribution services, has increased the predicted sensitivity of retail prices of imported goods to exchange rates. (pages 139 - 174)
This chapter is available at:
    University Press Scholarship Online

- Takatoshi Ito, Yuko Hashimoto
DOI: 10.7208/chicago/9780226387086.003.0007
[forecasting power, order flows, exchange rates, EBS, price impact]
This chapter analyzes the forecasting power of order flows (actual deals in the preceding thirty minutes) on future exchange rate movements at various frequencies: one-, five-, fifteen-, and thirty-minute windows. The data used in the analysis is extracted from the EBS from January 1999 to October 2003. There is strong evidence that order flows (deals) have prediction power for the price movement of one minute to five minutes, while thirty minutes is found to be too long for prediction. The degree of price impact diminishes over time, although intervention may induce lagged price impact, and there may be an adjustment process in exchange rate movements. (pages 177 - 218)
This chapter is available at:
    University Press Scholarship Online

- Eiji Ogawa, Kentaro Kawasaki
DOI: 10.7208/chicago/9780226387086.003.0008
[generalized-purchasing power parity model, Optimum Currency Area, common currency area, exchange rates]
A generalized-purchasing power parity (G-PPP) model is used to investigate whether a region is an Optimum Currency Area (OCA). The G-PPP is based on a PPP to extend to a multilateral exchange-rate version. In the case of bilateral exchange rates, the PPP holds in the long-run when a bilateral real exchange rate has stationarity, which means that the real exchange rate converges to a level in the long run. If a region has the convergence of the real exchange rates, the region can be an OCA where the nominal exchange rates can stay fixed with each other. This chapter begins with a theoretical background of the G-PPP model and the relationship between the G-PPP model and the OCA model. Next, it uses the G-PPP model to define a common currency area for the ASEAN plus three countries. It explains the adoption of a common currency basket arrangement into the ASEAN plus three countries. It then conducts an empirical analysis of the possibilities of adopting a common currency basket arrangement into the ASEAN plus three countries. (pages 219 - 234)
This chapter is available at:
    University Press Scholarship Online


- Peter Blair Henry, Prakash Kannan
DOI: 10.7208/chicago/9780226387086.003.0009
[stock markets, investments, developing countries, Latin America, Asia, economic growth, emerging markets, inflation, capital account liberalization, stock returns]
This chapter examines the empirical validity of the following rationale for investing in the stock markets of developing countries—that high rates of economic growth in emerging markets provide great absolute investment opportunities. The chapter is organized as follows. Section 8.2 discusses how average realized stock returns in emerging markets over the last 30 years have not been significantly higher than realized stock returns in the United States. Section 8.3 constructs measures of expected returns using dividend-price ratios and earnings yields. Section 8.4 presents short vignettes that focus on inflation stabilization and capital account liberalization episodes in Latin America and Asia. Section 8.5 discusses a simple and consistent explanation for high growth with low returns in Asia, and low growth with high returns in Latin America. Relative to the low expectations for Latin America at the start of the 1980s, the region achieved better outcomes than Asia over the next 20 years. This hypothesis is consistent with the results of the regressions carried out in Section 8.4, where unexpected returns were shown to be positively correlated with unexpected growth. (pages 241 - 266)
This chapter is available at:
    University Press Scholarship Online

- Barry Eichengreen, Pipat Luengnaruemitchai
DOI: 10.7208/chicago/9780226387086.003.0010
[bond markets, capital flows, Asia, market integration, investments, cross-holdings]
This chapter assesses bond markets as a conduit for capital flows. Using bilateral data it analyzes the importance of a range of factors determining nonresident holdings of a country's bonds. By comparing cross-country holdings in Asia with cross-country holdings in other regions, as well as analyzing the determinants of holdings across regions, the extent of bond market integration and how it compares across regions and over time can be determined. The results show that Europe is head and shoulders above other regions in terms of financial integration. Asia already seems to have made some progress on this front compared to Latin America and the world as a whole. Cross-holdings are heavily driven by financial conditions in the investing country, which suggests that bond market conditions could adjust abruptly for reasons having nothing to do with policies in the borrowing economy. Bondholders are attracted to the securities of countries whose returns co-vary with their own, suggesting return chasing rather than diversification behavior. (pages 267 - 314)
This chapter is available at:
    University Press Scholarship Online

- Lee-Rong Wang, Chung-Hua Shen, Ching-Yang Liang
DOI: 10.7208/chicago/9780226387086.003.0011
[financial liberalization index, WTO, General Agreement on Trade in Services, GATS, economic growth, financial liberalization]
This chapter examines financial liberalization as measured by General Agreement on Trade in Services (GATS) commitments, and the effect of liberalization on economic growth. The chapter is organized as follows. Section 10.2 introduces the history of WTO commitments and describes the construction of the financial liberalization index. Section 10.3 discusses some interesting patterns of the financial liberalization under the WTO. Section 10.4 describes the empirical models and data, while Section 10.5 presents the empirical findings. Finally, Section 10.6 summarizes the conclusions that are drawn. (pages 315 - 341)
This chapter is available at:
    University Press Scholarship Online

- Kyoji Fukao, Keiko Ito, Hyeog Ug Kwon, Miho Takizawa
DOI: 10.7208/chicago/9780226387086.003.0012
[foreign direct investment, Japan, productivity, profitability, acquisitions, foreign acquisitions, target firms]
This chapter analyzes foreign direct investment (FDI) into Japan. In particular, it examines whether a firm is chosen as an acquisition target based on its productivity level, profitability, and other characteristics. The results show no positive impact on target firms' return on assets in the case of both within-group in-in acquisitions and in-in acquisitions by domestic outsiders. Foreign acquisitions improved target firms' productivity and profitability more significantly and much faster than acquisitions by domestic firms. The positive effects of foreign acquisitions tend to be much larger in the case of the nonmanufacturing sector than in the case of the manufacturing sector. (pages 347 - 385)
This chapter is available at:
    University Press Scholarship Online

- Inseok Shin, Chang-gyun Park
DOI: 10.7208/chicago/9780226387086.003.0013
[capital costs, Korean stock market, market opening, foreign investment, dividend yield, foreign ownership]
This chapter uses firm level panel data to analyze the effects of increased foreign presence in the Korean stock market on dividend yield. It examines the trends that emerge when controlling for other factors and regressing the dividend yield on degrees of foreign ownership. The results show that the higher the degree of foreign ownership in a firm, the lower the dividend yield. The negative relationship between foreign ownership and the dividend yield is only significant during recent years when the Korea stock market has been fully opened. The finding that higher foreign ownership produces lower dividend yield is consistent with the hypothesis that market opening decreases the cost of capital. (pages 391 - 414)
This chapter is available at:
    University Press Scholarship Online


Author Index

Subject Index