Williams, Christopher John (1990) Exchange rates, expectations and international trade : theory and evidence. PhD thesis, University of Warwick.

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Abstract

Unprecedented movements in real exchange rates during the 1980s led to suspicions of instability in the exchange rate - trade relationships in the UK and elsewhere. 1be research in this thesis investigates the sensitivity of UK trade volumes to movements in the real exchange rate, and considers various interpretations of the alleged parameter instability: econometric misspecification; theoretical inadequacy due to the neglect of possible hysteresis effects and/or the neglect of supply side factors; and the Lucas critique effects of a changed policy regime on expectations formation. Against the background of UK experience we examine specific questions of theory and evidence within partial equilibrium frameworks. These share a common concern: considering the (macro economically important) case of mean reversion in real exchange rate expectations.

Clapters two and three introduce mean reversion into Dixit's (1989a) theory model of sunk cost hysteresis in trade. This research uses both analytic and numerical methods to characterise solutions with mean reversion in greater detail than elsewhere and uncovers some striking and unexpected results. Most important is the possible reversal of the stochastic and perfect foresight triggers under asymmetric sunk costs which reflects the essential difference between costly reversibility and strict irreversibility in investment Uncertainty does not always delay action, because the possibility of reversal must be allowed for. Chapter four explores the wider significance of the analysis for similar stochastic saddlepoint models such as the analysis of exchange rate target zones.

Chapters five and six consider the significance of the short run dynamic specification of quarterly UK manufactured export volumes equations to the reported instability in estimates of the long run competitiveness elasticity in the light of evidence that UK competitiveness measures follow stationary processes within an institutionally identified policy regime. Hausman specification tests, show that the long run competitiveness elasticity is misspecified and underestimated in recent (error correction mechanism) specifications of UK manufactured export volume equations. This inadequacy reflects the omission of long 'smoothing' lags on the competitiveness variable

Subsequently, chapter seven considers simulation evidence from the Dixit model as to the potential relevance of such effects to the UK experience under the large shock to competitiveness of 1980-1 but emphasises that the aggregate implications are not clear cut chapter eight considers whether the expectational effects of the 1979 Thatcher government's change in policy regime can be separated out from the other influences at work behind reduced form models but finds that the data do not support the particular approach adopted.

Concluding. we emphasise that the potential importance and complexity of expectational factors and theory combines with the our empirical findings to suggest that exchange rate uncertainty may be crucial to trade behaviour and that macroeconomic adjustment may be inhibited by excess exchange rate uncertainty. Overall export performance may also reflect supply factors which are not captured in existing models, such as hysteretic exit. or expected cost changes. But we doubt whether future research will achieve a data consistent aggregate econometric model of UK trade which is fully grounded in appropriate optimising economic theory with realistic adjustment costs. We may have to settle for approximations to the data generation process which do not employ recent theoretical insights. In that event. the use of such models in policy design should be circumscribed due to the possibility of Lucas critique effects, hysteresis mechanisms and supply side factors.

Item Type:	Thesis (PhD)
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HF Commerce
Library of Congress Subject Headings (LCSH):	Foreign exchange rates, International trade
Official Date:	December 1990
Dates:	Date Event December 1990 Submitted
Institution:	University of Warwick
Theses Department:	Department of Economics
Thesis Type:	PhD
Publication Status:	Unpublished
Supervisor(s)/Advisor:	Miller, Marcus, 1941- ; Wallis, Kenneth Frank
Sponsors:	Economic and Social Research Council (Great Britain)
Extent:	[11], 304 p.

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