Securitization issues such as mortgage backed securities, credit card receivables and auto loans have made a great deal of data on default and loss rates publicly available on these types of assets than was previously the case. Such data only exists and is useful in a handful of countries where securitization issues are relatively common and have been so for a number of years.
Securitization issues
Mar 29
Similar to the Balance of Payments Approach to exchange rates is that which focuses on the relationship between a long-term equilibrium value for the real exchange rate and the external balance. Under this, the long-term equilibrium exchange rate is that which generates both internal and external balance, where internal balance is defined as full employment and external balance as the current account. Since the creation of this model, the emphasis has shifted away from focusing on full employment to concentrating on achieving a sustainable current account balance — not necessarily zero — which will achieve a perceived economic and exchange rate equilibrium.
As with the Balance of Payments Approach, the current account is seen as the transmission mechanism for the exchange rate, albeit this time under both fixed and floating exchange rate regimes. If the current account balance is showing an unsustainably high deficit relative to historic deficit levels, this will require a real exchange rate depreciation to restore equilibrium. Conversely, if it is showing a very high current account surplus, this will require a real exchange rate appreciation to restore equilibrium.
The example that is often used with regard to this is Japan, which has had a structurally high current account surplus. Using the external balance approach, if that current account surplus is seen as unsustainably high relative to historical norms, it requires a rise in the yen’s real exchange rate to restore equilibrium. Barring periodic reversals, this is what we saw from 1971 to 1995. Since then, the yen has reversed course, not least because the strengthening of the nominal yen exchange rate to a record dollar–yen low of 79.85 caused such a real shock to the current account balance that it in turn required a significant real exchange rate depreciation to restore equilibrium once more.
Within the emerging markets, another good example is that of Russia. Before the Russian rouble crisis of August 1998, Russia continued to record significant current account deficits. The external balance approach suggested that at some point a real exchange depreciation would be required to restore equilibrium. However, the Russian rouble was pegged to the US dollar and in order to maintain that peg real interest rates were kept high. Eventually, the costs of defending the Russian rouble peg — yet another case of trying to have all three of monetary independence, reasonably high capital mobility and a fixed exchange rate regime — proved too much and the rouble was de-pegged and devalued, and for good value Russia defaulted on its domestic debt.
Under a floating exchange rate regime, we have to consider the capital account as well as the current account. Here, as national income rises, so import demand rises, in turn causing the current account balance to deteriorate. So far, this is just like the fixed exchange rate regime. However, in the case of the floating exchange rate regime, the exchange rate is able to be the transmission mechanism for restoring the balance of payments to equilibrium. On the capital account side, a rise in national income, causing the current account balance to deteriorate, must be accompanied by a rise in real interest rates. The higher real interest rate will dampen import demand, which will in turn cause the current account balance deterioration to reverse. As that happens, national income will fall back, causing real interest rates also to fall back. If we start off with national income falling, we achieve the same transmission mechanism, only in reverse, with real interest rates falling, causing capital account outflows and current account balance improvement to the extent that these developments cause on the one hand a revival in domestic demand and on the other a loss in export competitiveness. Thus, the current account improvement reverses and real interest rates rebound. We can express this transmission mechanism from a change in national income through the balance of payments within a floating exchange rate regime with the following diagram:
Change in national income -> Change in current account balance -> Change in real interest rates -> Change in capital flows -> National income change reversed -> Current account reversed -> Capital flows reversed -> Real interest rates reversed -> Balance of payments equilibrium restored