nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2008‒03‒01
twenty papers chosen by
Martin Berka
Massey University

  1. Real Exchange Rates and Fundamentals: A Cross-Country Perspective By Jaewoo Lee; Gian Maria Milesi-Ferretti; Luca Antonio Ricci
  2. The Effects of Foreign Price Uncertainty on Australian Production and Trade By Elie Appelbaum; Alan D. Woodland
  3. Openness, Income-Tax Progressivity, and Inflation By Joseph P. Daniels; David D. VanHoose
  4. Financial Frictions and Business Cycles in Middle-Income Countries By Jaime Guajardo
  5. The Feldstein-Horioka fact. By Domenico Giannone; Michele Lenza
  6. Where Did All the Borrowing Go? A Forensic Analysis of the U.S. External Position By Gian Maria Milesi-Ferretti; Philip R. Lane
  7. Real Implications of Financial Linkages Between Canada and the United States By Vladimir Klyuev
  8. Where Did All the Aid Go? An Empirical Analysis of Absorption and Spending By Shekhar Aiyar; Ummul Ruthbah
  9. Capital Flows and Economic Fluctuations: The Role of Commercials Banks in Transmitting Shocks By Yong Sarah Zhou
  10. One Money, Several Cycles? Evaluation of European business cycles using model-based cluster analysis By Crowley, Patrick
  11. Capital Flows and Demographics--An Asian Perspective By Erik Lueth
  12. The Impact of Trade Liberalization on the Trade Balance in Developing Countries By Yi Wu; Li Zeng
  13. The impact of capital flows on domestic investment in transition economies. By Elitza Mileva
  14. Exchange Market Pressure in African Lusophone Countries By Macedo, Jorge Braga de; Pereira, Luis Brites; Reis, Afonso Mendonça
  15. The Clash of Liberalizations: Preferential versus Multilateral Trade Liberalization in the European Union By Baybars Karacaovali; Nuno Limao
  16. Monetary exchange rate model: supportive evidence from nonlinear testing procedures By Liew , Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Habibullah, Muzafar Shah; Midi, Habshah
  17. On Asymmetry of Exchange Rate Volatility in New EU Member and Candidate Countries By Stavarek, Daniel
  18. How Remittances impact national accounts – A macro analysis By Laurent Gheeraert; Ritha Sukadi
  19. Assessing estimates of the exchange rate pass-through By Ida Wolden Bache
  20. Real interest rate parity: evidence from East Asian economies relative to China By Liew , Venus Khim-Sen; Ling, Tai-Hu

  1. By: Jaewoo Lee; Gian Maria Milesi-Ferretti; Luca Antonio Ricci
    Abstract: This paper employs newly constructed measures for productivity differentials, external imbalances, and commodity terms of trade to estimate a panel cointegrating relationship between real exchange rates and a set of fundamentals for a sample of 48 industrial countries and emerging markets. It finds evidence of a strong positive relation between the CPI-based real exchange rate and commodity terms of trade. The estimated impact of productivity growth differentials between traded and nontraded goods, while statistically significant, is small. Increases in net foreign assets and in government consumption tend to be associated with appreciating real exchange rates.
    Keywords: Real effective exchange rates , Productivity , Trade ,
    Date: 2008–01–30
  2. By: Elie Appelbaum (York University, Canada); Alan D. Woodland (Faculty of Economics and Business, University of Sydney)
    Abstract: This paper provides a framework for the empirical analysis of the role of uncertain international prices for the Australian economy’s production sector and its international trade. We model the movement of traded goods prices via a bivariate GARCH model and embed this within an expected utility maximizing model of the production sector. We find that the empirical results are consistent with expected utility maximization and that the hypothesis of risk neutrality is soundly rejected. Estimates of the effects of changes in expected prices and volatility of traded goods prices upon production decisions and the return to capital are presented and discussed, as are the impacts of changes in output growth of Australia’s major trading partners. The overall conclusion is that price uncertainty matters for the Australian production sector.
    Keywords: Price uncertainty, production under risk, expected utility maximization, international trade
    JEL: F10 C51
    Date: 2008–01
  3. By: Joseph P. Daniels (Center for Global and Economic Studies, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University)
    Abstract: This paper considers a model of an open economy in which the degree of income-tax progressivity influences the interaction among openness, central bank independence, and the inflation rate. Our model suggests that an increase in the progressivity of the tax system induces a smaller response in real output to a change in the price level. This implies that increased income-tax progressivity reduces the equilibrium inflation rate and that the effect of increased income-tax progressivity on inflation is smaller when the central bank places a higher weight on inflation or when there is greater openness. Examination of cross-country inflation data provides empirical support for these key predictions.
    Keywords: Openness, Tax Progressivity, Inflation
    JEL: F40 F41 F43
    Date: 2007–04
  4. By: Jaime Guajardo
    Abstract: A standard DSGE small open economy model can not generate the cyclical regularities of middle-income countries. It predicts excessive consumption smoothing, and procyclical, instead of countercyclical, real net exports. Previous studies have solved this problem by increasing the shocks’ persistence or by lowering the intertemporal elasticity of substitution. This paper tackles the problem by introducing market imperfections relevant for MICs into an otherwise standard model. More specifically, I build a model with limited access to the foreign capital market, identified as an external borrowing constraint, and asymmetric financing opportunities across nontradable and tradable sectors, identified as a sector-specific labor financing wedge. The key parameters associated to these frictions are deduced to replicate selected data for Chile between 1986 and 2004. I find that both frictions are necessary to replicate the cyclical regularities of middle-income countries as they help the model reproduce different features of the data: The external borrowing constraint makes investment and consumption of tradable goods more procyclical and volatile, and makes real net exports countercyclical, while the sector-specific labor financing wedge makes the model reproduce the cyclical moments of work hours and consumption of non tradable goods.
    Keywords: Consumption , Exports , Investment , Borrowing ,
    Date: 2008–01–30
  5. By: Domenico Giannone (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michele Lenza (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper shows that general equilibrium effects can partly rationalize the high correlation between saving and investment rates observed in OECD countries. We find that once controlling for general equilibrium effects the saving-retention coefficient remains high in the 70’s but decreases considerably since the 80’s, consistently with the increased capital mobility in OECD countries. JEL Classification: C23, F32, F41.
    Keywords: Saving-Investment Correlation, Capital Mobility, International Comovement, Dynamic Factor Model.
    Date: 2008–02
  6. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: The deterioration in the U.S. net external position in recent years has been much smaller than the extensive net borrowing associated with large current account deficits would have suggested. This paper examines the sources of discrepancies between net borrowing and accumulation of net liabilities for the U.S. economy over the past 25 years. In particular, it highlights and quantifies the role played by net capital gains on the U.S. external portfolio and 'residual adjustments' in explaining this discrepancy. It discusses whether these 'residual adjustments' are likely to be originating from measurement errors in external assets and liabilities, financial flows, or capital gains, and explores the implications of these conjectures for the U.S. financial account and external position.
    Keywords: Borrowing , United States , Capital flows , Current account deficits ,
    Date: 2008–02–01
  7. By: Vladimir Klyuev
    Abstract: This paper documents the extent of financial linkages between Canada and the United States and explores the impact of changes in U.S. financial conditions on financial conditions and real economic activity in Canada. It shows that close to a quarter of financing by Canadian corporations is raised south of the border. Empirical analysis using structural vector autoregressions establishes that a tightening in U.S. financial conditions has significant implications for real activity in Canada. For example, a percentage point increase in the 3- month T-bill rate, other things being equal, leads to a decline of slightly more than one percentage point in Canada's real GDP growth after 3 quarters. That decline can be decomposed into three channels: the direct financial channel, where the slowdown is attributed to a rising cost of funds for Canadian companies raising capital in the United States; the indirect financial channel, where growth is hampered as financial conditions in Canada tighten in response to a tightening in the United States; and the trade channel, which goes through a slowing in the U.S. economy, and correspondently lower demand for Canadian exports. As would be expected from the high degree of reliance on U.S. financing, the direct financial channel proves dominant in the short term.
    Keywords: Trade , Canada , United States , Economic conditions , Capital markets ,
    Date: 2008–01–31
  8. By: Shekhar Aiyar; Ummul Ruthbah
    Abstract: This paper examines the macroeconomic usage of aid using panel data for a broad sample of aid-recipients. By definition an increase in aid must go toward a reduction in the current account balance (absorbed aid), an increase in capital outflows, or reserve accumulation. It is found that short-run absorption is typically very low, with much aid exiting through the capital account. Moreover, aid spending, defined in terms of the increase in government fiscal expenditures as a result of aid, is significantly greater than aid absorption, implying that aid systematically leads to an injection of domestic liquidity in recipient economies. The evidence here may help illuminate the rather weak link between aid and growth found in the literature. It reinforces the case for greater coordination between fiscal and monetary authorities in response to aid inflows.
    Keywords: Development assistance , Government expenditures , Consumption , Investment , Current account balances ,
    Date: 2008–02–06
  9. By: Yong Sarah Zhou
    Abstract: This paper uses a general equilibrium model to examine the central role played by commercial banks in intermediating and amplifying the capital flow shocks to the local economy in the 1997 Asia financial crisis. It finds that a sudden stop of capital inflows affects the equilibrium credit supply through two channels: first, the plunge of foreign financing decreases the loanable funds directly; and second the sudden stop drives up the cost of providing banking services, thereby additionally reducing the available bank credit to firms through a "deposit run". Empirical results from a VAR model broadly support the theoretical implications.
    Keywords: Capital flows , Bank credit , Employment , Financial crisis ,
    Date: 2008–01–29
  10. By: Crowley, Patrick (College of Business, Texas A&M University)
    Abstract: Optimal currency area theory suggests that business cycle co-movement is a sufficient condition for monetary union, particularly if there are low levels of labour mobility between potential members of the monetary union. Previous studies of co-movement of business cycle variables found that there was a core of member states in the EU that could be grouped together as having similar business cycle co-movements, but these studies have always used Germany as the country against which to compare. This study updates and extends corresponding previous analyses. More specifically, it correlates the countries against both German and euro area macroeconomic aggregates and uses more recent techniques in cluster analysis, namely model-based clustering.
    Keywords: business cycles; co-movement; optimal currency areas; model-based cluster analysis
    JEL: F15 F31
    Date: 2008–02–27
  11. By: Erik Lueth
    Abstract: This paper calibrates the production functions of 176 countries to fit 2003 data and examines the capital flows that emerge, when labor forces change according to the 2007 UN population projections. It finds that demographic factors are no help in correcting today's global imbalances; that Japan's capital outflows have as much to do with population aging as with the yen carry-trade; and that China is key to understanding Asia's demographic impact on the world. It also finds that Asia offers the greatest arbitrage opportunities worldwide during the demographic transition and has the greatest potential for regional financial integration among world regions. Moreover, the demographic transition is unlikely to result in an asset price meltdown and could even raise world interest rates under perfect capital mobility.
    Keywords: Capital flows , Asia , Labor , Population , Aging , Interest rates ,
    Date: 2008–01–31
  12. By: Yi Wu; Li Zeng
    Abstract: Using two recently constructed measures of trade liberalization dates, this research studies the impact of trade liberalization on imports, exports, and overall trade balance for a large sample of developing countries. We find strong and consistent evidence that trade liberalization leads to higher imports and exports. However, in contrast Santos-Paulino and Thirwall (2004) who find a robustly negative impact of trade liberalization on the overall trade balance, we only find mixed evidence of such a negative impact. In particular, we find little evidence of a statistically significant negative impact using our first measure of liberalization dates which extends Li (2004). Using a second measure of liberalization dates compiled by Wacziarg and Welch (2003), we find some evidence that liberalization worsens the trade balance, but the evidence is not robust across different estimation specifications, and the estimated impact is smaller than that reported by Santos-Paulino and Thirwall (2004).
    Keywords: Trade liberalization , Balance of trade , Developing countries ,
    Date: 2008–01–30
  13. By: Elitza Mileva (Fordham University, Economics Department, 441 East Fordham Road, Bronx, New York 10458, USA.)
    Abstract: During the 1990s most transition economies undertook a series of market reforms, including opening their capital accounts. This paper uses static and dynamic panel techniques to assess the effect of FDI, foreign loans and portfolio flows on domestic investment. In this partial adjustment setup, capital flows can have contemporaneous and long-term effects on investment. For countries with less developed financial markets and weaker institutions, our estimates for the FDI coefficient are larger than one, suggesting FDI stimulates investment in other sectors of the economy (“spillover” effects). Over the longer term, each dollar of FDI generates at least one additional dollar of local investment. In transition countries with stronger governance indicators, long-term loans raise domestic investment and FDI produces small spillover effects in the long run. Limited portfolio flows into the transition economies have no effect on capital formation in either group. JEL Classification: F21, F30, P33.
    Keywords: Transition economies, capital inflows, domestic investmet, international financial integration.
    Date: 2008–02
  14. By: Macedo, Jorge Braga de; Pereira, Luis Brites; Reis, Afonso Mendonça
    Abstract: This paper explores the credibility of exchange rate arrangements for the five African Portuguese-speaking (PALOP) countries. Our working hypothesis is that credibility necessarily implies low mean exchange market pressure (EMP), low EMP conditional volatility and low-severity EMP crises. In addition, economic fundamentals must account for EMP dynamics. We also seek evidence of a risk-return relationship for mean EMP and of “bad news” (negative shocks) having a greater impact on EMP volatility than “good news” (positive shocks). Using our econometric models, we are able to rank PALOP countries’ conditional volatility in ordinal terms. Our main conclusion is that countries with currency pegs, such as Guinea-Bissau (GB) and Cape Verde (CV), clearly have lower volatility when compared to those with managed floats and are therefore more credible. Moreover, EMP crises episodes under pegs are much less severe. We find that economic fundamentals correctly account for mean EMP in all countries and that the risk-return relationship is much more favourable for investors under currency pegs, as the increase in volatility is lower for the same rate of return. The exception to this finding is Mozambique (MOZ), which apparently has a risk-return profile akin to that enjoyed by countries with pegs. A plausible reason is that MOZ has the only managed float in our sample implementing monetary and exchange rate policy within the confines of an IMF framework, which establishes floors for international reserves and ceilings for the central bank’s net domestic assets. This intuition needs to be tested, however. EMP conditional volatility is generally driven by changes in domestic credit (lowers it) and foreign reserve changes (raises it). The first effect is more pronounced under currency pegs, but also under MOZ’s managed float. “Bad news” increases volatility more that “good news” only in the case of CV’s currency peg, which we take to be another sign of its credibility. A few striking cross-country comparisons also emerge in our analysis. Among countries with managed floats, we find that Angola (ANG) has the most severe EMP crises whilst MOZ has the least severe. São Tomé & Princípe (STP), meanwhile, lies between these two extremes but its EMP crises behaviour is clearly much closer to that of MOZ. STP’s credibility may also be improving since its volatility has declined as of 2002 and its level is now much closer to that of MOZ, whose managed float has lowest volatility of such arrangements.
    Date: 2008
  15. By: Baybars Karacaovali (Fordham University, Department of Economics); Nuno Limao (University of Maryland, Department of Economics; NBER; CEPR)
    Abstract: Preferential trade agreements (PTAs) are characterized by liberalization with respect to only a few partners and thus they can potentially clash with, and retard multilateral trade liberalization (MTL). Yet there is almost no systematic evidence on whether the numerous existing PTAs actually affect MTL. We provide a model showing that PTAs hinder MTL unless they entail accession to a customs union with internal transfers. Using product-level tariffs negotiated by the European Union (EU) in the last two multilateral trade rounds we find that several of its PTAs have clashed with its MTL. However, this effect is absent for EU accessions. Moreover, we provide new evidence on the political economy determinants of trade policy in the EU.
    Keywords: Preferential trade agreements, customs unions, multilateral trade negotiations, MNF tariff concessions, reciprocity
    JEL: D78 F13 F14 F15
    Date: 2008
  16. By: Liew , Venus Khim-Sen; Baharumshah, Ahmad Zubaidi; Habibullah, Muzafar Shah; Midi, Habshah
    Abstract: Using nonlinear testing procedures relevant to the recent literature, this study provides evidence of nonlinear adjustment of nominal exchange rate towards monetary fundamentals in the context of ASEAN-5 countries. While it supports earlier findings supportive of monetary exchange rate model in this region using the linear testing procedures, this study provides insightful information in explaining why persistent misalignments between nominal exchange rate and monetary fundamentals are often observed in the sample data.
    Keywords: monetary model; exchange rate; nonlinear; unit root test; linearity test; STAR model
    JEL: C32 F31
    Date: 2008
  17. By: Stavarek, Daniel
    Abstract: In this paper, we examine the exchange rate volatility in selected new EU Member States (Czech Republic, Hungary, Poland, Slovakia) and candidate countries (Croatia, Romania, Turkey) using TARCH model and daily data from the period May 2004 – December 2006. Besides the volatility estimation, the paper analyzes the asymmetric effects. The results suggest that some symptoms of asymmetry were found in all exchange rates except for CZK/EUR. However, the most distinct effects are evident in Slovakia and Turkey where the appreciation of the national currency and the appreciation-side deviation from the target exchange rate contribute significantly to the increase in the exchange rate volatility.
    Keywords: asymmetry; European Union; exchange rate volatility; TARCH models
    JEL: G15 F31
    Date: 2007
  18. By: Laurent Gheeraert (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels.); Ritha Sukadi (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels.)
    Abstract: Recorded remittances flows have experienced an important growth over the last decade (from 68 billion $ in 1995, to an estimated 297 billion $ in 2006). For developing countries globally, these flows are today – in annual volume – even the second source of external financing, after foreign direct investments and before official direct aid. This has raised interest among policy makers and researchers, who increasingly recognize the potential of remittances as a tool for development. Micro-studies have shed light on potential uses of remittance flows. However, at macro-level, some unanswered questions remain regarding the relative importance of these uses, and the mechanisms through which remittances impact the economics of recipient countries. In order to assess the implications of remittances on long-term growth, we first need to better understand how remittances interact with the key components of long-term growth, such as investment or international commerce. Therefore, we conduct a global empirial study, to show how the effect of received remittances split between investment, consumption and the trade balance in the home country and to examine which local conditions are relevant predictors of remittance uses. We use data covering over 140 countries over the 1970-2005 period, from international statistical agencies (e.g., Worldbank, IMF, UN), and apply panel-data methodologies, following Giuliano and Ruiz-Arranz (2005) and Bosworth and Collins (1999). Early results indicate that, on the global sample, and after controlling for traditional macro-economic variables, more than 75% of remittances are used for consumption purposes, whereas investment uses only concern about 10% of received remittances (the rest of the impact being mainly on the trade balance). However, we also find important cross-country variations, according to a series of factors, such as the volume of received remittance flows, the level of development, or the level of financial sector development.
    Keywords: remittances, consumption, investment, growth
    JEL: F24 O16 G2
    Date: 2007–12
  19. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway))
    Abstract: This paper uses Monte Carlo techniques to address the question: are structural VAR estimates of exchange rate pass-through a useful tool to evaluate macroeconomic models of open economies? The data generating process is a small open economy DSGE model with incomplete pass-through. The results suggest that (i) the pass-through estimates obtained from a first-differenced VAR exhibit a systematic downward bias; (ii) by contrast, estimates derived from a low order vector equilibrium correction model are fairly accurate; but (iii) standard cointegration tests have low power to detect the cointegration relations implied by the DSGE model.
    Keywords: Exchange rate pass-through, structural VAR, DSGE models, cointegration
    JEL: C32 C52 F41
    Date: 2008–01–11
  20. By: Liew , Venus Khim-Sen; Ling, Tai-Hu
    Abstract: This study examines the real interest rate parity (RIP) hypothesis in the case of East Asian economies by taking China as foreign counterpart. Results obtained from panel unit root tests are in line with previous findings that are supportive of the hypothesis. The estimated half-life of the RIP deviations is 3.21 quarters, indicating RIP holds strongly in this region with respect to China. This implies that the choices and effectiveness of the monetary and fiscal policies in the East Asian economies will be very much influenced by the external factors originating from China, in additional to Japan and US as identified in other studies. Furthermore, judging from the another finding of this study that East Asian economies is more integrated with Japan than China, China has yet to further liberalize its financial system before it can overtake Japan as leading financial centre or as anchor country for common currency area in this region.
    Keywords: Real interest rate parity;East Asia; panel unit root test
    JEL: C23 F41 F36
    Date: 2008

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