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on Open MacroEconomics |
| By: | Andrea Ferrero; Mark Gertler; Lars E.O. Svensson |
| Abstract: | We explore the implications of current account adjustment for monetary policy within a simple two-country DSGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well. |
| JEL: | E0 F0 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13906&r=opm |
| By: | Viktoria Hnatkovska; Amartya Lahiri; Carlos A. Vegh |
| Abstract: | What is the relationship between interest rates and the exchange rate? The empirical literature in this area has been inconclusive. We use an optimizing model of a small open economy to rationalize the mixed empirical findings. The model has three key margins. First, higher domestic interest rates raise the demand for deposits, and, hence, the money base. Second, firms need bank loans to finance the wage bill, which reduces output when domestic interest rates increase. Lastly, higher interest rates raise the government’s fiscal burden, and, therefore, can lead to higher expected inflation. While the first effect tends to appreciate the currency, the remaining two effects tend to depreciate it. We then conduct policy experiments using a calibrated version of the model and show the central result of the paper: the relationship between interest rates and the exchange rate is non-monotonic. In particular, the exchange rate response depends on the size of the interest rate increase and on the initial level of the interest rate. Moreover, we also show that the model can replicate the heterogeneous responses of the exchange rate to interest rate innovations in several developing economies. |
| JEL: | E52 F41 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13925&r=opm |
| By: | Zuzana Janko |
| Date: | 2008–01–11 |
| URL: | http://d.repec.org/n?u=RePEc:clg:wpaper:2008-15&r=opm |
| By: | Joshua Aizenman; Yothin Jinjarak |
| Abstract: | This paper studies the association between the current account and real estate valuation across countries, subject to data availability [43 countries, of which 25 are OECD], during 1990-2005. We find robust and strong positive association between current account deficits and the appreciation of the real estate prices/(GDP deflator). Controlling for lagged GDP/capita growth, inflation, financial depth, institution, urban population growth and the real interest rate; a one standard deviation increase of the lagged current account deficits is associated with a real appreciation of the real estate prices by 10%. This real appreciation is magnified by financial depth, and mitigated by the quality of institutions. Intriguingly, the economic importance of current account variations in accounting for the real estate valuation exceeds that of the other variables, including the real interest rate and inflation. Among the OECD countries, we find evidence of a decline overtime in the cross country variation of the real estate/(GDP deflator), consistent with the growing globalization of national real estate markets. Weaker patterns apply to the non-OECD countries in the aftermath of the East Asian crisis. |
| JEL: | F15 F21 F32 R21 R31 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13921&r=opm |
| By: | Jón Steinsson |
| Abstract: | Existing empirical evidence suggests that real exchange rates exhibit hump-shaped dynamics. I show that this is a robust fact across nine large, developed economies. This fact can help explain why existing sticky-price business cycle models have been unable to match the persistence of the real exchange rate. The recent literature has focused on models driven by monetary shocks. These models yield monotonic impulse responses for the real exchange rate. It is extremely difficult for models that have this feature to match the empirical persistence of the real exchange rate. I show that in response to a number of different real shocks a two-country sticky-price business cycle model yields hump-shaped dynamics for the real exchange rate. The hump-shaped dynamics generated by the model are a powerful source of endogenous persistence that allows the model to match the long half-life of the real exchange rate. |
| JEL: | F31 F41 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13910&r=opm |
| By: | Joseph P. Daniels (Center for Global and Economic Studies, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University) |
| Abstract: | Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and realized inflation rates. In this paper, we utilize cross-country data to provide evidence of interacting effects between a greater extent of exchange-rate pass through and openness to international trade as factors that we find both contribute to lower inflation. The interplay between the inflation effects of pass through and openness suggest that both factors may influence the terms of the output-inflation trade-off. We develop a simple theoretical model showing how both pass through and openness can interact to influence the sacrifice ratio, and we empirically explore the nature of the interplay between the two variables as factors influencing the sacrifice ratio. Our results indicate that a greater extent of pass through depresses the sacrifice ratio and that once the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, the degree of openness to international trade exerts an empirically ambiguous effect on the sacrifice ratio. |
| Keywords: | Pass Through, Openness, Sacrifice Ratio |
| JEL: | F40 F41 F43 |
| Date: | 2008–03 |
| URL: | http://d.repec.org/n?u=RePEc:mrq:wpaper:0805&r=opm |
| By: | Zuzana Janko |
| Date: | 2008–01–11 |
| URL: | http://d.repec.org/n?u=RePEc:clg:wpaper:2008-17&r=opm |
| By: | Kristin J. Forbes |
| Abstract: | Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors "chase returns" in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances. |
| JEL: | F2 F3 F4 G1 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13908&r=opm |
| By: | Rod Tyers; Iain Bain |
| Abstract: | With exports almost half of its GDP and most of these directed to Europe and North America, negative financial shocks in those regions might be expected to retard China's growth. Yet mitigating factors include the temporary flight of North American and European savings into Chinese investment and some associated real exchange rate realignments. These issues are explored using a dynamic model of the global economy. A rise in American and European financial intermediation costs is shown to retard neither China's GDP nor its import growth in the short run. Should the Chinese government act to prevent the effects of the investment surge, through tighter inward capital controls or increased reserve accumulation, the associated losses would be compensated by a trade advantage since its real exchange rate would appreciate less against North America than those of other trading partners. The results therefore suggest that, so long as the financial shocks are restricted to North America and Western Europe, China's growth and the imports on which its trading partners rely are unlikely to be significantly hindered. |
| JEL: | C68 E17 F21 F17 F43 F47 O5 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:acb:cbeeco:2008-491&r=opm |
| By: | Frait, Jan (Czech National Bank); Komárek, Luboš (Czech National Bank) |
| Abstract: | The paper aims to enrich the debate on the overvaluation/undervaluation of China yuan Renminbi (CNY) against USD and JPY by applying the concept of the Debt-Adjusted Real Exchange Rate (DARER). This approach is offering to monetary policy makers another indicator for more responsive management of this important economic variable. The general motivation for constructing DARER is the fact that long-term current account surplus (deficits) is linked with capital outflows (inflows), which often leads to real undervaluation (overvaluation) of domestic currency. DARER can signal to the authorities that the real exchange rate is becoming unsustainable in the medium term. Based on the DARER approach we also introduce three indicators of exchange rate misalignment. |
| Keywords: | Exchange rate ; current account ; misalignment ; China ; DARER |
| JEL: | E58 F31 F32 F37 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:850&r=opm |
| By: | Ansgar Belke; Walter Orth |
| Abstract: | The belief that house prices are driven by specific regional and institutional variables and not at all by monetary conditions is so entrenched with some market participants and some commentators that the search for empirical support would seem to be a trivial task. However, this is not the case. This paper investigates the relationship between global excess liquidity and asset prices on a global scale:How important is global liquidity? How are asset (especially house) prices and other important macro variables like consumer prices affected by global monetary conditions? This paper analyses the international transmission of monetary shocks with a special focus on the effects of a global monetary aggregate ("global liquidity") on consumer prices and different asset prices.We estimate a variety of VAR models for the global economy using aggregated data that represent the major OECD countries. The impulse responses show that a positive shock to global liquidity leads to permanent increases in the global GDP deflator and in the global house price index, while the latter reaction is even more distinctive. Moreover, we find that there are subsequent spillovers to consumer prices. In contrast, we are not able to find empirical evidence in favour of the hypothesis that the MSCIWorld index as a measure of stock prices significantly reacts to changes in global liquidity. |
| Keywords: | Global liquidity, inflation control, international spillovers, asset prices, VAR analysis |
| JEL: | E31 E52 F01 F42 |
| Date: | 2007–12 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0037&r=opm |
| By: | Hervé Boulhol (Centre d'Economie de la Sorbonne et Paris School of Economics) |
| Abstract: | There is ample evidence that a country's labour market institutions are important determinants of unemployment. This study generalises Davis' (1998) idea according to which the institutions of the trade partners matter also for a country's equilibrium unemployment rate as they generate comparative advantages. Moreover, the empirical investigation provides some evidence that the interactions between bilateral trade and relative labour market regulations affect the equilibrium unemployment rate. Given data limitations in this area, the ambition of this paper is merely to draw the attention to the general relevance of these interactions as complementing factors to other explanations of unemployment. Another interesting finding is that a fairly low regulated country like Canada can be negatively affected because its main trading partner is even less regulated, while a high regulated country like Germany appears rather sheltered because its trading partners are also highly regulated. |
| Keywords: | Unemployment, trade, labour market institutions. |
| JEL: | F16 J50 F10 F41 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:bla08016&r=opm |