nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2008‒06‒21
eighteen papers chosen by
Martin Berka
Massey University

  1. Exchange Rate Regimes and Capital Mobility: How Much of the Swoboda Thesis Survives? By Eichengreen, Barry
  2. Made in America? The New World, the Old, and the Industrial Revolution By Clark, Gregory; O''Rourke, Kevin H; Taylor, Alan M
  3. Real convergence, financial markets, and the current account – Emerging Europe versus emerging Asia By Sabine Herrmann; Adalbert Winkler
  4. Real exchange rate volatility and disconnect: an empirical investigation By Riccardo Cristadoro; Andrea Gerali; Stefano Neri; Massimiliano Pisani
  5. Foreign Prices Shocks in a Small Open Economy By Marias Halldor Gestsson
  6. Do trade and financial linkages foster business cycle synchronization in a small economy? By Alicia García-Herrero; Juan M. Ruiz
  7. Welfare Gains of Aid Indexation in Small Open Economies By Anubha Dhasmana
  8. The Effect of Exchange Rate Volatility on International Trade: The Implication for Production Networks in East Asia By Hayakawa, Kazunobu; Kimura, Fukunari
  9. An eclectic third generation model of financial and exchange rate crises By Joaquin Novella Izquierdo; Joan Ripoll i Alcon
  10. External Shocks and Business Cycle Fluctuations in Mexico: How Important are U.S. Factors? By Sebastian Sosa
  11. The Decline of the Exchange Rate Pass-Through in Brazil: Explaining the ‘Fear of Floating’ By Carlos Eduardo Schönerward da Silva; Matias Vernengo
  12. Aid volatility, monetary policy rules and the capital account in African economies By Christopher Adam; Stephen O'Connell; Edward Buffie
  13. Monetary Transmission and the Yield Curve in a Small Open Economy By Mariano Kulish; Daniel Rees
  14. Exchange Rate Pass-Through Into Inflation: The Role of Asymmetries and NonLinearities By Reginaldo P. Nogueira Junior; Miguel Leon-Ledesma
  15. Relative Factor Endowments and International Portfolio Choice By Cuñat, Alejandro; Fons-Rosen, Christian
  16. Current Account Developments in New Member States of the European Union: Equilibrium, Excess, and EU-Phoria By Jesmin Rahman
  17. Globalisation, Tax Competition and the Harmonisation of Corporate Tax Rates in Europe: A Case of Killing the Patient to Cure the Disease? By Brigitte Unger; Killian McCarthy; Frederik van Doorn
  18. The Choice of Monetary and Exchange Rate Arrangements for a Small, Open, Low-Income Economy: The Case of Sao Tome and Principe By Márcio Valério Ronci; Misa Takebe; Nisreen Farhan; Amar Shanghavi; Jian-Ye Wang

  1. By: Eichengreen, Barry
    Abstract: Alexander Swoboda is one of the originators of the bipolar view that capital mobility creates pressure for countries to abandon intermediate exchange rate arrangements in favor of greater flexibility and harder pegs. This paper takes another look at the evidence for this hypothesis using two popular de facto classifications of exchange rate regimes. That evidence supports the bipolar view for the advanced countries, the sample for which it was originally developed, but not obviously for emerging markets and other developing countries. One interpretation of the contrast is that there is a tendency to move away from intermediate regimes in the course of economic and financial development, implying that emerging markets and other developing countries will eventually abandon intermediate regimes as well. Another interpretation is that the advanced countries have been faster to abandon soft pegs because they have been faster to develop attractive alternatives, notably Europe’s monetary union. In this view, other countries are unlikely to abandon soft pegs because of the absence of the distinctive political conditions that have made the European alternative feasible. A final interpretation is that the advanced countries have been able to abandon soft peg because of their success in substituting inflation targeting for exchange rate targeting as the anchor for monetary policy. The paper presents some evidence for this view, which suggests the feasibility of further movement by emerging markets and developing countries in the direct of greater exchange rate flexibility.
    Keywords: exchange rate regimes; exchange rates
    JEL: F30 F31
    Date: 2008–06
  2. By: Clark, Gregory; O''Rourke, Kevin H; Taylor, Alan M
    Abstract: For two decades, the consensus explanation of the British Industrial Revolution has placed technological change and the supply side at center stage, affording little or no role for demand or overseas trade. Recently, alternative explanations have placed an emphasis on the importance of trade with New World colonies, and the expanded supply of raw cotton it provided. We test both hypotheses using calibrated general equilibrium models of the British economy and the rest of the world for 1760 and 1850. Neither claim is supported. Trade was vital for the progress of the industrial revolution; but it was trade with the rest of the world, not the American colonies, that allowed Britain to export its rapidly expanding textile output and achieve growth through extreme specialization in response to shifting comparative advantage.
    Keywords: British Industrial Revolution; colonies; Great Divergence; growth; specialisation; trade
    JEL: F11 F14 F43 N10 N70 O40
    Date: 2008–06
  3. By: Sabine Herrmann (Deutsche Bundesbank, Wilhelmp-Epstein-Strasse 14, 60431 Frankfurt am Main.); Adalbert Winkler (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Global financial integration has been associated with divergent patterns of real convergence and the current account in emerging markets. While countries in emerging Asia have been running sizeable current account surpluses, countries in emerging Europe have been facing large current account deficits. In this paper we test for the relevance of financial market characteristics in explaining this divergence in the catching-up process in Europe and Asia. We assume that the two regions constitute distinct convergence clubs, with the euro area and the United States respectively at their core. In line with the theoretical literature, we find that better developed and more integrated financial markets increase emerging markets’ ability to borrow abroad. Moreover, the degree of financial integration within the convergence clubs – as opposed to the state of financial integration in the global economy – and the extent of reserve accumulation are significant factors in explaining the divergent patterns of real convergence and the current account in the regions under review. JEL Classification: F15, F21, O16, O52, O53.
    Keywords: Real convergence, economic integration, saving and investment, current account developments, financial markets, emerging market economies.
    Date: 2008–06
  4. By: Riccardo Cristadoro (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Andrea Gerali (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Stefano Neri (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Massimiliano Pisani (Bank of Italy, Economic Outlook and Monetary Policy Research Department)
    Abstract: A two-country model that incorporates many features proposed in the New Open Economy Macroeconomics literature is developed in order to replicate the volatility of the real exchange rate and its disconnect with macroeconomic variables. The model is estimated using data for the euro area and the U.S. and Bayesian methods. The analysis delivers the following results: (a) international price discrimination, home bias and shocks to the uncovered interest rate parity (UIRP) condition are key features to replicate the variance of the real exchange rate; (b) home bias, shocks to the UIRP condition and to production technologies help replicating the disconnect;(c) distribution services intensive in local nontradeables are an important source of international price discrimination.
    Keywords: International business cycle, Exchange rate volatility, Exchange rate pass-through, International transmission.
    JEL: F32 F33 F41 C11
    Date: 2008–04
  5. By: Marias Halldor Gestsson (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: Countries specialize in producing goods that they have comparative advantages in producing. This results in a country exporting some goods while it imports other. Hence, there is a reason to expect that changes in the prices of these goods have consid- erable economic e¤ect and that demand management can be used to improve welfare following such changes. This paper analyses this using a New Open Economy Macro (NOEM) model of a small open economy. Among others, the results indicate that, in a small open economy, a terms of trade appreciation results in increased consumption, labor use and output on impact while consumption increases but labor use and output decrease in future time periods. The results also indicate that the vulnerability of an economy towards such shocks is negatively related to its size. Finally, the results indicate that there exists a welfare improving demand management policy following a terms of trade shock.
    Keywords: Open Economy Macroeconomics, New Open Economy Macro Models, small open economy, tradeables,exportables, importables, terms of trade, demand management, stabilization
    JEL: E63 F41
    Date: 2007–06–01
  6. By: Alicia García-Herrero (BBVA); Juan M. Ruiz (Banco de España)
    Abstract: We estimate a system of equations to analyze whether bilateral trade and financial linkages influence business cycle synchronization directly and/or indirectly. Our paper builds upon the existing literature by using bilateral trade and financial flows for a small, open economy (Spain) as benchmark for the results, instead of the US as generally done in the literature. We find that both the similarity of productive structure and trade links promote the synchronization of cycles. However, bilateral financial links are inversely related to the co movement of output. This might point to financial integration allowing an easiertransfer of resources between two economies, which could enable their decoupling, as predicted by a standard model of international business cycles. Both the effects of trade and financial links on output synchronization are statistically significant and economically relevant.
    Keywords: business cycle synchronization, trade linkages, financial linkages, productive structure, integration
    JEL: E32 F41 F12 E44
    Date: 2008–06
  7. By: Anubha Dhasmana
    Abstract: Foreign aid flows to poor, aid-dependent economies are highly volatile and pro-cyclical. Shortfalls in aid coincide with shortfalls in GDP and government revenues. This increases the consumption volatility in aid dependent countries, thereby causing substantial welfare losses. This paper finds that indexing aid flows to exogenous shocks like a change in the terms of trade can significantly improve the welfare of aid-dependent country by lowering its output and consumption volatility. Compared to the benchmark specification with stochastic aid flows, indexation of aid flows to terms of trade shocks can reduce the cost of business cycle fluctuations in the recipient country by four percent of permanent consumption. Moreover, use of indexed aid can allow donors to reduce the aid flows by three percent without lowering the level of welfare in the recipient country.
    Keywords: Working Paper , Aid flows , Indexation , Low-income developing countries , Business cycles , Development assistance , Consumption , Terms of trade , Small states ,
    Date: 2008–04–28
  8. By: Hayakawa, Kazunobu; Kimura, Fukunari
    Abstract: This paper is an empirical investigation of the relationship between exchange rate volatility and international trade, focusing on East Asia. It finds that intra-East Asian trade is discouraged by exchange rate volatility more seriously than trade in other regions because intermediate goods trade in production networks, which is quite sensitive to exchange rate volatility compared with other types of trade, occupies a significant fraction of trade. In addition, this negative effect of volatility is mainly induced by the unanticipated volatility and has an even greater impact than that of tariffs.
    Keywords: Exchange rate volatility, Trade, East Asia, International trade, Foreign exchange
    JEL: F10 F31 N75
    Date: 2008–05
  9. By: Joaquin Novella Izquierdo; Joan Ripoll i Alcon (Universitat de Barcelona)
    Abstract: This paper presents an eclectic model that systematizes the dynamics of self-fulfilling crises, using the main aspects of the three typologies of third generation models, to describe the stylized facts that hasten the withdrawal of a pegged exchange rate system. The most striking contributions are the implications for economic policy as well the vanishing role of exchange rate as an instrument of macroeconomic adjustment, when balance-sheet effects are a real possibility.
    Keywords: speculative attack, financial liberalization, financial panic, financial and exchange rate crisis
    JEL: F41 F43 E44 F31 F32 F34 F36 E52
    Date: 2008
  10. By: Sebastian Sosa
    Abstract: This paper examines the relative importance of external shocks as sources of business cycle fluctuations in Mexico, and identifies the dynamic responses of domestic output to foreign disturbances. Using a VAR model with block exogeneity restrictions, it finds that U.S. shocks explain a large share of Mexico's macroeconomic fluctuations after NAFTA. This partly reflects greater trade integration-but also Mexico's "Great Moderation," as the country escaped its former pattern of macro-financial crises. In this period, Mexico's output fluctuations have been closely synchronized with the U.S. cycle, with a large and rapid impact of U.S. shocks on Mexican growth.
    Keywords: Working Paper , Mexico , Business cycles , External shocks , United States , Economic models ,
    Date: 2008–04–28
  11. By: Carlos Eduardo Schönerward da Silva; Matias Vernengo
    Abstract: This paper argues that the pass-through in Brazil has fallen compared with estimates in other studies on earlier time periods, and remains low. Whereas pass-through effects where high and close to 1 in the high-inflation period, they seem to have fallen to around 0.2 after the Real Plan stabilization, a number that is similar to the Import Substitution Industrialization (ISI) period of the 1950s and 1960s. Conventional results suggests that low and stable inflation environments lead to low levels of exchange rate pass-through and thus contribute to weakening the ‘fear of floating’ phenomenon experienced by some developing countries. In spite of lower pass-through effects the Brazilian Central Bank has maintained high interest rates in order to control the exchange rate. This paper suggests that ‘fear of inflation’ provides justification for the central bank’s persistent ‘fear of floating.’
    Keywords: Pass-Through, Inflation, Brazil
    JEL: E58 F41 O54
    Date: 2008–11
  12. By: Christopher Adam (University of Oxford); Stephen O'Connell (Swarthmore College); Edward Buffie (Indiana University)
    Abstract: We examine the properties of simple quantity-based monetary policy rules of the kind widely used in low-income African economies. Using a DSGE model and focusing our attention on responses to positive aid shocks, we suggest that policy rules involving substantial reserve accumulation in the face of aid surges serve to ease macroeconomic adjustment to shocks, particularly when a portion of aid is used to support fiscal adjustment. These rules are robust to assumptions about the degree of integration of the domestic public debt market with world capital markets. Although an open capital account facilitates smoother adjustment to temporary aid surges when an aid inflow is fully spent, it exacerbates the adjustment problem when aid is accompanied by fiscal adjustment and hence reinforces the case for a managed float in such circumstances.
    Keywords: Monetary policy, Africa, Aid volatility, foreign capital flows, stochastic simulation models
    Date: 2008–06
  13. By: Mariano Kulish (Reserve Bank of Australia); Daniel Rees (Reserve Bank of Australia)
    Abstract: Long-term nominal interest rates in a number of inflation-targeting small open economies have tended to be highly correlated with those of the United States. This observation has recently lent support to the view that the long end of the yield curve is determined abroad. We set up and estimate a micro-founded two-block small open economy model to study the co-movement of long-term nominal interest rates of different currencies. The expectations hypothesis together with uncovered interest rate parity, which both hold in our model, can account for much of the co-movement of interest rates observed in the data.
    Keywords: term structure of interest rates; yield curve; small open economy; DSGE model; transmission mechanism
    JEL: E43 E52 E58 F41
    Date: 2008–06
  14. By: Reginaldo P. Nogueira Junior; Miguel Leon-Ledesma
    Abstract: This paper investigates the empirical evidence on exchange rate pass through (ERPT) into CPI inflation for a set of emerging and developed countries. We argue that, theoretically, ERPT may be nonlinear in contrast to standard linear estimates in the literature. We use smooth transition models to investigate several possible sources of these nonlinearities. The results suggest that, although the sources of nonlinearities vary considerably across countries, they appear to be important. We find that for four countries ERPT responds nonlinearly to inflation and for three of them it responds nonlinearly to the output gap. We also find an asymmetric response of ERPT with respect to the magnitude of exchange rate changes for only two out of six countries. Finally, for some emerging markets, ERPT seems to be affected nonlinearly by measures of macroeconomic instability.
    Keywords: Exchange rate pass-through; smooth transition regression models
    JEL: E31 E52 F41
    Date: 2008–01
  15. By: Cuñat, Alejandro; Fons-Rosen, Christian
    Abstract: This paper presents a model of international portfolio choice based on the pattern of comparative advantage in goods trade. Countries have varying degrees of similarity in their factor endowment ratios, and are subject to aggregate productivity shocks. Risk averse consumers can insure against these shocks by investing their wealth at home and abroad. The change in relative prices after a positive shock in a particular country provides insurance to countries that have dissimilar factor endowment ratios, but is bad news for countries with similar factor endowment ratios, since their incomes will worsen. Therefore countries with similar comparative advantages have a stronger incentive to invest in one another for insurance purposes than countries with dissimilar comparative advantages. Empirical evidence linking bilateral international investment positions to a proxy for relative factor endowments supports our theory: the similarity of host and source countries in their relative capital-labor ratios has a positive effect on the source country's investment position in the host country. The effect of similarity is enhanced by the size of host countries as predicted by the theory.
    Keywords: factor endowments; gravity equation; International portfolio choice
    JEL: F21 F34 G11
    Date: 2008–06
  16. By: Jesmin Rahman
    Abstract: This paper analyzes current account (CA) developments in the following 10 new EU members states: Czech Republic, Bulgaria, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. During the last 15 years, these countries, on average, have run CA deficits that are considerably higher than the average CA deficit of other developing countries. However, more recently, a diverging pattern has emerged among these countries with one group, consisting of the Baltic countries, Bulgaria and Romania, experiencing rapid widening, while the others seeing a stabilization in their CA balances. Using panel data for 59 countries, this paper empirically investigates the following three questions: Are higher average deficits in EU-10 explained by medium-term macroeconomic fundamentals? What explains the diverging CA behavior among EU-10? And finally, how challenging is it for the group experiencing rapidly widening CA deficits to reverse the trend?
    Date: 2008–04–17
  17. By: Brigitte Unger; Killian McCarthy; Frederik van Doorn
    Abstract: This paper surveys the literature on tax competition, and uses it to analyse current European proposals to harmonise corporate tax rates. It begins, in the course of Section One, by introducing the phenomenon of international tax competition, and illustrates, with the use of secondary research, the reality of the regulatory "race to the bottom". Section Two, however, demonstrates the harmful consequences of tax competition - with reference to the immobile factors of production - and makes obvious the necessity of effective intervention. Section Three then introduces and evaluates the calibre of the current proposals to tackle tax competition through collusion and harmonisation, and concludes negatively in the process. As illustrated in this discussion, any efforts to harmonise corporate taxes above the international equilibrium will not only fail to solve the problem at hand, but will exacerbate them, and may even serve to undermine and destabilise the political Union. Section Four then introduce an alternative solution to the problem - in the form of the residence principle - and Section Five concludes.
    Keywords: International Competition, Europe, Public Finance, Taxation, Regulation
    JEL: E62 E65 F41 F42 H26 H87 O52
    Date: 2008–05
  18. By: Márcio Valério Ronci; Misa Takebe; Nisreen Farhan; Amar Shanghavi; Jian-Ye Wang
    Abstract: This paper assesses São Tomé and Príncipe's monetary and exchange rate arrangements in light of the country's monetary history and the relevant experience of comparable countries in Africa. The study highlights several structural characteristics of São Tomé and Príncipe including its very small size, high degree of openness, extensive use of foreign currencies, and inflexible product and factor markets in the consideration of an appropriate monetary and exchange regime. Firmly anchored currency arrangements, defined in this paper to include memberships in monetary unions or hard pegs, are found to be preferable to the status quo of a managed float. The paper applies statistical methods and takes into account other factors to identify the appropriate anchor currency. It stresses that fiscal discipline and prudent debt management are the main prerequisites for a firmly anchored currency arrangement.
    Keywords: Working Paper , Exchange rate regimes , São Tomé and Príncipe , Currencies , Monetary systems , Debt management , Fiscal management , Small states ,
    Date: 2008–05–05

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