nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2008‒07‒20
fourteen papers chosen by
Martin Berka
Massey University

  1. Input Substitution, Export Pricing, and Exchange Rate Policy By Kang Shi; Juanyi Xu
  2. Global liquidity glut or global savings glut? A structural VAR approach By Thierry Bracke; Michael Fidora
  3. Optimal Exchange Rate Stabilization in a Dollarized Economy with Inflation Targets By Nicoletta Batini; Paul Levine; Joseph Pearlman
  4. Wage growth dispersion across the euro area countries - some stylised facts By Malin Andersson; Arne Gieseck; Beatrice Pierluigi; Nick Vidalis
  5. Common Shocks, Common Dynamics, and the International Business Cycle By Marco Centoni; Gianluca Cubadda; Alain Hecq
  6. The Relative Size of New Zealand Exchange Rate and Interest Rate Responses to News By Andrew Coleman; Özer Karagedikli
  7. Bond risk premia, macroeconomic fundamentals and the exchange rate By Taboga, Marco; Pericoli, Marcello
  8. Hoarding of International Reserves: A Comparison of the Asian and Latin American Experiences By Yin-wong Cheung; Hiro Ito
  9. The Effectiveness of Monetary Policy Reconsidered By John Weeks
  10. Managing Capital Flows: Experiences from Central and Eastern By von Hagen, Jurgen; Siedschlag, Iulia
  11. The Country Risk and the nominal exchange rate between Peru and the United States. An approach through a model of asset markets for determining the exchange rate. (1998:12 - 2007:12) By Salazar, Eduardo
  12. Impact of Trade Liberalization on External Debt Burden: Econometric Evidence from Pakistan By Zafar, Sabahat; Butt, Muhammad Sabihuddin
  13. Exchange Rate and Interest Rate Volatility in a Target Zone: The Portuguese Case By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  14. Trends and Drivers of Bilateral FDI Flows in Developing Asia By Rabin Hattari; Ramkishen S. Rajan

  1. By: Kang Shi (The Chinese University of Hong Kong, Hong Kong Institute for Monetary Research); Juanyi Xu (Hong Kong University of Science and Technology, Simon Fraser University, Hong Kong Institute for Monetary Research)
    Abstract: This paper develops a small open economy model with sticky prices to show why a flexible exchange rate policy is not desirable in East Asian emerging market economies. We argue that weak input substitution between local labor and import intermediates in traded goods production and extensive use of foreign currency in export pricing in these economies can help to explain this puzzle. In the presence of these two trade features, the adjustment role of the exchange rate is inhibited, so even a flexible exchange rate cannot stabilize the real economy in face of external shocks. Instead, due to the high exchange rate pass-through, exchange rate changes will lead to instability in both inflation and production cost. As a result, a fixed exchange rate may dominate a monetary policy rule with high exchange rate flexibility in terms of welfare. In a sense, our finding provides a rationale for the "fear of floating" phenomenon in these economies. That is, "fear of floating" may be central banks' rational reaction when these economies are constrained by the trade features mentioned above.
    Keywords: Input Substitution, Export Pricing, Exchange Rate Flexibility, Welfare
    JEL: F3 F4
    Date: 2008–10
  2. By: Thierry Bracke (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michael Fidora (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Since the late-1990s, the global economy is characterised by historically low risk premia and an unprecedented widening of external imbalances. This paper explores to what extent these two global trends can be understood as a reaction to three structural shocks in different regions of the global economy - (i) monetary shocks (“excess liquidity” hypothesis), (ii) preference shocks (“savings glut” hypothesis), and (iii) investment shocks (“investment drought” hypothesis). In order to uniquely identify these shocks in an integrated framework, we estimate structural VARs for the two main regions with widening imbalances, the United States and emerging Asia, using sign restrictions that are compatible with standard New Keynesian and Real Business Cycle models. Our results show that monetary shocks potentially explain the largest part of the variation in imbalances and financial market prices. We find that havings shocks and investment shocks explain less of the variation. Hence, a “liquidity glut” may have been a more important driver of real and financial imbalances in the US and emerging Asia than a “savings glut”. JEL Classification: E2, F32, F41, G15.
    Keywords: Global imbalances, global liquidity, savings glut, investment drought, current account, structural VARs.
    Date: 2008–06
  3. By: Nicoletta Batini (International Monetary Fund); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We build a small open-economy model with partial dollarization–households hold wealth in domestic currency and a foreign currency as in Felices and Tuesta (2006). The degree of dollarization is endogenous to the extent of exchange rate stabilization by the central bank. We identify the optimal monetary policy response under com-mitment and discretion and assess the optimal degree of exchange rate stabilization inthis set up, drawing policy implications for countries that target inflation in economies of this kind.
    Keywords: dollarized economies, optimal monetary policy, managed exchange rates, inflation-forecast-based rules
    JEL: E52 E37 E58
    Date: 2008–02
  4. By: Malin Andersson (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Arne Gieseck (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Beatrice Pierluigi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Nick Vidalis (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This study presents some stylised facts on wage growth differentials across the euro area countries in the years before and in the first eight years after the introduction of Economic and Monetary Union (EMU) in 1999. The study shows that wage growth dispersion, i.e. the degree of difference in wage growth at a given point in time, has been on a clear downward trend since the early 1980s. However, wage growth dispersion across the euro area countries still appears to be higher than the degree of wage growth dispersion within West Germany, the United States, Italy and Spain. Differences in wage growth rates between individual euro area countries and the euro area in the years before and in the first eight years after the introduction of EMU appear to be positively related to the respective differences between their Harmonised Index of Consumer Prices (HICP) inflation and average HICP inflation in the euro area. Conversely, relative wage growth differentials across euro area countries have been somewhat unrelated to relative productivity growth differentials. Some countries combine positive wage growth differentials and negative productivity growth differentials vis-à-vis the euro area average over an extended period – and hence positive unit labour cost growth differentials. These countries run the risk of accumulating competitiveness losses and it is therefore a challenge to ensure that the necessary adjustment mechanisms operate fully, in the sense that wage developments are sufficiently flexible and reflect productivity developments. Wage growth persistence within individual euro area countries – largely reflecting inflation persistence and certain institutional factors – might also have contributed somewhat to wage growth differentials across the euro area countries. Moreover, wage level convergence has also played a role in explaining wage growth patterns in the 1980s and the 1990s. However, since 1999, the link between the initial compensation level and the subsequent growth rate of compensation per employee appears barely significant. The study also shows a limited co-movement of wage growth across countries, even in the context of a high degree of business cycle synchronisation seen in the last few years. This suggests that the impact on wage growth of country-specific developments across euro area countries has been larger than the impact of common cyclical developments and external shocks. This could reflect the normal and desirable working of adjustment mechanisms, which – in an optimally functioning currency union with synchronised business cycles – would take place via price and cost and wage developments. On the other hand, structural impediments, for example a relatively low degree of openness in domestically-oriented sectors in some countries, might prevent a stronger link between the degree of synchronisation of wage growth rates and business cycles. JEL Classification: E24, E31, C10.
    Keywords: Cross-country wage dispersion, wage and productivity levels across countries and sectors.
    Date: 2008–07
  5. By: Marco Centoni (Dipartimento SEGES - Università del Molise); Gianluca Cubadda (Dipartimento SEFEMEQ - Università di Roma "Tor Vergata"); Alain Hecq (University of Maastricht)
    Abstract: This paper proposes an econometric framework to assess the importance of common shocks and common transmission mechanisms in generating international business cycles. Then we show how to decompose the cyclical effects of permanent-transitory shocks into those due to their domestic and those due to foreign components. Our empirical analysis reveals that the business cycles of the US, Japan, Canada are clearly dominated by their domestic components. The Euro area is more sensitive to foreign shocks compared to the other three countries of our analysis.
    Keywords: International business cycles; Permanent-transitory decomposition; Serial correlation common features; Frequency domain analysis.
    JEL: C32 E32
    Date: 2008–07–07
  6. By: Andrew Coleman (Motu Economic and Public Policy Research); Özer Karagedikli (Bank of England)
    Abstract: This paper examines the relative size of the effects of New Zealand monetary policy and macroeconomic data surprises on the spot exchange rate, 2 and 5 year swap rate differentials, and the synthetic forward exchange rate schedule. We find that the spot exchange rate and 5 year swap rates respond by a similar magnitude to monetary surprises, implying there is little response of the forward exchange rate to this type of news. In contrast, the spot exchange rate responds by nearly three times as much as 5 year interest rates to CPI and GDP surprises, implying that forward rates appreciate to higher than expected CPI or GDP news. This is in contrast to standard theoretical models and US evidence. Lastly, we show that exchange rates but not interest rates respond to current account news. The implications of these results for monetary policy are considered.
    Keywords: New Zealand, interest rates, exchange rates, news
    Date: 2008–06
  7. By: Taboga, Marco; Pericoli, Marcello
    Abstract: We introduce a two-country no-arbitrage term-structure model to analyse the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by the interactions between macroeconomic variables and time-varying bond risk premia. Estimating the model with US and German data, we obtain an excellent fit of the yield curves and we are able to account for up to 75 per cent of the variability of the exchange rate. We find that time-varying risk premia play a non-negligible role in exchange rate fluctuations, due to the fact that a currency tends to appreciate when risk premia on long-term bonds denominated in that currency rise. A number of other novel empirical findings emerge.
    Keywords: Bond risk premia;exchange rate;no-arbitrage
    JEL: E43 C01
    Date: 2008–06
  8. By: Yin-wong Cheung (University of California, Santa Cruz, USA, Hong Kong Institute for Monetary Research); Hiro Ito (Portland State University, Portland, USA)
    Abstract: We examine the empirical determinants of the demand for international reserves and compare the experiences of some Asian and Latin American economies. Our empirical results indicate that different vintages of the model of international reserves give different inferences about the appropriate level of international reserves. The developed and developing economies have equations of the demand for international reserves that are quite different from each other. Further, the Asian economies and the Latin American economies have different empirical determinants of the demand for international reserves. Our results highlight the complexity of evaluating whether an economy is holding an excessive or deficient level of international reserves ¨C the inference can be heavily dependent on the choice of a benchmark model. A direct comparison affirms the perception that the Asian economies tend to hold more international reserves than the Latin American economies.
    Keywords: Foreign Exchange Reserves, Macro Determinants, Financial Factors, Institutional Variables, Excessive Hoarding of International Reserves
    JEL: F31 F33 F34 F36
    Date: 2008–07
  9. By: John Weeks (Professor Emeritus, School of Oriental and African Studies, University of London)
    Abstract: This paper inspects the standard policy rule that under a flexible exchange rate regime with perfectly elastic capital flows monetary policy is effective and fiscal policy is not. The logical validity of the statement requires that the domestic price level effect of devaluation be ignored. The price level effect is noted in some textbooks, but not analysed. When it is subjected to a rigorous analysis, the interaction between exchange rate changes and domestic price level changes render the standard statement false. The logically correct statement would be, under a flexible exchange rate regime with perfectly elastic capital flows the effectiveness of monetary policy depends on the values of the import share and the sum of the trade elasticities. Monetary policy will be more effective than fiscal policy if and only if the sum of the trade elasticities exceeds the import share. Inspection of data from developing countries indicates a low effectiveness of monetary policy under flexible exchange rates. In the more general case of less than perfectly elastic capital flows, the conditions for monetary policy to be more effective than fiscal policy are even more restrictive. Use of empirical evidence on trade shares and interest rate differentials suggest that for most countries fiscal policy would prove more effective than monetary policy under a flexible exchange rate regime. In any case, the general theoretical assertion that monetary policy is more effective is incorrect. The results sustain the standard Keynesian conclusion that fiscal policy is more effective, whether the exchange rate is fixed or flexible. (...)
    Keywords: The Effectiveness of Monetary Policy Reconsidered
    Date: 2008–06
  10. By: von Hagen, Jurgen; Siedschlag, Iulia (Economic and Social Research Institute (ESRI))
    Abstract: The countries of Central and Eastern Europe went from being largely closed to being largely open to international capital flows. This paper discusses their experience with capital account liberalization and coping with large capital inflows. We start with a discussion of basic economic characteristics and the real convergence achieved so far, and then discuss the pace and sequencing of capital account liberalization and the degree of international financial integration over the past decade. We then analyze trends and patterns of capital inflows in these countries in recent years. These stylized facts are useful for understanding the macroeconomic implications and policy challenges of coping with large capital inflows, which we discuss next. Finally we conclude with policy implications for emerging Asian economies.
    JEL: E44 F36 F41
    Date: 2008–04
  11. By: Salazar, Eduardo
    Abstract: This paper tries to explain, using a model that includes asset market risk country, the behavior of nominal exchange rate, as well as determine the impact of this risk in determining the exchange rate, also seeks to establish whether the exchange rate is below the level predicted by their bases to determine whether they have to take steps to bring its level of long-term. The econometric methodology used is that of the ordinary least squares, the results are consistent with the logic and economic theory, it shows that among the country risk and exchange rate there is a direct relationship, namely that reductions of country risk generate currency appreciations, also shows evidence that the nominal exchange rate is below its equilibrium level.
    Keywords: Riesgo país; Tipo de Cambio Nomina; Modelos de mercado de activos; Tipo de cambio de equilibrio
    JEL: F42 F41 C22 F31
    Date: 2008–04–14
  12. By: Zafar, Sabahat; Butt, Muhammad Sabihuddin
    Abstract: Pakistan’s leading challenge today is to lessen its debt burden in order to pursue a path that leads towards sustainable and impartial growth for poverty diminution. The consequences of trade liberalization are of growing concern, mainly in the emerging economies with severe brim over effects on their debt situation. The major objective of this paper is to discuss the current external debt problem in Pakistan and analyze how its external debt is interrelated with trade liberalization policies and measures .Using data from the last three decades, this paper investigated whether there exist a momentous relationship between external debt and the trade liberalization variables or not. In this case study ARDL bounds testing approach is employed to investigate the long run relationships and Error Correction Method (ECM) for short run dynamics. After finding the order of integration through implementing the Augmented Dickey Fuller (ADF) and Phillips-Perron unit root tests, our finding suggested a significant long run positive association between external debt and trade liberalization is existed in case of Pakistan
    Keywords: External Debt; Trade Liberalization; ARDL Bounds Testing; Error Correction Method
    JEL: C32 F0 F43 H63
    Date: 2008–06–23
  13. By: António Portugal Duarte (GEMF and Faculdade de Economia, Universidade de Coimbra); João Sousa Andrade (GEMF and Faculty of Economics of the University of Coimbra); Adelaide Duarte (GEMF and Faculty of Economics of the University of Coimbra)
    Abstract: This work examines the participation of the Portuguese economy in the ERM of the EMS based on some of the main predictions of the target zone literature. The exchange rate distribution reveals that the majority of the observations lie close to the central parity, thus rejecting one of the key predictions of the Krugman (1991) model. Using a M-GARCH model however we confirm that there is a trade-off between exchange rate volatility and interest rates differential volatility. These results express the increased credibility of the Portuguese monetary policy, due manly to the modernisation of the banking and financial system and to the progress made in terms of the disinflation process under an exchange rate target zone policy. In accordance to these results we can say that the participation of the Portuguese escudo in an exchange rate target zone was crucial to create the conditions of stability, credibility and confidence necessary for the adoption of a single currency.
    Keywords: Credibility, Exchange rate stability, M-GARCH, ERM, EMS, Volatility and target zones
    JEL: C32 C51 F31 F41 G15
    Date: 2008
  14. By: Rabin Hattari (George Mason University); Ramkishen S. Rajan (George Mason University, Hong Kong Institute for Monetary Research)
    Abstract: Developing countries are rapidly emerging as new and important sources of foreign direct investment (FDI) to other developing countries. While Asian companies have become significant foreign direct investors abroad, a large share of outward investments from Asia appears to have been recycled intraregionally. However, unlike trade flows, there has been little to no detailed examination of FDI flows between Asian economies at a bilateral level. This paper uses bilateral FDI flows data to investigate trends and patterns of intra-Asian FDI flows over the period 1990 to 2005. It also employs an augmented gravity model framework to examine the main determinants of intra-Asian FDI flows. A range of drivers of FDI flows, including transactional and informational distance (proxied by distance), real sector variables, financial variables and institutional quality are examined.
    Keywords: Developing Asia, Distance, Foreign direct investment (FDI), Institutions, Intra-regional, Gravity model
    JEL: F21 F23 F36
    Date: 2008–11

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