nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2008‒08‒31
fifteen papers chosen by
Martin Berka
Massey University

  1. Estimation of De Facto Exchange Rate Regimes: Synthesis of The Techniques for Inferring Flexibility and Basket Weights By Frankel, Jeffrey; Wei, Shang-Jin
  2. Capital Account Liberalization: Theory, Evidence, and Speculation By Henry, Peter B.
  3. The Impact of Trade on Aggregate Productivity and Welfare with Heterogeneous Firms and Business Cycle Uncertainty By Jang Ping Thia
  4. Capital Account Liberalization, Real Wages, and Productivity By Henry, Peter B.; Sasson, Diego
  5. Productivity, Preferences and UIP Deviations in an Open Economy Business Cycle Model By Jagjit S. Chadha
  6. How hard can it be? Inflation control around the world By Thórarinn G. Pétursson
  7. Transmission of business cycle shocks between the US and the euro area. By Martin Schneider; Gerhard Fenz
  8. Imperfect exchange rate pass-through : the role of distribution services and variable demand elasticity By Philippe Jeanfils
  9. Managing capital flows: The case of India. By Shah, Ajay; Patnaik, Ila
  10. International Portfolio Allocation and Income Smoothing: Evidence from Recent Changes in Euro Region. By Balli, Faruk; Louis, Rosmy J.; Osman, Mohammad
  11. Enlarging the EMU to the East: What Effects on Trade? By Belke, Ansgar; Spies, Julia
  12. Relative Factor Endowments and International Portfolio Choice By Alejandro Cuñat; Christian Fons-Rosen
  13. The Euro Changeover in the Slovak Republic: Implications for Inflation and Interest Rates By Felix Hüfner; Isabell Koske
  14. The Balance of Payments as a Constraint on Turkey’s Growth: 1960-2004 By Secil Pacaci Elitok; Al Campbell
  15. Foreign Currency Exposure and Hedging: Evidence from Foreign Acquisitions By Bartram, Söhnke M.; Burns, Natasha; Helwege, Jean

  1. By: Frankel, Jeffrey (Harvard U); Wei, Shang-Jin (Columbia U)
    Abstract: The paper offers a new approach to estimate de facto exchange rate regimes, a synthesis of two techniques. One is a technique that the authors have used in the past to estimate implicit de facto weights when the hypothesis is a basket peg with little flexibility. The second is a technique used by others to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency, but with a possibly-substantial degree of flexibility around that anchor. Since many currencies today follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. We try out the technique on twenty-some currencies, over the period 1980-2007. Most are currencies that have officially used baskets as anchors for at least part of this sample period. But a few are known floaters or known simple peggers. In general the synthesis technique seems to work as it should.
    JEL: F31
    Date: 2008–05
  2. By: Henry, Peter B. (Henry, Peter B.)
    Abstract: Research on the macroeconomic impact of capital account liberalization finds few, if any, robust effects of liberalization on real variables. In contrast to the prevailing wisdom, I argue that the textbook theory of liberalization holds up quite well to a critical reading of this literature. The lion’s share of papers that find no effect of liberalization on real variables tell us nothing about the empirical validity of the theory, because they do not really test it. This paper explains why it is that most studies do not really address the theory they set out to test. It also discusses what is necessary to test the theory and examines papers that have done so. Studies that actually test the theory show that liberalization has significant effects on the cost of capital, investment, and economic growth.
    Date: 2007–08
  3. By: Jang Ping Thia
    Abstract: This paper presents a model with monopolistic competition, productively heterogeneousfirms, and business cycle aggregate shocks. With firm-specific productive heterogeneity,weaker firms quit when faced with a negative aggregate shock. Consequently, trade does notalways increase firm-level aggregate productivity as negative shocks on the home market canbe compensated for by positive shocks elsewhere. Weaker firms, which would otherwise quitin autarky, can continue to operate by exporting. Despite this, trade can still improve welfarefor risk-averse consumers by reducing aggregate price fluctuations.
    Keywords: Firm Heterogeneity, Globalisation, Business Cycles
    JEL: F4 F12
    Date: 2008–07
  4. By: Henry, Peter B. (Stanford U); Sasson, Diego
    Abstract: For three years after the typical developing country opens its stock market to inflows of foreign capital, the average annual growth rate of the real wage in the manufacturing sector increases by a factor of seven. No such increase occurs in a control group of developing countries. The temporary increase in the growth rate of the real wage permanently drives up the level of average annual compensation for each worker in the sample by 752 US dollars—an increase equal to more than a quarter of their annual pre-liberalization salary. The increase in the growth rate of labor productivity in the aftermath of liberalization exceeds the increase in the growth rate of the real wage so that the increase in workers’ incomes actually coincides with a rise in manufacturing sector profitability.
    Date: 2008–02
  5. By: Jagjit S. Chadha
    Abstract: We show that a flex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.
    Keywords: current account dynamics; real exchange rates; incomplete markets; financial frictions
    JEL: E32 F32 F41
    Date: 2008–08
  6. By: Thórarinn G. Pétursson
    Abstract: During the last two decades, the level and variability of inflation has declined across the world. Some countries have, however, had more success in controlling inflation than others, and the fact is that these countries are usually the same countries that have been more successful over longer periods. The focus of this paper is to try to understand what factors explain this difference in inflation performance and, in particular, why inflation turns out to be more volatile in very small, open economies and in emerging and developing countries than in the large and more developed ones. Using a country sample of 42 of the most developed countries in the world spanning the period 1985-2005, the results suggest three main explanations: the volatility of currency risk premiums, the degree of exchange rate pass-through to inflation, and the size of monetary policy shocks. These three variables explain about three-quarters of the cross-country variation in inflation volatility. The results are found to be robust to changes in the country sample and to different estimation methods. In particular, they do not seem to arise because of reverse causality due to possible endogeneity of the explanatory variables.
    Date: 2008–08
  7. By: Martin Schneider (Oesterreichische Nationalbank, Economic Analysis Division, P.O. Box 61, A-1010 Vienna,); Gerhard Fenz (Oesterreichische Nationalbank, Economic Analysis Division, P.O. Box 61, A-1010 Vienna,)
    Abstract: We analyze the transmission of structural shocks between the US and the euro area within a two-country VAR framework. For that purpose, we simultaneously identify cost-push, demand and monetary policy shocks for both countries using sign restrictions. Our results show that domestic shocks explain the largest share of the forecast error variances for GDP, consumer prices and the interest rate in both countries in the short run, whilst spillovers from the other country and global factors gain importance in the medium run. The strength of the shock transmission between the two countries is quite symmetric. Our approach to the identification of structural shocks allows us to construct confidence bands that account both for estimation and identification uncertainty. We find impulse responses to domestic shocks to be significant while spillovers across countries are insignificant.
    Keywords: VAR, shock transmission, sign restrictions, Metropolis-Hastings, confidence intervals, bootstrap.
    JEL: C32 E37 E40
    Date: 2008–07–21
  8. By: Philippe Jeanfils (National Bank of Belgium, Research Department)
    Abstract: This paper examines which mechanisms are likely to dampen the price pressures in the wake of exchange rate movements. In addition to nominal frictions frequently used in sticky-price models, it jointly introduces two features that have hitherto been considered separately in the existing literature, i.e. a variable demand elasticity à la Kimball (1995) and distribution services in the form of non-traded goods as in Corsetti and Dedola (2005). The paper explores the respective role of each feature and assesses the quantitative importance of these theoretical explanations for the exchange rate pass-through to a broad range of prices as well as for the real exchange rate and for the trade balance. Segmentation of national markets through distribution services and imperfect competition with variable mark-ups are important for accounting for the observed stability of import prices "at the border". Hence, these mechanisms help to explain the observed stability of import prices in local currency with realistic durations of price contracts.
    Keywords: exchange rate pass-through, general equilibrium
    JEL: F3 F4
    Date: 2008–08
  9. By: Shah, Ajay (National Institute of Public Finance and Policy); Patnaik, Ila (National Institute of Public Finance and Policy)
    Abstract: From the early 1990s, India embarked on easing capital controls. Liberalization emphasised openness towards equity flows, both FDI and portfolio flows. In particular, there are few barriers in the face of portfolio equity flows. In recent years, a massive increase in the value of foreign ownership of Indian equities has come about, largely reflecting improvements in the size, liquidity and corporate governance of Indian firms. While the system of capital controls appears formidable, the de facto openness on the ground is greater than is apparent, particularly because of the substantial enlargement of the current account. These changes to capital account openness were not accompanied by commensurate monetary policy reform. The monetary policy regime has consisted essentially of a pegged exchange rate to the US dollar throughout. Increasing openness on the capital account, coupled with exchange rate pegging, has led to a substantial loss of monetary policy autonomy. The logical way forward now consists of bringing the de jure capital controls uptodate with the de facto convertibility, and embarking on reforms of the monetary policy framework so as to shift the focus of monetary policy away from the exchange rate to domestic inflation.
    Keywords: International investment ; Long term capital movements ; International lending and debt problems ; Monetary sysytems
    JEL: F21 F34 E42
    Date: 2008–05
  10. By: Balli, Faruk; Louis, Rosmy J.; Osman, Mohammad
    Abstract: In this paper, we make two contributions to the literature. First, we construct a new measurement to capture income smoothing effectively. Second, we present new empirical evidence on the linkages between international asset trading and income smoothing. We use factor income inflows instead of the commonly used net factor income and arrive at results, among others, similar to previous studies in the literature: (a) risk sharing and equity portfolio home bias are strongly correlated for EU members; and (b) Specialization in output plays a significant role in income smoothing. Our findings also confirm that the increased level of economic integration witnessed in the Euro area as a result of the monetary union fosters output specialization across EU members and leads to asymmetric output fluctuations. Cross-border financial assets’ trading within the Euro Area, though smaller in comparison to the overall OECD block, serves as a shock absorber as factor income flows to smooth domestic consumption and income. However, although we have observed a decrease in home bias for OECD members, we could not find any evidence of higher income smoothing as a result.
    Keywords: Capital Market Integration; Euro Portfolio Bias; Income Smoothing
    JEL: G11 F41
    Date: 2008–08–02
  11. By: Belke, Ansgar (University of Duisburg-Essen); Spies, Julia (Institut für Angewandte Wirtschaftsforschung (IAW))
    Abstract: The purpose of this paper is to assess the implications of the Economic and Monetary Union (EMU) accession of eight Central and Eastern European Countries (CEECs) on their share in EMU-12 imports. Overcoming biases related to endogeneity, omitted variables and sample selection, our results indicate that the common currency has boosted intra-EMU imports by 7%. Under the assumption that the same relationship between the explanatory variables and imports will hold for EMU-CEEC trade, we are able to predict the future impact of the Euro. Our findings suggest that except for the least integrated countries, Poland, Latvia and Lithuania, all CEECs can expect increases in the EMU-12 import share.
    Keywords: Central and Eastern European countries, Euro area enlargement, gravity model, panel estimation
    JEL: F15 F41
    Date: 2008–08
  12. By: Alejandro Cuñat; Christian Fons-Rosen
    Abstract: This paper presents a model of international portfolio choice based on cross-country differences inrelative factor abundance. Countries have varying degrees of similarity in their factor endowmentratios, and are subject to aggregate productivity shocks. Risk averse consumers can insure againstthese shocks by investing their wealth at home and abroad. In a many-good setup, the change inrelative prices after a positive shock in a particular country provides insurance to countries that havedissimilar factor endowment ratios, but is bad news for countries with similar factor endowmentratios, since their incomes will worsen. Therefore countries with similar relative factor endowmentshave a stronger incentive to invest in one another for insurance purposes than countries withdissimilar endowments. Empirical evidence linking bilateral international investment positions to aproxy for relative factor endowments supports our theory: the similarity of host and source countriesin their relative capital-labor ratios has a positive effect on the source country's investment position inthe host country. The effect of similarity is enhanced by the size of host countries as predicted by thetheory.
    Keywords: international portfolio equity investment, gravity equation, factor endowments
    JEL: F21 F34 G11
    Date: 2008–07
  13. By: Felix Hüfner; Isabell Koske
    Abstract: In January 2009, the Slovak Republic will adopt the euro and become the 16th member of the euro area. This paper investigates the implications of euro adoption in the Slovak Republic for inflation and interest rates with an attempt to quantify their likely size as well as their consequences for the general public. The empirical analysis – which makes use of the experience of the first-wave euro area countries – suggests that the cash changeover will most likely be associated with a moderate increase in consumer prices, estimated at around 0.3%. Policy measures to reduce this effect include public information campaigns, the conversion of publicly administered prices with the exact conversion rate and the reduction of administrative obstacles to increase supply. The minor purchasing power losses associated with this price increase will not be evenly distributed across the population with higher income households and families with children expected to be harder hit than others. Even though the exchange rate vis-à-vis the euro area will be irrevocably fixed, past appreciations of the koruna are still likely to pass-through to some downward pressure on consumer prices, with the cumulative effect estimated to amount to around 1.5% up to mid-2009. In the longer run, the Balassa-Samuelson effect and other factors affecting catch-up economies may raise the Slovak inflation rate above the euro area level. As capital markets have already fully priced in euro membership, no immediate effect on short- and long-term interest rates in the wholesale markets is to be expected for January 2009. In the longer run, euro adoption can be expected to foster financial integration, thereby leading to a convergence of Slovak retail interest rates towards euro area levels. This reduction in retail interest rates will benefit the general public with mortgage borrowers likely to reap the largest benefits. A potential risk of low real interest rates is the emergence of a boom-bust cycle; prudent fiscal policy and further structural reforms, including enhanced competition, would help to counter any such developments. <P>L’adoption de l’euro par la République slovaque : les implications pour l’inflation et les taux d’intérêt <BR>En janvier 2009, la République slovaque adoptera l'euro et deviendra le 16ème membre de la zone euro. Ce document examine les implications de l'adoption de l'euro dans la République slovaque pour l'inflation et les taux d'intérêt avec une tentative d'évaluer quantitativement leur taille probable aussi bien que leurs conséquences pour la population. L'analyse empirique – qui se sert de l'expérience des pays de la zone euro de la première vague – suggère que le changement des liquidités soit très probablement associé à une augmentation modérée des prix à la consommation, estimée à peu près à 0.3 %. Les mesures politiques pour réduire cet effet incluent des campagnes publiques d'information, la conversion des prix publiquement administrés avec le taux de conversion exact et la réduction d'obstacles administratifs pour augmenter l’offre. Les pertes de pouvoir d'achat mineures associées à cette augmentation des prix ne seront pas également distribuées à travers la population; les ménages aux revenus plus élevés et les familles avec des enfants pourraient être frappés plus durement que les autres. Bien que le taux de change vis-à-vis de la zone euro soit irrévocablement fixé, les appréciations passées de la couronne slovaque pourraient encore se répercuter sur les prix à la consommation; l'effet cumulatif des effets retardés est évalué à environ 1½ pour cent jusqu'au milieu de 2009. À plus long terme, l'effet Balassa-Samuelson et d'autres facteurs affectant des économies en rattrapage peuvent accroître l'inflation slovaque au-dessus du niveau de la zone euro. Comme les marchés financiers ont déjà entièrement tenu compte de l'adhésion de l'euro, aucun effet immédiat sur les taux d'intérêt de grande clientèle à court terme ou à long terme n’est attendu pour janvier 2009. À plus long terme, on peut s'attendre à ce que l'adoption de l'euro favorise l'intégration financière, menant ainsi à une convergence des taux d'intérêt aux particuliers vers les niveaux de la zone euro. Cette réduction de taux d'intérêt aux particuliers profitera au grand public avec des emprunteurs hypothécaires récoltant probablement les plus grands avantages. Un risque potentiel lié aux taux d'intérêt réels bas est l'apparition d’une phase d’essor suivie d’une récession ; une politique fiscale prudente et des nouvelles réformes structurelles, y compris l’amélioration de la compétitivité, aideraient à résister à de tels développements.
    Keywords: Slovak Republic, République slovaque, inflation, inflation, interest rate, taux d'intérêt, euro changeover, adoption de l’euro
    JEL: E31 E43 F36
    Date: 2008–08–12
  14. By: Secil Pacaci Elitok; Al Campbell
    Abstract: The aim of this study is to test the existence of balance of a payments constraint on the long run economic growth of the Turkish economy. The balance of payments constrained growth (BPCG) model which was developed by Thirlwall (1979) and extended by Thirlwall and Hussain (1982) is tested over the period of 1960-2004 using OLS. Empirical findings of this paper support the BPCG model for the whole period under consideration. For the different sub-periods, there are either different essential economic relations or behaviors behind the BOP constraint.
    Keywords: Balance of payments constraint, Turkey, economic growth, international trade, elasticity, neo-liberalism
    JEL: F14 F15 F41 F43 E12
    Date: 2008
  15. By: Bartram, Söhnke M.; Burns, Natasha; Helwege, Jean
    Abstract: Previous research on the impact of currency risk on stock returns has failed to find a significant role for foreign exchange rates. This paper addresses several explanations of this finding with a unique dataset of U.S. firms that acquire targets in other countries. The dataset allows estimation of the impact of exchange rates using firm-specific bilateral exchange rates and a time period over which underlying exposure is known to significantly change. We also relate the change in exposure from before to after the acquisition to various characteristics of the acquirer, such as its presence in the target country prior to the deal and its hedging activities, and characteristics of the target, such as the exposure of the target prior to the deal. The results suggest that identifying a relevant exchange rate can be an important consideration in studying the impact of exchange rate risk on stock returns, but identifying financial hedging information is not. Further, foreign targets often provide operational hedging benefits to the U.S. acquirers, as exposure estimates are significantly affected by the acquisition.
    Keywords: Exchange rates; exposure; hedging; derivatives; mergers; acquisitions
    JEL: F4 F3 G3
    Date: 2007–04–01

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