nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2008‒11‒25
eighteen papers chosen by
Martin Berka
Massey University

  1. Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model By Malin Adolfson; Stefan Laséen; Jesper Lindé; Lars E.O. Svensson
  2. On Financial Markets Incompleteness, Price Stickiness, and Welfare in a Monetary Union ? By Stéphane Auray; Aurélien Eyquem
  3. Does Real Exchange Rate Volatility Affect Sectoral Trade Flows?. By Mustafa Caglayan; Jing Di
  4. Budgetary and External Imbalances Relationship : a Panel Data Diagnostic By António Afonso; Christophe Rault
  5. Can Exchange Rates Forecast Commodity Prices? By Yu-chin Chen; Kenneth Rogoff; Barbara Rossi
  6. Prices and output co-movements : an empirical investigation for the CEECs. By Iuliana Matei
  7. China's Exports and the Oil Price By Joao Ricardo Faria; Andre Varella Mollick; Pedro H. Albuquerque; Miguel Leon-Ledesma
  8. Impact of exchange rate shock on prices of imports and exports By Duasa, Jarita
  9. Technological Change and the Wealth of Nations By Gino Gancia; Fabrizio Zilibotti
  10. Monetary Policy Design under Imperfect Knowledge: An Open Economy Analysis By Yu-chin Chen; Pisut Kulthanavit
  11. Domestic debt structures in emerging markets : new empirical evidence. By Arnaud Mehl; Julien Reynaud
  12. Imbalances in China and U.S. Capital Flows By Tatom, John
  14. Uncertainty, Trade Integration and the Optimal Level of Protection in a Ricardian Model with a Continuum of Goods By Michele Di Maio
  15. Openness, imported commodities and the Phillips Curve By Andrew Pickering; Hector Valle
  16. The Structure of Protection and Growth in the Late 19th Century By Sibylle H. Lehmann; Kevin H. O'Rourke
  17. Employment Adjustments in High-Trade-Exposed Manufacturing in Canada By Serge Coulombe
  18. An International Rule System to Avoid Financial Instability By Horst Siebert

  1. By: Malin Adolfson; Stefan Laséen; Jesper Lindé; Lars E.O. Svensson
    Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.
    JEL: E52 E58 F33 F41
    Date: 2008–11
  2. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Aurélien Eyquem (GATE, UMR 5824, Université de Lyon and Ecole Normale Supérieure Lettres et Sciences Humaines, France)
    Abstract: The paper builds a two-country model of a monetary union with home bias and price stickiness. Incompleteness of financial asset markets is allowed. In this environment, we derive the solution for optimal behavior by the monetary policymaker and show that welfare can be higher under incomplete markets than under complete markets. The argument is a second- best one. In a monetary union with equal nominal rigidity across countries, optimal monetary policy stabilizes aggregate, union-wide inflation, but cannot fully stabilize the country-level inflation rates. Market incompleteness results in less volatility of the terms of trade (because part of the adjustment goes through the current account), and hence less volatile national inflation rates. Through this channel, welfare ends up being higher under incomplete markets. These results are also robust when nominal rigidity differs across countries and when the form of the monetary policy is modified.
    Keywords: monetary union, asymmetric shocks, financial market incompleteness, price stickiness, welfare
    JEL: E51 E58 F36 F41
    Date: 2008
  3. By: Mustafa Caglayan; Jing Di (Department of Economics, The University of Sheffield)
    Abstract: This paper investigates empirically the effect of real exchange rate volatility on sectoral bilateral trade flows between the US and her top thirteen trading countries. Our investigation also considers those effects on trade flows which may arise through changes in income volatility and the interaction between income and exchange rate volatilities. We provide evidence that exchange rate volatility mainly affects sectoral trade flows of developing but not that of developed countries. We also find that the effect of the interaction term on trade flows is opposite that of exchange rate volatility yet there is little impact arising from income volatility.
    Keywords: exchange rates, volatility, trade flows.
    JEL: F17 F31 C22
    Date: 2008–09
  4. By: António Afonso; Christophe Rault
    Abstract: We assess the cointegration relationship between current account and budget balances, and effective real exchange rates, using recent bootstrap panel cointegration techniques and SUR methods. We investigate the magnitude of the relationship between the two imbalances for each country for the period 1970-2007, and for different EU and OECD country groupings. The panel cointegration tests used allow for within and between correlation, while the SUR results show both positive and negative effects of budget balances on current account balances for several countries. The magnitude of the effects varies across countries, and there is no evidence pointing to a direct and close relationship between budgetary and current account balances.
    Keywords: budget balance; external balance; EU; panel cointegration.
    JEL: C23 E62 F32 H62
    Date: 2008–10
  5. By: Yu-chin Chen (University of Washington); Kenneth Rogoff (Harvard University); Barbara Rossi (Duke University)
    Abstract: This paper demonstrates that “commodity currency” exchange rates have remarkably robust power in predicting future global commodity prices, both in-sample and out-of-sample. A critical element of our in-sample approach is to allow for structural breaks, endemic to empirical exchange rate models, by implementing the approach of Rossi (2005b). Aside from its practical implications, our forecasting results provide perhaps the most convincing evidence to date that the exchange rate depends on the present value of identifiable exogenous fundamentals. We also find that the reverse relationship holds; that is, that commodity prices Granger-cause exchange rates. However, consistent with the vast post-Meese-Rogoff (1983a,b) literature on forecasting exchange rates, we find that the reverse forecasting regression does not survive out-of-sample testing. We argue, however, that it is quite plausible that exchange rates will be better predictors of exogenous commodity prices than vice-versa, because the exchange rate is fundamentally forward looking. Therefore, following Campbell and Shiller (1987) and Engel and West (2005), the exchange rate is likely to embody important information about future commodity price movements well beyond what econometricians can capture with simple time series models. In contrast, prices for most commodities are extremely sensitive to small shocks to current demand and supply, and are therefore likely to be less forward looking. J.E.L. Codes: C52, C53, F31, F47. Key words: Exchange rates, forecasting, commodity prices, random walk. Acknowledgements. We would like to thank C. Burnside, C. Engel, M. McCracken, R. Startz, V. Stavreklava, A. Tarozzi, M. Yogo and seminar participants at the University of Washington for comments. We are also grateful to various staff members of the Reserve Bank of Australia, the Bank of Canada, the Reserve Bank of New Zealand, and the IMF for helpful discussions and for providing some of the data used in this paper.
    Date: 2008–02
  6. By: Iuliana Matei (Centre d'Economie de la Sorbonne)
    Abstract: This article studies the features of co-movements of prices and production between six CEECs recently joined the EU and the euro zone. More precisely, based partially on the methodology suggested by Alesina, Barro and Tenreyro [2002], we evaluate the size and the persistence of prices and outputs shocks between each CEECs and euro zone. Results will contribute to the debate around the participation of the new members to the EMU.
    Keywords: European monetary integration, co-movements, AR models, CEECs.
    JEL: C22 E30 F33 F42 F47
    Date: 2008–10
  7. By: Joao Ricardo Faria; Andre Varella Mollick; Pedro H. Albuquerque; Miguel Leon-Ledesma
    Abstract: The increase in oil prices in recent years has occurred concurrently with a rapid expansion of Chinese exports in the world markets, despite China being an oil importing country. In this paper we develop a theoretical model that explains the positive correlation between Chinese exports and the oil price. The model shows that Chinese growth can lead to an increase in oil prices that has a stronger impact on its export competitors. This is due to the large labor force surplus of China. We then examine this hypothesis by estimating a reduced form equation for Chinese exports using Rodrik (2006)’s measure of export competitiveness, together with the oil price, productivity, real exchange rate, and foreign industrial production over the monthly 1992-2005 period. The results suggest a stable relationship and yields slightly positive values for the price of oil and elastic coefficients for export competitiveness, along with the expected negative elasticity for the real exchange rate.
    Keywords: China; Oil prices; Competitiveness; Exports; Productivity
    JEL: F14 F43
    Date: 2008–11
  8. By: Duasa, Jarita
    Abstract: This study examines the significant impact of exchange rate shock on prices of Malaysian imports and exports. In methodology, the study adopts vector error correction (VECM) model using monthly data of nominal exchange rates, money supply, prices of imports and prices of exports covering the period of M1:1999 to M12:2006. For further analysis, we adopt an innovation accounting by simulating variance decompositions (VDC) and impulse response functions (IRF). VDC and IRF serve as tools for evaluating the dynamic interactions and strength of causal relations among variables in the system. In fact, IRF is used to calculate the exchange rate pass-through on import prices and export prices. The findings indicate that, while the exchange rate shock is significantly affect the fluctuation of import prices, the degree of pass-through is incomplete.
    Keywords: Import prices; Export prices; VECM; Impulse Response; Variance Decomposition.
    JEL: E30 C22 F31
    Date: 2008
  9. By: Gino Gancia; Fabrizio Zilibotti
    Abstract: We discuss a unified theory of directed technological change and technology adoption that can shed light on the causes of persistent productivity differences across countries. In our model, new technologies are designed in advanced countries and diffuse endogenously to less developed countries. Our framework is rich enough to highlight three broad reasons for productivity differences: inappropriate technologies, policy-induced barriers to technology adoption, and within-country misallocations across sectors due to policy distortions. We also discuss the effects of two aspects of globalization, trade in goods and migration, on the wealth of nations through their impact on the direction of technical progress. By doing so, we illustrate some of the equalizing and unequalizing forces of globalization.
    Keywords: Barriers to Technology Adoption, Directed Technology Adoption, Endogenous Growth, Globalization, Human Capital, Inappropriate Technologies, Market Power, Political Economy, Skill-biased Technical Chan
    JEL: F43 O11 O31 O33 O38 O41 O43 O47
    Date: 2008–10
  10. By: Yu-chin Chen (University of Washington); Pisut Kulthanavit (University of Washington)
    Abstract: This paper incorporates adaptive learning into a standard New-Keynesian open economy dynamic stochastic general equilibrium (DSGE) model and analyze under what conditions policymakers should target domestic producer price inflation (DI) versus consumer price inflation (CI). Our goal is to examine how monetary policy rules should adjust when agents’ information sets deviate from those assumed under the rational expectation paradigm. When agents form expectations using an adaptive learning mechanism, even though the central bank has no informational advantage, monetary policy can nonetheless facilitate the learning process and thus mitigate distortions associated with imperfect knowledge. We assume the policy-maker follows a forwardlooking Taylor rule and focus on analyzing the interplay between the source of the dominant shock and the extent of knowledge imperfection. We find that when agents have very limited knowledge and have to learn the dynamics governing both the relevant economic indicators and the underlying structural shocks, a DI targeting rule introduces fewer forecast errors and is better at stabilizing the economy. However, when agents can observe contemporaneous shocks and need only learn how key economic variables evolve (a situation akin to a post-structural-shift economy), targeting away from the dominant shocks helps anchor expectations and improve welfare. A CI target can then become the preferred policy rule when the economy is subject to large domestic shocks.
    Date: 2008–05
  11. By: Arnaud Mehl (European Central Bank); Julien Reynaud (European Central Bank et Centre d'Economie de la Sorbonne)
    Abstract: This paper explains why public domestic debt composition in emerging economies can be risky, namely in foreign currency, with a short maturity or indexed. It analyses empirically the determinants of these risk sources separately, developing a new large dataset compiled from national sources for 33 emerging economies over 1994-2006. The paper finds that economic size, the breadth of the domestic investor base, inflation and fiscal soundness are all associated with risky public domestic debt compositions, yet to an extent that varies considerably in terms of magnitude and significance across sources of risk. Only inflation impacts all types of risky debt, underscoring the overarching importance of monetary credibility to make domestic debt compositions in emerging economies safer. Given local bond markets' rapid development, monitoring risky public domestic debt compositions in emerging economies becomes increasingly relevant to global financial stability.
    Keywords: Public domestic debt, composition, risk, emerging economies.
    JEL: F34 F41 G15
    Date: 2008–10
  12. By: Tatom, John
    Abstract: China’s major imbalances include trade and capital account surpluses and a large annual build-up of international reserves. China has a capital account surplus reinforcing the accumulation of foreign exchange reserves, mainly U.S. dollar-denominated assets. Usually, a sustainable fixed or floating exchange rate system requires that a country with a large current account surplus run a capital account deficit. The U.S. is widely criticized for having a comparable trade deficit that mirrors, to a large extent, China’s surplus and for its dependence on large capital inflows including from China. There is political pressure for protectionism and for China to implement wasteful economic policies to reduce the surplus. Negative consequences of China’s imbalances include the build-up of large, low-return foreign exchange, leading to rapid growth in money and credit and to a sharp acceleration in inflation. Moreover, efforts to offset money growth and inflation have deepened inefficiencies in the financial system, which China had hoped to remedy by its efforts to recapitalize and list its banks’ equities on stock exchanges. China could eliminate these imbalances by policies that would reduce growth. One solution is to lift restrictions on capital outflows, allowing households and business to diversify their wealth holdings and realize higher returns and/or less volatility in their income and wealth. This would transform future asset growth to holdings of higher return, lower risk assets abroad and also would eliminate pressures on the People’s Bank of China, allowing for more rapid deregulation of banks, slower money and credit growth and lower inflation. The U.S. is already adjusting to these imbalances as the current account deficit began to decline in 2005 and the dollar has fallen dramatically. Unfortunately, such adverse developments are coming from political pressures to raise taxes, especially on capital resources income, and from protectionist policies, both of which are slowing growth in the U.S.
    Keywords: Capital account imbalance; capital controls and banking inefficiencies; capital outflows and financial development; exchange rate management; banking regulation
    JEL: F42 E58 G15
    Date: 2008–09
  13. By: Kerkela, Leena
    Abstract: In this paper, the welfare results in trade liberalisation scenarios in global CGE models (like GTAP) are analysed. The default modeling strategy in trade is the Armington assumption with bilateral trade flows in industries. The negative terms of trade effects that often dominate the negative welfare outcome in simulation experiments are decomposed to imports and exports price effects. The numerical examples show that even in unilateral liberalisation with decreasing import tariffs, the welfare effects are dominated by domestic price level changes that also drive the exports prices. The numerical examples are built around simple GTAP tariff cut experiments with 3x3 country and commodity aggregation. The inherent feature in this type of models is that they support arguments for unilateral market access, like preferences, at the expense of multilateral trade liberalisation.
    Keywords: CGE Modeling, trade liberalisation, terms of trade, International Relations/Trade, Research Methods/ Statistical Methods,
    Date: 2008
  14. By: Michele Di Maio (University of Macerata)
    Abstract: <p>This paper analyzes how increasing trade integration affects individual utility when the international specialization pattern is stochastic, i.e. when the number of varieties each country produces depends on the realization of a random variable. I employ a Ricardian continuum of goods model to show that in this case a trade off emerges. As in the standard model, higher trade integration reduces prices and increases expected real income. However, higher trade integration, reducing the number of active sectors in the economy, also increases the displacement cost the worker would suffer in a bad state (i.e. when the sector she is employed into has to close down because, ex-post, the foreign country’s competing sector results to be more efficient). The main result of the model is that there exists an optimal level of protection that it is higher the smaller the price reduction induced by trade integration and the more technologically similar are countries.</p>
    Keywords: Trade Intergration,Ricardian Model with a continuum of goods,Optimal protection,Uncertainty
    JEL: O1 O11
    Date: 2006–10
  15. By: Andrew Pickering; Hector Valle
    Abstract: This paper derives a Phillips curve with imported commodities as an additional input in the production process. Given greater reliance on exogenously priced imported commodities in production then changes in output lead to a reduced impact on marginal costs and prices. The Phillips curve becomes flatter relative to the bench-mark New Keynesian case. Empirical evidence supports the hypothesis that greater imported commodity intensity in production increases the sacrifice ratio. Econometrically controlling for imported commodity intensity also doubles the explanatory power of openness in determining the sacrifice ratio, as conjectured by Romer (1993).
    Keywords: openness, imported commodities, sacrifice ratio
    JEL: E31 E32 F41
    Date: 2008–10
  16. By: Sibylle H. Lehmann; Kevin H. O'Rourke
    Abstract: Many papers have explored the relationship between average tariff rates and economic growth, when theory suggests that the structure of protection is what should matter. We therefore explore the relationship between economic growth and agricultural tariffs, industrial tariffs, and revenue tariffs, for a sample of relatively well-developed countries between 1875 and 1913. Industrial tariffs were positively correlated with growth. Agricultural tariffs were negatively correlated with growth, although the relationship was often statistically insignificant at conventional levels. There was no relationship between revenue tariffs and growth.
    JEL: F13 F43 N10 N70 O49
    Date: 2008–11
  17. By: Serge Coulombe (Department of Economics, University of Ottawa)
    Abstract: The study presents a model and estimates the dynamic response of employment in high-trade-exposed manufacturing to the Canadian dollar’s appreciation. The evolution of employment shares of high-trade-exposed manufacturing for the 10 provinces from 1987 to 2006 is captured using a general error correction model. This model is estimated using state-of-the-art time-series–cross-sectional (TSCS) data econometrics. The main finding of the study is that a substantial part of the adjustment to the Canadian dollar’s appreciation since 2002 had already been completed in Canadian high-trade-exposed manufacturing industries by July 2007. However, simulation results suggest further employment losses in these industries if the value of the Canadian dollar remains around US$0.95. The reason for these further losses is that employment share does not adjust immediately to movements in the exchange rate. Estimates from the models indicate that between 60 percent and 70 percent of the adjustment to exchange rate movements is completed after two years. Consequently, most of the adjustment that still needs to be done results from the appreciation of the Canadian dollar thus far in 2007. The results also suggest that the effect of movements in the real exchange rate on employment in high-trade-exposed manufacturing is highly heterogeneous across provinces. Not surprisingly, the results suggest that the effect would be greater and particularly significant in Quebec and Ontario. If the dollar remains around US$0.95, simulation results suggest that the proportion of the adjustment that still needs to be done (July 2007) is less in Quebec (between 18 percent and 26 percent) and Ontario (between 27 percent and 33 percent) than in Canada as a whole (between 30 percent and 36 percent). If the Canadian dollar remains at or around parity with the U.S. dollar, the proportion of the adjustment still remaining increases to the 31 percent and 37 percent range for Quebec, 39 percent and 43 percent range for Ontario, and 42 percent and 46 percent range for Canada as a whole. There is a considerable amount of risk involved in simulation exercises of this type. The risks are related to uncertainty regarding the future evolution of two key variables of the models: the value of the Canadian dollar, and the evolution of the U.S. economy. Risk also results from model uncertainty.
    Keywords: Exchange rate, labor market adjustments, Dutch disease, Kiviet adjustment, Canadian provinces
    JEL: C5 F41 R1 R5
    Date: 2008
  18. By: Horst Siebert
    Abstract: In a series of summits, leading countries of the world will meet to draw up an in¬ternational arrangement for financial stability. Such a rule system should prevent a financial crisis as we have seen it in 2007 and 2008. It should include appropriate principles of mone¬tary policy, rules for financial soundness and agreements on the role of prudent regulation. The paper discusses the lessons from the subprime crisis, failures of regulation, crisis man¬agement in the US and in the EU and considers the problems that have to be solved by an in¬ternational rule system
    Keywords: Financial instability, lessons from the subprime crisis, failures of regulation, crisis management, elements of an international rule system, role of the IMF; climate change, financial crises, the world trading system, oil supplies, immigration
    JEL: E2 E3 E5 F02 F33 F37 F4 F5 G2 P00
    Date: 2008–11

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