nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2009‒02‒07
twelve papers chosen by
Martin Berka
Massey University

  1. Should Eastern European Countries Join the Euro? A Review and Update of Trade Estimates and Consideration of Endogenous OCA Criteria By Frankel, Jeffrey
  2. Sources of the Great Moderation: shocks, friction, or monetary policy? By Zheng Liu; Daniel F. Waggoner; Tao Zha
  3. Sudden stops, financial crises and leverage: a Fisherian deflation of Tobin's Q* By Enrique G. Mendoza
  4. A new solution to the Purchasing Power Parity puzzles: Risk-aversion, exchange rate uncertainty and the Law of One Price By Arghyrou, Michael G; Gregoriou, Andros; Pourpourides, Panayiotis M.
  5. Revisiting the importance of non-tradable goods' prices in cyclical real exchange rate fluctuations By Ida Wolden Bache; Kjersti Næss; Kjersti Næss; Tommy Sveen
  6. Matching International Financial Shocks in Emerging Markets By Almira Buzaushina; Michael Brei
  7. An Econometric Cntribution to the Intertemporal Approach of the Current Account By Wagner Piazza Gaglianone; João Victor Issler
  8. Exchange Rate Volatility and Investment, A Panel Data Cointegration Approach By Diallo , Ibrahima Amadou
  9. Current account benchmarks for central and eastern Europe - a desperate search? By Michele Ca’ Zorzi; Alexander Chudik; Alistair Dieppe
  10. Understanding forecast failure in ESTAR models of real exchange rates By Buncic, Daniel
  11. Wealth effects in emerging market economies By Tuomas A. Peltonen; Ricardo M. Sousa; Isabel S. Vansteenkiste
  12. Agglomeration and Growth with Endogenous Expenditure Shares By Fabio Cerina; Francesco Mureddu

  1. By: Frankel, Jeffrey (Harvard U)
    Abstract: An advantage of monetary union is facilitating trade. After many critiques, Rose's basic finding is left standing: currency unions have greater trade effects than previously believed. Updated estimates also find an effect of the euro on trade among members that is significant (though mysteriously still only 15%). An argument for retaining monetary independence is asymmetric shocks, i.e., low cyclical correlation. Eastern European countries might want to wait before joining, because their trade patterns and cyclical correlations have been gradually shifting toward Western Europe anyway; thus the argument for the euro strengthens as time passes, while the argument against it weakens.
    JEL: F10 F33
    Date: 2008–10
  2. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: We study the sources of the Great Moderation by estimating a variety of medium-scale DSGE models that incorporate regime switches in shock variances and in the inflation target. The best-fit model, the one with two regimes in shock variances, gives quantitatively different dynamics in comparison with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate much less nominal rigidities than those suggested in the literature.
    Keywords: Econometric models ; Business cycles
    Date: 2009
  3. By: Enrique G. Mendoza
    Abstract: This paper shows that the quantitative predictions of a DSGE model with an endogenous collateral constraint are consistent with key features of the emerging markets' Sudden Stops. Business cycle dynamics produce periods of expansion during which the ratio of debt to asset values raises enough to trigger the constraint. This sets in motion a deflation of Tobin's Q driven by Irving Fisher's debt-deflation mechanism, which causes a spiraling decline in credit access and in the price and quantity of collateral assets. Output and factor allocations decline because the collateral constraint limits access to working capital financing. This credit constraint induces significant amplification and asymmetry in the responses of macro-aggregates to shocks. Because of precautionary saving, Sudden Stops are low probability events nested within normal cycles in the long run.
    Date: 2008
  4. By: Arghyrou, Michael G (Cardiff Business School); Gregoriou, Andros; Pourpourides, Panayiotis M. (Cardiff Business School)
    Abstract: Market imperfections are the main explanation offered by the existing literature for violations of the Law of One Price and Purchasing Power Parity (PPP) among industrialised countries. We argue that even in perfectly frictionless markets risk aversion driven by exchange rate uncertainty causes a wedge between the domestic and foreign price of a totally homogeneous good. We test this hypothesis on a unique data set from a real-world market with minimum imperfections; and aggregate data for bilateral US dollar exchange rates in the G7 area. The empirical findings validate our hypothesis, thus providing a new, additional to market-imperfections, solution to the PPP puzzles.
    Keywords: Law of one price; purchasing power parity; risk aversion; exchange rate uncertainty
    JEL: F31 F41
    Date: 2009–01
  5. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway)); Kjersti Næss (Norges Bank (Central Bank of Norway)); Kjersti Næss (Norges Bank (Central Bank of Norway)); Tommy Sveen (Norges Bank (Central Bank of Norway))
    Abstract: In an influential paper Engel (1999. Accounting for U.S. Real Exchange Rate Changes, Journal of Political Economy 107, 507-538) argues that essentially all the flctuations in the real exchange rate can be attributed to fluctuations in the relative price of traded goods, and that only a small part of the fluctuations can be attributed to changes in the relative price of non-tradables. We instead decompose the real exchange rate into three components: the relative price of traded goods at-the-dock, the difference in the relative price of non-traded to traded goods and the difference in the wedge between retail prices of traded goods and the prices of traded goods at-the-dock. Using data on US bilateral real exchange rates we find that the fluctuations in the relative wedge between retail prices and traded goods prices at-the-dock account for on average between 30 and 70 percent of the movements in the real exchange rate. These findings suggest that the relationship between traded goods prices at-the-dock and retail prices of traded goods is key to understanding real exchange rate fluctuations.
    Keywords: Real exchange rates
    JEL: F31 F41
    Date: 2009–01–30
  6. By: Almira Buzaushina; Michael Brei
    Abstract: In the present paper, we develop a two-sector general equilibrium model of a small open economy to explore the transmission mechanisms of external financial shocks. In particular, we use a cash-in- advance model with limited participation augmented with a financial friction in the form of a fundamentals-related risk premium on external funds. The friction amplifies the effects of external financial shocks, especially when the economy is highly indebted in foreign currency. For a set of Latin American economies, the theoretical model is calibrated to match the empirical impulse responses of output, investment, trade balance, and domestic credits in response to an adverse shock to the country risk premium. In addition, we analyze the role of monetary policy during the financial crisis.
    Keywords: Emerging Markets, Financial Crises, International Capital Markets
    JEL: F34 F36 G21
    Date: 2009–01
  7. By: Wagner Piazza Gaglianone; João Victor Issler
    Abstract: This paper investigates an intertemporal optimization model to analyze the current account through Campbell & Shiller’s (1987) approach. In this setup, a Wald test is conducted to analyze a set of restrictions imposed to a VAR, used to forecast the current account for a set of countries. We focused here on three estimation procedures: OLS, SUR and the two-way error decomposition of Fuller & Battese (1974). We also propose an original note on Granger causality, which is a necessary condition to perform the Wald test. Theoretical results show that, in the presence of global shocks, OLS and SUR estimators might lead to a biased covariance matrix, with serious implications to the validation of the model. A small Monte Carlo simulation confirms these findings and indicates the Fuller & Battese procedure in the presence of global shocks. An empirical exercise for the G-7 countries is also provided, and the results of the Wald test substantially change with different estimation techniques. In addition, global shocks can account up to 40% of the total residuals of the G-7.
    Date: 2009–01
  8. By: Diallo , Ibrahima Amadou
    Abstract: This paper examines the link between the real exchange rate volatility and domestic investment by using the panel data cointegration techniques. In the first part of the paper, we study the theoretical link between the exchange rate, its volatility and the investment in a small open economy. The model shows that the effects of exchange rate volatility on investment are nonlinear. In the second part, we examine the empirical link between the exchange rate volatility and the investment. The results illustrate that the exchange rate volatility has a strong negative impact on investment. This outcome is robust in low income and middle income countries, and by using an alternative measurement of exchange rate volatility
    Keywords: Exchange rate volatility; Investment; Appreciation; Depreciation; Panel data cointegration; Dynamic Optimization; Capital goods; Expectations
    JEL: O11 O24 O16 O57 O19
    Date: 2008
  9. By: Michele Ca’ Zorzi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexander Chudik (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alistair Dieppe (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines two competing approaches for calculating current account benchmarks, i.e. the external sustainability approach á la Lane and Milesi-Ferretti (LM) versus the structural current accounts literature (SCA) based on panel econometric techniques. The aim is to gauge the medium term adjustment in current account positions that may be required in some central and eastern European countries. As regards the LM approach, we show how the outcome is especially sensitive to (i) the normative choice for external indebtedness and (ii) the decision to exclude the foreign direct investment subcomponent from the NFA aggregate. Turning our search to the SCA approach, we assess its sensitivity to model and parameter uncertainty by setting different selection criteria to choose amongst the over 8000 possible combinations of fundamentals. Furthermore, to test the robustness of our findings we combine all models, attaching to each a probability (Bayesian Averaging of Classical Estimates). We show both the LM and SCA methodologies are not immune from severe drawbacks and conceptual difficulties. Nevertheless pulling together the results of both approaches point to the countries that may need a current account adjustment over a medium term horizon. JEL Classification: C11, C33, F15, F32, F34, F41, O52.
    Keywords: Current account, capital flows, financial integration, central and eastern Europe, panel data, model uncertainty, model combination.
    Date: 2009–01
  10. By: Buncic, Daniel
    Abstract: The forecast performance of the empirical ESTAR model of Taylor et al. (2001) is examined for 4 bilateral real exchange rate series over an out-of-sample evaluation period of nearly 12 years. Point as well as density forecasts are evaluated relative to a simple AR(1) specification, considering horizons up to 22 steps head. The results of this study suggest that no forecast gains over a simple AR(1) model exist at any of the forecast horizons that are considered, regardless of whether point or density forecasts are used. Using simulation and non-parametric techniques in conjunction with graphical methods, this study shows that the non-linearity in the point forecasts of the ESTAR model decrease as the forecast horizon increases. Multiple steps ahead density forecasts of the ESTAR model are approximately normal looking, with no signs of skewness or bimodality. For an applied forecaster, there do not appear to exist any gains in using the non-linear ESTAR model over a simple AR(1) specification.
    Keywords: Purchasing power parity; regime modelling; non-linear real exchange rate models; ESTAR; forecast evaluation; density forecasts; non-parametric methods.
    JEL: C53 C52 C22 F47 F31
    Date: 2009–02–03
  11. By: Tuomas A. Peltonen (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Ricardo M. Sousa (University of Minho, Department of Economics and Economic Policies Research Unit (NIPE), Campus of Gualtar, 4710-057 - Braga, Portugal; London School of Economics, Department of Economics and Financial Markets Group (FMG), Houghton Street, London WC2 2AE, United Kingdom; European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main.); Isabel S. Vansteenkiste (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We build a panel of 14 emerging economies to estimate the magnitude of housing, stock market, and money wealth effects on consumption. Using modern panel data econometric techniques and quarterly data for the period 1990/1-2008/2, we show that; (i) wealth effects are statistically significant and relatively large in magnitude; (ii) housing wealth effects tend to be smaller for Asian emerging markets while stock market wealth effects are, in general, smaller for Latin American countries; (iii) housing wealth effects have increased for Asian coutries in recent years; and (iv) consumption reacts stronger to negative than to positive shocks in housing and financial wealth. JEL Classification: E21, E44, D12.
    Keywords: Wealth effects, consumption, emerging markets.
    Date: 2009–01
  12. By: Fabio Cerina; Francesco Mureddu
    Abstract: We develop a New Economic Geography and Growth model which, by using a CES utility function in the second-stage optimization problem, allows for expenditure shares in industrial goods to be endogenously determined. The implications of our generalization are quite relevant. In particular, we obtain the following novel results: 1) catastrophic agglomeration may always take place, whatever the degree of market integration, provided that the traditional and the industrial goods are sufficiently good substitutes; 2) the regional rate of growth is affected by the interregional allocation of economic activities even in the absence of localized spillovers, so that geography always matters for growth and 3) the regional rate of growth is affected by the degree of market openness: in particular, depending on whether the traditional and the industrial goods are good or poor substitutes, economic integration may be respectively growth-enhancing or growth-detrimental.
    Keywords: new economic geography, endogenous expenditure shares, substitution effect
    JEL: O41 F43 R12
    Date: 2008

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