nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2011‒01‒03
twenty papers chosen by
Martin Berka
Massey University, Albany

  1. The effect of openness in a small open monetary union By Orjasniemi, Seppo
  2. Examining the Evidence of Purchasing Power Parity by Recursive Mean Adjustment By Hyeongwoo Kim; Young-Kyu Moh
  3. Net Foreign Assets, Productivity and Real Exchange Rates in Constrained Economies By Dimitris K. Christopoulos; Karine Gente; Miguel A. Leon-Ledesma
  4. The Domestic and International Effects of Interstate U.S. Banking By Fabio Ghironi; Viktors Stebunovs
  5. The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages By Kimberly Beaton; René Lalonde; Stephen Snudden
  6. Equilibrium on International Financial Assets and Goods Marke By Patrice Fontaine; Cuong Le Van
  7. Current account and relative prices: cointegration in the presence of structural breaks in emerging economies By Uz, Idil; Ketenci, Natalya
  8. Prices and the Real Exchange Rate in Hong Kong: 1985-2006. By Paulina Etxeberria-Garaigort; Amaia Iza
  9. Determinants of current account in the EU: the relation between internal and external balances in the new members By Ketenci, Natalya; Uz, Idil
  10. Stochastic Convergence in the Euro Area By Giorgio Canarella; Stephen M. Miller; Stephen K. Pollard
  11. International real business cycles : a re-visit By Nguyen, Quoc Hung
  12. Financial intermediaries, leverage ratios, and business cycles By Mimir, Yasin
  13. External imbalances in a monetary union. Does the Lawson doctrine apply to Europe? By Mariam Camarero; Josep Lluís Carrion-i-Silvestre; Cecilio Tamarit
  14. When and Why Worry About Real Exchange Rate Appreciation? The Missing Link between Dutch Disease and Growth By Sebastian Sosa; Nicolas E Magud
  15. Tariff, Growth, and Welfare By Lee, Shun-Fa
  16. Monetary aspects of short-term capital inflows in the Central European Countries By Mirdala, Rajmund
  17. International Business Cycle Accounting By Keisuke Otsu
  18. Macroeconomic Interdependence in East Asia By Nagayasu, Jun
  19. Financial Integration and the Construction of Historical Financial Data for the Euro Area By Heather M. Anderson; Mardi Dungey; Denise R Osborn; Farshid Vahid
  20. Convergence Patterns in Financial Development: Evidence from Club Convergence By Nicholas Apergis; Christina Christou; Stephen M. Miller

  1. By: Orjasniemi, Seppo (Bank of Finland Research)
    Abstract: In this paper we build a dynamic stochastic general equilibrium model of a small open monetary union with optimal monetary and fiscal policy, to study the transmission of country specific shocks and associated exchange rate fluctuations. We show that movements of the monetary union’s exchange rate stabilize the output fluctuations inside the monetary union, reducing the need for fiscal stabilization. We also show that, under the optimal policy, fluctuations in the exchange rate and the union-wide aggregates are affected by the differences in the degree of nominal rigidities among the monetary union member countries.
    Keywords: monetary union; monetary policy; fiscal policy; exchange rate
    JEL: E52 E62 F41
    Date: 2010–12–02
  2. By: Hyeongwoo Kim; Young-Kyu Moh
    Abstract: This paper revisits the empirical evidence of purchasing power parity under the current float by recursive mean adjustment (RMA) proposed by So and Shin (1999). We first report superior power of the RMA-based unit root test in finite samples relative to the conventional augmented Dickey-Fuller (ADF) test via Monte Carlo experiments for 16 linear and nonlinear autoregressive data generating processes. We find that the more powerful RMA-based unit root test rejects the null hypothesis of a unit root for 16 out of 20 current float real exchange rates relative to the US dollar, while the ADF test rejects only 5 at the 10% significance level. We also find that the computationally simple RMA-based asymptotic confidence interval can provide useful information regarding the half-life of the real exchange rate.
    Keywords: Recursive Mean Adjustment, Finite Sample Performance, Purchasing Power Parity, Half-Life
    JEL: C12 C22 F31
    Date: 2010–12
  3. By: Dimitris K. Christopoulos; Karine Gente; Miguel A. Leon-Ledesma
    Abstract: Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an overlapping generations two-sector exogenous growth model in which RER determination may depend on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high demestic savings, the RER only depends on productivity spread between two sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, the RER depends on both net foreign assets (transfer effect) and productivity. We then analyze the empirical implications of the model and find that, in accordance with the theory, the RER is mainly driven by productivity and net foreign assets in constrained countries and by productivity in unconstrained countries.
    Keywords: Real Exchange Rate; Capital Inflows Constraint; Overlapping Generations
    JEL: E39 F32 F41
    Date: 2010–12
  4. By: Fabio Ghironi (Boston College); Viktors Stebunovs (Board of Governors of the Federal Reserve System)
    Abstract: This paper studies the domestic and international effects of the transition to an interstate banking system implemented by the U.S. since the late 1970s in a dynamic, stochastic, general equilibrium model with endogenous producer entry. Interstate banking reduces the degree of local monopoly power of financial intermediaries. We show that the an economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The rest of the world experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to a moderation of firm-level and aggregate output volatility. In turn, trade and financial ties between the two countries in our model allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. The results of the model are consistent with features of the U.S. and international business cycle after the U.S. began its transition to interstate banking.
    Keywords: Business cycle volatility; Current account; Deregulation; Interstate banking; Producer entry; Real exchange rate
    JEL: E32 F32 F41 G21
    Date: 2010–12–17
  5. By: Kimberly Beaton; René Lalonde; Stephen Snudden
    Abstract: This paper examines the transmission of U.S. real and financial shocks to Canada and, in particular, the role of financial frictions in affecting the transmission of these shocks. These questions are addressed within the Bank of Canada's Global Economy Model (de Resende et al. forthcoming), a dynamic stochastic general-equilibrium model with an active banking sector and a detailed role for financial frictions. We find that U.S. financial shocks, as well as real shocks, have important effects on the Canadian economy. Moreover, financial frictions on both the demand and supply sides of credit amplify the first round impact of all types of U.S. shocks on the U.S. economy, as well as the second round impact on Canada. Real-financial linkages also increase the persistence of the Canadian response to U.S. shocks. We find that the interaction between the endogenous response of commodity prices and U.S. financial frictions plays an important role in the propagation of U.S. shocks to the Canadian economy. Finally, real-financial linkages also help to generate the positive cross correlation between domestic demand in the United States and Canada observed in the data, which is difficult to explain with a model where the transmission of shocks between countries is only based only on trade.
    Keywords: Business fluctuations and cycles; Economic models; International topics
    JEL: E21 E27 E32 F36 F40
    Date: 2010
  6. By: Patrice Fontaine (Eurofidai, CERAG, University Pierre-Mendes-France, Grenoble); Cuong Le Van (CNRS, University of Exeter Business School Department of Economics, Paris School of Economicsm)
    Abstract: The international asset pricing models are mostly developed in the situation where purchasing power parity (PPP) is not respected. Investors of dierent countries do not agree on expected security real returns. In this case, an equilibrium on the international assets market may exist but not on the international goods market. Our purpose in this paper is to give conditions under which we have equilibrium, not only on the international nancial assets market but also on the international good market. More precisely, we focus on the link between no-arbitrage, equilibrium and PPP. At equilibrium, international nancial assets market must clear and international goods market balance. In particular, equilibrium goods prices will respect the PPP
    Keywords: International Financial Assets and Goods Markets, Exchange Rates, Securities Returns, No-Arbitrage, Covered Interest Rate Parity, Purchasing Power Parity, General Equilibrium.
    JEL: D53 F31 G11 G15
    Date: 2010
  7. By: Uz, Idil; Ketenci, Natalya
    Abstract: The aim of this study is to examine the long-run relationship between the current account and relative prices such as terms of trade and real exchange rate for the emerging economies. These variables have been exposed to large fluctuations for more than the last two decades nearly in all emerging economies. Therefore, structural breaks have to be taken into account in estimations. Therefore, the recent panel cointegration method developed by Westerlund (2006) was applied to the current account model allowing for structural breaks. The estimations of unit root tests proposed by Levin et al. (2002), Im et al. (2003) and by Hadri (2000) provided the evidence of the unit root existence in our series. The Hansen’s (1992) stability test illustrated the instability exist in series except for the cases of India and Turkey. The Westerlund (2006) cointegration test estimations detected multiple structural shifts in every panel case; however, the hypothesis of cointegration in the panel could not be accepted by the Lagrange Multiplier statistics.
    Keywords: Current account; Terms of trade; Panel cointegration; Structural breaks
    JEL: F32 F41
    Date: 2010
  8. By: Paulina Etxeberria-Garaigort (Department of Foundations of Economic Analysis II, University of the Basque Country); Amaia Iza (Department of Foundations of Economic Analysis II, University of the Basque Country)
    Abstract: This paper seeks to quantify to the extent to which price dynamics in Hong Kong are due to the Balassa-Samuelson hypothesis. From 1985 to 1998, the CPI in Hong Kong increased spectacularly, yet there was dramatic deflation from 1998 to 2006. This dynamics was mainly driven by the price pattern of the nontradable goods and services. We find that, the Balassa-Samuelson hypothesis seems to be a good explanation for the inflation differentials between Hong Kong and the US from 1985 to 1998. However, in the 1998-2006 period, we find that the Balassa-Samuelson hypothesis cannot explain the inflation di¤erentials between Hong Kong and the US. On the one hand, there is a significant deviation from the PPP in the price of tradable goods between both countries. On the other hand, the internal transmission of the Balassa-Samuelson hypothesis does not hold for either country.
    Keywords: Real Exchange Rate (RER), Balassa-Samuelson hypothesis, In‡ation
    JEL: E13 E32 F41
    Date: 2010–12–28
  9. By: Ketenci, Natalya; Uz, Idil
    Abstract: This paper considers the major determinants of the current account in the new members of the EU. It examines the long-run and short-run impact of real exchange rate, investment, private and public savings on current account. The bounds testing autoregressive distributed lag (ARDL) approach to cointegration is used and the results indicate that twin deficit exists; in another words, government budget deficit shocks have led to deficit in current accounts in Czech Republic, Latvia, Lithuania, Slovenia and Slovakia for the considered period. At the same time, empirical evidence was found that private savings, investment and real exchange rate are key variables as well, causing changes in the current account in the long-run as well as in the short-run. Finally, stability tests were applied to the model indicating no evidence of any structural instability in the model of these countries.
    Keywords: Twin deficit; current account balance; budget deficit; EU.
    JEL: F40 F32 F31
    Date: 2010
  10. By: Giorgio Canarella (California State University, Los Angeles, and University of Nevada, Las Vegas); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas); Stephen K. Pollard (California State University, Los Angeles)
    Abstract: We investigate the dynamics of stochastic convergence of the original Euro Area countries for inflation rates, nominal interest rates, and real interest rates. We test for convergence relative to Germany, taken as the benchmark for core EU standards, using monthly data over the period January 2001 to September 2010. We examine, in a time-series framework, three different profiles of the convergence process: linear convergence, nonlinear convergence, and linear segmented convergence. Our findings both contradict and support convergence. Stochastic convergence implies the rejection of a unit root in the inflation rate, nominal interest rate, and real interest rate differentials. We find that the differentials are consistent with a unit-root hypothesis when the alternative hypothesis is I(0) with a linear trend. But we frequently, but not always, reject the unit-root hypothesis when the alternative is I(0) with a broken trend. We also note that the current financial crisis plays a significant role in dating the breaks.
    Keywords: Stochastic convergence, Nonlinearity, Unit-root tests, Structural breaks.
    JEL: F36 F42 C20 C50
    Date: 2010–12
  11. By: Nguyen, Quoc Hung
    Abstract: It is well known that several quantitative properties of international real business cycle models with are at odds with the data. First, the cross-country correlations are much higher for consumption than for output, while in the data the opposite is true (the BKK puzzle). Second, cross-country correlations of employment and investment are negative, while in the data they are positive. This paper quantitatively shows that preferences with a zero income effect on labor supply help generate a correct cross-country correlation in employment even without any restrictions on financial markets. In a bond economy, a zero income effect in labor supply, combined with time-to-build investment, can generate a positive cross-country correlation in investment, and the BKK puzzle is also resolved when the inter-temporal elasticity of substitution in labor supply is low.
    Keywords: International real business cycles, Income effects, GHH preferences, Business cycles, International economic relations, Consumption, Investments, Employment
    JEL: E21 E22 E24 E32 F41
    Date: 2010–12
  12. By: Mimir, Yasin
    Abstract: I document cyclical properties of aggregate measures of liabilities, equity, and leverage ratio in the U.S. financial sector and those of credit spread. I find that (i) liabilities and equity are procyclical, leverage ratio is acyclical, and credit spread is countercyclical, (ii) financial variables are three to ten times more volatile than output, and (iii) financial variables lead the business cycle. I present a dynamic stochastic general equilibrium model with profit maximizing banks where bank equity mitigates a moral hazard problem between banks and their depositors. The driving sources of business cycles are shocks to bank equity as well as standard productivity shocks. The model generates real and financial fluctuations consistent with the U.S. data. The model also delivers some policy prescriptions about capital adequacy requirements of banks.
    Keywords: Banks; Financial Fluctuations; Credit Frictions; Bank Equity; Real Fluctuations
    JEL: E32 E44 E10 E20
    Date: 2010–09–01
  13. By: Mariam Camarero (Jaume I University); Josep Lluís Carrion-i-Silvestre (University of Barcelona); Cecilio Tamarit (University of Valencia)
    Abstract: A monetary union raises new economic questions about the interpretation and the implications of high current account de?cits for the economic performance of its members in the medium term. Recent literature has argued that conventional measures of external sustainability are misleading because they omit capital variations on net foreign asset positions. In this paper we analyze external sustainability making use of the database developed by Lane and Milesi-Ferretti (2007a) that incudes these valuation effects. The sample period studied covers from the launching of the monetary integration process in Europe (the creation of the ?European Snake? in 1972) up to 2007. The econometric methodology used accounts for the increasing cross-section dependence among EMU countries as well as possible structural breaks endogenously determined. The results point to the need of abrupt adjustments, either led by the markets or promoted by pro-active policy measures in order to offset external disequilibria. The lack of these timely interventions together with the rigidities and institutional imperfections of the present EMU are on the ground of the excessive cost in terms of growth and employment of the current crisis.
    Keywords: Current account imbalances, EMU, panel stationarity, structural breaks, cross-section dependence.
    JEL: F32 F41 C23
    Date: 2010–02
  14. By: Sebastian Sosa; Nicolas E Magud
    Abstract: We review the literature on Dutch disease, and document that shocks that trigger foreign exchange inflows (such as natural resource booms, surges in foreign aid, remittances, or capital inflows) appreciate the real exchange rate, generate factor reallocation, and reduce manufacturing output and net exports. We also observe that real exchange rate misalignment due to overvaluation and higher volatility of the real exchange rate lower growth. Regarding the effect of undervaluation of the exchange rate on economic growth, the evidence is mixed and inconclusive. However, there is no evidence in the literature that Dutch disease reduces overall economic growth. Policy responses should aim at adequately managing the boom and the risks associated with it.
    Keywords: Capital inflows , Commodity price fluctuations , Economic growth , Exchange rate appreciation , External shocks , Fiscal policy , Monetary policy , Real effective exchange rates ,
    Date: 2010–12–01
  15. By: Lee, Shun-Fa
    Abstract: We develop a two-country (Home and Foreign) by two-good (consumption good and investment good) by one factor (capital) endogenous growth model with international knowledge spillover to study the relationship between an import tariff and economic growth and welfare. First, unlike the past literature, we do not need to make an assumption such that the growth rates between countries are identical in a balanced growth path (BGP). Second, we show that there exists a unique and saddle-point BGP with both countries being incompletely specialized. Third, a higher import tariff on the consumption good in the domestic country may boost (reduce) the rate of economic growth when the foreign (domestic) country has an absolute advantage in the investment good. Finally, a rise in the tariff rate by one country may improve world welfare under some parameter spaces.
    Keywords: two-country endogenous growth model; international knowledge spillover; import tariff; economic growth; welfare
    JEL: F13 O41 F43
    Date: 2010–11–04
  16. By: Mirdala, Rajmund
    Abstract: International capital flows represents one of the key aspect of the globalisation process and refers to the continuous relieving the cross-border capital allocation barriers reflecting in huge increase in the common financial connections among the countries during the last decades. Flows of the capital among the countries stimulated by increased investment opportunities, expected profits and better risk diversification generated many positive, symmetric and multiplicative effects. On the other hand it also increases the exposure of the countries to many negative and asynchronous defects that led economists to revaluate the overall effects of financial liberalization and dynamic increase in the international capital flows. Rigorous assessment of general effects related to short-term capital inflows requires a consideration of a wide variety of country specific assumptions and determinants. Real conditions affecting overall effects of short-term capital inflows have to be also considered in the view of (dis)equilibrium trends in the balance of payments. In the paper we analyze selected monetary aspects of short-term capital inflows in the Central European countries (Czech republic, Hungary, Poland, Slovak republic) in the period 1999-2010 using VAR (vector autoregression) approach. In order to meet this objective we estimate a vector VAR model identified by the Cholesky decomposition of innovations that allows us to identify structural shocks hitting the model. Impulse-response functions are computed in order to estimate the impact of short-term capital inflows on exchange rate, money stock, price level and current account. Ordering of the endogenous variables in the model is also considered allowing us to check the robustness of the empirical results.
    Keywords: capital inflows; exchange rate; balance of payments; money stock; VAR; Cholesky decomposition; impulse-response function
    JEL: C32 F15
    Date: 2010–11
  17. By: Keisuke Otsu
    Abstract: In this paper, I extend the business cycle accounting method a la Chari, Kehoe and McGrattan (2007) to a two-country international business cycle model and quantify the effect of the disturbances in relevant markets on the business cycle correlation between Japan and the US over the 1980-2008 period. I find that disturbances in the labor market and production efficiency are important in accounting for the recent increase in the cross-country output correlation. Financial globalization can be the cause of the recent increase in cross-country output correlation if it operated through an increase in the cross- country correlation of disturbances in the labour market and production efficiency, not in the domestic or international capital markets.
    Keywords: Business Cycle Accounting; International Business Cycles; Financial Globalization
    JEL: E32 F41
    Date: 2010–12
  18. By: Nagayasu, Jun
    Abstract: This paper analyzes macroeconomic interdependence among 10 Asian economies. In this connection, we decompose their macroeconomic activities (real GDP) into common and country-specific components using the Bai-Ng method (2004). Our results suggest first that both components are nonstationary and have permanent effects on their overall economy. Second, we find the relative importance of common factors in all countries in terms of their contribution to variations in real GDP. But evidence is also obtained of country-specific effects becoming increasingly important in countries like China in recent years. Therefore, if, for example, China is expected to grow at a fast pace in future, our findings imply that creation of a regional monetary union of these 10 countries needs to be held back until the Chinese economy has become more dominant in the region.
    Keywords: Asian economic integration; factor models; common and factors
    JEL: F4
    Date: 2010–04–01
  19. By: Heather M. Anderson; Mardi Dungey; Denise R Osborn; Farshid Vahid
    Abstract: Time series analysis for the Euro Area requires the availability of sufficiently long historical data series, but the appropriate construction methodology has received little attention. The benchmark dataset, developed by the European Central Bank for use in its Area Wide Model (AWM), is based on fixed-weight aggregation across countries with historically distinct monetary policies and financial markets of varying international importance. This paper proposes a new methodology for producing back-dated financial series for the Euro Area, that is based on the time-varying distance of periphery countries from core countries with respect to monetary integration. Historical decompositions of the residuals of vector autoregressive models of the Euro Area economy are then used to explore and compare the monetary policy implications of using the new methodology versus the use of AWM fixed weight series.
    Date: 2010
  20. By: Nicholas Apergis (University of Piraeus); Christina Christou (University of Piraeus); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper analyzes the degree of convergence of financial development for a panel of 50 countries. We apply the methodology of Phillips and Sul (2007) to various financial development indicators to assess the existence of convergence clubs. We consider nine such indicators that various researchers use to proxy for the degree of financial development in countries. Overall, the results do not support the hypothesis that all countries converge to a single equilibrium state in financial development. Nevertheless, strong evidence exists of club convergence. Countries demonstrate a high degree of convergence in the sense that they form only two or three converging clubs, depending on the measure of financial development used. We then apply the Phillip-Sul method to per capita output and also find strong evidence of seven distinct convergence clubs in per capita output. Finally, we compare the various convergence clubs associated with financial development indicators to those clubs for per capita output. We conclude that strong evidence supports the correspondence between the convergence clubs for financial development and those for per capita output.
    Keywords: economic growth, financial development, convergence clustering approach, financial indicators
    JEL: F43 F32 G21 C33
    Date: 2010–12

This nep-opm issue is ©2011 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.