nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2011‒10‒15
eleven papers chosen by
Martin Berka
Victoria University of Wellington

  1. Gross Capital Flows: Dynamics and Crises By Broner, Fernando A; Didier, Tatiana; Erce, Aitor; Schmukler, Sergio
  2. The Real Exchange Rate, Real Interest Rates, and the Risk Premium By Charles Engel
  3. To What Extent Do Exchange Rates and their Volatility Affect Trade? By Marilyne Huchet-Bourdon; Jane Korinek
  4. Sectoral Labor Adjustment and Monetary Policy in a Small Open Economy By Kang Shi
  5. Europe as a convergence engine -- heterogeneity and investment opportunities in emerging Europe By Stojkov, Aleksandar; Zalduendo, Juan
  6. Evaluating the Effects of Entry Regulations and Firing Costs on International Income Differences By Hernan J. Moscos Boedo; Toshihiko Mukoyama
  7. Currency crises By Reuven Glick; Michael Hutchison
  8. Macro-finance interactions in the US: A global perspective By Fabio C. Bagliano; Claudio Morana
  9. Reserves and Baskets By Michael D. Bordo; Harold James
  10. Terms of Trade and Global Efficiency Effects of Free Trade Agreements, 1990-2002 By James E. Anderson; Yoto V. Yotov
  11. Exchange Rate Dynamics under Alternative Optimal Interest Rate Rules By Mahir Binici; Yin-Wong Cheung

  1. By: Broner, Fernando A; Didier, Tatiana; Erce, Aitor; Schmukler, Sergio
    Abstract: This paper analyzes the joint behavior of international capital flows by foreign and domestic agents--gross capital flows--over the business cycle and during financial crises. We show that gross capital flows are very large and volatile, especially relative to net capital flows. When foreigners invest in a country, domestic agents tend to invest abroad, and vice versa. Gross capital flows are also pro-cyclical, with foreigners investing more in the country and domestic agents investing more abroad during expansions. During crises, especially during severe ones, there is retrenchment, that is, a reduction in both capital inflows by foreigners and capital outflows by domestic agents. This evidence sheds light on the nature of shocks driving capital flows and helps discriminate among existing theories. Our findings seem consistent with shocks that affect foreign and domestic agents asymmetrically, such as sovereign risk and asymmetric information.
    Keywords: crises; domestic investors; foreign investors; gross capital flows; net capital flows
    JEL: F21 F30 F32
    Date: 2011–10
  2. By: Charles Engel (University of Wisconsin and Hong Kong Institute for Monetary Research)
    Abstract: The well-known uncovered interest parity puzzle arises from the empirical regularity that, among developed country pairs, the high interest rate country tends to have high expected returns on its short term assets. At the same time, another strand of the literature has documented that high real interest rate countries tend to have currencies that are strong in real terms - indeed, stronger than can be accounted for by the path of expected real interest differentials under uncovered interest parity. These two strands - one concerning short-run expected changes and the other concerning the level of the real exchange rate - have apparently contradictory implications for the relationship of the foreign exchange risk premium and interest-rate differentials. This paper documents the puzzle, and shows that existing models appear unable to account for both empirical findings. The features of a model that might reconcile the findings are discussed.
    Date: 2011–09
  3. By: Marilyne Huchet-Bourdon; Jane Korinek
    Abstract: Trade deficits and surpluses are sometimes attributed to intentionally low or high exchange rate levels. The impact of exchange rate levels on trade has been much debated but the large body of existing empirical literature does not suggest an unequivocally clear picture of the trade impacts of changes in exchange rates. The impact of exchange rate volatility on trade also does not benefit from a clear theoretical cause-effect relationship. This study examines the impact of exchange rates and their volatility on trade flows in China, the Euro area and the United States in two broadly defined sectors, agriculture on the one hand and manufacturing and mining on the other. It finds that exchange volatility impacts trade flows only slightly. Exchange rate levels, on the other hand, affect trade in both agriculture and manufacturing and mining sectors but do not explain in their entirety the trade imbalances in the three countries examined.
    Keywords: exchange rates, trade, euro, real exchange rates, volatility, trade deficit, US dollar, yuan, trade in agriculture, short-run effects, long-run effects, GARCH volatility, depreciation, currency movements, exchange rate appreciation, exchange hedging
    JEL: F01 F31 O24 Q17
    Date: 2011–10–10
  4. By: Kang Shi (The Chinese University of Hong Kong and Hong Kong Institute for Monetary Research)
    Abstract: This paper studies the welfare implications of sectoral labor adjustment cost in a two-sector small open economy model with sticky prices. We find that, when the economy faces external shocks, if monetary policy can stabilize the real economy, then sectoral labor market adjustment cost will lead to welfare loss. However, if monetary policy such as fixed exchange rates cannot stabilize real variables, then some degree of labor market friction will improve welfare instead and the gain will be significant. As a result, the welfare gap between flexible exchange rates and fixed exchange rates decreases with sectoral labor market friction. This is because the friction can offset some of the nominal rigidity and become a substitute for monetary policy to stabilize the real economy.
    Keywords: Labor Adjustment Cost, Exchange Rate Policy, Two-Sector Model, Welfare
    JEL: F3 F4
    Date: 2011–09
  5. By: Stojkov, Aleksandar; Zalduendo, Juan
    Abstract: This paper provides empirical evidence that countries in emerging Europe reaped the benefits of international financial integration over the past 12 years by attracting sizeable foreign capital inflows and accelerating medium-term growth. But the aggregate pattern masks substantial heterogeneity across countries; namely, new European Union member states and the European Union candidate countries are different from the European Union neighborhood. The growth benefits are supported from both a flow and a stock perspective in terms of the link between foreign savings and growth. While foreign savings might in part substitute for national savings, the analysis finds that the channel to high growth in these countries is, primarily, through making possible the pursuit of investment opportunities that would otherwise remain unfunded; in turn, this seems to be intimately linked to the opportunities created by European Union membership. Although this conclusion does not disappear if the outlier observations of the credit boom period that preceded the financial crisis are dropped from the sample, it does suggest that these excesses did not play as positive a role for growth.
    Keywords: Economic Theory&Research,Currencies and Exchange Rates,Achieving Shared Growth,Emerging Markets,Access to Finance
    Date: 2011–10–01
  6. By: Hernan J. Moscos Boedo; Toshihiko Mukoyama
    Abstract: This paper analyzes the effects of entry regulations and firing costs on cross-country differences in income and productivity. We construct a general equilibrium industry- dynamics model and quantitatively evaluate it using the cross-country data on entry costs and firing costs. Entry costs lower overall productivity in an economy by keeping low- productivity establishments in operation and making the establishment size inefficiently large. Firing costs lower productivity by reducing the reallocation of labor from low- productivity establishments to high-productivity establishments. The linear regression of the data on the model prediction accounts for 27% of the cross-sectional variation in total factor productivity. Moving the level of entry costs and firing costs from the U.S. level to that of the average of low income countries (countries with a Gross National Income below 2% of the U.S. level) reduces TFP by 27% in the model without capital, and by 34% in the model with capital and capital adjustment costs.
    Keywords: Entry cost, firing cost,international income differences,industry dynamics
    JEL: D24 E23 J65 L11 O11
    Date: 2011–10
  7. By: Reuven Glick; Michael Hutchison
    Abstract: A currency crisis is a speculative attack on the foreign exchange value of a currency, resulting in a sharp depreciation or forcing the authorities to sell foreign exchange reserves and raise domestic interest rates to defend the currency. This article discusses analytical models of the causes of currency and associated crises, presents basic measures of the incidence of crises, evaluates the accuracy of empirical models in predicting crises, and reviews work measuring the consequences of crises on the real economy. Currency crises have large measurable costs on the economy, but our ability to predict the timing and magnitude of crises is limited by our theoretical understanding of the complex interactions between macroeconomic fundamentals, investor expectations and government policy.
    Keywords: Capital movements ; Foreign exchange
    Date: 2011
  8. By: Fabio C. Bagliano (Department of Economics and Public Finance "G. Prato", University of Torino); Claudio Morana (Department of Economics, University of Milan-Bicocca)
    Abstract: The paper aims at understanding the main channels of macro-finance interaction that have featured in the US recent “Great Recession” episode. Domestic interactions of macro and financial shocks are investigated within a global framework, allowing for spillover effects of the US crisis to other OECD countries, as well as to major emerging economies, and controlling for further feedback effects on the US economy. A total of 50 countries is investigated by means of a large-scale open economy macroeconometric model, set in the factor vector autoregressive (F-VAR) framework, over the period 1980:1-2009:1. The overall picture appears to be consistent with a boom-bust credit cycle mechanism, whereby financial factors are the triggering force of the downturn in real activity and worsened economic conditions feed back to asset prices, starting a cumulative process.
    Keywords: Macro-finance interactions, financial crisis, economic crisis, international business cycles, factor vector autoregressive models
    JEL: C22 E32 F36
    Date: 2011–10
  9. By: Michael D. Bordo; Harold James
    Abstract: We discuss three well known plans that were offered in the twentieth century to provide an artificial replacement for gold and key currencies as international reserves: Keynes’ Bancor, the SDR and the Ecu( predecessor to the euro).The latter two of these reserve substitutes were institutionalized but neither replaced the dollar as the principal medium of international reserve.
    JEL: F02 F33
    Date: 2011–10
  10. By: James E. Anderson (Boston College); Yoto V. Yotov (Drexel University)
    Abstract: This paper infers the terms of trade effects of Free Trade Agreements (FTAs) with the structural gravity model. Using panel data methods to resolve two way causality between trade and FTAs, we estimate direct FTA effects on bilateral trade volume in 2 digit manufacturing goods from 1990-2002. We deduce the terms of trade changes implied by these volume effects for 40 countries plus a rest-of-the-world aggregate. Some gain over 10%, some lose less than 0.2%. Overall, using a novel measure of the change in iceberg melting, global efficiency rises 0.62%.
    Keywords: Free Trade Agreements, Gravity, Terms of Trade, Coefficient of Resource Utilization
    JEL: F13 F14 F16
    Date: 2011–09–29
  11. By: Mahir Binici; Yin-Wong Cheung
    Abstract: We explore the role of interest rate policy in the exchange rate determination process. Specifically, we derive exchange rate equations from interest rate rules that are theoretically optimal under a few alternative settings. The exchange rate equation depends on its underlying interest rate rule and its performance could vary across evaluation criteria and sample periods. The exchange rate equation implied by the interest rate rule that allows for interest rate and inflation inertia under commitment offers some encouraging results – exchange rate changes “calibrated” from the equation have a positive and significant correlation with actual data, and offer good direction of change prediction. Our exercise also demonstrates the role of the foreign exchange risk premium in determining exchange rates and the difficulty of explaining exchange rate variability using only policy based fundamentals.
    Keywords: Taylor Rule, Exchange Rate Determination, Mean Squared Prediction Error, Direction of Change, Foreign Exchange Risk Premium
    JEL: F31 E52 C52
    Date: 2011

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