nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2011‒11‒14
seventeen papers chosen by
Martin Berka
Victoria University of Wellington

  1. When Bonds Matter: Home Bias in Goods and Assets By Nicolas Coeurdacier; Pierre-Olivier Gourinchas
  2. Factor Proportions and International Business Cycles By Keyu Jin; Nan Li
  3. Medium-Term Determinants of International Investment Positions: The Role of Structural Policies By Davide Furceri; Stéphanie Guichard; Elena Rusticelli
  4. The Impossible Trinity and Capital Flows in East Asia By Grenville, Stephen
  5. The Forward Premium Puzzle in a Two-Country World By Ian Martin
  6. Risk Sharing through Capital Gains By Balli, Faruk; Kalemli-Ozcan, Sebnem; Sørensen, Bent E
  7. China's dominance hypothesis and the emergence of a tri-polar global currency system By Marcel Fratzscher; Arnaud Mehl
  8. Exchange Rate Pass-Through to Prices: Evidence from Mexico By Carlos Capistrán; Raúl Ibarra-Ramírez; Manuel Ramos Francia
  9. Trade in secured debt, adjustment in haircuts and international portfolios By Tommaso Trani
  10. Ownership Characteristics, Real Exchange Rate Movements and Labor Market Adjustment in China By Risheng Mao; John Whalley
  11. Capital flows and Japanese asset volatility By Christopher J. Neely; Brett W. Fawley
  12. The Effect of Episodes of Large Capital Inflows on Domestic Credit By Davide Furceri; Stéphanie Guichard; Elena Rusticelli
  13. Trilemma and Financial Stability Configurations in Asia By Aizenman, Joshua
  14. Financial liberalization and macroeconomic performance, empirical evidence from selected Asian countries By Raza, Muhammad Wajid; Mohsin, Hasan M
  15. A Linder Hypothesis for Foreign Direct Investment By Fajgelbaum, Pablo; Grossman, Gene; Helpman, Elhanan
  16. EMU, EU, Market Integration and Consumption Smoothing By Atanas Christev; Jacques Melitz
  17. Fluctuations in the international prices of oil, dairy products, beef and lamb between 2000 and 2008: A review of market-specific demand and supply factors By Phil Briggs; Carly Harker; Tim Ng; Aidan Yao

  1. By: Nicolas Coeurdacier; Pierre-Olivier Gourinchas
    Abstract: This paper presents a model of international portfolios with real exchange rate and non financial risks that accounts for observed levels of equity home bias. A key feature is that investors can trade equities as well as domestic and foreign real bonds. Bonds matter: in equilibrium, investors structure their bond portfolio to hedge real exchange rate risk since relative bond returns are strongly correlated with real exchange rate movements. Equity home bias does not arise from the co-movements between relative stock returns and real exchange rates, but from the hedging properties of stock returns against other sources of risk, conditionally on bond returns. We estimate the optimal equity and bond portfolios implied by the model for G-7 countries and find strong empirical support for the theory. We are able to account for a significant share of the equity home bias and obtain a currency exposure of bond portfolios comparable to the data.
    JEL: F30 F41 G11
    Date: 2011–11
  2. By: Keyu Jin; Nan Li
    Abstract: Positive investment comovements across OECD economies as observed in the data are difficult to replicate in open-economy real business cycle models, but also vary substantially in degree for individual country-pairs. This paper shows that a two-country stochastic growth model that distinguishes sectors by factor intensity (capital-intensive vs. labor-intensive) gives rise to an endogenous channel of the international transmission of shocks that first, can substantially ameliorate the "quantity anomalies" that mark large open-economy models, and second, generate a cross-sectional prediction that is strongly supported by the data: investment correlations tend to be stronger for country-pairs that exhibit greater disparity in the factor-intensity of trade. In addition, three new pieces of evidence support the central mechanism: (1) the production composition of capital versus labor-intensive sectors changes over the business cycle; (2) the prices of capital-intensive goods and labor-intensive goods are respectively, procyclical and countercyclical; (3) a positive productivity shock in the U.S. tilts the composition of production towards capital-intensive sectors in other countries.
    Keywords: International business cycles, international comovement, composition effects
    JEL: F41
    Date: 2011–11
  3. By: Davide Furceri; Stéphanie Guichard; Elena Rusticelli
    Abstract: This paper provides an empirical investigation of the medium-term determinants of international investment positions for a large sample of advanced and emerging economies. In addition to the usually considered drivers of foreign assets and liabilities, the analysis focuses on the role of structural policy indicators. Using cross-section and panel regression techniques the results suggest that structural policy settings are important long-term drivers of capital flows, having a relatively large impact on gross and net foreign capital positions and on their composition. In particular, the results suggest that certain kinds of structural policy reform could help to narrow global imbalances, and to modify the composition of international capital flows towards more stable and productive sources.<P>Déterminants à moyen terme des positions étrangères extérieures : le rôle des politiques structurelles<BR>Cet article présente une étude empirique des déterminants à moyen terme de positions de l'investissement international pour un large échantillon des économies avancées et émergentes. En plus des déterminants usuels des engagements et actifs internationaux, l'analyse met l'accent sur le rôle des indicateurs structurels. Les résultats des régressions en coupe transversale et en panel suggèrent que les politiques structurelles en place sont d'importants moteurs à long terme des flux de capitaux, ayant un impact relativement important sur les positions extérieures brutes et nettes et sur leur composition. En particulier, les résultats suggèrent que certains types de réforme des politiques structurelles pourraient aider à réduire les déséquilibres mondiaux et á modifier la composition des flux de capitaux vers des sources plus stables et plus productives.
    Keywords: capital flows, structural policy, global imbalances, politique structurelle, déséquilibres mondiaux, flux des capitaux
    JEL: E6 F21
    Date: 2011–05–17
  4. By: Grenville, Stephen (Asian Development Bank Institute)
    Abstract: While the initial certainty and stark simplicity of the Impossible Trinity have fuzzed and softened over time, this idea still holds a powerful sway over analysis of exchange rates and in the policy debate on capital flows. Yet the practical evidence suggests that the constraints on policy implicit in this doctrine are greatly exaggerated. This disconnect between the analysis and the practical world seems a major limitation on developing suitable policies for addressing the very real problems which large volatile capital flows are causing emerging countries. The Impossible Trinity argument has been an unhelpful element in developing an effective policy framework to address these foreign capital inflows.
    Keywords: impossible trinity; exchange rates; capital flows; emerging economies
    JEL: F21 F31 F32
    Date: 2011–11–06
  5. By: Ian Martin
    Abstract: I explore the behavior of asset prices and the exchange rate in a two-country world. When the large country has bad news, the relative price of the small country’s output declines. As a result, the small country’s bonds are risky, and uncovered interest parity fails, with positive excess returns available to investors who borrow at the large country’s interest rate and lend at the small country’s interest rate. I use a diagrammatic approach to derive these and other results in a calibration-free way.
    JEL: G12 G15
    Date: 2011–11
  6. By: Balli, Faruk; Kalemli-Ozcan, Sebnem; Sørensen, Bent E
    Abstract: We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries 1992-2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6 percent, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for Euro zone countries, at 14 percent, reflecting increased international asset and liability holdings in the Euro area.
    Keywords: capital markets; income insurance; international financial integration
    JEL: F21 F36
    Date: 2011–11
  7. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Arnaud Mehl (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: This paper assesses whether the international monetary system is already tripolar and centred around the US dollar, the euro and the Chinese renminbi (RMB). It focuses on what we call China’s “dominance hypothesis”, i.e. whether the renminbi is already the dominant currency in Asia, exerting a large influence on exchange rate and monetary policies in the region, a direct reference to the old “German dominance hypothesis” which ascribed to the German mark a dominant role in Europe in the 1980s-1990s. Using a global factor model of exchange rates and a complementary event study, we find evidence that the RMB has become a key driver of currency movements in emerging Asia since the mid-2000s, and even more so since the global financial crisis. These results are consistent with China’s dominance hypothesis and with the view that the international monetary system is already tri-polar. However, we also find that China’s currency movements are to some extent affected by those in the rest of Asia. JEL Classification: F30, F31, F33, N20.
    Keywords: International monetary system, exchange rates, tri-polarity, China, renminbi, US dollar, euro, German dominance hypothesis.
    Date: 2011–10
  8. By: Carlos Capistrán; Raúl Ibarra-Ramírez; Manuel Ramos Francia
    Abstract: This paper analyzes the pass-through of exchange rate to different price indexes in Mexico. The analysis is based on a vector autoregressive model (VAR) using monthly data from January 1997 to December 2010. The pass-through effects are calculated by means of accumulated impulse response functions to a recursively identified exchange rate shock. The results show that the exchange rate pass-through to import prices is complete, but it declines along the distribution chain in such a way that the impact on consumer prices is below 20 percent. Moreover, we find that the exchange rate pass-through seems to have decreased substantially from 2001 onwards, which coincides with the adoption of an inflation targeting regime by Banco de Mexico.
    Keywords: Exchange rate pass-through, import price, consumer price, distribution chain, inflation.
    JEL: E31 F31 F41
    Date: 2011–11
  9. By: Tommaso Trani (IHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: I study the composition of international portfolios under collateral constraints and the implied cross-border transmission of shocks. I develop an international portfolio model with these features, in which leveraged investors seek diversification in both assets and secured liabilities and in which the pledgeable portion of assets adjusts to the state of the economy, reflecting borrowers’ credit risk. The new analytical results are as follows. First, agents choose endogenously how much to borrow from each country. Second, the collateral constraint, being a contractual link between secured and unsecured financial instruments, permits to compute portfolios without an arbitrage condition between those classes of assets. Finally, haircuts adjust endogenously through the change in the collateral values. After estimating the parameters governing this adjustment, I find that both portfolios and international transmission mechanism are quite sensitive to leveraged investors’ funding. As for portfolios, secured bonds have particularly effective hedging properties in managing the terms of trade risk. As for the international transmission, tightening haircuts affect the economic slowdown: initially severe contractions are followed by quick reversions to the long-term equilibrium. On a cumulative basis, these two effects compensate if haircuts adjust precisely to the economic state. But in case of uncertainty about this adjustment, collateral constraints are a source of risk which cannot be internationally diversified.
    Keywords: Financial flows, borrowing limits, creditworthiness, risk premia, international business cycle, macroeconomic interdipendence.
    JEL: F32 F34 F41 G15
    Date: 2011–10
  10. By: Risheng Mao; John Whalley
    Abstract: This paper uses a firm level multi-industry data set covering 456 Chinese manufacturing sectors to assess the implications of Renminbi (RMB) real exchange rate appreciation for adjustments in employment and wage rates. We stress differences in both industry and firm characteristics within sectors. Our empirical results show that modest (and also larger) RMB real exchange rate appreciation would likely have pronounced effects on both net employment and wage rates. A 10% RMB appreciation would likely cause a net employment decline in Chinese manufacturing industries of between 4.1% and 5.3%, and a wage rate drop of 4% after controlling for other factors. Real exchange rate change effects by industry on net employment and wage rates vary significantly with the ownership characteristics of firms within industries. Employment and wage rates for private enterprises are less responsive to RMB real exchange rate fluctuations than is true for state owned enterprises (SOEs) and foreign invested enterprises (FIEs). This finding is opposite to the widely held belief that the labor market behavior of Chinese SOEs shows stronger labor market rigidities than for private firms. Impacts of exchange rate movements emerge as systematically related to export openness, overall import penetration and profit margins of individual manufacturing industries.
    JEL: F16 F31 J21 J31
    Date: 2011–11
  11. By: Christopher J. Neely; Brett W. Fawley
    Abstract: Characterizing asset price volatility is an important goal for financial economists. The literature has shown that variables that proxy for the information arrival process can help explain and/or forecast volatility. Unfortunately, however, obtaining good measures of volume and/or order flow is expensive or difficult in decentralized markets such as foreign exchange. We investigate the extent that Japanese capital flows—which are released weekly—reflect information arrival that improves foreign exchange and equity volatility forecasts. We find that capital flows can help explain transitory shocks to GARCH volatility. Transactions by Japanese residents in foreign bond markets have the most explanatory power among capital flows and that power is much greater in the second subsample.
    Keywords: Capital movements ; Foreign exchange ; Japan
    Date: 2011
  12. By: Davide Furceri; Stéphanie Guichard; Elena Rusticelli
    Abstract: This paper analyses the effect of capital inflow shocks on the evolution of domestic credit. Using a panel of developed and emerging economies from 1970 to 2007, it is shown that in the two years following the beginning of a capital inflow shock the credit-to-GDP ratio increases by about 2 percentage points. The effect is reversed in the medium-term with the credit-to-GDP ratio decreased by almost 4 percentage points seven years after the initial shock. The paper also finds that the effect is different depending on the type of flows characterising the episode (debt vs. portfolio equity vs. FDI), with large capital inflows that are debt-driven having the largest effect. The results of the paper also suggest that the short-term effect of capital inflow shocks on domestic credit depends on countries’ macroeconomic policy stances. In particular, it is found that this effect is lower in countries with higher real exchange rate flexibility and fiscal policy counter-cyclicality.<P>L'effet des épisodes d'entrées massives de capitaux sur le crédit intérieur<BR>Cette étude analyse l'effet des chocs d’entrées de capitaux sur l'évolution du crédit domestique. À l'aide d'un panel de pays développés et émergents de 1970 à 2007, il est montré que dans les deux années qui suivent le début d'un choc d’entrées de capitaux, le crédit rapporté au PIB augmente d'environ 2 points de pourcentage. L'effet est renversé à moyen terme, avec un rapport du crédit au PIB plus bas de près de 4 points de pourcentage, sept ans après le choc initial. Cette étude montre également que l'effet est différent selon le type de flux de capitaux qui caractérisent l'épisode (dette vs portefeuille en action vs IDE), avec un effet maximal pour les entrées dominées par la dette. Les résultats de l'étude suggèrent également que l'effet à court terme de chocs d'entrées de capitaux sur le crédit domestique dépend de l’orientation des politiques macroéconomiques des pays. En particulier, cet effet est plus faible dans les pays où la flexibilité du taux de change réel est plus élevée et la politique fiscale plus contracyclique.
    Keywords: capital inflows, credit booms, domestic credit, entrées de capitaux, crédit intérieur, flambée du crédit
    JEL: F30 F32
    Date: 2011–05–17
  13. By: Aizenman, Joshua (Asian Development Bank Institute)
    Abstract: This paper takes stock of recent research dealing with the degree to which the trilemma choices of Asian countries facilitated a smoother adjustment during the global crisis of 2008–2009, and the way the region has been coping with the adjustment to the postcrisis challenges. We point out that emerging Asia has converged to a middle ground of the trilemma configuration: limited financial integration, a degree of monetary independence, and controlled exchange rate buffered by sizable international reserves.
    Keywords: trilemma choices; financial stability; global crisis 2008–2009
    JEL: F31 F32 F33 F36
    Date: 2011–11–02
  14. By: Raza, Muhammad Wajid; Mohsin, Hasan M
    Abstract: Financially repressed economy cannot grow with an increasing growth rate. That’s why most of the developing countries move toward liberalized financial system. The basic objective of this paper is to provide a comparative analysis of Pakistan, China, and India financial sector liberalization and its impact on macroeconomic performance. This study uses Johansen co integration to provide cross country evidence of long run relationship between macroeconomic variables and financial openness. Results show that there is long run relation among financial openness and macro economic performance in all three countries. Financial liberalization has positive and significant effect on Pakistan macroeconomic performance while negative and significant effect on china economy. The relationship in India is positive but not significant
    Keywords: Financial liberalization; financial depth. Economic growth
    JEL: E0 N20 F43
    Date: 2011–05–15
  15. By: Fajgelbaum, Pablo; Grossman, Gene; Helpman, Elhanan
    Abstract: We study patterns of FDI in a multi-country world economy. First, we present evidence for a broad sample of countries that firms direct FDI disproportionately to markets with income levels similar to their home market. Then we develop a model featuring non-homothetic preferences for quality and monopolistic competition in which specialization is purely demand-driven and the decision to serve foreign countries via exports or FDI depends on a proximity-concentration trade-off. We characterize the joint patterns of trade and FDI when countries differ in income distribution and size and show that FDI is more likely to occur between countries with similar per capita income levels. The model predicts a Linder Hypothesis for FDI, consistent with the patterns found in the data.
    Keywords: FDI; monopolistic competition; multinational corporations; nested logit; product quality; trade; vertical specialization
    JEL: F12 F23
    Date: 2011–11
  16. By: Atanas Christev; Jacques Melitz
    Keywords: Capital market integration, consumption smoothing, currency union, European Monetary Union, European Union
    JEL: F36 F41 E00 G10 A A A A A
    Date: 2011–10
  17. By: Phil Briggs; Carly Harker; Tim Ng; Aidan Yao (Reserve Bank of New Zealand)
    Abstract: This paper looks at the boom period between 2000 and 2008 in the international prices of four internationally-traded commodities: oil, dairy products, beef and lamb. All are important drivers of macroeconomic dynamics in New Zealand. Our aim is to provide overviews of the demand and supply factors specific to each market and product, thus adding colour to more general analyses of the macroeconomic and financial drivers of the cycles in world commodity markets over the period. For each commodity market we examine here, we set out the structures of the markets and the major drivers of world demand and supply, and discuss the apparent relative strength of each of the drivers.
    JEL: F31 G14
    Date: 2011–05

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