nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2011‒11‒28
sixteen papers chosen by
Martin Berka
Victoria University of Wellington

  1. When Bonds Matter: Home Bias in Goods and Assets By Coeurdacier, Nicolas; Gourinchas, Pierre-Olivier
  2. Sovereigns, Upstream Capital Flows, and Global Imbalances By Alfaro, Laura; Kalemli-Ozcan, Sebnem; Volosovych, Vadym
  3. Global Rebalancing: Implications for Low-Income Countries By Yongzheng Yang
  4. Do Policy-Related Shocks Affect Real Exchange Rates? An Empirical Analysis Using Sign Restrictions and a Penalty-Function Approach By Taya Dumrongrittikul
  5. Exchange Rates and Individual Good’s Price Misalignment: Some Preliminary Evidence of Long-Horizon Predictability By Wei Dong; Deokwoo Nam
  6. Exchange rates and prices in the Netherlands and Britain over the past four centuries By James R. Lothian; John Devereux
  7. The Impact of International Portfolio Composition on Consumption Risk Sharing By Nils Holinski; Joan Muysken; Clemens Kool
  8. How Big are the Gains from International Financial Integration? By Hoxha, Indrit; Kalemli-Ozcan, Sebnem; Vollrath, Dietrich
  9. Firms entry, monetary policy and the international business cycle By Cavallari Lilia
  10. Terms of Trade in the Medium-run By Vahagn Galstyan;
  11. European exchange rates volatility and its asymmetrical components during the financial crisis By Daniel Stavárek
  12. Investment shocks and macroeconomic co-movement By Francesco Furlanetto; Gisle J. Natvik; Martin Seneca
  13. The External Impact of China's Exchange Rate Policy: Evidence from Firm Level Data By Barry Eichengreen; Hui Tong
  14. The Current Currency Situation By William R. Cline; John Williamson
  15. Relative prices, the price level and inflation: Effects of asymmetric and sticky adjustment By Shruti Tripathi; Ashima Goyal
  16. Default Risk Premium and Aggregate Fluctuations in a Small Open Economy By S. Meral Cakici

  1. By: Coeurdacier, Nicolas; Gourinchas, Pierre-Olivier
    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.
    Keywords: Equity home bias; International portfolios; International risk sharing
    JEL: F30 F41 G11
    Date: 2011–11
  2. By: Alfaro, Laura; Kalemli-Ozcan, Sebnem; Volosovych, Vadym
    Abstract: The paper presents new stylized facts on the direction of capital flows. We find (i) international capital flows net of government debt and/or official aid are positively correlated with growth; (ii) sovereign debt flows are negatively correlated with growth only if debt is financed by another sovereign; (iii) public savings are robustly positively correlated with growth as opposed to private savings. Sovereign to sovereign transactions can fully account for upstream capital flows and global imbalances. These empirical facts contradict the conventional wisdom and constitute a challenge for existing theories.
    Keywords: aid/government debt; current account; productivity; puzzles of flows; reserves
    JEL: F21 F41 O1
    Date: 2011–11
  3. By: Yongzheng Yang
    Abstract: While global rebalancing will mainly involve structural realignment among major advanced and emerging market economies, it could have significant impact on low-income countries (LICs). Simulations using a global general equilibrium model show that a more balanced global economy would tend to improve the current account balance in LICs with limited impact on domestic output. However, there could be adverse terms of trade effects on some LICs as the prices of manufactured goods rise. On the other hand, such prices increases could provide an impetus to export diversification in many LICs, raising growth in the long run. The output and terms of trade effects would be significantly amplified if structural adjustment is impeded by factor immobility and other rigidities.
    Keywords: Consumer goods , Current account balances , Demand , Export competitiveness , Export growth , Low-income developing countries , Manufacturing , Price increases , Terms of trade ,
    Date: 2011–10–19
  4. By: Taya Dumrongrittikul
    Abstract: We examine the response of real exchange rates to shocks in real exchange rate determinants, a monetary policy shock, and a fiscal policy shock in 30 countries over the period 1970-2008. The country set is divided into 4 groups - European, developed-country, Asian developing-country, and non Asian developing-country groups. We propose and apply a new approach, i.e. we employ a panel Bayesian structural vector error correction model, and we impose sign restrictions with a penalty-function approach to identify the shocks. We find that most of our impulse response analysis is in line with economic theories. Specifically, there is strong evidence that trade liberalization generates a real depreciation and an increase in government spending leads to a real appreciation over the long run. We also find that a contractionary monetary policy shock has only short-run impacts on real exchange rates, corresponding to the long-run neutrality of monetary policy. The responses to a productivity shock are interesting, i.e. productivity growth in traded sectors has no effect on the real exchange rate of the Asian developing-country group, and it leads to a long-run real appreciation in the non Asian developing-country group. In contrast, this shock causes a real depreciation in the European country group over the long run. Variance decomposition suggests that international trade policy contributes the most to real exchange rate movements in most country groups, with the exception of the non Asian developing-country group, for which fiscal policy via government spending seems to be the most important.
    Keywords: Real exchange rate, Vector error correction model, Monetary policy shocks, Sign restriction, Penalty function, Identification
    JEL: C33 C51 E52 F31
    Date: 2011–11–10
  5. By: Wei Dong; Deokwoo Nam
    Abstract: When prices are sticky, movements in the nominal exchange rate have a direct impact on international relative prices. A relative price misalignment would trigger an adjustment in consumption and employment, and may help to predict future movements in the exchange rate. Although purchasing-power-parity fundamentals, in general, have only weak predictability, currency misalignment may be indicated by price differentials for some goods, which could then have predictive power for subsequent re-evaluation of the nominal exchange rate. The authors collect good-level price data to construct deviations from the law of one price and examine the resulting price-misalignment model’s predictive power for the nominal exchange rates between the U.S. dollar and two other currencies: the Japanese yen and the U.K. pound. To account for small-sample bias and data-mining issues, inference is drawn from bootstrap distributions and tests of superior predictive ability (SPA) are performed. The slope coefficients and R-squares increase with the forecast horizon for the bilateral exchange rates between the U.S. dollar and the Japanese yen and the U.S. dollar and the U.K. pound. The out-of-sample SPA tests suggest that the authors’ price-misalignment model outperforms random walks either with or without drift for the U.S. dollar vis-à-vis the Japanese yen at the 5 per cent level of significance over long horizons.
    Keywords: Exchange rates; International topics
    JEL: F31 F47
    Date: 2011
  6. By: James R. Lothian (Fordham University); John Devereux (Queens College, CUNY)
    Abstract: This paper examines exchange-rate and price-level data for the long period 1590-2009 for the Netherlands and the United Kingdom (earlier the Dutch Republic and England), countries that at various times over this near four century span have differed substantially in terms of the pace at which their economies were developing, have operated under a variety of exchange rate regimes, and have been subjected to an extremely wide variety of real shocks. The principal conclusion of this study is the resiliency of the simple purchasing-power-parity model and of the law of one price at the microeconomic level. Both take some heavy blows during this close to four-century long sample period. In the end, however, they emerge surprisingly unscathed. Real factors at times appear to have had substantial effects on real exchange rates and hence PPP, but such effects ultimately dissipate. As a long-run equilibrium condition, PPP holds up remarkably well.
    Date: 2011–07
  7. By: Nils Holinski; Joan Muysken; Clemens Kool
    Abstract: Recent empirical work has shown that ongoing international financial integration facilitates cross-country consumption risk-sharing. These studies typically find that countries with high equity home bias exhibit relatively low international consumption risk sharing. We extend this line of research and demonstrate that it is not only a country's equity home bias that prevents consumption risk sharing. In addition, the composition of a country's foreign asset portfolio plays an important role. Using panel-data regression for a group of OECD countries over the period 1980-2007, we show that foreign investment bias has additional explanatory power for consumption risk sharing.
    Keywords: international financial integration, foreign investment bias, geography of international investment, equity home bias, international portfolio diversification
    JEL: F36 F41 G15
    Date: 2011–11
  8. By: Hoxha, Indrit; Kalemli-Ozcan, Sebnem; Vollrath, Dietrich
    Abstract: The literature has shown that the implied welfare gains from international financial integration are very small. We revisit the existing findings and document that welfare gains can be substantial if capital goods are not perfect substitutes. We use a model of optimal savings that includes a production function where the elasticity of substitution between capital varieties is less then infinity, but more than the value that would generate endogenous growth. This production structure is consistent with empirical estimates of the actual elasticity of substitution between capital types, as well as with the relatively slow speed of convergence documented in the growth literature. Calibrating the model, our results are that welfare gains from financial integration are equivalent to a 9% increase in consumption for the median developing country, and up to 14% for the most capital-scarce. These gains rise substantially if capital’s share in output increases even modestly above the baseline value of 0.3, and remain large even if inflows of foreign capital after integration are limited to a fraction of the existing capital stock.
    Keywords: FDI; financial integration; neoclassical growth model; productivity; welfare
    JEL: F36 F41 F43 O4
    Date: 2011–11
  9. By: Cavallari Lilia
    Abstract: This paper provides a novel theory of the international business cycle grounded on firms entry and sticky prices. It shows that under simple monetary rules pro-cyclical entry can generate fluctuations in consumption, output and investment as large as those observed in the data while at the same time providing positive international comovements and highly volatile terms of trade. The capacity to capture these stylized facts of the international business cycle overcomes the well-known difficulties of the standard open economy real business cycle model in this regard. Numerical simulations show that floating regimes exacerbate counter-cyclical markup movements. Fixed regimes, on the other hand, lead to an increase in the volatility of?firm entry.
    Keywords: product variety, firm entry, international business cycle, monetary policy, interest rate rules, exchange rate regimes
    JEL: E31 E32 E52
    Date: 2011–11
  10. By: Vahagn Galstyan (Institute for International Integration Studies, Trinity College Dublin);
    Abstract: This paper contributes to empirical research on the dynamics of the terms of trade. We start by proposing a method for constructing different measures of the terms of trade. This is achieved by estimating a range of substitution elasticities using a panel data approach and highly disaggregated data on trade flows. Next, various measures of the terms of trade and trade margins are related to productivity and demand proxies. We find that domestic demand side movements are positively related to the terms of trade, while domestic productivity gains result in a deterioration of the terms of trade. Our results suggest that higher relative productivity raises the real component of exports relative to imports along the intensive margin inducing a weakening of the terms of trade.
    Keywords: Terms of trade; Trade margins; International prices
    JEL: F40 F41
    Date: 2011–10
  11. By: Daniel Stavárek (Silesian University, School of Business Administration)
    Abstract: Two forms of asymmetry in the exchange rate volatility are examined in this paper. We analyze four currencies of new EU member states, two currencies of non euro area old EU members, US dollar and Swiss franc against the euro during the period financial crisis. We apply a modified TARCH model on data grouped into four phases of the financial crises differing in intensity and market sentiment. The results suggest that the exchange rates usually shared a similar trend in volatility. The presence of asymmetric attributes of the exchange rate volatility was relatively common. Similar symptoms of asymmetry were registered mainly in the new EU member states and Sweden. Appreciation movements seem to have significantly different effects on volatility than the depreciation movements of equal size (first form of asymmetry) particularly during the phases of crisis initialization and culmination. By contrast, a significant impact of divergence from the target exchange rate on the volatility (second form of asymmetry) was revealed principally during the crisis stabilization.
    Keywords: exchange rate volatility, asymmetry, TARCH model, financial crisis
    JEL: F31
    Date: 2011–11
  12. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Gisle J. Natvik (Norges Bank (Central Bank of Norway)); Martin Seneca (Norges Bank (Central Bank of Norway))
    Abstract: Recent studies find that shocks to the marginal efficiency of investment are a main driver of business cycles. Yet, they struggle to explain why consumption co-moves with real variables such as investment and output, which is a typical feature of an empirically recognizable business cycle. In this paper we show that within a conventional business cycle model, rule-of-thumb consumption provides a straightforward explanation of macroeconomic co-movement after a shock to the marginal efficiency of investment.
    Keywords: Investment shocks, consumption, rule-of-thumb consumers, nominal rigidities, co-movement
    JEL: E32
    Date: 2011–08–31
  13. By: Barry Eichengreen; Hui Tong
    Abstract: We examine the impact of renminbi revaluation on firm valuations, considering two surprise announcements of changes in China’s exchange rate policy in 2005 and 2010 and data on 6,050 firms in 44 countries. Renminbi appreciation has a positive effect on firms exporting to China but little positive or even a negative impact on those providing inputs for China’s processing exports. Stock prices rise for firms competing with China in their home market while falling for firms importing Chinese products with large imported-input content. Renminbi appreciation also reduces the valuation of financially-constrained firms, particularly in more financially integrated countries.
    JEL: F0 F3 F30 F31
    Date: 2011–11
  14. By: William R. Cline (Peterson Institute for International Economics); John Williamson (Peterson Institute for International Economics)
    Abstract: The currency markets have been extremely disturbed for the last three months. The period witnessed a major strengthening of the US dollar in September, then the European currency crisis, a recovery of the euro when the markets believed that the crisis was being controlled, and then a rebound of the dollar. In view of these developments, those who follow currency movements need a new guide as to how the current values of currencies compare to our estimates of fundamental equilibrium exchange rates (FEERs). The first section is devoted to a brief exposition of the main changes that have occurred since April, which our previous publication used as the benchmark. The second section updates information on the levels of effective exchange rates consistent with the FEER targets identified in our most recent estimates (Cline and Williamson 2011), as well as the FEER-consistent dollar rates as of late October. The third section steps outside our normal frame of reference in order to make some comments about the situation within Europe in view of the sovereign debt crisis currently raging there.
    Date: 2011–11
  15. By: Shruti Tripathi (Indira Gandhi Institute of Development Research); Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: The paper examines how relative price shocks can affect the price level and then inflation. Using Indian data we find: (i) price increases exceed price decreases. Aggregate inflation depends on the distribution of relative price changes-inflation rises when the distribution is skewed to the right, (ii) such distribution based measures of supply shocks perform better than traditional measures, such as prices of energy and food. They moderate the price puzzle, whereby a rise in policy rates increases inflation, and are significant in estimations of New Keynesian aggregate supply, (iii) an average Indian firm changes prices about once in a year; the estimated Calvo parameter implies half of Indian firms reset their prices in any period, and 66 percent of firms are forward looking in their price setting. The implication of these estimated real and nominal price rigidities for policy are drawn out.
    Keywords: WPI, NKPC, asymmetric, stickiness, size, frequency, inflation
    JEL: E31 E12 C32
    Date: 2011–10
  16. By: S. Meral Cakici (Institute for International Economics, University of Bonn)
    Abstract: This study investigates the implications of risk premium shocks for aggregate fluctuations in a small open economy with financial and informational frictions. A dynamic, stochastic, general equilibrium framework is developed, where the informational asymmetries among the agents in the model and the uncertainty in the production process necessitate financial intermediation in the economy. The Holmstrom-Tirole type of uncertainty in the production process also leads to collateralized borrowing by firms, with the physical capital stock of firms serving as the collateral as well as the factor of production. There is also a government sector in the economy that borrows domestically with a partial default risk. In order to compensate the lenders for the default risk included in the government bonds, the government has to offer them some risk premium in addition to the exogenously given world interest rate offered by the foreign bond issuers. It is shown that, under certain circumstances, it is possible for the government to reduce its debt and increase its spending in response to a positive, temporary risk premium shock.
    Keywords: default risk premium, dynamic stochastic general equilibrium, aggregate fluctuations
    JEL: F41 G15 G21 H39
    Date: 2011–11

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