nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒01‒03
twenty-one papers chosen by
Martin Berka
Victoria University of Wellington

  1. Home Bias in Open Economy Financial Macroeconomics By Nicolas Coeurdacier; Hélène Rey
  2. Fiscal Devaluations By Emmanuel Farhi; Gita Gopinath; Oleg Itskhoki
  3. International Contagion Through Leveraged Financial Institutions By Eric van Wincoop
  4. A Theory of Capital Controls as Dynamic Terms-of-Trade Manipulation By Arnaud Costinot; Guido Lorenzoni; Iván Werning
  5. Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies By Joshua Aizenman; Sebastian Edwards; Daniel Riera-Crichton
  6. Capital Inflows, Exchange Rate Flexibility, and Credit Booms By Nicolas E. Magud; Carmen M. Reinhart; Esteban R. Vesperoni
  7. Global Macroeconomic and Financial Supervision: Where Next? By Charles Goodhart
  8. Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy By Mohamed Tahar Benkhodja
  9. An equilibrium model of 'global imbalances' revisited By Körner, Finn Marten
  10. Import protection, business cycles, and exchange rates: evidence from the Great Recession By Chad Bown; Meredith Crowley
  11. Global Imbalances, the International Crisis and the Role of the Dollar By Riccardo Fiorentini
  12. "Currency intervention and the global portfolio balance effect: Japanese and Swiss lessons, 2003-2004 and 2009-2010" By Petra Gerlach; Robert N McCauley; Kazuo Ueda
  13. The behavior of real exchange rates: the case of Japan By Chang, Ming Jen; Lin, Chang Ching; Yin, Shou Yung
  14. Global imbalances and capital account openness: an empirical analysis By Saadaoui, Jamel
  15. Emerging from the war: Gold Standard mentality, current accounts and the international business cycle 1885-1939 By Mathias Hoffmann; Ulrich Woitek
  16. The world is not enough! Small open economies and regional dependence By Knut Are Aastveit; Hilde C. Bjørnland; Leif Anders Thorsrud
  17. How Do Credit Supply Shocks Propagate Internationally? A GVAR approach By Eickmeier, Sandra; Ng, Tim
  18. Bond market co-movements, expected inflation and the equilibrium real exchange rate By Corrado Macchiarelli
  19. Banking across Borders By Friederike Niepmann
  20. Why the current account may matter in a monetary union. Lesson from the financial crisis in the Euro area By Francesco Giavazzi; Luigi Spaventa
  21. Accounting for the economic relationship between Japan and the Asian Tigers By Hideaki Hirata; Keisuke Otsu

  1. By: Nicolas Coeurdacier; Hélène Rey
    Abstract: Home bias is a perennial feature of international capital markets. We review various explanations of this puzzling phenomenon highlighting recent developments in macroeconomic modelling that incorporate international portfolio choices in standard two-country general equilibrium models. We refer to this new literature as Open Economy Financial Macroeconomics. We focus on three broad classes of explanations: (i) hedging motives in frictionless financial markets (real exchange rate and non-tradable income risk), (ii) asset trade costs in international financial markets (such as transaction costs or differences in tax treatments between national and foreign assets), (iii) informational frictions and behavioural biases. Recent theories call for new portfolio facts beyond equity home bias. We present new evidence on crossborder asset holdings across different types of assets: equities, bonds and bank lending and new micro data on institutional holdings of equity at the fund level. These data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment.
    JEL: F21 F3 F32 F4 F41 G11
    Date: 2011–12
  2. By: Emmanuel Farhi; Gita Gopinath; Oleg Itskhoki
    Abstract: We show that even when the exchange rate cannot be devalued, a <i>small</i> set of <i>conventional</i> fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a standard New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions— producer or local currency pricing, along with nominal wage stickiness; under alternative asset market structures, and for anticipated and unanticipated devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation—one, a uniform increase in import tariff and export subsidy, and two, a value-added tax increase and a uniform payroll tax reduction. When the devaluations are anticipated, these policies need to be supplemented with a consumption tax reduction and an income tax increase. These policies have zero impact on fiscal revenues. In certain cases equivalence requires, in addition, a partial default on foreign bond holders. We discuss the issues of implementation of these policies, in particular, under the circumstances of a currency union.
    JEL: E32 E60 F30
    Date: 2011–12
  3. By: Eric van Wincoop
    Abstract: The 2008-2009 financial crises, while originating in the United States, witnessed a drop in asset prices and output that was at least as large in the rest of the world as in the United States. A widely held view is that this was the result of global transmission through leveraged financial institutions. We investigate this in the context of a simple two-country model. The paper highlights what the various transmission mechanisms associated with balance sheet losses are, how they operate, what their magnitudes are and what the role is of different types of borrowing constraints faced by leveraged institutions. For realistic parameters we find that the model cannot account for the global nature of the crisis, both in terms of the size of the impact and the extent of transmission.
    JEL: E32 F3 F4 G12 G2
    Date: 2011–12
  4. By: Arnaud Costinot; Guido Lorenzoni; Iván Werning
    Abstract: This paper develops a simple theory of capital controls as dynamic terms-of-trade manipulation. We study an infinite horizon endowment economy with two countries. One country chooses taxes on international capital flows in order to maximize the welfare of its representative agent, while the other country is passive. We show that capital controls are not guided by the absolute desire to alter the intertemporal price of the goods produced in any given period, but rather by the relative strength of this desire between two consecutive periods. Specifically, it is optimal for the strategic country to tax capital inflows (or subsidize capital outflows) if it grows faster than the rest of the world and to tax capital outflows (or subsidize capital inflows) if it grows more slowly. In the long-run, if relative endowments converge to a steady state, taxes on international capital flows converge to zero. Although our theory emphasizes interest rate manipulation, the country's net financial position per se is irrelevant.
    JEL: F13 F32 F33
    Date: 2011–12
  5. By: Joshua Aizenman; Sebastian Edwards; Daniel Riera-Crichton
    Abstract: We analyze the way in which Latin American countries have adjusted to commodity terms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degree to which the active management of international reserves and exchange rates impacted the transmission of international price shocks to real exchange rates. We find that active reserve management not only lowers the short-run impact of CTOT shocks significantly, but also affects the long-run adjustment of REER, effectively lowering its volatility. We also show that relatively small increases in the average holdings of reserves by Latin American economies (to levels still well below other emerging regions current averages) would provide a policy tool as effective as a fixed exchange rate regime in insulating the economy from CTOT shocks. Reserve management could be an effective alternative to fiscal or currency policies for relatively trade closed countries and economies with relatively poor institutions or high government debt. Finally, we analyze the effects of active use of reserve accumulation aimed at smoothing REERs. The result support the view that “leaning against the wind” is potent, but more effective when intervening to support weak currencies rather than intervening to slow down the pace of real appreciation. The active reserve management reduces substantially REER volatility.
    JEL: F1 F15 F31 F32 F36 O13 O54
    Date: 2011–12
  6. By: Nicolas E. Magud; Carmen M. Reinhart; Esteban R. Vesperoni
    Abstract: The prospects of expansionary monetary policies in the advanced countries for the foreseeable future have renewed the debate over policy options to cope with large capital inflows that are, at least partly, driven by low interest rates in the financial centers. Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, we analyze the impact of exchange rate flexibility on credit markets during periods of large capital inflows. We show that credit grows more rapidly and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. Our findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks’ incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency-dependent liquidity requirements, and higher capital requirement and/or dynamic provisioning on foreign exchange loans.
    JEL: E5 F2 G15
    Date: 2011–12
  7. By: Charles Goodhart
    Abstract: The overriding practical problem now is the tension between the global financial and market system and the national political and power structures. The main analytical short-coming lies in the failure to incorporate financial frictions, especially default, into our macro-economic models. Neither a move to a global sovereign authority, nor a reversion towards narrower economic nationalism, seems likely to take place in the near future. Meanwhile, the adjustment to economic imbalances remains asymmetric, with almost all the pressure on deficit countries. Almost by definition surplus countries are “virtuous”. But current account surpluses have to be matched by net capital outflows. Such capital flows to weaker deficit countries have often had unattractive returns. A program to give earlier and greater warnings of the risks of investing in deficit countries could lead to earlier policy reaction, and reduce the risk of crisis.
    JEL: E32 E42 E44 F02 F21 F33 F34 F4 F42 F51
    Date: 2011–12
  8. By: Mohamed Tahar Benkhodja (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: In this paper, we compare, first, the impact of a windfall and a boom sectors on the economy of an oil exporting country and their welfare implications ; in a second step, we analyze how monetary policy should be conducted to insulate the economy from the main impact of these shocks, namely the Dutch Disease. To do so, we built a Multisector DSGE model with nominal and real rigidities. The main finding is that Dutch disease effect arise after spending and resource movement effects in the following cases : i) flexible prices and wages both in the case of a windfall and in the case of a boom ; ii) flexible wage and sticky price only in the case of a …fixed exchange rate. In other cases, Dutch disease effect can be avoided if : prices are sticky and wages are flexible when the exchange rate is flexible ; iii) prices and wages are sticky whatever the objective of the central bank is in both cases : windfall and boom. We also compare the source of fluctuation that leads to Dutch disease effect and we conclude that the windfall leads to a strong e¤ect in terms of de-industrialization compared to a boom. The choice of flexible exchange rate regime also helps to improve welfare.
    Keywords: Monetary Policy, Dutch Disease, Oil Prices, Small Open Economy
    JEL: E52 F41 Q40
    Date: 2011
  9. By: Körner, Finn Marten
    Abstract: Global imbalances are almost universally regarded as a disequilibrium phenomenon. Caballero, Farhi, and Gourinchas (2008) challenge this notion with their dynamic general equilibrium model of global imbalances. The authors conclude that current account deficit nations need not worry about long-lasting deficits as long as the model is in equilibrium. The joint model in this paper combines the two model extensions for exchange rates and FDI which are disjunct in the original model. An analytical solution to the new joint model is neither as straightforward as for the separate models nor can previous results from calibrated simulation be confirmed without restriction. The model is highly dependent on parameter assumptions: A variation of calibrated parameters highlights the prime impact of investment costs previously assumed away. Sustainable equilibrium paths for global imbalances are much narrower in updated simulations than previously predicted. Policy recommendations on the sustainability of international debt holdings therefore need to be a lot more cautious. --
    Keywords: international debt,financial market development,foreign direct investment,real exchange rate,international macro-finance
    JEL: F31 F34 G15 O41
    Date: 2011–07
  10. By: Chad Bown; Meredith Crowley
    Abstract: This paper uses highly detailed, quarterly data for five major industrialized economies to estimate the impact of> macroeconomic fluctuations on import protection policies over 1988:Q1–2010:Q4. First, estimates on a pre-Great Recession sample of data provide evidence of two key relationships. We confirm that appreciations in bilateral real exchange rates lead to substantial increases in antidumping and related forms of import protection: e.g., a 4 percent appreciation results in 60–90 percent more products being subject to import protection. We also provide evidence of a previously overlooked result that policy-imposing countries historically imposed such bilateral import restrictions on trading partners that were going through periods of weak economic growth.> Second, we use the model to then provide the first estimates that link macroeconomic fluctuations to a change in policy-imposing behavior during the Great Recession so as to explain the realized protectionist response. During the Great Recession, the U.S. and other policy-imposing economies became less responsive to exchange rate appreciations. Furthermore, the U.S. and other economies “switched” from their historical behavior and shifted implementing new import protection away from those trading partners that were contracting and toward those experiencing economic growth. In a final exercise, we document how the model’s estimates imply that a 9–20 percent appreciation of China's real exchange rate vis-à-vis the U.S. dollar during the sample period would allow for China’s exporters to have received the "average" import protection treatment under antidumping that the U.S. imposed against other countries.
    Keywords: Antidumping duties ; Business cycles ; Foreign exchange rates ; Recessions
    Date: 2011
  11. By: Riccardo Fiorentini (Department of Economics (University of Verona))
    Abstract: The paper investigates the links between international global imbalances and the recent international financial crisis. It also focuses on the asymmetries of the dollar standard exchange rate regime. Global imbalances preceded the crisis but were one of the ingredients that led to the financial crash of 2007-2008. The paper rejects the ‘saving glut' explanation of the US trade deficit and shows that the key role of the dollar in the international monetary system allows the USA to exert seignorage in the international economy and created a circuit where Asian and oil-producing countries financed the US deficit. The inflow of foreign capitals increased the US domestic credit supply contributing to the development of the sub-prime bubble. The paper concludes that only the creation of a supranational monetary authority can eliminate the dangers of the asymmetric dollar standard regime.
    Keywords: Imbalances, crisis, dollaer
    JEL: F33 E21
    Date: 2011–12
  12. By: Petra Gerlach (Economic and Research Institute); Robert N McCauley (Bank for International Settlements (BIS)); Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: This paper shows that the Japanese and Swiss foreign exchange interventions in 2003/04 and 2009/10 seem to have lowered long-term interest rates in a range of industrial countries, including Japan and Switzerland. It seems that this decline was triggered by the investment of the intervention funds in US and euro area bonds and that a global portfolio balance effect made this decline in interest rate spread to other markets, thus easing monetary conditions at home and abroad.
    Date: 2011–12
  13. By: Chang, Ming Jen; Lin, Chang Ching; Yin, Shou Yung
    Abstract: The study examines the convergence rate of mean reversion by contrasting the estimated half-life of real exchange rate (RER). We employ an extensive monthly consumer price index (CPI)-based product price’s panel for Japan (the U.S. as the num´eraire). We find that the disaggregated RERs are persistent due to the cross-sectional dependence problems. By controlling common correlated effects, the estimated half-life for all goods may fall to as low as 2.54 years, below the consensus view of 3 to 5 years summarized by Rogoff (1996). After correcting the small-sample bias, the estimated half-life of deviations from purchasing power parity (PPP) increase by 1.03 year. Our findings also support that the half-life of mean reversion of RER is about 3.55 years for traded goods, about 0.11 year lower than non-traded goods. We also show that traded goods and non-traded goods perform distinct distributions of persistence.
    Keywords: Common correlated effect; cross-sectional dependence; purchasing power parity; real exchange rate; traded and non-traded goods
    JEL: C33 F31
    Date: 2011–04–10
  14. By: Saadaoui, Jamel
    Abstract: We investigate if capital account openness has played a major role in the evolution of global imbalances on the period 1980-2003. We estimate, with panel regression techniques, the impact of capital account openness on medium run current account imbalances for industrialized and emerging countries by using a de jure measure of capital account openness (the Chinn-Ito index of capital account openness, 2002, 2006) and a de facto measure of capital account openness (the gross foreign assets measured as the sum of foreign assets and foreign liabilities). By increasing the opportunities of overseas investments, the relative capital account openness has had positive impact on medium run current account balances of industrialized countries (because of downward pressures on domestic investment rates). Conversely, the relative capital account openness has had negative impact on medium run current account balances of emerging countries (because of upward pressures on domestic investment rates). The evolutions of domestic and foreign capital account openness have allowed increasing medium run current account balances in absolute value during this period.
    Keywords: Global Imbalances; Capital Account Openness; Chinn-Ito index
    JEL: F41 F31
    Date: 2011–11
  15. By: Mathias Hoffmann; Ulrich Woitek
    Abstract: We study international business cycles and capital flows in the UK, the United States and the Emerging Periphery in the period 1885-1939. Based on the same set of parameters, our model explains current account dynamics under both the Classical Gold Standard and during the Interwar period. We interpret this as evidence for Gold Standard mentality: the expectation formation mechanism with respect to major macroeconomic variables driving the current account – output, exchange rates and interest rates – has remained fundamentally stable between the two periods. Nonetheless, the macroeconomic environment changed: Volatility increased generally, but less so for international capital flows than for GDP. This pattern is consistent with shocks in the Interwar period becoming more persistent and more global.
    Keywords: Current accounts, capital flows, business cycles, Great Depression, Gold Standard, emerging markets, present-value models
    JEL: F32 F36 F40 F41 N1
    Date: 2011–12
  16. By: Knut Are Aastveit (Norges Bank (Central Bank of Norway)); Hilde C. Bjørnland (BI Norwegian Business School, University of California and Norges Bank (Central Bank of Norway)); Leif Anders Thorsrud (BI Norwegian Business School and Norges Bank (Central Bank of Norway))
    Abstract: This paper bridges the new open economy factor augmented VAR (FAVAR) studies with the recent findings in the business cycle synchronization literature emphasizing the importance of regional factors. That is, we estimate and identify a three block FAVAR model with separate world, regional and domestic blocks and study the transmission of both global and regional shocks to four small open economies (Canada, New Zealand, Norway and UK). The results show that foreign shocks explain a major share of the variance in all countries, most so shocks that are common to the world. However, regional shocks also play an important role, explaining more than 20 percent of the variance in the variables. Hence in small open economies, the world is not enough. The regional factors impact the four countries differently, though, some through trade and some through consumer sentiment. Our findings of a strong transmission of both global and regional shocks to open economies are in sharp contrast to the evidence from recently developed open economy DSGE models.
    Keywords: International transmission, World and region, Small open economy, FAVAR, Business cycles
    JEL: C32 E32 F41
    Date: 2011–12–01
  17. By: Eickmeier, Sandra; Ng, Tim
    Abstract: We study how credit supply shocks in the US, the euro area and Japan are transmitted to other economies. We use the recently-developed GVAR approach to model financial variables jointly with macroeconomic variables in 33 countries for the period 1983-2009. We experiment with inter-country links that distinguish bilateral trade, portfolio investment, foreign direct investment and banking exposures, as well as asset-side vs. liability-side financial channels. Capturing both bilateral trade and inward foreign direct investment or outward banking claim exposures in a GVAR fits the data better than using trade weights only. We use sign restrictions on the short-run impulse responses to financial shocks that have the effect of reducing credit supply to the private sector. We find that negative US credit supply shocks have stronger negative effects on domestic and foreign GDP, compared to credit supply shocks from the euro area and Japan. Domestic and foreign credit and equity markets respond clearly to the credit supply shocks. Exchange rate responses are consistent with a "flight to quality" to the US dollar. The UK, another international financial centre, is also responsive to the shocks. These results are robust to the exclusion of the 2007-09 crisis episode from the sample.
    Keywords: credit supply shocks; global VAR; international business cycles; sign restrictions; trade and financial integration
    JEL: C3 F15 F36 F41 F44
    Date: 2011–12
  18. By: Corrado Macchiarelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Since the end of the fixed rates in 1973 and after the EMS sterling dismissal in 1992, the value of the pound has undergone large cyclical fluctuations on average. Of particular interest to policy makers is the understanding of whether such movements are consistent with the lack or not of a correction mechanism to some long-run equilibrium. The purpose of the present study is to understand those dynamics, how the external value of the British sterling relative to the USD evolved during the recent floating experiences, and what have been the driving forces. In this paper we assume the real exchange rate to be determined by forces relating to the goods and capital market in a general equilibrium framework. This entails testing the purchasing power parity and the uncovered interest parity together. Our findings have two important implications, both for monetary policy. First, we show that some of the observed changes in the real exchange rates can not be solely attributed to changes in inflation rates, but, possibly, also to investors’ behavior. Secondly, we show that the special US dollar status of World reserve currency results into a weaker behavior of the US bond rate on international markets. JEL Classification: E31, E43, E44, F31, C58.
    Keywords: PPP, UIP, RIP, international parity conditions.
    Date: 2011–12
  19. By: Friederike Niepmann
    Abstract: This paper develops and tests a theoretical model that allows for the endogenous decision of banks to engage in international and global banking. International banking, where banks raise capital in the home market and lend it abroad, is driven by differences in factor endowments across countries. In contrast, global banking, where banks intermediate capital locally in the foreign market, arises from differences in country-level bank efficiency. Together, these two driving forces determine the foreign assets and liabilities of a banking sector. The model provides a rationale for the observed rise in global banking relative to international banking. Its key predictions regarding the cross-country pattern of foreign bank asset and liability holdings are strongly supported by the data
    Keywords: international banking; cross-border lending; capital flows; trade in banking services
    JEL: F21 F23 F34 G21
    Date: 2011–12
  20. By: Francesco Giavazzi; Luigi Spaventa
    Abstract: The current account has always been a neglected variable in the management of the Euro area and in the assessment of its members' performance; so has, as a consequence, the savings-investment balance. This paper first reviews the arguments that explain this attitude and justify, under some conditions and in some cases, the persistence of current account deficits. It then examines some peculiar features of the growth experience under monetary union in four Euro area countries which do not conform to the conventional convergence pattern. Models establishing the optimality of a succession of current account deficits in a catching-up process implicitly assume that the intertemporal budget constraint is satisfied, so that the accumulation of foreign liabilities is matched by future surpluses. In section 3 we first introduce explicitly this constraint in a simple two-period, two-good model and show that its fulfilment requires that growth be driven by an adequate increase of the country's production capacity of traded goods and services. By examining the composition of output and demand we show that this has not been the case in the four countries considered and argue that monetary union has helped relax the necessary discipline. The common monetary policy moreover did nothing to prevent an extraordinary growth of credit that fed the imbalances in the four countries. The paper closes addressing some policy issues related to the future sustainability o the monetray union.
    Date: 2011
  21. By: Hideaki Hirata; Keisuke Otsu
    Abstract: In this paper, we construct a two-country business cycle accounting model in order to investigate quantitatively the relationship between Japan and the Asian Tigers. Our model is based on Backus, Kehoe and Kydland (1994) in which each economy produces tradable intermediate goods that are aggregated to form final goods within each economy. We apply the business cycle accounting method of Chari, Kehoe and McGrattan (2007) and find that the main source of high frequency fluctuation in output in each economy is the fluctuation of production efficiency within its own economy. Furthermore, the growth in the Asian Tigers'production efficiency had a significant positive effect on Japanese economic growth over the 1980-2009 period through the endogenous terms of trade effect.
    Keywords: International Business Cycles; Business Cycle Accounting; Terms of trade; Productivity
    JEL: E13 E32 F41
    Date: 2011–11

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