nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒03‒28
twelve papers chosen by
Martin Berka
Victoria University of Wellington

  1. Home Bias in Open Economy Financial Macroeconomics By Coeurdacier, Nicolas; Rey, Hélène
  2. Nominal Stability and Financial Globalization By Devereux, Michael B; Senay, Ozge; Sutherland, Alan
  3. Portfolio Allocation and International Risk Sharing By Benigno, Gianluca; Küçük, Hande
  4. The international risk-sharing puzzle is at business-cycle and lower frequency By Giancarlo Corsetti; Luca Dedola; Francesca Viani
  5. Multilateral economic cooperation and the international transmission of fiscal policy By Corsetti, Giancarlo; Müller, Gernot
  6. A Darwinian Perspective on "Exchange Rate Undervaluation" By Du, Qingyuang; Wei, Shang-Jin
  7. Trade flows, exchange rate uncertainty and financial depth: evidence from 28 emerging countries By Demir, Firat; Caglayan, Mustafa; Dahi, Omar S.
  8. International Capital Flows with Limited Commitment and Incomplete Markets By von Hagen, Jürgen; Zhang, Haiping
  9. REAL Exchange Rate Misalignment and Economic Performance of WEST AFRICAN MONETARY ZONE:Implications for macroeconomic unionisation By Raji, Rahman Olanrewaju
  10. Exchange-Rate Dark Matter By Martin D. D. Evans
  11. Firm Productivity, Exchange Rate Movements, Sources of Finance and Export Orientation By Demir, Firat; Caglayan, Mustafa
  12. Liquidity, Risk and the Global Transmission of the 2007-08 Financial Crisis and the 2010-11 Sovereign Debt Crisis By Chudik, Alexander; Fratzscher, Marcel

  1. By: Coeurdacier, Nicolas; Rey, Hélène
    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.
    Keywords: home bias; open economy financial macroeconomics; portfolio choice
    JEL: F41 G11 G15
    Date: 2012–01
  2. By: Devereux, Michael B; Senay, Ozge; Sutherland, Alan
    Abstract: Over the one and a half decades prior to the global financial crisis, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This is a highly robust prediction of open economy macro models with endogenous portfolio choice. It holds across many different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.
    Keywords: Country Portfolios; Financial Globalization; Nominal stability
    JEL: E52 E58 F41
    Date: 2012–02
  3. By: Benigno, Gianluca; Küçük, Hande
    Abstract: We show that recent explanations of the consumption-real exchange rate anomaly which rely on goods and financial market frictions are not robust to introducing just one additional international asset. When portfolios are selected optimally, international trade in two nominal bonds implies a consumption-real exchange rate correlation that is too high compared to the data even when there are many shocks. Monetary policy specification plays a potentially important role for the degree of risk sharing provided by nominal bonds, both in the benchmark model with only tradable and non-tradable sector supply shocks and also in the model which allows for news or quality (i-pod) shocks.
    Keywords: Consumption-Real Exchange Rate anomaly; Incomplete Financial Markets; International Risk Sharing; Portfolio choice
    JEL: F31 F41
    Date: 2012–02
  4. By: Giancarlo Corsetti (Cambridge University); Luca Dedola (European Central Bank); Francesca Viani (Banco de España)
    Abstract: We decompose the correlation between relative consumption and the real exchange rate into its dynamic components at different frequencies. Using multivariate spectral analysis techniques we show that, at odds with a high degree of risk-sharing, in most OECD countries the dynamic correlation tends to be quite negative, and signifi cantly so, at frequencies lower than two years —the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open-economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; and a term variable across frequencies, which in bond economies is necessarily positive, refl ecting the insurance that intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum.
    Keywords: Consumption-exchange rate anomaly, incomplete markets, frequency domain analysis
    JEL: F41 F42
    Date: 2012–02
  5. By: Corsetti, Giancarlo; Müller, Gernot
    Abstract: During the global financial crisis 2007--2009 fiscal policy was widely used as a stabilization tool. Policymakers allowed a large build-up of public debt resulting from both automatic and discretionary expansionary measures. At the same time, calls for policy coordination stressed that international spillovers of fiscal policy might be sizeable. We reconsider the case for fiscal coordination by providing new evidence on the cross-border effects of discretionary fiscal measures. We rely on a vector autoregression model as well as on a quantitative business cycle model. We find that i) large spillover effects cannot be ruled out and, in contrast to conventional wisdom, ii) financial factors rather than trade flows lie at the heart of the international transmission mechanism. We discuss the implications of these results for policy coordination when markets price sovereign default risk, and put pressure on governments for implementing budget consolidation measures.
    Keywords: Financial Crisis; Fiscal Policy Coordination; Government spending; Spillover effects
    JEL: E62 F42
    Date: 2012–01
  6. By: Du, Qingyuang; Wei, Shang-Jin
    Abstract: Though the real exchange rate is a key price for most economies, our understanding of its determinants is still incomplete. This paper studies the implications of status competition in the marriage market for the real exchange rate. In theory, a rise in the sex ratio (increasing relative surplus of men) can generate a decline in the real exchange rate (RER) through both a savings channel and an effective labor supply channel. The effects can be quantitatively large if the biological desire for a marriage partner is strong. Empirically, we show that within China, those regions with a faster increase in the sex ratio also exhibit a faster decline in the RER (the relative price of nontradables). Furthermore, across countries, those with a high sex ratio tend to have a low real exchange rate, beyond what can be explained by the Balassa-Samuelson effect, financial underdevelopment, dependence ratio, and exchange rate regime classifications. As an application, the estimation suggests that these structural factors can account for the Chinese exchange rate almost completely.
    Keywords: currency manipulation; equilibrium real exchange rate; surplus men
    JEL: F3 F4 J1 J7
    Date: 2012–03
  7. By: Demir, Firat; Caglayan, Mustafa; Dahi, Omar S.
    Abstract: This paper investigates the effects of real exchange rate uncertainty on manufactures exports from 28 emerging economies, representing 82\% of all developing country manufactures exports, and explores the sources of heterogeneity in the uncertainty effects by controlling for the direction of trade (South-North or South-South), and the level of financial development of the exporting country. The empirical results show that for more than half of the countries the uncertainty effect is unidirectional, either South-South or South-North, and the median impact is negative. In addition, while we find that financial development augments trade, exchange rate shocks can negate this effect. Last but not the least, trade among developing economies improves export growth under exchange rate shocks.
    Keywords: Trade flows; Exchange rate uncertainty; South-South trade; Financial depth; Manufactured goods trade; Dynamic panel data
    JEL: F15 G15 E44 F31 O14
    Date: 2012–01–01
  8. By: von Hagen, Jürgen; Zhang, Haiping
    Abstract: Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their effects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production efficiency, and aggregate output.
    Keywords: financial development; financial frictions; foreign direct investment; international capital flows; limited commitment
    JEL: E44 F41
    Date: 2012–01
  9. By: Raji, Rahman Olanrewaju
    Abstract: The study assessed the real exchange rate misalignment and economic performance of WAMZ economies to determine its implications on economic unionization. The study uses Generalised Method of Moment of Dynamic Panel Estimation Method and supported with Cross Country Correlation Approach which comprises Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone covering the period from 2000 commencement of the zone to 2010 from international financial statistics of international monetary fund. The study discovered that the zone experiences asymmetrical correlations between real exchange rate misalignment and economic performance while the inclusion of equilibrium real exchange rate revealed a symmetrical relationship with economic performance. Further revelation in the study happened to be the cross country correlations which unveiled that four countries emerged to have a moderate degree of symmetrical relationship using some macroeconomic variables such real exchange rate, misaligned real exchange rate, openness, inflation and output. The study concluded by admonishing the zone to commence with four promising economies such as a Gambia, Ghana, Nigeria and Sierra Leone.
    Keywords: WAMZ; misalignment real exchange rate; currency union
    JEL: C33 F31 F43 F36
    Date: 2012–03–15
  10. By: Martin D. D. Evans (Department of Economics, Georgetown University)
    Abstract: Dark matter is believed to account for 83 percent of the matter in the universe and plays a central role in cosmology modeling. This paper argues that an analogous form of dark matter plays a similarly important role in international macroeconomics. Like its cosmological counterpart, exchange-rate dark matter cannot be directly observed, but its existence can be inferred from observations on the real exchange rates and interest rates. In the first part of this paper I show that dark matter is the dominant driver of short- and medium-term changes in real exchange rates for the G-7 countries; accounting for more than 90 percent of the variance at the five-year horizon. Although standard models stress the role of real interest differentials as the proximate drivers of real exchange-rate variations, my findings indicate that they are empirically unimportant. To understand the nature of exchange-rate dark matter, the second part of the paper develops an open-economy DSGE model in which the risk shocks driving households’ habits interact with collateral constraints and incomplete markets. The model not only shows that risk shocks can account for the role of dark matter as a driver of real exchange-rate dynamics, but also that these same shocks have significant macroeconomic implications. My analysis suggests that exchange rates appear disconnected from traditional macroeconomic fundamentals because they are particularly susceptible to risk shocks that play an important role in international macroeconomics
    Keywords: Exchange Rate Dynamics, Open-Economy Macro Models, Habits, Incomplete Markets, Collateral Constraints.
    Date: 2012–01–01
  11. By: Demir, Firat; Caglayan, Mustafa
    Abstract: We investigate the level and volatility effects of real exchange rates on the productivity growth of manufacturing firms with heterogeneous access to debt, and domestic and foreign equity markets in Turkey. We find that while exchange rate volatility affects productivity growth negatively, having access to foreign or domestic equity, or debt markets does not alleviate these effects. Furthermore, foreign owned or publicly traded companies do not appear to perform significantly better than the rest. We detect, however, that rm productivity is positively related to having access to external credit. Additionally, we find that while export (inward) oriented firms are aaffected less (more) by exchange rate appreciations, they are more (less) sensitive to exchange rate volatility.
    Keywords: Productivity growth; Exchange rate volatility; Source of finance; Capital structure; Export orientation
    JEL: G31 F23 G32 F31 F43
    Date: 2012–01–01
  12. By: Chudik, Alexander; Fratzscher, Marcel
    Abstract: The paper analyses the transmission of liquidity shocks and risk shocks to global financial markets. Using a Global VAR methodology, the findings reveal fundamental differences in the transmission strength and pattern between the 2007-08 financial crisis and the 2010-11 sovereign debt crisis. Unlike in the former crisis, emerging market economies have become much more resilient to adverse shocks in 2010-11. Moreover, a flight-to-safety phenomenon across asset classes has become particularly strong during the 2010-11 sovereign debt crisis, with risk shocks driving down bond yields in key advanced economies. The paper relates this evolving transmission pattern to portfolio choice decisions by investors and finds that countries' sovereign rating, quality of institutions and their financial exposure are determinants of cross-country differences in the transmission.
    Keywords: advanced economies; capital flows; emerging market economies; global financial crisis; high dimensional VARs; liquidity; risk; sovereign debt crisis; transmission
    JEL: C5 E44 F3
    Date: 2012–01

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