nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒04‒10
eleven papers chosen by
Martin Berka
Victoria University of Wellington

  1. Robustness and Exchange Rate Volatility By Edouard Djeutem; Ken Kasa
  2. Debt Deleveraging and The Exchange Rate By Pierpaolo Benigno; Federica Romei
  3. International Capital Flows and Aggregate Output By Jurgen von Hagen; Haiping Zhang
  4. Boom-and-bust cycles marked by capital inflows, current account deterioration and a rise and fall of the real exchange rate By Müller-Plantenberg, Nikolas
  5. Financial Development and the Patterns of International Capital Flows By Jurgen von Hagen; Haiping Zhang
  6. The Sustainability of Monetary Unions. Can the Euro Survive? By Paolo Canofari; Giancarlo Marini; Giovanni Piersanti
  7. International Capital Flows with Limited Commitment and Incomplete Markets By Jurgen von Hagen; Haiping Zhang
  8. Long swings in Japan’s current account and in the yen By Müller-Plantenberg, Nikolas
  9. Globalization and political trust By Fischer, Justina AV
  10. World Real Interest Rates: A Tale of Two Regimes By Jagjit S. Chadha

  1. By: Edouard Djeutem (Simon Fraser University); Ken Kasa (Simon Fraser University)
    Abstract: This paper studies exchange rate volatility within the context of the monetary model of exchange rates. We assume agents regard this model as merely a benchmark, or reference model, and attempt to construct forecasts that are robust to model misspecification. We show that revisions of robust forecasts are more volatile than revisions of nonrobust forecasts, and that empirically plausible concerns for model misspecification can easily explain observed exchange rate volatility.
    Keywords: Exchange rates; Volatility; Robustness
    JEL: F31 D81
    Date: 2012–03
  2. By: Pierpaolo Benigno; Federica Romei
    Abstract: Deleveraging from high debt can provoke deep recession with significant international side effects. The exchange rate of the deleveraging country will depreciate in the short run and appreciate in the long run. The real interest rate will fall by more than in the rest of the world. Bounds and policies that constrain the adjustment can prolong and deepen the recession. Early exit strategies from accommodating monetary policy can be quite harmful, as can such other policies as keeping interest rates too high during the deleveraging period. The analysis also applies to a monetary union facing internal adjustment of current account imbalances.
    JEL: E52 F32 F41
    Date: 2012–03
  3. By: Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University)
    Abstract: We show in a tractable, multi-country OLG model that cross-country differences in financial development explain three recent empirical patterns of international capital fl ows. International capital mobility affects output in each country directly through the size of domestic investment as well as indirectly through the composition of domestic investment and the level of domestic savings. In contrast to earlier literature, our model admits the possibility that the indirect effects dominate the direct effects and international capital mobility raises output in the poor country and globally, although net capital flows are in the direction of the rich country. Our model adds to the understanding of the benefits of international capital mobility in the presence of financial frictions.
    Keywords: financial frictions, financial development, foreign direct investment
    JEL: E44 F41
    Date: 2011–12
  4. By: Müller-Plantenberg, Nikolas (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: When the current account balance and net capital outflows do not exactly offset each other, net payment flows arise. Payment inflows into a country push the real exchange rate up, outflows push it down. This paper uses a model of optimal consumption and portfolio choice to determine the factors that drive international payment flows during boom-and-bust cycles. It shows that during such cycles, capital inflows first exceed the deficit on current account, strengthening the currency. Later on, when returns on domestic investments revert to their normal levels, the current account recovers, yet the overall decline of the international investment position provokes a fall of the real exchange rate even below its initial level. Case studies of countries experiencing rapid economic expansions followed by financial collapse confirm the paper’s theoretical predictions.
    Keywords: boom-and-bust cycles, optimal consumption and portfolio choice, capital inflows, current account deterioration, currency flows, crises.
    JEL: F31 F32 F34 G01 G11 N10
    Date: 2012–03
  5. By: Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University)
    Abstract: We develop a tractable two-country overlapping-generations model and show that cross-country differences in financial development can explain three recent empirical patterns of international capital flows: Financial capital flows from relatively poor to relatively rich countries while foreign direct investment fl ows in the opposite direction; net capital flows go from poor to rich countries; despite of its negative net international investment positions, the United States receives a positive net investment income. We also explore the welfare and distributional effects of international capital fl ows and show that the patterns of capital fl ows may reverse along the convergence process of a developing country.
    Keywords: Capital account liberalization, financial development, foreign direct investment, symmetry breaking
    JEL: E44 F41
    Date: 2011–12
  6. By: Paolo Canofari (Faculty of Economics, University of Rome "Tor Vergata"); Giancarlo Marini (Faculty of Economics, University of Rome "Tor Vergata"); Giovanni Piersanti (University of Teramo)
    Abstract: This paper aims to propose a new measure of exchange market pressure for countries operating in hard peg regimes, such as currency unions, currency boards or full dollarization. We use a general model of currency crisis to derive a sustainability index based upon the relationship between the shadow exchange rate and the output gap required to maintain the currency peg. We apply the new index to European Union countries in order to assess the sustainability of the Euro.
    Keywords: shadow exchange rate, currency crisis, exchange market pressure
    JEL: F3 F31 F41 G01
    Date: 2012–03–27
  7. By: Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University)
    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: E44, F41
    Date: 2012–01
  8. By: Müller-Plantenberg, Nikolas (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: The yen has experienced several big swings over recent decades. This paper argues that the fluctuations of the Japanese exchange rate resulted mainly from corresponding movements in the current account, which affected the demand for yen relative to other currencies. The paper builds a vector error correction model for the exchange rate and the current account, based on the idea that the exchange rate and its economic fundamental do not move too far apart over time. In addition, the model allows for a Markov-switching stochastic trend in the current account. Regime changes occur at uncertain dates, possibly in response to exchange rate changes. Bayesian estimation proceeds using an innovative Gibbs-sampling procedure. The empirical results suggest that recurrent structural breaks in the yen’s fundamentals account for the large fluctuations of the Japanese exchange rate.
    Keywords: Japanese exchange rate, current account, exchange rate fundamental, Markov-switching, cointegration, Gibbs-sampling, purchasing power parity puzzle.
    JEL: F31 F32 C32 C11 C15
    Date: 2012–03
  9. By: Fischer, Justina AV
    Abstract: This paper postulates that a country’s integration into the world economy may lower citizens’ political trust. I argue that economic globalization constrains government’s choice set of feasible policies, impeding responsiveness to the median voter. Matching individual-level survey data from 1981 to 2007, repeated cross-sections of altogether 260’000 persons from 80 countries, with a measure of a country’s degree of economic globalization for the same time period, I find that there is a trust-lowering impact of globalization; its magnitude, however, depends on whether or not the individual is informed about politics and the economy. Trust-lowering effects of globalization are larger for those who have no interest in politics, are unwilling to indicate their political leaning, or who have low educational levels. Two-stage least squares regressions and a set of country and time fixed effects support a causal interpretation. Obviously, viewing the domestic government as accountable for its policies plays a decisive role for the relation between economic globalization and political trust. Robustness against country’s degree of economic development, past globalization and different time periods is tested.
    Keywords: Political trust; globalization; international trade; openness; FDI; World Values Survey
    JEL: F15 H41 Z13
    Date: 2012–03–30
  10. By: Jagjit S. Chadha
    Abstract: Global real interest rates were driven up in the 1980s, partly to encourage disinflation, while subsequently structural and conjunctural factors have driven rates to lower levels. The increase in the global pool of savings and the fiscal correction associated with the long economic expansion from 1992 to 2007 had put downward pressure on real rates and the extraordinary monetary policy responses since 2008 have sustained that trend into negative territory. The initial consequences of low real rates in the early part of this century had been to elevate asset prices, promote leverage in financial institutions and, as a counterparty, increase private sector indebtedness. The management of deleveraging by policymakers implies setting a low path for real rates along the yield curve by using a combination of traditional and non-traditional monetary and fiscal policies for as long as the economic dislocation persists. Facing a public and private debt overhang, low real rates help the adjustment of global balance sheets but cannot be driven low permanently by policymakers. My analysis suggests that there are two regimes for real rates; those for normal times are positive and vary with the global economic cycle, while those that deal with economic dislocation are negative. Once growth is secured, real rates will rise quickly to more normal levels, not least because, in order to limit any increase in funding costs that may result from capital inadequacy (apparent or real), banks themselves have a considerable appetite for capital, and that will also start to crank up real rates given a fixed pool of savings. It therefore seems likely that, over the medium term, real yields are likely to be in the range of 2-4%, rather than their current levels.
    Keywords: Real rates; trends; globalisation
    JEL: E31 E40 E51
    Date: 2012–02
  11. By: André Nassif; Carmem Feijó; Eliane Araújo
    Abstract: We present a Structuralist-Keynesian theoretical approach on the determinants of the real exchange rate (RER) for open emerging economies. Instead of macroeconomic fundamentals, the long-term trend of the real exchange rate level is better determined not only by structural forces and long-term economic policies, but also by both short-term macroeconomic policies and their indirect effects on other short-term economic variables. In our theoretical model, the actual real exchange rate is broken down into long-term structural and short-term components, both of which may be responsible for deviations of that actual variable from its long-term trend level. We also propose an original concept of a long-term “optimal” real exchange rate for open emerging economies. The econometric models for the Brazilian economy in the 1999–2011 period show that, among the structural variables, the GDP per capita and the terms of trade had the largest estimated coefficients correlated with the long-term trend of the RER in Brazil. As to our variables influenced by the short-term economic policies, the short-term interest rate differential and the stock of international reserves reveal the largest estimated coefficients correlated with the long-term trend of our explained variable. The econometric results show two basic conclusions: first, the Brazilian currency was persistently overvalued throughout almost all of the period under analysis; and second, the long-term “optimal” real exchange rate was reached in 2004. According to our estimation, in April 2011, the real overvaluation of the Brazilian currency in relation to the long-term “optimal” level was around 80 per cent. These findings lead us to suggest in the conclusion that a mix of policy instruments should have been used in order to reverse the overvaluation trend of the Brazilian real exchange rate, including a target for reaching the “optimal” real exchange rate in the medium and the long-run.
    Date: 2011

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