nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒08‒23
sixteen papers chosen by
Martin Berka
Victoria University of Wellington

  1. Fiscal Unions By Ivan Werning; Emmanuel Farhi
  2. Capital controls or exchange rate policy? a pecuniary externality perspective By Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
  3. The simple macroeconomics of North and South in EMU By Jean Pisani-Ferry; Silvia Merler
  4. The Great Leveraging By Alan M. Taylor
  5. International Capital Flows and Debt Dynamics By Martin D. D. Evans
  6. Global banks, financial shocks and international business cycles: evidence from an estimated model By Robert Kollmann
  7. On the brink? Intra-euro area imbalances and the sustainability of foreign debt By Körner, Finn Marten; Zemanek, Holger
  8. Rethinking Capital Flows for Emerging East Asia By Stephen Grenville
  9. On International Policy Coordination and the Correction of Global Imbalances By Bruno Albuquerque; Cristina Manteu
  10. Banks, Sovereign Debt and the International Transmission of Business Cycles By Luca Guerrieri; Matteo Iacoviello; Raoul Minetti
  11. Global Commodity Prices, Monetary Transmission, and Exchange Rate Pass-Through in the Pacific Islands By Shanaka J. Peiris; Ding Ding
  12. Capital Inflows and Booms in Assets Prices: Evidence From a Panel of Countries By Eduardo Olaberría
  13. Risk-on/risk-off, capital flows, leverage and safe assets By Robert N McCauley
  14. Real exchange rate appreciation, resource boom, and policy reform in Myanmar By Kubo, Koji
  15. Dissecting the dynamics of the US trade balance in an estimated equilibrium model By Punnoose Jacob; Gert Peersman
  16. Risk Sharing in the Middle East and North Africa: The Role of Remittances and Factor Incomes By Balli, Faruk; Basher, Syed Abul; Jean Louis, Rosmy

  1. By: Ivan Werning; Emmanuel Farhi
    Abstract: We study cross-country insurance in a currency union with nominal price and wage rigidities. We provide two results that build the case for the creation of a fiscal union within a currency union. First, we show that, if financial markets are incomplete, the value of gaining access to any given level of insurance is greater for countries that are members of a currency union. Second, we show that, even if financial markets are complete, private insurance is inefficiently low. A role emerges for government intervention in macro insurance to both guarantee its existence and to influence its operation. The efficient insurance arrangement can be implemented by contingent transfers within a fiscal union. The benefits of such a fiscal union are larger, the bigger the asymmetric shocks affecting the members of the currency union, the more persistent these shocks, and the less open the member economies.
    JEL: E62 E63 F02 F15 F3 F40
    Date: 2012–08
  2. By: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
    Abstract: In the aftermath of the global nancial crisis, a new policy paradigm has emerged> in which old-fashioned policies such as capital controls and other government distor-> tions have become part of the standard policy toolkit (the so-called macro-prudential> policies). On the wave of this seemingly unanimous policy consensus, a new strand> of theoretical literature contends that capital controls are welfare enhancing and can> be justi ed rigorously because of second-best considerations. Within the same the-> oretical framework adopted in this fast-growing literature, we show that a credible> commitment to support the exchange rate in crisis times always welfare-dominates> prudential capital controls as it can achieve the rst best unconstrained allocation.> In this benchmark economy, prudential capital controls are optimal only when the set> of policy tools is restricted so that they are the only policy instrument available.
    Keywords: Foreign exchange rates ; Capital market
    Date: 2012
  3. By: Jean Pisani-Ferry; Silvia Merler
    Abstract: The euro area today consists of a competitive, moderately leveraged North and an uncompetitive, over-indebted South. Its main macroeconomic challenge is to carry out the adjustment required to restore the competitiveness of its southern part and eliminate its excessive public and private debt burden. This paper investigates the relationship between fiscal and competitiveness adjustment in a stylised model with two countries in a monetary union, North and South. To restore competitiveness, South implements a more restrictive fiscal policy than North. We consider two scenarios. In the first, monetary policy aims at keeping inflation constant in the North. The South therefore needs to deflate to regain competitiveness, which worsens the debt dynamics. In the second, monetary policy aims at keeping inflation constant in the monetary union as a whole. This results in more monetary stimulus, inflation in the North is higher, and this in turn helps the debt dynamics in the South. Our main findings are: The differential fiscal stance between North and South is what determines real exchange rate changes. South therefore needs to tighten more. There is no escape from relative austerity.If monetary policy aims at keeping inflation stable in the North and the initial debt is above a certain threshold, debt dynamics are perverse: fiscal retrenchment is self-defeating;If monetary policy targets average inflation instead, which implies higher inflation in the North, the initial debt threshold above which the debt dynamics become perverse is higher. Accepting more inflation at home is therefore a way for the North to contribute to restoring debt sustainability in the South.Structural reforms in the South improve the debt dynamics if the initial debt is not too high. Again, targeting average inflation rather than inflation in the North helps strengthen the favourable effects of structural reforms.
    Date: 2012–07
  4. By: Alan M. Taylor
    Abstract: What can history can tell us about the relationship between the banking system, financial crises, the global economy, and economic performance? Evidence shows that in the advanced economies we live in a world that is more financialized than ever before as measured by importance of credit in the economy. I term this long-run evolution “The Great Leveraging” and present a ten‐point examination of its main contours and implications.
    JEL: E3 E5 E6 N1 N2
    Date: 2012–08
  5. By: Martin D. D. Evans
    Abstract: This paper presents a new model for studying international capital flows and debt dynamics that emphasizes the role played by expectations concerning future trade flows and returns. I use the model to estimate the drivers of the U.S. external position and capital flows between 1973 and 2008. The estimates show that most of the secular rise in U.S. international indebtedness is attributable to growing optimism about future returns on U.S. holdings of foreign equity and FDI assets. They also show that the transformation of world savings into risky assets by the U.S. had little effect on its external position, but the expected future real depreciation of the dollar allowed the U.S. to sustain a higher level of international debt after the 1990s.
    Keywords: Capital flows , Economic models , External debt , Foreign direct investment , International trade , United States ,
    Date: 2012–07–05
  6. By: Robert Kollmann
    Abstract: This paper estimates a two-country model with a global bank, using U.S. and Euro area (EA) data, and Bayesian methods. The estimated model matches key U.S. and EA business cycle statistics. Empirically, a model version with a bank capital requirement outperforms a structure without such a constraint. A loan loss originating in one country triggers a global output reduction. Banking shocks matter more for EA macro variables than for U.S. real activity. During the Great Recession (2007–09), banking shocks accounted for about 20 percent of the fall in U.S. and EA GDP, and for more than half of the fall in EA investment and employment.
    Keywords: International finance ; Financial markets
    Date: 2012
  7. By: Körner, Finn Marten; Zemanek, Holger
    Abstract: In this paper we study the intra-euro area imbalances based on a dynamic general equilibrium model. We show that European financial integration and the introduction of the euro might have contributed to the development of imbalances. Interest rate convergence following EMU accession led to net foreign debt positions, which prove difficult to reverse. Simulation results for the euro area suggest that current account imbalances and foreign debt positions of today's crisis countries have significantly diverged from a sustainable path. Increasing investment in the EMU core and productivity in crisis countries may permit a return to sustainable foreign debt levels and correct macroeconomic imbalances in the euro area. --
    Keywords: current account imbalances,euro area,foreign debt,sustainability,general equilibrium model
    JEL: E44 F32 F34 G15
    Date: 2012
  8. By: Stephen Grenville (Asian Development Bank Institute (ADBI))
    Abstract: Since the 1980s, emerging countries have been urged to welcome foreign capital inflows. The result has often been a pattern of surges, where excessive inflows were followed by damaging “sudden stops†and reversals. This was dramatically evident in the Asian crisis of 1997–1998. Since that crisis, the emerging countries of East Asia have typically run current account surpluses and have accumulated substantial foreign exchange reserves. This has kept them largely protected from the impact of volatile capital flows, but this strategy is neither sustainable nor optimal. What is needed is a strategy that makes use of the potential benefits of capital “flowing downhill†(that would require these countries to run current account deficits) while at the same time protecting them from both the excessive inflows and the reversals. This strategy needs to take account not only of the fickle nature of the capital flows, but the structurally-higher profitability which is characteristic of emerging countries, which motivates the excessive inflows. This strategy would require more active management of both exchange rates and capital flows than has been the accepted “best practiceâ€. This requires a substantial shift in the current policy mindset. The International Monetary Fund has shifted some distance on this issue, but has further to go.
    Keywords: capital flows, emerging Asia, 1997 Asian financial crisis, current account, capital account
    JEL: F21 F31 F32
    Date: 2012–06
  9. By: Bruno Albuquerque; Cristina Manteu
    Abstract: Global current account imbalances are generally seen as a threat to world growth. Given that they are projected to remain high, in an environment of prevailing downside risks, what could be done to reduce these imbalances? Using NiGEM, a large-scale multi-country model, we build up a global rebalancing scenario by assuming policy coordination at world level. This scenario considers that advanced economies adopt more ambitious fiscal consolidation (Layer 1) and structural reforms to boost potential output (Layer 2), whereas large emerging market surplus economies increase exchange rate flexibility and carry out structural reforms aimed at supporting domestic demand (Layer 3). Our main findings are the following. The global rebalancing scenario would reduce global imbalances by one quarter and world GDP would rise in a five-year period, lending support to the view that multilateral coordinated policy action would imply stronger, more sustainable and balanced growth of the world economy. Nevertheless, and contrary to recent analysis by the IMF, this scenario would carry some costs, specifically for some of the major advanced deficit economies which would experience a fall in GDP relative to the baseline.
    JEL: E17 F32 F42 F47
    Date: 2012
  10. By: Luca Guerrieri; Matteo Iacoviello; Raoul Minetti
    Abstract: This paper studies the international propagation of sovereign debt default. We posit a two-country economy where capital constrained banks grant loans to firms and invest in bonds issued by the domestic and the foreign government. The model economy is calibrated to data from Europe, with the two countries representing the Periphery (Greece, Italy, Portugal and Spain) and the Core, respectively. Large contractionary shocks in the Periphery trigger sovereign default. We find sizable spillover effects of default from Periphery to the Core through a drop in the volume of credit extended by the banking sector.
    JEL: F4 G21 H63
    Date: 2012–08
  11. By: Shanaka J. Peiris; Ding Ding
    Abstract: Pacific Islands countries are vulnerable to commodity price shocks, and this poses challenges to monetary policy. The high degree of exchange rate pass-through to headline inflation and the weak monetary transmission mechanism in PICs suggest a greater efficacy of exchange rate changes in affecting inflation rather than monetary policy. To assess the tradeoff between the use of the exchange rate and monetary policy in macroeconomic stabilization, we employ a model-based approach to examine the optimal policy in response to the historical distribution of exogenous shocks in a Pacific Island (Tonga). The empirical evidence and model simulations tilt in the favor of exchange rate policy given the close relationship between exchange rate changes and headline inflation and the low interest rate sensitivity of aggregate demand.
    Keywords: Commodity prices , Economic models , Exchange rates , External shocks , Monetary policy , Monetary transmission mechanism , Pacific Island Countries ,
    Date: 2012–07–05
  12. By: Eduardo Olaberría
    Abstract: Policymakers and academics often associate large capital inflows with booms in asset prices. To date, however, methodical evidence of this association is still limited. This paper provides a systematic empirical analysis of the link between capital inflows and booms in asset prices. Using a panel of 40 countries from 1990 to 2010 and controlling for other macroeconomic factors, the paper finds that the link varies across capital inflow categories and across countries. In particular, emerging countries are more likely to experience booms in asset prices during periods of large capital inflows. In line with leading theories of financial crises the paper finds that financial development, the quality of institutions and the exchange rate regime can potentially influence the association between capital inflows and booms in asset prices. In contrast, this paper does not find evidence to support the view that capital controls help reduce this association.
    Date: 2012–08
  13. By: Robert N McCauley
    Abstract: This paper describes the international flow of funds associated with calm and volatile global equity markets. During calm periods, portfolio investment by real money and leveraged investors in advanced countries flows into emerging markets. When central banks in the receiving countries resist exchange rate appreciation and buy dollars against domestic currency, they end up investing in medium-term bonds in reserve currencies. In the process they fund themselves (or "sterilise" the expansion of local bank reserves) by issuing safe assets in domestic currency to domestic investors. Thus, calm periods, marked by leveraged investing in emerging markets, lead to an asymmetric asset swap (risky emerging market assets against safe reserve currency assets) and leveraging up by emerging market central banks. In declining and volatile global equity markets, these flows reverse, and, contrary to some claims, emerging market central banks draw down reserves substantially. In effect emerging market central banks then release safe assets from their reserves, supplying safe havens to global investors.
    Keywords: Capital flows, safe assets, international flow of funds, VIX, global liquidity
    Date: 2012–07
  14. By: Kubo, Koji
    Abstract: In the five-year period from 2006 to 2011, the real exchange rate of the Myanmar kyat appreciated 200 percent, signifying that the value of the US dollar in Myanmar diminished to one third of its previous level. While the resource boom is suspected as a source of the real exchange rate appreciation, its aggravation is related to administrative controls on foreign exchange and imports. First, foreign exchange controls prevented replacement of the negotiated transactions of foreign exchange with the bank intermediation. This hampered government interventions in the market. Second, import controls repressed imports, aggravating excess supply of foreign exchange. Relaxation of administrative controls is necessary for moderating currency appreciation.
    Keywords: Myanmar, Foreign exchange, Exchange control, Trade policy, Imports, Real exchange rate, Resource boom, Import controls
    JEL: F31 O24 Q33
    Date: 2012–07
  15. By: Punnoose Jacob (École Polytechnique Fédérale de Lausanne); Gert Peersman (Ghent University)
    Abstract: In an estimated two-country DSGE model, we find that shocks to the marginal efficiency of investment account for more than half of the forecast variance of cyclical fluctuations in the US trade balance. Both domestic and foreign marginal efficiency shocks have a substantial impact on the variability of the imbalance. On the other hand, while traditional technology shocks can generate counter-cyclical trade balance dynamics, they matter very little for the overall forecast variance.
    Keywords: Open Economy Macroeconomics, US Trade Balance, Investment Shocks, Bayesian Estimation of DSGE Models
    JEL: C11 F41
    Date: 2012–08
  16. By: Balli, Faruk; Basher, Syed Abul; Jean Louis, Rosmy
    Abstract: This paper investigates welfare gains and channels of risk sharing among 14 Middle Eastern and North African (MENA) countries, including the oil-rich Gulf region and the resource-scarce economies such as Egypt, Morocco and Tunisia. The results show that, for the 1992--2009 period, the overall welfare gains across MENA countries are higher than those documented for the Organization for Economic Cooperation and Development (OECD) nations. In the Gulf region, the amount of factor income smoothing does not differ considerably when output shocks are longer-lasting rather than transitory, whereas the amount smoothed by savings increases remarkably when shocks are longer-lasting. By contrast, both factor income flows and international transfers respond more to permanent shocks than to transitory shocks in the non-oil MENA countries. The results also show that a significant portion of shocks is smoothed via remittance transfers in the economically less developed MENA countries, but not in the oil-rich Gulf and OECD countries. Finally, for the overall MENA region, a large part of the shock remains unsmoothed, suggesting that more market integration is needed to remedy the weak link of incomplete risk-sharing.
    Keywords: MENA region; remittance transfer; risk sharing; welfare gain
    JEL: I31 E21 F36 E60
    Date: 2012–08–18

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