nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒09‒22
eleven papers chosen by
Martin Berka
Victoria University of Wellington

  1. Fiscal Multipliers: Liquidity Traps and Currency Unions By Emmanuel Farhi; Iván Werning
  2. On the Solvency of Nations: Cross-Country Evidence on the Dynamics of External Adjustment By C. Bora Durdu; Enrique G. Mendoza; Marco E. Terrones
  3. Factor Model Forecasts of Exchange Rates By Charles Engel; Nelson C. Mark; Kenneth D. West
  4. An Anatomy of Credit Booms and their Demise By Enrique G. Mendoza; Marco E. Terrones
  5. Nonlinear mechanism of the exchange rate pass-through: Does business cycle matter? By Ben Cheikh, Nidhaleddine
  6. Expected Currency Excess Returns and International Business Cycles By Sanglim Lee
  7. Sovereign default Risk in the Euro-Periphery and the Euro-Candidate Countries By Gabrisch, Hubert; Pusch, Toralf; Orlowski, Lucjan T
  8. International Risk Sharing with Market Segmentation By Eric Fesselmeyer; Leonard J. Mirman; Marc Santugini
  9. Credit Ratings and Debt Crises. By Bussière, M.; Ristiniemi, A.
  10. The fiscal implications of a banking union By Jean Pisani-Ferry; Guntram B. Wolff
  11. Disparities in Incomes and Prices Internationally By Kenneth W Clements; Grace Gao; Thomas Simpson

  1. By: Emmanuel Farhi; Iván Werning
    Abstract: We provide explicit solutions for government spending multipliers during a liquidity trap and within a fixed exchange regime using standard closed and open-economy models. We confirm the potential for large multipliers during liquidity traps. For a currency union, we show that self-financed multipliers are small, always below unity. However, outside transfers or windfalls can generate larger responses in out- put, whether or not they are spent by the government. Our solutions are relevant for local and national multipliers, providing insight into the economic mechanisms at work as well as the testable implications of these models.
    JEL: E52 E62 F41
    Date: 2012–09
  2. By: C. Bora Durdu; Enrique G. Mendoza; Marco E. Terrones
    Abstract: We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970-2006 period. Our analysis adapts Bohn’s (2007) error-correction reaction function approach—which tests for a negative long-run relationship between net exports (NX) and net foreign assets (NFA) as a sufficiency condition for the intertemporal budget constraint to hold—to a dynamic panel framework. Pooled Mean Group and Mean Group error-correction estimation yield evidence of a statistically significant, negative response of NX to NFA. Moreover, we cannot reject the hypothesis that the response is largely homogeneous across countries. Our sensitivity analysis shows that the countries with relatively weaker fundamentals need to respond more strongly to the changes in NFA to keep their NFAs on a sustainable path.
    JEL: E66 F32 F41
    Date: 2012–09
  3. By: Charles Engel; Nelson C. Mark; Kenneth D. West
    Abstract: We construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a “no change” benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
    JEL: C53 C58 F37 G17
    Date: 2012–09
  4. By: Enrique G. Mendoza; Marco E. Terrones
    Abstract: What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrial countries over the 1960-2010 period. We identify 70 credit boom events, half of them in each group of countries. Event analysis shows a systematic relationship between credit booms and a boom-bust cycle in production and absorption, asset prices, real exchange rates, capital inflows, and external deficits. Credit booms are synchronized internationally and show three striking similarities in industrial and emerging economies: (1) credit booms are similar in duration and magnitude, normalized by the cyclical variability of credit; (2) banking crises, currency crises or Sudden Stops often follow credit booms, and they do so at similar frequencies in industrial and emerging economies; and (3) credit booms often follow surges in capital inflows, TFP gains, and financial reforms, and are far more common with managed than flexible exchange rates.
    JEL: E32 E44 E51 G21
    Date: 2012–09
  5. By: Ben Cheikh, Nidhaleddine
    Abstract: This paper examines the presence of nonlinear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using logistic smooth transition models, we explore the existence of nonlinearity with respect to economic activity along the business cycle. Our results provide a strong evidence of nonlinearity in 6 out of 12 EA countries with significant differences in the degree of ERPT between the periods of expansion and recession. However, we find no clear direction in this regime-dependence of pass-through to business cycle. In some countries, ERPT is higher during expansions than in recessions; however, in other countries, this result is reversed. These cross-country differences in the nonlinear mechanism of pass-through would have important implications for the design of monetary policy and the control of inflation in the EA context.
    Keywords: Exchange Rate Pass-Through; Inflation; Smooth Transition Regression
    JEL: E31 C22 F31
    Date: 2012–09
  6. By: Sanglim Lee (University of Connecticut)
    Abstract: It is well known that the uncovered interest parity condition does not hold empirically, implying that investments in high-interest rate currencies in foreign currency markets result in a positive expected excess return. Verdelhan (2010) successfully explains this phenomenon by referring to exogenous consumption processes and external habit formation. In this paper, I extend his model by using an international real business cycle model (Backus, Kehoe, and Kydland 1994) with internal habit formation. When the production-based stochastic discount factor is used, this benchmark model, driven by total factor productivity, accounts for this empirical evidence as well. JEL Classification: E32, E44, F31, F44 Key words: Currency Excess Return, Real Business Cycle, Forward Premium Puzzle
    Date: 2012–09
  7. By: Gabrisch, Hubert; Pusch, Toralf; Orlowski, Lucjan T
    Abstract: This study examines the key drivers of sovereign default risk in five euro area periphery countries and three euro-candidates that are currently pursuing independent monetary policies. We argue that the recent proliferation of sovereign risk premiums stems from both domestic and international sources. We focus on contagion effects of external financial crisis on sovereign risk premiums in these countries, arguing that the countries with weak fundamentals and fragile financial institutions are particularly vulnerable to such effects. The domestic fiscal vulnerabilities include: economic recession, less efficient government spending and a rising public debt. External ‘push’ factors entail increasing liquidity- and counter-party risks in international banking, as well as risk-hedging appetites of international investors embedded in local currency depreciation against the US Dollar. We develop a model capturing the internal and external determinants of sovereign risk premiums and test for the examined country groups. The results lead us to caution against premature fiscal consolidation in the aftermath of the global economic crisis, since such policy might actually worsen sovereign default risk. The model works well for the euro-periphery countries; it is less robust for the euro-candidates that upon a future euro adoption will have to pursue real economy growth oriented policies in order to mitigate a potential increase in sovereign default risk.
    Keywords: sovereign default risk; euro area; euro-candidate countries; public debt; liquidity risk; counter-party risk
    JEL: E43 E63 G13
    Date: 2012–09–12
  8. By: Eric Fesselmeyer; Leonard J. Mirman; Marc Santugini
    Abstract: We study the effect of market segmentation on international risk sharing. In our model, entrepreneurs consider undertaking risky projects in the real sector as well as selling part of their projects to investors. To capture the idea of market segmentation (i.e., agents from different countries have different opportunity costs of participating in the risky projects), the returns on the alternative risk-free investment are allowed to differ between the entrepreneurs and the investors. We first show that market segmentation establishes links between the risk-free and risky sectors as well as between the real and financial sectors. In particular, if there is market segmentation, then the amount of risk sharing depends on the risk-free rates and the expected return of the risky project. Moreover, the level of real investment also depends on the risk-free rates. Second, we show how different risk-free rates may encourage or discourage risk sharing, and even prevent risk sharing altogether.
    Keywords: International financial markets, market segmentation, risk sharing, risk project
    JEL: G15 O16
    Date: 2012
  9. By: Bussière, M.; Ristiniemi, A.
    Abstract: This paper analyses the role of credit rating agencies in sovereign debt crises. Using a panel of 53 emerging and developing countries with annual data going back to 1977, the paper shows that credit ratings are not very good predictors of debt distress events once tested against a simple benchmark model with standard macroeconomic variables. Next, the paper turns to higher frequency data for a subset of countries to analyze the link between credit ratings and bond spreads. The results indicate that bond spreads react strongly to credit ratings, especially to downgrades in the non-investment grade category. The results are robust to a variety of additional tests.
    Keywords: Credit rating agencies, debt crises, fiscal policy, emerging market economies, developing countries, panel estimation.
    JEL: E60 C33 C35
    Date: 2012
  10. By: Jean Pisani-Ferry; Guntram B. Wolff
    Abstract: Systemic banking crises are a threat to all countries whatever their development level. They can entail major fiscal costs that can undermine the sustainability of public finances. More than anywhere else, however, a number of euro-area countries have been affected by a lethal negative feedback loop between banking and sovereign risk, followed by disintegration of the financial system, real economic fragmentation and the exposure of the European Central Bank. Recognising the systemic dimension of the problem, the Euro-Area Summit of June 2012 called for the creation of a banking union with common supervision and the possibility for the European Stability Mechanism to recapitalise banks directly. The findings of this paper were presented at the Informal ECOFIN in Nicosia on 14 September 2012.
    Date: 2012–09
  11. By: Kenneth W Clements (Business School, University of Western Australia); Grace Gao (Business School, University of Western Australia); Thomas Simpson (Business School, University of Western Australia)
    Abstract: The dispersion of the distribution of relative prices in poor countries is substantially higher than that in the rich. As in 130+ countries relative prices are closely related to incomes, we develop a model that shows that the prices of luxuries (necessities) rise (fall) with income growth. This model provides a link between price dispersion and incomes that leads to several interesting concepts, including minimum-variance income and dispersion-equivalent income, the income needed to compensate for higher dispersion, which are illustrated with data from the International Comparison Program. The paper also contains an analysis of the welfare cost of higher dispersion in poorer countries.
    Date: 2012

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