nep-opm New Economics Papers
on Open MacroEconomics
Issue of 2012‒11‒17
ten papers chosen by
Martin Berka
Victoria University of Wellington

  1. Fiscal devaluations By Emmanuel Farhi; Gita Gopinath; Oleg Itskhoki
  2. Adjustment Mechanisms in a Currency Area By C.A.E. Goodhart; D.J. Lee
  3. Sovereign default risk and uncertainty premia By Demian Pouzo; Ignacio Presno
  4. Current account sustainability in advanced economies By Lanzafame, Matteo
  5. Macroeconomic Adjustment and the History of Crises in Open Economies By Joshua Aizenman; Ilan Noy
  6. Capital Controls: Gates versus Walls By Michael W. Klein
  7. Has globalization increased the synchronicity of international business cycles? By Berge, Travis
  8. Is the real effective exchange rate biased against the PPP hypothesis? By Ventosa-Santaulària, Daniel; Wallace, Frederick; Gómez-Zaldívar, Manuel
  9. Short- and long-term growth effects of exchange rate adjustment By Evžen Kočenda; Mathilde Maurel; Gunther Schnabl
  10. Unsustainable Sovereign Debt - is the Euro Crisis only the Tip of the Iceberg? By Natasa Bilkic; Ben Carreras Painter; Thomas Gries

  1. By: Emmanuel Farhi; Gita Gopinath; Oleg Itskhoki
    Abstract: The authors show that even when the exchange rate cannot be devalued, a small set of conventional fiscal policy instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a standard New Keynesian open economy environment. They 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 the import tariff and export subsidy, and two, an increase in the value-added tax and a uniform reduction in the payroll tax. When the devaluations are anticipated, these policies need to be supplemented with a reduction in the consumption tax and an increase in income taxes. These policies have zero impact on fiscal revenues. In certain cases equivalence requires in addition a partial default on foreign bondholders. They discuss the issues regarding implementation of these policies, in particular in the case of a currency union.
    Keywords: Fiscal policy ; Foreign exchange rates
    Date: 2012
  2. By: C.A.E. Goodhart; D.J. Lee
    Abstract: Both the euro-area and the United States suffered an initially quite similar housing and financial shock in 2007/8, with several states in both regions being particularly badly affected. Yet there was never any question that the worst hit US states would need a special bail-out or leave the dollar area, whereas such concerns have worsened in the euro-area. We focus on three badly affected states, Arizona, Spain and Latvia, to examine the working of relative adjustment mechanisms within the currency region. We concentrate on four such mechanisms, relative wage adjustment, migration, net fiscal flows and bank flows. Only in Latvia was there any relative wage adjustment. Intra-EU migration has increased, but is more costly for those involved in the EU (than in the USA). Net federal financing helped Arizona and Latvia in the crisis, but not Spain. The locally focussed structure of banking amplified the crisis in Spain, whereas the role of out-of-state banks eased adjustment in Arizona and Latvia. The latter reinforces the case for an EU banking union.
    Date: 2012–11
  3. By: Demian Pouzo; Ignacio Presno
    Abstract: This paper studies how foreign investors' concerns about model misspecification affect sovereign bond spreads. We develop a general equilibrium model of sovereign debt with endogenous default wherein investors fear that the probability model of the underlying state of the borrowing economy is misspecified. Consequently, investors demand higher returns on their bond holdings to compensate for the default risk in the context of uncertainty. In contrast with the existing literature on sovereign default, we explain the bond spreads dynamics observed in the data as well as other business cycle features for Argentina, while preserving the default frequency at historical low levels.
    Keywords: Bonds ; Debts, External
    Date: 2012
  4. By: Lanzafame, Matteo
    Abstract: This paper investigates the sustainability of current accounts in advanced economies, using a panel of 27 countries and annual data over the 1980-2008 period. We find strong evidence in favour of nonlinear but stationary current-account trajectories for 14 countries, while the remaining 13 appear to be nonstationary and, thus, unsustainable. Our analysis indicates that careful empirical modeling of current-account dynamics, particularly in relation to cross-section dependence and nonlinear behaviour, is crucial for appropriate economic policymaking.
    Keywords: Current account sustainability; panel unit root tests; nonlinearity
    JEL: C33
    Date: 2012–11–01
  5. By: Joshua Aizenman; Ilan Noy
    Abstract: This paper investigates the impact of the history of crises on macroeconomic performance. We first study the impact of past banking crises on the probability of a future banking crisis. Applying data for 1980-2010 for all countries for which the required information is available, controlling for conventional macro variables and the history of banking crises occurring after 1970, we do not detect a learning process from past banking crises. Countries that have already experienced one banking crisis generally have a higher likelihood of experiencing another crisis; and the depth of the present crisis does not appear to be affected by the previous historical experience with crisis events. Evidence also suggests that, in middle-income countries, higher de jure capital account openness is associated with lower likelihood of a banking crisis, a lower ratio of non-performing loans during the crisis, and higher levels of forgone output in the crisis’ aftermath. In contrast, we find that past crisis experience has a significant impact on savings. When facing considerable political risk, the past does seem to matter – countries with more people who were exposed, over their lifetime, to larger disasters will tend to save more. This association, however, does not hold for countries with more stable political systems. We interpret these results as consistent with a differential sectoral adjustment to a crisis hypothesis. The private sector, by virtue of its harder budget constraints, adjusts faster, whereas the government adjusts at a slower pace following a crisis. The financial sector may find itself in between the two. The “too big to fail” doctrine associated with large banks provides them with a softer budget constraint, delaying the day of adjustment; for some, delaying bankruptcy. Occasionally, the separation between banks and the public sector is murky, further delaying necessary adjustments of the financial sector.
    JEL: E2 E4 F3 F36 F41
    Date: 2012–11
  6. By: Michael W. Klein
    Abstract: This paper examines the pattern of controls on capital inflows, and the association of these controls on financial variables, GDP, and exchange rates. A key point of the paper is the distinction between long-standing controls on a broad range of assets (walls) and episodic controls that are imposed and removed, and tend to be on a narrower set of assets (gates). The paper presents a new data set that differentiates between controls on different categories of assets for a set of 44 advanced and emerging market economies over the 1995 to 2010 period. The imposition of episodic controls is found to not follow the prescriptions of theories that suggest first imposing controls on international asset inflows that are most likely to contribute to financial vulnerability. Estimates show significant differences in the partial correlations of long-standing and episodic controls with the growth of financial variables and with GDP growth, but these differences seem to arise because countries with long-standing controls are poorer than the other countries in the sample. With a few exceptions, there is little evidence of the efficacy of capital controls on the growth of financial variables, the real exchange rate, or GDP growth at an annual frequency. These preliminary results raise doubts about assumptions behind recent calls for a greater use of episodic controls on capital inflows.
    JEL: F3 F33 F36
    Date: 2012–11
  7. By: Berge, Travis
    Abstract: The past 30 years have been witness to an inexorable change in the degree to which economies are connected internationally. At the same time, the 2007-2008 recession was the first ‘global recession’ in decades. This article explores how international trade and cross-border holdings financial assets impact the synchronization of business cycles internationally. The paper begins by producing chronologies of business cycle turning points for a group of 32 major economies covering 40 years of history. With these chronologies in hand, we document the degree of bilateral business cycle synchronization, relating cross-country differences in synchronization to bilateral trade and financial linkages. The analysis confirms that countries with deep trade linkages tend to experience similar business cycle fluctuations. However, we find no such relationship for financial linkages.
    Keywords: Globalization; international business cycle synchronization
    JEL: F4
    Date: 2012–10–01
  8. By: Ventosa-Santaulària, Daniel; Wallace, Frederick; Gómez-Zaldívar, Manuel
    Abstract: We show that the use of the real effective exchange rate to test for purchasing power parity, as in Astorga (2012) and other studies, introduces a bias against finding evidence of PPP. The bias is illustrated using unit root tests applied to bilateral real rates.
    Keywords: PPP; real effective exchange rate; stationarity
    JEL: C22 F31
    Date: 2012–09–29
  9. By: Evžen Kočenda (CERGE-EI - Center for Economic Research and Graduate Education - Economics Institute); Mathilde Maurel (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Gunther Schnabl (University of Leipzig - Institute for Economic Policy)
    Abstract: During the European sovereing debt crisis the discussion concerning the pros and cons of exchange rate adjustment in the face of asymmetric shocks was revived. Whereas one side has recommended (in the spirit of Keynes) the exist from the euro area to regain rapidly international competitiveness, exchange rate stability cum structural reforms have been argued (in the spirit of Schumpeter) to be a beneficial long-term strategy towards the reanimation of a robust growth performance. Previous literature has estimated the average growth of countries with different degrees of exhange rate volatility. We augment this literature by econometrically separating between the short-term and long-term growth effects of exchange rate volatility based on a panel-cointegration framework for a sample of 60 countries clustered in five country groups. The estimations show that countries with a low degree of exchange rate volatility exhibit a higher long-term growth performance, whereas over the short-run exchange rate flexibility provides some benefits. In line with Mundell (1961) we show that the degree of business cycle synchronization with the (potential) anchor country matters for the impact of exchange rate volatility on growth.
    Keywords: Exchange rate regime; crisis; shock adjustment; theory of optimum currency areas; Mundell; Schumpeter; cointegration, competitive depreciations.
    Date: 2012–10
  10. By: Natasa Bilkic (University of Paderborn); Ben Carreras Painter (University of Paderborn); Thomas Gries (University of Paderborn)
    Abstract: As a direct effect of the financial crisis in 2008, public debt began to accumulate rapidly, eventually leading to the European sovereign debt crisis. However, the dramatic increase in government debt is not only happening in European countries. All major G7 countries are experiencing similar developments. What are the implications of this kind of massive deficit and debt policy for the long term stability of these economies? Are there limits in debt-ratios that qualitatively change policy options? While theory can easily illustrate these limits, where are these limits in real economies? This paper examines the relationship between sovereign debt dynamics and capital formation, and accounts for the effects of the 2008 financial crisis on debt sustainability for the four largest advanced economies. We contribute to the literature on fiscal sustainability by framing the problem in an OLG model with government debt, physical capital, endogenous interest rates, and exogenous growth. For the calibration exercise we extract data from the OECD for Germany as a stabilization anchor in Europe, the U.S., the U.K., and Japan for almost two decades before the 2008 crisis. Except for intertemporal preferences all parameters are drawn or directly derived from the OECD database, or endogenously determined within the model. The results of the calibration exercise are alarming for all four countries under consideration. We identify debt ceilings that indicate a sustainable and unsustainable regime. For 2011, all four economies are either close to-, or have already passed the ceiling. The results call for a dramatic re-adjustment in budget policies for a consolidation period and long-term fiscal rules that make it possible to sustain sufficient capital intensity so that these economies can maintain their high income levels. Current conditions are already starting to restrict policy choices. However, the results also make it very clear that none of these economies would survive a second financial crisis such as the one in 2008.
    Keywords: fiscal sustainability, primary deficit, debt ceiling, fiscal rules, OLG, calibration, advanced economies
    JEL: H62 H63 E62 G01
    Date: 2012–09

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