nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒09‒06
eight papers chosen by
Martin Berka
Victoria University of Wellington

  1. Co-movements in real effective exchange rates: evidence from the dynamic hierarchical factor model By Jun Nagayasu
  2. International financial integration, credit frictions and exchange rate regimes By Pirovano, Mara
  3. The Ease of Trade Imbalances Within the Euro Area After the 2008 Recession By Marcus Scheiblecker
  4. Unemployment fluctuations, and optimal monetary policy in a small open economy By Hyuk Jae Rhee; Jeongseok Song
  5. International Debt Deleveraging By Luca Fornaro
  6. Household and firm leverage, capital flows and monetary policy in a small open economy By Pirovano, Mara
  7. The implications of TARGET2 in the European balance of payment crisis and beyond By Sergio Cesaratto
  8. A set of estimated fiscal rules for a cross-section of countries: Stabilization and consolidation through which instruments? By Christopher Reicher

  1. By: Jun Nagayasu (Faculty of engineering, Information & Systems, University of Tsukuba, Japan)
    Abstract: We analyze and quantify co-movements in real effective exchange rates while considering the regional location of countries. More specifically, using the dynamic hierarchical factor model (Moench et al 2011), we decompose exchange rate movements into several latent components; worldwide and two regional factors as well as country-specific elements. Then, we provide evidence that the worldwide common factor is closely related to monetary policies in large advanced countries while regional common factors tend to be captured by those in the rest of the countries in a region. However, a substantial proportion of the variation in the real exchange rates is reported to be country-specific; even in Europe country-specific movements exceed worldwide and regional common factors.
    Keywords: real effective exchange rates, dynamic hierarchical factor model, variance decomposition, bayesian model averaging
    JEL: F31
    Date: 2013–08
  2. By: Pirovano, Mara
    Abstract: This paper studies the stabilisation properties of different exchange rate policies in a small open economy with cross-border balance sheet interdependence. The model features price and wage rigidities, credit frictions à la Bernanke, Gertler and Gilchrist (1999) both between households and banks and between banks and entrepreneurs, as well as international fi?nancial linkages à la Ueda (2012). I fi?nd that, overall, the argument in favor of ?flexible exchange rates holds irrespectively of the degree of fi?nancial integration. In fact, for all shocks considered, a fi?xed exchange rate policy delivers larger output losses and higher volatility of real and fi?nancial variables. Furthermore, my results reveal that the cost of pegging the exchange rate is inversely related to the degree of fi?nancial integration. Finally, I fi?nd that the presence of fi?nancial linkages increases the trade-off between infl?ation and output volatility faced by the central bank of a small open economy.
    Date: 2013–08
  3. By: Marcus Scheiblecker (WIFO)
    Abstract: Right from the start of the European currency union, trade imbalances could be observed in the current accounts and trade balances of the euro countries. The business cycle upswing reaching into 2008 and the strong inflow of cheap money led to a strong economic expansion especially in the periphery of the euro area. Traditionally abundant wage increases in these countries persisted. In the more export oriented economies in the core of the euro area, however, hardly any wage increases could be observed due to the lacklustre internal demand. As a consequence, those countries gained further in competitiveness in comparison to the periphery. This led to an increase in foreign trade imbalances. With the sharp drop of economic activity in 2008 and the swift dry-up of cheap financial means this process was interrupted. Since, labour unit costs of Spain, Portugal and Greece evolved much more muted than the average of the euro area. As a result, imports of those countries stagnated while exports increased at the same time which led to a nearly balanced external trade in 2012.
    Keywords: External imbalances Euro area Current account
    Date: 2013–08–29
  4. By: Hyuk Jae Rhee (Department of Economics, University of Windsor); Jeongseok Song (Department of Economics,Chung-Ang University)
    Abstract: In this paper, we incorporate key ingredients of a small open economy into the New Keynesian model with unemployment of Gali (2011a,b) to discuss the design of the monetary policy. The main findings regarding the issue of monetary policy design can be summarized as threefold. First, the optimal policy is to seek to minimize variance of domestic price inflation, wage inflation, and the output gap if both domestic price and wage are sticky. Second, stabilizing unemployment rate is important to reduce the welfare loss incurred by both technology and labor supply shocks. Therefore, introducing the unemployment rate as an another argument into the Taylor-rule type interest rate rule will be welfare-enhancing. Last, controlling CPI inflation is the best when the policy is not allowed to respond to unemployment rate.
    Keywords: Unemployment; Monetary policy; Small open economy.
    JEL: E31 E58 F41
    Date: 2013–08–28
  5. By: Luca Fornaro
    Abstract: I provide a framework for understanding debt deleveraging in a group of financially integrated countries. During an episode of international deleveraging world consumption demand is depressed and the world interest rate is low, reecting a high propensity to save. If exchange rates are allowed to oat, deleveraging countries can depreciate their nominal exchange rate to increase production and mitigate the fall in consumption associated with debt reduction. The key insight of the paper is that in a monetary union this channel of adjustment is shut off, and therefore the falls in consumption demand and in the world interest rate are amplified. Hence, monetary unions are especially prone to hit the zero lower bound on the nominal interest rate and enter a liquidity trap during deleveraging. In a liquidity trap deleveraging gives rise to a union-wide recession, which is particularly severe in high-debt countries. The model suggests several policy interventions that mitigate the negative impact of deleveraging on output in monetary unions. JEL classification: E31, E44, E52, F32, F34, F41, G01, G15
    Keywords: Global Debt Deleveraging, Liquidity Trap, Monetary Union, Precautionary Savings, Debt Deflation
    Date: 2013–06–10
  6. By: Pirovano, Mara
    Abstract: This paper presents a framework to analyze the interplay between ?financial frictions at the household and fi?rm level, liability dollarization and monetary policy in a small open economy subject to productivity and capital infl?ow shocks. Optimized monetary policy rules are calculated under several speci?cations (infl?ation targeting, exchange rate targeting, fi?xed exchange rate, credit growth targeting) and for two central bank?s objectives (macreconomic stability and macroeconomic plus fi?nancial stability). I ?find that, fi?rst, adding ?financial stability to the central bank?s objectives results in more inertial monetary policy rules. Second, the optimized Taylor rules under the ?financial stability objective achieve a lower volatility of infl?ation and of credit growth at the same time. However, this comes at the expense of a higher standard deviation of production. Third, when ?financial stability is included among the central bank?s objectives, engaging in exchange rate smoothing delivers the smallest value of the central bank?s loss function, mainly arising through a much reduced volatility of the credit aggregate. In the considered economy, credit growth targeting is suboptimal because of the effect of stronger interest rate increase on currency ?uctuations, which reinforce the ?financial accelerator. Finally, for the considered shocks, the extent of co-movement of fi?nancial variables pertaining to entrepreneurs and homeowners crucially depends on the degree of exchange rate fl?exibility.
    Date: 2013–08
  7. By: Sergio Cesaratto
    Abstract: The paper provides an account of the meaning and implications of TARGET 2 in the Eurozone (EZ) balance of payments crisis. In this context, it discusses Hans-Werner Sinn’s thesis about a stealth bail-out of the EZ periphery by the ECB from a heterodox perspective. Financial liberalisation, a relatively loose monetary policy and the provisional fading of devaluation risks generated ephemeral growth in some peripheral EZ countries sustained by capital flows from corecountries. This has been followed by real exchange rate revaluation and deterioration of foreign accounts. As a result, external financing flows dried up and the previous stock of loans began to be repatriated. TARGET 2 has played a fundamental role in avoiding a precipitous crisis. This distinguishes the European crisis from more traditional balance of payments crises. However, the presence of TARGET 2 does not offset the absence of the financial crisis prevention and resolution mechanisms that are characteristic of fully-fledged political and currency unions
    JEL: E11 E12 E42 E58 F32 F33 F34 F36 N24
    Date: 2013–08
  8. By: Christopher Reicher
    Abstract: This paper provides a set of detailed estimated fiscal reaction functions for a panel of twenty industrialized countries, and it discusses commonalities and differences with regard to systematic fiscal policies across countries. In general, the countries in the panel adjust tax revenues strongly in response to the public debt, and they adjust tax revenues and transfer payments, but, interestingly, not tax rates, strongly in response to output fluctuations. Some countries such as Germany appear to adjust government consumption and investment relatively strongly in response to the public debt, while the United States adjusts capital tax rates relatively strongly. In general, an increased emphasis in the theoretical literature on the effects of procyclical tax revenues and countercyclical transfer payments as automatic stabilizers may be warranted
    Keywords: Fiscal policy, fiscal rule, deficits, taxes, government purchases, transfer payments
    JEL: E62 E63 H20 H62
    Date: 2013–08

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