nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒10‒18
twelve papers chosen by
Martin Berka
Victoria University of Wellington

  1. Banking globalization, transmission, and monetary policy autonomy By Linda S. Goldberg
  2. Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises By Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
  3. Optimal Exchange Rate Policy in a Growing Semi-Open Economy. By Bacchetta, P.; Benhima, K.; Kalantzis, Y.
  4. Risk Sharing and Real Exchange Rate : The Roles of Non-tradable Sector and Trend Shocks By Huseyin Cagri Akkoyun; Yavuz Arslan; Mustafa Kilinc
  5. Current-account adjustments and exchange-rate misalignments By Blaise Gnimasoun; Valérie Mignon
  6. Price Transmission and Effects of Exchange Rates on Domestic Commodity Prices via Offshore and Currency Hedging By Nongnuch Tantisantiwong
  7. Foreign exchange constraints and macroeconomic dynamics in a small open economy By Senbeta, Sisay Regassa
  8. Debt Levels, Debt Composition, and Sovereign Spreads in Emerging and Advanced Economies By Dell'Erba, Salvatore; Hausmann, Ricardo; Panizza, Ugo
  9. Fiscal Imbalances and Current Account Adjustments in the European Transition Economies By Mirdala, Rajmund
  10. Menu Costs, Trade Flows, and Exchange Rate Volatility By Logan Lewis
  11. Banks in international trade finance: evidence from the U.S. By Friederike Niepmann; Tim Schmidt-Eisenlohr
  12. Modern Currency Wars: The United States versus Japan By McKinnon, Ronald; Liu, Zhao

  1. By: Linda S. Goldberg
    Abstract: International financial linkages, particularly through global bank flows, generate important questions about the consequences for economic and financial stability, including the ability of countries to conduct autonomous monetary policy. I address the monetary autonomy issue in the context of the international policy trilemma: Countries seek three typically desirable but jointly unattainable objectives—stable exchange rates, free international capital mobility, and monetary policy autonomy oriented toward, and effective at, achieving domestic goals. I argue that global banking entails some features that are distinct from the broad issues of capital market openness captured in existing studies. In principle, if global banks with affiliates in foreign markets can reduce frictions in international capital flows, then the macroeconomic policy trilemma could bind tighter and interest rates will exhibit more co-movement across countries. However, if the information content and stickiness of the claims and services provided are enhanced relative to a benchmark alternative, then global banks can weaken the trilemma rather than enhance it. The result is a prediction of heterogeneous effects on monetary autonomy, tied to the business models of the global banks and whether countries are investment or funding locations for those banks. Empirical tests of the trilemma support this view that global bank effects are heterogeneous and that the primary drivers of monetary autonomy are exchange rate regimes.
    Keywords: Monetary policy ; International economic integration ; Foreign exchange rates ; Capital movements ; Banks and banking, International ; Flow of funds
    Date: 2013
  2. By: Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
    Abstract: We propose a continuous time model of nominal debt and investigate the role of inflation credibility in the potential for self-fulfilling debt crises. Inflation is costly, but reduces the real value of outstanding debt without the full punishment of default. With high inflation credibility, which can be interpreted as joining a monetary union or issuing foreign currency debt, debt is effectively real. By contrast, with low inflation credibility, sovereign debt is nominal and in a debt crisis a government may opt to inflate away a fraction of the debt burden rather than explicitly default. This flexibility potentially reduces the country's exposure to self-fulfilling crises. On the other hand, the government lacks credibility not to inflate in the absence of crisis. This latter channel raises the cost of debt in tranquil periods and makes default more attractive in the event of a crisis, increasing the country's vulnerability. We characterize the interaction of these two forces. We show that there is an intermediate inflation credibility that minimizes the country's exposure to rollover risk. Low inflation credibility brings the worst of both worlds—high inflation in tranquil periods and increased vulnerability to a crisis.
    JEL: E31 E4 E62 F34 G15
    Date: 2013–10
  3. By: Bacchetta, P.; Benhima, K.; Kalantzis, Y.
    Abstract: In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modeling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.
    Keywords: China, exchange rate policy and international reserves.
    JEL: E58 F31 F41
    Date: 2013
  4. By: Huseyin Cagri Akkoyun; Yavuz Arslan; Mustafa Kilinc
    Abstract: In this paper, we show that tradable and non-tradable TFP processes of the US and Europe have unit roots and can be modeled by a vector error correction model (VECM). Then, we develop a standard two country and two good (tradable and non-tradable) DSGE model. Our model implies that using cointegrated TFP processes improves the real exchange rate (RER) volatility and risk sharing puzzles compared to the model with transitory TFP processes. Cointegrated TFP shocks, or trend shocks, generate signi?cant income e¤ects, and amplify the mechanisms that produce high RER volatility. Moreover, trend shocks break the tight link between relative consumption and RER for low and high values of trade elasticity parameters.
    Keywords: Trends Shocks, Risk Sharing, Real Exchange Rates
    JEL: E32 F41 F44
    Date: 2013
  5. By: Blaise Gnimasoun; Valérie Mignon
    Abstract: This paper aims at studying current-account imbalances by paying a particular attention to exchange-rate misalignments. We rely on a nonlinear model linking the persistence of current-account imbalances to the deviation of the exchange rate to its equilibrium value. Estimating a panel smooth transition regression model on a sample of 22 industrialized countries, we show that persistence of current-account imbalances strongly depends on currency misalignments. More specifically, while there is no persistence in cases of currency undervaluation or weak overvaluation, persistence tends to augment for overvaluations higher than 11%. In addition, whereas disequilibria are persistent even for very low overvaluations in the euro area, persistence is observed only for overvaluations higher than 14% for non-eurozone members.
    Keywords: current-account imbalances, current-account persistence, exchange-rate misalignments, panel smooth transition regression models
    JEL: F32 F31 C33
    Date: 2013
  6. By: Nongnuch Tantisantiwong
    Abstract: The framework presents how trading in the foreign commodity futures market and the forward exchange market can affect the optimal spot positions of domestic commodity producers and traders. It generalizes the models of Kawai and Zilcha (1986) and Kofman and Viaene (1991) to allow both intermediate and final commodities to be traded in the international and futures markets, and the exporters/importers to face production shock, domestic factor costs and a random price. Applying mean-variance expected utility, we find that a rise in the expected exchange rate can raise both supply and demand for commodities and reduce domestic prices if the exchange rate elasticity of supply is greater than that of demand. Whether higher volatilities of exchange rate and foreign futures price can reduce the optimal spot position of domestic traders depends on the correlation between the exchange rate and the foreign futures price. Even though the forward exchange market is unbiased, and there is no correlation between commodity prices and exchange rates, the exchange rate can still affect domestic trading and prices through offshore hedging and international trade if the traders are interested in their profit in domestic currency. It illustrates how the world prices and foreign futures prices of commodities and their volatility can be transmitted to the domestic market as well as the dynamic relationship between intermediate and final goods prices. The equilibrium prices depends on trader behaviour i.e. who trades or does not trade in the foreign commodity futures and domestic forward currency markets. The empirical result applying a two-stage-least-squares approach to Thai rice and rubber prices supports the theoretical result.
    Keywords: commodity markets, offshore hedging, currency hedging, asset pricing, price transmission
    JEL: F1 F3 G1 Q1
    Date: 2013–10
  7. By: Senbeta, Sisay Regassa
    Abstract: Firms in most low-income countries depend almost entirely on imported capital and intermediate inputs. As a result, the availability and cost of foreign exchange play a crucial role on the macroeconomic performance of these countries. In this study we introduce foreign exchange constraints that importing ?rms face and the foreign exchange reserve management problem of the central banks in such economies into a small open economy New Keynesian model. We calibrated the model to the Ethiopian economy. Our simulation experiments show that given the foreign exchange constraints and the standard monetary policy rule, contractionary monetary policy leads to expansion in output and consumption and contraction in employment. This e¤ect is more pronounced if the duration of price stickiness for the imported goods is short relative to that of the domestically produced goods which seems to be the case for countries like Ethiopia. This result, to the minimum, reminds us that one needs to be cautious about the e¤ectiveness of conventional macroeconomic policies when applied to low-income countries.
    Date: 2013–09
  8. By: Dell'Erba, Salvatore (Graduate Institute, Geneva); Hausmann, Ricardo (Harvard University); Panizza, Ugo (Graduate Institute, Geneva)
    Abstract: This paper studies the relationship between sovereign spreads and the interaction between debt composition and debt levels in advanced and emerging market countries. It finds that in emerging market countries there is a significant correlation between spreads and debt levels. This correlation, however, is not statistically significant in countries where most public debt is denominated in local currency. In advanced economies, the magnitude of the correlation between debt levels and spreads is about one fifth of the corresponding correlation for emerging market economies. In Eurozone countries, however, the correlation between spreads and debt ratios is similar to that of emerging market countries. The paper also shows that the financial crisis amplified the relationship between spreads and debt levels within the Eurozone but had no effect on the relationship between spreads and debt in standalone countries. Finally, the paper shows that the relationship between debt levels and spreads is amplified by the presence of large net foreign liabilities. This amplifying effect of net foreign liabilities is larger in the Eurozone than in standalone advanced economies. The paper concludes that debt composition matters and corroborates the original sin hypothesis that, rather than being a mere reflection of institutional weaknesses, the presence of foreign currency debt increases financial fragility and leads to suboptimal macroeconomic policies.
    JEL: F33 H63
    Date: 2013–09
  9. By: Mirdala, Rajmund
    Abstract: Origins and implications of twin deficits occurrence in a large scale of countries seems to be a center of rigorous empirical as well as theoretical investigation for decades. The reality of persisting fiscal and current account deficits became obvious in many advanced as well as advancing, emerging and low-income countries seemingly without a direct association with the phase of business cycle or trends in key fundamental indicators. European transition economies experienced current account deficits during the most of the pre-crisis period. Despite generally improved economic environment and high rates of economic growth it seems that countries with weaker nominal anchor experienced periods of persisting fiscal imbalances during the most of the pre-crisis period. Crises period affected both fiscal stance of government budgets and current account pre-crisis levels and trends in all countries from the group. As a result, leading path of both indicators significantly changed. In the paper we analyze effects of fiscal policies on current accounts in the European transition economies. Our main objective is to investigate causal relationship between fiscal policy discretionary changes and associated current account adjustments. We identify episodes of large current account and fiscal policy changes to provide an in-depth insight into frequency as well as parallel occurrence of deteriorations (improvements) in current accounts and fiscal stance of government budgets. From employed VAR model we estimate responses of current accounts in each individual country to the cyclically adjusted primary balance shocks.
    Keywords: fiscal imbalances, current account adjustments, economic crisis, vector autoregression, impulse-response function
    JEL: C32 E62 F32 F41 H60
    Date: 2013–08
  10. By: Logan Lewis (Federal Reserve Board)
    Abstract: U.S. imports and exports respond little to exchange rate changes in the short run. Pricing behavior has long been thought central to explaining this response: if local prices do not respond to exchange rates, neither will trade flows. Sticky prices and strategic complementarities in price setting generate sluggish responses, and they are necessary to match newly available international micro price data. I test models capable of replicating price data against trade flows. Even with significant short-run frictions, the models still imply a trade response to exchange rates stronger than found in the data. Moreover, using significant cross-sector heterogeneity, comparative statics implied by the model find little to no support in the data. These results suggest that while complementarity in price setting and sticky prices can explain pricing patterns, some other short-run friction is needed to match actual trade flows. Furthermore, the muted response found for sectors with high long-run substitutability implies that simply assuming low elasticities may be inappropriate. Finally, there is evidence of an asymmetric response to exchange rate changes.
    Date: 2013
  11. By: Friederike Niepmann; Tim Schmidt-Eisenlohr
    Abstract: Banks play a critical role in facilitating international trade, in particular by reducing the risk of trade transactions. This paper uses unique information on the trade finance business of U.S. banks to document new empirical patterns. The data reveal that banks' trade finance claims differ substantially across destination countries. They are hump-shaped in country credit risk and increase with the time to import of a destination market. The extent to which trading partners use bank guarantees also varies systematically with global conditions, expanding when aggregate risk is higher and funding is cheaper. The response of bank trade finance to changes in these macro factors is heterogeneous, however. In countries with intermediate levels of credit risk, which rely the most on bank guarantees, bank trade finance adjusts the least. We show that a modification of the standard model of payment contract choice in international trade is needed to rationalize these empirical findings.
    Keywords: International trade ; Banks and banking, International ; Risk ; Credit
    Date: 2013
  12. By: McKinnon, Ronald (Asian Development Bank Institute); Liu, Zhao (Asian Development Bank Institute)
    Abstract: In 2013, through massive quantitative easing by the Bank of Japan (BOJ), the yen depreciated about 25% against the US dollar, stoking fears of Japan bashing by the US. However, this sharp depreciation simply restored the purchasing power parity of the yen with the dollar. Since 2008, quantitative easing by the BOJ has been similar to that carried out by the US Federal Reserve, the Bank of England, and the European Central Bank. So the BOJ can only be faulted as a currency belligerent if there is further significant yen depreciation. Led by the US, now all mature industrial countries are addicted to near-zero interest liquidity traps in both the short and long terms. Such ultra-low interest rates are causing lasting damage to the countries' financial systems, and to those of emerging markets, which naturally have higher interest rates. But exiting the trap creates a risk of chaos in long-term bond markets and is proving surprisingly difficult.
    Keywords: currency wars; liquidity trap; quantitative easing; dollar versus yen; purchasing power parity
    JEL: F31 F32
    Date: 2013–10–10

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