nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒11‒22
twelve papers chosen by
Martin Berka
Victoria University of Wellington

  1. Stabilizing Properties of Flexible Exchange Rates: Evidence from the Global Financial Crisis By Joseph E. Gagnon
  2. Asia Chartbook: Crises, Credit and Debt, 1835-2013 By Carmen M. Reinhart
  3. The Optimal Design of a Fiscal Union By Jonathan Hoddenbagh; Mikhail Dmitriev
  4. The Effects of the Saving and Banking Glut on the U.S. Economy By Alejandro Justiniano; Giorgio Primiceri; Andrea Tambalotti
  5. The Financialization of Commodity Markets By Ing-Haw Cheng; Wei Xiong
  6. Household and firm leverage, capital flows and monetary policy in a small open economy By Mara Pirovano
  7. Capital Account Openness and the Losses from Financial Frictions By Minsoo Han
  8. Volatility and Pass-through By David Berger; Joseph S. Vavra
  9. Testing the Prebisch-Singer Hypothesis Since 1650: Evidence from panel techniques that allow for multiple breaks By Rabah Arezki; Kaddour Hadri; Yao Rao
  10. Currency Wars in Action: How Foreign Exchange Interventions Work in an Emerging Economy By Moura, Marcelo L.; Pereira, Fatima R.; Attuy, Guilherme de Moraes
  11. The social impact of financial crises: evidence from the global financial crisis By Otker-Robe, Inci; Podpiera, Anca Maria
  12. Crowding Out Redefined: The Role of Reserve Accumulation By Carmen M. Reinhart; Takeshi Tashiro

  1. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: Inflation targeting countries with flexible exchange rates performed better during the global financial crisis and its aftermath than countries with a fixed exchange rate. Countries that maintained a hard fixed exchange rate throughout the past six years performed somewhat better than those that abandoned it. But, abandoning a hard fix during a crisis is itself evidence of the economic costs of fixed rates. It is particularly telling that no inflation targeting country with a flexible exchange rate abandoned its regime during the crisis. Policymakers in many countries are averse to volatile exchange rates—they have a "fear of floating." Gagnon's results strongly suggest that flexible exchange rates enable countries to weather crises better than fixed rates and that the benefits of flexible rates are not limited to large countries. Policymakers should replace their fear of floating with a fear of fixing.
    Date: 2013–11
  2. By: Carmen M. Reinhart
    Abstract: This Chartbook, which is a companion piece to Carmen M. Reinhart and Takeshi Tashiro (2013) “Crowding Out Redefined: The Role of Reserve Accumulation,” focuses on nine Asian economies: China, India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore and Thailand. Like its predecessor (Reinhart, 2010), it provides a pictorial history, on a country-by-country basis. In addition to public debt, we trace out the evolution of its composition between domestic and external borrowing. Total external debt (public and private) and domestic credit are also included through 2013. This combination gives a broad (but not complete) picture of a country’s indebtedness. It should be ideally supplemented (where relevant) by indicators and trends in the shadow banking sector, as discussed in Shin (2013). It is also timeline of a country’s creditworthiness and financial turmoil (including its history, if any, with IMF programs).
    JEL: E51 F3 G01 H63 N25
    Date: 2013–11
  3. By: Jonathan Hoddenbagh; Mikhail Dmitriev
    Abstract: We study cooperative and non-cooperative fiscal policy in an open economy model where cross-country risk sharing is imperfect and countries face terms of trade externalities. We show that the optimal form of fiscal cooperation, or fiscal union, is defined by one parameter: the Armington elasticity of substitution between goods from different countries. We prove that members of a fiscal union should: (1) harmonize steady state income tax rates when the Armington elasticity is low in order to ameliorate terms of trade externalities; and (2) send fiscal transfers across countries when the Armington elasticity is high in order to improve risk sharing. Our analytical predictions hold both outside of and within currency unions. For standard calibrations, we find that the welfare gain from the optimal fiscal union is as high as 5% of permanent consumption when countries are able to trade safe government bonds, and can approach 20% when countries lose access to international financial markets. We also find that labor mobility significantly improves welfare and alleviates the need for a transfer union entirely.
    JEL: E50 F41 F42
    Date: 2013–11–14
  4. By: Alejandro Justiniano; Giorgio Primiceri; Andrea Tambalotti
    Abstract: We use a quantitative equilibrium model with houses, collateralized debt and foreign borrowing to study the impact of global imbalances on the U.S. economy in the 2000s. Our results suggest that the dynamics of foreign capital flows account for between one fourth and one third of the increase in U.S. house prices and household debt that preceded the financial crisis. The key to these findings is that the model generates the sustained low level of interest rates observed over that period.
    JEL: E20 E21 E44 F32 G21
    Date: 2013–11
  5. By: Ing-Haw Cheng; Wei Xiong
    Abstract: The large inflow of investment capital to commodity futures markets in the last decade has generated a heated debate about whether financialization distorts commodity prices. Rather than focusing on the opposing views concerning whether investment flows either did or did not cause a price bubble, we critically review academic studies through the perspective of how financial investors affect risk sharing and information discovery in commodity markets. We argue that financialization has substantially changed commodity markets through these mechanisms.
    JEL: G00 Q02 Q1 Q4
    Date: 2013–11
  6. By: Mara Pirovano (University of Antwerp, Faculty of Applied Economics; Catholic University of Leuven, Center of Economic Studies)
    Abstract: This paper outlines a framework for analysing the interaction between financial frictions at the household and firm level, liability dollarization and optimal monetary policy in a small, open economy subject to productivity and capital inflow shocks. It is found that, first, for the shocks under review, the extent of co-movement of financial variables pertaining to entrepreneurs and homeowners crucially depends on the degree of exchange rate flexibility. Second, for a central bank not concerned with financial stability, reacting to inflation and output is considered optimal. Third, including financial stability in the central bank's objectives results in an optimal monetary policy rule reacting to exchange rate depreciation, but not to credit growth, even in the case of large capital inflow shocks. In fact, reacting to credit growth reinforces the initial shock, increasing financial imbalances.
    Keywords: DSGE model, capital inflows, financial frictions, liability dollarization, financial stability
    JEL: E44 E47 E52 F41 F47
    Date: 2013–11
  7. By: Minsoo Han (Pennsylvania State University)
    Abstract: The goal of this paper is to isolate the role of openness to international financial markets (capital account openness) on the total factor productivity (TFP) effect of financial frictions. To do so, I formulate a model in which individual households are either workers or entrepreneurs, can only save in the form of capital, and entrepreneurs are subject to a collateral constraint. Using this structure, I compare two steady states of a calibrated model numerically: one in which the capital rental rate must clear a domestic capital rental market (closed economy), and one in which that rate is given by the world (small open economy). The model predicts that a small open economy is affected less by financial frictions than a closed economy: for the tightest collateral constraint, TFP in a small open economy is only about 1% lower than in the economy without a collateral constraint, while it is 15% lower in a closed economy. TFP losses in a small open economy reflect factor misallocation among incumbent entrepreneurs (intensive margin), not distortions along entry-exit margin, whereas for a tight financial frictions, there are distortions on both intensive and entry-exit margins in a closed economy. Using macro data, I find that a 1% rise in openness is associated with 0.196% decline in the effect of financial frictions on TFP. Running the same regression on subsamples, I also find that this empirical result mainly comes from a group of low income countries.
    Date: 2013
  8. By: David Berger; Joseph S. Vavra
    Abstract: Time-variation in microdata matters empirically for aggregate dynamics: using confidential BLS data we document a robust positive relationship between aggregate exchange rate pass-through and the dispersion of item-level price changes. Furthermore, we find large time-variation in microeconomic dispersion. Ignoring this variation causes huge, time-varying bias when estimating pass-through. For example, constant pass-through specifications are overstated by 50 percent during the mid-1990s and understated by 200 percent during the 2008 trade-collapse. This purely empirical result arises naturally if items differ in their "responsiveness" to cost shocks. More responsive items should have greater price change dispersion and pass-through. We formally estimate price-setting models with alternative forms of heterogeneity and show only heterogeneous responsiveness explains our results. Interestingly, our evidence does not support "uncertainty" shocks as an explanation for countercyclical dispersion but does suggest promising alternatives.
    JEL: E10 E30 E31 F31
    Date: 2013–11
  9. By: Rabah Arezki; Kaddour Hadri; Yao Rao
    Abstract: In this paper, we re-examine two important aspects of the dynamics of rel- ative primary commodity prices, namely the secular trend and the short run volatility. To do so, we employ 25 series, some of them starting as far back as 1650 and powerful panel data stationarity tests that allow for endogenous multiple structural breaks. Results show that all the series are stationary after allowing for endogeneous multiple breaks. Test results on the Prebisch-Singer hypothesis, which states that relative commodity prices follow a downward sec- ular trend, are mixed but with a majority of series showing negative trends. We also make a .rst attempt at identifying the potential drivers of the structural breaks. We end by investigating the dynamics of the volatility of the 25 relative primary commodity prices also allowing for endogenous multiple breaks. We describe the often time-varying volatility in commodity prices and show that it has increased in recent years. � �
    Date: 2013–10–10
  10. By: Moura, Marcelo L.; Pereira, Fatima R.; Attuy, Guilherme de Moraes
    Date: 2013–10
  11. By: Otker-Robe, Inci; Podpiera, Anca Maria
    Abstract: Financial systems can contribute to economic development by providing people with useful tools for risk management, but when they fail to manage the risks they retain, they can create severe financial crises with devastating social and economic effects. The financial crisis that hit the world economy in 2008–2009 has transformed the lives of many individuals and families, even in advanced countries, where millions of people fell, or are at risk of falling, into poverty and exclusion. For most regions and income groups in developing countries, progress to meet the Millennium Development Goals by 2015 has slowed and income distribution has worsened for a number of countries. Countries hardest hit by the crisis lost more than a decade of economic time. As the efforts to strengthen the financial systems and improve the resilience of the global financial system continue around the world, the challenge for policy makers is to incorporate the lessons from the failures to take into consideration the complex linkages between financial, fiscal, real, and social risks and ensure effective risk management at all levels of society. The recent experience underscores the importance of: systematic, proactive, and integrated risk management by individuals, societies, and governments to prepare for adverse consequences of financial shocks; mainstreaming proactive risk management into development agendas; establishing contingency planning mechanisms to avoid unintended economic and social consequences of crisis management policies and building a better capacity to analyze complex linkages and feedback loops between financial, sovereign, real and social risks; maintaining fiscal room; and creating well-designed social protection policies that target the vulnerable, while ensuring fiscal sustainability.
    Keywords: Population Policies,Economic Theory&Research,Labor Policies,Emerging Markets,Debt Markets
    Date: 2013–11–01
  12. By: Carmen M. Reinhart; Takeshi Tashiro
    Abstract: It is well understood that investment serves as a shock absorber at the time of crisis. The duration of the drag on investment, however, is perplexing. For the nine Asian economies we focus on in this study, average investment/GDP is about 6 percentage points lower during 1998-2012 than its average level in the decade before the crisis; if China and India are excluded, the estimated decline exceeds 9 percent. We document how in the wake of crisis home bias in finance usually increases markedly as public and private sectors look inward when external financing becomes prohibitively costly, altogether impossible, or just plain undesirable from a financial stability perspective. Also, previous studies have not made a connection between the sustained reserve accumulation and the persistent and significantly lower levels of investment in the region. Put differently, reserve accumulation involves an official institution (i.e., the central bank) funneling domestic saving abroad and thus competing with domestic borrowers in the market for loanable funds. We suggest a broader definition of crowding out, driven importantly by increased “liability” home bias in finance and by official capital outflows. We present evidence from Asia to support this interpretation.
    JEL: E02 E5 F30 F4 G01 G15 H6
    Date: 2013–11

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