nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒12‒15
twenty-two papers chosen by
Martin Berka
Victoria University of Wellington

  1. Global Current Account Imbalances and Exchange Rate Adjustments By Kenneth Rogoff; William Brainard; George Perry
  2. Financial stability in open economies By Ippei Fujiwara, Yuki Teranishi
  3. On the Impact of Oil Price Volatility on the Real Exchange Rate - Terms of Trade Nexus : Revisiting Commodity Currencies By Virginie Coudert; Cécile Couharde; Valérie Mignon
  4. Why Does Monetary Policy Respond to the Real Exchange Rate in Small Open Economies? A Bayesian Perspective By Carlos Garcia
  5. Dilemma not Trilemma? Capital Controls and Exchange Rates with Volatile Capital Flows By Emmanuel Farhi; Ivan Werning
  6. Perspectives on PPP and Long-Run Real Exchange Rates By Ken Froot; Kenneth Rogoff
  7. Reserves of Natural Resources in a Small Open Economy By Isaac Gross; James Hansen
  8. Purchasing power parity and the Taylor rule By Hyeongwoo Kim, Ippei Fujiwara, Bruce E. Hansen, Masao Ogaki
  9. The changing relationship between commodity prices and equity prices in commodity exporting By Barbara Rossi
  10. The Unsustainable US Current Account Position Revisited By Maurice Obstfeld; Kenneth Rogoff; Richard Clarida
  11. External Debt and Taylor Rules In a Small Open Economy By Shigeto Kitano; Kenya Takaku
  12. Distributional Impact of Commodity Price Shocks: Australia over a Century By Sambit Bhattacharyya; Jeffrey G. Willliamson
  13. Financial Globalization, Growth and Volatility In Developing Countries By Ayhan Kose; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei; Ann Harrison
  14. The Six Major Puzzles in International Macroeconomics: Is there a Common Cause? By Maurice Obstfeld; Kenneth Rogoff; Ben Bernanke; Kenneth Rogoff
  15. The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification? By Richard Meese; Kenneth Rogoff; Jacob Frenkel
  16. Combining Monetary and Fiscal Policy in an SVAR for a Small Open Economy By Alfred A. Haug; Tomasz Jedrzejowicz; Anna Sznajderska
  17. On Graduation from Default, Inflation and Banking Crises: Elusive or Illusion? By Rong Qian; Carmen M. Reinhart; Kenneth Rogoff
  18. Perspectives on OECD Capital Market Integration: Implications for U.S. Current Account Adjustment By Maurice Obstfeld; Kenneth Rogoff
  19. The EMS, the EMU, and the Transition to a Common Currency By Kenneth Froot; Kenneth Rogoff; Olivier Blanchard; Stanley Fischer
  20. Boom or gloom? Examining the Dutch disease in a two-speed economy By Hilde C. Bjørnland; Leif Anders Thorsrud
  21. Estimates of Fundamental Equilibrium Exchange Rates, November 2013 By William R. Cline
  22. Trade Openness, Institutional Change and Economic Growth By Antonio Navas

  1. By: Kenneth Rogoff; William Brainard; George Perry
  2. By: Ippei Fujiwara, Yuki Teranishi
    Abstract: Do financial frictions call for policy cooperation? This paper investigates the implications of financial frictions for monetary policy in the open economy. Welfare analysis shows that there are long-run gains which result from cooperation, but, dynamically, financial frictions per se do not require policy cooperation to improve global welfare over business cycles. In addition, inward-looking financial stability, namely eliminating inefficient fluctuations of loan premiums in the home country, is the optimal monetary policy in the open economy, irrespective of the existence of policy coordination.Length: 42 pages
    Keywords: Optimal monetary policy in open economy; financial market imperfectionsd estimator; Grid-t Confidence Interval
    JEL: E50 F41
    Date: 2013
  3. By: Virginie Coudert; Cécile Couharde; Valérie Mignon
    Abstract: The aim of this paper is to study the relationship between terms of trade and real exchange rates of commodityproducing Commodity currencies,countries on both the short and the long run. We pay particular attention to the dominant role played by oil among commodities by investigating the potential non-linear effect exerted by the situation on the oil market on the real exchange rate - terms of trade nexus. To this end, we rely on the panel smooth transition regression methodology to estimate the adjustment process of the real effective exchange rate to its equilibrium value depending on the volatility on the oil market. Considering a panel of 52 commodity exporters and 17 oil exporters over the 1980-2012 period, our findings show that while exchange rates are mainly driven by fundamentals in the low-volatility regime, they are mostly sensitive to changes in terms of trade when oil price variations exceed a certain threshold. The commodity-currency property is thus at play in the short run only for important variations in the oil price.
    Keywords: Commodity currencies;Oil price;Non-linearity
    JEL: C23 F31 Q43
    Date: 2013–12
  4. By: Carlos Garcia (Facultad de Economía y Negocios, Universidad Alberto Hurtado)
    Abstract: To estimate how monetary policy works in small open economies, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of small open economies (including Australia, Chile, Colombia, Peru, and New Zealand) is rather similar to that observed in closed economies. Our results also indicate, however, that there are strong differences due to shocks from the international financial markets (mainly risk premium shocks). These differences explain most of the variability of the real exchange rate, which has important reallocation effects in the short run. Our results are consistent with an old idea from the Mundell-Fleming model: namely, a real depreciation to confront a risk premium shock is expansive or procyclical, in contradiction to the predictions of the balance sheet effect, the J curve effect, and the introduction of working capital into RBC models. In line with this last result, we have strong evidence that only in one of the five countries analyzed in this study does not intervene the real exchange rate, the case of New Zealand.
    Keywords: small open economy models; monetary policy rules; exchange rates; Bayesian econometrics
    JEL: F33 E52 F41
    Date: 2012–11
  5. By: Emmanuel Farhi; Ivan Werning
    Abstract: We consider a standard New Keynesian model of a small open economy with nominal rigidities and study optimal capital controls. Consistent with the Mundellian view, we find that the exchange rate regime is key. However, in contrast with the Mundellian view, we find that capital controls are desirable even when the exchange rate is flexible. Optimal capital controls lean against the wind and help smooth out capital flows.
    Date: 2013–01
  6. By: Ken Froot; Kenneth Rogoff
    Abstract: This paper reviews the large and growing literature which tests PPP and other models of the long-run real exchange rate. We distinguish three different stages of PPP testing and focus on what has been learned from each. The most important overall lesson has been that the real exchange rate appears stationary over sufficiently long horizons. Simple, univariate random walk specifications can be rejected in favor of stationary alternatives. However, we argue that multivariate tests, which ask whether any linear combination of prices and exchange rates are stationary, have not necessarily provided meaningful rejections of nonstationarity. We also review a number of other theories of the long run real exchange rate -- including the Balassa-Samuelson hypothesis -- as well as the evidence supporting them. We argue that the persistence of real exchange rate movements can be generated by a number of sensible models and that Balassa- Samuelson effects seem important, but mainly for countries with widely disparate levels of income of growth. Finally, this paper presents new evidence testing the law of one price on 200 years of historical commodity price data for England and France, and uses a century of data from Argentina to test the possibility of sample-selection bias in tests of long-run PPP.
  7. By: Isaac Gross (Reserve Bank of Australia); James Hansen (Reserve Bank of Australia)
    Abstract: This paper studies the effect of a shock to resource prices in a small open economy where the stock of natural resources is responsive to exploration activity, and where extraction reduces the future availability of reserves. We show that the effects of a resource price shock on resource investment, labour utilisation and extraction are all amplified in the presence of endogenous reserves. We also find that spillovers to broader economic activity, including changes in domestic production, non-resource exports and consumption, are all greater in the presence of exploration activity. However, we find that incorporating endogenous reserves does not fundamentally change the effects of a resource price shock on key price measures including consumer prices, the real exchange rate and domestic interest rates.
    Keywords: natural resources; small open economy
    JEL: F41 Q33
    Date: 2013–12
  8. By: Hyeongwoo Kim, Ippei Fujiwara, Bruce E. Hansen, Masao Ogaki
    Abstract: It is well-known that there is a large degree of uncertainty around Rogoff's (1996) consensus half-life of the real exchange rate. To obtain a more efficient estimator, we develop a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. Further, we propose a median unbiased estimator for the system method based on the generalized method of moments with nonparametric grid bootstrap confidence intervals. Applying the method to real exchange rates of 18 developed countries against the US dollar, we find that most half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals. Our Monte Carlo simulation results are consistent with an interpretation of these results that the true half-lives are short but long half-life estimates from single equation methods are caused by the high degree of uncertainty of these methods.
    Keywords: purchasing power parity; Taylor Rule; half-life of PPP deviations;median unbiased estimator; Grid-t Confidence Interval
    JEL: C32 E52 F31
    Date: 2013
  9. By: Barbara Rossi
    Abstract: We explore the linkage between equity and commodity markets, focusing in particular on its evolution over time. We document that a country's equity market value has significant out-of-sample predictive ability for the future global commodity price index for several primary commodity-exporting countries. The out-of-sample predictive ability of the equity market appears around 2000s. The results are robust to using several control variables as well as firm-level equity data. Finally, our results indicate that exchange rates are a better predictor of commodity prices than equity markets, especially at very short horizons.
    Keywords: Commodity prices, equity prices, exchange rates, forecasting.
    JEL: C22 C52 C53
    Date: 2012–10
  10. By: Maurice Obstfeld; Kenneth Rogoff; Richard Clarida
    Abstract: We show that when one takes into account the global equilibrium ramifications of an unwinding of the US current account deficit, currently estimated at 5.4% of GDP, the potential collapse of the dollar becomes considerably larger (more than 50% larger) than our previous estimates (Obstfeld and Rogoff 2000a). That global capital markets may have deepened (as emphasized by US Federal Reserve Chairman Alan Greenspan) does not affect significantly the extent of dollar decline in the wake of global current account adjustment. Rather, the dollar adjustment to global current account rebalancing depends more centrally on the level of goods-market integration. Whereas the dollar’s decline may be benign as in the 1980s, we argue that the current conjuncture more closely parallels the early 1970s, when the Bretton Woods system collapsed. Finally, we use our model to dispel some common misconceptions about what kinds of shifts are needed to help close the US current account imbalance. Faster growth abroad helps only if it is relatively concentrated in nontradable goods; faster productivity growth in foreign tradable goods is more likely to exacerbate the US adjustment problem.
  11. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Graduate School of Economics, Nagoya University)
    Abstract: We develop a dynamic stochastic general equilibrium model of a small open economy in which both price rigidity and financial friction exist. We compare two cases featuring different interest rate rules. Both cases use the standard Taylor-type interest rate rules, but the second case also considers external debt levels. We find that when friction in foreign borrowing is large, adding an external debt level to Taylor rules improves welfare. The welfare curve, however, exhibits a hump shape since excessive reactions to changes in external debt reduce welfare.
    Keywords: External debt; Taylor rules; small open economy; DSGE; welfare; emerging market economies
    JEL: E5 F4
    Date: 2013–11
  12. By: Sambit Bhattacharyya; Jeffrey G. Willliamson
    Abstract: Abstract. This paper studies the distributional impact of commodity price shocks over the both the short and very long run. Using a GARCH model, we find that Australia experienced more volatility than many commodity exporting developing countries over the periods 1865- 1940 and 1960-2007. A single equation error correction model suggests that commodity price shocks increase the income share of the top 1, 0.05, and 0.01 percents in the short run. The very top end of the income distribution benefits from commodity booms disproportionately more than the rest of the society. The short run effect is mainly driven by wool and mining and not agricultural commodities. A sustained increase in the price of renewables (wool) reduces inequality whreas the same for non-renewable resources (minerals) increases inequality. We expect that the initial distribution of land and mineral resources explains the asymmetric result.
    Keywords: comodity price shocks, commodity exporters, top incomes, inequality
    JEL: F14 F43 N17 O13
    Date: 2013–07–23
  13. By: Ayhan Kose; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei; Ann Harrison
    Abstract: This paper provides a comprehensive assessment of empirical evidence about the impact of financial globalization on growth and volatility in developing countries. The results suggest that it is difficult to establish a robust causal relationship between financial integration and economic growth. Furthermore, there is little evidence that developing countries have been consistently successful in using financial integration to stabilize fluctuations in consumption growth. However, we do find that financial globalization can be beneficial under the right circumstances. Empirically, good institutions and quality of governance are crucial in helping developing countries derive the benefits of globalization. Similarly, macroeconomic stability appears to be an important prerequisite for ensuring that financial globalization is beneficial for developing countries. Finally, countries that employ relatively flexible exchange rate regimes and succeed in maintaining fiscal discipline are more likely to enjoy the potential growth and stabilization benefits of financial globalization.
  14. By: Maurice Obstfeld; Kenneth Rogoff; Ben Bernanke; Kenneth Rogoff
    Abstract: The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs but more broadly, tariffs, nontariff barriers and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home bias in trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity home bias puzzle, and the Backus-Kehoe- Kydland consumption correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad arrange of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing power parity puzzle emphasized by Rogoff, and what we term the exchange-rate disconnect puzzle.' The latter category of riddles includes both the Meese-Rogoff exchange rate forecasting puzzle and the Baxter-Stockman neutrality of exchange rate regime puzzle. Here although many elements need to be added to our extremely simple model, we can still show that trade costs play an essential role.
  15. By: Richard Meese; Kenneth Rogoff; Jacob Frenkel
  16. By: Alfred A. Haug (Department of Economics, University of Otago, New Zealand); Tomasz Jedrzejowicz (National Bank of Poland); Anna Sznajderska (National Bank of Poland)
    Abstract: This paper combines a monetary structural vector-autoregression (SVAR)with a fiscal SVAR for Poland. Fiscal foresight, in the form of implementation lags, is accounted for with respect to both discretionary government spending and tax changes. We demonstrate the importance of combining monetary and fiscal transmission mechanisms. However, ignoring fiscal foresight has no statistically significant effects. We calculate an initial government spending multiplier of 0.14, which later peaks at 0.48. The tax multiplier is close to zero. We also find that monetary policy in Poland transmits mainly through the real sector, that is through real GDP and the real exchange rate.
    Keywords: Structural vector autoregressions, monetary and fiscal policy, fiscal foresight, narrative approach
    JEL: E52 E62 C51
    Date: 2013–10
  17. By: Rong Qian; Carmen M. Reinhart; Kenneth Rogoff
    Abstract: This paper uses a data set of over two hundred years of sovereign debt, banking and inflation crises to explore the question of how long it takes a country to “graduate†from the typical pattern of serial crisis that most emerging markets experience. We find that for default and inflation crises, twenty years is a significant market, but the distribution of recidivism has extremely fat tails. In the case of banking crises, it is unclear whether countries ever graduate. We also examine the more recent phenomenon of IMF programs, which sometimes result in “near misses†but sometimes end in default even after a program is instituted. The paper raises the important theoretical question of why countries experience serial default, and how they might graduate.
  18. By: Maurice Obstfeld; Kenneth Rogoff
  19. By: Kenneth Froot; Kenneth Rogoff; Olivier Blanchard; Stanley Fischer
  20. By: Hilde C. Bjørnland; Leif Anders Thorsrud
    Abstract: Traditional studies of the Dutch disease do not typically account for productivity spillovers between the booming energy sector and non-oil sectors. This study identifies and quantifies these spillovers using a Bayesian Dynamic Factor Model (BDFM). The model allows for resource movements and spending effects through a large panel of variables at the sectoral level, while also identifying disturbances to the real oil price, global demand and non-oil activity. Using Norway as a representative case study, we find that a booming energy sector has substantial spillover effects on the non-oil sectors. Furthermore, windfall gains due to changes in the real oil price also stimulate the economy, but primarily if the oil price increase is caused by global demand. Oil price increases due to, say, supply disruptions, while stimulating activity in the technologically intense service sectors and boosting government spending, have small spillover effects on the rest of the economy, primarily because of reduced cost competitiveness. Yet, there is no evidence of Dutch disease. Instead, we find evidence of a two-speed economy, with non-tradables growing at a much faster pace than tradables. Our results suggest that traditional Dutch disease models with a fixed capital stock and exogenous labor supply do not provide a convincing explanation for how petroleum wealth a effects a resource rich economy when there are productivity spillovers between sectors.
    Keywords: Resource boom, oil prices, Dutch disease, learning by doing, two-speed economy, Bayesian Dynamic Factor Model(BDFM)
    JEL: C32 E32 F41 Q33
    Date: 2013–12
  21. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: Since the previous estimates of fundamental equilibrium exchange rates (FEERs) in May 2013, numerous exchange rates have moved substantially in response to the US Federal Reserve's announcement that it would likely begin to "taper" its quantitative easing. Despite widespread concern that this "taper shock" has wreaked havoc in international capital and currency markets, exchange rate misalignments have tended to narrow in the past six months. Overvalued currencies have corrected downward in Turkey, South Africa, India, Indonesia, and even Australia. Medium-term surplus estimates have moderated in Taiwan, Sweden, Switzerland, and Japan, narrowing the extent of their undervaluations. Cases of large misalignments persist, however, with Singapore once again undervalued by 21 percent, New Zealand again overvalued by nearly 18 percent, and Turkey still overvalued by 18 percent despite some correction. The overvaluation of the dollar and undervaluation of the Chinese renminbi remain modest and no longer constitute the severe imbalances of 2006–07.
    Date: 2013–12
  22. By: Antonio Navas (Department of Economics, The University of Sheffield)
    Abstract: This paper creates a theory of endogenous growth with endogenous institutional change to analyse the impact that trade openness has on economic growth through a change in institutions in pre-industrial societies. An elite (landowners) controlling the political power expropriates another social group (capitalists). This reduces investment in physical capital, the source of endogenous growth. The rival group (capitalists) can take a military action to expel the group in power. I study optimal expropriation, growth and institutional change under two scenarios, autarky and free trade. The simulation results suggest that for a vast majority of cases economies open to trade generally experience higher growth and earlier institutional change. This is the consequence of the fact that the elite reduces the expropriation rate when the economy opens up to trade. In addition, economies specialising in manufacturing products tend to grow more and introduce institutional change earlier. This is consistent with the divergent pattern in growth and institutions that Western European Economies were experiencing during the modern era and the industrial revolution.
    Keywords: trade; institutions; growth in the very long run
    JEL: F43 O43
    Date: 2013

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