nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒12‒20
six papers chosen by
Martin Berka
Victoria University of Wellington

  1. The Quantitative Importance of Openness in Development By Wenbiao Cai; B. Ravikumar; Raymond G. Riezman
  2. Firm Risk and Leverage Based Business Cycles By Sanjay K. Chugh
  3. REER Imbalances and Macroeconomic Adjustments in the Proposed West African Monetary Union By Asongu Simplice
  4. Real financial market exchange rates and capital flows By Gelman, Maria; Jochem, Axel; Reitz, Stefan
  5. Current account adjustment in EU countries: Does euro-area membership make a difference? By Herrmann, Sabine; Jochem, Axel
  6. Exchange rate dynamics revisited By Jorge Braga de Macedo; Urho Lempinen

  1. By: Wenbiao Cai; B. Ravikumar; Raymond G. Riezman
    Abstract: This paper deals with a classic development question: how can the process of economic development – transition from stagnation in a traditional technology to industrialization and prosperity with a modern technology – be accelerated? Lewis (1954) and Rostow (1956) argue that the pace of industrialization is limited by the rate of capital formation which in turn is limited by the savings rate of workers close to subsistence. We argue that access to capital goods in the world market can be quantitatively important in speeding up the transition. We develop a parsimonious open-economy model where traditional and modern technologies coexist (a dual economy in the sense of Lewis (1954)). We show that a decline in the world price of capital goods in an open economy increases the rate of capital formation and speeds up the pace of industrialization relative to a closed economy that lacks access to cheaper capital goods. In the long run, the investment rate in the open economy is twice as high as in the closed economy and the per capita income is 23 percent higher.
    JEL: O11 F43 O14
    Date: 2013–11
  2. By: Sanjay K. Chugh (Boston College)
    Abstract: I characterize cyclical fluctuations in the cross-sectional dispersion of firm-level productivity in the U.S. manufacturing sector. Using the estimated dispersion, or "risk," stochastic process as an input to a baseline DSGE financial accelerator model, I assess how well the model reproduces aggregate cyclical movements in the financial conditions of U.S. non-financial firms. In the model, risk shocks calibrated to micro data induce large and empirically-relevant fluctuations in leverage, a nancial measure typically thought to be closely associated with real activity. In terms of aggregate quantities, however, pure risk shocks account for only a small share of GDP fluctuations in the model, less than one percent. Instead, it is standard aggregate productivity shocks that explain virtually all of the model's real fluctuations. These results reveal a dichotomy at the core of a popular class of DSGE financial frictions models: risk shocks induce large financial fiuctuations, but have little effect on aggregate quantity fluctuations.
    Keywords: leverage, second-moment shocks, time-varying volatility, credit frictions, financial accelerator, business cycles
    JEL: E10 E20 E32 E44
    Date: 2013–03–02
  3. By: Asongu Simplice (Yaoundé/Cameroun)
    Abstract: With the spectre of the Euro crisis hunting embryonic monetary unions, we use a dynamic model of a small open economy to analyze REERs imbalances and examine whether the movements in the aggregate real exchange rates are consistent with the underlying macroeconomic fundamentals in the proposed West African Monetary Union (WAMU). Using both country-oriented and WAMU panel-based specifications, we show that the long-run behavior of the REERs can be explained by fluctuations in the terms of trade, productivity, investment, debt and openness. While there is still significant evidence of cross-country differences in the relationship between underlying macroeconomic fundamentals and corresponding REERs, the embryonic WAMU has a stable error correction mechanism with four of the five cointegration relations having signs that are consistent with the predictions from economic theory. Policy implications are discussed and the conclusions of the analysis are a valuable contribution to the scholarly and policy debate over whether the creation of a sustainable monetary union should precede convergence in macroeconomic fundamentals that determine REER adjustments.
    Keywords: Exchange rate; Macroeconomic impact; Proposed WAMU
    JEL: F31 F33 F42 O55
    Date: 2013–09
  4. By: Gelman, Maria; Jochem, Axel; Reitz, Stefan
    Abstract: Foreign exchange rates and capital movements are expected to be closely related to each other as international capital markets become more and more integrated. To account for this fact we construct an index of real effective exchange rates as a weighted average of cross-country asset price ratios. The empirical analysis reveals that a country's real financial effective exchange rate is cointegrated with net foreign holdings of its assets. Comparing the empirical performance of the new index with a standard effective exchange rate deflated by goods prices we find that only the former exhibits an influence on the international flow of capital. --
    Keywords: Real Effective Exchange Rate,Capital Flows,Financial Markets
    JEL: F31 G15 E58
    Date: 2013
  5. By: Herrmann, Sabine; Jochem, Axel
    Abstract: The paper evaluates current account dynamics in countries with different exchange rate regimes within the EU. In this, the empirical analysis explicitly differentiates between countries with a flexible and a fixed exchange rate regime and members of a monetary union. In addition, we model the adjustment process of external disequilibria by referring to the flexibility of exchange rates and interest rates. The sample covers annual data for 27 EU countries from 1994 to 2011. The estimation is based on a simple autoregressive model and comes to the conclusion that current account adjustment is significantly hampered in countries that are members of a monetary union. This holds particularly in comparison with floating exchange rate regimes owing to lower exchange rate flexibility. However, the persistence of current account balances in member countries of a monetary union is also more pronounced than in fixed-rate regimes due to less flexible interest rates as a result of the single monetary policy. --
    Keywords: Balance of Payments,European Monetary Union,Exchange Rate Regime,Current Account Adjustment,Financial Crisis
    JEL: E52 F32 F33 F34
    Date: 2013
  6. By: Jorge Braga de Macedo; Urho Lempinen
    Abstract: Many monetary and fiscal policy decision makers and economists hold the view that exchange rates are volatile even though nominal exchange rates vary less than many other financial market prices and yields. This paper seeks an explanation for this puzzle by contrasting exchange rate dynamics in a general equilibrium model to those presented in Dornbusch (1976) and Kouri (1978). Kouri introduced the "acceleration hypothesis'', according to which the rate of currency depreciation is given by the ratio of the current account deficit to the sum of holdings of foreign assets by domestic agents and holdings of domestic assets by foreign agents. In this paper, we derive the "generalized acceleration hypothesis'', assuming price flexibility but imperfect substitutability of assets. A Kouri type gradual adjustment of the current account induces stickiness in portfolio adjustments and exchange rate adjustment. Uncertainty in the model arises from monetary policy and supply side shocks. Due to general equilibrium constraints on wealth and investment behavior, the speed of adjustment is defined by the sum of speculative (expectations sensitive) demand for foreign (domestic) assets by domestic (foreign) agents, deducted by the stock of domestic assets traded out by domestic residents. The adjustment speed is then higher and the market correction mechanism through the current account stronger. The model developed in this paper includes the three key channels of external adjustment of an economy: the capital account or portfolio allocation channel as applied by Kouri (and also by Dornbusch, although under perfect substitutability of assets), the current account channel as applied by Kouri and the asset valuation channel as applied in Gourinchas & Rey (2007). In a linearized testing environment, we study three different cases of exchange rate dynamics. Sampling 10 000 continuous time paths of Monte Carlo simulations for 30 years, and using the 90% variation range as the metric, the Dornbusch formulation yields a 200% variation range about the mean, reduced to 100% in the Kouri case and to 20% in the general equilibrium case.
    JEL: F31 F32
    Date: 2013–12

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