nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2013‒12‒29
twenty-two papers chosen by
Martin Berka
Victoria University of Wellington

  1. Information Frictions and the Law of One Price: “When the States and the Kingdom became United” By Steinwender, Claudia
  2. Default Externalities in Emerging Market Systemic Private Debt Crises By Gondo, Rocío
  3. Fiscal devaluation in a Monetary Union By Engler, Philipp; Ganelli, Giovanni; Tervala, Juha; Voigts, Simon
  4. Dutch disease and fiscal policy By Orrego, Fabrizio; Vega, Germán
  5. Supplement to “Limited Participation in International Business Cycle Models: A Formal Evaluation†By Gao, Xiaodan; Hnatkovska, Viktoria; Marmer, Vadim
  6. Global spillovers and domestic monetary policy By Menzie D Chinn
  7. Nominal Stability and Financial Globalization By Devereux, Michael B; Senay, Ozge; Sutherland, Alan
  8. China's Growth, Stability, and Use of International Reserves By Joshua Aizenman; Yothin Jinjarak; Nancy P. Marion
  9. Role of Financial and Productivity Shocks in the US and Japan: A Two-Country Economy By Yue ZHAO
  10. Co-movements in Real Effective Exchange Rates: Evidence from the Dynamic Hierarchical Factor Model By Nagayasu, Jun
  11. Current account sustainability in Sub-Saharan Africa: Does the exchange rate regime matter? By Issiaka Coulibaly; Blaise Gnimassoun
  12. Productivity shocks and monetary policy in a two-country model By Jang, Tae-Seok; Okano, Eiji
  13. Evaluating the Welfare Effects of International Bankruptcy Regimes in a Political Economy Model By Burcu Eyigungor; Satyajit Chatterjee
  14. How Does the Exchange Rate Affect the Real Economy? A Literature Survey By Enzo Cassino; David Oxley
  15. House Prices Drive Current Accounts: Evidence from Property Tax Variations By Geerolf, François; Grjebine, Thomas
  16. Transmitting global liquidity to East Asia: policy rates, bond yields, currencies and dollar credit By Dong He; Robert N McCauley
  17. Foreign capital and exchange rate movement in developing economies: a theoretical note By Biswas, Anindya; Mandal, Biswajit; Saha, Nitesh
  18. Asset Bubbles & Global Imbalances By Daisuke Ikeda; Toan Phan
  19. Anatomy of credit booms and their demise By Marco Terrones; Enrique Mendoza
  20. Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective By Eric Young; Alessandro Rebucci; Christopher Otrok
  21. Was This Time Different? Fiscal Policy in Commodity Republics By Luis Felipe Céspedes; Andrés Velasco
  22. This Time They're Different: Heterogeneity;and Nonlinearity in the Relationship;between Debt and Growth By Markus Eberhardt; Andrea Filippo Presbitero

  1. By: Steinwender, Claudia
    Abstract: How do information frictions distort international trade? This paper exploits a unique historical experiment to estimate the magnitude of these distortions: the establishment of the transatlantic telegraph connection in 1866. I use a newly collected data set based on historical newspaper records that provides daily data on information flows across the Atlantic together with detailed, daily information on prices and trade flows of cotton. Information frictions result in large and volatile deviations from the Law of One Price. What is more, the elimination of information frictions has real effects: Exports respond to information about foreign demand shocks. Average trade flows increase after the telegraph and become more volatile, providing a more efficient response to demand shocks. I build a model of international trade that can explain the empirical evidence. In the model, exporters use the latest news about a foreign market to forecast expected selling prices when their exports arrive at the destination. Their forecast error is smaller and less volatile the more recent the available information. I estimate the welfare gains from information transmission through the telegraph to be roughly equivalent to those from abolishing a 6% ad valorem tariff.
    Date: 2013–12
  2. By: Gondo, Rocío (Banco Central de Reserva del Perú)
    Abstract: This paper analyzes how default externalities lead to an excessive incidence of systemic private debt crises. An individual defaulting borrower does not internalize that her default leads to a depreciation in the exchange rate because international lenders will sell any seizable assets and flee the country. The exchange rate depreciation in turn reduces the value of non-tradable collateral and induces other borrowers to default, leading to a chain reaction of defaults. The inefficiency in default spillovers can be corrected by strengthening the enforcement of creditor rights, so that individual agents default less often, reducing the frequency of systemic default.
    Keywords: Financial crisis, default, capital ows, pecuniary externalities, creditor rights, real exchange rate
    JEL: D62 F32 F41
    Date: 2013–12
  3. By: Engler, Philipp; Ganelli, Giovanni; Tervala, Juha; Voigts, Simon
    Abstract: Between 1999 and the onset of the economic crisis in 2008 real exchange rates in Greece, Ireland, Italy, Portugal and Spain appreciated relative to the rest of the euro area. This divergence in competitiveness was reflected in the emergence of current account imbalances. Given that exchange rate devaluations are no longer available in a monetary union, one potential way to address such imbalances is through a fiscal devaluation. We use a DSGE model calibrated to the euro area to investigate the impact of a fiscal devaluation, modeled as a revenue-neutral shift from employers´ social contributions to the Value Added Tax. We find that a fiscal devaluation carried out in Southern European countries has a strong positive effect on output, but a mild effect on the trade balance of these countries. In addition, the negative effect on Central-Northern countries output is weak. --
    Keywords: fiscal devaluation,fiscal policy,euro area,currency union,current account
    JEL: E32 E62 F32 F41
    Date: 2013
  4. By: Orrego, Fabrizio (Banco Central de Reserva del Perú); Vega, Germán (Universidad de Piura)
    Abstract: We study the implications of the so-called Dutch disease in a small open economy that receives signifficant inflows of funds due to an extraordinary increase in the international price of minerals. We consider three sectors, the tradeable sector, the booming sector and the non-tradeable sector in an otherwise standard real-business-cycle model. We find that the booming sector, that benefits from high international prices, induces the Dutch disease, that is, the tradeable sector declines, the real exchange rate appreciates, wages increase and the non-tradeable sector improves. We then introduce fiscal policies that aim to alleviate the consequences of the Dutch disease. One particular rule that boosts the productivity of firms seems to offset the effects of the Dutch disease.
    Keywords: Small open economy, Dutch disease, scal policy
    JEL: F31 F41 E62
    Date: 2013–12
  5. By: Gao, Xiaodan; Hnatkovska, Viktoria; Marmer, Vadim
    Abstract: This paper contains supplemental material for Gao, Hnatkovska, and Marmer (2013) "Limited Participation in International Business Cycle Models: A Formal Evaluation".
    Keywords: international business cycles, incomplete markets, limited asset market participation
    Date: 2013–12–21
  6. By: Menzie D Chinn
    Abstract: I discuss how the unconventional monetary policy measures implemented over the past several years – quantitative and credit easing, and forward guidance – can be analysed in the context of conventional models of asset prices, with particular reference to exchange rates. I then discuss alternative approaches to interpreting the effects of such policies, and review the empirical evidence. Finally, I examine the ramifications for thinking about the impact on exchange rates and asset prices of emerging market economies. I conclude that although the implementation of unconventional monetary policy measures may introduce more volatility into global markets, in general it will support global rebalancing by encouraging the revaluation of emerging market currencies.
    Keywords: Balance sheet, money supply, portfolio balance, forward guidance, yield curve, spreads, signaling, capital flows, rebalancing
    Date: 2013–12
  7. By: Devereux, Michael B; Senay, Ozge; Sutherland, Alan
    Abstract: Over the past four decades, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This appears to be a robust prediction of open economy macro models with endogenous portfolio choice. It holds across different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.
    Keywords: Nominal stability, Financial Globalization, Country Portfolios,
    Date: 2013
  8. By: Joshua Aizenman; Yothin Jinjarak; Nancy P. Marion
    Abstract: In the run-up to the financial crisis the world economy was characterized by large and growing current-account imbalances. Since the onset of the crisis, China and the U.S. have rebalanced. As a share of GDP, their current-account imbalances are now less than half their pre-crisis levels. For China, the reduction in its current-account surplus post-crisis suggests a structural change. Panel regressions for a sample of almost 100 countries over the thirty-year period 1983-2013 confirm that the relationship between current-account balances and economic variables such as performance, structure, wealth and the exchange rate changed in important ways after the financial crisis.
    JEL: F3 F31 F32 F36 F4
    Date: 2013–12
  9. By: Yue ZHAO (yGraduate School of Economics, Kyoto University)
    Abstract: Jermann and Quadrini (2012) show that compared with productivity shocks, direct shocks to the credit system ("nancial shocks") have contributed to the most frequently observed dynamics of both real and nancial variables in the US within a closed economy framework. We develop a simple two-country model featuring an international bond market and enforcement constraints within both countries in an attempt to quantify the role of productivity and nancial shocks. We construct time series of productivity shocks and nancial shocks using the US and Japanese quarterly data since 2001 and conduct simultaneous replication on major indicators of real variables and aggregate nancial ows. The main results were as follows. First, for both the US and Japan, productivity shocks account for most real variable dynamics such as output and investment, while nancial shocks well capture the trend of consumption, current account, and labor trends in the US and succeed in replicating Japan's debt repurchase behavior. Nevertheless, it is noteworthy that nancial shocks served as key factors in accounting for the observed troughs of output, labor, and consumption, as well as the peaks of debt repurchase and the US current account during the 2007-09 nancial crisis. Second, it is surprising that observable international spillover eect appeared only in Japan's debt repurchases. As it is widely considered that the Japanese economy have been deeply in uenced by US economic uctuations, our quantitative results raise questions about this opinion.
    Keywords: Business uctuations, nancial friction, open economy, simulation
    JEL: E32 E37 E44 F41
    Date: 2013–12
  10. By: Nagayasu, Jun
    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 e ffective exchange rates, dynamic hierarchical factor model, variance decomposition, Bayesian model averaging,
    Date: 2013
  11. By: Issiaka Coulibaly; Blaise Gnimassoun
    Abstract: This paper aims at studying the sustainability of current accounts in Sub-Saharan Africa and determining whether this sustainability depends on the exchange rate regime. Relying on a formal theoretical framework and recent panel cointegration techniques, our findings show that current accounts have been globally sustainable in Sub-Saharan Africa countries over the 1980-2011 period. However, this sustainability has been lower for countries operating a fixed exchange rate regime or belonging to a monetary union. We also find that the difference in the level of sustainability could be explained by a higher persistence in the current account adjustment of countries operating under rigid exchange rate regimes.
    Keywords: Current account, Exchange rate regime, Panel cointegration tests, Sub-Saharan Africa
    JEL: F31 F33 C33
    Date: 2013
  12. By: Jang, Tae-Seok; Okano, Eiji
    Abstract: In this paper, we examine the effects of foreign productivity shocks on monetary policy in a symmetric open economy. Our two-country model incorporates the New Keynesian features of price stickiness and monopolistic competition based on the cost channel of Ravenna and Walsh (2006). In particular, in response to asymmetric productivity shocks, firms in one country achieve a more efficient level of production than those in another economy. Because the terms of trade are directly affected by changes in both economies’ output levels, international trade creates a transmission channel for inflation dynamics in which a deflationary spiral in foreign producer prices reduces domestic output. When there is a decline in economic activity, the monetary authority should react to this adverse situation by lowering the key interest rate. The impulse response function from the model shows that a productivity shock can cause a real depreciation of the exchange rate when economies are closely integrated through international trade.
    Keywords: cost channel; new Keynesian model; productivity shocks; terms of trade; two-country model
    JEL: E24 E31 J3
    Date: 2013–12
  13. By: Burcu Eyigungor (Federal Reserve Bank of Phildelphia); Satyajit Chatterjee (Federal Reserve Bank of Philadelphia)
    Abstract: We evaluate the welfare benefits of international bankruptcy regimes in a political economy model of debt and default. We show that the socially optimal bankruptcy regime is likely to feature lower restructuring costs than the politically optimal bankruptcy regime. To the extent the current regime reflects the political preferences of borrowing countries, a case can be made for an international bankruptcy regime aimed at reducing (but not eliminating) restructuring costs.
    Date: 2013
  14. By: Enzo Cassino; David Oxley (The Treasury)
    Abstract: We examine the relationship between exchange rate movements and the real economy – an area that has been the focus of considerable debate in recent years. We consider different concepts of exchange rate equilibrium, and review recent evidence on whether the New Zealand dollar exchange rate reflects its fundamental determinants. We also review the theoretical and empirical evidence on the relationship between movements in the exchange rate and the resulting impacts on the wider economy. We conclude that the nature of the relationship between the movements in the exchange rate and the resulting adjustment in the real economy depends on the nature of the shocks that affect the economy. This has important policy implications as policymakers need to have a clear understanding of the nature of the shock when deciding on appropriate responses. In practice, however, it is often difficult for policymakers to identify accurately the types of shocks hitting the economy, especially in real time. While the New Zealand dollar exchange rate may be overvalued at present, the equilibrium value of the exchange rate may also have risen, possibly due to higher export commodity prices. Tradable sector output growth has declined since the mid-2000s, but within the tradable sector, activity in resource-based industries has risen strongly, while manufacturing output and exports of services has declined. This is consistent with “Dutch disease” effects, as higher commodity prices lead to a crowding out of non-commodity exports. Sensitivity to exchange rate movements also varies across New Zealand’s economic sectors and industries. The agricultural sector is relatively insensitive to exchange rate movements, while the manufacturing and service sectors are more vulnerable.
    Keywords: Exchange Rate Valuation; Fundamentals; Equilibrium; Economic Growth, Dutch Disease
    JEL: F31 F41 F43
    Date: 2013–12
  15. By: Geerolf, François; Grjebine, Thomas
    Abstract: We study the causal link between house prices and current accounts. Across time and countries, we find a very large and significant impact of house prices on current accounts. In order to rule out endogeneity concerns, we instrument house prices for a panel of countries, using property tax variations. A 10% instrumented appreciation in house prices leads to a deterioration in the current account of 1.7% of GDP. These results are very robust to the inclusion of the determinants of current accounts. Following a house price increase, private savings decrease, through wealth effects rather than consumer-finance based mechanisms, while non-residential investment rises through a relaxation of financing constraints for firms.
    Keywords: current accounts
    JEL: F32 F36 F40
    Date: 2013–12
  16. By: Dong He; Robert N McCauley
    Abstract: We review extant work on the transmission of monetary policy, both conventional and unconventional, of the major advanced economies to East Asia through monetary policy reactions, integrated bond markets and induced currency appreciation. We present new results on the growth of foreign currency credit, especially US dollar credit, as a transmission mechanism. Restrained growth of dollar credit in Korea contrasts with very rapid growth on the Chinese mainland and in Hong Kong SAR.
    Keywords: global liquidity, Taylor rule, monetary policy, bond markets, exchange rates, foreign currency debt, dollarisation, macroprudential policy, capital controls
    Date: 2013–10
  17. By: Biswas, Anindya; Mandal, Biswajit; Saha, Nitesh
    Abstract: This study attempts to provide with underlying theoretical explanations for exchange rate appreciation due to foreign capital inflow. We use an extended three sector specific factor model to explain why and how an inflow of foreign capital boosts the price of a nontradable good that helps tilting the exchange in rate in favor of the host country. We also strive to look at the possible consequences on factor prices and on sectoral de-composition of a representative economy.
    Keywords: Foreign capital inflow, Real exchange rate, Developing economies
    JEL: F21 F3 F31
    Date: 2013–12
  18. By: Daisuke Ikeda; Toan Phan
    Abstract: We introduce asymmetry in financial frictions into a two-country growth model with overlapping generations, by assuming that the South faces more severe financial frictions than the North. We show that this asymmetry causes capital to flow upstream from South to North, thus explaining the so called global imbalances. More importantly, we show that capital inflows from the South enable a rational bubble to emerge in the North, despite that a Northern bubble could never emerge if the North were a closed economy. Furthermore, the bubble is inefficient as it crowds out global investment in Northern capital, and the bubble reduces steady state welfare in both North and South. Our model formalizes the idea that a “savings glut†flowing from financially underdeveloped emerging economies into the U.S. fueled the boom of a subprime mortgage bubble in the 2000s.
    Keywords: inefficient rational bubble; financial friction; global imbalances.
    JEL: F32 F41 F44
    Date: 2013–12–20
  19. By: Marco Terrones (International Monetary Fund); Enrique Mendoza (University of Pennsylvania)
    Abstract: What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrial countries over the 1960-2010 period. We identify 70 credit boom events, half of them in each group of countries. Event analysis shows a systematic relationship between credit booms and a boom-bust cycle in production and absorption, asset prices, real exchange rates, capital inflows, and external deficits. Credit booms are synchronized internationally and show three striking similarities in industrial and emerging economies: (1) credit booms are similar in duration and magnitude, normalized by the cyclical variability of credit; (2) banking crises, currency crises or Sudden Stops often follow credit booms, and they do so at similar frequencies in industrial and emerging economies; and (3) credit booms often follow surges in capital inflows, TFP gains, and financial reforms, and are far more common with managed than flexible exchange rates.
    Date: 2013
  20. By: Eric Young (University of Virginia); Alessandro Rebucci (Inter-American Development Bank); Christopher Otrok (University of Missouri/St Louis Fed)
    Abstract: In the aftermath of the global financial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distortions have become part of the standard policy toolkit (the so-called macro-prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justified rigorously because of second-best considerations. Within the same theoretical framework adopted in this fast-growing literature, we show that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls as it can achieve the unconstrained allocation.
    Date: 2013
  21. By: Luis Felipe Céspedes; Andrés Velasco
    Abstract: We revisit the issue of fiscal procyclicality in commodity-rich nations –commodity republics in the nomenclature of this paper. Since commodity prices are plausibly a main driver of fiscal policy outcomes in these countries, we focus on the behavior of fiscal variables across the commodity cycle, in contrast to behavior across the output cycle, which has been the main focus of earlier research on fiscal procyclicality. We present evidence of reduced fiscal policy procyclicality in a number of countries. Our empirical results suggest that improvements in institutional quality have led to a more countercyclical fiscal policy stance in a number of countries. The presence of fiscal rules also seems to have made a difference: countries that use them displayed a larger shift toward fiscal counter-cyclicality between the two episodes.
    JEL: E62 F21 F32 F41 H12 H6 H63
    Date: 2013–12
  22. By: Markus Eberhardt (School of Economics, University of Nottingham, UK, Centre for the Study of African Economies, Department of Economics, University of Oxford, UK); Andrea Filippo Presbitero (International Monetary Fund, Universit… Politecnica delle Marche - MoFiR)
    Abstract: We study the long-run relationship between public debt and growth in a large panel of countries. Our analysis takes particular note of theoretical arguments and data considerations in modelling the debt-growth relationship as heterogeneous across countries. We investigate the issue of nonlinearities ('debt thresholds') in both the cross-country and within-country dimensions, employing novel methods and diagnostics from the time-series literature adapted for use in the panel. We find some support for a nonlinear relationship between debt and long-run growth across countries, but no evidence for a common debt threshold within countries over time.
    Keywords: common factor model, economic growth, nonlinearity, public debt
    JEL: C23 E62 F34 O11
    Date: 2013–12

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