nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2014‒01‒24
fourteen papers chosen by
Martin Berka
Victoria University of Wellington

  1. Exchange Rates and Fundamentals:Closing a Two-country Model By Takashi Kano;
  2. Recovery from Financial Crises: Evidence from 100 Episodes By Carmen M. Reinhart; Kenneth S. Rogoff
  3. Understanding the gains from wage flexibility: The exchange rate connection By Jordi Galí; Tommaso Monacelli
  4. Understanding Law-of-One-Price Deviations across Europe Before and After the Euro By Marina Glushenkova; Marios Zachariadis
  5. Welfare Reversals in a Monetary Union By Stéphane Auray; Aurélien Eyquem
  6. International Portfolios: A Comparison of Solution Methods By Katrin Rabitsch; Serhiy Stepanchuk; Viktor Tsyrennikov
  7. Sovereign Borrowing, Financial Assistance and Debt Repudiation By Florian Kirsch; Ronald Rühmkorf
  8. Uncertainty and Episodes of Extreme Capital Flows in the Euro Area By Torsten Schmidt; Lina Zwick
  9. Competitiveness, Adjustment and Macroeconomic Risk Management in the Eurozone By Peter Spahn
  10. Time-varying Business Cycles Synchronisation in Europe By Degiannakis, Stavros; Duffy, David; Filis, George
  11. Unbundling the Great European Recession (2009-2013): Unemployment, Consumption, Investment, Inflation and Current Account By Campiglio, Luigi Pierfranco
  12. Addressing Currency Manipulation Through Trade Agreements By C. Fred Bergsten
  13. Real Output and Prices Adjustments Under Different Exchange Rate Regimes By Rajmund Mirdala
  14. Fiscal Imbalances and Current Account Adjustments in the European Transition Economies By Rajmund Mirdala

  1. By: Takashi Kano (Faculty of Economics, Hitotsubashi University);
    Abstract: In an influential paper, Engel and West (2005) claim that the near random-walk behavior of nom- inal exchange rates is an equilibrium outcome of a variant of present-value models when economic fundamentals follow exogenous first-order integrated processes and the discount factor approaches one. Subsequent empirical studies further confirm this proposition by estimating a discount factor that is close to one under distinct identification schemes. In this paper, I argue that the unit market discount factor implies the counterfactual joint equilibrium dynamics of random-walk ex- change rates and economic fundamentals within a canonical, two-country, incomplete market model. Bayesian posterior simulation exercises of a two-country model based on post-Bretton Woods data from Canada and the United States reveal difficulties in reconciling the equilibrium random-walk proposition within the two-country model; in particular, the market discount factor is identified as being much lower than one.
    Keywords: Exchange rates; Present-value model; Economic fundamentals; Random walk; Two- country model; Incomplete markets; Cointegrated TFPs; Debt elastic risk premium.
    JEL: E31 E37 F41
    Date: 2013–09
  2. By: Carmen M. Reinhart; Kenneth S. Rogoff
    Abstract: We examine the evolution of real per capita GDP around 100 systemic banking crises. Part of the costs of these crises owes to the protracted nature of recovery. On average, it takes about eight years to reach the pre-crisis level of income; the median is about 6 ½ years. Five to six years after the onset of crisis, only Germany and the US (out of 12 systemic cases) have reached their 2007-2008 peaks in real income. Forty-five percent of the episodes recorded double dips. Postwar business cycles are not the relevant comparator for the recent crises in advanced economies.
    JEL: E32 E44 F44 G01 N10 N20
    Date: 2014–01
  3. By: Jordi Galí; Tommaso Monacelli
    Abstract: We study the gains from increased wage flexibility and their dependence on exchange rate policy, using a small open economy model with staggered price and wage setting. Two results stand out: (i) the impact of wage adjustments on employment is smaller the more the central bank seeks to stabilize the exchange rate, and (ii) an increase in wage flexibility often reduces welfare, and more likely so in economies under an exchange rate peg or an exchange rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.
    Keywords: sticky wages, nominal rigidities, New Keynesian model, stabilization policies, exchange rate policy, currency unions, monetary policy rules.
    JEL: E32 E52 F41
    Date: 2013–12
  4. By: Marina Glushenkova; Marios Zachariadis
    Abstract: We use a panel of thousands of good-level prices before and after the euro in order to compare the determinants and understand the evolution of goods price dispersion across Europe during these two periods. We find that tradeability plays a substantially smaller role in lowering cross-country dispersion after the adoption of the euro as compared to before, and that the role of non-traded inputs in raising price dispersion is also reduced after the euro. We then compare the overall and country-level distributions of law-of-one-price (LOP) deviations at the early and late part of our sample to inform us about the degree of integration across European economies before and after the euro. Our tests reveal that the distributions after the euro are significantly different than those before, consistent with a greater degree of integration. Utilizing our panel to trace the location of individual goods in the distribution of LOP deviations, we ask how the price advantage or disadvantage of individual economies evident in these price distributions has been shifting over time, and whether goods characteristics play a role for the persistence of these LOP deviations. LOP deviations for these goods are highly correlated, on average, over five or ten year horizons, but much less so over twenty-year or longer horizons. These correlations are greater for homogeneous as compared to differentiated goods, and vary across countries. Finally, for the great majority of these European economies and goods, price advantage is typically revealed to be more persistent than price disadvantage.
    Keywords: micro prices, law-of-one-price, euro, integration, price advantage
    Date: 2014–01
  5. By: Stéphane Auray (EQUIPPE - ECONOMIE QUANTITATIVE, INTEGRATION, POLITIQUES PUBLIQUES ET ECONOMETRIE - Université Lille I - Sciences et technologies, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique); Aurélien Eyquem (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon)
    Abstract: We show that welfare can be lower under complete financial markets than under autarky in a monetary union with home bias, sticky prices and asymmetric shocks. Such a monetary union is a second-best environment in which the structure of financial markets affects risk-sharing but also shapes the dynamics of inflation rates and the welfare costs from nominal rigidities. Welfare reversals arise for a variety of empirically plausible degrees of price stickiness when the Marshall-Lerner condition is met. These results carry over a model with active fiscal policies, and hold within a medium-scale model, although to a weaker extent.
    Keywords: Monetary Union; Financial Markets Incompleteness; Sticky Prices; Fiscal and Monetary Policy
    Date: 2014–01–08
  6. By: Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business); Serhiy Stepanchuk (École Polytechnique Fédérale de Lausanne); Viktor Tsyrennikov (Cornell University)
    Abstract: We compare the performance of the perturbation-based (local) portfolio solution method of Devereux and Sutherland (2010a, 2011) with a global solution method. We find that the local method performs very well when the model is designed to capture stylized macroeconomic facts and countries/agents are symmetric, i.e. when the latter have similar size, face similar risks and trade assets with similar risk properties. It performs less satisfactory when the agents engaged in financial trade are asymmetric. The global solution method performs substantially better when the model is parameterized to match the observed equity premium, a key stylized finance fact.
    Keywords: Country Portfolios, Solution Methods
    JEL: E44 F41 G11 G15
    Date: 2014–01
  7. By: Florian Kirsch; Ronald Rühmkorf
    Abstract: Official lenders provide financial assistance to countries that face sovereign debt crisis. The availability of financial assistance has counteracting effects on the default incentives of governments. On the one hand, financial assistance can help to avoid defaults by bridging times of fundamental crises or resolving coordination failures among private investors. On the other hand, the insurance effect of financial assistance lowers borrowing costs which induces the sovereign to accumulate higher debt levels. To assess the overall effect of financial assistance on the probability of default we construct a quantitative model of endogenous credit structure and sovereign default that allows for self-fulfilling expectations of default. Calibrating the model to Argentinean data we find that the availability of financial assistance reduces the number of defaults that occur due to self-fulfilling runs by private investors. However, at the same time it raises average debt levels causing an overall increase of the probability of default.
    Keywords: Sovereign debt, Sovereign default, Self-fulfilling runs, Bailout
    JEL: F34 G15 O19
    Date: 2013–01
  8. By: Torsten Schmidt; Lina Zwick
    Abstract: During the Euro Area crisis huge changes in international capital flows occurred associated with a high level of economic uncertainty. While it is evident that both factors are able to trigger or amplify economic shocks posing a threat for economic activity it is a natural question whether they are related. The aim of this paper is to analyse the link between different measures of uncertainty and episodes of extreme capital flows for the core Euro Area countries using gross capital flows. We find that country-specific risk factors seem to play a more important role than global risk factors. Moreover, country-specific uncertainty seems to be more relevant for foreign direct investors.
    Keywords: Capital flows; uncertainty; Euro Area crisis; sudden stops; retrenchment
    JEL: F32 F21 G01
    Date: 2013–12
  9. By: Peter Spahn
    Abstract: Gaps in competitiveness, rooted in economic as well as in political factors, characterise postwar European economic history. The eurozone experience showed the emergence of large current account imbalances. The peculiar mixture of financial markets integration and national cycles in wages and prices gave rise to severe macroeconomic instability. The Swan Diagram is used to analyse alternative adjustment policies. Although there are signs of convergence in wage costs, the overall picture of EMU remains somewhat gloomy, requiring the decision between full political union or a renewed gold standard.
    Keywords: Currency union, euro crisis, current account imbalances, wage policy, Swan diagram
    JEL: E50 E58 E63 F32 F34
    Date: 2013–12
  10. By: Degiannakis, Stavros; Duffy, David; Filis, George
    Abstract: The paper investigates the time-varying correlation between the EU12-wide business cycle and the initial EU12 member-countries based on scalar-BEKK and multivariate Riskmetrics model frameworks for the period 1980-2009. The paper provides evidence that changes in the business cycle synchronisation correspond to institutional changes that have taken place at a European level. Business cycle synchronisation has moved in a direction positive for the operation of a single currency suggesting that the common monetary policy is less costly in terms of lost flexibility at the national level. Thus, any questions regarding the optimality and sustainability of the common currency area in Europe should not be attributed to the lack of cyclical synchronisation.
    Keywords: Scalar-BEKK, Multivariate Riskmetrics, time varying correlation, EU business cycle, business cycle synchronisation.
    JEL: C32 E32 F44 O52
    Date: 2013–10–15
  11. By: Campiglio, Luigi Pierfranco
    Abstract: The aim of the paper is to unbundle the main economic variables involved in the European Crisis and clarify their reciprocal relationship. The variable considered are: unemployment, inflation, consumptions, investments and current accounts. We use annual, quarterly and monthly data, until 2012, mid-2013 or an estimate of 2013 for the main European countries. The main results are the following: a) we show an emerging European economic divide, b) we detect a quasi-Okun relationship between investment and unemployment, c) we show the revival of the Phillips curve, especially in Germany, d) we test for the relationship between unemployment and the Government deficit, e) we show the existence of a relationship between unemployment and current account, f) we show how countries with high unemployment rate could bear the burden, g) we unbundle the unemployment-current account relationship, showing first the relationship between unemployment and final consumption, h) and then between final consumption, imports and corrent account, i) we show why a stable and growing inflation differential is not sustainable, but argue that internal devalution is not an effective policy, pushing inflation rates to a worrisome lower level and even outright deflation, l) we argue and show how to implement a more effective policy looking to the inflation differentials of specific products, looking to the case of Italy, m) we analyze the trade relationship between Germany and China, arguing that since the onset of the EMU and the successive membership of China to the WTO a European structural break occurred, with some European countries relying much more on exports rather than domestic demand. A more general issue of sustainability and replicability of the Germany’s export led growth model is raised.
    Keywords: Great Recession, Europe, Germany, Unemployment, Inflation, Consumption, Investment, Current Account.
    JEL: E24 E29 E31 E32 H62
    Date: 2014–01
  12. By: C. Fred Bergsten (Peterson Institute for International Economics)
    Abstract: Currency manipulation—governments of foreign countries intervening to suppress the value of their currencies to lower the prices of their exports and increase the prices of their imports—has vexed the United States for many years. Because most of the intervention takes place in US dollars, the dollar has been pushed to systemically overvalued levels. The US current account deficit has averaged $200 billion to $500 billion per year higher as a result of the manipulation. Several other countries, including the weak euro area economies, emerging-market countries such as Brazil and India, and many small and poor countries, have also suffered the ill effects of currency manipulation. In light of large and widespread trade effects, Bergsten calls for addressing the issue through trade agreements, especially when the International Monetary Fund and other institutions have failed to resolve it for so long. He recommends adding a currency chapter in the Trans-Pacific Partnership (TPP), which is currently under negotiation and could be the earliest trade agreement to come before Congress for approval. Including clear obligations to avoid currency manipulation in the TPP and other future trade agreements, along with an effective dispute settlement mechanism and sanctions against violators, would very likely deter future manipulation.
    Date: 2014–01
  13. By: Rajmund Mirdala
    Abstract: Exchange rate regimes evolution in the European transition economies refers to one of the most crucial policy decision in the beginning of the 1990s employed during the initial stages of the transition process. During the period of last two decades we may identify some crucial milestones in the exchange rate regimes evolution in the European transition economies. due to existing diversity in exchange rate arrangements in the European transition economies in the pre-ERM2 period there seems to be two big groups of countries - “peggers” (Bulgaria, Estonia, Latvia, Lithuania) and “floaters” (Czech republic, Hungary, Poland, Romania, Slovak republic, Slovenia). Despite the fact, there seems to be no real prospective alternative to euro adoption for the European transition economies, we emphasize disputable effects of sacrificing monetary sovereignty in the view of positive effects of exchange rate volatility and exchange rate based adjustments in the country experiencing sudden shifts in the business cycle. In the paper we analyze effects of the real exchange rate volatility on real output and inflation in ten European transition economies. From estimated VAR model (recursive Cholesky decomposition is employed to identify structural shocks) we compute impulse-response functions to analyze responses of real output and inflation to negative real exchange rate shocks. Results of estimated model are discussed from a prospective of the fixed versus flexible exchange rate dilemma. To provide more rigorous insight into the problem of the exchange rate regime suitability we estimate the model for each particular country employing data for two subsequent periods 2000-2007 and 2000-2011.
    Keywords: exchange rate volatility, economic growth, economic crisis, vector autoregression, variance decomposition, impulse-response function
    JEL: C32 F32 F41
    Date: 2013–11–15
  14. By: Rajmund Mirdala
    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: 2013–11–15

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