nep-opm New Economics Papers
on Open Economy Macroeconomic
Issue of 2014‒04‒18
fourteen papers chosen by
Martin Berka
University of Auckland

  1. The Euro and The Geography of International Debt Flows By Galina Hale; Maurice Obstfeld
  2. Understanding the Great Recession By Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt
  3. Credit Risk in the Euro Area By Simon Gilchrist; Benoît Mojon
  4. Sovereign defaults, external debt and real exchange rate dynamics By Asonuma, Tamon
  5. The importance of the exchange rate regime in limiting current account imbalances in sub-Saharan African countries By Blaise Gnimassoun
  6. Quality, Trade, and Exchange Rate Pass-Through By Chen, Natalie; Juvenal, Luciana
  7. Financialisation, distribution, growth and crises – long-run tendencies By Eckhard Hein; Nina Dodig
  8. Exchange rates and commodity prices: measuring causality at multiple horizons By Hui Jun Zhang; Jean-Marie Dufour; John Galbraith
  9. The possible trinity: Optimal interest rate, exchange rate, and taxes on capital flows in a DSGE model for a small open economy By Escudé, Guillermo J.
  10. What Drives the German Current Account ?And How Does It Affect Other EU Member States ? By Robert Kollmann; Marco Ratto; Werner Roeger; Jan in'tVeld; Lukas Vogel
  11. The Rise of the “Redback” and the People’s Republic of China’s Capital Account Liberalization: An Empirical Analysis of the Determinants of Invoicing Currencies By Ito, Hiro; Chinn, Menzie
  12. Productivity and the Welfare of Nations By Basu, Susanto; Pascali, Luigi; Schiantarelli, Fabio; Serven, Luis
  13. Early warning indicators: financial and macroeconomic imbalances in Central and Eastern European countries By Orsolya Csortos; Zoltán Szalai
  14. Varieties of Sovereign Crises: Latin America 1820-1931 By Graciela Laura Kaminsky; Pablo Vega-García

  1. By: Galina Hale; Maurice Obstfeld
    Abstract: Greater financial integration between core and peripheral EMU members had an effect on both sets of countries. Lower interest rates allowed peripheral countries to run bigger deficits, which inflated their economies by allowing credit booms. Core EMU countries took on extra foreign leverage to expose themselves to the peripherals. The result has been asset-price bubbles and collapses in some of the peripheral countries, area-wide banking crisis, and sovereign debt problems. We analyze the geography of international debt flows using multiple data sources and provide evidence that after the euro’s introduction, Core EMU countries increased their borrowing from outside of EMU and their lending to the EMU periphery.
    JEL: F32 F34 F36
    Date: 2014–04
  2. By: Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt
    Abstract: We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions interacting with the zero lower bound. We reach this conclusion looking through the lens of a New Keynesian model in which firms face moderate degrees of price rigidities and no nominal rigidities in the wage setting process. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.
    JEL: E1 E2 E3
    Date: 2014–04
  3. By: Simon Gilchrist; Benoît Mojon
    Abstract: We construct credit risk indicators for euro area banks and non-financial corporations. These are the average spreads on the yield of euro area private sector bonds relative to the yield on German federal government securities of matched maturities. The indicators are also constructed at the country level for Germany, France, Italy and Spain. These indicators reveal that the financial crisis of 2008 has dramatically increased the cost of market funding for both banks and non-financial firms. In contrast, the prior recession following the 2000 U.S. dot-com bust led to widening credit spreads of non-financial firms but had no effect on the credit spreads of financial firms. The 2008 financial crisis also led to a systematic divergence in credit spreads for financial firms across national boundaries. This divergence in cross-country credit risk increased further as the European debt crisis has unfolded since 2010. Since that time, credit spreads for both non-financial and financial firms increasingly reflect national rather than euro area financial conditions. Consistent with this view, credit spreads provide substantial predictive content for a variety of real activity and lending measures for the euro area as a whole and for individual countries. VAR analysis implies that disruptions in corporate credit markets lead to sizable contractions in output, increases in unemployment, and declines in inflation across the euro area.
    JEL: E32 E44 G12
    Date: 2014–04
  4. By: Asonuma, Tamon
    Abstract: Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of a dynamic stochastic general equilibrium model. The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk. Our quantitative analysis, using the case of Argentina�s default in 2001, replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data. Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign�s large share of foreign currency debt, trigger defaults. In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation.
    Keywords: Sovereign defaults; External debt; Real exchange rate; Currency composition of debt;
    JEL: E43 F32 F34 G12
    Date: 2014–03–23
  5. By: Blaise Gnimassoun
    Abstract: One of the major current concerns of economic policy in developing countries is the choice of the appropriate exchange rate regime to consolidate and accelerate the pace of economic growth. This paper aims to investigate whether the choice of a country’s exchange rate regime may affect current account imbalances for sub-Saharan African economies. To this end, we first use Bayesian model averaging (BMA) to address concerns about model uncertainty and identify the key determinants (fundamentals) of external balances. Then, estimating current account imbalances over the 1980-2012 period, we show that flexible exchange rate regimes are more effective in preventing such disequilibria. Consequently, candidates for membership of monetary unions should discuss widely the possible adjustment mechanisms before forming such unions; one potential measure being the sharing of external risks at regional level
    Keywords: Current account imbalances, Exchange rate regime, Bayesian model averaging, Sub-Saharan Africa.
    JEL: F32 F33 C11
    Date: 2014
  6. By: Chen, Natalie (University of Warwick, CAGE and CEPR); Juvenal, Luciana (International Monetary Fund)
    Abstract: This paper investigates the heterogeneous response of exporters to real exchange rate ‡uctuations due to product quality. We combine a unique data set of highly disaggregated Argentinean …rm-level wine export values and volumes between 2002 and 2009 with experts wine ratings as a measure of quality. In response to a real depreciation, we …nd that …rms signi…cantly increase more their markups and less their export volumes for higher quality products, but only when exporting to high income destination countries. These results remain robust to di¤erent measures of quality, samples, speci…cations and to the potential endogeneity of quality. To motivate our …ndings we extend the model of Corsetti and Dedola (2005) with local distribution costs and allow …rms to export multiple products with heterogeneous levels of quality. The model shows that the elasticity of demand perceived by exporters decreases with a real depreciation and with quality, leading to more pricing-to-market and to a smaller response of export volumes to a real depreciation for higher quality goods. Overall our results help to explain the low exchange rate pass-through that is typically observed in aggregate data.
    Keywords: Exchange rate pass-through, pricing-to-market, quality, unit values, exports, …rms, wine.
    Date: 2013
  7. By: Eckhard Hein (Berlin School of Economics and Law, and Institute for International Political Economy Berlin (IPE)); Nina Dodig (Berlin School of Economics and Law, and Institute for International Political Economy Berlin (IPE))
    Abstract: In this paper we review the empirical and theoretical literature on the effects of changes in the relationship between the financial sector and the non-financial sectors of the economy associated with ‘financialisation’ on distribution, growth, instability and crises. We take a macroeconomic perspective and examine four channels of transmission of financialisation to the macroeconomy: first, the effect on income distribution, second, the effects on investment in capital stock, third, the effects on household debt and consumption, and fourth, the effects on net exports and current account balances. For each of these channels we briefly review some empirical and econometric literature supporting the presumed channels, some theoretical and modelling literature examining the macroeconomic effects via these channels, and finally, we present small models generating the most important macroeconomic effects. We show that, against the background of redistribution of income at the expense of the labour income share and depressed investment in capital stock, each a major feature of financialisation, short- to medium-run dynamic ‘profits without investment’ regimes may emerge, which can be driven by flourishing consumption demand or by rising export surpluses, compensating for low or falling investment in capital stock. However, each type of these regimes, the ‘debt- led consumption boom’ type and the ‘export-led mercantilist’ type, contains internal contradictions, with respect to household debt in the first regime and with respect to foreign debt of the counterpart current account deficit countries in the second regime, which finally undermine the sustainability of these regimes and lead to financial and economic crises.
    Keywords: financialisation, distribution, growth, instability, financial and economic crises, Kaleckian models, current account imbalances.
    JEL: E12 E22 E24 E44 F41 G01
    Date: 2014–02–15
  8. By: Hui Jun Zhang; Jean-Marie Dufour; John Galbraith
    Abstract: Understanding and measuring the relative roles of different causal channels between commodity prices and exchange rates has important implications in financial decision making, especially for market participants with short horizons. From a macroeconomic perspective, this can also be useful for interpreting exchange rate movements, financial market monitoring and monetary policy. Basic economic reasoning on currency demand suggests that the currencies of countries whose exports depend heavily on a particular commodity should be strongly influenced by its price, so commodity price movements should lead (Granger-cause) exchange rate movements (macroeconomic/trade mechanism). In contrast, the present value model of forward-looking exchange rates suggests reverse causation, i.e. exchange rates should Granger-cause commodity prices (expectations mechanism). We examine empirically the causal relationship between commodity prices and exchange rates, using data on three commodities (crude oil, gold, copper) and three countries (Canada, Australia, Chile), over the period 2000-2009. To go beyond pure significance tests of non-causality and to provide a relatively complete picture of the links, measures of the strength of causality for different horizons and directions are estimated and compared. Since low-frequency data may easily fail to capture important features of the relevant causal links in volatile financial markets – such as foreign exchange and commodity markets – high-frequency (daily and 5-minute) data are exploited. Both unconditional and conditional (given general stock market conditions) causality measures are considered, and allowance for “dollar effects” is made by considering non-U.S. dollar variables. We identify clear causal patterns: (1) Granger causality between commodity prices and exchange rates is visible in both directions; (2) it is stronger at short horizons, and becomes weaker as the horizon increases; (3) causality from commodity prices to exchange rates is stronger than causality in the reverse direction across multiple horizons: the ratios of causality measures in two different directions can be quite high (for example, as high as 5 or 10 in favor of causation from commodity prices to exchange rates), especially at short horizons; (4) eliminating dollar effects weakens causality from exchange rates to commodity prices, and reveals a more definite pattern where causality from commodity prices to exchange rates dominates across multiple horizons. In contrast with earlier results on the non-predictability of exchange rates, we find that the macroeconomic/trade-based mechanism plays a central role in exchange rate dynamics, despite the financial features of these markets.
    Keywords: multi-horizon causality, causality measures, commodity prices, exchange rates, stock prices, high-frequency data, spurious causality, financial markets,
    JEL: F31 G15 G17
    Date: 2013–10–01
  9. By: Escudé, Guillermo J.
    Abstract: A traditional way of thinking about the exchange rate regime and capital account openness has been framed in terms of the 'impossible trinity' or 'trilemma', according to which policymakers can only have two of three possible outcomes: open capital markets, monetary independence and pegged exchange rates. The present paper is a natural extension of Escude (A DSGE Model for a SOE with Systematic Interest and Foreign Exchange Policies in Which Policymakers Exploit the Risk Premium for Stabilization Purposes, 2013), which focuses on interest rate and exchange rate policies, since it introduces the third vertex of the 'trinity' in the form of taxes on private foreign debt. These affect the risk-adjusted uncovered interest parity equation and hence influence the SOE's international financial flows. A useful way to illustrate the range of policy alternatives is to associate them with the faces of an isosceles triangle. Each of three possible government intervention policies taken individually (in the domestic currency bond market, in the foreign currency market, and in the foreign currency bonds market) corresponds to one of the vertices of the triangle, each of the three possible pairs of intervention policies corresponds to one of the three edges of the triangle, and the three simultaneous intervention policies taken jointly correspond to the triangle's interior. This paper shows that this interior, or 'possible trinity' is quite generally not only possible but optimal, since the central bank obtains a lower loss when it implements a policy with all three interventions. --
    Keywords: DSGE models,small open economy,monetary and exchange rate policy,capital controls,optimal policy
    JEL: E58 O24
    Date: 2014
  10. By: Robert Kollmann; Marco Ratto; Werner Roeger; Jan in'tVeld; Lukas Vogel
    Abstract: We estimate a three-country model using 1995-2013 data for Germany, the Rest of the Euro Area (REA) and the Rest of the World (ROW) to analyze the determinants of Germany’s current account surplus after the launch of the Euro. The most important factors driving the German surplus were positive shocks to the German saving rate and to ROW demand for German exports, as well as German labour market reforms and other positive German aggregate supply shocks. The convergence of REA interest rates to German rates due to the creation of the Euro only had a modest effect on the German current account and on German real activity. The key shocks that drove the rise in the German current account tended to worsen the REA trade balance, but had a weak effect on REA real activity. Our analysis suggests these driving factors are likely to be slowly eroded, leading to a very gradual reduction of the German current account surplus. An expansion in German government consumption and investment would raise German GDP and reduce the current account surplus, but the effects on the surplus are likely to be weak.
    Keywords: current account; intra-european imbalances; monetary union; eurozone crisis; estimated DSGE model
    JEL: F40 F30 F21 E30
    Date: 2014–04
  11. By: Ito, Hiro (Asian Development Bank Institute); Chinn, Menzie (Asian Development Bank Institute)
    Abstract: This study investigates the determinants of currency choice for trade invoicing in a cross-country context while focusing on the link between capital account liberalization and its impact on the use of the renminbi (RMB). The authors find that while countries with more developed financial markets tend to invoice less in the US dollar, countries with more open capital accounts tend to invoice in either the euro or their home currency. These results indicate that financial development and financial openness are among the keys to challenging the US dollar dominance in general, and to internationalizing the RMB for the People’s Republic of China (PRC). The model also suggests that the share of the RMB in export invoicing should have been higher than the actually observed share of less than 10%. The underperformance of RMB export invoicing can be attributed to the inertia in the choice of currency for trade invoicing; once a currency is used for trade invoicing or settlements, it becomes difficult for traders to switch from one currency to another. This same phenomenon was also observed in the cases of the Japanese yen and the euro at their inceptions as international currencies. The model predicts that the share of RMB invoicing for the PRC’s exports will rise to above 25% in 2015 and above 30% in 2018, whether or not the PRC implements drastic financial liberalization. As the near future path of RMB use is also expected to be inertial, these forecasts are probably at the upper end of the actual path of RMB export invoicing.
    Keywords: RMB internationalization; capital account liberalization; US dollar; export invoicing; currency invoicing; settlement currency
    JEL: F32 F41
    Date: 2014–04–09
  12. By: Basu, Susanto (Boston College and NBER); Pascali, Luigi (University of Warwick); Schiantarelli, Fabio (Boston College and IZA); Serven, Luis (World Bank)
    Abstract: We show that the welfare of a countrys in…nitely-lived representative consumer is summarized, to a …rst order, by total factor productivity (TFP) and by the capital stock per capita. These variables su¢ ce to calculate welfare changes within a country, as well as welfare di¤erences across countries. The result holds regardless of the type of production technology and the degree of product market competition. It applies to open economies as well, if TFP is constructed using domestic absorption, instead of gross domestic product, as the measure of output. Welfare relevant TFP needs to be constructed with prices and quantities as perceived by consumers, not …rms. Thus, factor shares need to be calculated using after-tax wages and rental rates, and will typically sum to less than one. These results are used to calculate welfare gaps and growth rates in a sample of advanced countries with high-quality data on output, hours worked, and capital. We also present evidence for a broader sample that includes both advanced and developing countries.
    Keywords: Productivity, Welfare, TFP, Solow Residual.
    Date: 2013
  13. By: Orsolya Csortos (Magyar Nemzeti Bank (the central bank of Hungary)); Zoltán Szalai (Magyar Nemzeti Bank (the central bank of Hungary))
    Abstract: In this paper we apply the Early Warning System methodology to ten Central and Eastern European Countries to find useful sets of indicators which could predict macroeconomic and financial imbalances. We argue that finding such indicators is crucial in the current monetary policy framework because significant imbalances could build up without any sign of risk to price stability. We examine the stylised behaviour of the most important macroeconomic variables over the business cycle and select the most preferred indicator variables. Our methodology consists of choosing the most useful combination of variables in terms of false alarms and misses, taken as given the preferences of the decision maker in terms of committng various types of errors. We find, that a certain combination of the global financial variable, the real exchange rate, capital flows and credit is a plausible signal macroeconomic imbalances. The results suggest that although the above indicators should not be used mechanically, they could usefully complement analytical tools available to modern central banks.
    Keywords: early warning indicators, signalling approach, macroeconomic stability, financial stability, monetary policy strategy
    JEL: E32 E37 E44 E58
    Date: 2014
  14. By: Graciela Laura Kaminsky; Pablo Vega-García
    Abstract: The literature on sovereign defaults has focused on adverse shocks to debtors’ economies, suggesting that defaults are of an idiosyncratic nature. Still, many of the sovereign crises are of a systemic nature, clustered around panics in the financial centers. Crises in the financial centers are rare events and their effects on the periphery can only be captured by examining long episodes. This paper examines sovereign defaults in Latin America from 1820 to 1931. We find that systemic crises are different. The international collapse of liquidity is at their core. Default spells and recovery rates are also affected by liquidity crashes.
    JEL: F3 F34
    Date: 2014–04

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