nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒05‒17
twenty papers chosen by
Martin Berka
University of Auckland

  1. In Search of the Armington Elasticity By Robert C. Feenstra; Philip Luck; Maurice Obstfeld; Katheryn N. Russ
  2. Trade adjustment dynamics and the welfare gains from trade By Alessandria, George; Choi, Horag; Ruhl, Kim J.
  3. Optimal Exchange Rate Policy in a Growing Semi-Open Economy By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  4. Firms, Destinations, and Aggregate Fluctuations By Julian di Giovanni; Andrei A. Levchenko; Isabelle Mejean
  5. Invoicing Currency in International Trade: An Empirical Investigation and Some Implications for the Renminbi By Edwin L.-C. Lai; Xiangrong Yu
  6. Do Real Exchange Rate Appreciations Matter for Growth? By Matthieu Bussière; Claude Lopez; Cédric Tille
  7. What drives the German current account? And how does it affect other EU member states? By Robert Kollmann; Marco Ratto; Werner Roeger; Jan in’t Veld; Lukas Vogel
  8. Non-Traded Goods and Capital Flows to Developing Countries By Jacek Rothert; Jacob Short
  9. International Capital Flows and the Boom-Bust Cycle in Spain By Jan in'tVeld; Robert Kollmann; Beatrice Pataracchia; Marco Ratto; Werner Roeger
  10. Welfare Benefits of Capital Controls:The Case of Spain By Shigeto Kitano; Yoichi Matsubayashi
  11. Business Cycle Accounting in a Small Open Economy By Jacek Rothert; Mohammad Rahmati
  12. Credit booms, banking crises, and the current account By Davis, J. Scott; Mack, Adrienne; Phoa, Wesley; Vandenabeele, Anne
  13. Natural-Resource Booms, Fiscal Rules and Welfare in a Small Open Economy By Jair N. Ojeda; Julián A. Parra-Polanía; Carmiña O. Vargas
  14. Trade linkages and the globalisation of inflation in Asia and the Pacific By Auer, Raphael; Mehrotra, Aaron
  15. International Reserves and Gross Capital Flows Dynamics. By Enrique Alberola; Aitor Erce; José Maria Serena
  16. Through the Looking Glass: A WARPed View of Real Exchange Rate History By Campbell, Douglas L; Pyun, Ju Hyun
  17. GCC Countries and the Nexus between Exchange Rate and Oil Price: What wavelet decomposition reveals? By Bouoiyour, Jamal; Selmi, Refk
  18. The Impact of Financial Constraints and Wealth Inequality on International Trade Flows, Capital Movements and Entrepreneurial Migration By Spiros Bougheas; Rod Falvey
  19. The impact of exchange rate volatility on trade: Evidence for the Czech Republic By Oxana Babecka Kucharcukova
  20. The role of direct flights in trade costs By Yilmazkuday, Demet; Yilmazkuday, Hakan

  1. By: Robert C. Feenstra; Philip Luck; Maurice Obstfeld; Katheryn N. Russ
    Abstract: The elasticity of substitution between goods from different countries---the Armington elasticity---is important for many questions in international economics, but its magnitude is subject to debate: the "macro" elasticity between home and import goods is often found to be smaller than the "micro" elasticity between foreign sources of imports. We investigate these two elasticities in a model using a nested CES preference structure. We explore estimation techniques for the macro and micro elasticities using both simulated data from a Melitz-style model, and highly disaggregate U.S. production data matched to Harmonized System trade data. We find that in up to one-half of goods there is no significant difference between the macro and micro elasticities, but in the other half of goods the macro elasticity is significantly lower than the micro elasticity, even when they are estimated at the same level of disaggregation.
    JEL: F12 F14 F42
    Date: 2014–04
  2. By: Alessandria, George (Federal Reserve Bank of Philadelphia); Choi, Horag (Monash University); Ruhl, Kim J. (NYU Stern School of Business)
    Abstract: We build a micro-founded two-country dynamic general equilibrium model in which trade responds more to a cut in tariffs in the long run than in the short run. The model introduces a time element to the fixed-variable cost trade-off in a heterogeneous producer trade model. Thus, the dynamics of aggregate trade adjustment arise from producer-level decisions to invest in lowering their future variable export costs. The model is calibrated to match salient features of new exporter growth and provides a new estimate of the exporting technology. At the micro level, we find that new exporters commonly incur substantial losses in the first three years in the export market and that export profits are backloaded. At the macro level, the slow export expansion at the producer level leads to sluggishness in the aggregate response of exports to a change in tariffs, with a long-run trade elasticity that is 2.9 times the short-run trade elasticity. We estimate the welfare gains from trade from a cut in tariffs, taking into account the transition period. While the intensity of trade expands slowly, consumption overshoots its new steady-state level, so the welfare gains are almost 15 times larger than the long-run change in consumption. Models without this dynamic export decision underestimate the gains to lowering tariffs, particularly when constrained to also match the gradual expansion of aggregate trade flows.
    Keywords: Sunk cost; Fixed cost; Establishment heterogeneity; Tariffs; Welfare; DSGE
    JEL: E31 F12
    Date: 2014–04–25
  3. By: Philippe Bacchetta (University of Lausanne and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Kenza Benhima (University of Lausanne and Centre for Economic Policy Research); Yannick Kalantzis (Banque de France)
    Abstract: In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.
    JEL: E58 F31 F32
    Date: 2014–05
  4. By: Julian di Giovanni; Andrei A. Levchenko; Isabelle Mejean
    Abstract: This paper uses a database covering the universe of French firms for the period 1990--2007 to provide a forensic account of the role of individual firms in generating aggregate fluctuations. We set up a simple multi-sector model of heterogeneous firms selling to multiple markets to motivate a theoretically-founded decomposition of firms' annual sales growth rate into different components. We find that the firm-specific component contributes substantially to aggregate sales volatility, mattering about as much as the components capturing shocks that are common across firms within a sector or country. We then decompose the firm-specific component to provide evidence on two mechanisms that generate aggregate fluctuations from microeconomic shocks highlighted in the recent literature: (i) when the firm size distribution is fat-tailed, idiosyncratic shocks to large firms directly contribute to aggregate fluctuations; and (ii) aggregate fluctuations can arise from idiosyncratic shocks due to input-output linkages across the economy. Firm linkages are approximately three times as important as the direct effect of firm shocks in driving aggregate fluctuations.
    JEL: E32 F12 F41
    Date: 2014–04
  5. By: Edwin L.-C. Lai (Hong Kong University of Science and Technology and Hong Kong Institute for Monetary Research); Xiangrong Yu (Hong Kong Institute for Monetary Research)
    Abstract: To play the role of a unit of account, an international currency must be a currency widely used to invoice international trade. This paper investigates the determinants of the use of currency in trade invoicing and evaluates the potential of the renminbi for the denomination of cross-border transactions in the Asia-Pacific region. In particular, we develop a simple model and establish the evidence showing that there is a convex relationship between the invoicing share of a currency and the economic size of its issuing country because of a coalescing effect and thick market externalities. We use the ratio of the foreign exchange turnover share of a currency to the global GDP share of its issuing country as a proxy for the size of thick market externalities, which we argue reflects capital account openness, financial development, and exchange rate stability of a country. This ratio is very small for the renminbi compared with that for established international currencies. Our quantitative analysis suggests that the renminbi can be a major invoicing currency in the region only if China sufficiently opens up its capital account and liberalizes its financial sector. We also draw a parallel between the renminbi and the euro and forecast the invoicing share of the renminbi in the Asia-Pacific region if the renminbi market attained the same degree of thickness as the euro.
    JEL: F33 F36 F47
    Date: 2014–04
  6. By: Matthieu Bussière; Claude Lopez; Cédric Tille (IHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: While the impact of exchange rate changes on economic growth has long been an issue of key importance in international macroeconomics, it has received renewed attention in recent years, owing to weaker growth rates and the debate on “currency wars”. However, in spite of its prevalence in the policy debate, the connection between real exchange rates and growth remains an unsettled question in the academic literature. We fill this gap by providing an empirical assessment based on a broad sample of emerging and advanced economies. We assess the impact of appreciations, productivity booms and capital flow surges using a propensity-score matching approach to address causality issues. We show that appreciations associated with higher productivity have a larger impact on growth than appreciations associated with capital inflows. Furthermore, the appreciation per se tends to have a negative impact on growth. We provide a simple theoretical model that delivers the contrasted growth-appreciation pattern depending on the underlying shock. The model also implies adverse effects of shocks to international capital flows, so concerns about an appreciation are not inconsistent with concerns about a depreciation. The presence of an externality through firms’ destruction leads to inefficient allocations. Nonetheless, addressing them does not require a dampening of exchange rate movements.
    Keywords: exchange rate, currency crises, endaka, international trade, international capital flows, lending booms, small open economy macroeconomics
    JEL: F10 F30 F41
    Date: 2014–04–03
  7. By: Robert Kollmann; Marco Ratto; Werner Roeger; Jan in’t Veld; 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: F4 F3 F21 E3
    Date: 2014–05
  8. By: Jacek Rothert (United States Naval Academy); Jacob Short (Western Ontario University)
    Abstract: We study capital ows to developing countries and explore the role of (i) the non- traded sector and (ii) structural change in shaping long-run patterns of net savings. We show these two features help account for small net international capital ows if tradable and non-tradable goods are complements. The two-sector model accounts for as much as (i) 37% of the cross-country variation in the savings wedge that Gourinchas and Jeanne (2013) estimated to match the empirical capital ows (the Allocation Puzzle); and for (ii) 55 % of the savings-investment correlation found in our sample of countries (Feldstein-Horioka Puzzle).
    Date: 2014–03
  9. By: Jan in'tVeld; Robert Kollmann; Beatrice Pataracchia; Marco Ratto; Werner Roeger
    Abstract: We study the joint dynamics of foreign capital flows and real activity during the recent boom-bust cycle of the Spanish economy, using a three-country New Keynesian model with credit-constrained households and firms, a construction sector and a government. We estimate the model using 1995Q1-2013Q2 data for Spain, the rest of the Euro Area (REA) and the rest of the world. We show that falling risk premia on Spanish housing and non-residential capital, a loosening of collateral constraints for Spanish households and firms, as well as a fall in the interest rate spread between Spain and the REA fuelled the Spanish output boom and the persistent rise in foreign capital flows to Spain, before the global financial crisis. During and after the global financial crisis, falling house prices, and a tightening of collateral constraints for Spanish borrowers contributed to a sharp reduction in capital inflows, and to the persistent slump in Spanish real activity. The credit crunch was especially pronounced for Spanish households; firm credit constraints tightened later and more gradually, and contributed much less to the slump.
    Keywords: international capital flows; boom-bust cycle; sudden stop; housing market; financial frictions; spain; european monetary union
    JEL: C11 E21 E32 E62
    Date: 2014–04
  10. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Yoichi Matsubayashi (Graduate School of Economics, Kobe University, Japan)
    Abstract: We estimate a small open economy RBC model augmented with a simple form of financial frictions using Spanish data and Bayesian methods. The estimated model matches well with key Spanish business cycle statistics. Using the estimated model, we find that significant welfare benefits may accrue from capital controls.
    Keywords: Capital controls, Welfare, DSGE, Small open economy models, Bayesian estimation
    JEL: F41
    Date: 2014–05
  11. By: Jacek Rothert (United States Naval Academy); Mohammad Rahmati (Sharif University of Technology)
    Abstract: Building on Chari et al. (2007), we develop a method to assess theories of business cycles in small open economies. We build a diagnostic economy with time-varying distortions (wedges), which measure the gap between model generated aggregates and the data. We introduce two new wedges, which allow us to fully account for the movements in the trade balance and the current account: (i) the trend-shock wedge and (ii) the debt price wedge. We show how various detailed models with frictions map to economy with new wedges. Finally, we empirically evaluate dierent theories of uctuations in emerging economies.
    Date: 2014–03
  12. By: Davis, J. Scott (Federal Reserve Bank of Dallas); Mack, Adrienne (Federal Reserve Bank of Dallas); Phoa, Wesley (The Capital Group Companies); Vandenabeele, Anne (The Capital Group Companies)
    Abstract: What is the marginal effect of an increase in the private sector debt-to-GDP ratio on the probability of a banking crisis? This paper shows that the marginal effect of rising debt levels depends on an economy's external position. When the current account is in surplus or in balance, the marginal effect of an increase in debt is rather small; a 10 percentage point increase in the private sector debt-to-GDP ratio increases the probability of a crisis by about 1 to 2 percentage points. However, when the economy is running a sizable current account deficit, implying that any increase in the debt ratio is financed through foreign borrowing, this marginal effect can be large. When a country has a current account deficit of 10% of GDP (which is similar to the value in the Eurozone periphery on the eve of the recent crisis) a 10 percentage point increase in the private sector debt ratio leads to a 10 percentage point increase in the probability of a crisis.
    Keywords: money supply; credit; financial economics
    JEL: E51 F32 G01
    Date: 2014–05–13
  13. By: Jair N. Ojeda; Julián A. Parra-Polanía; Carmiña O. Vargas
    Abstract: This document analyzes the macroeconomic effects of a boom in a small-open economy’s natural-resource sector. We study the effects of this shock on the most important macroeconomic variables, the resource reallocation across sectors and on welfare under alternative fiscal rules. We employ a DSGE featuring three productive sectors (non-tradable, manufacturing and commodity goods), government and two types of consumers (Ricardian and non-Ricardian). Our results show that the natural-resource boom leads to an initial reduction of the manufacturing sector’s employment and production. The opposite temporal effect is obtained in the remaining two productive sectors. However, the effect on welfare is positive for all consumers since the boom increases consumption in all households. Finally, we find that a countercyclical fiscal rule leads to a slight increase in welfare compared with a balanced-budget rule.
    Keywords: Fiscal rule, Natural-Resource Boom, Consumer Welfare, Equilibrium Model
    JEL: E62 F47 H30 H63
    Date: 2014–01–31
  14. By: Auer, Raphael (Swiss National Bank); Mehrotra, Aaron (Bank for International Settlements)
    Abstract: Some observers argue that increased real integration has led to greater co-movement of prices internationally. We examine the evidence for cross-border price spillovers among economies participating in the pan-Asian cross-border production networks. Starting with country-level data, we find that both producer price and consumer price inflation rates move more closely together between those Asian economies that trade more with one another, ie that share a higher degree of trade intensity. Next, using a novel data set based on the World Input-Output Database (WIOD), we examine the importance of the supply chain for cross-border price spillovers at the sectoral level. We document the increasing importance of imported intermediate inputs for economies in the Asia-Pacific region and examine the impact on domestic producer prices of changes in costs of imported intermediate inputs. Our results suggest that real integration through the supply chain matters for domestic price dynamics in the Asia-Pacific region.
    Keywords: price level; inflation; deflation; international trade
    JEL: E31 F14 F15 F40
    Date: 2014–04–01
  15. By: Enrique Alberola; Aitor Erce; José Maria Serena
    Abstract: This paper explores the role of international reserves as a stabilizer of international capital flows, in particular during periods of global financial stress. In contrast with previous contributions, aimed at explaining net capital flows, we focus on the behavior of gross capital flows. We analyze an extensive cross-country quarterly database -63 countries, 1991-2010- using standard panel regressions. We document significant heterogeneity in the response of resident investors to financial stress and relate it to a previously undocumented channel through which reserves act as a buffer during financial stress. A robust result of the analysis is that international reserves facilitate financial disinvestment overseas by residents –a fall in capital outflows-. This partially offsets the drop in foreign capital inflows in such periods, which are only marginally mitigated by reserves under some specifications of the model. For the whole period, we also find that larger stocks of reserves are linked to higher gross inflows and lower gross outflows.
    Date: 2014–01–11
  16. By: Campbell, Douglas L; Pyun, Ju Hyun
    Abstract: Commonly used trade-weighted real exchange rate indices are computed as indices-of-indices, and thus do not adequately account for growth in trade with developing countries. Weighted Average Relative Price (WARP) indices solve this problem but do not control for productivity differences, as developing countries are observed to have lower price levels via the Balassa-Samuelson effect. In this paper, we remedy these problems in two ways. First we propose a Balassa-Samuelson productivity adjustment to Weighted Average Relative Price indices (BS-WARP). Secondly, we introduce a Weighted Average Relative Unit Labor Cost index (WARULC) for manufacturing and show that this measure does a much better job predicting trade imbalances and declines in manufacturing employment than the IMF's Relative ULC measure created as an index-of-indices. Our series reveal that for many countries currently mired in liquidity traps, relative prices reached historic highs heading into the financial crisis of 2008. We document that in 2002 -- during the surprisingly sudden collapse in US manufacturing -- US relative prices had not been that high relative to trading partners since the worst year of the Great Depression.
    Keywords: Real Exchange Rate Indices, Relative Unit Labor Cost Indices, Balassa-Samuelson, Trading Partner Substitution Bias
    JEL: C43 F31 F32 N7
    Date: 2014–05–10
  17. By: Bouoiyour, Jamal; Selmi, Refk
    Abstract: We employ wavelet decomposition and nonlinear causality test to investigate the nexus between the real oil price and the real effective exchange rate in three GCC countries : Qatar, Saudi Arabia and UAE. We find strong evidence in favor of a feedback hypothesis in Qatar and UAE and of a neutrality hypothesis in Saudi Arabia. The first observation outcome means that Qatar and UAE should reinforce the downward effect of oil price on real exchange rate by improving diversification policy. The second one implies that the behavior of Saudi Arabia as a price maker may allows it to maintain a quick recovery under oil shocks.
    Keywords: real oil price, real effective exchange rate, wavelets, nonlinear causality.
    JEL: Q4 Q43
    Date: 2014
  18. By: Spiros Bougheas; Rod Falvey
    Abstract: We introduce financial frictions into a simple two sector model of international trade with heterogeneous agents and investigate the impact of differences in the strength of financial institutions and wealth inequality on trade flows, capital movements and entrepreneurial migration. Distinct cost-cutting and career-changing motives for entrepreneurial migration exist, which can lead to two-way entrepreneurial flows. We establish presumptions that countries with stronger financial systems or greater wealth inequality will export the output of the financially dependent sector, will import capital and will be a (net) exporter of entrepreneurs. Important exceptions are shown.
    Keywords: entrepreneurial migration; trade flows; capital flows; wealth inequality; financial frictions
    Date: 2014
  19. By: Oxana Babecka Kucharcukova (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic and Czech National Bank)
    Abstract: This paper aims to quantify the impact of nominal exchange rate volatility on nominal trade flows with a particular focus on the Czech Republic. The paper shows that the magnitude of the impact differs when a dynamic model is used instead of static model.
    Keywords: Gravity model of trade, Exchange rate volatility, Poisson estimator
    JEL: F14 F31 F4
    Date: 2014–01
  20. By: Yilmazkuday, Demet (Florida International University); Yilmazkuday, Hakan (Florida International University)
    Abstract: The role of direct flights in trade costs is investigated by introducing and using a micro price data set on 49 goods across 433 international cities covering 114 countries. It is shown that having at least one direct flight reduces trade costs by about 1,400 miles in distance equivalent terms, while an international border increases trade costs by about 14,907 miles; hence, the positive effects of having at least one direct flight between any two cities can compensate for about 10% of the negative effects of an average international border. Trade costs also decrease with the number of direct flights: on average, one direct flight reduces trade costs by about 305 miles in distance equivalent terms, which corresponds to 7% of the average distance and can compensate for about 2% of the negative effects of an average international border. The results are shown to be robust to alternative empirical strategies.
    Keywords: economic integration; foreign exchange
    JEL: F15 F31
    Date: 2014–05–13

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