nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒05‒24
twelve papers chosen by
Martin Berka
University of Auckland

  1. Sectoral interdependence and business cycle synchronization in small open economies By Drago Bergholt; Tommy Sveen
  2. Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops By Emmanuel Farhi; Jean Tirole
  3. Coordination and Crisis in Monetary Unions By Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
  4. Regionalization vs. Globalization By Hideaki Hirata; M. Ayhan Kose; Chris Otrok
  5. A New Taxonomy of Sudden Stops: Which Sudden Stops Should Countries Be Most Concerned About? By Pilar Tavella; Mathieu Pedemonte; Andrew Powell; Eduardo A. Cavallo
  6. Exporters and Shocks: Dissecting the International Elasticity Puzzle By Doireann Fitzgerald; Stefanie Haller
  7. Preference Shocks, International Frictions, and International Business Cycles By Hideaki Hirata
  8. International Capital Flows and the Boom-Bust Cycle in Spain By Jan in’t Veld; Robert Kollmann; Beatrice Pataracchia; Marco Ratto; Werner Roeger
  9. Real Effective Exchange Rate Misalignment in the Euro Area: A Counterfactual Analysis By Makram El-Shagi; Axel Lindner; Gregor von Schweinitz
  10. Exports and real exchange rates in a small open economy By Alvaro Brunini; Gabriela Mordecki; Lucía Ramírez
  11. International asset allocations and capital flows : the benchmark effect By Raddatz, Claudio; Schmukler, Sergio L.; Williams, Tomas
  12. The effect of asymmetries in fiscal policy conducts on business cycle correlation in the EU By Petr Rozmahel; Ladislava Grochová; Marek Litzman

  1. By: Drago Bergholt (BI Norwegian Business School and Norges Bank); Tommy Sveen (BI Norwegian Business School and Norges Bank)
    Abstract: Existing DSGE models are not able to reproduce the observed influence of international business cycles on small open economies. We construct a two-sector New Keynesian model to address this puzzle. The set-up takes into account intermediate trade and producer heterogeneity, where goods and service industries differ in terms of i) price flexibility, ii) trade intensity, iii) technology, iv) I-O structure, and v) the volatility of productivity innovations. The combination of intermediate markets and heterogeneous producers makes international business cycles highly important for the small economy, even if it has a large service sector. Exploiting I-O matrices of Canadian and US industries, the model is able to reproduce the role of international disturbances typically found in empirical studies. Model simulations deliver cross-country correlations in macroeconomic variables of about 0:7, with half of the variation in domestic variables attributed to foreign shocks.
    Keywords: Small open economy, Multi-sector, Intermediate trade, International business cycles.
    JEL: E32 F41 F44
    Date: 2014–04–14
  2. By: Emmanuel Farhi; Jean Tirole
    Abstract: The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency, and provided an impetus for the European banking union. This paper provides a “double-decker bailout†theory of the feedback loop that allows for both domestic bailouts of the banking system by the domestic government and sovereign debt forgiveness by international creditors. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.
    Date: 2014–01
  3. By: Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
    Abstract: We characterize fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment.� We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
    Date: 2014–01
  4. By: Hideaki Hirata; M. Ayhan Kose; Chris Otrok
    Abstract: Both global and regional economic linkages have strengthened substantially over the past quarter century. We employ a dynamic factor model to analyze the implications of these linkages for the evolution of global and regional business cycles. Our model allows us to assess the roles played by the global, regional, and country-specific factors in explaining business cycles in a large sample of countries and regions over the period 1960–2010. We find that, since the mid-1980s, the importance of regional factors has increased markedly in explaining business cycles especially in regions that experienced a sharp growth in intra-regional trade and financial flows. By contrast, the relative importance of the global factor has declined over the same period. In short, the recent era of globalization has witnessed the emergence of regional business cycles.
  5. By: Pilar Tavella; Mathieu Pedemonte; Andrew Powell; Eduardo A. Cavallo
    Abstract: This paper proposes a new taxonomy of Sudden Stops comprised of seven categories with definitions depending on the behavior of gross and net capital flows. The incidence of different types of Sudden Stops is tracked over time and the type of Sudden Stop related to economic performance. Sudden Stops in Net Flows associated with reductions in Gross Inflows are more disruptive than those where surges in (only) Gross Outflows dominate. The paper further discusses the mechanisms that might result in Sudden Stops in Gross Flows that are not Sudden Stops in Net Flows, such that shifts in financial assets or liabilities do not require a sharp current account adjustment. Still, it is found that Sudden Stops in Gross Inflows that do not provoke a sharp contraction in Net Flows may also be disruptive, including Sudden Stops that are driven by "other flows" -which include banking flows. The results suggest new avenues for research and future policy analysis.
    Keywords: Financial Crises & Economic Stabilization, Capital flows, Financial Sector, Investment, IDB-WP-430
    Date: 2013–08
  6. By: Doireann Fitzgerald (Federal Reserve Bank of Minneapolis); Stefanie Haller (University College Dublin)
    Abstract: Aggregate exports are not very responsive to real exchange rates, though they re- spond strongly to trade liberalizations, a fact sometimes referred to as the International Elasticity Puzzle. We use micro data on firms and exports for Ireland to dissect the puzzle. Our identification strategy uses within-firm-year cross-market variation in real exchange rates and tariffs to identify the responses of export participation, export rev- enue and the product dimension of exporting to these variables. We show that (i) the weak response of export revenue of long-time market participants to real exchange rates is key to the behavior of aggregate exports, (ii) export participation also responds less to real exchange rates than to tariffs, but this alone cannot explain the puzzle; and (iii) the revenue response of long-time market participants cannot be accounted for by product entry responses. Hence any model that can successfully account for the puzzle needs to match the intensive margin responses of exporting firms.
    Keywords: firm exports, tariffs, exchange rates, international elasticity puzzle
    Date: 2014–04–17
  7. By: Hideaki Hirata
    Abstract: Replicating the degree of cross-country comovements of macroeconomic aggregates, dynamics of prices and quantities of international trade, and the behavior of consumption and labor remains an important challenge in international business cycle literature. This paper incorporates preference shocks into a standard two-country model in which there exist international frictions, such as costs of transportation and restrictions to international asset trade. Country-specific preference shocks that generate fluctuations in each country’s consumption and labor solve the puzzles, except for the discrepancy between theory and data regarding international trade variables. The presence or absence of international frictions plays a limited role in solving the puzzles.
    Date: 2014–01
  8. By: Jan in’t Veld; 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: 2014–05
  9. By: Makram El-Shagi; Axel Lindner; Gregor von Schweinitz
    Abstract: Were real effective exchange rates (REER) of Euro area member countries drastically misaligned at the outbreak of the global financial crisis? The answer is difficult to determine because economic theory gives no simple guideline for determining the equilibrium values of real exchange rates, and the determinants of those values might have been distorted as well. To overcome these limitations, we use synthetic matching to construct a counterfactual economy for each member as a linear combination of a large set of non-Euro area countries. We find that Euro area crisis countries are best described by a mixture of advanced and emerging economies. Comparing the actual REER with those of the counterfactuals gives sensible estimates of the misalignments at the start of the crisis: All peripheral countries were strongly overvalued, while high undervaluation is only observed for Finland.
    Keywords: REER misalignment; Euro breakup; synthetic matching
    JEL: C22 F41 G14
    Date: 2014–05
  10. By: Alvaro Brunini (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía); Gabriela Mordecki (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía); Lucía Ramírez (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía)
    Abstract: This paper analyzes the relationship between exports and real exchange rate (RER) of six Uruguayan export products: beef, leather, dairy, chemical, metallurgical and plastics, selected for their importance in total exports during 1993-2011. We considered the sectoral RER and used the Johansen cointegration methodology to adjust the models. No evidence was found of a long-term relationship between sectoral exports and its sectoral RER. However, we found a long-term relationship between beef exports and cattle slaughter, which shows the high supply dependence of these exports, with an elasticity of 2.7. We also found a long-term relationship between dairy exports and the international price of skim milk, with a price-elasticity close to one. For metallurgical industry exports, the results show a long-term relationship with Argentinean GDP - main destination of those sales - with an income-elasticity of 1.7. In the case of the chemical industry, we found and elasticity near to one in relation to chemical imports, due to the fact that Uruguay must import the raw material for this industry. Finally, for plastic exports we found a cointegration vector with plastic imports and the sectoral RER, showing the importance of relative prices between exports and imports, and not only for exports.
    Keywords: exports, sectoral real exchange rate, cointegration
    JEL: C22 F31 F41
    Date: 2013–12
  11. By: Raddatz, Claudio; Schmukler, Sergio L.; Williams, Tomas
    Abstract: This paper studies channels through which well-known benchmark indexes impact asset allocations and capital flows across countries. The study uses unique monthly micro-level data of benchmark compositions and mutual fund investments during 1996-2012. Benchmarks have important effects on equity and bond mutual fund portfolios across funds with different degrees of activism. Benchmarks explain, on average, around 70 percent of country allocations and have significant impact even on active funds. Benchmark effects are important after controlling for industry, macroeconomic, and country-specific, time-varying effects. Reverse causality does not drive the results. Exogenous, pre-announced changes in benchmarks result in movements in asset allocations mostly when these changes are implemented (not when announced). By impacting country allocations, benchmarks affect capital flows across countries through direct and indirect channels, including contagion. They explain apparently counterintuitive movements in capital flows, generating outflows from countries when upgraded and with large market capitalization and better relative performance.
    Keywords: Mutual Funds,Debt Markets,Economic Theory&Research,Information Security&Privacy,Emerging Markets
    Date: 2014–05–01
  12. By: Petr Rozmahel; Ladislava Grochová; Marek Litzman
    Abstract: The paper examines the effects of asymmetries in fiscal policy conduct upon the correlation of business cycles in the European Union. In particular the paper estimates the effects of fiscal indiscipline and dissimilarity on business cycle correlation in the period 1996-2012 using a panel of 27 EU countries. The paper pays special attention to Central and Eastern European countries and examines the effects of interactions between fiscal policy measures and the fact that the country has not yet adopted the Euro. The results show a significant and robust negative effect of fiscal indiscipline and dissimilarity upon business cycle correlation in the EU. The paper also provides some evidence for the significance of intra-industry trade as well as of the interactions between fiscal measures and non-Euro area membership. The study provides arguments for fiscal policy harmonisation and fiscal discipline of the Euro area member as well as acceding countries, as undisciplined and dissimilar fiscal policies are shown as sources of business cycle deviations from the average European cycle.
    Keywords: European integration, Euro area, business cycle correlation, fiscal divergence, fiscal irresponsibility, optimum currency area
    JEL: E32 E62 F15
    Date: 2014–05

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