nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒06‒14
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies By Enrique G. Mendoza; Linda L. Tesar; Jing Zhang
  2. International capital flows and the boom-bust cycle in Spain By in 't Veld, Jan; Kollmann, Robert; Pataracchia, Beatrice; Ratto, Marco; Roeger, Werner
  3. An Equilibrium Foundation of the Soros Chart By Kano, Takashi; Morita, Hiroshi
  4. Dynamic Transition of the Exchange Rate Regime in the People’s Republic of China By Naoyuki Yoshino; Sahoko Kaji; Tamon Asonuma
  5. 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 Hiro Ito; Menzie Chinn
  6. International Evidence on the Interaction between Cross-Border Capital Flows and Domestic Credit Growth By Yavuz Arslan; Temel Taskin
  7. The Relationship between Inflation Targeting and Exchange Rate Pass-Through in Turkey with a Model Averaging Approach By Ferhat Arslaner; Dogan Karaman; Nuran Arslaner; Suleyman Hilmi Kal
  8. Monetary policy options for mitigating the impact of the global financial crisis on emerging market economies. By Dąbrowski, Marek A.; Śmiech, Sławomir; Papież, Monika
  9. Stock Market Co-Movement and Exchange Rate Flexibility : Experience of the Republic of Korea By Yung Chul Park; Hail Park
  10. Country Terms of Trade 1960-2012: Trends, unit roots, over-differencing, endogeneity, time dummies, and heterogeneity By Ziesemer T.H.W.
  11. Monetary policy, long real yields and the financial crisis By Moretti, Laura
  12. The impact of sovereign and credit risk on interest rate convergence in the euro area By Ivo Arnold; Saskia van Ewijk
  13. Multinational production and trade in an endogenous growth model with heterogeneous firms By Maemir H.; Ziesemer T.H.W.

  1. By: Enrique G. Mendoza; Linda L. Tesar; Jing Zhang
    Abstract: What are the macroeconomic effects of tax adjustments in response to large public debt shocks in highly integrated economies? The answer from standard closed-economy models is deceptive, because they underestimate the elasticity of capital tax revenues and ignore cross-country spillovers of tax changes. Instead, we examine this issue using a two-country model that matches the observed elasticity of the capital tax base by introducing endogenous capacity utilization and a partial depreciation allowance. Tax hikes have adverse effects on macro aggregates and welfare, and trigger strong cross-country externalities. Quantitative analysis calibrated to European data shows that unilateral capital tax increases cannot restore fiscal solvency, because the dynamic Laffer curve peaks below the required revenue increase. Unilateral labor tax hikes can do it, but have negative output and welfare effects at home and raise welfare and output abroad. Large spillovers also imply that unilateral capital tax hikes are much less costly under autarky than under free trade. Allowing for one-shot Nash tax competition, the model predicts a "race to the bottom" in capital taxes and higher labor taxes. The cooperative equilibrium is preferable, but capital (labor) taxes are still lower (higher) than initially. Moreover, autarky can produce higher welfare than both Nash and Cooperative equilibria.
    JEL: E6 E62 F34 F42 H6
    Date: 2014–06
  2. By: in 't Veld, Jan (DG-ECFIN, EU Commission); Kollmann, Robert (ECARES, Université Libre de Bruxelles and CEPR); Pataracchia, Beatrice (JRC, EU Commission); Ratto, Marco (JRC, EU Commission); Roeger, Werner (DG-ECFIN, EU Commission)
    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: capital flows; boom-bust cycle; global financial crisis
    JEL: C11 E21 E32 E62
    Date: 2014–05–01
  3. By: Kano, Takashi; Morita, Hiroshi
    Abstract: The most prominent characteristic of the Japanese yen/U.S. dollar nominal exchange rate in the post-Plaza Accord era is its near random-walk behavior sharing a common stochastic trend with the monetary base differential, which is augmented by the excess reserves, between Japan and the United States. In this paper, we develop a simple two-country incomplete-market model equipped with a specification of domestic reserve markets to structurally investigate this anecdotal evidence known as the Soros chart. In this model, we theoretically verify that a market discount factor close to one generates near random-walk behavior of an equilibrium nominal exchange rate in accordance with a permanent I(1) component of the augmented monetary base differential as an economic fundamental. Results of a Bayesian posterior simulation with post-Plaza Accord data of Japan and the United States plausibly support our model as a data generating process of the Japanese yen/U.S. dollar exchange rate.
    Keywords: Japanese yen/U.S. dollar exchange rate, Soros chart, Random walk, Bayesian analysis
    JEL: E31 E37 F41
    Date: 2014–05–29
  4. By: Naoyuki Yoshino (Asian Development Bank Institute (ADBI)); Sahoko Kaji; Tamon Asonuma
    Abstract: This paper analyzes the optimal transition of the exchange rate regime in the People’s Republic of China (PRC). How the PRC can successfully reach the desired regime—whether a basket peg or floating regime—from the current dollar-peg regime remains a major question. To answer it, we develop a dynamic small open-economy general equilibrium model. We construct four transition policies toward the basket-peg or floating regime and compare the welfare gains of these policies to those of maintaining the dollar-peg regime. Quantitative analysis using PRC data from Q1 1999 to Q4 2010 leads to two conclusions. First, a gradual adjustment toward a basket-peg regime seems the most appropriate option for the PRC, and would minimize the welfare losses associated with a shift in the exchange rate regime. Second, a sudden shift to a basket peg is the second-best solution. This is preferable to a sudden shift to a floating regime, since it would enable the authorities to implement optimal weights efficiently in order to achieve policy goals once a decision has been made to adopt a basket-peg regime.
    Keywords: exchange rate regime, PRC, China, dollar-peg regime, basket-peg regime, floating regime, general equilibrium model
    JEL: E42 F33 F41 F42
    Date: 2014–04
  5. By: Hiro Ito (Asian Development Bank Institute (ADBI)); Menzie Chinn
    Abstract: We investigate 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). We 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). Our 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. Our 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: Capital account liberalization, renminbi (RMB), PRC, export invoicing currency
    JEL: F32 F41
    Date: 2014–04
  6. By: Yavuz Arslan; Temel Taskin
    Abstract: The extent of interaction between international capital flows and macro-financial stability is an important and unsettled topic of debate. We contribute to this discussion by providing empirical evidence on the relationship between capital flows and domestic credit growth using a large cross-country panel dataset which includes both developed and developing economies. In the benchmark regression, we use a fixed effect model, and find a statistically significant and positive co-movement between the two variables, which is consistent with common wisdom and recent theory a la Bruno and Shin (2014). This empirical regularity is more pronounced in upper-middle income countries in comparison with the lower-middle and high income countries. The main results are robust to other econometric specifications and a variety of alternative measures for credit growth and capital flows.
    Keywords: Cross-border capital flows, Domestic credit growth, Macro-financial stability, Cross-country evidence
    JEL: E51 F32 G15
    Date: 2014
  7. By: Ferhat Arslaner; Dogan Karaman; Nuran Arslaner; Suleyman Hilmi Kal
    Abstract: Turkey, as an emerging economy, has a unique experience regarding to the relationship between the rate of inflation and the exchange rate. As opposed to developed countries, the effects of exchange rate fluctuations are felt significantly on inflation dynamics and these fluctuations also influence many other macroeconomic variables via different channels with different magnitudes in developing countries. Therefore, the main concern of the paper, which is to evaluate the exchange rate pass-through (ERPT), has an important role in the success of inflation targeting regime. Using correlation coefficients between exchange rates and inflation differentials, single equation regressions, vector auto-regressions (VAR) and Markov switching regression methods; the determinants of ERPT to producer and consumer prices are quantitatively analyzed between January 1986 and August 2013. Error correction models are used to estimate the exchange rate pass-through. According to the estimation results, it is found that, similar to other developing countries, there is a substantial degree of ERPT for Turkey the greater part of which is realized almost instantaneously. Comparing to the studies on industrial countries, it is found that ERPT is higher but there are additional transmission channels just like the other emerging economies. The higher degree of ERPT in Turkey is found in those studies conducted for industrialized countries implies that there are additional transmission channels for Turkey. ERPT for producer price-index-based inflation is found to be higher than for consumer-price-index-based inflation. We also found that the degree of ERPT increases as the data frequency falls. We also determined an asymmetry in pricing behavior : while exchange rates increase, this increase is passed on to prices, yet decreases in exchange rates. Estimation results also indicate that the main factors contributing to high pass-through are past currency crises and the high degree of openness of the economy. These factors are the basis for the indexation behavior of agents. Although, the aforementioned factors are the main determinants of the degree of exchange rate pass-through, the persistency and the volatility of exchange rates can significantly affect the short run dynamics of the pass-through. The results also imply that, even if the pass-through slows down due to changing pattern of exchange rates, in order to achieve a low and stable inflation in the long run, fundamental factors that exacerbate the link between exchange rates and prices should change. Another crucial point is that according to Markov switching regression results of ERPT coefficients of domestic prices, the exchange rate pass-through coefficients vary significantly between different states.
    Keywords: Monetary Policy, Inflation Targeting, Exchange Rate Pass-Through, Vector Autogression, Markov Switching Regression
    JEL: C22 C87 E30 E31 E59
    Date: 2014
  8. By: Dąbrowski, Marek A.; Śmiech, Sławomir; Papież, Monika
    Abstract: Though the hypothesis that exchange rate regimes fully predetermine monetary policy in the face of external shocks hardly finds any advocates on theoretical ground it has crept in the most of empirical research. This study adopts a more discerning empirical approach that looks at monetary policy tools used in order to accommodate the recent financial crisis. We investigated the GDP growth in 45 emerging market economies in the most intense phase of the crisis and found out that there is no clear difference in the growth performance between countries at the opposite poles of the exchange rate regime spectrum. Depreciation cum international reserve depletion outperforms the other policy options, especially the rise in the interest rate spread. We discovered certain complementarities between the information on the policy option and on exchange rate regime. Taking into account non-Gaussian settings, we decided to use quantile regression, which provide in addition, more complete picture of relationship between the covariates and the distribution of the GDP growth.
    Keywords: Global financial crisis, Emerging market economies, Monetary policy, Exchange rate regime, Quantile regressions
    JEL: C21 E52 F31 F41
    Date: 2013–02–24
  9. By: Yung Chul Park (Asian Development Bank Institute (ADBI)); Hail Park
    Abstract: This paper argues that for countries where equity investments dominate cross-border capital flows, the proper framework for analyzing the role of a flexible exchange rate system as a buffer against external shocks is the uncovered stock return parity condition, rather than the uncovered interest parity condition. Estimation of the stock return parity condition shows that it fails to hold in the Republic of Korea largely because of co-movement in the Republic of Korea and United States stock markets. Three global factors are largely responsible for the co-movement : global financial integration, which may be generating a global financial cycle; acceptance of insensitivity of exchange risk by global equity investors; and domestic investors imitating the trading behavior of foreign equity investors.
    Keywords: equity investment, cross-border capital flows, flexible exchange rate system, stock return parity condition, interest parity condition, the Republic of Korea, Stock Markets, co-movement
    JEL: F31 G15
    Date: 2014–05
  10. By: Ziesemer T.H.W. (UNU-MERIT)
    Abstract: The debate about the Prebisch-Singer thesis has focused on primary commodities with some extensions to manufactured goods. We analyse trends in country terms-of-trade for goods and services rather than those for commodities according to the World Bank income classification. We find that the natural logarithm of the terms of trade for all groups except for the poorest has common unit roots, but none has individual unit roots. As low-income countries have no unit roots over-differencing is inefficient and biases significance levels in first differences against the fall in the terms of trade. For the low-income countries the terms of trade of goods and services are falling at a rate that is significantly negative without and with endogeneity treatment by system GMM. A comprehensive analysis of the effects of time dummies supports the result of falling terms of trade for low-income countries. When all coefficients are country-specific 50 per cent of all low-income countries have falling terms of trade in a simultaneous equation estimation using the SUR method. Food crisis and financial crisis have no effect on the number of countries with falling terms of trade, but improve or dis-improve the terms of trade for a very small number of countries. Key words country terms of trade; Prebisch-Singer thesis; long-run development; World Bank income classification
    Keywords: Economic Growth of Open Economies; International Linkages to Development; Role of International Organizations;
    JEL: F43 O19
    Date: 2014
  11. By: Moretti, Laura
    Abstract: This paper investigates the role of monetary policy in the collapse in the long-term real interest rates in the decade before the onset of the financial crisis using a sample of five advanced economies (United States, United Kingdom, the euro area, Sweden and Canada). The results from an estimated panel VAR with monthly data show that, while monetary policy shocks had negligible effects on long-term real interest rates, shocks to the long-term real interest rates had a one-to-one effect on the short nominal rate. --
    Keywords: monetary policy,long-term real interest rates,panel VAR
    JEL: E43 E52 E58
    Date: 2014
  12. By: Ivo Arnold; Saskia van Ewijk
    Abstract: This paper employs a time-varying parameter state space model to explore the impact of the crisis on bank retail rates in the euro area. We show that σ-convergence in interest rates has been adversely affected by the crisis and quantify the role of sovereign and credit risk as two alternative explanations for the increase in financial fragmentation. A key finding is that the heterogeneity in sovereign risk across member states accounts for a sizable part of the increase in the cross-sectional dispersion of various lending and deposit rates. In contrast, the impact of the increased heterogeneity in credit risk on bank retail rates is negligible. Our results suggest that efforts to reduce sovereign tensions - as exemplified by the ECB's OMT program - may help to reduce financial fragmentation.
    Keywords: bank retail rates; σ-convergence; sovereign risk; credit risk; state space model
    JEL: E43 G21 H63
    Date: 2014–06
  13. By: Maemir H.; Ziesemer T.H.W. (UNU-MERIT)
    Abstract: This paper offers a unified framework to explore both the static and dynamic welfare effects of trade and multinational production MP in the presence of firm-specific productivity heterogeneity. The model captures the dynamic effects by allowing for RD spillovers between firms in a framework of Helpman et al. 2004 that generates endogenous growth without scale effects. We show that multinational presence improves average productivity by strengthening the selection process among heterogeneous firms, but leads to a lower growth rate of intermediate varieties along the transition path toward the new steady state. Thus the presence of multinationals has an ambiguous effect on overall welfare. We also compare the welfare implications of a change in trade cost in our model and in trade models without multinationals. We find that the gains from trade can be higher or lower than the gains obtained in the trade-only models, depending on the degree of firm heterogeneity, the size of trade and FDI costs, and the magnitude of technology spillover parameters. We further show that firm heterogeneity always magnifies average productivity, international spillovers and fixed costs of developing a new variety, which leads to ambiguous effects on overall welfare. Calibrating the model to the US economy suggests that aggregate welfare improves in response to a reduction in trade and FDI costs for empirically plausible parameter values.Keywords firm heterogeneity, endogenous growth, trade, multinational production, technology spillovers.
    Keywords: Models of Trade with Imperfect Competition and Scale Economies; Multinational Firms; International Business; Economic Growth of Open Economies; Innovation and Invention: Processes and Incentives; One, Two, and Multisector Growth Models;
    JEL: F12 F23 F43 O31 O41
    Date: 2014

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