nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒06‒28
fourteen papers chosen by
Martin Berka
University of Auckland

  1. Trying to Understand the PPPs in ICP2011: Why are the Results so Different? By Angus Deaton; Bettina Aten
  2. Geographic Barriers to Commodity Price Integration: Evidence from US Cities and Swedish Towns, 1732–1860 By Mario J. Crucini; Gregor W. Smith
  3. Real unit labour costs in Eurozone countries: Drivers and clusters By Javier Ordóñez; Hector Sala Lorda; Hector José I. Silva
  4. Global Value Chains and Effective Exchange Rates at the Country-Sector Level By Nikhil Patel; Zhi Wang; Shang-Jin Wei
  5. A small open economy in the Great Depression: the case of Switzerland By Peter Rosenkranz; Tobias Straumann; Ulrich Woitek
  6. International Financial Market Integration, Asset Compositions and the Falling Exchange Rate Pass-Through By Buzaushina, Almira; Enders, Zeno; Hoffmann, Mathias
  7. The Eurocrisis: Muddling Through, or On the Way to a More Perfect Euro Union? By Joshua Aizenman
  8. Business cycles in emerging markets: the role of liability dollarization and valuation effects By Stefan Notz; Peter Rosenkranz
  9. Exchange Rate Regimes and Business Cycles: An Empirical Investigation By Fatma Pinar Erdem; Erdal Ozmen
  10. Open-economy Distribution Forecast Targeting, Macroeconomic Volatility and Financial Implication By Alessandro Flamini; Iftekhar Hasan; Costas Milas
  11. Explaining International Differences in the Prices of Tradables and Non-Tradables (with a New Zealand Perspective) By Falvey, Rodney E; Gemmell, Norman; Chang, Cherry; Zheng, Guanyu
  12. Sovereign and bank CDS spreads: two sides of the same coin for European bank default predictability? By Avino, Davide; Cotter, John
  13. Banking and Sovereign Debt Crises in a Monetary Union Without Central Bank Intervention By Jing Cheng; Meixing Dai; Frédéric Dufourt
  14. A macro-financial analysis of the euro area sovereign bond market By Hans Dewachter; Leonardo Iania; Marco Lyrio; Maite de Sola Perea

  1. By: Angus Deaton; Bettina Aten
    Abstract: The 2011 round of the International Comparison Program (ICP) has published a set of purchasing power parities (PPPs) that are sharply different from those that were expected from extrapolation of the 2005 round. In particular, the world in 2011 looks sharply more equal than previously calculated, because consumption and GDP in most poor countries were revised upward relative to the U.S. and other rich countries. Here we attempt to find out what happened. It is first noted that the 2005 round was itself sharply different from what was then expected, and made the world much less equal. We argue that the 2011 round is superior to the 2005 round, and that many of the changes in 2011 undo what happened in 2005. We identify a likely source of the problem, which is the way that the regions of the ICP were linked in 2005. We use two different methods for measuring the size of the effect. Both suggest that the 2005 PPPs for consumption for countries in Asia (excluding Japan), Western Asia, and Africa were overstated by between 20 to 30 percent. If these results are correct, they call for substantive backward revision of international comparisons, as well as estimates of global poverty and inequality.
    JEL: E01 F00 O11 O47
    Date: 2014–06
  2. By: Mario J. Crucini; Gregor W. Smith
    Abstract: We study the role of distance and time in statistically explaining price dispersion for 14 commodities from 1732 to 1860. The prices are reported for US cities and Swedish market towns, so we can compare international and intranational dispersion. Distance and commodity-specific fixed effects explain a large share—roughly 60%—of the variability in a panel of more than 230,000 relative prices over these 128 years. There was a negative "ocean effect": international dispersion was less than would be predicted using distance, narrowing the effective ocean by more than 3000 km. The absolute effect of distance declined over time beginning in the 18th century. This process of convergence was broad- based, across commodities and locations (both national and international). But there was a major interruption in convergence in the late 18th and early 19th centuries, at the time of the Napoleonic Wars, stopping the process by two or three decades on average.
    JEL: N70
    Date: 2014–06
  3. By: Javier Ordóñez (Departament d’Economia, Universitat Jaume I de Castelló); Hector Sala Lorda (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona); Hector José I. Silva (School of Economics, Keynes College, University of Kent,)
    Abstract: We examine the trajectories of the real unit labour costs (RULCs) in a selection of Eurozone economies. Strong asymmetries in the convergence process of the RULCs and its components —real wages, capital intensity, and technology— are uncovered through decomposition and cluster analyses. In the last three decades, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) succeeded in reducing their RULCs by more than their northern partners. With the exception of Ireland, however, technological progress was weak; it was through capital intensification that periphery economies gained efficiency and competitiveness. Cluster heterogeneity, and lack of robustness in cluster composition, is a reflection of the difficulties in achieving real convergence and, by extension, nominal convergence. We conclude by outlining technology as the key convergence factor, and call for a renewed attention to real convergence indicators to strengthen the process of European integration.
    Keywords: Real unit labour costs, Eurozone, Real wages, Capital intensity, Technology
    JEL: F43 O47 O52
    Date: 2014–06
  4. By: Nikhil Patel; Zhi Wang; Shang-Jin Wei
    Abstract: The real effective exchange rate (REER) is one of the most cited statistical constructs in international macroeconomics. With the rising importance of offshoring and outsourcing, the standard measures are increasingly flawed. In addition, because different sectors within a country may participate in international production sharing at different stages, sector level variations are also important. We develop a theoretical framework to compute REER at both the sector and country levels. It nests the existing measures in the literature and addresses their shortcomings. As an application, we exploit the recently available World Input-Output Database (WIOD) to study the properties of the new measures of the REER for 40 countries, 35 sectors, over 1995-2011.
    JEL: F1 F3
    Date: 2014–06
  5. By: Peter Rosenkranz; Tobias Straumann; Ulrich Woitek
    Abstract: In historical accounts of the world economic crisis of the 1930s, Switzerland is known for its staunch defense of the gold standard and the rise of corporatist policies. Yet, so far, the literature has not discussed the implications of these two features. This paper tries to show how the combination of hard-currency policy and nominal rigidities introduced by corporatist policies proved to be fatal for growth. Estimating a New Keynesian small open economy model for the period 1926-1938, we show that the decision to participate in the Gold Bloc after 1933 at an overvalued currency can be identified as the main reason for the unusual long lasting recession and that price rigidities from 1931 to 1936 significantly slowed down the adjustment process.
    Keywords: Great Depression, Switzerland, New Keynesian Business Cycle Model
    JEL: E12 E32 N14
    Date: 2014–06
  6. By: Buzaushina, Almira; Enders, Zeno; Hoffmann, Mathias
    Abstract: This paper provides an explanation for the observed decline of the exchange rate pass-through into import prices by modeling the effects of financial market integration on the optimal choice of the pricing currency in the context of rigid nominal goods prices. Contrary to previous literature, the interdependence of this choice with the optimal portfolio choice of internationally traded financial assets is explicitly taken into account. In particular, price setters move towards more local-currency pricing while the debt portfolio includes more foreign assets following increased financial integration. Both predictions are in line with novel empirical evidence.
    Keywords: Exchange rate pass-through; financial integration;portfolio home bias; international price setting
    Date: 2014–06–18
  7. By: Joshua Aizenman
    Abstract: This paper looks at the short history of the Eurozone through the lens of an evolutionary approach to forming new institutions. The euro has operated as a currency without a state, under the dominance of Germany. This has so far allowed the euro to achieve a number of design objectives, and this may continue, as long as Germany does not shirk its growing responsibility for the euro’s future. Germany’s resilience and dominant size within the EU may explain its “muddling-through” approach towards the Eurozone crisis. We review several manifestations of this muddling through process. Greater mobility of labor and lower mobility of under-regulated capital may be the costly “second best” adjustment until the arrival of more mature institutions in the Eurozone.
    JEL: F32 F36 F41
    Date: 2014–06
  8. By: Stefan Notz; Peter Rosenkranz
    Abstract: Understanding differences in business cycle phenomena between Emerging Market Economies (EMEs) and industrialized countries has been at the center of recent research on macroeconomic fluctuations. The purpose of this paper is to investigate the importance of certain credit market imperfections in different EMEs. To this end, we develop a small open economy Dynamic Stochastic General Equilibrium (DSGE) framework featuring both permanent and transitory productivity shocks, differentiated home and foreign goods, and endogenous exchange rate movements. Furthermore, our model incorporates liability dollarization as a particular form of financial frictions in EMEs. In this vein, we account for the fact that emerging markets traditionally have had difficulties in borrowing in domestic currency on international capital markets and thus allow for valuation effects in our analysis. We estimate our model using Bayesian techniques for a number of EMEs and thereby control for potential heterogeneity across countries. Contrary to previous studies in this strand of the literature, we include a (vector-)autoregressive measurement error component to capture off-model dynamics. Regarding business cycles in emerging markets, our main findings are that (i) even though we incorporate financial frictions in the framework, trend shocks are the main determinant of macroeconomic fluctuations, (ii) accounting for liability dollarization ameliorates the model fit, and (iii) valuation effects on average stabilize changes in the net foreign asset position.
    Keywords: Emerging markets, liability dollarization, valuation effects, financial frictions, real business cycles, DSGE Model, Bayesian estimation
    JEL: E13 E44 F32 F34 F41 F44 F47 O11
    Date: 2014–06
  9. By: Fatma Pinar Erdem (Central Bank of the Republic of Turkey); Erdal Ozmen (Department of Economics, METU)
    Abstract: This paper investigates the impacts of domestic and external factors along with exchange rate regimes on business cycles in a large panel of advanced and emerging market economies by employing panel logit, cointegration and autoregressive distributed lag model estimation procedures. The results for classical business cycles suggest that emerging market economies tend to experience much deeper recessions and relatively steeper expansions during almost the same duration. The probability of expansions significantly increases with exchange rate regimes flexibility. Our results, different from the bipolar view, strongly support exchange rate regime flexibility for both AE and EME other than the East Asian countries. The impacts of external real and financial shocks and domestic variables are significantly greater under managed regimes as compared to floats. Our results strongly suggest that the evolution and determinants of both classical business and growth cycles are not invariant to the prevailing exchange rate regimes.
    Keywords: Business cycles, Exchange rate regimes, Emerging markets.
    JEL: C33 E32 F33 F41
    Date: 2014–06
  10. By: Alessandro Flamini (Department of Economics and Management, University of Pavia); Iftekhar Hasan (Fordham University and Bank of Finland); Costas Milas (University of Liverpool)
    Abstract: In an open-economy faced with model uncertainty, this paper uses distribution forecasts to investigate the impact of alternative infl?ation targeting policies on macroeconomic volatility and their potential implications on ?financial stability. Theoretically, Domestic Infl?ation Targeting (DIT) leads to less volatility than Consumer Price index In?flation Targeting (CPIIT) for several macroeconomic variables and, in particular, for the interest rate. Empirically, a positive relationship between interest rate volatility and fi?nancial instability emerges for the US, UK and Sweden since the early 1990s. Bridging theory and empirical evidence, we conclude that the choice of the in?flation targeting regime has an important impact on macroeconomic volatility and potential implications for fi?nancial stability.
    Keywords: Macroeconomic volatility; fi?nancial stability; interest rate volatility; multiplicative uncertainty; Markov jump linear quadratic systems; open-economy; optimal montary policy; infl?ation index.
    JEL: E52 E58 F41
    Date: 2014–06
  11. By: Falvey, Rodney E; Gemmell, Norman; Chang, Cherry; Zheng, Guanyu
    Abstract: The World Bank's International Comparison Program (ICP) data on national price levels for tradables and non-tradables (and goods compared to services) reveals that New Zealand has relatively high prices of both tradables and non-tradables when compared to a sample of over 40 OECD-Eurostat countries (Gemmell, 2013). The present paper seeks to explain both those observed international variations in non-tradables and tradables prices in general, and New Zealand's especially high prices in particular.
    Keywords: Tradables, Non-tradables, Consumer prices, Trade - New Zealand,
    Date: 2014
  12. By: Avino, Davide; Cotter, John
    Abstract: This paper investigates the relationship between sovereign and bank CDS spreads with reference to their ability to convey timely signals on the default risk of European sovereign countries and their banking systems. For a sample including six major European economies, we find that sovereign and bank CDS spreads are cointegrated variables at the country level. We then perform a more in-depth investigation of the underlying price discovery mechanisms, and find that both variables have an important price discovery role in the period preceding the financial crisis of 2007-2009. However, during the global financial crisis and the subsequent European sovereign debt crisis, sovereign CDS spreads dominate the price discovery process. Our findings strongly suggest that, especially during crisis periods, sovereign CDS spreads incorporate more timely information on the default probability of European banks than their corresponding bank CDS spreads. Price discovery measures based on CDS prices could be used as market triggers to increase equity levels at financial institutions and in the various forms of contingent capital
    Keywords: Credit default swap spreads; price discovery; information flow; financial crisis; banks; sovereign risk; bank capital; contingent capital
    JEL: D8 G01 G12 G14 G20
    Date: 2013–06
  13. By: Jing Cheng (Université de Strasbourg (BETA), CNRS); Meixing Dai (Université de Strasbourg (BETA), CNRS); Frédéric Dufourt (Aix-Marseille UniversitÈ (Aix-Marseille School of Economics), CNRS-GREQAM & EHESS and Institut Universitaire de France)
    Abstract: We analyze the conditions of emergence of a twin banking and sovereign debt crisis within a monetary union in which: (i) the central bank is not allowed to provide direct financial support to stressed member states or to play the role of lender of last resort in sovereign bond markets, and (ii) the responsibility of fighting against large scale bank runs, ascribed to domestic governments, is ensured through the implementation of a financial safety net (banking regulation and government deposit guarantee). We show that this broad institutional architecture, typical of the Eurozone at the onset of the financial crisis, is not always able to prevent the occurrence of a twin banking and sovereign debt crisis triggered by pessimistic investors' expectations. Without significant backstop by the central bank, the financial safety net may actually aggravate, instead of improve, the financial situation of banks and of the government.
    Keywords: banking crisis, sovereign debt crisis, bank runs, financial safety net, liquidity regulation, government deposit guarantee, self-fulfilling propheties
    JEL: E32 E44 F3 F4 G01 G28
    Date: 2014–06
  14. By: Hans Dewachter (National Bank of Belgium, Research Department; Center for Economic Studies, University of Leuven; CESifo); Leonardo Iania (Louvain School of Management, Université Catholique de Louvain; Center for Economic Studies, University of Leuven); Marco Lyrio (Insper Institute of Education and Research); Maite de Sola Perea (National Bank of Belgium, Research Department)
    Abstract: We estimate the 'fundamental' component of euro area sovereign bond yield spreads, i.e. the part of bond spreads that can be justified by country-specific economic factors, euro area economic fundamentals, and international influences. The yield spread decomposition is achieved using a multi-market, no-arbitrage affine term structure model with a unique pricing kernel. More specifically, we use the canonical representation proposed by Joslin, Singleton, and Zhu (2011) and introduce next to standard spanned factors a set of unspanned macro factors, as in Joslin, Priebsch, and Singleton (2013). The model is applied to yield curve data from Belgium, France, Germany, Italy, and Spain over the period 2005-2013. Overall, our results show that economic fundamentals are the dominant drivers behind sovereign bond spreads. Nevertheless, shocks unrelated to the fundamental component of the spread have played an important role in the dynamics of bond spreads since the intensification of the sovereign debt crisis in the summer of 2011.
    Keywords: Euro area sovereign bonds, yield spread decomposition, unspanned macro factors, fair spreads
    JEL: E43 E44 E47
    Date: 2014–06

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