nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒07‒13
twelve papers chosen by
Martin Berka
University of Auckland

  1. Quality, Trade, and Exchange Rate Pass-Through By Natalie Chen; Luciana Juvenal
  2. Credit rating agency downgrades and the Eurozone sovereign debt crises By Christopher F Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephen
  3. Capital inflows and euro area long-term interest rates By Daniel Carvalho; Michael Fidora
  4. Exchange Rate Management and Crisis Susceptibility: A Reassessment By Atish R. Ghosh; Jonathan David Ostry; Mahvash Saeed Qureshi
  5. Real Exchange Rate Appreciation in Emerging Markets: Can Fiscal Policy Help? By Marialuz Moreno Badia; Alex Segura-Ubiergo
  6. A provincial view of global imbalances: regional capital flows in China By Samuel Cudré; Mathias Hoffmann
  7. Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime By Andrew Berg; Rafael A Portillo; Luis-Felipe Zanna
  8. Sovereign CDS Spreads in Europe: The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers By Frigyes F Heinz; Yan Sun
  9. Do Remittances Facilitate a Sustainable Current Account? By Gazi M. Hassan; Mark J. Holmes
  10. Fiscal shocks and the exchange rate By Giorgio Di Giorgio Author-Name-First Giorgio; Salvatore Nistico' Author-Name-First Salvatore; Guido Traficante Author-Name-First Guido
  11. Carry Trade, Uncovered Interest Parity and Monetary Policy By Dániel Felcser; Balázs Vonnák
  12. Real Unit Labour Costs in Eurozone Countries: Drivers and Clusters By Ordóñez, Javier; Sala, Hector; Silva, José I.

  1. By: Natalie Chen; Luciana Juvenal
    Abstract: This paper investigates theoretically and empirically the heterogeneous response of exporters to real exchange rate fluctuations due to product quality. Our 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. We test the proposed theory using a highly disaggregated Argentinean firm-level wine export dataset between 2002 and 2009 combined with experts wine rankings as a measure of quality. The model predictions find strong support in the data and the results are robust to different measures of quality, samples, specifications, and to the potential endogeneity of quality.
    Keywords: Exchange rates;Agricultural exports;Producer prices;Real effective exchange rates;External shocks;Economic models;Exchage rate pass-through, pricing-to-market, quality, unit values, exports, firms
    Date: 2014–03–12
  2. By: Christopher F Baum (Boston College; DIW Berlin); Margarita Karpava (MediaCom London); Dorothea Schäfer (DIW Berlin; JIBS); Andreas Stephen (JIBS; DIW Berlin; Ratio Institute Stockholm)
    Abstract: This paper studies of credit rating agency (CRA) downgrade announcements on the value of the Euro and the yields of French, Italian, German and Spanish long-term sovereign bonds during the culmination of the Eurozone debt crisis in 2011-2012. The employed GARCH models show that CRA downgrade announcements negatively affected the value of the Euro currency and also increased the volatility. Downgrading increased the yields of French, Italian and Spanish bonds but lowered the German bond’s yields, although Germany’s rating status was never touched by CRA. There is no evidence for Gander causality from bond yields to rating announcement. We infer from these findings that CRA announcements increasingly influenced crisis-time capital allocation in the Eurozone. Their downgradings caused investors to rebalance their portfolio across member countries, out of ailing states’ debt into more stable borrowers’ securities.
    Keywords: Credit Rating Agencies, Euro Crisis, Sovereign Debt, Euro Exchange Rate
    JEL: G24 G01 G12 G14 E42 E43 E44 F31 F42
    Date: 2014
  3. By: Daniel Carvalho; Michael Fidora
    Abstract: Capital flows into the euro area were particularly large in the mid-2000s and the share of foreign holdings of euro area securities increased substantially between the introduction of the euro and the outbreak of the global financial crisis. We show that the increase in foreign holdings of euro area bonds in this period is associated with a reduction of euro area long-term interest rates by about 1.55 percentage points, which is in line with previous studies that document a similar impact of foreign bond buying on US Treasury yields. These results are relevant for understanding developments both in the euro area and abroad, as lower levels of long-term interest rates resulting from foreign accumulation of euro area debt securities may have added to increased risk appetite and hunt for yield at the global level.
    JEL: E43 E44 F21 F41 G15
    Date: 2014
  4. By: Atish R. Ghosh; Jonathan David Ostry; Mahvash Saeed Qureshi
    Abstract: This paper revisits the bipolar prescription for exchange rate regime choice and asks two questions: are the poles of hard pegs and pure floats still safer than the middle? And where to draw the line between safe floats and risky intermediate regimes? Our findings, based on a sample of 50 EMEs over 1980-2011, show that macroeconomic and financial vulnerabilities are significantly greater under less flexible intermediate regimes—including hard pegs—as compared to floats. While not especially susceptible to banking or currency crises, hard pegs are significantly more prone to growth collapses, suggesting that the security of the hard end of the prescription is largely illusory. Intermediate regimes as a class are the most susceptible to crises, but “managed floatsâ€â€”a subclass within such regimes—behave much more like pure floats, with significantly lower risks and fewer crises. “Managed floating,†however, is a nebulous concept; a characterization of more crisis prone regimes suggests no simple dividing line between safe floats and risky intermediate regimes.
    Keywords: Exchange rate regimes;Emerging markets;Currency pegs;Floating exchange rates;Economic models;Time series;crisis, vulnerabilities, real exchange rate, flexible exchange rate, intermediate exchange rate, exchange rate flexibility, intermediate exchange rate regimes, flexible exchange rate regimes, nominal exchange rate, exchange rate overvaluation, real exchange rate overvaluation, flexible exchange rates, exchange rate arrangements, current account balance, overvalued exchange rates, effective exchange rate, exchange rate regime classification, exchange rate guarantee, exchange rate volatility, fixed exchange rates, currency basket, nominal effective exchange rate, real effective exchange rate, history of exchange rate, exchange rate management, alternative exchange rate regimes, currency boards, currency appreciation, exchange rate movements, exchange rate regime classifications, real exchange rate misalignment, real exchange rates, de facto exchange rate regime, exchange reserves, foreign exchange, exchange rate parity, foreign exchange reserves, exchange rate systems
    Date: 2014–01–24
  5. By: Marialuz Moreno Badia; Alex Segura-Ubiergo
    Abstract: A number of emerging markets have experienced substantial real exchange rate appreciation in recent years, generating concerns about competitiveness and prompting policymakers to respond with a combination of mitigating policies. This paper shows that fiscal policy can play a role in alleviating these pressures. Using a sample of 28 emerging market economies over 1983-2011, we estimate a dynamic model of the real exchange rate and find that a permanent fiscal adjustment may reduce appreciation pressures over the long term. Furthermore, the composition of public spending matters, with reductions in current spending playing a key role. To illustrate the importance of these findings, the paper focuses on the case of Brazil. Our results suggest that maintaining fiscal discipline while increasing public investment in Brazil is likely to ease real appreciation pressures, highlighting the importance of tackling long-standing budget rigidities.
    Keywords: Real effective exchange rates;Exchange rate appreciation;Emerging markets;Brazil;Fiscal policy;Economic models;real exchange rate, public consumption, public investment, purchasing power parity, real exchange rate depreciation, real exchange rate appreciation, nominal exchange rate, real exchange rates, current account balance, government spending, fiscal adjustment, fiscal affairs, flexible exchange rates, composition of public spending, floating exchange rates, taxation, fiscal affairs department, fiscal performance, public expenditures, budget rigidities, ppp, foreign exchange, exchange rate forecasting
    Date: 2014–01–10
  6. By: Samuel Cudré; Mathias Hoffmann
    Abstract: We model capital flows among Chinese provinces using a theory-based variance decomposition that allows us to gauge the importance of various channels of external adjustments at the regional level: variation in intertemporal prices—domestic and international interest rates and the real exchange rate—and intertemporal variation in quantities (cash flows of output, investment and government spending). We find that our simple framework can account for around 85 percent of the variation in regional capital flows over the 1985-2010 period. Our results suggest that the relative importance of private and state-owned enterprises, a province’s level of integration into the world economy and its sectoral composition play an important role for external adjustment vis-à-vis the rest of China and the world. Specifically, we find strong empirical support for the view that differential access of private and state-owned enterprises to finance is a key driver of China’s surpluses. We discuss implications of our results for global imbalances in capital flows.
    Keywords: China, Chinese provinces, capital flows, current account, global imbalances, external adjustment, present-value models, regional business cycles
    JEL: F30 F32 F40
    Date: 2014–06
  7. By: Andrew Berg; Rafael A Portillo; Luis-Felipe Zanna
    Abstract: We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption — an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption—and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.
    Keywords: Exchange rate regimes;Aid flows;Africa;Foreign exchange;Reserves accumulation;Central banks;Monetary policy;Fiscal policy;Economic models;Reserve Accumulation Policies, Sterilization Policies, Transfer Problem., fixed exchange rate, fixed exchange rate regime, flexible exchange rate, flexible exchange rate regime, real exchange rate, exchange rate appreciation, exchange rates, real exchange rate appreciation, fixed exchange rate regimes, nominal exchange rate, flexible exchange rates, flexible exchange rate regimes, exchange sales, exchange rate commitment, foreign exchange sales, exchange rate policies, currency substitution, exchange rate peg, exchange reserves, fixed exchange rates, foreign exchange reserves, exchange rate policy, exchange rate target
    Date: 2014–01–30
  8. By: Frigyes F Heinz; Yan Sun
    Abstract: By analysing data from January 2007 to December 2012 in a panel GLS error correction framework we find that European countries’ sovereign CDS spreads are largely driven by global investor sentiment, macroeconomic fundamentals and liquidity conditions in the CDS market. But the relative importance of these factors changes over time. While during the 2008/09 crisis weak economic fundamentals (such as high current account decifit, worsening underlying fiscal balances, credit boom), a drop in liquidity and a spike in risk aversion contributed to high spreads in Central and Eastern and South-Eastern European (CESEE) countries, a marked improvement in fundamentals (e.g. reduction in fiscal deficit, narrowing of current balances, gradual economic recovery) explains the region’s resilience to financial market spillovers during the euro area crisis. Our generalised variance decomposition analyisis does not suggest strong direct spillovers from the euro area periphery. The significant drop in the CDS spreads between July 2012 and December 2012 was mainly driven by a decline in risk aversion as suggested by the model’s out of sample forecasts.
    Keywords: Sovereign debt;Europe;Euro Area;Spillovers;Capital markets;Liquidity;Economic models;debt threshold, current account, public debt, current account balance, debt crisis, global liquidity, debt sustainability, sovereign bonds, financial markets, debt restructuring, external financing, public finances, sovereign debt crisis, stock market volatility, international financial markets, external shock, financial sector, debt defaults, current account deficit, current account balances, sovereign default, budget balances, corporate bond
    Date: 2014–01–28
  9. By: Gazi M. Hassan (University of Waikato); Mark J. Holmes (University of Waikato)
    Abstract: We examine how workers’ remittances impact on the current account. In doing so, we focus on how remittances affect the sustainability rather than size of current account balances. We find that the presence of remittances make it more likely that exports and imports are cointegrated thereby lending support to weak sustainability where increased remittances are associated with a faster speed of current account adjustment (lower persistence), particularly for those countries characterised by already highly persistent current account balances. We find that remittances are beneficial to the current account balance. This is in contrast to a literature that emphasises an adverse Dutch disease impact of workers’ remittances on the real exchange rate in terms of reduced external competitiveness.
    Keywords: remittances; current account; sustainability; panel cointegration
    JEL: F0 F4 O1
    Date: 2014–06–30
  10. By: Giorgio Di Giorgio Author-Name-First Giorgio (LUISS University); Salvatore Nistico' Author-Name-First Salvatore (University of Rome Sapienza); Guido Traficante Author-Name-First Guido (European University of Rome)
    Abstract: This paper shows that the result implied by the Redux model of Obstfeld and Rogoff (1995) - that the exchange rate depreciates in response to balanced-budget fiscal expansions - is completely reversed once we account for two key features of modern New Open Economy Macroeconomics models: home bias in public consumption and endogenous monetary policy.
    Keywords: Redux Model, Exchange Rate, Fiscal Shocks, Endogenous Monetary and Fiscal Policy.
    JEL: E43 E44 E50 E52
    Date: 2014
  11. By: Dániel Felcser (Magyar Nemzeti Bank (the central bank of Hungary)); Balázs Vonnák (Magyar Nemzeti Bank (the central bank of Hungary))
    Abstract: It is well documented in the literature that identified vector autoregression (VAR) models often produce puzzling results when the effect of unexpected monetary policy movements is estimated. Many authors find that raising interest rate generates protracted appreciation of the exchange rate (the so-called delayed overshooting puzzle) which is in contradiction with traditional theory of exchange rate dynamics based on uncovered interest parity. Since the dynamics of exchange rate is determined to a substantial extent by carry traders, we investigate the behaviour of the exchange rate and carry trade activity within the same VAR for a panel of small open economies. We identify structural shocks by allowing the interest rate and exchange rate to react simultaneously to monetary policy and changes in expected risk premium. Our results show that the delayed overshooting is not a robust finding. Exchange rate appreciation and carry trade movements take place almost on impact after an unexpected interest rate hike. Roughly half of the variation in carry trade positions can be explained by domestic interest rate changes and risk premium shocks.
    Keywords: delayed overshooting, vector autoregressions, carry trade, monetary policy
    JEL: E52 F31
    Date: 2014
  12. By: Ordóñez, Javier (Universitat Jaume I de Castelló); Sala, Hector (Universitat Autònoma de Barcelona); Silva, José I. (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

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