nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒08‒09
four papers chosen by
Martin Berka
University of Auckland

  1. Globalisation, pass-through and the optimal policy response to exchange rates By Michael B Devereux; James Yetman
  2. Financial crises and exchange rate policy By Luca Fornaro
  3. Higher order beliefs and the dynamics of exchange rates By F. Pancotto; G. Pignataro; D. Raggi
  4. The impact of an exchange rate realignment on the trade balance: Euro vs. national currency - Some preliminary results with a/simmetrie model of the Italian economy By Alberto Bagnai; Christian Alexander Mongeau Ospina

  1. By: Michael B Devereux; James Yetman
    Abstract: In this paper we examine how monetary policy should respond to nominal exchange rates in a New Keynesian open economy model that allows for a non-trivial role for sterilised intervention. The paper develops the argument against the backdrop of the evolving policy-making environment of Asian economies. Sterilised intervention can be a potent tool that offers policymakers an additional degree of freedom in maximising global welfare. We show that the gains to sterilised intervention are greater when goods market integration is low and exchange rate pass-through is high. However, increased financial internationalisation reduces the effectiveness of sterilised intervention, as the international policy trilemma becomes more relevant. Unsterilised intervention may also have a role to play, although the potential welfare gains from this are generally smaller. Most central banks in Asia have actively used sterilised foreign exchange intervention as a policy tool to smooth exchange rates. But, over time, declining exchange rate pass-through and the increasing international integration of financial and goods markets will tend to reduce the efficacy of sterilised intervention. Given the limited effectiveness of unsterilised intervention, our model implies that the role of exchange rate movements in the optimal setting of monetary policy in Asia is decreasing.
    Keywords: globalisation; foreign exchange intervention; exchange rate pass-through
    Date: 2014–06
  2. By: Luca Fornaro
    Abstract: This paper studies exchange rate policy in a small open economy model featuring an occasionally binding collateral constraint and Fisherian deflation. The goal is to evaluate the performance of alternative exchange rate policies in sudden stopprone economies. The key element of the analysis is a pecuniary externality arising from frictions in the international credit markets, which creates a trade-off between price and financial stability. The main result is that the appropriate exchange rate policy sustains the value of collateral and access to international credit markets during financial crises.
    Keywords: Financial crises, Monetary Policy, Sudden Stops, Exchange Rate Regime, Nominal Wage Rigidities, Pecuniary Externalities.
    JEL: G01 E44 E52 F32 F34 F41
    Date: 2014–07
  3. By: F. Pancotto; G. Pignataro; D. Raggi
    Abstract: This paper investigates the role of higher order beliefs in the formation of exchange rates. Our model combines a standard macroeconomic dynamics for the exchange rates with a microeconomic specification of agents' heterogeneity and their interactions. The empirical analysis relies on a state space model estimated through Bayesian methods. We exploit data on macroeconomic fundamentals in a panel of subjective forecasts on the euro/dollar exchange rate. The equilibrium strategy on the optimization process of the predictors shows that higher order beliefs is the relevant factor in performing individual forecasting. Moreover public information, namely past exchange rates and fundamentals, plays a crucial role as a coordination device to generate expectations among agents on the basis of their forecasting abilities.
    JEL: D82 F41 C11
    Date: 2014–07
  4. By: Alberto Bagnai (Department of Economics, Gabriele d'Annunzio University); Christian Alexander Mongeau Ospina (a/simmetrie, Italian Association for the Study of Economic Asymmetries)
    Abstract: It is frequently claimed that the current EUR/USD exchange rate is too high and that a depreciation of the EUR against the USD would contribute to relieve the Eurozone economy from the current state of persistent crisis. Evidence provided by the a/simmetrie annual econometric model suggests that this claim is unsupported by the data, at least as far as the Italian economy is concerned. In fact, the size and sign of the trade elasticities show that the increases in net exports towards non-Eurozone countries, brought about by the depreciation of the euro, would be offset by an increase in net imports towards Eurozone countries, brought about by the increase in Italian domestic demand. To put it simply, in case of a depreciation of the EUR, the Italian economy would not only suffer a higher costs of energy (because of the depreciation vis-à-vis OPEC countries), but also spend in Germany much of the money it earned in the US, Japan, and the emerging countries, with a net effect likely to be almost zero or negative in the first three to four years.
    Keywords: Simulation methods, Trade forecasting and simulations, Foreign exchange, Current account adjustment, Comparative analysis of economic systems
    JEL: C53 F17 F31 F32 P51
    Date: 2014–06

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