nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒08‒28
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Sovereign Debt Booms in Monetary Unions By Aguiar, Mark; Amador, Manuel; Farhi, Emmanuel; Gopinath, Gita
  2. Japan's Exorbitant Privilege By Kenneth S. ROGOFF; TASHIRO Takeshi
  3. A Model of the Twin DS: Optimal Default and Devaluation By Seunghoon Na; Stephanie Schmitt-Grohe; Martin Uribe; Vivian Z. Yue
  4. International Trade and Intertemporal Substitution By Fernando Leibovici; Michael E. Waugh
  5. Asset Price Bubbles and Monetary Policy in a Small Open Economy By Martha López
  6. The Domestic and International Effects of Interstate U.S. Banking By Cacciatore, Matteo; Ghironi, Fabio; Stebunovs, Viktors
  7. Financial crises, debt volatility and optimal taxes By Julian A. Parra-Polania; Carmiña O. Vargas
  8. Export Dynamics in Large Devaluations By George Alessandria; Sangeeta Pratap; Vivian Yue
  9. Commodity Price Co-Movement and Global Economic Activity By Ron Alquist; Olivier Coibion
  10. Global Imbalances and the External Solvency of Nations By Michael Bleaney; Mo Tian
  11. The Power of International Reserves: the impossible trinity becomes possible By Layal Mansour
  12. The Effects of Exchange Rates on Employment in Canada By Haifang Huang, Ke Pang, Yao Tang
  13. Has Regional Integration Led to Greater Risk-Sharing in Asia? By Ng, Thiam Hee; Yarcia, Damaris Lee
  14. Capital Accumulation and Structural Change in a Small-Open Economy By Yunfang Hu; Kazuo Mino
  15. International Reserves Before and After the Global Crisis: Is There No End to Hoarding? By Joshua Aizenman; Yin-Wong Cheung; Hiro Ito

  1. By: Aguiar, Mark; Amador, Manuel; Farhi, Emmanuel; Gopinath, Gita
    Abstract: We propose a continuous time model to investigate the impact of inflation credibility on sovereign debt dynamics. At every point in time, an impatient government decides fiscal surplus and inflation, without commitment. Inflation is costly, but reduces the real value of outstanding nominal debt. In equilibrium, debt dynamics is the result of two opposing forces: (i) impatience and (ii) the desire to conquer low inflation. A large increase in inflation credibility can trigger a process of debt accumulation. This rationalizes the sovereign debt booms that are often experienced by low inflation credibility countries upon joining a currency union.
    Date: 2014
  2. By: Kenneth S. ROGOFF; TASHIRO Takeshi
    Abstract: The concept of "exorbitant privilege" has received great attention from policy makers as well as academics worldwide. The idea originally referred to the willingness of foreigners to hold large quantities of US government debt at extremely low interest rates, due to the dollar's world reserve currency status. In recent years, the term exorbitant privilege has been expanded to explain why the US appears to be enjoying excess return from its external assets over liabilities across all asset classes, including foreign direct investment, equities and other forms of portfolio investment. In this paper, we give a brief review of the recent literature on exorbitant privilege, and then proceed to discuss exorbitant privilege in the context of another country, Japan, which has been the world's largest creditor nation for more than two decades. In contrast to the common perception that Japan has been a particularly poor international investor, we find that Japan enjoys exorbitant privilege in both the broad and narrow sense. Japan also earns higher expected returns from maturity transformation. Thus although the dollar is the reserve currency, the yen also has enjoyed a safe haven effect in the recent period.
    Date: 2014–08
  3. By: Seunghoon Na; Stephanie Schmitt-Grohe; Martin Uribe; Vivian Z. Yue
    Abstract: This paper characterizes jointly optimal default and exchange-rate policy. The theoretical environment is a small open economy with downward nominal wage rigidity as in Schmitt-Grohe and Uribe (2013) and limited enforcement of international debt contracts as in Eaton and Gersovitz (1981). It is shown that under optimal policy default is accompanied by large devaluations. At the same time, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are found to be able to support less external debt than economies with optimally floating rates. In addition, the following three analytical results are presented: 1) Real economies with limited enforcement of international debt contracts in the tradition of Eaton and Gersovitz (1981) can be decentralized using capital controls; 2) Real economies in the tradition of Eaton and Gersovitz can be interpreted as the centralized version of models with downward nominal wage rigidity, optimal capital controls, and a full-employment exchange-rate policy; and 3) Full-employment is optimal in an economy with downward nominal wage rigidity, limited enforcement of debt contracts, and optimal capital controls.
    Date: 2014–08
  4. By: Fernando Leibovici (Department of Economics, York University, Toronto, Canada); Michael E. Waugh (New York University and NBER)
    Abstract: This paper studies the dynamics of international trade flows at business cycle frequencies. We show that introducing dynamic considerations into an otherwise standard model of trade can account for several puzzling features of trade flows at business cycle frequencies. Our insight is that because international trade is time-intensive, variation in the rate at which agents are willing to substitute across time affects how trade volumes respond to changes in output and prices. We formalize this idea and calibrate our model to match key features of U.S. data. We find that, in contrast to standard staticmodels of international trade, ourmodel is quantitatively consistent with salient features of U.S. cyclical import fluctuations. We also find that our model accounts for two-thirds of the peak-to-trough decline in imports during the 2008-2009 recession.
    Date: 2014–08–11
  5. By: Martha López
    Abstract: In this paper we expanded the closed economy model by Bernanke and Gertler (1999) in order to account for the macroeconomic effects of an asset price bubble in the context of a small open economy model. During the nineties emerging market economies opened their financial accounts to foreign investment but it generated growing macroeconomic imbalances in these economies. Our goal in this paper is twofold: first we want to analyze if the conclusions of Bernanke and Gertler (1999) remain in the case of a small open economy. And second, we want to compare the results in terms of macroeconomic volatility of the model for a closed economy versus the model for a small open economy. Our results show that the conclusion about the fact that the Central Bank should not react to asset prices remains as in the case of a closed economy model, and that small open economies are more vulnerable to asset prices bubbles due to capital inflows and the exchange rate mechanism of the monetary policy. Therefore in small open economies the business cycle is deeper. Finally, in the face of a boom followed by a bust in an asset price bubble, macroeconomic volatility would be dampened if the monetary authority focus only on inflation. Classification JEL: E32, R40, E47, E52.
    Date: 2014–08
  6. By: Cacciatore, Matteo (Institute of Applied Economics); Ghironi, Fabio (University of Washington); Stebunovs, Viktors (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper studies the domestic and international effects of national bank market integration in a two-country, dynamic, stochastic, general equilibrium model with endogenous producer entry. Integration of banking across localities reduces the degree of local monopoly power of financial intermediaries. The economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The foreign economy experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to moderation of firm-level and aggregate output volatility. In turn, trade and financial ties allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. These results are consistent with features of U.S. and international fluctuations after the United States began its transition to interstate banking in the late 1970s.
    Keywords: Business cycle volatility; current account; deregulation; interstate banking; producer entry; real exchange rate
    JEL: E32 F32 F41 G21
    Date: 2014–08–01
  7. By: Julian A. Parra-Polania; Carmiña O. Vargas
    Abstract: We study ?financial crises in a model of a small open production economy subject to a credit constraint and to uncertainty on the real value of debt repayments. We find that, unlike most of the previous literature, the decentralized equilibrium exhibits underborrowing. The future possibility of reducing the severity of crises gives the incentives to the central planner (CP) to increase both current debt and the crisis probability. We also ?find that the CP equilibrium can be implemented by means of a tax on debt (a macro-prudential policy) and, only during crises, subsidies on consumption and a tax on non-tradable labor. The welfare gain of moving to the CP equilibrium is small for the baseline scenario but very sensitive to changes in debt volatility and the degree of openness of the economy.
    Keywords: Financial crisis, capital controls, debt shocks, optimal tax.
    JEL: F34 F41 H21
    Date: 2014–08–13
  8. By: George Alessandria; Sangeeta Pratap; Vivian Yue
    Abstract: We study the source and consequences of sluggish export dynamics in emerging markets following large devaluations. We document two main features of exports that are puzzling for standard trade models. First, given the change in relative prices, exports tend to grow gradually following a devaluation. Second, countries with higher interest rates tend to have slower export growth. To address these features of export dynamics, we embed a model of endogenous export participation due to sunk and per period export costs into an otherwise standard small open economy. In response to shocks to productivity, the interest rate, and the discount factor, we find the model can capture the salient features of the documented export dynamics. At the aggregate level, the features giving rise to sluggish exports lead to more gradual net export reversals, sharper contractions and recoveries in output, and endogenous stagnation in labor productivity.
    Date: 2014–08
  9. By: Ron Alquist; Olivier Coibion
    Abstract: Guided by a macroeconomic model in which non-energy commodity prices are endogenously determined, we apply a new factor-based identification strategy to decompose the historical sources of changes in commodity prices and global economic activity. The model yields a factor structure for commodity prices and identification conditions that provide the factors with an economic interpretation: one factor captures the combined contribution of shocks that affect commodity markets only through general-equilibrium forces. Applied to a cross-section of commodity prices since 1968, the theoretical restrictions are consistent with the data and yield structural interpretations of the common factors in commodity prices. Commodity-related shocks have contributed modestly to global economic fluctuations.
    Keywords: Economic models, International topics
    JEL: E3 F4
    Date: 2014
  10. By: Michael Bleaney; Mo Tian
    Abstract: Global current account imbalances were a major subject of concern in the years before the recent financial crisis. It is shown that the expected (negative) equilibrium relationship between net foreign assets and the trade balance that had held in the previous twenty years appeared to break down in this period. The explosion of the magnitude and equity component of cross-border assets and liabilities has made net foreign assets much harder to track, and may have introduced significant measurement errors and/or bubble effects into the series. The structural break is not evident if net property income flows are used in place of net foreign assets. This suggests that net exports do indeed adjust so as to maintain external solvency in the long run. JEL No.: F31
    Keywords: current account, exchange rates, net foreign assets, trade balance
  11. By: Layal Mansour (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon - Université Jean Monnet - Saint-Etienne - Université Claude Bernard - Lyon I (UCBL))
    Abstract: This aim of the present paper is to measure first, the degree of trilemma indexes: exchange rate stability, monetary independence capital account openness while taking into account the increase of hording IR ratio over GDP, over External Debt and over Short Term External Debt. The evolution of the trilemma indexes shows that countries applying de facto flexible Exchange Rate Regime (ERR) take advantage of the IR and become able to adopt a managed ERR that consist of achieving the three trilemma indexes simultaneously without renouncing to anyone of them. We found that different IR ratio could have different interpretations and different directions of monetary policies, where external debt should be taken into consideration in such study while using the IR. As for country that is applying a de facto fixed exchange rate regime, the IR (different ratio) do not play any role in changing the patter of the Mundell trilemma and do not intervene in monetary authority policies. This paper treats as well the normative aspects of the trilemma, relating the policy choices to macroeconomic outcomes such as the volatility of output growth. We found different results from country to another, while taking different ratios of measuring IR, concluding that the impact of IR on the output volatility could change due to the level of external debt and adopted exchange rate regime.
    Keywords: Monetary policy; International Reserve; External Debts; Impossible Trinity; Managed Exchange Rate; Quadrilemma; Output Volatilily
    Date: 2014
  12. By: Haifang Huang, Ke Pang, Yao Tang (Wilfrid Laurier University)
    Abstract: Under the flexible exchange rate regime, the Canadian economy is constantly af- fected by fluctuations in exchange rates. This paper focuses on the employment effect of the exchange rate in Canada. We find that appreciations of the Canadian dol- lar have significant effects on employment in manufacturing industries; such effects are mostly associated with the export-weighted exchange rate and not the import- weighted exchange rate. Meanwhile, the exchange rate has little effect on jobs in nonmanufacturing industries. Because the manufacturing sector accounts for only about 10% of the employment in Canada, the overall employment effect of the ex- change rate is small. In addition, we quantify the loss of manufacturing employment associated with a boom in the commodity market during which the Canadian dollar tends to appreciate. Our estimates suggest that when commodity prices increase by 15.77% (one standard deviation of annual change in commodity price between 1994 and 2010), Canada’s manufacturing employment decreases by 0.8%, about 0.08% of the total employment.
    Keywords: exchange rate, employment in Canada
    JEL: F1 F3 J2
    Date: 2014–04–29
  13. By: Ng, Thiam Hee (Asian Development Bank); Yarcia, Damaris Lee
    Abstract: The 1997–1998 Asian financial crisis revealed the latent risks present in an increasingly integrated global economy and how virulent these risks can be when roused from dormancy. Given the inevitability of integration, the challenge is how to maximize its benefits while minimizing its costs. One benefit of greater integration, particularly financial integration, is that countries can diversify their risks, thus allowing them to smooth out their consumption. This paper analyzes whether the degree of risk-sharing in East Asia has improved along with the observed rise in integration in the region. Higher risk-sharing is expected to result in (i) higher intraregional correlation of consumption across time and relative to output, and (ii) a higher residual in the panel regression of consumption on output. The results show that risk-sharing continues to be low in Asia. The increase in cross-economy correlation in consumption coincided with an even higher cross-economy correlation in output. Furthermore, the correlation between domestic consumption and domestic output growth remains high. And finally, correlation within the region is lower than correlation with the global economy. These findings suggest that higher consumption correlation is the result of stronger economic ties rather than greater risk-sharing.
    Keywords: risk-sharing; ASEAN; integration
    JEL: F36 F51
    Date: 2014–07–01
  14. By: Yunfang Hu (Kobe University); Kazuo Mino (Kyoto University)
    Abstract: This paper explores the relation between capital accumulation and transformation of industrial structure in a small open-economy. Using a three-sector, neoclassical growth model with non-homothetic preferences, we examine dynamic behavior of the small country in the alternative trade regimes. We show that capital accumulation plays a leading role in the process of structural transformation. It is also revealed that the trade pattern significantly affects structural change. We demonstrate that our model can mimic a typical pattern of change in industrial structure that has been observed in many developed economies.
    Keywords: Structural change, Small-open economy, Trade Pattern, Three-sector model, Non-homothetic preferences
    JEL: E21 O10 O41
    Date: 2014–08
  15. By: Joshua Aizenman; Yin-Wong Cheung; Hiro Ito
    Abstract: We evaluate the impact of the global financial crisis (GFC) and recent structural changes in the patterns of hoarding international reserves (IR). We confirm that the determinants of IR hoarding evolve with developments in the global economy. During the pre-GFC period of 1999-2006, gross saving is associated with higher IR in developing and emerging markets. The negative impact of outward direct investment on IR accumulation is consistent with the recent trend of diverting international assets from the international reserve account into tangible foreign assets; the "Joneses' effect" lends support to the regional rivalry in hoarding IR as a motivation; and commodity price volatility induces precautionary buffer hoarding. During the 2007–2009 GFC period, previously significant variables become insignificant or display the opposite effect, probably reflecting the frantic market conditions driven by financial instability. Nevertheless, the propensity to import and gross saving continue to display strong and even larger positive effects on IR holding. The results from the 2010–2012 post-GFC period are dominated by factors that had been mostly overlooked in earlier decades. While the negative effect of swap agreements and the positive effect of gross saving on IR holdings are in line with our expectations, we find a change in the link between outward direct investment and IR in the pre- and post-crisis period. The macro-prudential policy tends to complement IR accumulation. Developed countries display different demand behaviors for IRs -- higher gross saving is associated with lower IR holding, possibly reflecting high-income countries' tendency to deploy their savings in the global capital markets. The presence of sovereign wealth funds motivates developed countries to hold a lower level of IR. Our predictive exercise affirms that an emerging market economy with insufficient IR holdings in 2012 tends to experience exchange rate depreciation against the U.S. dollar when many emerging markets were adjusted to the news of tapering quantitative easing (QE) in 2013.
    JEL: F3 F31 F32 F36
    Date: 2014–08

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