nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒09‒05
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Price Setting in Online Markets: Basic Facts, International Comparisons, and Cross-border Integration By Yuriy Gorodnichenko; Oleksandr Talavera
  2. Credit Rating Agency Downgrades and the Eurozone Sovereign Debt Crises By Christopher Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephan
  3. EMU Imbalances in a Two-Country Overlapping Generations Model By Karl Farmer
  4. The role of investment-specific technology shocks in driving international business cycles: a bayesian approach. By Dey, Jaya
  5. Pricing-to-Market and Optimal Interest Rate Policy By Cooke, Dudley
  6. House Prices, Capital Inflows and Macroprudential Policy By Maria Teresa Punzi; Caterina Mendicino
  7. Stability and Eurozone membership: Should a small transition country join? By Timo Baas
  8. Common Macroeconomic Shocks and Business Cycle Fluctuations in Euro Area Countries By Antonio Ribba; Antonella Cavallo
  9. Cross-Border Investment and the Global Financial Crisis in the Asia-Pacific Region By Sayuri Shirai
  10. Capital Flows and Financial Intermediation: is EMU different? By Bezemer, Dirk; Samarina, Anna
  11. An estimated DSGE model of a Small Open Economy within the Monetary Union: Forecasting and Structural Analysis By Yuliya Rychalovska; Massimiliano Marcellino (EUI)
  12. Investment Shocks: Sources of Fluctuations in Small Open Economy By Akande, Emmanuel
  13. MacSim 2 : a computer package for teaching international macroeconomics. By Jean Louis Brillet; Gilbert Cette; Ian Gambini; Raymond Gambini
  14. Monetary policy and financial shocks in an empirical small open-economy DSGE model By Rudi Steinbach; Stan du Plessis; Ben Smit
  15. The Effect of the Mining Boom on the Australian Economy By Peter Downes; Kevin Hanslow; Peter Tulip

  1. By: Yuriy Gorodnichenko; Oleksandr Talavera
    Abstract: We document basic facts about prices in online markets in the U.S. and Canada, a rapidly growing segment of the retail sector. Relative to prices in regular stores, prices in online markets are more flexible as well as exhibit stronger pass-through (60-75 percent) and faster convergence (half-life less than 2 months) in response to movements of the nominal exchange rate. Multiple margins of adjustment (frequency of price changes, direction of price changes, size of price changes, exit of sellers) are active in the process of responding to nominal exchange rate shocks. Furthermore, we use the richness of our dataset to show that degree of competition, stickiness of prices, synchronization of price changes, reputation of sellers, and returns to search effort are important determinants of pass-through and speed of price adjustment for international price differentials.
    JEL: E3 F40 F41
    Date: 2014–08
  2. By: Christopher Baum; Margarita Karpava; Dorothea Schäfer; Andreas Stephan
    Abstract: This paper studies the impact 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.GARCH modeling of sovereign bond yields and the value of the EuroCRA downgrade announcements negatively affected the value of the Euro currency and also increased its volatility. Downgrading increased the yields of French, Italian and Spanish bonds but lowered the German bond's yields. We infer from these findings that CRA announcements significantly influenced crisis-time capital allocation in the Eurozone.
    Keywords: France, Italy, Germany, Spain, Impact and scenario analysis, Finance
    Date: 2014–07–03
  3. By: Karl Farmer
    Abstract: The present sovereign debt crisis in the Economic and Monetary Union of the EU (EMU) is partly attributable to the pronounced increase in external imbalances across northern and southern euro zone countries during the years running up to 2007 (Lane and Milesi-Ferretti, 2011). While the behavior and extent of external imbalances during the pre-crisis period is empirically well documented (e.g. Lane and Pels 2012) it remains an open theoretical question how the evolution of the observed external imbalances can best be reproduced within an intertemporal general equilibrium model of the EMU. Fagan and Gaspar (2008) compare in a two-good, two-country Yaari (1965)-Blanchard (1985) overlapping generations (OLG) pure exchange model without government debt the pre-euro financial autarky steady state to euro-related financial integration between northern and southern euro countries (called core and periphery, respectively). They find that the evolution of intra-EMU external imbalances can be traced back to North-South differences in time preference. While the neglect of production and capital accumulation may be justified by the similarity of northern and southern GDP growth rates in the pre-crisis period the rather huge private capital movements from core to periphery over this period suggest a two-country overlapping generations model with production and private capital accumulation in order to check whether the observed EMU external imbalances can be attributed to differences in economic fundamentals within this model framework, too. In addition, we introduce government debt into our basic model in order to investigate whether in view of the pre-crisis time-stationarity in the debt to GDP ratios of both EMU core and periphery the observed external imbalances can be traced back to which economic fundamentals. Thus, there are two main objectives of the paper: First, to present stylized facts regarding the intra-EMU macroeconomic data running up to the financial crisis 2007 in order to motivate the model set-up. Secondly, to develop a two-zone OLG model with production, capital accumulation and government debt in order to figure out how EMU’s North-South external imbalances can be attributed to financial integration due to the common currency. To pursue the second objective, a one-good, two-country Diamond (1965)-Buiter (1981) OLG model with time preference and technological differences across countries (e.g. EMU’s North, South) and time-stationary debt to GDP ratios will be developed. It will be used (i) to see how the pre-euro real interest differential between EMU South (periphery) and EMU North (core) can be depicted in the proposed model and (ii) whether the observed external imbalances (net foreign asset positions) can be referred to the euro-related interest rate convergence between EMU core and periphery. Both countries in the model economy are interconnected through free international trade in commodities, real capital and bonds emitted by national governments. The objective of this highly stylized model is to figure out major economic mechanisms triggering the observed intra-EMU imbalances in the run-up towards the global financial crisis. This is clearly the first step to set up a dynamic applied general equilibrium model along the lines of Fagan and Gaspar (2008). The author finds that the pre-euro real interest differential can be attributed to a relatively high time preference, low total factor productivity and high capital production share in the periphery. Exactly these differences in economic fundamentals cause the pre-crisis evolution of the external imbalances among EMU core and periphery.
    Keywords: EMU, Finance, General equilibrium modeling
    Date: 2013–06–21
  4. By: Dey, Jaya
    Abstract: This paper uses a Bayesian approach to estimate a standard international real business cycle model augmented with preferences with zero wealth-effect, variable capacity utilization and investment adjustment costs. First, I find that the bulk of fluctuations in country-specific outputs, consumption, investments, and international relative prices are attributed to country-specific neutral technology, investment-specific technology and preference shocks. Second, my estimated model with economically meaningful shocks simultaneously accounts for the negative correlation between the real exchange rate and relative consumption, and the negative correlation between the terms of trade and relative output. Lastly, by using marginal likelihood comparison exercise, I find that the success of the model depends on preferences with zero wealth effects; other frictions and alternative asset market structures play a less important role.
    Keywords: Bayesian; investment-specific technology; real exchange rate
    JEL: C11 E32 F32 F41
    Date: 2013–01–09
  5. By: Cooke, Dudley (University of Exeter)
    Abstract: I study optimal interest rate policy in a small open economy with consumer search in the product market. When there are search frictions, firms price-to-market, with implications for the design of monetary policy. Country-specific shocks generate deviations from the law of one price for traded goods which monetary policy acts to stabilize by influencing firm markups. However, stabilizing law of one price deviations results in greater fluctuations in output.
    Keywords: interest rates; monetary policy; price
    JEL: E31 E52 F41
    Date: 2014–08–01
  6. By: Maria Teresa Punzi (Department of Economics, Vienna University of Economics and Business); Caterina Mendicino (Economics and Research Department, Bank of Portugal)
    Abstract: This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkages between current account deficits and financial vulnerabilities. We develop a two-country dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household debt. In this context, optimal policy features an interest-rate response to credit and a LTV ratio that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy.
    Keywords: house prices, financial frictions, global imbalances, saving glut, dynamic loan-to value ratios, monetary policy, optimized simple rules
    JEL: C33 E51 F32 G21
    Date: 2014–08
  7. By: Timo Baas
    Abstract: In the last years, Baltic countries joined or prepare to join the European Monetary Union. Accession comes in a time, were trading share between these countries and the Eurozone are declining. From a theoretical point of view, the optimality of currency unions depends on bilateral trade between it's members. In this paper it is shown that countries might benefit from a currency union as an alternative to fixed exchange rates. Using a DSGE model of a small country and a currency union, it is shown that membership in the union is beneficial to a fixed exchange rate system without a common monetary policy in terms of output and price stability. This result is robust even if trading shares decline significantly.In this paper we compare different monetary policy rules in a two-country open-economy DSGE model with Calvo price setting. Membership in the currency union is always beneficial in terms of macroeconomic stability. The benefits of joining a monetary union, however, are increasing with a declining share of foreign goods in the consumption basket of domestic households. The decision of Baltic countries to join the monetary union, therefore, is a second best solution in an environment were there is a fear of floating.
    Keywords: Baltic countries, General equilibrium modeling, EU enlargement
    Date: 2014–07–03
  8. By: Antonio Ribba; Antonella Cavallo
    Abstract: This paper investigates the dynamic effects of common macroeconomic shocks in shaping business cycle fluctuations in a group of Euro-area countries. In particular, by using the structural (Near)VAR methodology, we investigate the effect of area-wide shocks, with particular attention to monetary policy shocks, on the evolution of inflation and output of the national economies. Preliminary results show that there are two distinct groups of countries: a first group, including the biggest European economies, in which business cycle fluctuations are mainly explained by common, areawide shocks; a second one, including Greece, Ireland and Portugal, in which the national shocks play, instead, a much greater role.
    Keywords: Euro-area countries , Business cycles, Macroeconometric modeling
    Date: 2014–07–03
  9. By: Sayuri Shirai (Professor of Economics, Faculty of Policy Management at Keio University, Japan. (
    Abstract: The subprime mortgage crisis erupted in the United States in mid-2007 and was then transformed into the global financial crisis after the failure of Lehman Brothers in September 2008. The total amount of write-downs of loans and securities by financial institutions for 2007-2010 is estimated to reach $1 trillion in the United States, $604 billion in the United Kingdom, and $814 billion in the Euro Area. By contrast, the Asia-Pacific region is expected to have write-downs of only $210 billion, suggesting the limited damages incurred on the banking sector. Nonetheless, the Asia-Pacific region suffered from the global financial crisis through two channels. One channel was mainly through capital withdrawals from equity markets by foreign investors, causing a sharp drop in stock prices. The other channel was through trade linkages with advanced nations. Nearly all countries faced a contraction in exports and production owing to an abrupt decline in import demand in the United States and Europe. This paper analyses how the Asia-Pacific region was affected by the global financial crisis. To do so, the paper focuses on cross-border capital flows and investment patterns by looking at the pre-crisis features of the United States in relation to the world, as well as the Asia-Pacific region. It also focuses on net international investment positions of the Asia- Pacific region in the pre-crisis period. The paper then sheds light on the impact of the global financial crisis on the cross-border capital flows and the balance of payments in the region. * Professor
  10. By: Bezemer, Dirk; Samarina, Anna (Groningen University)
    Abstract: The share of domestic bank credit allocated to non-financial business declined significantly in EMU economies since 1990. This paper examines the impact of capital inflows on domestic credit allocation, taking account of (future) EMU membership. The study utilizes a novel data set on domestic credit allocation for 38 countriesover 1990?2011 and data on capital inflows into the bank and non-bank sectors. We estimate panel models controlling for initial financial development, income level, inflation, interest rate, credit market deregulation and current account positions. The results suggest that the decline in the share of credit to non-financial business was significantly larger in (future) EMU economies which experienced more capital inflows into their non-bank sectors. We discuss implications.
    Date: 2014
  11. By: Yuliya Rychalovska; Massimiliano Marcellino (EUI)
    Abstract: In this paper we build and estimate a two-region DSGE model of a small open economy within the European Monetary Union. We evaluate the properties of the estimated model and assess its forecasting performance (point and density) relative to reduced form models such as VARs. In addition, we study the empirical validity of the DSGE model restrictions (based on micro-foundations) by applying a DSGE-VAR approach. Finally, the estimated model is used to analyze the sources of macroeconomic fluctuations and examine the We allow for a sufficiently rich specification which enables us to include unemployment as well as open economy variables such as the real exchange rate into the estimation procedure, along with the standard macroeconomic and labor market indicators. The model contains a set of frictions and structural shocks typically used in the DSGE literature. We evaluate the properties of the estimated model and assess its forecasting performance relative to reduced form models such as VARs. In addition, we study the empirical validity of the DSGE model restrictions by applying a DSGE-VAR approach. Finally, the estimated model is used to analyze the sources of macroeconomic fluctuations and examine the responses of the economy to structural shocks. The model is built in the New Keynesian tradition and contains real and nominal rigidities such as habit formation in consumption, price and wage stickiness as well as rich stochastic structure. The framework also incorporates the theory of unemployment as in Gali et al. (2011), small open economy aspects and a nominal interest rate that is set exogenously by the area-wide monetary authority. The model is estimated using Bayesian techniques. We demonstrate that the estimated DSGE model is relatively well identified, has good data fit and reasonably estimated parameters. In addition, the model shows a competitive forecasting performance (in terms of both point and density) compared to reduced form models such as VARs. In this respect, our results are in line with the conclusions reached in previous studies that the new generation of DSGE models no longer faces the tension between rigor and fit. In particular, we illustrate that the DSGE model produces sizable one-step-ahead forecasting gains in terms of RMSE and the Score over the unrestricted VAR, especially for such variables as GDP, real exchange rate, unemployment and real wages. The predictions stay competitive at longer forecasting horizons. DSGE-VAR analysis demonstrates that the optimal weight on the DSGE restrictions is significant and the VAR(2) correction is not helpful in improving the DSGE model fit. At the same time, the DSGE-based prior significantly improves the short term forecast accuracy of the unrestricted VAR for output, and also determines a superior performance of the DSGE-VAR model in predicting exchange rate, unemployment and wages over all the forecast horizons considered here. When compared to an atheoretical Minnesota-style prior, the DSGE restrictions appear to be more useful in forecasting output and REER, whereas the opposite is true for employment. Application of the model to the analysis of the business cycle fluctuations demonstrates that "open economy" disturbances such as relative price, foreign demand and interest rate shocks explain a significant portion of the variation of output growth, inflation, real exchange rate and employment. Price and wage markup shocks are important determinants of inflation and real wages dynamics respectively.
    Keywords: Euro Area, Luxembourg, General equilibrium modeling, Forecasting and projection methods
    Date: 2013–06–21
  12. By: Akande, Emmanuel
    Abstract: This paper contributes to the existing Real Business Cycle (RBC) literature by introducing Marginal Efficiency of Investment (MEI) shocks into small open economic model. Investment shocks are the most important drivers of business cycle fluctuations in small open economy because the fluctuations in all the macroeconomic variables showed a significant response to MEI shocks than productivity shocks. The anticipation of pro-cyclical behavior of the external accounts when the model was augmented with the form of share of consumption in the household utility function, μ, and an appealing, but complex, concave adjustment cost function becomes a standpoint that differentiates this study from other investment shocks literatures. The pattern of the rise in investment in both shocks explains why investment shocks is so important in times of recession and it reveals the main source of fluctuations in a small open economy.
    Keywords: Real Business Cycle, Marginal Efficiency of Investment, productivity shocks, adjustment cost.
    JEL: E32 E37 F4
    Date: 2013–04
  13. By: Jean Louis Brillet; Gilbert Cette; Ian Gambini; Raymond Gambini
    Abstract: This presentation will start with a global description of the package features, then move to an interactive computer session. The purpose of MacSim is to describe the main macroeconomic interactions, both inside and between countries, based on a set of small quarterly econometric country models, linked by their trade flows. The countries treated are, in alphabetical order : Belgium, France, Germany, Italy, Japan, Luxemburg, Nederlands, United Kingdom, USA, plus an artificial grouping of the remaining EMU-12 elements (Austria, Finland, Greece, Ireland, Portugal, Spain) , and a sketchy Rest of the World. Each model includes the main usual economic mechanisms describing : The production function : Cobb-Douglas, with an explicit impact of the relative cost of labor and capital on their role in production. Unemployment, depending on employment and the potential work force. A price block, with wages depending on inflation, productivity and unemployment, the GDP deflator on the wage cost and the rate of use of capacities, and trade prices on local cost and competitors prices. Household consumption and change in inventories are also included. The trade between countries is treated as follows : First global imports are defined, depending on foreign demand to the country, available local capacities (compared with foreign) and local price competitiveness.. Then imports are shared between providers, using a predefined share modified again by a comparison of their rates of use and price competitiveness, Both the interest rate and exchange rate can be set to follow specific rules : nominal fixed, real fixed and Taylor rule for the first, nominal fixed, real fixed and uncovered interest rate parity for the other. Of course, EMU countries follow ECB defined rates. But a risk premium is applied to the individual interest rates. The package itself provides a base solution, to which the user applies shocks on the external environment and the State policy, for a specific country or a set. Decisions are made at the beginning of the year, and applied over it. Comprehensive results are presented in tables and graphs. A global function computes the efficiency of policies, depending on the usual elements : GDP growth, inflation, State and Trade balances. This allows to use the package as a game, with a variable number of players. Two examples of the process will be presented as a second part. See above See above
    Keywords: NA, Macroeconometric modeling, Miscellaneous
    Date: 2013–06–21
  14. By: Rudi Steinbach; Stan du Plessis; Ben Smit
    Abstract: Determine the optimal response of a small open economy's central bank to financial shocks that lead to increases in credit spreads. Increasing credit spreads reduce the efficacy of monetary policy when the central bank is reducing the policy rate to accommodate a lowering in economic activity.Used a DSGE model that incorporates heterogeneous households and financial intermediaries. Financial shocks leads to an increase in non-performing loans, which in turn causes the financial intermediary to increase the spread over the policy rate at which it is willing to lend.The central bank should reduce the policy rate in response to rising credit spreads, however this response is more muted when compared to a closed economy facing a similar shock.
    Keywords: South Africa / Italy, Monetary issues, Macroeconometric modeling
    Date: 2014–07–03
  15. By: Peter Downes (Outlook Economics); Kevin Hanslow (Centre of Policy Studies, Victoria University); Peter Tulip (Reserve Bank of Australia)
    Abstract: This paper estimates the effects of the mining boom in Australia, using a large-scale structural macroeconometric model, AUS-M. We estimate that the mining boom boosted real per capita household disposable income by 13 per cent by 2013. The boom has contributed to a large appreciation of the Australian dollar that has weighed on other industries exposed to trade, such as manufacturing and agriculture. However, because manufacturing benefits from higher demand for inputs to mining, the deindustrialisation that sometimes accompanies resource booms – the so-called 'Dutch disease' – has not been strong.
    Keywords: mining boom; Dutch disease; macroeconomic modelling
    JEL: E17 Q33
    Date: 2014–08

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