nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒10‒22
seven papers chosen by
Martin Berka
University of Auckland

  1. Rare Disasters and Exchange Rates By Emmanuel Farhi; Xavier Gabaix
  2. The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule By Joscha Beckmann; Ansgar Belke; Christian Dreger
  3. Fiscal multipliers in a small euro area economy: How big can they get in crisis times? By Gabriela Castro; Ricardo M. Felix; Paulo Julio; Jose R. Maria
  4. International Transmission of Credit Shocks: Evidence from Global Vector Autoregression Model By Ludmila Fadejeva; Martin Feldkircher; Thomas Reininger
  5. Monetary and macroprudential policy with foreign currency loans By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  6. The great (De)leveraging in the GIIPS countries. Domestic credit and net foreign liabilities 1998–2013 By Juan Carlos Cuestas; Karsten Staehr
  7. Policy uncertainty spillovers to emerging markets – evidence from capital flows By Gauvin, Ludovic; McLoughlin, Cameron; Reinhardt, Dennis

  1. By: Emmanuel Farhi; Xavier Gabaix
    Abstract: We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our model is frictionless, has complete markets, and works for an arbitrary number of countries. Each country's exposure to disaster risk varies over time according to a mean-reverting process. Risky countries command high risk premia: they feature a depreciated exchange rate and a high interest rate. As their risk premium mean reverts, their exchange rate appreciates. Therefore, currencies of high interest rate countries appreciate on average. We calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate, the forward premium puzzle regression coefficients, and near-random walk exchange rate dynamics. A signature prediction of the model is that when a country's riskiness increases, its currency depreciates and put premia on this currency increase. The implied negative correlation between exchange rate movements and put premia is borne out by the data.
    Date: 2014–01
  2. By: Joscha Beckmann; Ansgar Belke; Christian Dreger
    Abstract: Deviations of policy interest rates from the levels implied by the Taylor rule have been persistent before the financial crisis and increased especially after the turn of the century. Compared to the Taylor benchmark, policy rates were often too low. This paper provides evidence that both international spillovers, for instance international dependencies in the interest rate setting of central banks, and nonlinear reaction patterns can offer a more realistic specification of the Taylor rule in the main industrial countries. The inclusion of international spillovers and, even more, nonlinear dynamics improves the explanatory power of standard Taylor reaction functions. Deviations from Taylor rates tend to be smaller and their negative trend can be eliminated.
    Keywords: Taylor rule, international spillovers, monetary policy interaction, smooth transition models
    JEL: E43 F36 C22
    Date: 2014
  3. By: Gabriela Castro (Economics and Research Department, Banco de Portugal); Ricardo M. Felix (Economics and Research Department, Banco de Portugal); Paulo Julio (Economics and Research Department, Banco de Portugal; and CEFAGE); Jose R. Maria (Economics and Research Department, Banco de Portugal)
    Abstract: Using PESSOA, a DSGE model for a small euro area economy, we analyze the size of fiscal multipliers associated with a large fiscal consolidation in "normal times" and in "crisis times." The crisis times scenario embodies a temporary increase in nominal rigidities and in financial frictions, purportedly better reflecting the underlying economic environment during the "Great Recession." Results show that impact multipliers are around 50-70 percent larger in crisis times for expenditure-based fiscal consolidations. A government consumption-based adjustment yields the highest impact multiplier (1.8 in crisis times vis-à-vis 1.2 in normal times). Revenue-based fiscal consolidations are also more recessive in crisis times, though the differences against normal times are less pronounced. Length: 37 pages
    Keywords: Fiscal multipliers; crisis; DSGE model; euro area; monetary union; small open economy.
    JEL: E62 F41 H62
    Date: 2014
  4. By: Ludmila Fadejeva; Martin Feldkircher; Thomas Reininger
    Abstract: In this paper, we examine international transmission of the negative credit supply shock, which originated in the euro area and the US. We use the multi-country global vector autoregression (GVAR) approach with trade and bilateral banking exposures as weights, and identify five structural shocks via sign restrictions. Special focus of this research is on CESEE – a region that shares strong financial linkages with the euro area. Our main results are as follows. First, US-specific shocks account for a significant share in explaining the deviations from growth trends in output and total credit in both the euro area and the US; second, compared to a domestic aggregate demand shock, the economic downturn caused by the credit supply shock in the US and the euro area can bring more harm in the long run, yet the international spillover of the former is stronger; third, the transmission of euro area shocks to emerging Europe is faster and more pronounced compared to US shocks; fourth, there is strong heterogeneity in responses of emerging Europe to shocks in the euro area and the US.
    Keywords: credit shock, global vector autoregressions, sign restrictions
    JEL: C32 F44 E32 O54
    Date: 2014–09–25
  5. By: Michał Brzoza-Brzezina (Narodowy Bank Polski and Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Warsaw School of Economics); Krzysztof Makarski (Narodowy Bank Polski and Warsaw School of Economics)
    Abstract: In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions where housing loans can be denominated in domestic or foreign currency. We calibrate the model for Poland - a typical small open economy with a large share of foreign currency loans (FCL) - and use it to conduct a series of simulations. They show that FCLs negatively affect the transmission of monetary policy. In contrast, their impact on the effectiveness of macroprudential policy is much weaker but positive. We also demonstrate that FCLs increase welfare when domestic interest rate shocks prevail and decrease it when risk premium (exchange rate) shocks dominate. Under a realistic calibration of the stochastic environment FCLs are welfare reducing. Finally, we show that regulatory policies that correct the share of FCLs may cause a cyclical slowdown.
    Keywords: foreign currency loans, monetary and macroprudential policy, DSGE models with banking sector
    JEL: E32 E44 E58
    Date: 2014
  6. By: Juan Carlos Cuestas; Karsten Staehr
    Abstract: This paper considers the relationship between domestic credit and foreign capital flows in the GIIPS countries before and after the outbreak of the global financial crisis. Cointegration analyses on the pre-crisis sample reveal that domestic credit and net foreign liabilities are cointegrated for Greece, Italy, Portugal and Spain, but not for Ireland. For the first four countries the long-run coefficient is in all cases around one, suggesting a one-to-one relationship between domestic leveraging and foreign capital inflows. Estimation of VECMs on data from the pre-crisis period shows that the adjustment to deviations from the long-run relationship takes place through changes in domestic credit for Greece and Italy, while the adjustment is bidirectional for Portugal and Spain. These results suggest that “push” from foreign capital inflows was an important factor in the pre-crisis leveraging. The deleveraging after the crisis was largely unrelated to developments in foreign capital flows
    Keywords: leveraging, capital flows, financial crisis, cointegration
    JEL: F32 E51 E44 C32
    Date: 2014–10–10
  7. By: Gauvin, Ludovic (EconomiX-CNRS and Banque de France); McLoughlin, Cameron (Graduate Institute, Geneva); Reinhardt, Dennis (Bank of England)
    Abstract: We examine the extent to which uncertainty with regard to macroeconomic policies in advanced countries spills over to emerging market economies (EMEs) via gross portfolio bond and equity flows. We find that the impact of fluctuations in policy uncertainty on portfolio equity flows differs markedly depending on whether changes in policy uncertainty originate from the Untied States or the European Union (EU). Increases in US policy uncertainty reduce both bond and equity inflows into EMEs. Conversely, increases in EU policy uncertainty decrease bond inflows, but increase equity inflows. The size and direction of these spillover effects depends on the level of global risk, with increased European policy uncertainty only having a negative impact on bond inflows into EMEs when global risk is high. For equity inflows, the level of country-specific sovereign default risk also matters for non-linearities: increased EU policy uncertainty pushes portfolio equity inflows into EMEs even if global risk is high, but only into countries with low sovereign default risk.
    Keywords: Policy uncertainty; portfolio capital flows; EMEs; non-linearities
    JEL: F21 F32 F42
    Date: 2014–09–26

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