nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒11‒01
eighteen papers chosen by
Martin Berka
University of Auckland

  1. Global Imbalances, Risk, and the Great Recession By Martin Evans
  2. The Macroeconomics of a Financial Dutch Disease By Alberto Botta
  3. Foreign shocks in an estimated multi-sector model By Drago Bergholt
  4. Global and European Imbalances:A critical review By Carlos A. Carrasco; Felipe Serrano
  5. Exchange Rate Movements and the Australian Economy By Josef Manalo; Dilhan Perera; Daniel Rees
  6. Capital Inflows, Exchange Rate Regimes and Credit Dynamics in Emerging Market Economies By Robin Boudias
  7. Can Financial Stability be Maintained in Developing Countries after the Global Crisis: The Role of External Financial Shocks? By Hasan Comert; Mehmet Selman Colak
  8. Home Production and Small Open Economy Business Cycles By Kuan-Jen Chen; Angus C. Chu; Ching-Chong Lai
  9. Foreign Technology Acquisition and Changes in the Real Exchange Rate By Roberto Alvarez; Ricardo A. Lopez
  10. Sovereign Defaults, Bank Runs, and Contagion By Stephan Luck; Paul Schempp
  11. Macroeconomic Imbalances and Structural Change in the EMU By Stefan Ederer; Peter Reschenhofer
  12. Common Macroeconomic Shocks and Business Cycle Fluctuations in Euro Area Countries By Antonella Cavallo; Antonio Ribba
  13. Capital Inflows, Current Accounts and Investment Cycle in Italy: 1861-1913 By Barbara Pistoresi; Alberto Rinaldi
  14. Inspecting the Mechanism Leverage and the Great Recession in the Eurozone By Philippe Martin; Thomas Philippon
  15. The Great Mortgaging: Housing Finance, Crises, and Business Cycles By Oscar Jorda; Moritz Schularick; Alan M. Taylor
  16. Delayed Overshooting: It’s an 80s Puzzle. By Seong-Hoon Kim; Seongman Moon; Carlos Velasco
  17. Financial Crisis, Unconventional Monetary Policy and International Spillovers By Qianying Chen; Andrew Filardo; Dong He; Feng Zhu
  18. 'N Sync: how do countries' economies move together? By James Graham

  1. By: Martin Evans (Department of Economics, Georgetown University)
    Abstract: This paper describes a new analytical framework for the quantitative assessment of international external positions. The framework links each country's current net foreign asset position to its current trade flows, forecasts of future trade flows, and expectations concerning future returns on foreign assets and liabilities in an environment where countries cannot run Ponzi schemes or exploit arbitrage opportunities in world financial markets. It provides guidance on how external positions should be measured in the data, and on how the sustainability of a country's current position can be assessed. To illustrate its usefulness, I study the external positions of 12 countries (Australia, Canada, China, France, Germany, India, Italy, Japan, South Korea, Thailand, The United States and The United Kingdom) between 1970 and 2011. In particular, I examine how changes in the perceived risk associated with future returns across world financial markets contributed to evolution of external positions before the 2008 financial crisis, and during the ensuing Great Recession.
    Keywords: Global Imbalances, Foreign Asset Positions, Current Accounts, International Debt, International Solvency, Great Recession
    JEL: F31 F32 F34
    Date: 2013–11–04
  2. By: Alberto Botta (Mediterranean University of Reggio Calabria and University of Pavia)
    Abstract: In this paper we describe the medium-run macroeconomic effects and long-run development consequences of a financial Dutch disease that may take place in a small developing country with abundant natural resources. The first move of such a peculiar Dutch disease is on financial markets. An initial surge in FDI targeting domestic natural resources sets in motion a perverse cycle between exchange rate appreciation and mounting short-term capital flows. Such a spiral easily gives rise to exchange rate volatility, foreign capital reversals, and sharp macroeconomic instability. In the long run, such acute macroconomic instability as well as overdependence on natural resource exports all dampen the development of non-traditional tradable good sectors and curtail labor productivity dynamics. We advice the introduction of constraints to short-term capital flows, in the form of taxes on exchange rate-based capital gains, to tame exchange rate/capital flows boom-and-bust cycles. We also provide support to a developmentalist monetary policy that targets competitive nominal and real exchange rates in order to favor the process of production and export diversification. Such a policy stand can be particularly effective to counter-act the long-run negative effects of the financial Dutch disease we describe.
    Keywords: Financial Dutch Disease; exchange rate volatility; macroeconomic instability; developmentalist monetary policy
    JEL: O14 F32 O24
    Date: 2014–10
  3. By: Drago Bergholt
    Abstract: How are macroeconomic fluctuations in open economies affected by interna- tional business cycles? To shed some light on this question, I develop and estimate a medium scale DSGE model for a small open economy. The model incorporates i) international markets for firm-to-firm trade in production inputs, and ii) producer heterogeneity where technology and price setting constraints vary across industries. Using Bayesian techniques on Canadian and US data, I document several macroe- conomic regularities in the small open economy, all attributed to international dis- turbances. First, foreign shocks are crucial for domestic fluctuations at all forecast- ing horizons. Second, productivity is the most important driver of business cycles. Investment efficiency shocks on the other hand have counterfactual implications for international spillover. Third, the relevance of foreign shocks accumulates over time. Fourth, business cycles display strong co-movement across countries, even though shocks are uncorrelated and the trade balance is countercyclical. Fifth, exchange rate pass-through to aggregate CPI inflation is moderate, while pass-through at the sector level is positively linked to the frequency of price changes. Few of these fea- tures have been accounted for in existing open economy DSGE literature, but all are consistent with reduced form evidence. The model presented here offers a structural interpretation of the results.
    Keywords: DSGE, small open economy, international business cycles, Bayesian estimation
    JEL: C11 F41 F44
    Date: 2014–04
  4. By: Carlos A. Carrasco (University of the Basque Country (EHU/UPV)); Felipe Serrano (University of the Basque Country (EHU/UPV))
    Abstract: In this paper, we survey and analyse the economic literature on global and European imbalances and their connection with the global financial crisis. In the years preceding the crisis, there was increased attention to the existence of large current account imbalances among large economies worldwide. Research and policy papers divided into two positions regarding these imbalances. Some authors viewed global imbalances as part of a new equilibrium in the international financial system. Others urged policy intervention to reduce these imbalances. The Great Recession revived the debate over global imbalances and their influence on the gestation of the crisis. However, more recent work has clarified the relationship between the crisis and global imbalances, emphasising the roots of the crisis in financial liberalisation and the fragility of the international financial system. From this perspective, we highlight the need for deeper analysis of gross capital flows and the need to monitor credit levels as measures to prevent future financial crises.
    Keywords: savings glut, current account, global imbalances, financial fragility
    JEL: E44 F32 F33 F44 G15
  5. By: Josef Manalo (Reserve Bank of Australia); Dilhan Perera (Reserve Bank of Australia); Daniel Rees (Reserve Bank of Australia)
    Abstract: We use a structural vector autoregression model to characterise the aggregate and industry effects of exchange rate movements on the Australian economy. We find that a temporary 10 per cent appreciation of the real exchange rate that is unrelated to the terms of trade or interest rate differentials lowers the level of real GDP over the subsequent one-to-two years by 0.3 per cent and year-ended inflation by 0.3 percentage points. The mining, manufacturing, personal services, construction and business services industries are the most exchange rate sensitive sectors of the economy. In the context of the boom in the terms of trade over the past decade, we use our model to explore how the Australian economy might have evolved under alternative scenarios. These suggest that real exchange rate movements over the past decade have had a broadly stabilising effect on the domestic economy and can largely be explained by economic fundamentals.
    Keywords: structural vector autoregression; exchange rates
    JEL: C32 F31 F41
    Date: 2014–09
  6. By: Robin Boudias
    Abstract: This paper investigates the impact of the exchange rate regime (ERR) on the cycle of capital fl ows, the private credit growth rate and the level of dollarization in emerging market economies. We consider two different panels including 12 and 22 countries over the periods 1980-2010 and 1994-2008, respectively. We estimate a Panel Smooth Transition Regression (PSTR) model in order to assess whether the impact of ERR on credit dynamics is affected by the cyclical component of capital fl ows. Our fi ndings are threefold. First, the ERR has no impact on the cyclical component of capital fl ows. Second, credit expansion is procyclical in economies with pegged curencies. Third, during capital infl ows or low outfl ows periods, economies with fi xed exchange rate regimes show a higher level of dollarization. When outfl ows are sizeable, ERR no longer impacts the level of dollarization. These results suggest that ERR should be an important variable in conceiving the policy mix to cope with domestic credit expansions and liability dollarization.
    Keywords: Emerging market economies;capital flows;domestic credit;dollarization;PSTR
    JEL: C33 E42 F31 O16
    Date: 2014–09
  7. By: Hasan Comert (Department of Economics, METU); Mehmet Selman Colak (Central Bank of Republic of Turkey)
    Abstract: In the recent global turmoil, even though some developing economies were severely affected, in general, developing countries survived the crisis with less damage than advanced countries. The majority of developing countries did not experience a financial system collapse. What are the main factors behind the solid performance of many developing countries in the recent crisis? This paper argues that the main reason is the fact that developing countries did not face a strong financial account shock, especially in the form of capital reversals, during this period. In comparison to past developing country crises of the 80s and 90s, the financial account shocks in the global crisis were much more moderate. To a great extent, the fact that advanced countries could not fully serve their roles as safe havens in the global crisis explains why developing economies were not tested by destructive financial shocks in the recent crisis. Furthermore, developing countries enjoyed greater autonomy and legitimacy in implementing expansionary monetary and fiscal policies without much fear of the bigger financial shocks in an environment in which international cooperation partially meet the need for an international lender of last resort through swap operations and credit lines. If the developed countries, essentially European Union (EU) and the US, start serving fully their safe haven roles and the returns in the developed countries become much more attractive, developing countries may face larger external financial shocks. Even large reserves, flexible exchange rate regimes, healthy balance sheets on the papers and some so-called other strong fundamentals would not be enough to avoid financial collapses.
    Keywords: Developing Countries, Recent Global Crisis, Financial Flows and Financial Markets.
    JEL: E52 E58 F32 F31 G15
    Date: 2014–09
  8. By: Kuan-Jen Chen (Institute of Economics, Academia Sinica, Taipei, Taiwan); Angus C. Chu (University of Liverpool); Ching-Chong Lai (Institute of Economics, Academia Sinica, Taipei, Taiwan)
    Abstract: This paper incorporates home production into a real business cycle (RBC) model of a small open economy to provide a parsimonious explanation of the empirical pattern of international business cycles in developed economies and emerging markets. It is well known in the literature that in order for the RBC model to replicate quantita- tively plausible empirical moments of small open economies, the model needs to feature counterfactually a small income effect on labor supply. This paper provides a plausible solution to this puzzle by considering home production that introduces substitutability between market consumption and home consumption, which in turn generates a high volatility in market consumption in accordance with the data, even in the presence of a sizable income effect on labor supply. Furthermore, the model with estimated parameter values based on the simulated method of moments is able to match other empirical moments, such as the standard deviations of output, investment and the trade balance and the correlations between output and other standard macroeconomic variables. Given that home production is more prevalent in emerging markets than in developed economies, the model is also able to replicate empirical differences between emerging markets and developed economies in the volatility of market consumption and the volatility/countercyclicality of the trade balance. JEL Classification-JEL: D13, E32, F41, O16
    Keywords: small open economy, home production, emerging markets, business cycles
    Date: 2014–09
  9. By: Roberto Alvarez (University of Chile); Ricardo A. Lopez (International Business School, Brandeis University)
    Abstract: This paper uses plant-level data from the manufacturing sector of Chile to investigate how changes in the real exchange rate affect the decision to purchase foreign technologies through licensing. Theoretically, a real depreciation has an ambiguous effect on foreign technology adoption. On the one hand, a real depreciation makes exports more competitive, and since exporters tend to adopt and use more advanced technologies, we should observe a higher propensity to import technologies among them. On the other hand, a real depreciation can also make imports of technology relatively more expensive. Thus, this question must be examined empirically. The empirical analysis shows that a real depreciation significantly increases the probability of using foreign technology licenses for plants that export and for plants in the intermediate range of the size and productivity distribution.
    Date: 2014–10
  10. By: Stephan Luck (Max Planck Institute for Research on Collective Goods, Bonn); Paul Schempp (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: We provide a model that unifies the notion of self-fulfilling banking crises and sovereign debt crises. In this model, a bank run can be contagious by triggering a sovereign default, and vice versa. A deposit insurance scheme can eliminate the adverse equilibrium only if the government can repay its debt and credibly insure deposits irrespective of the performance of the financial sector. Moreover, we analyze how banking crises and sovereign defaults can be contagious across countries. We give conditions under which the implementation of a banking union is effective and costless. Finally, we discuss the current proposals for a banking union in the euro area and argue that it should be extended by a supranational Deposit Guarantee Scheme.
    Keywords: bank run, financial crisis, sovereign default, vicious cycle, financial contagion, banking union, deposit insurance
    JEL: G21 G28 H81 H63
    Date: 2014–09
  11. By: Stefan Ederer; Peter Reschenhofer
    Abstract: Macroeconomic imbalances in the EMU are at the heart of the current crisis. A widely popular explanation for the high current account deficits in the Southern European countries is that they lack a large, competitive and export-oriented industrial sector. The paper tests the hypothesis that parts of the structural change which happened in the EU before 2008 were supported by the divergent unit labour cost developments in the EMU. We look into patterns of structural change and sectoral competitiveness in all EU member countries and assess their linkages by means of a descripitve analysis as well as through econometric estimations. Our results broadly support the hypothesis. Structural policies alone to foster new competitive export-oriented industries in Southern Europe in order to reduce macroeconomic imbalances in the EMU would not be efficient without accompanying adjustments in relative labour costs.
    Keywords: Macroeconomic imbalances, structural change, labour costs, dynamic panel regression
    JEL: C33 F41 J31 O40
    Date: 2014–10
  12. By: Antonella Cavallo; Antonio Ribba
    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. The main conclusion is that: (a) contractionary monetary policy shocks cause similar recessionary effects in all countries; (b) as far as business cycle fluctuations are concerned, there is a separation into two distinct groups of countries, with a first group including the biggest European economies in which business cycle fluctuations are mainly explained by common, area-wide shocks and a second one, including Greece, Ireland and Portugal, in which the national shocks play, instead, a much greater role
    Keywords: Business Cycle Fluctuations; Euro area; Common Shocks; Near-Structural VARs.
    JEL: E31 C32
    Date: 2014–09
  13. By: Barbara Pistoresi; Alberto Rinaldi
    Abstract: By relying on a new dataset, this paper presents an econometric strategy to test the Fenoaltea’s thesis with regard to both the genesis of current account fluctuations and of the investment cycle. We perform a Granger causality test that shows that the persistent current account deficits in the years from unification from WW1 were generated by variations in capital inflows, as pointed by Fenoaltea, and not by the dynamics of the GDP, as claimed by the Bonelli-Cafagna model. Finally, this paper supports the Fenoaltea’s thesis that these capital inflows prompted a general investment cycle which included both construction and industrial investments
    Keywords: Capital imports, current accounts, investment cycle, Italy, integration, cointegration and Granger causation analysis
    JEL: F43 O11 N1 N7
    Date: 2014–04
  14. By: Philippe Martin (Département d'économie); Thomas Philippon (Department of Mechanical Engineering, Massachusetts Institute of Technology)
    Abstract: We provide a first comprehensive account of the dynamics of Eurozone countries from the creation of the Euro to the Great recession. We model each country as an open economy within a monetary union and analyze the dynamics of private leverage, fiscal policy and spreads. Our parsimonious model can replicate the time-series for nominal GDP, employment, and net exports of Eurozone countries between 2000 and 2012. We then ask how periphery countries would have fared with: (i) more conservative fiscal policies; macro-prudential tools to control private leverage; (iii) a central bank acting earlier to limit sovereign spreads; and (iv) the possibility to recoup the competitiveness they lost in the boom. To perform these counterfactual experiments, we use U.S. states as a control group that did not suffer from a sudden stop. We find that periphery countries could have stabilized their employment if they had followed more conservative fiscal policies during the boom. This is especially true in Greece. For Ireland, however, given the size of the private leverage boom, such a policy would have required buying back almost all of the public debt. Macro-prudential policy would have been helpful, especially in Ireland and Spain. However, in presence of a spending bias in fiscal rules, macro-prudential policies would have led to less prudent fiscal policies in the boom. Central bank actions would have stabilized employment during the bust but not public debt. Finally, if these countries had been able to regain in the bust the competitiveness they lost in the boom, they would have experienced a shorter and milder recession.
    Date: 2014–10
  15. By: Oscar Jorda (Federal Reserve Bank of San Francisco and University of California, Davis); Moritz Schularick (University of Bonn and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Alan M. Taylor (University of California, Davis and National Bureau of Economic Research and Centre for Economic Policy Research)
    Abstract: This paper unveils a new resource for macroeconomic research: a long-run dataset covering disaggregated bank credit for 17 advanced economies since 1870. The new data show that the share of mortgages on banks' balance sheets doubled in the course of the 20th century, driven by a sharp rise of mortgage lending to households. Household debt to asset ratios have risen substantially in many countries. Financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries. Housing finance has come to play a central role in the modern macroeconomy.
    Keywords: Leverage, Recessions, Mortgage Lending, Financial Crises, Business Cycles, Local Projections
    JEL: C14 C38 C52 E32 E37 E44 E51 G01 G21 N10 N20
    Date: 2014–09
  16. By: Seong-Hoon Kim (University of St Andrews); Seongman Moon (Universidad Carlos III de Madrid); Carlos Velasco (Universidad Carlos III de Madrid)
    Abstract: We re-investigate the delayed overshooting puzzle. We find that delayed overshooting is primarily a phenomenon of the 1980s when the Fed was under the chairmanship of Paul Volcker. Related findings are as follows: (1) Uncovered interest parity fails to hold during the Volcker era and tends to hold in the other periods considered. (2) US monetary policy shocks have substantial impacts on exchange rate variations but misleadingly appear to have small impacts when monetary policy regimes are pooled. In brief, we confirm Dornbusch’s overshooting hypothesis.
    Keywords: delayed overshooting, UIP, Dornbusch overshooting hypothesis, Volcker, monetary policy regime
    JEL: F31 E52 E65
    Date: 2014–05–01
  17. By: Qianying Chen (International Monetary Fund); Andrew Filardo (Bank for International Settlements); Dong He (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); Feng Zhu (Bank for International Settlements)
    Abstract: This paper studies the effects of unconventional monetary policies in the major advanced economies. We first examine the cross-border financial market impact of central bank announcements of asset purchase programmes based on event studies. We find marked effects, as expansionary balance sheet policies influence the prices of a broad range of emerging market assets, raising equity prices, lowering government and corporate bond yields and compressing CDS spreads. We then study the economic impact of US quantitative easing on both emerging and advanced economies, based on an estimated global vector error-correcting macroeconomic (VECM) model, which takes into account trade and financial linkages. We focus on the effects of reductions in US term and corporate spreads, and in US market volatility. The estimated effects are sizeable and differ across economies. First, US QE measures which help to lower market volatility and reduce corporate spreads appear to have had far greater impact than lowering term spreads, as Blinder (2012) suggested. Second, such measures have prevented a prolonged recession and severe deflation in the advanced economies. Third, the impact on emerging economies has varied but is generally stronger than in the US and other advanced economies. US QE measures contributed to overheating in Brazil, China and other emerging economies in 2010 and 2011, but supported recovery in 2009 and 2012. The sign and size of QE effects differ across economies, implying that their costs and benefits are unevenly distributed.
    Keywords: Announcement Effects, Emerging Economies, Financial Markets, Global VECM, International Spillovers, Quantitative Easing, Unconventional Monetary Policy
    JEL: E43 E44 E52 E65 F42 F47
    Date: 2014–09
  18. By: James Graham (Reserve Bank of New Zealand)
    Abstract: Connections between short-term fluctuations in one country's economic activity and those in the rest of world received renewed focus after the 2008/09 recession. This paper examines some of those connections using several statistical techniques.
    Date: 2014–08

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