nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒11‒07
twenty-one papers chosen by
Martin Berka
University of Auckland

  1. Real Exchange Rates and Sectoral Productivity in the Eurozone By Martin Berka; Michael B. Devereux; Charles Engel
  2. Forex Trading and the WMR Fix By Martin Evans
  3. The competitiveness of U.S. manufacturing By Diez, Federico J.; Gopinath, Gita
  4. Debt Deleveraging and the Zero Bound: Potentially Perverse Effects of Real Exchange Rate Movements By Paul Luk; David Vines
  5. Sectoral Interdependence and Business Cycle Synchronization in Small Open Economies By Drago Bergholt; Tommy Sveen
  6. Boom or gloom? Examining the Dutch disease in two-speed economies By Hilde C. Bjørnland; Leif Anders Thorsrud
  7. Trade linkages and the globalisation of inflation in Asia and the Pacific By Raphael A Auer; Aaron Mehrotra
  8. Recent Estimates of Exchange Rate Pass-Through to Import Prices in the Euro Area By Nidhaleddine Ben Cheikh; Christophe Rault
  9. Labor Market Reforms and Current Account Imbalances - Beggar-thy-Neighbor Policies in a Currency Union? By Timo Baas; Ansgar Belke
  10. Time-varying equilibrium rates in small open economies: Evidence for Canada By Tino Berger; Bernd Kempa
  11. The Real Exchange Rate and Growth in Zimbabwe: Does the Currency Regime Matter? By Zuzana Brixiová; Mthuli Ncube
  12. Sovereign Risk, Currency Risk, and Corporate Balance Sheets By Jesse Schreger; Wenxin Du
  13. Utility functions, fiscal shocks and the open economy - In the search of a positive consumption multiplier By Philipp Wegmueller
  14. Effective Exchange Rates in Central and Eastern European Countries: Cyclicality and Relationship with Macroeconomic Fundamentals By Daniel StavaÌrek; Cynthia Miglietti
  15. Financial News, Banks and Business Cycles By Alok Johri; Christopher M. Gunn
  16. The Role of the Business Cycle in Exchange Rate Pass-Through: The Case of Finland By Nidhaleddine Ben Cheikh; Christophe Rault
  17. Monetary Policy in Oil Exporting Economies By Drago Bergholt
  18. Inspecting the Mechanism Leverage and the Great Recession in the Eurozone By Philippe Martin; Thomas Philippon
  19. Risk Aversion, Financial Stress and Their Non-Linear Impact on Exchange Rates By Tomas Adam; Sona Benecka; Jakub Mateju
  20. Shock transmission through international banks: the Italian case By Marianna Caccavaio; Luisa Carpinelli; Giuseppe Marinelli; Enrico Sette
  21. Investment Hangover and the Great Recession By Matthew Rognlie; Andrei Shleifer; Alp Simsek

  1. By: Martin Berka; Michael B. Devereux; Charles Engel
    Abstract: We investigate the link between real exchange rates and sectoral total factor productivity measures for countries in the Eurozone. Real exchange rate patterns closely accord with an amended Balassa-Samuelson interpretation, both in cross-section and time series. We construct a sticky price dynamic general equilibrium model to generate a crosssection and time series of real exchange rates that can be directly compared to the data. Under the assumption of a common currency, estimates from simulated regressions are very similar to the empirical estimates for the Eurozone. Our findings contrast with previous studies that have found little relationship between productivity levels and the real exchange rate among high-income countries, but those studies have included country pairs which have a floating nominal exchange rate.
    Keywords: Balassa-Samuelson, Real Exchange Rates, Eurozone, Total Factor Productivity, Unit Labor Cost
    JEL: F41 F31
    Date: 2014–10
  2. By: Martin Evans (Department of Economics, Georgetown University)
    Abstract: Since 2013 regulators have been investigating the activities of some of the world's largest banks around the setting of daily benchmarks for forex prices. These benchmarks are a key linchpin of world financial markets, providing standardize prices used to value global equity and bond portfolios, to hedge currency exposure, and to write and execute derivatives' contracts. The most important of these benchmarks,called the "London 4pm Fix", "the WMR Fix" or just the "Fix", is published by the WM Company and Reuters based on forex trading around 4:00 pm GMT. This paper undertakes a detailed empirical analysis of the how forex rates behave around the Fix drawing on a decade of tick-by-tick data for 21 currency pairs. The analysis reveals that the behavior of spot rates in the minutes immediately before and after 4:00 pm are quite unlike that observed at other times. Pre- and post-Fix changes in spot rates are extraordinarily volatile and exhibit strong negative serial correlation, particularly on the last trading day of each month. These statistical features appear pervasive, they are present across all 21 currency pairs throughout the decade. However, they are also inconsistent with the predictions of existing microstructure models of competitive forex trading.
    Keywords: Forex Trading, Order Flows, Forex Price Fixes, Microstructure Trading Models
    JEL: F3 F4 G1
    Date: 2014–08–01
  3. By: Diez, Federico J. (Federal Reserve Bank of Boston); Gopinath, Gita (Harvard University)
    Abstract: We study the competitiveness of U.S. manufacturing. For the period 1999–2012 we find little support for a significant offshoring reversal. We show that the share of domestic demand that is met by imports and the terms of trade show no signs of reversal, even in sectors dominated by imports from China. We do, however, find some evidence consistent with the U.S. shale-gas energy revolution raising the competiveness of U.S. energy-intensive sectors.
    Keywords: competitiveness; U.S. manufacturing; reshoring; onshoring
    JEL: F41 L60
    Date: 2014–06–01
  4. By: Paul Luk (Oxford University and Hong Kong Institute for Monetary Research); David Vines (Oxford University and Centre for Applied Macroeconomic Analysis and Australian National University and Centre for Economic Policy Research)
    Abstract: We present a microfounded two-country model of global imbalances and debt deleveraging. A sustained rise in saving in one country can lead to a worldwide fall in interest rates and an accumulation of debt in the other country. When a subsequent deleveraging shock occurs, interest rates are forced down further. In the presence of a zero bound to interest rates, the deleveraging country may face a combination of a large fall in output, deflation, a rise in real interest rates and real exchange rate appreciation. Such exchange rate appreciation will intensify the loss in output, magnify the deflation and further tighten the deleveraging constraint.
    Keywords: Global Imbalances, Debt Deleveraging, Liquidity Trap, Real Exchange Rate Number: 202014
    JEL: E5 F3
    Date: 2014–08
  5. By: Drago Bergholt; Tommy Sveen
    Abstract: Existing DSGE models are not able to reproduce the observed influence of international business cycles on small open economies. We construct a two-sector New Keynesian model to address this puzzle. The set-up takes into account intermediate trade and producer heterogeneity, where goods and service industries differ in terms of i) price flexibility, ii) trade intensity, iii) technology, iv) I-O structure, and v) the volatility of productivity innovations. The combination of intermediate markets and heterogeneous producers makes international business cycles highly important for the small economy, even if it has a large service sector. Exploiting I-O matrices of Canadian and US industries, the model is able to reproduce the role of international disturbances typically found in empirical studies. Model simulations deliver cross-country correlations in macroeconomic variables of about 0.7, with half of the variation in domestic variables attributed to foreign shocks.
    Keywords: small open economy, multi-sector, international trade, international business cycle
    JEL: E32 F41 F44
    Date: 2014
  6. By: Hilde C. Bjørnland; Leif Anders Thorsrud
    Abstract: Traditional studies of the Dutch disease do not account for productivity spillovers between the booming resource sector and other domestic sectors. We put forward a simple theory model that allows for such spillovers. We then identify and quantify these spillovers using a Bayesian Dynamic Factor Model (BDFM). The model allows for resource movements and spending effects through a large panel of variables at the sectoral level, while also identifying disturbances to the commodity price, global demand and non-resource activity. Using Australia and Norway as representative cases studies, we find that a booming resource sector has substantial productivity spillovers on non-resource sectors, effects that have not been captured in previous analysis. That withstanding, there is also evidence of two-speed economies, with non-traded industries growing at a faster pace than traded. Furthermore, com- modity prices also stimulate the economy, but primarily if an increase is caused by higher global demand. Commodity price growth unrelated to global activity is less favourable, and for Australia, there is evidence of a Dutch disease effect with crowding out of the tradable sectors. As such, our results show the importance of distinguishing between windfall gains due to volume and price changes when analysing the Dutch disease hypothesis.
    Keywords: Resource boom, commodity prices, Dutch disease, learning by doing, two-speed economy, Bayesian Dynamic Factor Model (BDFM)
    JEL: C32 E32 F41 Q33
    Date: 2014–09
  7. By: Raphael A Auer (Swiss National Bank); Aaron Mehrotra (Bank for International Settlements)
    Abstract: Some observers argue that increased real integration has led to greater co-movement of prices internationally. We examine the evidence for cross-border price spillovers among economies participating in the pan-Asian cross-border production networks. Starting with country-level data, we find that both producer price and consumer price inflation rates move more closely together between those Asian economies that trade more with one another, ie that share a higher degree of trade intensity. Next, using a novel data set based on the World Input-Output Database (WIOD), we examine the importance of the supply chain for cross-border price spillovers at the sectoral level. We document the increasing importance of imported intermediate inputs for economies in the Asia-Pacific region and examine the impact on domestic producer prices of changes in costs of imported intermediate inputs. Our results suggest that real integration through the supply chain matters for domestic price dynamics in the Asia-Pacific region.
    Date: 2014–10
  8. By: Nidhaleddine Ben Cheikh; Christophe Rault
    Abstract: This paper provides an update on the exchange rate pass-through (ERPT) estimates for 12 Euro area (EA) countries. First, based on quarterly data over the 1990-2012 period, our study does not find a significant heterogeneity in the degree of pass-through across the monetary union members, in contrast to previous empirical studies. As we use a longer time span for the post-EA era than existing studies, this is not surprising, since the process of monetary union has entailed some convergence towards more stable macroeconomic conditions across Euro Area (EA) Member States. Second, when assessing the stability of pass-through elasticities we find very weak evidence of a decline around the inception of the Euro in 1999. However, our results reveal that a downtrend in ERPT estimates became apparent starting from the beginning of the 1990s. This observed decline was synchronous to the shift towards reduced inflation regimes in our sample of countries. Finally, we notice that the distinction between “peripheral” and “core” EA economies in terms of pass-through has significantly decreased over the last two decades.
    Keywords: Exchange Rate Pass-Through, Import Prices, Euro area
    JEL: E31 F31 F40
    Date: 2014–08–01
  9. By: Timo Baas; Ansgar Belke
    Abstract: Member countries of the European Monetary Union (EMU) initiated wideranging labor market reforms in the last decade. This process is ongoing as countries that are faced with serious labor market imbalances perceive reforms as the fastest way to restore competitiveness within a currency union. This fosters fears among observers about a beggar-thy-neighbor policy that leaves non-reforming countries with a loss in competitiveness and an increase in foreign debt. Using a two-country, two-sector search and matching DSGE model, we analyze the impact of labor market reforms on the transmission of macroeconomic shocks in both, non-reforming and reforming countries. By analyzing the impact of reforms on foreign debt, we contribute to the debate on whether labor market reforms increase or reduce current account imbalances.
    Keywords: Current account deficit; labor market reforms; DSGE models; search and matching labor market
    JEL: E24 E32 J64 F32
    Date: 2014–09
  10. By: Tino Berger; Bernd Kempa
    Abstract: This paper estimates equilibrium rates of macroeconomic aggregates for small open economies. We simultaneously identify the transitory and permanent components of output, inflation, the interest rate and the exchange rate by means of a multivariate trend-cycle decomposition. Realizations of the observed macroeconomic aggregates are explained in terms of unobserved equilibrium rates and unobserved transitory components. The transitory components of the variables are linked to each other through an aggregate demand equation, a Phillips curve, and an equation specifying the interest rate-exchange rate nexus. The model is then applied to Canadian data.
    Keywords: unobserved components, potential output, natural rate of interest, equilibrium exchange rate
    JEL: C11 C32 E32 E43 F41
    Date: 2014–10
  11. By: Zuzana Brixiová; Mthuli Ncube
    Abstract: Zimbabwe faces growth and external competitiveness challenges, as indicated by its low trend growth and investment, declining share in the world exports, high current account deficits, and external debt. The stock-flow approach to the equilibrium exchange rate reveals that the real exchange rate experienced periods of sizeable overvaluation, both prior to the 2008 economic collapse and under the current multicurrency regime. While overvaluation hampers GDP growth, as well as growth and employment in export sectors, we have not found that undervaluation would raise it. Replacing the multicurrency regime anchored in the US$ by the South African rand as the sole transaction currency would help reduce overvaluation and stimulate exports and growth. Under any currency regime, Zimbabwe needs to adhere to sound macroeconomic policies, avoid overspending on public wages, and create environment conducive for investment.
    Keywords: real exchange rate misalignment, growth, employment, currency regime, Zimbabwe
    JEL: F36 F41 C22 O11
    Date: 2014–08–01
  12. By: Jesse Schreger; Wenxin Du
    Abstract: Job Market Paper - to be posted soon. � We examine the question of why a government would default on debt denominated in its own currency. By combining a number of international and national data sources, we show that emerging market sovereigns increasingly borrow from foreign investors in local currency but the private sector continues to borrow from abroad in foreign currency. Motivated by the empirical finding that sovereign credit spreads increase with the share of foreign currency private borrowing, we introduce local currency sovereign debt and a corporate sector that borrows in foreign currency into the canonical sovereign debt model and explore how corporate currency mismatch can generate sovereign default risk. The model demonstrates how the composition of corporate borrowing affects the sovereign's incentive to inflate away the debt or explicitly default in times of fiscal stress. A calibration of the model generates the empirical patterns of currency and credit risk in local currency sovereign debt documented in Du and Schreger (2013). The model suggests that relatively small reductions in the share of private external borrowing in foreign currency could significantly reduce the probability of a sovereign default.
    Date: 2014–10
  13. By: Philipp Wegmueller
    Abstract: This paper analyzes the dynamic effects of a fiscal policy shock and its transmission mechanism in a small open economy and compares the responses under different specifications of the utility function. The traditional Mundell-Flemming model tells that fiscal policy is more effective under a peg than under a float. This result is not confirmed for a baseline small open economy model with separable preferences. The present paper offers a survey of non-separable utility found in the literature on fiscal policy shocks and compares their implications for the transmission mechanism. The aim is to overturn the negative wealth effect of an increase in government spending, which causes a decrease in private consumption under the baseline separable utility function. Using a plausible calibration of the model, I find that if the complementarity between consumption and hours worked is large enough, then the response of private consumption is likely to be positive, although the assumptions have to be strong. This result holds for any specification of exchange rate regime.
    Keywords: Fiscal Shocks; Non-Separable Utility; Exchange Rate Regimes; Private Consumption
    JEL: E52 E62 F41
    Date: 2014–10
  14. By: Daniel StavaÌrek (Department of Finance and Accounting, School of Business Administration, Silesian University); Cynthia Miglietti (Department of Applied Sciences, Firelands College, Bowling Green State University)
    Abstract: This paper provides direct empirical evidence on the nature of the relationship between effective exchange rates and selected macroeconomic fundamentals in nine central and Eastern European countries. Therefore, the paper addresses a key precondition of numerous exchange rate determination models and theories that will explain the role of exchange rates in the economy. Additionaly, short-term volatility and medium-term variability of effective exchange rates are examined. The results suggest that flexible exchange rate arrangements are reflected in higher volatility and variability of nominal as well as real effective exchange rates. Furthermore, the results provide mixed evidence in intensity, direction and cyclicality but show a weak correlation between exchange rates and fundamentals. Sufficiently high coefficients are found only for the money supply. Consequently, using fundamentals for the determination of exchange rates and using the exchange rate for an explanation of economic development can be limited for the countries analyzed.
    Keywords: effective exchange rates, volatility, variability, cycle, high/low analysis, peak/trough analysis, cross correlation
    JEL: E32 E44 F31
    Date: 2014–10
  15. By: Alok Johri; Christopher M. Gunn
    Abstract: Can variations in the expected future return on a portfolio of sovereign bonds itself have real effects on a small open economy? We build a model where banks face a capital sufficiency requirement to demonstrate that news about a fall in the expected return on a portfolio of long bonds can lead to an immediate recession. Even if the news never materializes, the model can generate a severe recession followed by a slow recovery. The presence of long bonds in bank portfolios causes the news to have an immediate impact on bank capital via an immediate fall in bond prices. The portfolio adjustment induced by the capital sufficiency requirements leads to a rise in loan rates while aggregate output, investment and employment collapse. The model contributes to the news-shock literature by showing that imperfect signals about future financial returns can create business cycles without relying on the usual suspects: variation in domestic fundamentals such as technology shocks, preference shocks and fiscal policy. It also contributes to the emerging economy business cycle literature in that disturbances in world financial markets can lead to domestic business cycles without relying on shocks to the world interest rate or to country spreads.
    Keywords: expectations-driven business cycles, news shocks, financial intermediation, business cycles, small open economy, capital adequacy requirements
    JEL: E3 E44 F4 G21
    Date: 2014–10
  16. By: Nidhaleddine Ben Cheikh; Christophe Rault
    Abstract: In this paper we investigate whether exchange rate pass-through (ERPT) responds nonlinearly to economic activity along the business cycle. Using quarterly data spanning the period 1975:1 to 2011:1, we explore the existence of nonlinearities in ERPT to CPI inflation for the Finnish economy. Within a logistic smooth transition framework, our investigations reveal a strong regime-dependence of pass-through, depending positively on economic activity. Besides, point estimates indicate that the long-run pass-through coefficient is equal to 0.15% (weakly significant) when GDP growth is below a threshold of 3%. However, when the Finnish economy’s growth rate speeds up - above the threshold of 3% - ERPT elasticity increases to 0.47%. These results provide some useful guidance on how policymakers should act over different phases of the business cycle. More specifically, monetary policy should factor in the nonlinear mechanism of ERPT over the business cycle in order to prevent exchange rate movements from fueling a continuous inflationary process.
    Keywords: Exchange rate pass-through, Inflation, Business cycle, Smooth Transition Regression models
    JEL: C22 E31 F31
    Date: 2014–06–01
  17. By: Drago Bergholt
    Abstract: How should monetary policy be constructed when national income depends on oil exports? I set up a general equilibrium model for an oil exporting small open economy to analyze this question. Fundamentals include an oil sector and domestic non-oil firms – some of which are linked to oil markets via supply chains. In the model, the intermediate production network implies transmission of international oil shocks to all domestic industries. The presence of wage and price rigidities at the sector level leads to non-trivial trade-offs between different stabilization tar- gets. I characterize Ramsey-optimal monetary policy in this environment, and use the framework to shed light on i) welfare implications of the supply chain channel, and ii) costs of alternative policy rules. Three results emerge: First, optimal policy puts high weight on nominal wage stability. In contrast, attempts to target impulses from the oil sector can be disastrous for welfare. Second, while oil sector activities contribute to macroeconomic fluctuations, they do not change the nature of optimal policy. Third, operational Taylor rules with high interest rate inertia can approximate the Ramsey equilibrium reasonably well.
    Keywords: Monetary policy, oil exports, small open economy, Ramsey equilibrium, DSGE
    JEL: E52 F41 Q33 Q43
    Date: 2014–07
  18. 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
  19. By: Tomas Adam; Sona Benecka; Jakub Mateju
    Abstract: This paper shows how the reaction of selected emerging CEE currencies to increased uncertainty depends on market sentiment in a core advanced economy or even on the global scale. On the example of the Czech koruna, a highly stylized model of portfolio allocation between EUR- and CZK-denominated assets suggests the presence of two regimes characterized by different reactions of the exchange rate to increased stress in the euro area. The “diversification" regime is characterized by appreciation of the koruna in reaction to an increase in the expected variance of EUR assets, while in the “flight to safety" regime, the koruna depreciates in response to increased variance. We suggest that the switch between regimes may be related to changes in risk aversion, driven by the actual level of strains in the financial system as captured by financial stress indicators. Using the Bayesian Markov-switching VAR model, the presence of these regimes is identified in the case of the Czech koruna and to a lesser extent in the case of the Polish zloty and the Hungarian forint. We find that a slight increase in euro area financial stress causes the koruna to appreciate, but as financial market tensions intensify (and investors’ risk aversion increases), the Czech currency depreciates in response to a financial stress shock.
    Keywords: Asset allocation, exchange rates, financial stress, Markov-switching
    JEL: E44 F31 G12 G20
    Date: 2014–09
  20. By: Marianna Caccavaio (Banca d'Italia); Luisa Carpinelli (Banca d'Italia); Giuseppe Marinelli (Banca d'Italia); Enrico Sette (Banca d'Italia)
    Abstract: This paper studies what impact liquidity shocks have on liquid assets and domestic and cross-border lending. In particular, we look for differences across banks depending on their international exposure and we account for the effects of the sovereign debt crisis and the ECBÂ’s non-conventional monetary policy measures. Our main findings are that liquid assets are important drivers of lending adjustment to liquidity risk and that this effect is significant for domestic lending but not for foreign lending even considering the characteristics of the destination market. Differences in banksÂ’ international exposure play a limited role in the way liquidity shocks are transmitted. Creation-Date: 2014-09
    Keywords: liquidity shock, cross-border lending, international banks
    JEL: G20 G21
  21. By: Matthew Rognlie; Andrei Shleifer; Alp Simsek
    Abstract: We present a model of investment hangover motivated by the Great Recession. In our�model, overbuilding of residential capital requires a reallocation of productive resources to�nonresidential sectors, which is facilitated by a reduction in the real interest rate. If the�fall in the interest rate is limited by the zero lower bound and nominal rigidities, then the�economy enters a liquidity trap with limited reallocation and low output. The drop in output�reduces nonresidential investment through a mechanism similar to the acceleration principle�of investment. The burst in nonresidential investment is followed by an even greater boom�due to low interest rates during the liquidity trap. The boom in nonresidential investment�induces a partial and asymmetric recovery in which the residential sector is left behind,�consistent with the broad trends of the Great Recession.
    Date: 2014–09

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