nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒11‒17
twelve papers chosen by
Martin Berka
University of Auckland

  1. International Financial Integration and Crisis Contagion By Devereux, Michael B.; Yu, Changhua
  2. Currency Manipulation By Weithing Zhang; Thomas Mertens; Tarek Hassan
  3. Trade linkages and the globalisation of inflation in Asia and the Pacific By Raphael Anton Auer; Aaron Mehrotra
  4. Labor Market Reforms and Current Account Imbalances – Beggar-thy-neighbor Policies in a Currency Union? By Ansgar Belke; Timo Baas
  5. Exchange Rate Flexibility under the Zero Lower Bound By Cook, David; Devereux, Michael B.
  6. Sovereign Default and the Choice of Maturity By Sanchez, Juan M.; Sapriza, Horacio; Yurdagul, Emircan
  7. Contagion in the Euro crisis: capital flows and trade linkages By Eleonora Cutrini and Giorgio Galeazzi
  8. Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time By Bernd Hayo; Britta Niehof
  9. The Multiple Impacts of the Exchange Rate on Export Diversification By Daniel Goya
  10. Fiscal devaluation in the euro area: a model-based analysis By Sandra Gomes; P. Jacquinot; M. Pisani
  11. Effects of US Policy Uncertainty on Swedish GDP Growth By Stockhammar, Pär; Österholm, Pär
  12. Expectations and the Dynamic Feedback between Foreign Direct Investment and Economic Growth By Escobari, Diego; Vacaflores, Diego

  1. By: Devereux, Michael B. (Unniversity of British Columbia); Yu, Changhua (University of International Business and Economics)
    Abstract: International financial integration helps to diversify risk but also may increase the transmission of crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with endogenous portfolio choice and collateral constraints. Collateral constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. The analysis allows for different degrees of financial integration, moving from financial autarky to bond market integration and equity market integration. Financial integration leads to a significant increase in global leverage, doubles the probability of balance sheet crises for any one country, and dramatically increases the degree of ‘contagion’ across countries. Outside of crises, the impact of financial integration on macro aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a tradeoff emerges between the probability of crises and the severity of crises. Financial integration can raise or lower welfare, depending on the scale of macroeconomic risk. In particular, in a low risk environment, the increased leverage resulting from financial integration can reduce welfare of investors.
    JEL: D52 F36 F44 G11 G15
    Date: 2014–09–01
  2. By: Weithing Zhang (University of Chicago); Thomas Mertens (New York University); Tarek Hassan (The University of Chicago)
    Abstract: Many central banks manage the stochastic behavior of their currencies' exchange rates by imposing pegs relative to a target currency. We study the effects of such currency manipulation in a multi-country model of exchange rate determination with endogenous capital accumulation. We find that the imposition of an exchange rate peg relative to a given target currency increases the volatility of consumption in the target country and decreases the volatility of the target currency's exchange rate relative to all other currencies in the world. In addition, currency pegs affect the formation of capital across sectors and countries. For example, an economically smaller country (such as Saudi Arabia) pegging its currency to an economically large country (such at the U.S.) decreases capital accumulation in the larger country and increases its real and nominal interest rate
    Date: 2014
  3. By: Raphael Anton Auer; Aaron Mehrotra
    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.
    Keywords: globalisation, inflation, Asian manufacturing supply chain, price spillovers
    JEL: E31 F4 F14 F15
    Date: 2014
  4. By: Ansgar Belke; Timo Baas
    Abstract: Member countries of the European Monetary Union (EMU) initiated wide-ranging 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 beggarthy- 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
  5. By: Cook, David (Hong Kong University of Science and Technology); Devereux, Michael B. (University of British Columbia)
    Abstract: An independent currency and a flexible exchange rate generally helps a country in adjusting to macroeconomic shocks. But recently in many countries, interest rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in countries with flexible exchange rates. This paper argues that if the zero bound constraint is binding and policy lacks an effective ‘forward guidance’ mechanism, a flexible exchange rate system may be inferior to a single currency area. With monetary policy constrained by the zero bound, under flexible exchange rates, the exchange rate exacerbates the impact of shocks. Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries freely adjust their interest rates under an optimal targeting rule. In a zero lower bound environment, in order for a regime of multiple currencies to dominate a single currency, it is necessary to have effective forward guidance in monetary policy.
    JEL: E2 E5 E6
    Date: 2014–09–01
  6. By: Sanchez, Juan M. (Federal Reserve Bank of St. Louis); Sapriza, Horacio (Federal Reserve Board); Yurdagul, Emircan (Washington University in St. Louis)
    Keywords: Debt Crises; Restructuring; Yield Curves; Bond Duration; Debt Dilution.
    JEL: F34 F41 G15
    Date: 2014–10–27
  7. By: Eleonora Cutrini and Giorgio Galeazzi (University of Macerata)
    Abstract: Against the backdrop of the contagion literature, the paper analyses the impact of financial and trade linkages on sovereign bonds spreads in the Eurozone crisis. Using quarterly data for a sample of EMU countries during the period 2000-2013, we estimate fixed-effect panel models with Driscoll and Kraay standard errors that are robust to general forms of spatial and temporal dependence. Our main results can be summarized as follows. First, we suggest that the "sudden stop" of capital inflow toward the peripheral sovereign debt triggered a re-segmentation of financial markets and economic systems along national borders, with negative implications for risk sharing and the efficient allocation of capital. The "home bias" effect - i.e. the increase in the share of sovereign debt held by domestic banks - worsened the country-specific risk because the twin crisis (sovereign and banking) began to be conceived as more closely intertwined within countries than before. Second, the structure of international trade helps to account for the geographic scope of contagion, even after controlling for macroeconomic and fiscal vulnerabilities. Finally, the potential influence of wider financial spillovers related to the emerging markets' decoupling hypothesis is confirmed by our analysis. However, the "substitution-effect" of public debt securities of stand-alone emerging countries has affected more the sovereign spreads in the core than in the periphery.
    Keywords: Eurozone,decoupling,sovereign debt crisis,contagion,trade and financial linkages,foreign debt
    JEL: E44 F36 F40 F42 G12 H63
    Date: 2014–10
  8. By: Bernd Hayo (University of Marburg); Britta Niehof (University of Marburg)
    Abstract: To analyse the interdependence between monetary and fiscal policy during a financial crisis, we develop an open-economy DSGE model with monetary and fiscal policy as well as financial markets in a continuous-time framework based on stochastic differential equations. Monetary policy is modelled using both a standard and a modified Taylor rule and fiscal policy is modelled as either expansionary or austere. In addition, we differentiate between open economies and monetary union members. We find evidence that the modified Taylor rule notably reduces the likelihood that the financial market crisis affects the real economy. But if we assume that households are averse with respect to outstanding government debt, we find that a combination of expansionary monetary policy and austere fiscal policy provides better stabilisation of both domestic and foreign economies in terms of both output and inflation. In the case of a monetary union, we find that stabilisation of output in the country where the financial shock originates is no longer as easy and, in terms of prices, there is now deflation in the country where the crisis originated and a positive inflation rate in the other country.
    Keywords: New Keynesian Models, Financial Crisis, Dynamic Stochastic General Equilibrium Models, Continuous Time Model, Fiscal Policy, Monetary Policy
    JEL: C63 E44 E47 E52 E62 F41
    Date: 2014
  9. By: Daniel Goya
    Abstract: There is evidence that suggests that one of the channels through which the exchange rate could have an impact on growth is export product diversification. I distinguish between the variety and concentration dimensions of export diversification and review the theoretical and empirical literature relating these two dimensions to the level and the volatility of the exchange rate. Using disaggregated trade data for a long panel of countries, I investigate these relationships employing an econometric methodology that allows for heterogeneity of coefficients across countries, and discuss two sources of bias which are often overlooked. I find that the variety dimension of export diversification is positively related to a weaker exchange rate and negatively related to exchange rate volatility. These relationships seem to be stronger for goods with higher technological intensity. I do not find a clear relationship between the exchange rate and the concentration of exports.
    Keywords: export diversification, variety, concentration, exchange rate, exchange rate volatility, pooled mean group.
    JEL: F14 F40 O30
    Date: 2014–10–03
  10. By: Sandra Gomes; P. Jacquinot; M. Pisani
    Abstract: We assess the effects of a temporary fiscal devaluation enacted in Spain or Portugal on the trade balance by simulating EAGLE, a large-scale multi-country dynamic general equilibrium model of the euro area. Social contributions paid by firms are reduced by 1 percent of GDP for four years and are financed by increasing the consumption tax. Our main results are the following. First, in the first year following implementation, the Spanish trade balance improves by 0.5 percent of GDP, the (before-consumption tax) real exchange rate depreciates by 0.7 percent and the terms of trade deteriorate by 1 percent. Second, similar results are obtained in the case of Portugal. Third, the trade balance improves when the fiscal devaluation is also enacted in the rest of the euro area, albeit to a lower extent than in the case of unilateral (country-specific) implementation. Fourth, quantitative results crucially depend on the degree of substitutability between domestic and imported tradables.
    JEL: F32 F47 H20
    Date: 2014
  11. By: Stockhammar, Pär (National Institute of Economic Research); Österholm, Pär (National Institute of Economic Research)
    Abstract: In this paper, we study the effects of US policy uncertainty – measured as the policy uncertainty index of Baker et al. (2013) – on Swedish GDP growth. Another source of spillovers of shocks to small open economies is thereby examined. We apply both Bayesian VAR models and spectral analysis to quarterly data from 1988 to 2013. Results show that increasing US policy uncertainty has significant negative effects on Swedish GDP growth. The effect seems to primarily stem from effects on investment growth and export growth. Our findings could prove useful to those who analyse and forecast the Swedish economy and potentially also other similar small open economies.
    Keywords: Spillovers; Small open economy; Political uncertainty index; Bayesian VAR; Spectral analysis
    JEL: C32 F43
    Date: 2014–10–17
  12. By: Escobari, Diego; Vacaflores, Diego
    Abstract: This paper sets to analyze the dynamic feedback between Foreign Direct Investment (FDI) and economic growth—larger FDI promotes higher GDP, while higher GDP can be achieved with higher levels of FDI. We use panels and a sample of 19 Latin American countries to estimate a dynamic FDI and a dynamic GDP equation that jointly characterize the evolution of both variables. We find that the dynamics of GDP and FDI are mostly driven by the expectations. Shocks of GDP or FDI were found to play no role affecting the dynamics.
    Keywords: Foreign Direct Investment, Economic Growth, Rational Expectations
    JEL: F36 F43 O11 O47 O54
    Date: 2014–07–17

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