nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒11‒22
seventeen papers chosen by
Martin Berka
University of Auckland

  1. The Federal Reserve in a Globalized World Economy By Taylor, John B.
  2. Long-run determinants and misalignments of the real effective exchange rate in the EU By Comunale, Mariarosaria
  3. From tapering to tightening : the impact of the fed's exit on India By Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
  4. Euro- US Real Exchange Rate Dynamics: How Far Can We Push Equilibrium Models? By Aydan Dogan
  5. Home Production and Small Open Economy Business Cycles By Chen, Kuan-Jen; Chu, Angus C.; Lai, Ching-Chong
  6. Capital Flows and Capital Account Management in Selected Asian Economies By Sen Gupta, Abhijit; Sengupta, Rajeswari
  7. Optimal Monetary Policy in a Currency Union: Implications of a Country-specific Cost Channel By Jochen Michaelis; Jakob Palek
  8. The International Policy Trilemma in the Post-Bretton Woods Era By Alex Mandilaras
  9. Current account imbalances in the Euro area: Competitiveness or financial cycle? By Mariarosaria Comunale; Jeroen Hessel
  10. Real Exchange Rate and Real Effective Exchange Rate Measurement: Some theoretical Extensions By ibrahim, waheed; Jimoh, Ayodele
  11. Government Spending Shocks in Open Economy VARs By Mario Forni; Luca Gambetti
  12. Exchange Rates Contagion in Latin America By Rubén Albeiro Loaiza Maya; José Eduardo Gómez-González; Luis Fernando Melo Velandia
  13. The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule By Joscha Beckmann; Ansgar Belke; Christian Dreger
  14. On International Consumption Risk Sharing, Financial Integration and Financial Development By Yasin Mimir
  15. Cross-Country Interactions, the Great Moderation and the Role of Output Volatility in Growth By Steven Trypsteen
  16. The real exchange rate as a target of macroeconomic policy By Frenkel, Roberto; Rapetti, Martin
  17. Rethinking the Twin Deficits By Constantine, Collin

  1. By: Taylor, John B. (Stanford University)
    Abstract: This paper starts from the theoretical observation that simple rules-based monetary policy will result in good economic performance in a globalized world economy and the historical observation that this occurred during the Great Moderation period of the 1980s and 1990s. It tries to answer a question posed by Paul Volcker in 2014 about the global repercussions of monetary policies pursued by advanced economy central banks in recent years. I start by explaining the basic theoretical framework, its policy implications, and its historical relevance. I then review the empirical evidence on the size of the international spillovers caused by deviations from rules-based monetary policy, and explore the many ways in which these spillovers affect and interfere with policy decisions globally. Finally, I consider ways in which individual monetary authorities and the world monetary system as a whole could adhere better to rules-based policies in the future and whether this would be enough to achieve the goal of stability in the globalized world economy.
    JEL: E5 F4 F5
    Date: 2014–10–01
  2. By: Comunale, Mariarosaria
    Abstract: Exchange rate assessment is becoming increasingly relevant for economic surveillance in the EU. The persistence of different wage and productivity dynamics among EMU countries or EU members with a fixed exchange regime with euro, coupled with the impossibility of correcting competitiveness differentials via the adjustment of nominal rates, have resulted into divergent dynamics in Real Effective Exchange Rates. This paper explores the role of economic fundamentals in explaining medium/long-run movements in the Real Effective Exchange Rates in the European Union over the period 1994-2012 by using heterogeneous, cointegrated panel frameworks in static and dynamic terms. In addition, the paper provides an analysis of the misalignments of the rate for each member state based on the “equilibrium†measure calculated from the permanent component of the fundamentals (BEER). The misalignments in EU28 are huge and the patterns differ significantly among groups. Therefore, despite the influence of the fundamentals is quite similar, the differences in the transfer variable (which affect the BEER) and in the actual Real Effective Exchange Rate are key. The core countries have been undervalued for almost the whole period, which entails from an important increase in competitiveness for those countries. Instead the periphery has experienced high rates, especially in Portugal. In addition, the behavior of CEECs is driven, as expected, by the transition process and influenced by the criteria to the accession to the EU. The misalignments in this case are still extremely wide and reflect these phenomena.
    Keywords: real effective exchange rate, European Union, behavioral effective exchange rate,transfer problem, panel cointegration
    JEL: C23 F31
    Date: 2014–07
  3. By: Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
    Abstract: The"tapering talk"starting on May 22, 2013, when Federal Reserve Chairman Ben Bernanke first spoke of the possibility of the U.S. central bank reducing its security purchases, had a sharp negative impact on emerging markets. India was among those hardest hit. The rupee depreciated by 18 percent at one point, causing concerns that the country was heading toward a financial crisis. This paper contends that India was adversely impacted because it had received large capital flows in prior years and had large and liquid financial markets that were a convenient target for investors seeking to rebalance away from emerging markets. In addition, India's macroeconomic conditions had weakened in prior years, which rendered the economy vulnerable to capital outflows and limited the policy room for maneuver. The paper finds that the measures adopted to handle the impact of the tapering talk were not effective in stabilizing the financial markets and restoring confidence, implying that there may not be any easy choices when a country is caught in the midst of rebalancing of global portfolios. The authors suggest putting in place a medium-term policy framework that limits vulnerabilities in advance, while maximizing the policy space for responding to shocks. Elements of such a framework include a sound fiscal balance, sustainable current account deficit, and environment conducive to investment. In addition, India should continue to encourage relatively stable longer-term flows and discourage volatile short-term flows, hold a larger stock of reserves, avoid excessive appreciation of the exchange rate through interventions with the use of reserves and macroprudential policy, and prepare the banks and firms to handle greater exchange rate volatility.
    Keywords: Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Macroeconomic Management
    Date: 2014–10–01
  4. By: Aydan Dogan
    Abstract: This paper re-assesses the problem of general equilibrium models in matching the behaviour of real exchange rate. We do so by developing a two country general equilibrium model with non-traded goods, home bias, incomplete markets and partial degrees of pass through as well as nominal rigidities both in the goods and labour markets. We combine this comprehensive framework with a data consistent shock structure. Our key finding is that presenting an encompassing model structure improves the performance of the model in addressing the behaviour of the real exchange rate but this improvement is at the expense of failing to replicate some other characteristics of the data, such as high consumption volatility and negative cross-country consumption correlation. We argue that the ability of a general equilibrium model to account for the features of the data is closely related to the predominant driving source of the fluctuations.
    Keywords: Real Exchange Rates; Non-traded goods; Incomplete Asset Markets; Imperfect Exchange Rate Pass Through; Nominal Rigidities
    JEL: F31 F32 F41
    Date: 2014–10
  5. By: Chen, Kuan-Jen; Chu, Angus C.; Lai, Ching-Chong
    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 quantitatively 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.
    Keywords: small open economy; home production; emerging markets; business cycles
    JEL: D13 E32 F41 O16
    Date: 2014–09
  6. By: Sen Gupta, Abhijit; Sengupta, Rajeswari
    Abstract: Gross capital inflows and outflows to and from emerging market economies (EMEs) have witnessed a significant increase since early 2000s. This rapid increase in the volume of flows accompanied by sharp swings in volatility has amplified the complexity of macroeconomic management in EMEs. While capital inflows provide additional financing for productive investment and offer avenues for risk diversification, unbridled flows could also exacerbate financial instability.In this paper we focus on the evolution of capital flows in a few select emerging Asian economies, and analyze surge and stop episodes as well as changes in the composition of flows across these episodes. We also provide a comprehensive description of the capital account management policies adopted by the host countries and evaluate the efficacy of these measures by analyzing whether they achieved the desired goals.This kind of an analysis is highly relevant especially a time when EMEs around the world are about to face the repercussions of a potential Quantitative Easing (QE) tapering by the US or launch of fresh QE measures by the Euro-zone, either of which could once again heighten the volatility of cross-border capital flows thereby posing renewed macroeconomic challenges for major EMEs.
    Keywords: Capital flows, Exchange market pressure, Impossible Trinity, Sterilized intervention, Capital controls, Global financial crisis.
    JEL: F32 F36 F41
    Date: 2014–09–29
  7. By: Jochen Michaelis (University of Kassel); Jakob Palek (University of Kassel)
    Abstract: There is growing empirical evidence that the strength of the cost channel of monetary policy differs across countries. Using a New Keynesian model of a two-country monetary union, we show how the introduction of a cost channel (differential) alters the optimal monetary responses to union-wide and national shocks. The cost channel makes monetary policy less effective in combating inflation, but it is shown that the optimal response to the decline in effectiveness is a stronger use of the instrument. On the other hand, the larger the cost channel differential, the less aggressive will the optimal monetary policy be. For almost all parameter constellations, our welfare analysis suggests a clear-cut ranking of policy regimes: commitment outperforms the Taylor rule, the Taylor rule outperforms strict inflation targeting, and strict inflation targeting outperforms discretion.
    Keywords: cost channel; optimal monetary policy; monetary union; open economy macroeconomics
    JEL: E31 E52 F41
    Date: 2014
  8. By: Alex Mandilaras (University of Surrey)
    Abstract: The international macroeconomic policy trilemma suggests that de- spite the appeal of exchange rate stability, financial account openness and monetary sovereignty, these cannot be achieved simultaneously. Us- ing elements of Euclidean geometry, this paper proposes a new method for testing the trilemma and finds considerable evidence in support of it. Further tests indicate that, on average, policy configurations are not on the trilemma constraint, i.e. there is a degree of `trilemma- ineffectiveness’, which is costly for real output growth and price inflation. It is shown that these costs can be attributed to limited exchange rate stability and financial account openness, respectively.
    JEL: F33
    Date: 2014–11
  9. By: Mariarosaria Comunale; Jeroen Hessel
    Abstract: The current account imbalances that are at the heart of the European sovereign debt crisis are often attributed to differences in price competitiveness. However, recent research suggests that domestic demand booms related to the financial cycle may have been more important. As this would have very different policy implications, this paper aims to investigate the relative role of price competitiveness and domestic demand as drivers of the current account imbalances in the euro area. We estimate panel error-correction models for exports, imports and the trade balance. We specifically look at fluctuations in domestic demand at the frequency of the financial cycle. We conclude that although differences in price competitiveness have an influence, differences in domestic demand are more important than is often realized. Fluctuations at the frequency of the financial cycle are more suitable to explain the trade balance than fluctuations at the frequency of the normal business cycle. Our results call for more emphasis on credit growth and macro prudential policy, in addition to the current attention for competitiveness and structural reforms.
    Keywords: Current account deficits; Economic and Monetary Union; competitiveness; domestic boom; financial cycle
    JEL: E32 F32 F41 F44
    Date: 2014–10
  10. By: ibrahim, waheed; Jimoh, Ayodele
    Abstract: ABSTRACT The paper has provided theoretical extensions to the computations of nominal effective exchange rate and the real effective exchange rate over time. The extension took cognizance of the common base currency (USD) to which all currencies of the world is usually converted. The paper compared its computations with that of the CBN computations in attempt to provide a litmus test on the extensions. It was observed that the two computations were of preserving order with a very high correlation coefficient between the two computations. However, it was observed that the extensions perform better as it’s reflects more of changes in exchange rate of Nigerian economy. The difference was attributed to the increased in the number of trading partners that was involved in the latter. At the end from the result obtained, the paper recommends that the extension should always be taken into considerations in the computations of effective exchange rate especially for the developing nations like Nigeria; also, Central banks of these countries should endeavour to include as many trading partners as possible into their computations. The paper believes that until this done, their effective rates computations may not reflect the actual changes in the exchange rate of their respective countries.
    Keywords: Keywords: nominal, Real, Effective rates, CBN, correlation coefficients, trading partners
    JEL: F3 F31
    Date: 2012
  11. By: Mario Forni; Luca Gambetti
    Abstract: We identify government spending news and surprise shocks using a novel identification based on the Survey of Professional Forecasters. News shocks lead, through an increase of the interest rate, to a real appreciation of US dollar and a worsening of the trade balance. The opposite is found for the standard surprise shock which raises government spending on impact: the currency depreciates and net exports improve. We reconcile the two conflicting results showing the dierent timing of the spending reversals associated with the two shocks. The eects of the news shock on government spending are much more persistent and the reversal occurs much later.
    Keywords: Business Cycle Fluctuations; Euro area; Common Shocks; Near-Structural VARs.
    JEL: C32 E32 E62
    Date: 2014–10
  12. By: Rubén Albeiro Loaiza Maya; José Eduardo Gómez-González; Luis Fernando Melo Velandia
    Abstract: A regular vine copula approach is implemented for testing for contagion among the exchange rates of the six largest Latin American countries. Using daily data from June 2005 through April 2012, we find evidence of contagion among the Brazilian, Chilean, Colombian and Mexican exchange rates. However, there are interesting differences in contagion during periods of large exchange rate depreciation and appreciation. Our results have important implications for the response of Latin American countries to currency crises originated abroad.
    Keywords: Exchange Rates, Contagion, Copula, Regular Vine, Local correlation.
    JEL: C32 C51
    Date: 2014–09–01
  13. 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: 2014–09
  14. By: Yasin Mimir
    Abstract: This paper investigates the empirical link between international consumption risk sharing, financial integration, and financial development for a group of twenty-nine developed and developing countries in the G7, the Euro area and the OECD. We first compute the degree of consumption risk sharing of these countries using an average risk sharing measure. We then relate the average risk sharing measure of these countries to their level of financial integration and financial development. We find that (i) the average consumption risk sharing in the Euro area is higher than those in the G-7 and the OECD, and (ii) a higher degree of international consumption risk sharing is associated with a greater degree of financial integration and a lower level of financial development. Based on these results, we argue that more financially integrated countries with more developed financial markets are better able and less in need to insure themselves against idiosyncratic income shocks. Inclusion of per capita income, output risk and trade openness as additional control variables reduces the effects of financial integration and financial development on consumption risk sharing. Holding financial integration and financial development equal, countries in the Euro area engage in significantly more consumption risk sharing than the ones in the G7 and the OECD.
    Keywords: Consumption Risk Sharing, Financial Integration, Financial Development
    JEL: E21 F15 F36 G15 O1
    Date: 2014
  15. By: Steven Trypsteen
    Abstract: This paper investigates the effect of output volatility and the great moderation on growth in a model that simultaneously accounts for cross-country interactions, structural breaks and heterogeneous effects. This is done by augmenting the univariate GARCH-M model of growth for each G7 country with cross-country weighted averages of growth and shift dummies. I find that volatility affects growth positively, that there is a great moderation in five of the G7 countries and that the great moderation has a negative effect on growth in all G7 countries. A simulation exercise shows that cross-country interactions are important in estimating the volatility effect.
    Keywords: Cross-country interactions, Volatility, Growth, GARCH-M, The great moderation.
    Date: 2014
  16. By: Frenkel, Roberto; Rapetti, Martin
    Abstract: In recent years several authors have argued that developing countries should aim to target a stable and competitive real exchange rate (SCRER) to foster economic growth. A growing body of empirical research gives support to this claim. Although more theoretical work is needed, some ideas from development theory can help to explain the empirical findings. For instance, if modern tradable activities display some form of increasing returns to scale, market forces alone would deliver a set of relative prices that would make capital accumulation in these activities suboptimal. This paper supports the view that developing countries could target SCRER as a part of a development strategy that promotes the expansion of modern tradable activities. We review the empirical findings, discuss the channels through which a SCRER can stimulate economic growth, and describe the policies needed to pursue a strategy based on a SCRER.
    Keywords: Real exchange rate, development, macroeconomic policy
    JEL: E61 F41 F43
    Date: 2014
  17. By: Constantine, Collin
    Abstract: This article reexamines the thesis that fiscal deficits cause trade deficits and challenges this explanation of the twin deficits with the following propositions. Differences in competitiveness among nations do not lead to balanced trade. Using a Eurozone case study, the article discusses the nexus between competitiveness and the trade balance. Secondly, the author proposes that causality runs from trade deficits to fiscal deficits when the free trade-balanced trade theory is overthrown, and finally, the article overturns the argument that austerity works.
    Keywords: twin deficits, competitiveness, free trade, Eurozone, austerity
    JEL: E62 F15 F32 F34 F41
    Date: 2014

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