nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒12‒08
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Official Financial Flows, Capital Mobility, and Global Imbalances By Tamim Bayoumi; Joseph E. Gagnon; Christian Saborowski
  2. Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences By Robert Kollmann
  3. Friedman Redux: External Adjustment and Exchange Rate Flexibility By Atish R. Ghosh; Mahvash Saeed Qureshi; Charalambos G. Tsangarides
  4. Portfolio Flows, Global Risk Aversion and Asset Prices in Emerging Markets By Nasha Ananchotikul; Longmei Zhang
  5. Macroeconomic Policy Games By Bodenstein, Martin; Guerrieri, Luca; LaBriola, Joe
  6. Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone By Philippe Martin; Thomas Philippon
  7. Financial Frictions and Optimal Monetary Policy in a Small Open Economy By Jesús A. Bejarano; Luisa F. Charry
  8. Monetary Policy as an Optimum Currency Area Criterion By Dominik Groll
  9. Current Accounts in the Eurozone Countries: The Role of Euro, Fiscal Policies and Financial Developments By Jaromír Baxa; Tomáš Olešòaník
  10. Microeconomic Uncertainty, International Trade, and Aggregate Fluctuations By George Alessandria; Horag Choi; Joseph P. Kaboski; Virgiliu Midrigan
  11. Capital Flow Deflection By Paolo Giordani; Michele Ruta; Hans Weisfeld; Ling Zhu
  12. The relevance of international spillovers and asymmetric effects in the Taylor rule By Beckmann, Joscha; Belke, Ansgar; Dreger, Christian
  13. Capital flows and macroprudential policies - A multilateral assessment of effectiveness and externalities By Beirne, John; Friedrich, Christian
  14. The Revived Bretton Woods System's First Decade By Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
  15. Oil prices, exchange rates and asset prices By Fratzscher, Marcel; Schneider, Daniel; Van Robays, Ine

  1. By: Tamim Bayoumi (International Monetary Fund); Joseph E. Gagnon (Peterson Institute for International Economics); Christian Saborowski (International Monetary Fund)
    Abstract: We use a cross-country panel framework to analyze the effect of net official flows (chiefly foreign exchange intervention) on current accounts. We find that net official flows have a large but plausible effect on current account balances. The estimated effects are larger with instrumental variables (42 cents to the dollar on average compared with 24 without instruments), reflecting a possible downward bias in regressions without instruments owing to an endogenous response of net official flows to private financial flows. We consistently find larger impacts of net official flows when international capital flows are restricted and smaller impacts when capital is highly mobile. A further result is that there is an important positive effect of lagged net official flows on current accounts that we believe operates through the portfolio balance channel.
    Keywords: reserve accumulation, intervention, capital mobility
    JEL: E5 F3
    Date: 2014–10
  2. By: Robert Kollmann
    Abstract: Standard macro models cannot explain why real exchange rates are volatile anddisconnected from macro aggregates. Recent research argues that models with persistentgrowth rate shocks and recursive preferences can solve that puzzle. I show that this resultis highly sensitive to the structure of financial markets. When just a bond is tradedinternationally, then long-run risk generates insufficient exchange rate volatility. A longrunrisk model with recursive-preferences can generate realistic exchange rate volatility,if all agents efficiently share their consumption risk by trading in complete financialmarkets; however, this entails massive international wealth transfers, and excessiveswings in net foreign asset positions. By contrast, a long-run risk, recursive-preferencesmodel in which only a fraction of households trades in complete markets, while theremaining households lead hand-to-mouth lives, can generate realistic exchange rate andexternal balance volatility.
    Keywords: exchange rate; long-run risk; recursive preferences; complete financial markets; financial frictions; international risk sharing
    JEL: F31 F36 F41 F43
    Date: 2014–11
  3. By: Atish R. Ghosh; Mahvash Saeed Qureshi; Charalambos G. Tsangarides
    Abstract: Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments†of exogenous changes in bilateral exchange rate regimes.
    Keywords: Flexible exchange rates;Exchange rate adjustments;Exchange rate regimes;Balance of trade;Current account balances;external dynamics, exchange rate regimes, global imbalances
    Date: 2014–08–08
  4. By: Nasha Ananchotikul; Longmei Zhang
    Abstract: In recent years, portfolio flows to emerging markets have become increasingly large and volatile. Using weekly portfolio fund flows data, the paper finds that their short-run dynamics are driven mostly by global “push†factors. To what extent do these cross-border flows and global risk aversion drive asset volatility in emerging markets? We use a Dynamic Conditional Correlation (DCC) Multivariate GARCH framework to estimate the impact of portfolio flows and the VIX index on three asset prices, namely equity returns, bond yields and exchange rates, in 17 emerging economies. The analysis shows that global risk aversion has a significant impact on the volatility of asset prices, while the magnitude of that impact correlates with country characteristics, including financial openness, the exchange rate regime, as well as macroeconomic fundamentals such as inflation and the current account balance. In line with earlier literature, portfolio flows to emerging markets are also found to affect the level of asset prices, as was the case in particular during the global financial crisis.
    Keywords: Capital flows;Financial risk;Emerging markets;Asset prices;Stock prices;Bond yields;Exchange rates;Asset markets;Spillovers;Econometric models;portfolio flows; global risk aversion; asset prices, exchange rate
    Date: 2014–08–19
  5. By: Bodenstein, Martin (National University of Singapore); Guerrieri, Luca (Board of Governors of the Federal Reserve System (U.S.)); LaBriola, Joe (University of California, Berkeley)
    Abstract: Strategic interactions between policymakers arise whenever each policymaker has distinct objectives. Deviating from full cooperation can result in large welfare losses. To facilitate the study of strategic interactions, we develop a toolbox that characterizes the welfare-maximizing cooperative Ramsey policies under full commitment and open-loop Nash games. Two examples for the use of our toolbox offer some novel results. The first example revisits the case of monetary policy coordination in a two-country model to confirm that our approach replicates well-known results in the literature and extends these results by highlighting their sensitivity to the choice of policy instrument. For the second example, a central bank and a macroprudential regulator are assigned distinct objectives in a model with financial frictions. Lack of coordination leads to large welfare losses even if technology shocks are the only source of fluctuations.
    Keywords: Optimal policy; strategic interaction; welfare analysis; monetary policy cooperation; marcroprudential regulation
    JEL: E44 E61 F42
    Date: 2014–09–23
  6. By: Philippe Martin; Thomas Philippon
    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; (ii) 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.
    JEL: E2 E3 E4 E6 F3 F4
    Date: 2014–10
  7. By: Jesús A. Bejarano; Luisa F. Charry
    Abstract: In this paper we set up a small open economy model with financial frictions, following Curdia and Woodford (2010)’s model. Unlike other results in the literature such as Curdia and Woodford (2010), McCulley and Ramin (2008) and Taylor (2008), we find that optimal monetary policy should not respond to changes in domestic interest rate spreads when the source of fluctuations are exogenous financial shocks. A novel result here is that the optimal size of policy responses to changes in the credit spread is large when the disturbance source are shocks to the foreign interest rate. Our results suggest that such a response is welfare enhancing.
    Keywords: Financial frictions, optimal interest rate rules, interest rate spreads, welfare, small open economy, second order approximation
    JEL: E44 E50 E52 E58 F41
    Date: 2014–11–13
  8. By: Dominik Groll
    Abstract: Whether countries benefit from forming a monetary union depends critically on the way monetary policy is conducted. This is mainly because monetary policy determines whether and to what extent a flexible nominal exchange rate fosters or hampers macroeconomic stabilization, even if monetary policy does not target the nominal exchange rate explicitly
    Keywords: Monetary union, macroeconomic stabilization, welfare analysis, optimum currency area theory, trade openness
    JEL: F33 F41 E52
    Date: 2014–11
  9. By: Jaromír Baxa (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic. Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Pod Vodárenskou veží 4, 182 08 Prague 8, Czech Republic); Tomáš Olešòaník (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic)
    Abstract: Should we blame the euro for widening of current account deficits in the EMU? In this paper, we employ time-specific fixed effect estimator to study determinants of the current account deficits of the EU countries before and after adoption of the euro. Our aim is to assess to what extent the increased current account deficits could be attributed to the single currency and to the role of other variables, especially fiscal policy and developments of financial sector. We show that euro had negative effect on current account balances of southern countries. Moreover, we provide evidence that the role of fiscal policy in current account dynamics changed with euro adoption and twin deficits emerged in many countries. Finally, we document significant role of growing credits to private sector for built-up of persistent current account deficits, hence the negative effects of excessive lending on external balance should be addressed by the regulators and policy makers in the future.
    Keywords: current account, euro, fiscal balance, financial system
    JEL: E42 E62 F14
    Date: 2014–09
  10. By: George Alessandria; Horag Choi; Joseph P. Kaboski; Virgiliu Midrigan
    Abstract: The extent and direction of causation between micro volatility and business cycles are debated. We examine, empirically and theoretically, the source and effects of fluctuations in the dispersion of producer- level sales and production over the business cycle. On the theoretical side, we study the effect of exogenous first- and second-moment shocks to producer-level productivity in a two-country DSGE model with heterogenous producers and an endogenous dynamic export participation decision. First-moment shocks cause endogenous fluctuations in producer-level dispersion by reallocating production internationally, while second-moment shocks lead to increases in trade relative to GDP in recessions. Empirically, using detailed product-level data in the motor vehicle industry and industry-level data of U.S. manufacturers, we find evidence that international reallocation is indeed important for understanding cross-industry variation in cyclical patterns of measured dispersion.
    JEL: E31 F12
    Date: 2014–10
  11. By: Paolo Giordani; Michele Ruta; Hans Weisfeld; Ling Zhu
    Abstract: This paper focuses on the coordination problem among borrowing countries imposing controls on capital infl ows. In a simple model of capital flows and controls, we show that inflow restrictions distort international capital flows to other countries and that, in turn, such capital flow deflection may lead to a policy response. We then test the theory using data on inflow restrictions and gross capital inflows for a large sample of developing countries between 1995 and 2009. Our estimation yields strong evidence that capital controls deflect capital flows to other borrowing countries with similar economic characteristics. Notwithstanding these strong cross-border spillover effects, we do not find evidence of a policy response.
    Keywords: Capital flows;Capital controls;Capital inflows;Spillovers;Econometric models;capital flows, capital controls, cross-border spillovers, policy response.
    Date: 2014–08–08
  12. By: Beckmann, Joscha; Belke, Ansgar; Dreger, Christian
    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
  13. By: Beirne, John; Friedrich, Christian
    Abstract: This paper assesses the effectiveness and associated externalities that arise when macro- prudential policies (MPPs) are used to manage international capital flows. Using a sample of up to 139 countries, we examine the impact of eight different MPP measures on cross-border bank flows over the period 1999-2009. Our panel analysis takes into account the structure of the banking system as well as the presence of potential cross-country and cross-asset class spillover effects. Our results indicate that the structure of the domestic banking system matters for the effectiveness of MPPs. We specifically find that a high share of non-resident bank loans in the MPP-implementing country reduces the domestic effectiveness of most MPPs, while a high return on assets in the domestic banking system has the opposite effect. Our results on the spillover analysis indicate that both types of spillover can occur. First, we find that a high return on assets in the banking system of countries other than the MPP-implementing one leads to a reduction, and a greater degree of trade integration leads to an increase in spillovers across countries. However, the economic significance of the results suggests that only a limited number of countries will tend to experience substantial geographical spillover effects. Second, we also find some evidence of spillover effects across asset classes within countries. JEL Classification: F3, F5, G01, G11
    Keywords: banking system, international capital flows, macroprudential policies
    Date: 2014–08
  14. By: Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
    Abstract: The revived Bretton Woods framework we proposed in 2003 remains a useful way to understand the international financial system. We document that the system survived the 2008 crisis. Looking forward, we argue that the system will continue to evolve as we expected. China is likely to graduate from the periphery to the center in the next few years. This graduation process could be smooth or associated with recurrent financial crises. During this transition the magnitude of net capital outflows from the periphery will continue to depress real interest rates in industrial countries at every phase of the business cycle. Finally, recent policy initiatives suggest that India is poised to replace China as the dominant periphery country.
    JEL: F21 F3 F43
    Date: 2014–09
  15. By: Fratzscher, Marcel; Schneider, Daniel; Van Robays, Ine
    Abstract: This paper takes a financial market perspective in examining the relationship between oil prices, the US dollar and asset prices, and it exploits the heteroskedasticity for the identification of causality in a multifactor model. It finds a bidirectional causality between the US dollar and oil prices since the early 2000s. Moreover, both oil prices and the US dollar are significantly affected by changes in equity market returns and risk. By contrast, oil prices did not react to changes in these financial assets before 2001. The paper provides evidence that this may be explained by the increased use of oil as a financial asset over the past decade, which intensified the link between oil and other assets. The model can account well for the strong and rising negative correlation between oil prices and the US dollar since the early 2000s, with risk shocks and the financialisation process of oil prices explaining most of the strengthening of this correlation. JEL Classification: F30, G15
    Keywords: asset prices, exchange rates, identification, oil prices, time-varying correlation, US dollar
    Date: 2014–07

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