nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒12‒13
fourteen 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. Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences By Robert Kollmann
  3. Labor Market Reforms and Current Account Imbalances: Beggar-Thy-Neighbor Policies in a Currency Union? By Baas, Timo; Belke, Ansgar
  4. International Financial Integration and Crisis Contagion By Michael B. Devereux; Changhua Yu
  5. Monetary Policy in Open Economies: Practical Perspectives for Pragmatic Central Bankers By Richard Clarida
  6. Vulnerability to Changes in External Financing Due to Global Factors By Gabriela Contreras; Francisco Pinto
  7. International investment positions and exchange rate dynamics By Binder, Michael; Offermanns, Christian J.
  8. Banks, Capital Flows and Financial Crises By Akinci, Ozge; Queraltó, Albert
  9. The Impact of Yuan Internationalization on the Euro-Dollar Exchange Rate By Agnès Bénassy-Quéré; Yeganeh Forouheshfar
  10. Credit Market Frictions and Sudden Stops By Yuko Imura
  11. Capital Flows, Financial Intermediation and Macroprudential Policies By Matteo Ghilardi; Shanaka J. Peiris
  12. Liquidity Premia and Interest Rate Parity By Ludger Linnemann; Andreas Schabert
  13. Fiscal devaluation in the euro area: a model-based analysis By Gomes, Sandra; Jacquinot, Pascal; Pisani, Massimiliano
  14. A Distant Mirror of Debt, Default, and Relief By Carmen M. Reinhart; Christoph Trebesch

  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 cross-section 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.
    JEL: F31 F41
    Date: 2014–09
  2. By: Robert Kollmann
    Abstract: Standard macro models cannot explain why real exchange rates are volatile and disconnected from macro aggregates. Recent research argues that models with persistent growth rate shocks and recursive preferences can solve that puzzle. I show that this result is highly sensitive to the structure of financial markets. When just a bond is traded internationally, then long-run risk generates insufficient exchange rate volatility. A long-run risk model with recursive-preferences can generate realistic exchange rate volatility, if all agents efficiently share their consumption risk by trading in complete financial markets; however, this entails massive international wealth transfers, and excessive swings in net foreign asset positions. By contrast, a long-run risk, recursivepreferences model in which only a fraction of households trades in complete markets, while the remaining households lead hand-to-mouth lives, can generate realistic exchange rate and external balance volatility.
    Keywords: exchange rate, long-run risk, recursive preferences, complete financial markets, financial frictions, international risk sharing
    JEL: F31 F36 F41 F43 F44
    Date: 2014–11
  3. By: Baas, Timo (University of Duisburg-Essen); Belke, Ansgar (University of Duisburg-Essen)
    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 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
  4. By: Michael B. Devereux; Changhua Yu
    Abstract: International financial integration helps to diversify risk but also may increase the trans- mission 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 con- straints. 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. Fi- nancial 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 trade-off 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
  5. By: Richard Clarida
    Abstract: This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary ('stable') nominal exchange rate - let alone a fixed exchange rate or one that remains inside a target zone ‐ because, absent a commitment device, optimal monetary can't deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an 'inflation' shock - the 'bad news god news' result of Clarida -Waldman (2008;2014). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.
    JEL: E52 E58 F3
    Date: 2014–10
  6. By: Gabriela Contreras; Francisco Pinto
    Abstract: Stops or reversals of foreign capital inflows can result in costly current account adjustments unless they are offset by other forms of external financing, such as capital inflows driven by a retrenchment of domestic investors. In this paper we propose a measure of vulnerability that differentiates between countries that have experienced this compensatory effect, and thus are more resilient to changes in external financing, and those that are more vulnerable, where declines in foreign capital inflows lead to current account adjustments. Then, we compare the impact on GDP growth and real exchange rates during episodes of strong capital flow fluctuations in both resilient and vulnerable economies. In the case of surges of capital inflows, we find that vulnerable economies experience higher increases in economic growth and real exchange rate appreciations compared to more resilient ones, while during sudden stops, they suffer higher exchange rate depreciations. In addition, we explore policy and structural determinants of our metric of vulnerability to external financing. We find that economies that are less financially open and have lower credit rating and net foreign assets tend to be more vulnerable to reversions of foreign investment.
    Date: 2014–08
  7. By: Binder, Michael; Offermanns, Christian J.
    Abstract: We revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we make use of a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country's international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions; furthermore, long-run exchange rate equilibria may have little relation to purchasing power parity outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality.
    Keywords: exchange rate determination,international financial integration,dynamic panel data models
    JEL: F31 F37 C23
    Date: 2014
  8. By: Akinci, Ozge (Board of Governors of the Federal Reserve System (U.S.)); Queraltó, Albert (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper proposes a macroeconomic model with financial intermediaries (banks), in which banks face occasionally binding leverage constraints and may endogenously affect the strength of their balance sheets by issuing new equity. The model can account for occasional financial crises as a result of the nonlinearity induced by the constraint. Banks' precautionary equity issuance makes financial crises infrequent events occurring along with "regular" business cycle fluctuations. We show that an episode of capital infl ows and rapid credit expansion, triggered by low country interest rates, leads banks to endogenously decrease the rate of equity issuance, contributing to an increase in the likelihood of a crisis. Macroprudential policies directed at strengthening banks' balance sheets, such as capital requirements, are shown to lower the probability of financial crises and to enhance welfare.
    Keywords: Financial intermediation; sudden stops; leverage constraints; occasionally binding constraints.
    JEL: E32 F41 F44 G15
    Date: 2014–11–07
  9. By: Agnès Bénassy-Quéré (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Yeganeh Forouheshfar (Université Paris-Dauphine - Université Paris-Dauphine)
    Abstract: We study the implication of a multipolarization of the international monetary system on crosscurrency volatility. More specifically, we analyze whether the internationalization of the yuan could modify the impact of asset supply and trade shocks on the euro-dollar exchange rate, within a threecountry, three-currency portfolio model. Our static model shows that the internationalization of the yuan (defined as a rise in the yuan in international portfolios) would be either neutral or stabilizing for the euro-dollar rate, whatever the exchange-rate regime of China. Moving to a dynamic, stockflow framework, we show that the internationalization of the yuan would make exchange-rate variations more efficient to stabilize net foreign asset positions after a trade shock.
    Keywords: China ; Yuan ; Exchange-rate regime ; Euro ; Dollar
    Date: 2013–02
  10. By: Yuko Imura
    Abstract: Financial crises in emerging economies in the 1980s and 1990s often entailed abrupt declines in foreign capital inflows, improvements in trade balance, and large declines in output and total factor productivity (TFP). This paper develops a two-sector small open economy model wherein heterogeneous firms face collateralized credit constraints for investment loans. The model is calibrated using Mexican data, and explains the economic downturn and subsequent recoveries following financial crises. In response to a sudden tightening of credit availability, the model generates a large decline in external debt, an improvement in trade balance, and declines in output and TFP, consistent with the stylized facts of sudden stop episodes. Tighter borrowing constraints lead firms to reduce investment and production, which in turn results in some firms holding capital stock disproportionate to their productivity levels. This disrupts the optimal allocation of capital across firms, and generates an endogenous fall in measured TFP. Furthermore, the subsequent recovery is driven by the traded sector, since the credit crunch is more persistent among domestic financing sources relative to foreign financing sources. This is consistent with the experience of Mexico, where the relatively fast recovery from the 1994-95 crisis was driven mainly by the traded sector, which had access to international financial markets.
    Keywords: Business fluctuations and cycles; Credit and credit aggregates; Financial markets; International topics
    JEL: E22 E32 F41 G01
    Date: 2014
  11. By: Matteo Ghilardi; Shanaka J. Peiris
    Abstract: This paper develops an open-economy DSGE model with an optimizing banking sector to assess the role of capital flows, macro-financial linkages, and macroprudential policies in emerging Asia. The key result is that macro-prudential measures can usefully complement monetary policy. Countercyclical macroprudential polices can help reduce macroeconomic volatility and enhance welfare. The results also demonstrate the importance of capital flows and financial stability for business cycle fluctuations as well as the role of supply side financial accelerator effects in the amplification and propagation of shocks.
    Keywords: Capital flows;Asia;Emerging markets;Business cycles;Macroprudential policies and financial stability;Financial intermediation;Monetary policy;Banking sector;Open economies;General equilibrium models;Financial Frictions, Capital Regulation, Monetary Policy
    Date: 2014–08–21
  12. By: Ludger Linnemann; Andreas Schabert
    Abstract: Due to the US dollar's dominant role for international trade and finance, risk-free assets denominated in US currency not only offer a pecuniary return, but also provide transactions services, both nationally and internationally. Accordingly, the responses of bilateral US dollar exchange rates to interest rate shocks should differ substantially with respect to the (US or foreign) origin of the shock. We demonstrate this empirically and apply a model of liquidity premia on US treasuries originating from monetary policy implementation. The liquidity premium leads to a modification of uncovered interest rate parity (UIP), which enables the model to explain an appreciation of the dollar subsequent to an increase in US interest rates if foreign interest rates follow the US monetary policy rate.
    Keywords: Exchange rate dynamics, uncovered interest rate parity, monetary policy shocks, liquidity premia
    JEL: E4 F31 F41
    Date: 2014–10–28
  13. By: Gomes, Sandra; Jacquinot, Pascal; Pisani, Massimiliano
    Abstract: We assess the effects on trade balance of a temporary fiscal devaluation enacted by Spain or Portugal 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 consumption tax. Our main results are the following. First, 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 enacted also 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 Classification: F32, F47, H20
    Keywords: dynamic general equilibrium modeling, fiscal devaluation, trade deficit
    Date: 2014–08
  14. By: Carmen M. Reinhart; Christoph Trebesch
    Abstract: We take a first pass at quantifying the magnitudes of debt relief achieved through default and restructuring in two distinct samples: 1979-2010, focusing on credit events in emerging markets, and 1920-1939, documenting the official debt hangover in advanced economies that was created by World War I and its aftermath. We examine the economic performance of debtor countries during and after these overhang episodes, by tracing the evolution of real per capita GDP (levels and growth rates); sovereign credit ratings; debt servicing burdens relative to GDP, fiscal revenues, and exports; as well as the level of government debt (external and total). Across 45 crisis episodes for which data is available we find that debt relief averaged 21 percent of GDP for advanced economies (1932-1939) and 16 percent of GDP for emerging markets (1979-2010), respectively. The economic landscape after a final debt reduction is characterized by higher income levels and growth, lower debt servicing burdens and lower government debt. Also ratings recover markedly, albeit only in the modern period.
    JEL: E6 F3 H6 N0
    Date: 2014–10

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