nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2014‒12‒29
seventeen papers chosen by
Martin Berka
University of Auckland

  1. Geographic Barriers to Commodity Price Integration: Evidence from US Cities and Swedish Towns, 1732 - 1860 By Mario J. Crucini; Gregor W. Smith
  2. Examining the volatility of exchange rate: Does monetary policy matter? By Lim, Shu Yi; Sek, Siok Kun
  3. International capital flows, external assets and output volatility By Hoffmann, Mathias; Krause, Michael; Tillmann, Peter
  4. A threshold model of the US current account By Duncan, Roberto
  5. The Impact of U.S. Monetary Policy Normalization on Capital Flows to Emerging-Market Economies By Tatjana Dahlhaus; Garima Vasishtha
  6. Real Exchange Rates and Sectoral Productivity in the Eurozone By Berka, Martin; Devereux, Michael B; Engel, Charles M
  7. Estimates of Fundamental Equilibrium Exchange Rates, November 2014 By William R. Cline
  8. The impact of diverging economic structure on current account imbalances in the euro area By Ehmer, Philipp
  9. Real Effective Exchange Rate Imbalances and Macroeconomic Adjustments: evidence from the CEMAC zone By Asongu Simplice
  10. International Financial Integration and Crisis Contagion By Devereux, Michael B; Yu, Changhua
  11. Leverage constraints and real interest rates By Isohätälä , Jukka; Kusmartsev, Feo; Milne, Alistair; Robertson, Donald
  12. The Real Effects of Capital Controls: Financial Constraints, Exporters, and Firm Investment By Laura Alfaro; Anusha Chari; Fabio Kanczuk
  13. Merchanting and Current Account Balances By Beusch, Elisabeth; Döbeli, Barbara; Fischer, Andreas M; Yesin, Pinar
  14. The persistence of real exchange rates in the Central and Eastern European countries By Ahmad Zubaidi Baharumshah; Siew-Voon Soon; Stilianos Fountas; Nurul Sima Md. Shariff
  15. Real exchange rates and fundamentals: robustness across alternative model specifications By Konrad Adler; Christian Grisse
  16. Government Spending Multipliers and the Zero Lower Bound in an Open Economy By Charles Olivier Mao Takongmo
  17. What makes a currency procyclical ? an empirical investigation By Cordella, Tito; Gupta, Poonam

  1. By: Mario J. Crucini; Gregor W. Smith
    Abstract: We study the role of distance and time in statistically explaining price dispersion for 14 commodities from 1732 to 1860. The prices are reported for US cities and Swedish market towns, so we can compare international and intranational dispersion. Distance and commodity-specific fixed effects explain a large share - roughly 60% - of the variability in a panel of more than 230,000 relative prices over these 128 years. There was a negative “ocean effect”: international dispersion was less than would be predicted using distance, narrowing the effective ocean by more than 3000 km. Price dispersion declined over time beginning in the 18th century. This process of convergence was broad-based, across commodities and locations (both national and international). But there was a major interruption in convergence in the late 18th and early 19th centuries, at the time of the Napoleonic Wars, stopping the process by two or three decades on average.
    Keywords: distance effect, border effect, law of one price
    JEL: N70
    Date: 2014–12
  2. By: Lim, Shu Yi; Sek, Siok Kun
    Abstract: We conduct empirical analysis on examining the changes in exchange rate volatility under two monetary policy regimes, i.e. the pre- and post- inflation targeting (IT) regimes. In addition, we also investigate if the monetary decisions can have impacts on the volatility of exchange rate. The study is focused in four Asian countries that experienced drastic in the switch of monetary policy from the rigid exchange rate to flexible exchange rate and inflation targeting after the Asian financial crisis of 1997. The exponential generalized autoregressive conditional heteroskedasticity model is applied and our results show that exchange rate is more persistent and volatile in the pre-IT period as compared to post-IT period. The exchange rate persistency is higher in the long-run but the persistency is low in the short run. We fail to find evidence to show that the adoption of flexible exchange rate and inflation targeting lead to greater volatility in exchange rate. The monetary decisions can have impacts on the volatility of exchange rate but the impacts vary across countries.
    Keywords: exchange rate volatility; monetary policy; shock persistency
    JEL: E6 E66
    Date: 2014–07
  3. By: Hoffmann, Mathias; Krause, Michael; Tillmann, Peter
    Abstract: This paper proposes a new perspective on international capital flows and countries' long-run external asset position. Cross-sectional evidence for 84 developing countries shows that over the last three decades countries that have had on average higher volatility of output growth (1) accumulated higher external assets in the long-run and (2) experienced more procyclical capital outflows over the business cycle than those countries with a same growth rate but a more stable output path. To explain this finding we provide a theoretical mechanism within a stochastic real business cycle growth model in which higher uncertainty of the income stream increases the precautionary savings motive of households. They have a desire to save more when the variance of their expected income stream is higher. We show that in the model the combination of income risk and a precautionary savings motive will lead to procyclical capital outflows at business cycle frequency and a higher long-run external asset position.
    Keywords: capital flows,net foreign assets,productivity growth,uncertainty,precautionary savings
    JEL: F32 F36 F43 F44
    Date: 2014
  4. By: Duncan, Roberto (Ohio University)
    Abstract: What drives US current account imbalances? Is there solid evidence that the behavior of the current account is different during deficits and surpluses or that the size of the imbalance matters? Is there a threshold relationship between the US current account and its main drivers? We estimate a threshold model to answer these questions using the instrumental variable estimation proposed by Caner and Hansen (2004). Rather than concluding that the size or the sign of (previous) external imbalances matters, we find that time is the most important threshold variable. One regime exists before and another one exists after the third quarter of 1997, a period that coincides with the onset of the Asian financial crisis and the Taxpayer Relief Act of 1997. Statistically significant determinants in the second regime are the fiscal surplus, productivity, productivity volatility, oil prices, the real exchange rate, and the real interest rate. Productivity has become a more important driver since 1997.
    JEL: E32 E65 F32 F41
    Date: 2014–10–01
  5. By: Tatjana Dahlhaus; Garima Vasishtha
    Abstract: The Federal Reserve’s path for withdrawal of monetary stimulus and eventually increasing interest rates could have substantial repercussions for capital flows to emerging-market economies (EMEs). This paper examines the potential impact of U.S. monetary policy normalization on portfolio flows to major EMEs by using a vector autoregressive model that explicitly accounts for market expectations of future monetary policy. The “policy normalization shock” is defined as a shock that increases both the yield spread of U.S. long-term bonds and monetary policy expectations while leaving the policy rate per se unchanged. Results indicate that the impact of this shock on portfolio flows as a share of GDP is expected to be economically small. The estimated impact is closely in line with that seen during the end-May to August 2013 episode in response to a comparable rise in the yield spread of U.S. long-term bonds. However, as the events during the summer of 2013 have shown, relatively small changes in portfolio flows can be associated with significant financial turmoil in EMEs. Further, there is also a strong association between the countries that are identified by our model as being the most affected and the ones that saw greater outflows of portfolio capital over May to September 2013.
    Keywords: International topics; Transmission of monetary policy
    JEL: C32 E52 F33 F42
    Date: 2014
  6. By: Berka, Martin; Devereux, Michael B; Engel, Charles M
    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.
    Keywords: Balassa-Samuelson; Eurozone; Real Exchange Rates; Total Factor Productivity; Unit Labor Cost
    JEL: F31 F41
    Date: 2014–10
  7. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: This semiannual review finds that most of the major international currencies, including the US dollar, euro, Japanese yen, UK pound sterling, and Chinese renminbi, remain close to their fundamental equilibrium exchange rates (FEERs). The new estimates find this result despite numerous significant exchange rate movements associated with increased volatility in international financial markets at the beginning of the fourth quarter of 2014, and despite a major reduction in the price of oil. The principal cases of exchange rate misalignment continue to be the undervalued currencies of Singapore, Taiwan, and to a lesser extent Sweden and Switzerland, and the overvalued currencies of Turkey, New Zealand, South Africa, and to a lesser extent Australia and Brazil. Even so, the medium-term current account deficit for the United States is already at the outer limit in the FEERs methodology (3 percent of GDP), and if the combination of intensified quantitative easing in Japan and the euro area with the end to quantitative easing in the United States were to cause sizable further appreciation of the dollar, an excessive US imbalance could begin to emerge.
    Date: 2014–11
  8. By: Ehmer, Philipp
    Abstract: The measures implemented to reduce current account deficits within several euro area econ-omies are aimed at boosting competitiveness to raise exports. Due to low industrial capacities in Greece, Portugal and Spain, for instance, it is questionable, however, whether exports can contribute much to the required turnaround of the current account. The existing literature on current account determinants ignores the impact of economic structure. However, as industrial goods are more tradable than services, a specialisation on manufacturing industries should ceteris paribus lead to an improved current account. The empirical analysis of this paper con-firms a significant impact of the sectoral focus on the current account within the euro area. Hence, the turnaround in crisis-hit economies has to be accomplished mostly through imports. As can be observed, this brings about severe recessions - more severe than in manufacturing-based economies which use the exports channel to a larger extent. Within a currency union where there is no depreciation which facilitates the adjustment economies should aim at har-monising their economic structure regarding export capacity.
    Keywords: euro area,current account imbalances,current account determinants,savings rate, economic structure,sectoral focus,optimum currency area
    JEL: E21 F32 F41 L16 O14
    Date: 2014
  9. By: Asongu Simplice (Yaoundé/Cameroun)
    Abstract: We assess the behavior of real effective exchange rates (REERs) of members of the CEMAC zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate (FEER) model is estimated and associated misalignments are derived for the period 1980 to 2009. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that, only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. Ultimately, there is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths.
    Keywords: Exchange rate; Macroeconomic impact; CEMAC zone
    JEL: F31 F33 F42 O55
    Date: 2014–01
  10. By: Devereux, Michael B; Yu, Changhua
    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 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.
    Keywords: financial contagion; international financial integration; leverage; occasionally binding contracts
    JEL: D52 F36 F44 G11 G15
    Date: 2014–10
  11. By: Isohätälä , Jukka (Department of Physics, Loughborough University); Kusmartsev, Feo (Department of Physics, Loughborough University); Milne, Alistair (School of Business and Economics, Loughborough University); Robertson, Donald (Faculty of Economics, University of Cambridge)
    Abstract: This paper investigates the macroconomics of real interest rates when there are constraints on debt finance, used both for insurance against income shocks and transferability of resources over time. We amend a standard continuous-time deterministic model of international exchange, with patient and impatient countries, introducing country level shocks fully diversifiable at the global level. A series of shocks that push one country towards its leverage limit induces substantial pre-cautionary saving and a collapse of real interest rate relative to the deterministic benchmark. We discuss the resulting dynamics of interest rates and the broader implications for macroeconomic modelling.
    Keywords: borrowing constraints; debt management; incomplete financial markets; international macroeconomics; finance and macroeconomics; macroeconomic propagation; precautionary saving
    JEL: E44
    Date: 2014–11–06
  12. By: Laura Alfaro; Anusha Chari; Fabio Kanczuk
    Abstract: In aftermath of the global financial crisis of 2008–2009, emerging-market governments have increasingly restricted foreign capital inflows. The data show a statistically significant drop in cumulative abnormal returns for Brazilian firms following capital control announcements. Large firms and the largest exporting firms appear less negatively affected compared to external finance-dependent firms, and capital controls on equity have a more negative announcement effect than those on debt. Real investment falls following the controls. Overall, the results suggest that capital controls segment international financial markets, increase the cost of capital, reduce the availability of external finance, and lower firm-level investment.
    JEL: F3 F4 G11 G15 L2
    Date: 2014–12
  13. By: Beusch, Elisabeth; Döbeli, Barbara; Fischer, Andreas M; Yesin, Pinar
    Abstract: Merchanting is goods trade that does not cross the border of the firm's country of residence. Merchanting grew strongly in the last decade in several European economies and has become an important determinant of these countries' current account. Because merchanting firms reinvest their earnings abroad to expand their international activities, this practice raises national savings in the home country without increasing domestic investment. This results in a larger current account surplus. To show the empirical links between merchanting and the current account balance, two exercises are performed in this paper using a sample of 53 countries during 1980-2011. The first exercise estimates the savings impact of merchanting countries in empirical models of the medium-term current account. The second exercise shows that merchanting's impact on the country's current account is sensitive to firm mobility.
    Keywords: current account adjustment; industry dynamics; Merchanting
    JEL: F10 F20 F32
    Date: 2014–05
  14. By: Ahmad Zubaidi Baharumshah; Siew-Voon Soon; Stilianos Fountas (Department of Economics, University of Macedonia); Nurul Sima Md. Shariff
    Abstract: This paper investigates the mean reversion in real exchange rates for Central and Eastern European countries. In contrast to previous studies, we use the local-persistent model to measure the half-life. We find that the adjustment to purchasing power parity is more rapid after accounting for structural breaks, taking less than 18 months to be cut in half. The empirical evidence shows that there is no clear-cut difference in the speed of adjustment to shocks between the transition economies and the larger member countries of the European Union. The narrow confidence intervals for the half-lives that accord with the standard sticky-price models provide strong support for purchasing power parity. The purchasing power parity puzzle does not seem to hold in these transition countries. The practical implication of our findings is that the transition countries have successfully adopted trade policies that mimic those of the European Union, with a view to alignment in readiness for European Union membership..
    Keywords: half-lives; local persistence; structural breaks; real exchange rate; PPP puzzle; transition economies.
    JEL: C0 F21 F36
    Date: 2014–11
  15. By: Konrad Adler; Christian Grisse
    Abstract: This paper explores the robustness of behavioural equilibrium exchange rate (BEER) models, focusing on a panel specification with Swiss franc real bilateral rates as dependent variables. We use Bayesian model averaging to illustrate model uncertainty, and employ real exchange rates computed from price level data to explore robustness to the inclusion or exclusion of fixed effects. We find that the estimated coefficients - and therefore also the implied equilibrium values - are sensitive to (1) the combination of explanatory variables included in the model, (2) the set of currencies included in the panel and (3) the inclusion of fixed effects. Increases in government consumption and net foreign assets and improvements in the terms of trade in Switzerland relative to foreign countries are associated with a Swiss franc real appreciation, as predicted by economic theory. By contrast, several macroeconomic variables commonly thought to be linked to real exchange rates are found not to exhibit a robust relationship with Swiss franc real rates. Our findings can help policymakers in understanding the uncertainty associated with estimates of equilibrium exchange rates.
    Keywords: Equilibrium exchange rates, model uncertainty, model combination, panel data
    JEL: C11 C33 F31 F32 F41
    Date: 2014
  16. By: Charles Olivier Mao Takongmo
    Abstract: What is the size of the government-spending multiplier in an open economy when the Zero Lower Bound (ZLB) on the nominal interest rate is binding? Using a theoretical framework, in a closed economy, Christiano, Eichenbaum, and Rebelo (2011), show that, when the nominal interest rate is binding, the government-spending multiplier can be close to four. Their theory helps us to understand the government spending multiplier in ZLB, but it is difficult to match that theory with the data. We propose a dynamic stochastic general equilibrium in open macroeconomics, with market imperfections, wage and price rigidities and endogenous smoothing monetary policy. We argue that, in a closed economy and in the presence of ZLB, there is no crowding out effect through interest rates. We also argue that in an open economy, there is another channel for the crowding out effect via the real exchange rate. For an open economy, the multiplier falls to the levels usually observed in small, closed economies for which the ZLB is not binding. <P>
    Keywords: Government-spending multiplier, zero lower bound, sticky price, sticky wages, Taylor rule,
    JEL: E52 E62 F41 F44
    Date: 2014–11–01
  17. By: Cordella, Tito; Gupta, Poonam
    Abstract: This paper looks at the correlation between the cyclical components of gross domestic product and the exchange rate and classifies countries'currencies as procyclical if they appreciate in good times, countercyclical if they appreciate in bad times, and acyclical otherwise. With this classification, the paper shows that: (i) the countries that are commodity exporters and experience procyclical capital flows tend to have procyclical currencies; (ii) countries with procyclical currencies tend to restrict their capital accounts, perhaps as an attempt to reduce the degree of procyclicality; (iii) countries with procyclical currencies pursue procyclical monetary policy; (iv) however, in the last decade, there is a disconnect between the cyclicality of currency and monetary policy; and (v) the disconnect may reflect a decline in the fear of floating, which can be partially attributed to an improvement in countries'net foreign asset positions.
    Keywords: Currencies and Exchange Rates,Emerging Markets,Debt Markets,Economic Stabilization,Macroeconomic Management
    Date: 2014–11–01

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