nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒01‒03
twelve papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences By Kollmann, Robert
  2. Imported Inputs and Invoicing Currency Choice: Theory and Evidence from UK Transaction Data By Wanyu Chung
  3. Sovereign Default and Capital Accumulation By Park, JungJae
  4. Quality Pricing-to-Market By Auer, Raphael; Chaney, Thomas; Sauré, Philip
  5. Market Size, Competition, and the Product Mix of Exporters By Thierry Mayer; Marc J. Melitz; Gianmarco Ottaviano
  6. Exchange rates, expected returns and risk: UIP unbound By Anella Munro
  7. The Evolution of Comparative Advantage: Measurement and Implications By Levchenko, Andrei A.; Zhang, Jing
  8. Equilibrium Sovereign Default with Exchange Rate Depreciation By Popov, Sergey V.; Wiczer, David
  9. Monetary Policy, Incomplete Asset Markets, and Welfare in a Small Open Economy By Shigeto Kitano; Kenya Takaku
  10. Credit Booms, Banking Crises, and the Current Account By Scott Davis; Adrienne Mack; Wesley Phoa; Anne Vandenabeele
  11. The Effects of Productivity Gains in Asian Emerging Economies: A Global Perspective By Taya Dumrongrittikul; Heather Anderson; Farshid Vahid
  12. 'Optimal Fiscal Management of Commodity Price Shocks' By Pierre-Richard Agénor

  1. By: Kollmann, Robert
    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 can be traded internationally, then long-run risk generates insufficient exchange rate volatility. A longrun risk model with recursive-preferences in which all agents trade in complete global financial markets can generate realistic exchange rate volatility; however, I show that this entails huge international wealth transfers, and excessive swings in net foreign asset positions. By contrast, a long-run risk, recursive-preferences model in which only a small fraction of households trades in complete markets, while the remaining households lead hand-to-mouth lives, generates realistic exchange rate and external balance volatility
    Keywords: complete financial markets; exchange rate; financial frictions; international risk sharing; long-run risk; recursive preferences
    JEL: F31 F36 F41 F43 F44
    Date: 2014–11
  2. By: Wanyu Chung
    Abstract: What determines the currency denomination of international trade? This is the first paper to consider in theory and data how exporters' dependence on imported inputs affects their choice of invoicing currency. My model predicts that exporters more dependent on foreign currency-denominated inputs are more likely to use foreign currency for pricing. Using a novel dataset that covers all UK trade transactions with non-EU countries, I provide firm-level evidence by matching import and export data and relate exporters' invoicing currency choice to their import behavior. I find considerable support for the model's predictions, and these findings have strong implications for the variation of exchange rate pass-through across industries.
    Keywords: Invoicing Currency, Exchange Rate Pass-through, Trade in Intermediate Goods JEL Classification: F1, F31, F41
    Date: 2014
  3. By: Park, JungJae
    Abstract: I introduce endogenous capital accumulation into an otherwise standard quantitative sovereign default model in the tradition of Eaton and Gersovitz (1981), and find that conditional on a level of debt, default incentives are U shaped in the capital stock: the economy with too small or too large amounts of capital is likely to default. In addition to an “excusable” motive for default in line with Grossman and Huyck (1989), our model also predicts an “opportunistic” motive for default in line with Kehoe and Levine (1993). The model predicts the “opportunistic” motive for default, because (1) capital is used as a consumption insurance vehicle during autarky after default, (2) installed capital within the border cannot be seized by foreign lenders, and (3) our model does not use an ad-hoc output cost of default which only penalizes default in high income states. The two different motives for default allow the calibrated model to generate defaults in “good” and “bad” times in simulation with a frequency of 38% and 62%, respectively. This is consistent with Tomz and Wright (2007)’s empirical finding that throughout history and across countries, around one third of sovereign defaults occurred in “good” times, when output is above trend, whereas most defaults occur in “bad” times. The model is calibrated to the business cycle moments of Argentina, and simulation results show that the model matches business cycle facts regarding emerging economies along other dimensions. Moreover, simulation results show that default in “good” times occurs (1) after the economy has accumulated a significantly large amount of capital and (2) when the economy faces a modestly good shock, both of which reduce the value of external borrowing but increase the value of staying in autarky. On the other hand, around defaults in “bad” times, the model economy displays typical “V” shape economic dynamics, with a collapse in absorption upon default, especially investment. Aggregating quarterly data from the model into annual frequency is found to overestimate the fraction of defaults in “good” times around twofold.
    Keywords: Sovereign default, capital accumulation, excusable default, opportunistic default, default in good times
    JEL: F34 F4 F41
    Date: 2011–12
  4. By: Auer, Raphael; Chaney, Thomas; Sauré, Philip
    Abstract: We examine firm's pricing-to-market decisions in vertically differentiated industries featuring a large number of firms that compete monopolistically in the quality space. Firms sell goods of heterogeneous quality to consumers with non-homothetic preferences that differ in their income and thus their marginal willingness to pay for quality increments. We derive closed-form solutions for the pricing game under costly international trade, thus establishing existence and uniqueness. We then examine how the interaction of good quality and market demand for quality affects firms' pricing-to-market decisions. The relative price of high quality goods compared to that of low quality goods is an increasing function of the income in the destination market. When relative costs change, the rate of exchange rate pass-through is decreasing in quality in high income countries, yet increasing in quality in low-income countries. We then document that these predictions receive empirical support in a dataset of prices and quality in the European car industry.
    Keywords: exchange rate pass-through; intra-industry trade; monopolistic competition; pricing-to-market; vertical differentiation
    JEL: E3 E41 F12 F4 L13
    Date: 2014–07
  5. By: Thierry Mayer (Département d'économie); Marc J. Melitz (Department of Economics); Gianmarco Ottaviano (Università di Bologna)
    Abstract: We build a theoretical model of multi-product firms that highlights how competition across market destinations affects both a firm's exported product range and product mix. We show how tougher competition in an export market induces a firm to skew its export sales toward its best performing products. We find very strong confirmation of this competitive effect for French exporters across export market destinations. Theoretically, this within-firm change in product mix driven by the trading environment has important repercussions on firm productivity. A calibrated fit to our theoretical model reveals that these productivity effects are potentially quite large.
    JEL: D21 D24 F13 F14 F41 L11
    Date: 2014–02
  6. By: Anella Munro
    Abstract: No-arbitrage implies a close link between exchange rates and interest returns, but evidence of that link has been elusive. This paper derives an exchange rate asset price model with consumption-risk adjustments. Interest rates and exchange rates reflect common risks which bias their reduced-form relationship. As markets become more complete, the model predicts increasing disconnect between exchange rates and observed interest rates, and between premia that price bonds and premia that price currency returns. When accounting for risk, the estimated interest rate - exchange rate relationship is considerably closer to theory for eight USD currency pairs. Exchange rates, risk and returns need to be jointly modeled.
    Keywords: Exchange rate, asset price, risk adjustment, uncovered interest parity, bond premium, currency premium
    JEL: F31 G12
    Date: 2014–12
  7. By: Levchenko, Andrei A. (University of Michigan); Zhang, Jing (Federal Reserve Bank of Chicago)
    Abstract: We estimate productivities at the sector level for 72 countries and 5 decades, and examine how they evolve over time in both developed and developing countries. In both country groups, comparative advantage has become weaker: productivity grew systematically faster in sectors that were initially at greater comparative disadvantage. These changes have had a significant impact on trade volumes and patterns, and a non-negligible welfare impact. In the counterfactual scenario in which each country's comparative advantage remained the same as in the 1960s, and technology in all sectors grew at the same country-specific average rate, trade volumes would be higher, cross-country export patterns more dissimilar, and intra-industry trade lower than in the data. In this counterfactual scenario, welfare is also 1.6% higher for the median country compared to the baseline. The welfare impact varies greatly across countries, ranging from −1.1% to +4.3% among OECD countries, and from −6% to +41.9% among non-OECD countries.
    Keywords: technological change; sectoral TFP; Ricardian models of trade; welfare
    JEL: F11 F43 O33 O47
    Date: 2014–10–07
  8. By: Popov, Sergey V. (Queen's University Belfast); Wiczer, David (Federal Reserve Bank of St. Louis)
    Abstract: This study proposes and quantitatively assesses a terms-of-trade penalty for defaulting: defaulters must exchange more of their own goods for imports, which causes an adjustment to the equilibrium exchange rate. This penalty can take the place of an ad hoc fall in output: Facing only this penalty and temporary exclusion from debt markets, countries are willing to maintain borrowing obligations up to a realistic level of debt. The terms-of-trade penalty is consistent with the observed relationship between sovereign default and a country's trade flows and prices. The defaulter's currency depreciates while trade volume falls drastically. We demonstrate that a default episode can imply up to a 30% real depreciation, which matches observed crisis events in developing countries.
    Keywords: endogenous default; exchange rate; trade balance.
    JEL: F11 F17 F34
    Date: 2014–11–24
  9. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We develop a small open economy model with capital, sticky prices, and a simple form of financial frictions. We compare welfare levels under three alternative rules: a domestic inflation-based Taylor rule, a CPI inflation-based Taylor rule, and an exchange rate peg. We show that the superiority of an exchange rate peg over a domestic inflation-based Taylor rule becomes more pronounced under incomplete financial asset markets and more severe financial frictions.
    Keywords: Small open economy, DSGE, Welfare comparison, Incomplete financial market, Ramsey policy, Exchange rate regime
    JEL: E42 E44 E52 F31 F41 G15
    Date: 2014–12
  10. By: Scott Davis (Hong Kong Institute for Monetary Research and Federal Reserve Bank of Dallas); Adrienne Mack (Federal Reserve Bank of Dallas); Wesley Phoa (The Capital Group Companies); Anne Vandenabeele (The Capital Group Companies)
    Abstract: A number of papers have shown that rapid growth in private sector credit is a strong predictor of a banking crisis. This paper will ask if credit growth is itself the cause of a crisis, or is it the combination of credit growth and external deficits? This paper estimates a probabilistic model to find the marginal effect of private sector credit growth on the probability of a banking crisis. The model contains an interaction term between credit growth and the level of the current account, so the marginal effect of private sector credit growth may itself be a function of the level of the current account. We find that the marginal effect of rising private sector debt levels depends on an economy's external position. When the current account is in balance, the marginal effect of an increase in debt is rather small. However, when the economy is running a sizable current account deficit, implying that any increase in the debt ratio is financed through foreign borrowing, this marginal effect is large.
    Keywords: Banking Crises, Credit Booms, Current Account
    JEL: E51 F32 F40
    Date: 2014–11
  11. By: Taya Dumrongrittikul; Heather Anderson; Farshid Vahid
    Abstract: This paper investigates international responses of key macroeconomic variables, particularly real exchange rates, to simultaneous shocks to productivity in the traded sector in eight Asian emerging and developing countries. We use panel estimation techniques to construct component submodels in a thirty country global vector autoregressive (GVAR) model. The GVAR approach can account for interaction among all countries and capture many potential international transmission channels. We identify the shocks by using sign restricted impulse responses. We find that increases in traded-sector productivity in Asian developing countries lead to a real appreciation of the domestic currencies, in line with the Balassa-Samuelson hypothesis. Inflation also increases in many Asian developing countries. After the shocks, nontraded sector productivity in the US and other developed countries increases, suggesting that there is a compositional shift in their production, away from the traded goods toward the nontraded goods. This allows productivity in the nontraded sector to increase. Further, the traded sector productivity shocks in Asia stimulate international trade in most countries.
    Keywords: Asian developing countries; Exchange rate fundamentals; Global vector autoregression; Panel vector error correction model; Real exchange rates; Sign restricted impulse response.
    JEL: C51 E52 F31
    Date: 2014
  12. By: Pierre-Richard Agénor
    Abstract: A dynamic stochastic general equilibrium model is used to study the optimal fiscal response to commodity price shocks in a small open low-income country. The model accounts for imperfect access to world capital markets and a variety of externalities associated with public infrastructure, including utility benefits, a direct complementarity effect with private investment, and reduced distribution costs. However, public capital is also subject to congestion and absorption constraints, with the latter affecting the efficiency of infrastructure investment. The model is parameterized and used to examine the transmission process of a temporary resource price shock under a benchmark case (cash transfers) and alternative fiscal rules, involving either higher public spending or accumulation in a sovereign fund. The optimal allocation rule between spending today and asset accumulation is determined so as to minimize a social loss function defined in terms of the volatility, relative to the benchmark case, of private consumption and either the nonresource primary fiscal balance or a more general index of macroeconomic stability, which accounts for the volatility of the real exchange rate. Sensitivity analysis is conducted with respect to various structural parameters and model specification.
    Date: 2014

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