nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒01‒09
fifteen papers chosen by
Martin Berka
University of Auckland

  1. The Domestic and International Effects of Interstate U.S. Banking By Cacciatore, Matteo; Ghironi, Fabio; Stebunovs, Viktors
  2. Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone By Martin, Philippe; Philippon, Thomas
  3. Exchange Rate Flexibility under the Zero Lower Bound By Cook, David; Devereux, Michael B
  4. Exchange rate and price dynamics in a small open economy - the role of the zero lower bound and monetary policy regimes By Gregor Bäurle; Daniel Kaufmann
  5. Exchange rate pass-through and product heterogeneity: does quality matter on the import side? By Michele Bernini; Chiara Tomasi
  6. Corporate Saving in Global Rebalancing By Bacchetta, Philippe; Benhima, Kenza
  7. External Liabilities and Crises By Catão, Luis A. V.; Milesi-Ferretti, Gian Maria
  8. Testing 'the trilemma' in post-transitional Europe: a new empirical measure of capital mobility By Tomislav Globan
  9. Noisy information, distance and law of one price dynamics across US cities By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  10. Exchange Rate Forecasts and Expected Fundamentals By Christian D. Dick; Ronald MacDonald; Lukas Menkhoff
  11. The Macroeconomic Effects of Debt- and Equity-Based Capital Inflows By Scott Davis
  12. European Integration and the Feldstein-Horioka Puzzle By Margarita Katsimi; Gylfi Zoega
  13. Good News is Bad News: Leverage Cycles and Sudden Stops By Ozge Akinci; Ryan Chahrour
  14. Fewer but Better: Sudden Stops, Firm Entry, and Financial Selection By Sînâ T. Ateş; Felipe E. Saffie
  15. Re-Distribution, Aggregate Demand, and Growth in an Open Economy: The Crucial Interaction of Portfolio Considerations and External Account Constraints By Razmi, Arslan

  1. By: Cacciatore, Matteo; Ghironi, Fabio; Stebunovs, Viktors
    Abstract: This paper studies the domestic and international effects of national bank market integration in a two-country, dynamic, stochastic, general equilibrium model with endogenous producer entry. Integration of banking across localities reduces the degree of local monopoly power of financial intermediaries. The economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The foreign economy experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to moderation of firm-level and aggregate output volatility. In turn, trade and financial ties allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. These results are consistent with features of U.S. and international fluctuations after the United States began its transition to interstate banking in the late 1970s.
    Keywords: Business cycle volatility; Current account; Deregulation; Interstate banking; Producer entry; Real exchange rate
    JEL: E32 F32 F41 G21
    Date: 2014–05
  2. By: Martin, Philippe; Philippon, Thomas
    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.
    Keywords: Eurozone crisis; Fiscal policy; Macroprudential policy; private leverage; sudden stop
    JEL: E44 E62 F32 F41 G01
    Date: 2014–10
  3. By: Cook, David; Devereux, Michael B
    Abstract: An independent currency and a flexible exchange rate generally helps a country in adjusting to macroeconomic shocks. But recently in many countries, interest rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in countries with flexible exchange rates. This paper argues that if the zero bound constraint is binding and policy lacks an effective `forward guidance' mechanism, a flexible exchange rate system may be inferior to a single currency area. With monetary policy constrained by the zero bound, under flexible exchange rates, the exchange rate exacerbates the impact of shocks. Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries freely adjust their interest rates under an optimal targeting rule. In a zero lower bound environment, in order for a regime of multiple currencies to dominate a single currency, it is necessary to have effective forward guidance in monetary policy.
    Keywords: Forward Guidance; Lower Bound; Monetary Policy; Optimal Currency Area
    JEL: E2 E5 E6
    Date: 2014–10
  4. By: Gregor Bäurle; Daniel Kaufmann
    Abstract: We analyse nominal exchange rate and price dynamics after risk premium shocks with short-term interest rates constrained by the zero lower bound (ZLB). In a small-open-economy DSGE model, temporary risk premium shocks lead to shifts of the exchange rate and the price level if a central bank implements an inflation target by means of a traditional Taylor rule. These shifts are strongly amplified and become more persistent once the ZLB is included in the model. We also provide empirical support for this finding. Using a Bayesian VAR for Switzerland, we find that responses of the exchange rate and the price level to a temporary risk premium shock are larger and more persistent when the ZLB is binding. Our theoretical discussion shows that alternative monetary policy rules that stabilise price-level expectations are able to dampen exchange rate and price fluctuations when the ZLB is binding. This stabilisation can be achieved by including either the price level or, alternatively, the nominal exchange rate in the policy rule.
    Keywords: Exchange rate and price dynamics, zero lower bound on short-term interest rates, small-open-economy DSGE model, monetary policy regimes, monetary transmission, Bayesian VAR, sign restrictions
    JEL: C11 C32 E31 E37 E52 E58 F31
    Date: 2014
  5. By: Michele Bernini (University of Sheffield); Chiara Tomasi (University of Trento)
    Abstract: Using Italian firm-level data for the period 2000-2006, this paper investigates the role of the quality of imported inputs and exported output in determining the heterogeneous response of exporters' prices to real exchange rate fluctuations. The analysis confirms previous findings that the imports of intermediate inputs and the quality of the exported output increase an exporter's ability to reduce the exchange rate pass-through into the prices perceived by foreign consumers. Our novel finding is that the `intermediate imports channel' has a weaker negative impact on the exchange rate pass-through into the price of higher quality exported varieties. The paper shows that this finding is consistent with the predictions of a model where both the suppliers of high quality intermediate inputs and the exporters of high quality final goods follow pricing strategies that offset exchange rate variations.
    Keywords: Importers, Exporters, Quality, Exchange Rate Disconnect
    JEL: F12 F14 F31 F41
    Date: 2014–11
  6. By: Bacchetta, Philippe; Benhima, Kenza
    Abstract: In this paper, we examine theoretically how corporate saving in emerging markets is contributing to global rebalancing. We consider a two-country dynamic general equilibrium model, based on Bacchetta and Benhima (2014), with a Developed and an Emerging country. Firms need to save in liquid assets to finance their production projects, especially in the Emerging country. In this context, we examine the impact of a credit crunch in the Developed country and of a growth slowdown in both countries. These three shocks imply smaller global imbalances and a positive output comovement, but have a different impact on interest rates. Contrary to common wisdom, a slowdown in the Emerging market implies a trade balance improvement in the Developed country.
    Keywords: Capital Flows; Credit Constraints; Financial Crisis; Global Imbalances
    JEL: E22 F21 F41 F44
    Date: 2014–06
  7. By: Catão, Luis A. V.; Milesi-Ferretti, Gian Maria
    Abstract: We examine the determinants of external crises, focusing on the role of foreign liabilities and their composition. Using a variety of statistical tools and comprehensive data spanning 1970-2011, we find that the ratio of net foreign liabilities to GDP is a significant crisis predictor. This is primarily due to the net position in debt instruments--the effect of net equity liabilities is weaker and net FDI liabilities seem if anything an offset factor. We also find that: i) breaking down net external debt into its gross asset and liability counterparts does not add significant explanatory power to crisis prediction; ii) the current account is a powerful predictor; iii) foreign exchange reserves reduce the likelihood of crisis more than other foreign asset holdings; iv) a parsimonious probit containing those and a handful of other variables has good predictive performance in- and out-of-sample. The latter result stems largely from our focus on external crises sensu stricto.
    Keywords: currency crises; current account imbalances; foreign exchange reserves; international investment positions; sovereign deebt
    JEL: E44 F32 F34 G15 H63
    Date: 2014–07
  8. By: Tomislav Globan (Faculty of Economics and Business, University of Zagreb)
    Abstract: This paper develops a new empirical measure of capital mobility. It tests the hypothesis that the degree of capital mobility can be estimated by measuring the reaction intensity of capital flows to shocks in interest rates, on a sample of eight European post-transitional economies. This hypothesis can be derived from the Mundell-Fleming open economy model, implications of which are essentially based on the assumption of a close link between the degree of capital mobility in a country and the reaction of its capital flows to changes in domestic and external interest rates. Precisely because of this interrelationship, policy holders, in theory, face the policy trilemma or the 'impossible trinity', i.e. the inability to achieve three following objectives simultaneously – a stable exchange rate, financial openness, and an independent monetary policy. Using impulse response and historical decomposition analysis in a VAR framework, the results show a significant increase in the explanatory power of interest rates for the movement of capital flows shortly before and after the accession of post-transitional economies to the European Union. On the other hand, the recent financial crisis made capital flows less sensitive to interest rates due to increased risk aversion on international capital markets. Results suggest that the degree of capital mobility, i.e. the level of financial integration with EU-15, is highest in Bulgaria, Latvia and Lithuania, and least pronounced in Poland and Croatia. Results are verified by a number of robustness checks, with three separate alternative measures of capital mobility confirming the results obtained from the econometric model.
    Keywords: capital flows; capital mobility; the trilemma; impossible trinity; interest rate shocks; VAR model; historical decomposition
    JEL: F21 F32 F36
    Date: 2014–11–21
  9. By: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
    Abstract: Using US micro price data at the city level, we provide evidence that both the volatility and the persistence of deviations from the law of one price (LOP) are rising in the distance between US cities. A standard, two-city, stochastic equilibrium model with trade costs can predict the relationship between volatility and distance but not between persistence and distance. To account for the latter fact, we augment the standard model with noisy signals about the state of nominal aggregate demand that are asymmetric across cities. We further show that the main predictions of the model continue to hold even if we allow for the interaction of imperfect information, sticky prices, and multiple cities.
    Keywords: Real exchange rates, Law of one price, Relative prices, Trade cost
    JEL: E31 F31 D40
    Date: 2014–12
  10. By: Christian D. Dick; Ronald MacDonald; Lukas Menkhoff
    Abstract: Using a large panel of individual professionals' forecasts, this paper demonstrates that good exchange rate forecasts are related to a proper understanding of fundamentals, specifically good interest rate forecasts. This relationship is robust to individual fixed effects and further controls. Reassuringly, the relationship is stronger during phases when the impact from fundamentals is more obvious, e.g., when exchange rates substantially deviate from their PPP values. Finally, forecasters largely agree that an interest rate increase relates to a currency appreciation, but only good forecasters get expected interest rates right
    Keywords: Exchange Rate Determination, Individual Expectations, Macroeconomic Fundamentals
    JEL: F31 F37 E44
    Date: 2014–11
  11. By: Scott Davis (Hong Kong Institute for Monetary Research and Federal Reserve Bank of Dallas)
    Abstract: This paper will consider whether debt- and equity-based capital inflows have different macroeconomic effects. Using external instruments in a structural VAR, we first identify the component of capital inflows that is driven not by domestic economic and financial conditions but by conditions in the rest of the world. We then estimate the response to an exogenous shock to debt or equity-based capital inflows in a structural VAR model that includes domestic variables like GDP, inflation, the exchange rate, stock prices, credit growth, and interest rates. An exogenous increase in debt inflows leads to a significant increase in GDP, inflation, stock prices and credit growth and an appreciation of the exchange rate. An exogenous increase in equity-based capital inflows has almost no effect on the same variables. Thus the macroeconomic effects of exogenous capital inflows are almost entirely due to changes in debt, not equity-based, capital inflows.
    Keywords: Capital Inflows, Debt, Equity, Macroeconomic Effects
    JEL: F3 F4
    Date: 2014–11
  12. By: Margarita Katsimi (Athens University of Economics and Business; CESifo, Munich); Gylfi Zoega (Department of Economics, Mathematics & Statistics, Birkbeck; University of Iceland)
    Abstract: We estimate the Feldstein-Horioka equation for the period 1960-2012 and find structural breaks that coincide with the introduction of the European single market in 1993, the introduction of the euro in 1999 and the financial crisis in 2008. The results suggest that the correlation between investment and savings depends on institutions, exchange rate risk and credit risk. Furthermore, we find that the pattern of capital flows within the euro zone reflect differences in output per capita, the rate of growth of output per capita and budget balances.
    Keywords: Feldstein-Horioka puzzle, European integration.
    JEL: E2
    Date: 2014–11
  13. By: Ozge Akinci (Board of Governors of the Federal Reserve System); Ryan Chahrour (Boston College)
    Abstract: We show that a model with imperfectly forecastable changes in future productivity and an occasionally-binding collateral constraint can match a set of stylized facts about Sudden Stop events. "Good" news about future productivity raises leverage during times of expansions, increasing the probability that the constraint binds, and a Sudden Stop occurs, in future periods. During the Sudden Stop, the nonlinear effects of the constraint induce output, consumption and investment to fall substantially below trend, as they do in the data. Also consistent with data, the economy exhibits a boom period prior to the Sudden Stop, with output, consumption, and investment all above trend.
    Keywords: News Shocks, Sudden Stops, Leverage, Boom-Bust Cycle
    JEL: E32 F41 F44 G15
    Date: 2014–12–05
  14. By: Sînâ T. Ateş (Department of Economics, University of Pennsylvania); Felipe E. Saffie (Department of Economics, University of Maryland)
    Abstract: We combine the real business cycle small open economy framework with the endogenous growth literature to study the productivity cost of a sudden stop. In this economy, productivity growth is determined by successful implementation of business ideas, yet the quality of ideas is heterogeneous and good ideas are scarce. A representative financial intermediary screens and selects the most promising ideas, which gives rise to a trade-off between mass (quantity) and composition (quality) in the entrant cohort. Chilean plant-level data from the sudden stop triggered by the Russian sovereign default in 1998 confirms the main mechanism of the model, as firms born during the credit shortage are fewer, but better. A calibrated version of the economy shows the importance of accounting for heterogeneity and selection, as otherwise the permanent loss of output generated by the forgone entrants doubles, which increases the welfare cost by 30%.
    Keywords: Financial Selection, Sudden Stop, Endogenous Growth, Firm Entry, Firm Heterogeneity
    JEL: F40 F41 F43 O11 O16
    Date: 2014–11–17
  15. By: Razmi, Arslan (The University of Massachusetts at Amherst)
    Abstract: A large body of literature inspired by the seminal contribution of Marglin and Bhaduri (1988) has debated the distributional determinants of demand and growth. A general conclusion has been that open economy considerations weaken the potential for a wage-led growth regime. How- ever, this literature has largely ignored asset portfolio considerations and the stock and flow interactions that result from the feedback from savings to wealth and from wealth to the current account. This paper develops a theoretical framework that a fuller system of (instantaneous) flow equilibria embedded in a medium-run framework with stable steady state stocks of real and financial assets. The balance of payments constraint that results ensures that simply raising the wage does not yield a higher stock of real capital. A lower mark-up may increase the steady state stock of capital but only through the relative price channel. These results are much stronger than those derived by existing literature, and more importantly, emerge regardless of whether the demand regime is wage-led or profit-led in autarky.
    Keywords: Wage-led growth, stagnationism, exhilarationism, neo-Kaleckian models, distribution, accumulation.
    JEL: F32 F43 E64
    Date: 2014

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