nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒02‒05
eighteen papers chosen by
Martin Berka
University of Auckland

  1. Equilibrium Technology Diffusion, Trade, and Growth By Jesse Perla; Christopher Tonetti; Michael E. Waugh
  2. Macroeconomic Volatility and External Imbalances By Alessandra Fogli; Fabrizio Perri
  3. International Currency Exposures, Valuation Effects and the Global Financial Crisis By Bénétrix, Agustín; Lane, Philip R.; Shambaugh, Jay C
  4. Revisiting the Concept of Dollarization: The Global Financial Crisis and Dollarization in Low-Income Countries By Nkunde Mwase; Francis Y. Kumah
  5. Betting the House By Jordà, Òscar; Schularick, Moritz; Taylor, Alan M.
  6. Global Liquidity and Drivers of Cross-Border Bank Flows By Cerutti, Eugenio; Claessens, Stijn; Ratnovski, Lev
  7. Adjustment mechanisms in a currency area By C. A. E. Goodhart; D. J. Lee
  8. The Effects of Financial and Real Shocks, Structural Vulnerability and Monetary Policy on Exchange Rates from the Perspective of Currency Crises Models By Ryota Nakatani
  9. Interest Rates, Eurobonds and Intra-European Exchange Rate Misalignments: the Challenge of Sustainable Adjustments in the Eurozone. By Vincent Duwicquet; Jacques Mazier; Jamel Saadaoui
  10. The Long and the Short of It: Sovereign Debt Crises and Debt Maturity By Fernández, Raquel; Martin, Alberto
  11. Systemic sovereign risk: macroeconomic implications in the euro area By Saleem A. Bahaj
  12. Relative Prices and Sectoral Productivity By Margarida Duarte; Diego Restuccia
  13. Exchange Rate Pass-Through, Domestic Competition, and Inflation: Evidence from the 2005/08 Revaluation of the Renminbi By Auer, Raphael
  14. Rare Disasters and Exchange Rates By Farhi, Emmanuel; Gabaix, Xavier
  15. Monetary Policy Independence under Flexible Exchange Rates: An Illusion? By Sebastian Edwards
  16. Optimal monetary responses to oil discoveries By Samuel Wills
  17. Is the international border effect larger than the domestic border effect?: evidence from US trade By Cletus C. Coughlin; Dennis Novy
  18. A Long-Run Relationship between Real Exchange Rates and Real Commodity Prices: The Case of Mongolia By Byambasuren, Tsenguunjav

  1. By: Jesse Perla; Christopher Tonetti; Michael E. Waugh
    Abstract: This paper develops a dynamic model of trade and growth that we use to study how openness affects economic growth. In our model, heterogeneous firms choose to either produce with their existing technology or search within the domestic economy to adopt a better technology. These choices determine the productivity distribution from which firms can acquire new technologies and, hence, the equilibrium rate of technological diffusion. Opening to trade changes the relative profitability between high and low productivity firms through expanded export opportunities and foreign competition. These reallocation effects change the timing of when firms adopt new technologies and, thus, the rate of technological diffusion. This results in growth effects from openness via within-firm productivity improvements.
    JEL: A1 E1 F00 F43 O4
    Date: 2015–01
  2. By: Alessandra Fogli; Fabrizio Perri
    Abstract: Does macroeconomic volatility/uncertainty affects accumulation of net foreign assets? In OECD economies over the period 1970-2012, changes in country specific aggregate volatility are, after controlling for a wide array of factors, significantly positively associated with net foreign asset position. An increase in volatility (measured as the standard deviation of GDP growth) of 0.5% over period of 10 years is associated with an increase in the net foreign assets of around 8% of GDP. A standard open economy model with time varying aggregate uncertainty can quantitatively account for this relationship. The key mechanism is precautionary motive: more uncertainty induces residents to save more, and higher savings are in part channeled into foreign assets. We conclude that both data and theory suggest uncertainty/volatility is an important determinant of the medium/long run evolution of external imbalances in developed countries.
    JEL: F32 F34 F41
    Date: 2015–01
  3. By: Bénétrix, Agustín; Lane, Philip R.; Shambaugh, Jay C
    Abstract: We examine the evolution of international currency exposures, with a particular focus on the 2002-12 period. During the run up to the global financial crisis, there was a widespread shift towards positive net foreign currency positions, such that relatively few countries exhibited the archetypal emerging-market “short foreign currency” position on the eve of the global financial crisis. During the crisis, the upheaval in currency markets generated substantial currency-generated valuation effects - much of which were not reversed. There is some evidence that the distribution of valuation effects was stabilizing in the sense of showing a negative covariation pattern with pre-crisis net foreign asset positions.
    Keywords: global financial crisis; international currency exposures; valuation effects
    JEL: F30 F31
    Date: 2015–01
  4. By: Nkunde Mwase; Francis Y. Kumah
    Abstract: The economic literature has examined deposit dollarization in nominal terms, typically focusing on the ratio of foreign currency deposits to broad money. However, while private agent demand for foreign currency may remain unchanged in foreign currency terms, there could be large fluctuations in the dollarization ratio simply due to exchange rate movements. This paper proposes a new approach to measuring dollarization that removes these exchange rate effects, and demonstrates that beyond the variance of inflation and depreciation, the level of inflation and size of depreciation also matter for dollarization. While dollarization in nominal terms surged during the recent global financial crisis, there was a downward trend in real terms. Employing a set of econometric estimators, this paper investigates whether “real†dollarization during 2006–09 was associated with the crisis, and the role of initial macroeconomic conditions, quality of institutions, risk aversion, and prudential measures. We find that exchange rate appreciation and reductions in sovereign risk do moderate dollarization; but the results for global volatility have low statistical significance, perhaps because global shocks tend to preserve, to a large extent, relative attractiveness of foreign assets. Nonetheless, estimated impulse-response functions point to a large but short-lived positive impact of global volatility on dollarization, which could reflect economic agents heightened concerns about spillover effects of global uncertainty on the domestic economy.
    Keywords: Dollarization;Low-income developing countries;Global Financial Crisis 2008-2009;Exchange rate appreciation;Sovereign risk;Econometric models;deposit dollarization, financial crisis, GMM, impulse response, flight to quality.
    Date: 2015–01–22
  5. By: Jordà, Òscar; Schularick, Moritz; Taylor, Alan M.
    Abstract: Is there a link between loose monetary conditions, credit growth, house price booms, and financial instability? This paper analyzes the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. We use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.
    Keywords: credit; financial crises; house prices; instrumental variables; leverage; local projections; monetary policy
    JEL: C14 C38 E32 E37 E42 E44 E51 E52 F41 G01 G21 N10 N20
    Date: 2014–12
  6. By: Cerutti, Eugenio; Claessens, Stijn; Ratnovski, Lev
    Abstract: This paper studies the determinants of global liquidity using data on cross-border bank flows, with a longer time series and broader country sample than previous studies. We define global liquidity as non-price determinants of cross-border credit supply, consistent with its meaning as the “ease of financing” in international financial markets. We find that global liquidity is driven primarily by uncertainty (VIX), US monetary policy (term premia), and UK and Euro Area bank conditions (proxied by leverage and TED spreads). This expands on previous studies by highlighting non-US drivers of global liquidity, and is consistent with the dominant role of European banks in cross-border lending. We also show that borrowing countries can limit their exposures to global liquidity fluctuations through adapting their macro frameworks, capital flow management tools, and bank regulation.
    Keywords: Capital Flows; Global liquidity; International Banking
    JEL: F21 F34 G15 G18 G21 G28
    Date: 2014–12
  7. By: C. A. E. Goodhart; D. J. Lee
    Abstract: Both the euro-area and the United States suffered an initially quite similar housing and financial shock in 2007/8, with several states in both regions being particularly badly affected. Yet there was never any question that the worst hit US states would need a special bail-out or leave the dollar area, whereas such concerns have worsened in the euro-area. We focus on three badly affected states, Arizona, Spain and Latvia, to examine the working of relative adjustment mechanisms within the currency region. We concentrate on four such mechanisms, relative wage adjustment, migration, net fiscal flows and bank flows. Only in Latvia was there any relative wage adjustment. Intra-EU migration has increased, but is more costly for those involved in the EU (than in the USA). Net federal financing helped Arizona and Latvia in the crisis, but not Spain. The locally focussed structure of banking amplified the crisis in Spain, whereas the role of out-of-state banks eased adjustment in Arizona and Latvia. The latter reinforces the case for an EU banking union.
    Keywords: adjustment mechanisms; asymmetric shocks; banking union; fiscal transfers; migration and relative unit labour costs
    JEL: F3 G3
    Date: 2013–09
  8. By: Ryota Nakatani (Bank of Japan)
    Abstract: Is there any factor that is not analyzed in the literature but is important for preventing currency crises? What kind of shock is important as a trigger of a currency crisis? Given the same shock, how does the impact of a currency crisis differ across countries depending on the degree of each country’s structural vulnerability? To answer these questions, this paper analyzes currency crises both theoretically and empirically. In the theoretical part, I argue that exports are an important factor to prevent currency crises that has not been frequently analyzed in the existing theoretical literature. Using the third generation model of currency crises, I derive a simple and intuitive formula that captures an economy’s structural vulnerability characterized by the elasticity of exports and repayments for foreign currency denominated debt. I graphically show that the possibility of currency crisis equilibrium depends on this structural vulnerability. In the empirical part, I use unbalanced panel data comprising 51 emerging countries from 1980 to 2011. The results obtained here are consistent with the prediction of the theoretical models. First, I found that monetary tightening by the central banks can have a significant effect on exchange rates. Second, I found that both productivity shocks in the real sector and shocks to a country’s risk premium in the financial markets affect exchange rate dynamics, while productivity shocks appeared more quantitatively important during the Asian currency crisis. Finally, the structural vulnerability of the country plays a statistically significant role for propagating the effects of the shock.
    Keywords: Currency Crisis; Foreign Currency Debt; Exports; Productivity Shock; Risk Premium; Monetary Policy; Elasticity
    JEL: E22 E4 E5 F1 F3 F4 G15 G2 O43
    Date: 2014–12
  9. By: Vincent Duwicquet; Jacques Mazier; Jamel Saadaoui
    Abstract: The euro zone crisis illustrates the deficiencies of adjustment mechanisms in a monetary union characterized by a large heterogeneity. Exchange rate adjustments being impossible, they are very few alternative mechanisms. At the level of the whole euro zone the euro is close to its equilibrium parity. But the euro is strongly overvalued for Southern European countries, France included, and largely undervalued for Northern European countries, especially Germany. The paper gives a new evaluation of these exchange rate misalignments inside the euro zone, using a FEER approach, and examines the evolution of competitiveness. In a second step, we use a two-country SFC model of a monetary union with endogenous interest rates and eurobonds issuance. Three main results are obtained. Facing a competitiveness loss in southern countries due to exchange rates misalignments, increasing intra-European financing by banks of northern countries or other institutions could contribute to reduce the debt burden and induce a partial recovery but public debt would increase. Implementation of eurobonds as a tool to partly mutualize European sovereign debt would have a rather similar positive impact, but with a public debt limited to 60% of GDP. Furthermore, eurobonds could also be used to finance large European projects which could impulse a stronger recovery in the entire euro zone with stabilized current account imbalances. However, the settlement of a European Debt Agency in charge of the issuance of the eurobonds would face strong political obstacles.
    Keywords: Eurozone Crisis, Sustainable Adjustments, Exchange Rate Misalignments, Eurobonds, Interest Rate.
    JEL: C23 F31 F32 F37 F41 E12
    Date: 2015
  10. By: Fernández, Raquel; Martin, Alberto
    Abstract: We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent. We show that in order to satisfy incentive compatibility the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. We examine two policies -- restructuring and reprofiling -- and show that both improve ex ante welfare if structured correctly. Key to the welfare results is the country's ability to choose its debt structure so as to neutralize any negative effects resulting from redistribution of payments across creditors in times of crises.
    Keywords: dilution; optimal maturity; sovereign debt
    JEL: F15 F33 F34 F36 F41
    Date: 2014–12
  11. By: Saleem A. Bahaj
    Abstract: What are the macroeconomic implications of changes in sovereign risk premia? In this paper, I use a novel identification strategy coupled with a new dataset for the Euro Area to answer this question. I show that exogenous innovations in sovereign risk premia were an important driver of the economic dynamics of crisis-hit countries, explaining 30-50% of the forecast error of unemployment. I also shed light on the mechanisms through which this occurs. Fluctuations in sovereign risk premia explain 20-40% of the variance of private borrowing costs. Increases in sovereign risk result in substantial capital flight, external adjustment and import compression. In contrast, governments appear not to increase their primary balances in response to increases in sovereign risk. Identifying these causal effects involves isolating a source of fluctuations in sovereign borrowing costs exogenous to the economy in question. I address this problem by relying upon the transmission of country-specific events during the crisis in Europe to the sovereign risk premia in the remainder of the union. I construct a new dataset of critical events in foreign crisis-hit countries and I measure the impact of these events on yields in the economy of interest at an intraday frequency. An aggregation of foreign events serve as a proxy variable for structural innovations to the yield to identify shocks in a proxy SVAR. I extend this methodology into a Bayesian setting to allow for flexible panel assumptions. A counterfactual analysis is used to remove the impact of foreign events from the bond yields of crisis hit countries: I find that 40-60% of the trough-to-peak moves in bond yields in crisis-hit countries are explained by foreign events, thereby suggesting that the crisis was not purely a function of weak local economic conditions.
    Keywords: high frequency identification; narrative identification; contagion; Bayesian VARs; proxy SVARs; panel VAR
    JEL: E44 E65 F42
    Date: 2014–05
  12. By: Margarida Duarte; Diego Restuccia
    Abstract: The relative price of services rises with development. A standard interpretation of this fact is that cross-country productivity differences are larger in manufacturing than in services. The service sector comprises heterogeneous categories. We document that the behavior of relative prices is markedly different across two broad classifications of services: traditional services, such as health and education, feature a rising relative price with development and non-traditional services, such as communication and transportation, feature a falling relative price with income. Using a standard model of structural transformation with an input-output structure, we find that cross-country productivity differences are much larger in non-traditional services (a factor of 106.5-fold between rich and poor countries) than in manufacturing (24.5-fold). Moreover, this relative productivity difference is reduced by more than half when abstracting from intermediate inputs. Development requires an emphasis on solving the productivity problem in non-traditional services in poor countries.
    Keywords: Productivity, services, traditional, non-market, structural transformation, input-output structure.
    JEL: O1 O4 E0
    Date: 2015–01–21
  13. By: Auer, Raphael
    Abstract: Import competition from China is pervasive in the sense that for many good categories, the competitive environment that US firms face in these markets is strongly driven by the prices of Chinese imports, and so is their pricing decision. This paper quantifies the effect of the government-controlled appreciation of the Chinese renminbi vis-à-vis the USD from 2005 to 2008 on the prices charged by US domestic producers. In a panel spanning the period from 1994 to 2010 and including up to 519 manufacturing sectors, import price changes of Chinese goods pass into US producer prices at an average rate of 0.7, while import price changes that can be traced back to exchange rate movements of other trade partners only have mild effects on US prices. Further analysis points to the importance of trade integration, variable markups, and demand complementarities on the one side, and to the importance of imported intermediate goods on the other side as drivers of these patterns. Simulations incorporating these microeconomic findings reveal that a substantial revaluation of the renminbi would result in a pronounced increase of aggregate US producer price inflation.
    Keywords: China; exchange rate pass-through; inflation; monetary policy; price complementarities
    JEL: E31 E37 F11 F12 F14 F15 F16 F40 L16
    Date: 2015–01
  14. By: Farhi, Emmanuel; Gabaix, Xavier
    Abstract: We propose a new model of exchange rates, based on the hypothesis that the possibility of rare but extreme disasters is an important determinant of risk premia in asset markets. The probability of world disasters as well as each country's exposure to these events is time-varying. This creates joint fluctuations in exchange rates, interest rates, options, and stock markets. The model accounts for a series of major puzzles in exchange rates: excess volatility and exchange rate disconnect, forward premium puzzle and large excess returns of the carry trade, and comovements between stocks and exchange rates. It also makes empirically successful signature predictions regarding the link between exchange rates and telltale signs of disaster risk in currency options.
    Keywords: disaster risk; forward premium puzzle; international macro-finance puzzles; risk-reversals; uncovered interest rate parity
    JEL: G12 G15
    Date: 2015–01
  15. By: Sebastian Edwards
    Abstract: I analyze whether countries with flexible exchange rates are able to pursue an independent monetary policy, as suggested by traditional theory. I use data for three Latin American countries with flexible exchange rates, inflation targeting, and capital mobility – Chile, Colombia and Mexico – to investigate the extent to which Federal Reserve actions are translated into local central banks’ policy rates. The results indicate that there is significant “policy contagion,” and that these countries tend to “import” Fed policies. The degree of monetary policy independence is lower than what traditional models suggest.
    JEL: E5 E52 E58 F30 F31 F32
    Date: 2015–01
  16. By: Samuel Wills
    Abstract: This paper studies how monetary policy should respond to news about an oil discovery, using a workhorse New Keynesian model. Good news about future production can create a recession today under exchange rate pegs and a simple Taylor rule, as seen in practice. This is explained by forward-looking inflation. Recession is avoided by a Taylor rule that accommodates changes in the natural level of output, which closely approximates optimal policy. Central banks have an incentive to exploit oil revenues by appreciating the terms of trade, creating “Dutch disease” and a deflationary bias which is overcome by committing to future policy.
    Keywords: natural resources; oil; optimal monetary policy; small open economy; news shock
    JEL: E52 E62 F41 O13 Q30 Q33
    Date: 2014–04
  17. By: Cletus C. Coughlin; Dennis Novy
    Abstract: Many studies have found that international borders represent large barriers to trade. But how do international borders compare to domestic border barriers? We investigate international and domestic border barriers in a unified framework. We consider a data set of exports from individual US states to foreign countries and combine it with trade flows between and within US states. After controlling for distance and country size, we estimate that relative to state-to-state trade, crossing an individual US state’s domestic border appears to entail a larger trade barrier than crossing the international US border. Due to the absence of governmental impediments to trade within the United States, this result is surprising. We interpret it as highlighting the concentration of economic activity and trade flows at the local level.
    Keywords: international border; intranational home bias; domestic border; gravity; trade costs; distance
    JEL: F10 F15
    Date: 2013–06
  18. By: Byambasuren, Tsenguunjav
    Abstract: In Mongolia, the mining sector has been upgraded and developed very sharply last few years and some international experts stated that this growth will be hold up related to the strategic deposits such as Oyu tolgoi, Tavan tolgoi. It shows that Mongolia will become more relative to the foreign economy in the further. So, this paper tries to examine whether the real exchange rate and the real price of commodity exports move together over time in case of Mongolia. In this paper, we used the Engle and Granger (1987) co-integration approach to assess the long-run relationships between two variables and according to empirical results, the increase in price of Mongolian commodity exports appreciates the domestic real exchange rate. Also, the average half-life of adjustment of real exchange rates to commodity price is found to be about six months.
    Keywords: Commodity currency, exchange rates, cointegration approach, developing country
    JEL: C51 F11
    Date: 2013–01–13

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