nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒02‒11
nineteen papers chosen by
Martin Berka
University of Auckland

  1. Noisy information, distance and law of one price dynamics across US cities By Crucini, Mario J.; Shintani, Mototsugu; Tsuruga, Takayuki
  2. The role of two frictions in geographic price dispersion: when market friction meets nominal rigidity By Choi, Chi-Young; Choi, Horag
  3. Exchange Rate Dynamics under Financial Market Frictions By Cristina Terra; Hyunjoo Ryou
  4. Tracking the Exchange Rate Management in Latin America By César Carrera
  5. International Credit Flows and Pecuniary Externalities By Brunnermeier, Markus K; Sannikov, Yuliy
  6. Trilemma, not dilemma: financial globalisation and Monetary policy effectiveness By Georgiadis, Georgios; Mehl, Arnaud
  7. Trends and cycles in small open economies: making the case for a general equilibrium approach By Chen, Kan; Crucini, Mario J.
  8. The international transmission of credit bubbles: theory and policy By Alberto Martin; Jaume Ventura
  9. Capital Controls and the Cost of Debt By Eugenia Andreasen; Martin Schindler; Patricio Valenzuela
  10. Unconventional monetary policy in an open economy By Gieck, Jana
  11. Bitcoin and the PPP Puzzle By Calebe de Roure; Paolo Tasca
  12. Financial Integration, Volatility of Financial Flows and Macroeconomic Volatility By Mirdala, Rajmund; Svrčeková, Aneta
  13. Global liquidity, house prices and the macroeconomy: evidence from advanced and emerging economies By Cesa-Bianchi, Ambrogio; Cespedes, Luis; Rebucci, Alessandro
  14. Geographic barriers to commodity price integration: evidence from US cities and Swedish towns, 1732-1860 By Crucini, Mario J.; Smith, Gregor W.
  15. A seniority arrangement for sovereign debt By Chatterjee, Satyajit; Eyigungor, Burcu
  16. External Equity Financing Costs, Financial Flows, and Asset Prices By Xiaoji Lin; Fan Yang; Frederico Belo
  17. Macroeconomic consequences of the real-financial nexus: Imbalances and spillovers between China and the U.S. By Pang, Ke; Siklos, Pierre L.
  18. The Liquidation of Government Debt By Carmen Reinhart; M. Belen Sbrancia
  19. Globalization and synchronization of innovation cycles By Kiminori Matsuyama; Iryna Sushko; Laura Gardini

  1. By: Crucini, Mario J. (Vanderbilt University); Shintani, Mototsugu (Vanderbilt University); Tsuruga, Takayuki (Kyoto University and CAMA)
    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.
    JEL: D40 E31 F31
    Date: 2014–11–01
  2. By: Choi, Chi-Young (University of Texas at Arlington); Choi, Horag (Monash University)
    Abstract: This paper empirically investigates and theoretically derives the implications of two frictions, market friction and nominal rigidity, on the dynamic properties of intra-national relative prices, with an emphasis on the interaction of the two frictions. By analyzing a panel of retail prices of 45 products for 48 cities in the U.S., we make two major arguments. First, the effect of each type of friction on the dynamics of intercity price gaps is quite different. While market frictions arising from physical distance and transportation costs contribute significantly to volatile and persistent movements of intercity price disparities, nominal rigidity is associated with higher persistence, but not with a greater volatility of the intercity price disparity. This empirical evidence is different from what is predicted by standard theoretical models based on price stickiness. Second, the strength of the marginal effect of a market friction hinges on the extent of nominal rigidity, in a counteracting manner. The marginal effect of a market friction dwindles as the extent of price stickiness increases. We provide an alternative theoretical explanation for this finding by extending the state- dependent pricing(SDP)model of Dotsey et al.(1999) and show that our two-city model with nominal rigidity andd market frictions can successfully explain the salient features of the dynamic behavior of intercity price differences.
    JEL: E31 F15 L16 R12
    Date: 2014–12–01
  3. By: Cristina Terra; Hyunjoo Ryou (Université de Cergy-Pontoise, THEMA)
    Abstract: This paper extends Dornbusch's overshooting model by proposing a generalized interest parity condition (GIP), which captures a sluggish adjustment on the asset market. The exchange rate model under the GIP is able to reproduce the delayed overshooting and the hump-shaped response to monetary shocks of both nominal and real exchange rates. Fur- thermore, we present empirical results for OECD member countries which fit the theoretical predictions.
    Keywords: Exchange rates; Interest rate parity; Overshooting; Purchasing power parity puzzle; Monetary policy
    JEL: E52 F31 F41 F47
    Date: 2015
  4. By: César Carrera (Banco Central de Reserva del Perú)
    Abstract: The exchange rate is one of the most important prices in any open economy. Tracking deviations from its long-run value may provide important information for policymakers. One way to track such deviations is to compute the distribution of exchange-rate observed values and compare them with those of Benford’s law. I document such cases for 15 Latin American countries, for the two most widely traded currencies. Latin American countries are small open economies that are characterized for having different degrees of dollarization and intervention in the forex market. This is an alternative view of how these characteristics play a role with respect to an implied equilibrium exchange rate.
    Keywords: Exchange rate, Forex, Benford’s law
    JEL: C16 F31 F41
    Date: 2015–01
  5. By: Brunnermeier, Markus K; Sannikov, Yuliy
    Abstract: This paper develops a dynamic two-country neoclassical stochastic growth model with incomplete markets. Short-term credit flows can be excessive and reverse suddenly. The equilibrium outcome is constrained inefficient due to pecuniary externalities. First, an undercapitalized country borrows too much since each firm does not internalize that an increase in production capacity undermines their output price, worsening their terms of trade. From an ex-ante perspective each firm undermines the natural “terms of trade hedge.” Second, sudden stops and fire sales lead to sharp price drops of illiquid capital. Capital controls or domestic macro-prudential measures that limit short-term borrowing can improve welfare.
    Keywords: hot money; international capital flows; international credit flows; pecuniary externalities; sudden stops; terms of trade hedge
    JEL: F33 F34 F36 F41 G15
    Date: 2015–01
  6. By: Georgiadis, Georgios (European Central Bank); Mehl, Arnaud (European Central Bank)
    Abstract: We investigate whether the classic Mundell-Flemming "trilemma" has morphed into a "dilemma" due to financial globalisation. According to the dilemma hypothesis, global financial cycles determine domestic financial conditions regardless of an economy's exchange rate regime and monetary policy autonomy is possible only if capital mobility is restricted. We find that global financial cycles indeed reduce domestic monetary policy effectiveness in more financially integrated economies. However, we also find that another salient feature of financial globalisation has the opposite effect and amplifies monetary policy effectiveness. Economies increasingly net long in foreign currency experience larger valuation effects on their external balance sheets in response to exchange rate movements triggered by monetary policy impluses. Overall, we find that the net effect of financial globalisation since the 1990s has been to amplify monetary policy effectiveness in the typical advanced and emerging market economy. Specifically, our results suggest that the output effect of a tightening in monetary policy has been stronger by 40% due to financial globalisation. Insofar as valuation effects can only play out if an economy's exchange rate is flexible, the choice of the exchange rate regime remains critical for monetary policy autonomy under capital mobility and in the presence of global financial cycles. Thus, our results suggest that the classic trilemma remains valid.
    JEL: E52 F30 F41
    Date: 2015–01–01
  7. By: Chen, Kan (International Monetary Fund); Crucini, Mario J. (Vanderbilt University)
    Abstract: Economic research into the causes of business cycles in small open economies is almost always undertaken using a partial equilibrium model. This approach is characterized by two key assumptions. The first is that the world interest rate is unaffected by economic developments in the small open economy, an exogeneity assumption. The second assumption is that this exogenous interest rate combined with domestic productivity is sufficient to describe equilibrium choices. We demonstrate the failure of the second assumption by contrasting general and partial equilibrium approaches to the study of a cross- section of small open economies. In doing so, we provide a method for modeling small open economies in general equilibrium that is no more technically demanding than the small open economy approach while preserving much of the value of the general equilibrium approach.
    JEL: E32 F41
    Date: 2014–11–01
  8. By: Alberto Martin; Jaume Ventura
    Abstract: We live in a new world economy characterized by financial globalization and historically low interest rates. This environment is conducive to countries experiencing credit bubbles that have large macroeconomic effects at home and are quickly propagated abroad. In previous work, we built on the theory of rational bubbles to develop a framework to think about the origins and domestic effects of these credit bubbles. This paper extends that framework to two-country setting and studies the channels through which credit bubbles are transmitted across countries. We find that there are two main channels that work through the interest rate and the terms of trade. The former constitutes a negative spillover, while the latter constitutes a negative spillover in the short run but a positive one in the long run. We study both cooperative and noncooperative policies in this world. The interest-rate and terms-of-trade spillovers produce policy externalities that make the noncooperative outcome suboptimal.
    Keywords: financial globalization, international capital flows, exchange rates, interest rates, asset bubbles, capital controls
    JEL: E32 E44 O40
    Date: 2015–01
  9. By: Eugenia Andreasen; Martin Schindler; Patricio Valenzuela
    Abstract: Using a novel panel data set for international corporate bonds and capital account restrictions in advanced and emerging economies, we find that restrictions on capital inflows produce a substantial and economically meaningful increase in corporate bond spreads. By contrast, we find no robust significant effect of restrictions on outflows. The effect of capital account restrictions on inflows is particularly strong for bonds maturing in the short-term, issued by small firms and in countries with underdeveloped financial markets. Additionally, the paper shows that capital account restrictions on inflows have a greater effect during periods of financial distress than during periods of financial stability. These results are suggestive of a causal interpretation of the estimated effects and establish a novel channel through which capital controls affect economic outcomes.JEL CODE: F3, F4, G1, G3. Key words: KEY WORDS: Credit spreads; Capital account restrictions; Financial instability; Financial openness.
    Date: 2015
  10. By: Gieck, Jana
    Abstract: The impact of unconventional monetary policies on exchange rates and its spillovers to other economies is not yet fully understood. In this paper I develop a two-country DSGE model with interbank markets and endogenous default probabilities to analyze the cross-border impacts of unconventional monetary policy. I examine the impact of two unconventional measures commonly used: central bank liquidity injections and asset swaps. I find that liquidity injections lead to a short run appreciation of domestic currency, but a mild long run depreciation. In contrast, asset swaps cause a short run depreciation of domestic currency, but a long run appreciation. Lastly, when both countries coordinate on the implementation of unconventional policies, the model yields the following results: Non-coordinated liquidity injections lead to higher increases with respect to output and inflation variation, but have negative spillovers on the other economy in terms of lower growth. By contrast, coordinating asset swaps leads to higher increases in output and lower fluctuation in inflation in both countries. The results of this paper suggest that coordination in unconventional monetary policy may not always yield an optimal outcome, and macroeconomic outcomes in both countries depend crucially on the choice of instrument.
    Keywords: Unconventional Monetary Policy,Quantitative Easing,Asset Swaps,Open Economy DSGE,Currency Wars,Policy Coordination
    JEL: E02 E44 E52 G21 G28
    Date: 2014
  11. By: Calebe de Roure; Paolo Tasca
    Abstract: This paper approaches the PPP puzzle by using the Bitcoin/US Dollar exchange rate. The use of the virtual currency as macroeconomic laboratory allows us to remove frictions that previously impeded the empirical demonstration of the law of one price. We show that price adjustments are still far from perfect due to information asymmetry between agents. Nevertheless, the real exchange rate is stationary and adjusts by 81% within one day. Finally, because of the different speed of information spread, good market arbitrage takes place in the Bitcoin economy but not in the US economy. Thus, we conclude that in a frictionless economy the PPP holds and the speed of arbitrage for the good market depends on the speed of information spread among agents.
    Keywords: bitcoin; purchase power parity; silk road
    JEL: J1
    Date: 2014–07–30
  12. By: Mirdala, Rajmund; Svrčeková, Aneta
    Abstract: Macroeconomic instability is usually associated with increased short-term volatility in key fundamental variables. The recent literature that empirically examines implications of the macroeconomic volatility provides strong evidence of its negative growth effects. Stable macroeconomic environment represents a substantial fundamental pillar of a long-term economic growth. International financial integration as one of the phenomenon of last few decades still differentiate economists examining its direct and side effects on macroeconomic performance and volatility. In the paper we examine the relationship between international financial integration, volatility of financial flows and macroeconomic volatility. Examination of the international financial integration and its effects on macroeconomic volatility or stability is particularly important due to existence of generally expected positive relationship between macroeconomic volatility and economic growth, common trends of decreased macroeconomic instability worldwide and occurrence of negative sides of financial integration - financial crises. Following our results we suggest that relationship between financial integration, volatility of financial flows and macroeconomic volatility is positive, however not significant. Moreover the relationship is stronger in case of developing countries.
    Keywords: international financial integration, volatility of international financial flows, macroeconomic volatility
    JEL: F36 F41 F43
    Date: 2014–04
  13. By: Cesa-Bianchi, Ambrogio (Bank of England); Cespedes, Luis (Universidad Adolfo Ibanez); Rebucci, Alessandro (Johns Hopkins University Carey Business School)
    Abstract: In this paper we first compare house price cycles in advanced and emerging economies using a new quarterly house price data set covering the period 1990-2012. We find that house prices in emerging economies grow faster, are more volatile, less persistent and less synchronised across countries than in advanced economies. We also find that they correlate with capital flows more closely than in advanced economies. We then condition the analysis on an exogenous change to a particular component of capital flows: global liquidity, broadly understood as a proxy for the international supply of credit. We identify this shock by aggregating bank-to-bank cross-border credit flows and by using the external instrumental variable approach introduced by Stock and Watson and Mertens and Ravn. We find that in emerging markets a global liquidity shock has a much stronger impact on house prices and consumption than in advanced economies. We finally show that holding house prices constant in response to this shock tends to dampen its effects on consumption in both advanced and emerging economies, but possibly through different channels: in advanced economies by boosting the value of housing collateral and hence supporting domestic borrowing; in emerging markets, by appreciating the exchange rate and hence supporting the international borrowing capacity of the economy.
    Keywords: Capital flows; emerging markets; global liquidity; house prices; external instrumental variables
    JEL: C32 E44 F44
    Date: 2015–01–23
  14. By: Crucini, Mario J. (Vanderbilt University); Smith, Gregor W. (Federal Reserve Bank of Dallas)
    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 apoleonic Wars, stopping the process by two or three decades on average.
    JEL: N70
    Date: 2014–11–01
  15. By: Chatterjee, Satyajit (Federal Reserve Bank of Philadelphia); Eyigungor, Burcu (Federal Reserve Bank of Philadelphia)
    Abstract: A sovereign's inability to commit to a course of action regarding future borrowing and default behavior makes long-term debt costly (the problem of debt dilution). One mechanism to mitigate the debt dilution problem is the inclusion of a seniority clause in sovereign debt contracts. In the event of default, creditors are to be paid off in the order in which they lent (the “absolute priority" or “first-in-time" rule). In this paper, we propose a modification of the absolute priority rule that is more suited to the sovereign debt context and analyze its positive and normative implications within a quantitatively realistic model of sovereign debt and default.
    Keywords: Debt dilution; Seniority; Sovereign default
    JEL: E44 F34 G12 G15
    Date: 2015–01–31
  16. By: Xiaoji Lin (The Ohio State University); Fan Yang (University of Hong Kong); Frederico Belo (University of Minnesota and NBER)
    Abstract: The recent financial crisis in 2007-2008 suggests that financial shocks, the aggregate disturbances that originate directly in the financial sector, can play an important role as a source of business cycle fluctuations. In this paper, we explore the impact of aggregate shocks to the cost of equity issuance on asset prices in the cross section. We document that an empirical proxy of equity issuance cost shocks forecast future economic activity (output, consumption, and investment), and is a source of systematic risk: exposure to this shock helps price the cross section of stock returns including book-to-market, size, investment, and cash-flow portfolios. We propose a dynamic investment-based model that features an aggregate shock to the firms’ cost of external equity issuance, and a collateral constraint. Our central finding is that time-varying external ï¬nancing costs are crucial for the model to quantitatively capture the joint dynamics of firms’ real quantities, financing flows, and asset prices. Furthermore, the model also replicates the failure of the unconditional CAPM in pricing the cross-sectional expected returns.
    Date: 2014
  17. By: Pang, Ke (BOFIT); Siklos, Pierre L. (BOFIT)
    Abstract: Relying on quarterly data since 1998 we estimate, for China and the U.S., small scale econometric models that economize on the number of variables employed and yet are rich enough to provide useful insights about spillover effects between the two countries under different maintained assumptions about the exogeneity of the macroeconomic relationship between them. We conclude that inflation in China responds to credit shocks. Indeed, the monetary transmission mechanism in China resembles that of the US even if the channels through which monetary policy affects their respective economies differ. We also find that the monetary policy stance of the PBOC was helpful in mitigating the impact of the global financial crisis of 2008-9. Finally, spillovers from the US to China are significant and originate from both through the real and financial sectors of the US economy.
    Keywords: spillovers; monetary policy in China; dynamic factor models; credit
    JEL: C32 E52 E58
    Date: 2015–01–18
  18. By: Carmen Reinhart; M. Belen Sbrancia
    Abstract: High public debt often produces the drama of default and restructuring. But debt is also reduced through financial repression, a tax on bondholders and savers via negative or belowmarket real interest rates. After WWII, capital controls and regulatory restrictions created a captive audience for government debt, limiting tax-base erosion. Financial repression is most successful in liquidating debt when accompanied by inflation. For the advanced economies, real interest rates were negative ½ of the time during 1945–1980. Average annual interest expense savings for a 12—country sample range from about 1 to 5 percent of GDP for the full 1945–1980 period. We suggest that, once again, financial repression may be part of the toolkit deployed to cope with the most recent surge in public debt in advanced economies.
    Keywords: Public debt;Real interest rates;Negative interest rates;Interest rate ceilings;Debt reduction;Developed countries;deleveraging, inflation, financial repression, public debt
    Date: 2015–01–21
  19. By: Kiminori Matsuyama (Northwestern University, USA); Iryna Sushko (Institute of Mathematics, National Academy of Science of Ukraine); Laura Gardini
    Abstract: We propose and analyze a two-country model of endogenous innovation cycles. In autarky, innovation fluctuations in the two countries are decoupled. As the trade costs fall and intra-industry trade rises, they become synchronized. This is because globalization leads to the alignment of innovation incentives across firms based in different countries, as they operate in the increasingly global (hence common) market environment. Furthermore, synchronization occurs faster (i.e., with a smaller reduction in trade costs) when the country sizes are more unequal, and it is the larger country that dictates the tempo of global innovation cycles with the smaller country adjusting its rhythm to the rhythm of the larger country. These results suggest that adding endogenous sources of productivity fluctuations might help improve our understanding of why countries that trade more with each other have more synchronized business cycles.
    Keywords: Endogenous innovation cycles and productivity co-movements; Globalization, Home market effect; Synchronized vs. Asynchronized cycles; Synchronization of coupled oscillators; Basins of attraction; Two-dimensional, piecewise smooth, noninvertible maps
    JEL: C61 E32 F12 F44 O31
    Date: 2015–02

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