nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒03‒22
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Can International Macroeconomic Models Explain Low-Frequency Movements of Real Exchange Rates? By Pau Rabanal; Juan F. Rubio-Ramírez
  2. Sovereign Debt, Bail-Outs and Contagion in a Monetary Union By Eijffinger, S.C.W.; Kobielarz, M.L.; Uras, R.B.
  3. Capital Flows and Domestic and International Order: Trilemmas from Macroeconomics to Political Economy and International Relations By Michael Bordo; Harold James
  4. Crash Risk in Currency Markets By Emmanuel Farhi; Samuel Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan
  5. Gambling for Redemption and Self-Fulfilling Debt Crises By Juan Carlos Conesa; Timothy J. Kehoe
  6. Dynamic Effect of a Change in the Exchange Rate System: From a Fixed Regime to a Basket-Peg or a Floating Regime By Yoshino, Naoyuki; Kaji, Sahoko; Asonuma, Tamon
  7. Prolonged Reserves Accumulation, Credit Booms, Asset Prices and Monetary Policy in Asia By Andrew J. Filardo, Pierre L. Siklos
  8. Estimating Capital Flows to Emerging Market Economies with Heterogeneous Panels By Hernandez Vega Marco A
  9. Euro-Dollar Polarixation and Heterogeneity in Exchange Rate Pass-Throughs Within the Euro Zone By Mariarosaria Comunale
  10. Monetary Union with A Single Currency and Imperfect Credit Market Integration. By V. Bignon; R. Breton; M. Rojas Breu
  11. Optimum Currency Area and Business Cycle Synchronization Across U.S. States By Luís Aguiar-Conraria; Pedro Brinca; Haukur Viðar Guðjónsson; Maria Joana Soares
  12. Globalization, Market Structure and the Flattening of the Phillips Curve. By S. Guilloux-Nefussi
  13. 'Sudden Floods, Macroprudential Regulation and Stability in an Open Economy' By Pierre-Richard Agénor; K. Alper; L. Pereira da Silva

  1. By: Pau Rabanal; Juan F. Rubio-Ramírez
    Abstract: Real exchange rates exhibit important low-frequency fluctuations. This makes the analysis of real exchange rates at all frequencies a more sound exercise than the typical business cycle one, which compares actual and simulated data after the Hodrick- Prescott filter is applied to both. A simple two-country, two-good, international real business cycle model can explain the volatility of the real exchange rate when all frequencies are studied. The puzzle is that the model generates too much persistence of the real exchange rate instead of too little, as the business cycle analysis asserts. We show that the introduction of input adjustment costs in production, cointegrated productivity shocks across countries, and lower home bias allows us to reconcile theory and this feature of the data.
    Date: 2015–04
  2. By: Eijffinger, S.C.W. (Tilburg University, Center For Economic Research); Kobielarz, M.L. (Tilburg University, Center For Economic Research); Uras, R.B. (Tilburg University, Center For Economic Research)
    Abstract: Abstract: The European sovereign debt crisis is characterized by the simultaneous surge in borrowing costs in the GIPS countries after 2008. We present a theory, which can account for the behavior of sovereign bond spreads in Southern Europe between 1998 and 2012. Our key theoretical argument is related to the bail-out guarantee provided by a monetary union, which endogenously varies with the number of member countries in sovereign debt trouble. We incorporate this theoretical foundation in an otherwise standard small open economy DSGE model and explain (i) the convergence of interest rates on sovereign bonds following the European monetary integration in late 1990s, and (ii) - following the heightened default risk of Greece - the sudden surge in interest rates in countries with relatively sound economic and financial fundamentals. We calibrate the model to match the behavior of the Portuguese<br/>economy over the period of 1998 to 2012.
    Keywords: EMU; sovereign debt crisis; contagion; bail-out; interest rate spread
    JEL: F33 F34 F36 F41
    Date: 2015
  3. By: Michael Bordo; Harold James
    Abstract: This paper explains the problem of adjustment to the challenges of globalization in terms of the logic underpinning four distinct policy constraints or trilemmas, and their interrelationship, and in particular the disturbances that arise from capital flows. The analysis of a policy trilemma was developed first as a diagnosis of exchange rate problems (the incompatibility of free capital flows with monetary policy autonomy and a fixed exchange rate regime); but the approach can be extended. The second trilemma we describe is the incompatibility between financial stability, capital mobility and fixed exchange rates. The third example extends the analysis to politics, and looks at the strains in reconciling democratic politics with monetary autonomy and capital movements. Finally we examine the security aspect and look at the interactions of democracy with capital flows and international order. The trilemmas in short depict the way that domestic monetary, financial, economic and political systems are interconnected with the international. They can be described as the impossible policy choices at the heart of globalization. Frequently, the trilemmas conjure up countervailing anti-globalization tendencies and trends.
    JEL: E4 E6 N1
    Date: 2015–03
  4. By: Emmanuel Farhi; Samuel Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan
    Abstract: Since the Fall of 2008, out-of-the money puts on high interest rate currencies have become significantly more expensive than out-of-the-money calls, suggesting a large crash risk of those currencies. To evaluate crash risk precisely, we propose a parsimonious structural model that includes both Gaussian and disaster risks and can be estimated even in samples that do not contain disasters. Estimating the model for the 1996 to 2014 sample period using monthly exchange rate spot, forward, and option data, we obtain a real-time index of the compensation for global disaster risk exposure. We find that disaster risk accounts for more than a third of the carry trade risk premium in advanced countries over the period examined. The measure of disaster risk that we uncover in currencies proves to be an important factor in the cross-sectional and time-series variation of exchange rates, interest rates, and equity tail risk.
    Date: 2015–01
  5. By: Juan Carlos Conesa; Timothy J. Kehoe
    Abstract: We develop a model for analyzing the sovereign debt crises of 2010–2013 in the Eurozone. The government sets its expenditure-debt policy optimally. The need to sell large quantities of bonds every period leaves the government vulnerable to self-fulfilling crises in which investors, anticipating a crisis, are unwilling to buy the bonds, thereby provoking the crisis. In this situation, the optimal policy of the government is to reduce its debt to a level where crises are not possible. If, however, the economy is in a recession where there is a positive probability of recovery in fiscal revenues, the government may optimally choose to “gamble for redemption,” running deficits and increasing its debt, thereby increasing its vulnerability to crises.
    JEL: F34 G01
    Date: 2015–03
  6. By: Yoshino, Naoyuki (Asian Development Bank Institute); Kaji, Sahoko (Asian Development Bank Institute); Asonuma, Tamon (Asian Development Bank Institute)
    Abstract: This paper theoretically evaluates the dynamic effects of a shift in an exchange rate system from a fixed regime to a basket peg, or to a floating regime, and obtains transition paths for the shift based on a dynamic stochastic general equilibrium model of a small open economy. We apply quantitative analysis using data from the People's Republic of China and Thailand and find that a small open country would be better off shifting to a basket peg or to a floating regime than maintaining a dollar-peg regime with capital controls over the long run. Furthermore, due to the welfare losses associated with volatility in nominal interest rates, the longer the transition period, the larger the benefits of shifting suddenly to a basket-peg regime from a dollar-peg regime than proceeding gradually. Regarding sudden shifts to desired regimes, the welfare gains are higher under a shift to a basket peg if the exchange rate fluctuates significantly. Finally, shifting to a managed-floating regime is less attractive than moving to a basket peg, as the interventions necessary to maintain the exchange rate for certain periods result in higher losses and the authority lacks monetary policy autonomy.
    Keywords: basket peg; floating regime; exchange rate transition; peoples republic of china; thailand; monetary policy; Finance
    JEL: F33 F41 F42
    Date: 2015–03–09
  7. By: Andrew J. Filardo, Pierre L. Siklos (Wilfrid Laurier University)
    Abstract: This paper examines past evidence of prolonged periods of foreign exchange reserves accumulation in the Asia-Pacific region. Several proxies for this unobserved variable are considered, including a newly proposed one based on a factor model. We focus on identifying periods of prolonged interventions and identify its key macro-financial determinants. Two broad conclusions emerge from the stylized facts and the econometric evidence. First, the best protection against costly reserves accumulation is a more flexible exchange rate. Second, the necessity to accumulate reserves as a bulwark against goods price inflation is misplaced. Instead, there is a strong link between asset price movements and the likelihood of accumulating foreign exchange reserves that are costly. Policy implications are also drawn.
    Keywords: foreign exchange reserves accumulation, monetary and financial stability
    JEL: F41 F32 E44 D52
    Date: 2015–02–01
  8. By: Hernandez Vega Marco A
    Abstract: Current data provide macroeconomic information for a large number of countries and for a long period of time (macro panels). This causes that in these panels slope heterogeneity and cross-section dependence (CSD) are a rule rather than the exception, leading to fixed effects slope estimators to be biased and inconsistent. This paper analyzes gross capital flows to emerging economies employing the Augmented Mean Group (AMG) model to account for slope heterogeneity and CSD. The results suggest that the AMG performs better than the fixed effects model. In addition, this work also suggests that not only the heterogeneity across countries is important to analyze capital inflows to emerging economies, but also the different responses of the different types of capital inflows to movements in macroeconomic variables.
    Keywords: Capital Flows;Push and Pull Factors;Slope Heterogeneity;Common Factors;Cross-Section Dependence.
    JEL: C33 F3 F21 G15
    Date: 2015–02
  9. By: Mariarosaria Comunale (Economics Department, Bank of Lithuania)
    Abstract: This paper provides an empirical study of the asymmetrical spillovers of the euro-US dollar exchange rate on the inflation in the euro zone, dividing the sample in two groups of countries: core and periphery. Then we test if the euro-US dollar exchange rate is still able to give a different impact on the groups’ performance as in the past US dollar-deutschmark polarization phenomenon studying the intra-euro area differences in exchange rate passthrough (ERPT), as an important element of inflation dynamics. Using a dynamic panel data framework based on an exchange rate pass-through model, we estimate the elasticities of the two groups by system IV-GMM and the common correlated effects mean group estimator, which deals with the presence of cross-sectional dependence. We conclude that the euro-US dollar is still an important factor, but not the only key factor, in determining the asymmetry in HICP inflation between core and periphery. The nominal effective exchange rate instead is an important driver for the inflation, but only considering the euro zone as a whole. The EMU seems to not have insulated enough some member countries from nominal external shocks. The nominal effective exchange rate is also a factor to take into account in order to analyze the recent low inflation in the euro zone, even if the size of the ERPT is relatively small.
    Keywords: Exchange Rate Pass-Through, Dynamic Panel Data, Inflation, Exchange Rates, European Monetary Union, Cross-sectional dependence
    JEL: C33 E31 F31 F36 F41
    Date: 2015–03–13
  10. By: V. Bignon; R. Breton; M. Rojas Breu
    Abstract: With the Euro Area context in mind, we show that currency arrangements impact on credit available through default incentives. To this end we build a symmetric two-country model with money and imperfect credit market integration. Differences in credit market integration are captured by variations in the cost for banks to grant credit for cross-border purchases. We show that for high enough levels of this cost, currency integration may magnify default incentives, leading to more stringent credit rationing and lower welfare than in a regime of two currencies. The integration of credit markets restores the optimality of the currency union.
    Keywords: banks, currency union, monetary union, credit, default.
    JEL: E42 E50 F3 G21
    Date: 2015
  11. By: Luís Aguiar-Conraria (Universidade do Minho, NIPE and Departamento de Economia); Pedro Brinca (European University Institute); Haukur Viðar Guðjónsson (Stockholm University); Maria Joana Soares (Universidade do Minho, NIPE and Departmento de Matemática e Aplicações)
    Abstract: We use wavelet analysis to investigate to what extent individual U.S. states' business cycles are synchronized. The results show that the U.S. states are remarkably well synchronized compared to the previous findings w.r.t. the Euro Area. There is also a strong and significant correlation between business cycle dissimilitudes and the distance between each pair of states, consistent to gravity type mechanisms where distance affects trade. Trade, in turn, increases business cycle synchronization. Finally we show that a higher degree of industry specialization is associated with a higher dissimilitude of the state cycle with the aggregate economy.
    Keywords: Optimum currency areas, business cycle synchronization, continuous wavelet transform, trade
    JEL: E37 E52 R11
    Date: 2015
  12. By: S. Guilloux-Nefussi
    Abstract: The decline in the sensitivity of inflation to domestic slack observed in developed countries over the last 25 years has been often attributed to globalization. However, this intuition has so far not been formalized. I develop a general equilibrium setup that can rationalize the flattening of the Phillips curve in response to a fall in trade costs. In order to do so, I add three ingredients to an otherwise standard two-country new-Keynesian model: strategic interactions generate time varying desired markup; endogenous firm entry makes the market structure change with globalization; heterogeneous productivity allows for self-selection among firms. Because of productivity heterogeneity, only high-productivity firms (that are also the bigger ones) enter the export market. They tend to transmit less marginal cost fluctuations into inflation because they absorb them into their desired markup in order to protect their market share. At the aggregate level, the increase in the proportion of large firms reduces the pass-through of marginal cost into inflation.
    Keywords: Inflation; Phillips curve; Macroeconomic Impacts of Globalization.
    JEL: E31 F41
    Date: 2015
  13. By: Pierre-Richard Agénor; K. Alper; L. Pereira da Silva
    Abstract: The performance of a countercyclical reserve requirement rule is studied in a dynamic stochastic model of a small open economy with financial frictions, imperfect capital mobility, a managed float regime, and sterilized foreign exchange market intervention. Bank funding sources, domestic and foreign, are imperfect substitutes. The model is calibrated and used to study the effects of a temporary drop in the world risk-free interest rate. Consistent with stylized facts, the shock triggers an expansion in domestic credit and activity, asset price pressures, and a real appreciation. A credit-based reserve requirement rule helps to mitigate both macroeconomic and financial volatility, with the latter defined both in terms of a narrow measure based on the credit-to-output ratio, the ratio of capital flows to output, and interest rate spreads, and a broader measure that includes real asset prices as well. An optimal rule, based on minimizing a composite loss function, is also derived. Sensitivity tests, related to the intensity of sterilization, the degree of exchange rate smoothing, and the rule used by the central bank to set the cost of bank borrowing, are also performed, both in terms of the transmission process and the optimal rule.
    Date: 2015

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