nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒05‒16
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Uncovered Interest Parity and Monetary Policy Near and Far from the Zero Lower Bound By Menzie D. Chinn; Yi Zhang
  2. Self-Fulfilling Debt Crises: Can Monetary Policy Really Help? By Philippe Bacchetta; Elena Perazzi; Eric van Wincoop
  3. Market Structure and Exchange Rate Pass-Through By Auer, Raphael; Schoenle, Raphael
  4. International Reserves for Emerging Economies: A Liquidity Approach. By Jung, Kuk Mo; Pyun, Ju Hyun
  5. On the savings wedge in international capital fl ows By Jacek Rothert
  6. Bank sovereign bond holdings, sovereign shock spillovers, and moral hazard during the European crisis By Andrea Beltratti; René M. Stulz
  7. Sovereign Debt and Structural Reforms By Müller, Andreas; Storesletten, Kjetil; Zilibotti, Fabrizio
  8. Home Bias in Multimarket Cournot Games By Catherine Roux; Luís Santos-Pinto; Christian Thöni
  9. Indirect exporters and importers By M. Grazzi; C.Tomasi
  10. Real effects of sovereign bond market spillovers in the euro area By Gadatsch, Niklas
  11. Price-Level Convergence in the Eurozone By Alfredo García Hiernaux; David Esteban Guerrero Burbano
  12. Import Response to Exchange Rate Fluctuations: A Micro-level Investigation By Yao Amber Li; Jenny Xu; Carol Zhao Chen
  13. Carry and Trend Following Returns in the Foreign Exchange Market By Andrew Clare; James Seaton; Peter N. Smith; Stephen Thomas

  1. By: Menzie D. Chinn; Yi Zhang
    Abstract: Relying upon a standard New Keynesian DSGE, we propose an explanation for two empirical findings in the international finance literature. First, the unbiasedness hypothesis – the proposition that expost exchange rate depreciation matches interest differentials – is rejected much more strongly at short horizons than at long. Second, even at long horizons, the unbiasedness hypothesis tends to be rejected when one of the currencies has experienced a long period of low interest rates, such as in Japan and Switzerland. Using a calibrated New Keynesian dynamic stochastic general equilibrium model, we show how a monetary policy rule can induce the negative (positive) correlation between depreciation and interest differentials at short (long) horizons. The tendency to reject unbiasedness for Japan and Switzerland even at long horizons we attribute to the interaction of the monetary reaction function and the zero lower bound.
    JEL: E12 F21 F31 F41 F47
    Date: 2015–05
  2. By: Philippe Bacchetta; Elena Perazzi; Eric van Wincoop
    Abstract: This paper examines quantitatively the potential for monetary policy to avoid self-fulfilling sovereign debt crises. We combine a version of the slow-moving debt crisis model proposed by Lorenzoni and Werning (2014) with a standard New Keynesian model. We consider both conventional and unconventional monetary policy. Under conventional policy the central bank can preclude a debt crisis through inflation, lowering the real interest rate and raising output. These reduce the real value of the outstanding debt and the cost of new borrowing, and increase tax revenues and seigniorage. Unconventional policies take the form of liquidity support or debt buyback policies that raise the monetary base beyond the satiation level. We find that generally the central bank cannot credibly avoid a self-fulfilling debt crisis. Conventional policies needed to avert a crisis require excessive inflation for a sustained period of time. Unconventional monetary policy can only be effective when the economy is at a structural ZLB for a sustained length of time.
    JEL: E52 E60 E63
    Date: 2015–05
  3. By: Auer, Raphael; Schoenle, Raphael
    Abstract: We study firm-level pricing behavior through the lens of exchange rate pass-through and provide new evidence on how firm-level market shares and price complementarities affect pass-through decisions. Using micro-data from U.S. import prices, we identify two facts: First, exactly the firms that react the most with their prices to changes in their own costs are also the ones that react the least to changing competitor prices. Second, the response of import Prices to exchange rate changes is U-shaped in market share while it is hump-shaped in response to competitor prices. We show that both facts are consistent with a model based on Dornbusch (1987) that generates variable markups through a nested-CES demand system. Finally, based on the model, we find that direct cost pass-through and price complementarities play approximately equally important roles in determining pass-through but also partly offset each other. This suggests that equilibrium feedback effects in pricing are large. Omission of either channel in an empirical analysis results in a failure to explain how market structure affects price-setting in industry equilibrium.
    Keywords: exchange rate pass-through; price complementarities; price setting; U.S. import prices
    JEL: E3 E31 F41
    Date: 2015–05
  4. By: Jung, Kuk Mo; Pyun, Ju Hyun
    Abstract: The massive stocks of foreign exchange reserves, mostly held in the form of U.S. T-Bonds by emerging economies, are still an important puzzle. Why do emerging economies continue to willingly loan to the United States despite the low rates of return? We propose that a dynamic general equilibrium model incorporating international capital markets, characterized by a non-centralized trading mechanism and U.S. T-Bonds as facilitators of trade, can provide an answer to this question. Declining financial frictions in these over-the-counter (OTC) markets would generate rising liquidity premiums on U.S. T-Bonds. Meanwhile, the higher liquidity properties of the U.S. T-Bonds would induce recipients of foreign investments, namely emerging economies, to hold more liquidity, that is U.S. T-Bonds, in equilibrium. The prediction of our model is confirmed by an empirical simultaneous equations approach considering an endogenous relationship between OTC capital inflows and reserves holdings.
    Keywords: international reserves, over-the-counter markets, liquidity, simultaneous equations
    JEL: E44 E58 F21 F31 F36 F41
    Date: 2015–05
  5. By: Jacek Rothert (United States Naval Academy)
    Abstract: I explore the determinants of the savings wedge in international capital flows computed for a sample of 68 developing countries in Gourinchas and Jeanne (2013). I show that size (rather than direction (allocation)) of net capital fl ows we observe in the data is the major driver of the negative correlation between the calibrated savings wedge and productivity growth.
    Date: 2015–04
  6. By: Andrea Beltratti; René M. Stulz
    Abstract: From 2010 to 2012, the relation between bank stock returns from European Union (EU) countries and the returns on sovereign CDS of peripheral (GIIPS) countries is negative. We use days with tail sovereign CDS returns of peripheral countries to identify the effects of shocks to the cost of borrowing of these countries on EU banks from other countries. A CDS tail return affects banks with greater exposure to the country experiencing that return more, but it has an impact on banks regardless of exposure. Shocks to peripheral countries that are more pervasive impact the returns of banks from countries that experience no shock more than shocks to small individual peripheral countries. In general, the impact of tail returns is asymmetric in that banks suffer less from adverse shocks to peripheral countries than they gain from favourable shocks to such countries.
    JEL: F34 G12 G15 G21 H63
    Date: 2015–05
  7. By: Müller, Andreas; Storesletten, Kjetil; Zilibotti, Fabrizio
    Abstract: Motivated the European debt crisis, we construct a tractable theory of sovereign debt and structural reforms under limited commitment. The government of a sovereign country which has fallen into a recession of an uncertain duration issues one-period debt and can renege on its obligations by suffering a stochastic default cost. When faced with a credible default threat, creditors can make a take-it-or-leave-it debt haircut offer to the sovereign. The risk of renegotiation is reflected in the price at which debt is sold. The sovereign government can also do structural policy reforms that speed up recovery from the recession. We characterize the competitive equilibrium and compare it with the constrained efficient allocation. The equilibrium features increasing debt, falling consumption, and a non-monotone reform effort during the recession. In contrast, the constrained optimum yields step-wise increasing consumption and step-wise decreasing reform effort. Markets for state-contingent debt alone do not restore efficiency. The constrained optimum can be implemented by a flexible assistance program enforced by an international institution that monitors the reform effort. The terms of the program are improved every time the country poses a credible threat to leave the program unilaterally without repaying the outstanding loans.
    Keywords: austerity programs; debt overhang; default; European debt crisis; fiscal policy; Great Recession; Greece; International Monetary Fund; limited commitment; moral hazard; renegotiation; risk premia; sovereign debt; structural reforms
    JEL: E62 F33 F34 F53 H12 H63
    Date: 2015–05
  8. By: Catherine Roux; Luís Santos-Pinto; Christian Thöni
    Abstract: We explore the role played by trade costs for the home bias in trade. In a series of Cournot duopoly experiments with a home and an export market, we compare output choices when firms face different levels of export costs. We find that there is two-way trade in identical products and that firms hold the majority market share in their home market. The resulting home bias turns out to be, however, stronger than that predicted by theory, and it even occurs without trade costs. We have strong evidence that collusion contributes to the home bias observed in our experiment.
    Keywords: Intra-Industry Trade; Spatial Oligopoly; Home Bias; Collusion; Experiment
    JEL: F12 L13 C91
    Date: 2015–04
  9. By: M. Grazzi; C.Tomasi
    Abstract: This paper analyses the relation between firms' productivity and the different modes of participation to international trade. In particular, we account for the possibility that firms can not only export their products, but also internationally source their inputs, either directly or indirectly. Using a cross section of firm-level data for several advanced and developing economies, the study confirms the productivity-sorting prediction according to which domestic firms are less efficient than those resorting to an export intermediary, while the latter are less productive than producers which export directly. We show that the same sorting exists also on the import side. Finally, we investigate the effects of source country characteristics on the sorting of firms into different modes of international trade.
    JEL: F14 D22 L22
    Date: 2015–04
  10. By: Gadatsch, Niklas
    Abstract: This paper develops a small open economy model to investigate the impact of rising sovereign bond market spreads on the real economy. One key element of the model is a "sovereign risk channel" through which tensions in the sovereign bond market tend to spill over into private credit markets. The model is estimated with Bayesian methods and data for "high-spread" countries in the euro area. It turns out that spread shocks during the Euro crisis had a negative effect on real GDP growth in these countries, up to 0.8 percentage points (PP) Portugal and Ireland, 0.3 PP in Italy and 0.2 PP in Spain.
    Keywords: Small open economy,Business cycles,Sovereign risk premium,DSGE modeling
    JEL: E32 E43 F41
    Date: 2015
  11. By: Alfredo García Hiernaux (Departamento de Fundamentos del Análisis Económico II (Economía Cuantitativa). Universidad Complutense de Madrid.); David Esteban Guerrero Burbano (CUNEF. Colegio Universitario de Estudios Financieros.)
    Abstract: This paper shows that price level trends in many of the EMU countries evolve with different patterns and that these patterns will not converge in the long-run. We propose that the hypothesis of price convergence should be evaluated and tested employing the relative prices. To this aim, we: (i) define the asymptotic price level convergence in mean and variance, (ii) provide a model for relative price levels that includes a transition path, and (iii) show how to properly test the definitions stated. Our results show that only French and German price levels converge in mean to a zero gap in the EMU while some others, not many, converge to a nonzero significant gap. This should be a matter of concern for the European monetary policy makers as it implies that the monetary policy does not affect all the EMU members equally.
    Keywords: Price convergence; Price levels; Relative price; Inflation; EMU.
    JEL: E30 E31 E52 C22 F15
    Date: 2015–05
  12. By: Yao Amber Li (Department of Economics, Hong Kong University of Science and Technology; Institute for Emerging Market Studies, Hong Kong University of Science and Technology); Jenny Xu (Department of Economics, Hong Kong University of Science and Technology; Institute for Emerging Market Studies, Hong Kong University of Science and Technology); Carol Zhao Chen (Department of Economics, Hong Kong University of Science and Technology)
    Abstract: This paper presents theory and evidence on firms' import responses to exchange rate fluctuations using disaggregated Chinese imports data. The paper develops a heterogeneous-firm trade model that predicts import responses at both extensive and intensive margins as well as the more profound adjustment under ordinary trade than processing trade. Next, the paper empirically investigates import responses to exchange rate fluctuations at extensive and intensive margins in both the short run and the long run, and confirms the model predictions. We also find variations among import responses under different exchange rate regimes, including fixed exchange rate, expected appreciation, and confirmed appreciation.
    Keywords: exchange rate, import, extensive margin, intensive margin, processing trade, exchange rate regimes, pass-through
    JEL: F14 F31
    Date: 2015–05
  13. By: Andrew Clare; James Seaton; Peter N. Smith; Stephen Thomas
    Abstract: Recent research has confirmed the behaviour of traders that significant excess returns can be achieved from following the predictions of the carry trade which involves buying currencies with relatively high short-term interest rates, or equivalently a high forward premium, and selling those with relatively low interest rates. This paper shows that similar-sized excess returns can be achieved by following a trend-following strategy which buys long positions in currencies that have achieved positive returns and otherwise holds cash. We demonstrate that market risk is an important determinant of carry returns but that the standard unconditional CAPM is inadequate in explaining the cross-section of forward premium ordered portfolio returns. We also show that the downside risk CAPM fails to explain this cross-section, in contrast to recent literature. A conditional CAPM which makes the impact of the market return as a risk factor depend on a measure of market liquidity performs very well in explaining more than 90% of the variation in portfolio returns and more than 90% of the average returns to the carry trade. Trend following is found to provide a significant hedge against these risks. The performance of the trend following factor is more surprising given that it does not have the negative skewness or maximum drawdown characteristic which is shown by the carry trade factor.
    Keywords: Forward exchange rate returns, trend following, carry trade, market liquidity and exchange risk
    JEL: F31 G12 G11 G15
    Date: 2015–05

This nep-opm issue is ©2015 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.