nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒05‒30
eleven papers chosen by
Martin Berka
University of Auckland

  1. Order Flow Information and Spot Rate Dynamics By Martin Evans; Dagfinn Rime
  2. International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals? By Ahmed, Shaghil; Coulibaly, Brahima; Zlate, Andrei
  3. Capital Mobility and Monetary Policy: An Overview By Fuentes, Miguel; Raddatz, Claudio; Reinhart, Carmen
  4. “Twin deficits” in Greece: in search of causality By Michalis Nikiforos; Laura Carvalho, Christian Schoder
  5. Hard Pegs versus Intermediate Currency Arrangements in the Pacific By Helble, Matthias; Prasetyo, Ahmad; Yoshino, Naoyuki
  6. Foreign Capital Flows, Credit Growth and Macroprudential Policy in a DSGE Model with Traditional and Matter-of-Fact Financial Frictions By Fabia A. de Carvalho; Marcos R. Castro
  7. Convergence of absolute purchasing power parity By Zhang, Zhibai
  8. Time varying pass-through: Will the yen depreciation help Japan hit the inflation target? By Etsuro Shioji
  9. Culture and Global Sourcing By Yuriy Gorodnichenko; Bohdan Kukharskyy; Gerard Roland
  10. Asymmetric shocks in a currency union: The role of central bank collateral policy. By F. Koulischer
  11. Immigration, Trade and Productivity in Services: Evidence from U.K. Firms By Gianmarco I.P. Ottaviano; Giovanni Peri; Greg C. Wright

  1. By: Martin Evans (Department of Economics, Georgetown University); Dagfinn Rime (BI Norwegian Business School and Norges Bank, Oslo Norway)
    Abstract: This paper examines why order flows are empirically important drivers of spot exchange rate dynamics. We consider a decomposition for the depreciation rate that must hold in any model and show that order flows will appear as important proximate drivers when they convey significant incremental information about future interest rate differentials, risk premiums and/or long-run exchange rate levels (i.e., information that cannot be inferred from publicly observed variables). We estimate the importance of these incremental information flows for the EURNOK spot exchange rate using eight years of high- quality, disaggregated, end-user order flow data collected by the Norges Bank.
    Keywords: exchange rate dynamics, microstructure, order flow.
    JEL: F3 F4 G1
    Date: 2015–04–21
  2. By: Ahmed, Shaghil (Board of Governors of the Federal Reserve System (U.S.)); Coulibaly, Brahima (Board of Governors of the Federal Reserve System (U.S.)); Zlate, Andrei (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs). Our analysis covers the so-called taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persisted throughout this episode. (3) Controlling for economic fundamentals, we also find that, during the taper tantrum, financial conditions deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode. Differences in economic fundamentals played a role in explaining the heterogeneous EME financial market responses during the global financial crisis of 2008, and the role of fundamentals appeared to progressively increase through the European crisis in 2011 and subsequently the 2013 taper tantrum.
    Keywords: Emerging market economies; financial spillovers; economic fundamentals; vulnerability; depreciation pressure; taper tantrum; financial stress
    JEL: E50 F30
    Date: 2015–04–22
  3. By: Fuentes, Miguel; Raddatz, Claudio; Reinhart, Carmen
    Abstract: While the global economic environment has changed considerably from end-2011 to the present for advanced and emerging economies alike, the themes and policy issues addressed by these papers share a timeless dimension. Collectively, the studies that comprise this volume deal with various aspects of the causes, consequences, and policy challenges associated with the repeated boom-bust cycles that have characterized market economies throughout most of their history. The papers have a decided open-economy focus and connect the prosperity-crisis-depression cycle to international capital flows and their impact on domestic and external indebtedness, currency fluctuations, and the banking sector; their connection to global factors, such as international interest rates, commodity prices and crises or turbulence outside the national borders is explored. While the analysis is tilted towards emerging markets—particularly in Latin America, the relevance of these topics for mature economies has been made plain by the Global Financial Crisis.
    Keywords: capital flows, contagion, capital controls, credit booms
    JEL: E0 E50 F3 F32 F4
    Date: 2015–04
  4. By: Michalis Nikiforos; Laura Carvalho, Christian Schoder
    Abstract: The paper discusses the trajectories of the Greek public deficit and sovereign debt between 1980 and 2010 and its connection to the political and economic environment of the same period. We pay special attention to the causality between the public and the external deficit in the period after 1995, the post-Maastricht treaty period. We argue that, due to the European monetary unification process and the adoption of the common currency, causality ran from the external deficit to the public deficit. This hypothesis is tested econometrically using both Granger Causality and Cointegration analyses. We find empirical support for this hypothesis
    Keywords: Greece; crisis; public debt; twin deficits; imbalances
    JEL: E62 F21 F34 F41
    Date: 2015–05–20
  5. By: Helble, Matthias (Asian Development Bank Institute); Prasetyo, Ahmad (Asian Development Bank Institute); Yoshino, Naoyuki (Asian Development Bank Institute)
    Abstract: The 14 Pacific developing member countries (DMCs) of the Asian Development Bank (ADB) have opted for very different exchange rate regimes with varying degrees of flexibility. Whereas several microstates have adopted an external currency as their legal tender, others have decided to use a basket currency and yet others have chosen a managed float. The choice of exchange rate regime can have far reaching economic consequences. In this paper, we first build a simple exchange rate model that illustrates how monetary authorities should best determine the weights of the basket currencies in order to keep fluctuations in gross domestic product (GDP) and in exchange rates to a minimum. We add to the literature by explicitly modeling tourism flows. In the second part of the paper we study the recent developments of the Pacific DMCs in terms of the volatility of their exchange rates, their GDP and their balance of trade. We find that Pacific DMCs with external currencies systematically exhibit lower GDP volatility compared to Pacific DMCs with basket currencies or floats. We conclude that Pacific DMCs with basket currencies or floats seem to have managed their exchange rate with the objective to minimize fluctuations of exchange rates, rather than those of their GDP. Our model therefore provides valuable guidance for those monetary authorities in the Pacific that would like to lower GDP fluctuations.
    Keywords: exchange rate policy; economic integration; economic development; microstates
    JEL: F31 F33
    Date: 2015–05–12
  6. By: Fabia A. de Carvalho; Marcos R. Castro
    Abstract: We investigate the transmission channel of reserve requirements, capital requirements, and risk weights of different types of credit in the computation of capital adequacy ratios and compare the power of each macroprudential instrument to counteract the impact of domestic and international shocks that potentially challenge financial stability. To this end, we model a small open economy that receives inflows of foreign direct investment, foreign portfolio investment, and issues foreign debt. The central bank manages international reserves, with an impact on the foreign exchange market and on the country risk premium. Shocks in international markets affect domestic credit even though foreign capital flows are directly destined to non-financial institutions. Banks operate in four distinct credit markets: consumer, housing and commercial– each of them facing default risk and having specific borrowing constraints– and safe export-related credit lines in the form of working capital loans to exporters. Consumer loans are granted based on banks’ expectations with respect to borrowers’ future labor income net of senior debt services. Banks optimize their balance sheet allocation facing frictions intended to reproduce banks’ incentives given regulatory constraints. The model is estimated with Bayesian techniques using data from Brazil
    Date: 2015–05
  7. By: Zhang, Zhibai
    Abstract: In this paper, we study the convergence of 40 main bilateral real exchange rates (RERs) constructed by actual price levels to be consistent with absolute purchasing power parity (PPP), rather than by price indexes as used in popular studies. The time series ADF and KPSS unit root tests reveal that 39 RERs are stationary in their periods of about 60 years or less. The half-lives span from 1 to 40 years and are mostly outside of the consensus range of 3–5 years. Some cases suggest that the half-life may be not an appropriate method for measuring the convergence of absolute PPP. In contrast, some statistic indexes (e.g., root mean squared error) can be applied for this use and may have more power than the half-life.
    Keywords: absolute purchasing power parity; real exchange rate; convergence; half-life
    JEL: F3 F31
    Date: 2015–01–30
  8. By: Etsuro Shioji (Department of Economics, Hitotsubashi University)
    Abstract: There is a growing recognition that pushing up the public’s inflation expectation is a key to a successful escape from a chronic deflation. The question is how this can be achieved when the economy is stuck in a liquidity trap. This paper argues that, for Japan, the currency depreciation since the late 2012 could turn out to be useful for ending the country’s long battle with falling prices. Prior studies have suggested that household expectations are greatly influenced by prices of items that they purchase frequently. This paper demonstrates that the extent of exchange rate pass-through to those prices, once near-extinct, has come back strong in recent years. Evidence based on VARs as well as TVP-VARs indicates that a 25% depreciation of the yen would produce a 2% increase in the prices of goods that households purchase regularly.
    Keywords: exchange rate, pass-through, expected inflation, CPI by purchase frequency class, time series analysis.
    Date: 2015–03
  9. By: Yuriy Gorodnichenko; Bohdan Kukharskyy; Gerard Roland
    Abstract: This paper develops a model of global sourcing with culturally dissimilar countries. Production of final goods requires the coordination of decisions between the headquarter of a multinational firm and managers of their component suppliers. Managers of both units are assumed to have strong beliefs about the right course of action and are reluctant to adjust their decisions. We characterize the optimal allocation of decision rights across firms when contracts are incomplete. Our theoretical model delivers two key predictions: the incentive of a firm to integrate (rather than outsource) its input supply is decreasing in the cultural distance between the home and the host country and decreasing in trade costs between the two countries. Combining data from the U.S. Census Bureau's Related Party Trade with various measures for cultural distance and trade cost, we find empirical evidence strongly supportive of these two predictions.
    JEL: F1 F14 F23 P14 P26 P48 Z1
    Date: 2015–05
  10. By: F. Koulischer
    Abstract: Currency unions limit the ability of the central bank to use interest rate policy to accommodate asymmetric shocks. I show that collateral policy can serve to dampen asymmetric shocks in a currency area when these shocks also affect the collateral held by banks and when collateral portfolios of banks differ systematically across countries. In my model banks from 2 countries use collateral to borrow from the money market or a central bank that targets a level of interest rate (or investment) in each economy. The distressed bank may enter a “collateral crunch” regime where it is constrained in its access to funding due to a moral hazard problem. The central bank faces an heterogeneous transmission of its interest rate: a unit change in rate has a smaller effect on the economy rate of the distressed country. The central bank therefore sets a high interest rate which is well transmitted in the booming economy and relaxes the haircut on the collateral owned by the distressed bank.
    Keywords: Central banking, currency union, collateral policy, repo, monetary policy.
    JEL: E58 G01 G20
    Date: 2015
  11. By: Gianmarco I.P. Ottaviano; Giovanni Peri; Greg C. Wright
    Abstract: This paper explores the impact of immigrants on the imports, exports and productivity of service-producing firms in the U.K. Immigrants may substitute for imported intermediate inputs (offshore production) and they may impact the productivity of the firm as well as its export behavior. The first effect can be understood as the re-assignment of offshore productive tasks to immigrant workers. The second can be seen as a productivity or cost cutting effect due to immigration, and the third as the effect of immigrants on specific bilateral trade costs. We test the predictions of our model using differences in immigrant inflows across U.K. labor markets, instrumented with an enclave-based instrument that distinguishes between aggregate and bilateral immigration, as well as immigrant diversity. We find that immigrants increase overall productivity in service-producing firms, revealing a cost cutting impact on these firms. Immigrants also reduce the extent of country-specific offshoring, consistent with a reallocation of tasks and, finally, they increase country-specific exports, implying an important role in reducing communication and trade costs for services.
    JEL: F16 F22 F23
    Date: 2015–05

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