nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒06‒20
fourteen papers chosen by
Martin Berka
University of Auckland

  1. Monetary Policy and Dutch Disease: The Case of Price and Wage Rigidity By Hevia, Constantino; Nicolini, Juan Pablo
  2. How Important Are Terms Of Trade Shocks? By Schmitt-Grohé, Stephanie; Uribe, Martín
  3. International Transmission of Credit Shocks in an Equilibrium Model with Production Heterogeneity By Yuko Imura; Julia Thomas
  4. German Wage Moderation and European Imbalances: Feeding the Global VAR with Theory By Timo Bettendorf; Miguel A. Leon-Ledesma
  5. Inflation, financial conditions and non-standard monetary policy in a monetary union. A model-based evaluation By Lorenzo Burlon; Andrea Gerali; Alessandro Notarpietro; Massimiliano Pisani
  6. Global Trends in the Choice of Exchange Rate Regime By Michael Bleaney; Mo Tian; Lin Yin
  7. The Taylor Rule, Wealth Effects and the Exchange Rate By Rudan Wang; Bruce Morley; Javier Ordóñez
  8. Foreign Exchange Interventions at the Zero Lower Bound in the Czech Economy: A DSGE Approach By Simona Malovana
  9. Testing the global banking glut hypothesis By Kauko, Karlo; Punzi, Maria Teresa
  10. The Skill-Biased Effects of Exchange Rate Fluctuations By Michael Siegenthaler; Boris Kaiser
  11. The impossible trinity: Where does India stand? By Rajeswari Sengupta
  12. Measuring the On-Going Changes in China's Capital Flow Management: A De Jure and a Hybrid Index Data Set By Jinzhao Chen; Xingwang Qian
  13. The geographic distribution of international currencies and RMB internationalization By He, Qing; Korhonen, Iikka; Guo, Junjie; Liu , Fangge
  14. Does Inequality Drive the Dutch Disease: Theory and Evidence By Richard Chisik; Nazanin Behzadan; Harun Onder; Bill Battaile

  1. By: Hevia, Constantino (Universidad Di Tella); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis)
    Abstract: We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
    Keywords: Dutch disease; Inflation targeting; Foreign exchange intervention
    JEL: F31 F41
    Date: 2015–06–08
  2. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: According to conventional wisdom, terms of trade shocks represent a major source of business cycles in emerging and poor countries. This view is largely based on the analysis of calibrated business-cycle models. We argue that the view that emerges from empirical SVAR models is strikingly different. We estimate country-specific SVARs using data from 38 poor and emerging countries and find that terms-of-trade shocks explain only 10 percent of movements in aggregate activity. We then build a fully-fledged, open economy model with three sectors, importables, exportables, and nontradables, and use data from each of the 38 countries to obtain country-specific estimates of key structural parameters, including those defining the terms-of-trade process. In the estimated theoretical business-cycle models terms-of-trade shocks explain on average 30 percent of the variance of key macroeconomic indicators, three times as much as in SVAR models.
    Keywords: business cycles.; nontradable goods; real exchange rates; Terms of trade
    JEL: E32 F41 F44
    Date: 2015–06
  3. By: Yuko Imura; Julia Thomas
    Abstract: Many policy-makers and researchers view the recent financial and real economic crises across North America, Europe and beyond as a global phenomenon. Some have argued that this global recession has a common source: the U.S. financial crisis. This paper investigates the extent to which a credit shock in one country is transmitted to its trade partners. To this end, we develop a quantitative two-country dynamic stochastic general equilibrium model wherein intermediate-good producers face persistent idiosyncratic productivity shocks and occasionally binding collateralized borrowing constraints for investment loans. We find that a negative credit shock to one country induces a sharp contraction in that country’s economy, whereas the resulting recession in the economy of its trading partner is quantitatively minor. Transmission through goods trade is limited by the calibrated average trade share, which we find insufficient to deliver a sizable recession abroad. The degree of credit-shock transmission depends on the home bias in international trade and the type of goods countries trade with each other. We show that lower home bias dampens the domestic recession following a credit shock, but it amplifies international transmission. Similarly, when traded goods are less substitutable, the domestic recession is less severe, while real consequences abroad are greater. Our model also predicts that credit shocks cause larger declines in international trade than do productivity shocks. These results shed light on the great trade collapse over 2008-09, suggesting that tightened financial constraints may have been a contributing factor.
    Keywords: Business fluctuations and cycles, Economic models, Financial markets, Financial stability, International topics
    JEL: E E2 E22 E3 E32 E4 E44 F F4 F41 F44
    Date: 2015
  4. By: Timo Bettendorf; Miguel A. Leon-Ledesma
    Abstract: German labor market reforms in the 1990s and 2000s are generally believed to have driven the large increase in the dispersion of current account balances in the Euro Area. We investigate this hypothesis quantitatively. We develop an open economy New Keynesian model with search and matching frictions from which we derive robust sign restrictions for a wage bargaining shock. We then impose these restrictions on a Global VAR consisting of Germany and 8 EMU countries to identify a wage bargaining shock in Germany. Our results show that, although the German current account was significantly affected by wage bargaining shocks, their contribution to European current account imbalances was negligible. We conclude that the reduction in bargaining power of German unions after labor market reforms cannot be the lone driver of European imbalances.
    Keywords: European imbalances; German wage moderation; DSGE; Global VAR; sign restrictions
    JEL: F10 F32 F41
    Date: 2015–06
  5. By: Lorenzo Burlon (Bank of Italy); Andrea Gerali (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: This paper evaluates the macroeconomic effects of purchases of long-term sovereign bonds by a central bank in a monetary union when (1) the private sector faces tight financial conditions and (2) the zero lower bound (ZLB) on the policy rate holds. To this end, we calibrate a dynamic general equilibrium model to the euro area (EA). We assume that households in one member country have a large initial debt position and are subject to a borrowing constraint. We simulate the effects of a negative EA-wide demand shock that induces a decline in inflation. The main results are as follows. First, the reduction in inflation amplifies the domestic and cross-country spillovers of the negative demand shock because of the country-specific borrowing constraint and the ZLB. Second, sovereign bond purchases boost economic activity and, hence, indirectly allow households to reduce their debt and relax the borrowing constraint. Third, the new, lower value of debt allows households to smooth consumption, fostering macroeconomic resilience not only in the member country concerned but also in the rest of the monetary union.
    Keywords: DSGE models, financial frictions, open-economy macroeconomics, non-standard monetary policy, zero lower bound
    JEL: E43 E44 E52 E58
    Date: 2015–06
  6. By: Michael Bleaney; Mo Tian; Lin Yin
    Abstract: The raw data suggest that the global trend towards greater exchange rate flexibility that was evident before 1990 has since stopped. An optimum currency area (OCA) model of exchange rate regime choice is estimated. Four different schemes for classifying exchange rate regime are investigated. Trends in the explanatory variables made little difference to the trend towards greater flexibility before 1990 but have worked against it since, largely because of the reduction in inflation. Underlying preferences are still shifting gradually in the direction of greater flexibility.
    Keywords: exchange rate regimes, inflation, openness JEL codes: F31
    Date: 2015–03
  7. By: Rudan Wang (Department of Economics, University of Bath, UK); Bruce Morley (Department of Economics, University of Bath, UK); Javier Ordóñez (Department of Economics, Universitat Jaume I, Castellón, Spain)
    Abstract: The aim of this study is to develop models of the Taylor rule and a Taylor rule based exchange rate model incorporating wealth effects, as represented by both asset prices and asset wealth. In addition these wealth effects are further divided into stock market and housing wealth. Using data for Australia, Sweden, UK and the US, the Taylor model is estimated and then used to forecast out-of-sample. The results suggest that the effects of the asset prices and wealth on the Taylor rule are mixed and depend on the country and the form the wealth takes. The outof-sample forecast performance of both the wealth augmented Taylor rule model and Taylor rule exchange rate model are then compared with the conventional Taylor Rule model and a random walk and overall the wealth augmented models outperform the conventional model and random walk in these countries.
    Keywords: exchange rate, wealth effect, forecast
    JEL: F30 F37
    Date: 2015
  8. By: Simona Malovana (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic; Czech National Bank)
    Abstract: The paper contributes to understanding the economic dynamics at the zero lower bound and the exchange rate movements under different central bank intervention regimes. It provides a theoretical framework for modeling foreign exchange interventions at the ZLB within a dynamic general equilibrium model. We find a pronounced volatility of real and nominal macroeconomic variables in response to the domestic demand shock, the foreign demand and financial shocks and the terms-of-trade shock at the ZLB. This effects become severe in response to highly persistent shocks which leads to stronger reaction of variables and prolong period of binding constraint. The FX interventions have proven to be effective in mitigating deflationary pressures and recovering the economic activity in response to all examined shocks at the ZLB. In this sense, the central bank achieves the best performance by fixing the nominal exchange rate temporarily at the ZLB.
    Keywords: zero lower bound, foreign exchange interventions, dynamic stochastic general equilibrium, Bayesian estimation, exchange rate and price dynamics
    JEL: C11 E31 E43 E52 E58 F31
    Date: 2015–05
  9. By: Kauko, Karlo; Punzi, Maria Teresa
    Abstract: This paper presents VAR results on the recent economic history of the USand focuses on the dependence of US macro financial variables on international capital flows. Both gross and net flows are included in the analysis. The results indicate that cross-border funding has affected the build-up in the US housing market irrespective of how these flows are defined and measured. Both the savings glut hypothesis and the banking glut hypothesis are supported by these findings. However, net banking flows appear to explain the higher volatility in the increase in house prices as well as the mortgage loan boom.
    Keywords: Global Banking Glut,Global Savings Glut,Cross-Border Banking Transactions,House Prices,Mortgage Loans,VAR model
    JEL: F32 F33 F34
    Date: 2015
  10. By: Michael Siegenthaler (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Boris Kaiser (Department of Economics, University of Bern, Switzerland)
    Abstract: This paper examines the linkages between real exchange rate movements and firms’ skill demand. Real exchange rate movements may affect unskilled workers differently than skilled workers because of skill-specific adjustment costs, or because exchange rates lead to changes in relative factor prices and firms’ competition intensity. Using panel data on Swiss manufacturers, we find that an appreciation increases high-skilled and reduces low-skilled employment in most firms, while total employment remains roughly unchanged. We find evidence that exchange rates influence firms’ skill intensity because they affect outsourcing activities, innovation efforts, and firms’ compensation schemes.
    Keywords: Labor Demand, Skill Intensity, Employment, Real Exchange Rates, Firms’ Foreign Exposure
    JEL: E24 F16 F31
    Date: 2015–06
  11. By: Rajeswari Sengupta (Indira Gandhi Institute of Development Research)
    Abstract: The Global Financial Crisis of 2008 and the heightened macroeconomic and financial volatility that followed the crisis raised important questions about the current international financial architecture as well as about individual countries' external macroeconomic policies. Policy makers dealing with the global crisis have been confronted with the 'impossible trinity' or the 'Trilemma', a potent paradigm of open economy macroeconomics asserting that a country may not target the exchange rate, conduct an independent monetary policy and have full financial integration, all at the same time. This issue is highly pertinent for India. A number of challenges have emanated from India's greater integration with the global financial markets during the last two decades, one of which includes managing the policy tradeoffs under the Trilemma. In this chapter, I present a comprehensive overview of a few empirical studies that have explored the issue of Trilemma in the Indian context. Based on these studies I attempt to analyze how have Indian policy makers dealt with the various trade-offs while managing the Trilemma over the last two decades.
    Keywords: Impossible Trinity, Financial Integration, Currency Stabilization, International Reserves, Sterilized Intervention
    JEL: F3 F4
    Date: 2015–03
  12. By: Jinzhao Chen (The University of Hong Kong); Xingwang Qian (SUNY Buffalo State and Hong Kong Institute for Monetary Research)
    Abstract: Liberalizing China's capital account may have profound implications for the RMB exchange rate, monetary policy autonomy, and Chinese and the world economy. Owing to the scarcity of proper measurements of China's capital controls, rigorous studies on the effectiveness and implications of China's capital controls are limited. We contribute to the literature by creating a new data set of indices including de jure and hybrid measurements of the changes in China's capital controls, hoping to inspire a new avenue of research in this area. In contrasting to other capital control indices that are compiled in a yes-or-no style, we quantify the intensity of changes in China's capital controls. Our indices reveal a persistent but uneven process of capital account liberalization in China between 1999 and 2012. This paper describes the de jure and hybrid indices, including indices for capital controls on individual asset categories, gross flows, inflows and outflows, as well as for residents and nonresidents asset transactions. Understanding that China usually implements policies in a step by step gradualist style, we extract those gradual information from the lines of the text in the IMF's Annual Report on Exchange Arrangement and Exchange Restrictions (AREAER) and some supplementary material from other sources.
    Keywords: Capital Flows, China's Capital Controls, De Jure Index, Hybrid Index
    JEL: C82 F15 F21
    Date: 2015–05
  13. By: He, Qing (BOFIT); Korhonen, Iikka (BOFIT); Guo, Junjie (BOFIT); Liu , Fangge (BOFIT)
    Abstract: The paper investigates the determinants of geographical distribution of international currencies in global financial market transactions. We implement a gravity model, in which international currency distribution depends on the characteristics of the source and destination countries. We find that the source country’s currency is more likely to be used in the financial market transactions of the destination country if the bilateral trade and capital flows are large or the destination country’s economy is the larger of the two. We also find that the level of development of the destination country’s financial market and whether the two countries use a common language are important determinants of the currency distribution. In addition, our model suggests that, to be a true international currency, the renminbi should be used more extensively in the financial markets of the US and UK.
    Keywords: currency internationalization; distribution of currencies; gravity model
    JEL: F33 F36 G15
    Date: 2015–06–03
  14. By: Richard Chisik (Department of Economics, Ryerson University, Toronto, Canada); Nazanin Behzadan (Department of Economics, Ryerson University, Toronto, Canada); Harun Onder (The World Bank); Bill Battaile (The World Bank)
    Abstract: We show that the Dutch disease can arise solely from inequality in the distribution of natural resource rents. In particular, a less equal distribution of the natural resource rents can generate manufacturing sector stagnation and lower long-run growth even for a country with a smaller resource base and (initially) higher manufacturing productivity. In our framework the Dutch disease arises through a shift in demand. The new found wealth from the resource find increases demand for non-tradable luxury consumption services and this increase is larger if the distribution of the natural resource rents is less equal. Labor that could be used to develop the manufacturing sector is pulled into the service sector. Manufactured goods are more likely to be imported and the learning and production process improvements accrue to the foreign exporters. As opposed to conventional models where income distribution has no effect on economic outcomes, an unequal distribution of the resource wealth can generate or further intensify the Dutch disease dynamics within this framework. We then take our theoretical model to the data and show that, in cross-section, static panel data, and dynamic panel data estimation, inequality plays a significant role in whether being resource-rich is a blessing or a curse for a country. Our empirical findings do not refute our hypothesis that the Dutch Disease is directly linked with how well the natural resource rents are distributed. The more unequal is this distribution, the stronger is the disease.
    Date: 2015–06

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