nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒06‒27
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rate Implications of Reserve Changes: How Non-EZ European Countries Fared during the Great Recession By Kathryn M. E. Dominguez
  2. Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies By Enrique G. Mendoza; Linda L. Tesar; Jing Zhang
  3. Financialization and the Financial and Economic Crises: The Case of Greece By Yanis Varoufakis; Lefteris Tserkezis
  4. Monetary policy and sovereign debt vulnerability By Galo Nuño; Carlos Thomas
  5. Business cycle synchronization of the Visegrad Four and the European Union By Hanus, Lubos; Vacha, Lukas
  6. Exchange rate fluctuations and the margins of exports By Richard Fabling; Lynda Sanderson
  7. The euro as an international currency By Agnès Bénassy-Quéré
  8. When Bonds Matter: Home Bias in Goods and Assets By Nicolas Coeurdacier; Pierre-Olivier Gourinchas
  9. The interest rate pass-through in the euro area during the sovereign debt crisis By von Borstel, Julia; Eickmeier, Sandra; Krippner, Leo
  10. Commodity prices and fiscal policy design: Procyclical despite a rule By Hilde C. Bjørnland; Leif Anders Thorsrud
  11. Fertility, Longevity and International Capital Flows By Zsofia Barany; Nicolas Coeurdacier; Stéphane Guibaud
  12. Fiscal Discoveries and Yield Decouplings By Luis Catão; Ana Fostel; Romain Ranciere
  13. Capital Controls, Exchange Market Intervention and International Reserve Accumulation in India By Naveen Srinivasan; Vidya Mahambare; M. Ramachandran
  14. Commodity Currencies Revisited By Passari, Evgenia
  15. Real unit labour costs in Eurozone countries: Drivers and clusters By Javier Ordóñez; Hector Sala; José I. Silva

  1. By: Kathryn M. E. Dominguez (University of Michigan and NBER)
    Abstract: The relationships between exchange rates, capital controls and foreign reserves during the financial crisis suggest that reserve management plays a much more central role than has typically been emphasized in international finance models. Reserves seem to be especially important for non-EZ European countries, not only for those with currencies in the ERM II, but also for those European countries in intermediate regimes that hope to deter currency market pressure, and in so doing help to mitigate trilemma trade-offs.
    Keywords: foreign exchange reserves, global financial crisis, exchange market pressure
    JEL: F32 F41
  2. By: Enrique G. Mendoza (University of Pennsylvania and NBER); Linda L. Tesar (University of Michigan and NBER); Jing Zhang (Federal Reserve Bank of Chicago)
    Abstract: What are the macroeconomic effects of tax adjustments in response to large public debt shocks in highly integrated economies? The answer from standard closed-economy models is deceptive, because they underestimate the elasticity of capital tax revenues and ignore cross-country spillovers of tax changes. Instead, we examine this issue using a two-country model that matches the observed elasticity of the capital tax base by introducing endogenous capacity utilization and a partial depreciation allowance. Tax hikes have adverse effects on macro aggregates and welfare, and trigger strong crosscountry externalities. Quantitative analysis calibrated to European data shows that unilateral capital tax increases cannot restore fiscal solvency, because the dynamic Laffer curve peaks below the required revenue increase. Unilateral labor tax hikes can do it, but have negative output and welfare effects at home and raise welfare and output abroad. Large spillovers also imply that unilateral capital tax hikes are much less costly under autarky than under free trade. Allowing for one-shot Nash tax competition, the model predicts a "race to the bottom" in capital taxes and higher labor taxes. The cooperative equilibrium is preferable, but capital (labor) taxes are still lower (higher) than initially. Moreover, autarky can produce higher welfare than both Nash and Cooperative equilibria.
    Keywords: fiscal austerity, tax, public debt
    JEL: E6 E62 F34 F42 H6
  3. By: Yanis Varoufakis (National & Kapodistrian University of Athens); Lefteris Tserkezis (National & Kapodistrian University of Athens)
    Abstract: The present essay analyzes the changing relationship between the real and the financial sector in the course of the long-run development of the Greek economy, focusing on the effects of financialization and on its connection to the current economic crisis. The first section offers a brief discussion of the basic tendencies characterizing the long-run development of the Greek economy over the past three decades. The second section examines the effect of financialization on several aspects of the real economy, including income distribution, gross capital formation, consumption and the evolution of the current account. In the third section, the results of the preceding analysis are linked to the outbreak of the current crisis, in an attempt to explain the reasons behind this crisis’ excessive severity in the case of the Greek economy, while the fourth section concludes.
    Keywords: capital flows, current account deficit, debt crisis, financialization, Greek economy, trade imbalances
    JEL: E25 E62 E63 F34 F40 H21 H62 H63
    Date: 2014–12–01
  4. By: Galo Nuño (Banco de España); Carlos Thomas (Banco de España)
    Abstract: We investigate the trade-offs between price stability and the sustainability of sovereign debt, using a small open economy model where the government issues nominal defaultable debt and chooses fiscal and monetary policy under discretion. Inflation reduces the real value of outstanding debt, thus making it more sustainable; but it also raises nominal yields and entails direct welfare costs. We compare this scenario with a situation in which the government gives up the ability to deflate debt away, e.g. by issuing foreign currency debt or joining a monetary union with an anti-inflationary stance. We find that the benefits of giving up this adjustment margin outweigh the costs, both for our preferred calibration and for a wide range of parameter values.
    Keywords: monetary-fiscal interactions, discretion, sovereign default, continuous time, optimal stopping
    JEL: E5 E62 F34
    Date: 2015–06
  5. By: Hanus, Lubos; Vacha, Lukas
    Abstract: In this paper, we map the process of synchronization of the Visegrad Four within the framework of the European Union using the wavelet techniques. In addition, we show that the relationship of output and key macroeconomic indicators is dynamic and varies over time and across frequencies. We study the synchronization applying the wavelet cohesion measure with time-varying weights. This novel approach allows for studying the dynamic relationship among countries from a different perspective than usual timedomain models. Analysing monthly data from 1990 to 2014, the results for the Visegrad region show an increasing co-movement with the European Union after the countries began with preparation for the accession to the European union. The participation in a currency union possibly increases the co-movement. Further, analysing the Visegrad and South European countries' synchronization with the European Union core countries, we find a high degree of synchronization in long-term horizons.
    Keywords: business cycle synchronization,time-frequency,wavelets,co-movement,Visegrad Four,European Union
    JEL: E32 C40 F15
    Date: 2015
  6. By: Richard Fabling; Lynda Sanderson (The Treasury)
    Abstract: This paper examines the relationship between exchange rate fluctuations and New Zealand export performance. To isolate the impact of the exchange rate, as opposed to contemporaneous (and related) fluctuations in New Zealand’s economic performance or overseas market characteristics, we focus on bilateral export relationships at the firm level and control for both time-invariant country characteristics and changes in aggregate economic conditions. We examine two key margins of export adjustment – the probability of exporting (the extensive margin) and the average value of exports per firm (the intensive margin) – and distinguish between impacts on market incumbents and new or potential entrants. Finally, we specifically take account of the potential for interaction between the level and volatility of the exchange rate to affect exporting, as implied by theories of exchange rate hysteresis.
    JEL: D22 F14 F31
    Date: 2015–06
  7. By: Agnès Bénassy-Quéré (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS)
    Abstract: The euro, in spite of having many of the required attributes put forward by the theoretical literature and past experience, has failed to fulfill all the criteria that would enable it to rival the dollar as an international currency. This does not mean that the euro cannot achieve a status similar to that of the dollar; however, the window of opportunity may not last much more than a decade before the renminbi overtakes the euro. European monetary unification has never explicitly sought for its currency to gain an international status. This makes sense insofar as the key elements required for the euro to expand internationally are also those to be pursued internally: GDP growth; a fiscal backing to the single currency; a deep, liquid and resilient capital market; and a unified external representation of the euro area.
    Date: 2015–03
  8. By: Nicolas Coeurdacier (Département d'économie); Pierre-Olivier Gourinchas
    Abstract: This paper presents a model of international portfolios with real exchange rate and non financial risks that accounts for observed levels of equity home bias. A key feature is that investors can trade domestic and foreign bonds in addition to equities. Bonds matter: in equilibrium, investors structure their bond portfolio to hedge real exchange rate risks and equity home bias arises when non-financial income risk is negatively correlated with equity returns, after controlling for bond returns. Our framework allows us to derive equilibrium bond and equity portfolios in terms of sufficient statistics - directly measurable hedge ratios. We estimate equity and bond portfolios implied by the model for G-7 countries an find strong empirical support for the theory. We are able to account for a significant share of the equity home bias and obtain a currency exposure of bond portfolios comparable to the data.
    Keywords: International risk sharing; International portfolios; Equity home bias
    JEL: F30 F41 G11
    Date: 2015–03
  9. By: von Borstel, Julia; Eickmeier, Sandra; Krippner, Leo
    Abstract: We investigate the pass-through of monetary policy to bank lending rates in the euro area during the sovereign debt crisis, in comparison to the pre-crisis period. We make the following contributions. First, we use a factor-augmented vector autoregression, which allows us to assess the responses of a large number of country-specific interest rates and spreads. Second, we analyze the effects of monetary policy on the components of the interest rate pass-through, which reflect banks' funding risk (including sovereign risk) and markups charged by banks over funding costs. Third, we not only consider conventional but also unconventional monetary policy. We find that while the transmission of conventional monetary policy to bank lending rates has not changed with the crisis, the composition of the IP has changed. Specifically, expansionary conventional monetary policy lowered sovereign risk in peripheral countries and longer-term bank funding risk in peripheral and core countries during the crisis, but has been unable to lower banks' markups. This was not, or not as much, the case prior to the crisis. Unconventional monetary policy helped decreasing lending rates, mainly due to large shocks rather than a strong propagation.
    Keywords: interest rate pass-through,factor model,sovereign debt crisis,unconventional monetary policy
    JEL: E5 E43 E44 C3
    Date: 2015
  10. By: Hilde C. Bjørnland; Leif Anders Thorsrud
    Abstract: We analyse if the adoption of a fiscal spending rule insulates the domestic economy from commodity price fluctuations in a resource-rich economy. To do so we develop a time-varying Dynamic Factor Model, in which we allow both the volatility of structural shocks and the systematic fiscal policy responses to change over time. We focus on Norway, a country that is put forward as exemplary with its handling of resource wealth. Unlike most oil exporters, Norway has devised a fiscal framework with the view to shield the domestic economy from oil price fluctuations. By transferring its petroleum revenues to a sovereign wealth fund, and then consuming only the expected real return on the fund, fiscal policy allows for a gradual phasing in of the petroleum revenue, unrelated to movements in oil prices. We find that, contrary to common perception, fiscal policy has been more (not less) procyclical with commodity prices since the adoption of the fiscal rule in 2001. Fiscal policy has thereby worked to exacerbate the commodity price fluctuations on the domestic economy. Large inflows of money to the fund during a period of rapidly increasing oil prices is part of the explanation. Still, Norway has managed to save a large share of its petroleum income for future generations. Compared to many other resource-rich economies practising a more spend-as-you-go strategy, this is a great success.
    Keywords: Commodity prices, fiscal policy, Time-varying Dynamic Factor Model
    Date: 2015–06
  11. By: Zsofia Barany (Département d'économie); Nicolas Coeurdacier (Département d'économie); Stéphane Guibaud (Département d'économie)
    Abstract: The neoclassical growth model predicts large capital flows towards fast-growing emerging countries. We show that incorporating fertility and longevity into a lifecycle model of savings changes the standard predictions when countries differ in their ability to borrow inter-temporally and across generations through social security. In this environment, global aging triggers capital flows from emerging to developed countries, and countries’ current account positions respond to growth adjusted by current and expected demographic composition. Data on international capital flows are broadly supportive of the theory. The fact that fast-growing emerging countries are also aging faster, while having less developed credit markets and pension systems, explains why they are more likely to export capital. Our quantitative multi-country overlapping generations model explains a significant fraction of the patterns of capital flows, across time and across developed and emerging countries.
    Date: 2015–06
  12. By: Luis Catão; Ana Fostel; Romain Ranciere
    Abstract: The recent Eurozone debt crisis has witnessed sharp decouplings in cross-country bond yields without commensurate shifts in relative fundamentals. We rationalize this phenomenon in a model wherein countries with different fundamentals are on different equilibrium paths all along, but which become discernible only during bad times. Key ingredients are cross-country differences in the volatility and persistence of fiscal revenue shocks combined with their unobservability by investors. Differences in the cyclicality of fiscal revenues affect the option value of borrowing and resulting default risk; unobservability of fiscal shocks makes bond pricing responsive to market actions. When tax revenues are hit by common positive shocks, no country increases net debt and interest spreads stay put. When a common negative revenue shock hits and is persistent, low volatility countries adjust spending while others resort to borrowing. This difference signals a relative deterioration of fiscal outlooks, interest spreads jump and decoupling takes place.
    JEL: E62 F34 G15 H3
    Date: 2014–05
  13. By: Naveen Srinivasan (Madras School of Economics); Vidya Mahambare (Great Lakes Institute of Management, Chennai); M. Ramachandran (Professor, Department of Economics, Pondicherry University)
    Abstract: The build up of international reserves by many Asian countries over the last decade or so has attracted widespread interest and debate. This paper seeks to make a contribution to this discussion from the point of view of India. The empirical results are designed to identify the extent to which the accumulation of reserves in India has been driven by two motives which are commonly identified with respect to the recent accumulation of reserves by the Asian EMEs, namely a demand to have insurance against external shocks and a demand to have a high level of export competitiveness, so as to have export-led growth. Our results provide evidence in support of both the motives in explaining India’s international reserves accumulation strategy, although, their relative importance does seem to vary overtime depending on external factors. This in turn offers some helpful insights into the causes and likely future path of the global imbalances.
    Keywords: Reserve accretion; Capital controls; Exports competitiveness
    JEL: E58 F31 F32
    Date: 2015–04
  14. By: Passari, Evgenia
    Abstract: I build an exchange rate strategy that trades currencies conditional on changes in the global prices of commodity indices; hence, termed “commodity strategy”. First, I document that commodity prices have signicant out-of-sample forecasting ability for the future exchange rates of several commodity exporters and importers at the daily frequency. However, I report that the reverse forecasting relationship does not survive out-of-sample testing. Second, I find a signicant cross-sectional spread, in both spot and excess returns, of 6% p.a. between the currencies that are predicted to appreciate and those that are predicted to depreciate. The returns appear to be uncorrelated to those of popular exchange rate strategies such as the carry trade and currency momentum. Furthermore, the spread in returns is not explained by traditional risk factors; however, it is partly accounted for by the strategy’s high transaction costs. Net probability can be restored by either implementing a simple market timing rule or by investing in developed markets with low costs and high liquidity.
    Keywords: Foreign Exchange; Commodity Currencies; Asset Pricing;
    JEL: F31 F37 G10 G11
    Date: 2015–06
  15. By: Javier Ordóñez (Department of Economics, Universitat Jaume I, Castellón, Spain); Hector Sala (IZA and Department of Economics, Universitat Autònoma de Barcelona, Spain); José I. Silva (Department of Economics, Universitat de Girona, Spain)
    Abstract: We examine the trajectories of the real unit labour costs (RULCs) in a selection of Eurozone economies. Strong asymmetries in the convergence process of the RULCs and its components —real wages, capital intensity, and technology— are uncovered through decomposition and cluster analyses. In the last three decades, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) succeeded in reducing their RULCs by more than their northern partners. With the exception of Ireland, however, technological progress was weak; it was through capital intensification that periphery economies gained efficiency and competitiveness. Cluster heterogeneity, and lack of robustness in cluster composition, is a reflection of the difficulties in achieving real convergence and, by extension, nominal convergence. We conclude by outlining technology as the key convergence factor, and call for a wider strategy in labour market policies, which should be more oriented to promote the sources of productivity growth.
    Keywords: Real unit labour costs, Eurozone, Real wages, Capital intensity, Technology
    JEL: F43 O47 O52
    Date: 2015

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