nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒08‒25
eight papers chosen by
Martin Berka
University of Auckland

  1. A Model of the Twin Ds: Optimal Default and Devaluation By Vivian Yue; Stephanie Schmitt-Grohe; Martin Uribe; Seunghoon Na
  2. Asymmetric Exchange Rate Pass-Through in Japanese Exports: Application of the threshold vector autoregressive model By Thi-Ngoc Anh NGUYEN; SATO Kiyotaka
  3. External Balance Sheets as Countercyclical Crisis Buffers By Joyce, Joseph
  4. Incorporating Financial Cycles in Output Gap Measures: Estimates for the Euro Area By Pau Rabanal; Marzie Sanjani
  5. The stabilising properties of a European Banking Union in case of financial shocks in the Euro Area By Fritz Breuss; Werner Roeger; Jan in ’t Veld
  6. Common and Country Specific Economic Uncertainty By Haroon Mumtaz; Konstantinos Theodoridis
  7. Real Exchange Rate and Economic Growth in China: A Cointegrated VAR Approach By Tang, Bo
  8. Risk-Taking, Global Diversification and Growth: Comment By Patrick A. Pintus

  1. By: Vivian Yue (Emory University); Stephanie Schmitt-Grohe (Columbia University); Martin Uribe (Columbia University); Seunghoon Na (Columbia University)
    Abstract: This paper characterizes jointly optimal default and exchange-rate policy in a small open economy with limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default occurs during contractions and is accompanied by large devaluations. The latter inflate away real wages thereby avoiding massive unemployment. Thus, the Twin Ds phenomenon emerges endogenously as the optimal outcome. By contrast, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are shown to have stronger default incentives and therefore support less external debt than economies with optimally floating rates.
    Date: 2015
  2. By: Thi-Ngoc Anh NGUYEN; SATO Kiyotaka
    Abstract: This paper employs a threshold vector autoregressive (TVAR) model to analyze a possible asymmetric behavior of exchange rate pass-through (ERPT) or pricing-to-market (PTM) in Japanese exports between the yen appreciation and depreciation regimes. We developed a new approach to estimating the exporting firm's reference (predicted) exchange rate by applying the threshold autoregressive (TAR) model with a rolling window. We also use an industry-specific nominal effective exchange rate on a contract currency basis to better capture a role of the U.S. dollar as the third currency for trade invoicing. It is found that the degree of PTM (ERPT) was larger (smaller) in the yen depreciation regime up to the end of the 1990s but became smaller (larger) in the 2000s and after. A decline (increase) in PTM (ERPT) in the yen depreciation regime suggests that Japanese exporters tend to lower the yen-based export price and fail to fully exploit foreign exchange gain in response to the yen depreciation, likely due to an increase in export competition in the world market.
    Date: 2015–08
  3. By: Joyce, Joseph
    Abstract: The external balance sheets of many emerging market countries are distinguished by their holdings of assets primarily in the form of foreign debt and foreign exchange reserves, while their liabilities are predominantly equity, either FDI or portfolio. In this paper we investigate the claim that this composition served as a buffer for the emerging markets during the global financial crisis of 2008-09. We use data from a sample of 67 emerging market and advanced economies, and several indicators of the crisis are utilized: GDP growth rates in 2008-09, the occurrence of bank crises and the use of IMF credit. Our results show that those countries that issued FDI liabilities had higher growth rates, fewer bank crises and were less likely to borrow from the IMF. Countries with debt liabilities, on the other hand, had more bank crises and were more likely to use IMF credit. We conclude that the “long debt, short equity” strategy of emerging markets did mitigate the effects of the global financial crisis.
    Keywords: external balance sheet, foreign assets and liabilities, FDI, portfolio equity, debt
    JEL: F3 F4
    Date: 2015–08
  4. By: Pau Rabanal (IMF); Marzie Sanjani (International Monetary Fund)
    Abstract: During the early 2000s, the euro area periphery countries experienced a credit and house price boom, but with moderate CPI inflation. We suggest a new approach for analyzing the role of credit and house prices in potential output and estimating the output gap. We present a two-country DSGE model for the core and periphery of the euro area, with financial frictions at the household level. We use several macroeconomic variables, including house prices and household credit for each region, to estimate the model. We find that, in the core, the measure of output gap is independent of financial frictions and is similar to that obtained with the Hodrick and Prescott filter, because of the absence of a credit boom. On the contrary, in the periphery, the presence of financial frictions amplify economic fluctuations and the output gap. We also present evidence of the trade-offs faced by the European Central Bank when trying to stabilize two regions in a currency union with divergent economic cycles.
    Date: 2015
  5. By: Fritz Breuss; Werner Roeger; Jan in ’t Veld
    Abstract: This paper analyses the stabilising properties of a European Banking Union in case of financial shocks in the euro area.
    JEL: C54 E12 E32 E42 E63 F41 G21
    Date: 2015–06
  6. By: Haroon Mumtaz (Queen Mary University of London); Konstantinos Theodoridis (Bank of England)
    Abstract: We use a factor model with stochastic volatility to decompose the time-varying variance of Macro economic and Financial variables into contributions from country-specific uncertainty and uncertainty common to all countries. We find that the common component plays an important role in driving the time-varying volatility of nominal and financial variables. The cross-country co-movement in volatility of real and financial variables has increased over time with the common component becoming more important over the last decade. Simulations from a two-country DSGE model featuring Epstein Zin preferences suggest that increased globalisation and trade openness may be the driving force behind the increased cross-country correlation in volatility.
    Keywords: FAVAR, Stochastic Volatility, Uncertainty Shocks, DSGE Model
    JEL: C15 C32 E32
    Date: 2015–08
  7. By: Tang, Bo
    Abstract: This study investigates the relationship between the real exchange rate (RER) and economic growth in China applying a cointegrated VAR (CVAR) model. However, in contrast to the assumptions of trade partners, this paper finds that the Chinese economy has not benefited from the lower exchange rate of the RMB, and no direct linkages exist between the RER and growth in the long run. Interestingly, it appears that the Chinese economy is stimulated by the expansion of exports and inflow of foreign capital according to the empirical evidence, which also suggests that the long run equilibrium RER is jointly determined by the foreign trade, foreign reserves and the foreign direct investment. In addition, the 2005 RMB policy reform did not show any significant impact on the RER, but instead contributed to the steady economic growth. It is clear that, after the 2008 world crisis, the RMB exchange rates were largely dependent on the enhancing of the national strength and inflow of foreign capital, rather than the slow increase in foreign trade. As for policy implications, China may insist on the managed floating exchange rate policy making limited adjustments to the currency's daily floating range in response to the pressures from trade partners.
    Keywords: real exchange rate (RER), economic growth, CVAR, China
    JEL: C32 F31 F43 O24
    Date: 2014–11
  8. By: Patrick A. Pintus (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université)
    Abstract: In a seminal article, Obstfeld (1994) showed that growth and welfare gains from international risk-sharing arise in a continuous-time stochastic AK model. More precisely, he proved that a portfolio shift from safe and low-return capital to riskier and high-return capital triggers an unambiguous increase in growth. In this note I stress necessary and sufficient conditions ensuring stochastic stability of the exponential balanced-growth path, an issue that has not been addressed by Obstfeld. Not surprisingly, stability requires the average of the wealth growth rate to be positive, which makes clear how mean growth should be defined. Differently, Obstfeld defines mean growth as the growth rate of average wealth, which is smaller than the mean growth rate of wealth under the maintained assumption that wealth is log-normally distributed, because the latter growth concept is risk-adjusted. The two notions of mean growth have very different comparative statics properties both for economies that hold some risk-free capital and for economies that fully specialize in risky capital. Different from Obstfeld’s results, international financial integration increases the stability-related mean growth rate for both complete and incomplete specialization, if risk aversion takes on moderate values and provided that the intertemporal substitution elasticity is smaller than one. Although the welfare computations presented by Obstfeld are preserved, because they ultimately depend on parameter values, this note shows that stochastic stability sheds new light on the mechanisms that trigger growth changes under financial integration and underlines the intuition behind them.
    Date: 2015–02

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.