nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒09‒26
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Risk Sharing and Growth in Small-Open Economies By Raouf Boucekkine; Giorgio Fabbri; Patrick A. Pintus
  2. Does a Currency Union Need a Capital Market Union? By Thomas Philippon; Joseba Martinez
  3. Extent of Exchange Rate Coordination in Asia By Sen Gupta, Abhijit
  4. Demand for Value Added and Value-Added Exchange Rates By Rudolfs Bems; Robert C. Johnson
  5. Unprecedented Changes in the Terms of Trade By Mariano Kulish; Daniel Rees
  6. The law of one price revisited: How do goods market frictions generate large and volatile price deviations? By Lee, Inkoo; Park, Sang Soo
  7. Currency Areas and Voluntary Transfers By Pierre M. Picard; Tim Worrall
  8. Exit expectations and debt crises in currency unions By Kriwoluzky, Alexander; Müller, Gernot; Wolf, Martin
  9. Measuring Contagion-Induced Funding Liquidity Risk in Sovereign Debt Markets By Cho-Hoi Hui; Chi-Fai Lo; Xiao-Fen Zheng; Tom Fong
  10. Financial Shocks, Customer Captial and the Trade Collapse of 2008-2009 By Alok Johri; Terry Yip
  11. Exchange Rates, Cross-Border Travel, and Retailers: Theory and Empirics By Jen Baggs; Loretta Fung; Beverly Lapham
  12. Breaking the Curse of Kareken and Wallace with Private Information By Gomis-Porqueras, Pedro; Kam, Timothy; Waller, Christopher J.
  13. A New Look at the Determinants of Growth in Asian Countries By Manuk Ghazanchyan; Janet Gale Stotsky; Qianqian Zhang
  14. Capital Allocation and Productivity in South Europe By Gopinath, Gita; Kalemli-Ozcan, Sebnem; Karabarbounis, Loukas; Villegas-Sanchez, Carolina
  15. 'Capital Controls and Welfare with Cross-Border Bank Capital Flows' By Pierre-Richard Agénor; Pengfei Jia

  1. By: Raouf Boucekkine (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); Giorgio Fabbri (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); Patrick A. Pintus (DGEI-DEMFI-POMONE – Banque de France)
    Abstract: In this paper, we revisit the question of how domestic and foreign risks affect growth through the lens of an AK small-open economy model with risky borrowing/lending and global diversification. Wealth is allocated between domestic and foreign assets and the optimal allocation depends on both the difference in deterministic returns and the relative magnitude and correlation of domestic and foreign risks. Depending on parameters, the small-open economy may choose to either borrow from abroad, despite the fact that this is risky, or lend. In contrast to standard N-country models, whether growth is faster or slower (and whether growth is more or less volatile) compared to autarky is not entirely driven by relative risk aversion but also depends on the return and risk characteristics of domestic and foreign assets. We also show that growth volatility and mean growth have typically nonmonotonic relationships with the the levels and correlation of domestic and foreign risks. We argue that these results are in line with, and lay down some theoretical foundations for explaining the conflicting empirical results regarding the impact of international financial integration on growth and in particular threshold effects.
    Keywords: international financial integration, endogenous growth, small open economy, domestic and foreign risks
    Date: 2015–09
  2. By: Thomas Philippon (New York University); Joseba Martinez (New York University)
    Abstract: We study financial linkages and risk sharing in the context of the Eurozone crisis. We consider four types of currency unions: a currency union with (potentially) segmented markets; a banking union; a capital market union; and a currency union with complete financial markets. We then analyze how these economies respond to deleveraging shocks and to technology shocks. We find that a banking union is enough to deal with public and private deleveraging shocks, but a capital market union is necessary to approximate the complete market allocation when there are shocks that affect productivity or the terms of trade
    Date: 2015
  3. By: Sen Gupta, Abhijit
    Abstract: High level of intra-regional trade and negative spillovers from competitive devaluation make exchange rate coordination extremely desirable in Asia. Employing a hypothetical Asian Currency Unit we evaluate the degree of coordination among Asian currencies. Traditional empirical tests yield little evidence of coordination among real and nominal exchange rates. However, introducing endogenously determined structural breaks to account for changes in exchange rate regimes provides more mixed evidence. While there is still little evidence for coordination in nominal terms, some degree of coordination among real rates emerges. The limited evidence for exchange rate coordination can be explained by the diverse exchange rate regimes prevailing in these economies, signaling differences in policy objectives.
    Keywords: Asian Currency Unit, currency coordination, structural breaks, exchange rate regimes, panel unit root
    JEL: E58 F33 F36 N15
    Date: 2015
  4. By: Rudolfs Bems; Robert C. Johnson
    Abstract: We examine the role of cross-border input linkages in governing how international relative price changes influence demand for domestic value added. We define a novel value-added real effective exchange rate (REER), which aggregates bilateral value-added price changes, and link this REER to demand for value added. Input linkages enable countries to gain competitiveness following depreciations by supply chain partners, and hence counterbalance beggar-thy-neighbor effects. Cross-country differences in input linkages also imply that the elasticity of demand for value added is country specific. Using global input-output data, we demonstrate these conceptual insights are quantitatively important and compute historical value-added REERs.
    Date: 2015–09–08
  5. By: Mariano Kulish (School of Economics, University of New South Wales); Daniel Rees (Reserve Bank of Australia)
    Abstract: The ongoing development of Asia has led to unprecedented changes in the terms of trade of commodity-exporting economies. Using a small open economy model we estimate changes in the long-run level and variance of Australia's terms of trade and study the quantitative implications of these changes. We find that the long-run prices of commodities that Australia exports started to increase significantly in mid 2003 and that the volatility of shocks to commodity prices doubled soon after. The persistent increase in the level of commodity prices is smaller than single-equation estimates suggest, but our inferences rely on many observables that in general equilibrium also respond to shifts in the long-run level of the terms of trade.
    Keywords: Bayesian analysis; open economy macroeconomics; terms of trade
    JEL: C11 F41 Q33
    Date: 2015–08
  6. By: Lee, Inkoo; Park, Sang Soo
    Abstract: This paper analyzes the role of goods market frictions in accounting for the large and volatile deviations from the Law of One Price in a framework of flexible prices. We draw a distinction between goods market frictions that are required to consume tradable goods (e.g., distribution costs) and those that are necessary for international transactions (e.g., trade costs). We find that trade costs generate LOP deviations by introducing a no-arbitrage band, while distribution costs cause the price to deviate from the LOP by affecting the probability that trade will occur, given the band. We then conduct a Monte Carlo simulation to show that real exchange rate volatility is positively associated with trade costs, but negatively related to distribution costs. This effect depends on the interplay of trade costs and distribution costs, as they work in opposite directions when creating arbitrage opportunities.
    Keywords: Distribution costs, trade costs, law of one price, real exchange rate volatility
    JEL: F31 F37
    Date: 2015–09–01
  7. By: Pierre M. Picard (CREA, Université de Luxembourg); Tim Worrall (University of Edinburgh)
    Abstract: This paper discusses the relationship between the formation of a currency area and the use of voluntary fiscal transfers between countries. We show that there is a trade off between the benefits of flexible exchange rates and the additional risk sharing benefits of voluntary transfers that can be sustained in a currency area. We show that whether a currency area is beneficial or not will depend on the magnitude of economic parameter values. In particular, we show that in a simple two country model and for a plausible set of economic parameter values, a currency area is optimal.
    Keywords: Monetary Union; Currency Areas; Fiscal Federalism; Limited Commitment; Mutual Insurance
    JEL: F12 F15 F31 F33
    Date: 2015
  8. By: Kriwoluzky, Alexander; Müller, Gernot; Wolf, Martin
    Abstract: Membership in a currency union is not irreversible. Expectations of exit may emerge during a sovereign debt crisis, because by exiting countries can redenominate and reduce their liabilities. This possibility alters the dynamics of sovereign debt crises. We establish this formally within a small open economy model of changing policy regimes. The model permits explosive dynamics of debt and sovereign yields inside the currency union and allows us to distinguish between exit expectations and those of an outright default. By estimating the model on Greek data, we quantify the contribution of exit expectations to the crisis dynamics during 2009-2012.
    Keywords: currency union; euro crisis; exit; fiscal policy; redenomination premium; regime-switching model; sovereign debt crisis
    JEL: E41 E52 E62
    Date: 2015–09
  9. By: Cho-Hoi Hui (Hong Kong Monetary Authority); Chi-Fai Lo (The Chinese University of Hong Kong); Xiao-Fen Zheng (The Chinese University of Hong Kong); Tom Fong (Hong Kong Monetary Authority)
    Abstract: The euro-area sovereign debt crisis demonstrated how liquidity shocks can build up in a sovereign debt market due to contagion. This paper proposes a model based on the probability density associated with the dynamics of sovereign bond spreads to measure contagion-induced systemic funding liquidity risk in the market. The two risk measures with closed-form formulas derived from the model, are (1) the rate of change of the probability of triggering a liquidity shock determined by the joint sovereign bond spread dynamics of the systemically important countries (i.e., Italy and Spain) and small country (i.e., Portugal); and (2) the distress correlation between bond spreads, which can provide forward-looking signals of such risk. A signal of the rate of change of the joint probability appeared in April 2011 before the liquidity shock occurred in November 2011. There exist endogenous critical levels of sovereign spreads, above which the signal materializes. The empirical results show that when funding cost, risk aversion and equity prices pass through certain levels, the rate of change of the joint probability will rise sharply.
    Keywords: European Sovereign Debt Crisis, Liquidity Risk, Contagion
    JEL: F30 G13
    Date: 2015–08
  10. By: Alok Johri; Terry Yip
    Abstract: The collapse in trade relative to GDP during 2008-09 was unusually large and also puzzling relative to the predictions of canonical two-country models. In a calibrated model of customer capital where firms must acquire a customer base before any sales can occur, we show that credit shocks can cause a fall in the trade-GDP ratio equal to 43 percent of the observed value. The key mechanism involves a reallocation of scarce marketing resources from international to domestic customers, who are acquired more cheaply. Bayesian estimation shows that financial shocks are important in accounting for recent fluctuations in the trade-GDP ratio.
    JEL: E32 F41
    Date: 2015–09
  11. By: Jen Baggs (University of Victoria); Loretta Fung (National Tsing Hua University); Beverly Lapham (Queen's University)
    Abstract: This paper provides a theoretical and empirical analysis of the effects of nominal exchange rate movements on cross-border travel by consumers and on retail firms' sales. We develop a search-theoretic model of price-setting heterogeneous retailers and traveling consumers who face nominal exchange rate shocks. These exchange rate shocks act as both a supply side shock for retailers though imported input prices and a demand side shock though their effect on the propensity for consumers to cross the border and shop at foreign retail stores. The model provides predictions regarding relationships between firm and regional characteristics and the magnitude of the effects of nominal exchange rate fluctuations and resulting cross-border travel activity on retailers' sales. We use our theoretical framework to motivate an empirical methodology applied to Canadian firm and consumer level data from 1987 to 2007. Our findings indicate that an appreciation of the Canadian dollar substantially increases cross border travel which in turn has a significant negative effect on the sales of Canadian retailers. These effects diminish with the distance of the retailer from the border and with the shopping opportunities available at relevant US destinations. Using counterfactual experiments, we quantify the effects of more restrictive border controls after September 2001 which discouraged cross-border trips and reduced retailer losses from cross-border shopping as well as the effects of increased duty free allowances which raised cross-border trips and reduced retailer sales.
    Keywords: International Price Differences, Cross-Border Shopping, Firm Dynamics, Exchange Rate Pass-Through
    JEL: F10 F14 L81
    Date: 2015–08
  12. By: Gomis-Porqueras, Pedro (Deakin University, Australia); Kam, Timothy (The Australian National University); Waller, Christopher J. (Federal Reserve Bank of St. Louis)
    Abstract: We study the endogenous choice to accept at objects as media of exchange and their implications for nominal exchange rate determination. We consider a two-country environment with two currencies which can be used to settle any transactions. However, currencies can be counterfeited at a fixed cost and the decision to counterfeit is private information. This induces equilibrium liquidity constraints on the currencies in circulation. We show that the threat of counterfeiting can pin down the nominal exchange rate even when the currencies are perfect substitutes, thus breaking the Kareken-Wallace indeterminacy result. When the two currencies are not perfect substitutes, an international currency can exist whereby one country has two currencies circulating while the other country uses only one. We also find that with appropriate fiscal policies we can enlarge the set of monetary equilibria with determinate nominal exchange rates. Finally, we show that the threat of counterfeiting can also help determine nominal exchange rates in a variety of different trading environments.
    Keywords: Multiple Currencies; Counterfeiting Threat; Liquidity; Exchange Rates
    JEL: D82 D83 E4 F4
    Date: 2015–06–20
  13. By: Manuk Ghazanchyan; Janet Gale Stotsky; Qianqian Zhang
    Abstract: This study examines the drivers of growth in Asian countries, with focus on the role of investment, the exchange rate regime, financial risk, and capital account openness. We use a panel data set of a sample of Asian countries over the period 1980 to 2012. Our results indicate that private and public investments are strong drivers of growth, while more limited evidence is found that reduced financial risk and higher foreign direct investment support growth. The exchange rate regime does not appear to be a strongly significant determinant of growth, but some specifications suggest that more flexible regimes are beneficial in this respect. Financial crises have a stronger dampening effect on growth in countries with more open capital accounts.
    Date: 2015–09–03
  14. By: Gopinath, Gita; Kalemli-Ozcan, Sebnem; Karabarbounis, Loukas; Villegas-Sanchez, Carolina
    Abstract: Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. We use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. We develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. We conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.
    Keywords: Capital Flows; Dispersion; Europe; Misallocation; Productivity
    JEL: D24 E22 F41 O16 O47
    Date: 2015–09
  15. By: Pierre-Richard Agénor; Pengfei Jia
    Abstract: This paper studies the performance of time-varying capital controls on cross-border bank borrowing in an open-economy, dynamic stochastic general equilibrium model with credit market frictions and imperfect capital mobility. The model is calibrated for a middle-income country and is shown to replicate the main stylized facts associated with a fall in world interest rates (capital inflows, real appreciation, credit boom, asset price pressures, and output expansion). A capital controls rule, which is fundamentally macroprudential in nature, is defined in terms of either changes in bank foreign borrowing or cyclical output. An optimal, welfare-maximizing rule is established numerically. The analysis is then extended to solve jointly for optimal countercyclical reserve requirements and capital controls rules. These instruments are complements in the sense that both are needed to maximize welfare. However, a more aggressive reserve requirement rule (which responds to the credit-output ratio) also induces less reliance on capital controls. Thus, at the margin, countercyclical reserve requirements and capital controls are partial substitutes in maximizing welfare.
    Date: 2015

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