nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒11‒21
nineteen papers chosen by
Martin Berka
University of Auckland

  1. Coordination and Crisis in Monetary Unions By Manuel Amador; Gita Gopinath; Emmanuel Farhi; Mark Aguiar
  2. The Distributional Consequences of Large Devaluations By Javier Cravino; Andrei A. Levchenko
  3. Bad Investments and Missed Opportunities? Postwar Capital Flows to Asia and Latin America By Ohanian, Lee E.; Restrepo-Echavarria, Paulina; Wright, Mark L. J.
  4. Exchange Rate and Current Account Dynamics: the Role of Asset Market Structure, Long-Run Risk and Risk Appetite By Robert Kollmann
  5. When Is Foreign Exchange Intervention Effective? Evidence from 33 Countries By Marcel Fratzscher; Oliver Goede; Lukas Menkhoff; Lucio Sarno; Tobias Stöhr
  6. On the desirability of capital controls By Fabrizio Perri; Jonathan Heathcote
  7. Risk Sharing in a World Economy with Uncertainty Shocks By Kollmann, Robert
  8. Financial Heterogeneity and Monetary Union By jae sim; Raphael Schoenle; Egon Zakrajsek; Simon Gilchrist
  9. The grand divergence: global and European current account surpluses By Zsolt Darvas
  10. Explaining Foreign Holdings of Asiafs Debt Securities: The Feldstein-Horioka Paradox Revisited By Charles Yuji Horioka; Akiko Terada-Hagiwara; Takaaki Nomoto
  11. Current Account and Real Effective Exchange Rate Misalignments in Central Eastern EU Countries: an Update Using the Macroeconomic Balance Approach By Mariarosaria Comunale
  12.  National Financial Frictions and International Business Cycle Synchronization By Jean-François Rouillard
  13. Estimates of Fundamental Equilibrium Exchange Rates, November 2015 By William R. Cline
  14. Exchange Rate Dynamics and its Effect on Macroeconomic Volatility in Selected CEE Countries By Volha Audzei; Frantisek Brazdik
  15. What determines the extent of real exchange rate misalignment in developing countries? By Ridha R. Nouira; Khalid Sekkat
  16. Exchange Rate Pass-through in Russia By Ponomarev, Yuri; Trunin, Pavel V.; Uljukaev, Aleksej V.
  17.  International Risk Sharing and Financial Shocks By Jean-François Rouillard
  18. The Heterogeneous Responses of the World Commodity Prices to Exchange Rate Shocks By Hyeongwoo Kim; Jintaek Kim
  19. Skilled Emigration, Wages and Real Exchange Rate in a Globalized World By Ouyang, Alice; Paul, Saumik

  1. By: Manuel Amador (Federal Reserve Bank of Minneapolis); Gita Gopinath (Harvard); Emmanuel Farhi (Harvard University); Mark Aguiar (Princeton University)
    Abstract: We study fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment. We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
    Date: 2015
  2. By: Javier Cravino (University of Michigan and NBER); Andrei A. Levchenko (University of Michigan, NBER, and CEPR)
    Abstract: We study the differential impact of large exchange rate devaluations on the cost of living at different points on the income distribution. Across product categories, the poor have relatively high expenditure shares in tradeable products. Within tradeable product categories, the poor consume lower-priced varieties. Changes in the relative price of tradeables and the relative prices of lower-priced varieties following a devaluation will affect the cost of the consumption basket of the low-income households relative that of the high-income households. We quantify these effects following the 1994 Mexican peso devaluation and show that their distributional consequences can be large. In the two years that follow the devaluation, the cost of the consumption basket of those in the bottom decile of the income distribution rose between 1.46 and 1.6 times more than the cost of the consumption basket for the top income decile.
    Keywords: exchange rates, large devaluations, distributional effects, consumption baskets
    JEL: F31
  3. By: Ohanian, Lee E. (University of California); Restrepo-Echavarria, Paulina; Wright, Mark L. J. (Federal Reserve Bank of Chicago)
    Abstract: Since 1950, the economies of East Asia grew rapidly but received little international capital, while Latin America received considerable international capital even as their economies stagnated. The literature typically explains the failure of capital to flow to high growth regions as resulting from international capital market imperfections. This paper proposes a broader thesis that country-specific distortions, such as domestic labor and capital market distortions, also impact capital flows. We develop a DSGE model of Asia, Latin America, and the Rest of the World that features an open-economy business cycle accounting framework to measure these domestic and international distortions, and to quantify their contributions to international capital flows. We find that domestic distortions have been the predominant drivers of international capital flows, and that the general equilibrium effects of these distortions are very large. International capital market distortions also matter, but less so.
    Keywords: Investments; capital flows; Asia; Latin America
    JEL: E22 N25 N26
    Date: 2013–11–25
  4. By: Robert Kollmann (ECARES, Universite Libre de Bruxelles)
    Abstract: Standard macro models cannot explain why real exchange rates are volatile and disconnected from macro aggregates. Recent research argues that models with persistent growth rate shocks and recursive preferences can solve that puzzle (e.g., Colacito and Croce, 2013). I show that this result is highly sensitive to the structure of financial markets. When just a bond is traded internationally, then long-run risk generates insufficient exchange rate volatility. A long-run risk model with recursive-preferences can generate realistic exchange rate volatility, if all agents efficiently share their consumption risk by trading in complete financial markets; however, this entails massive international wealth transfers, and excessive swings in net foreign asset positions. By contrast, a long-run risk, recursive-preferences model in which only a fraction of households trades in complete markets, while the remaining households lead hand-to-mouth lives, can generate realistic exchange rate and external balance volatility. In that framework, a rise in the volatility of a country's endowment or in the risk appetite of local investors is predicted to deteriorate the country's trade balance, and to appreciate its real exchange rate. A rise in global volatility and risk aversion improves a country's current account if that country has lower steady state risk aversion than the rest of the world. These predictions seem consistent with the fact that fluctuations in the VIX are positively correlated with the US current account.
    Date: 2015
  5. By: Marcel Fratzscher; Oliver Goede; Lukas Menkhoff; Lucio Sarno; Tobias Stöhr
    Abstract: This study examines foreign exchange intervention based on novel daily data covering 33 countries from 1995 to 2011. We find that intervention is widely used and a highly effective policy tool, with a success rate in excess of 80 percent under some criteria. The policy works very well in terms of smoothing the path of exchange rates, and in stabilizing the exchange rate in countries with narrow band regimes. Moving the level of the exchange rate in flexible regimes requires that some conditions are met, including the use of large volumes and that intervention is made public and supported via communication.
    Keywords: Foreign exchange intervention, exchange rate regimes, effectiveness measures, communication, capital controls
    JEL: F31 F33 E58
    Date: 2015
  6. By: Fabrizio Perri (University of Minnesota); Jonathan Heathcote (Minneapolis FED)
    Abstract: In a standard two country international macro model we ask whether shutting down the market for international non-contingent borrowing and lending is ever desirable. The answer is yes. Imposing capital controls is unilaterally desirable when initial conditions are such that ruling out bond trade generates a sufficiently favorable change in the expected path for the terms of trade. Imposing capital controls can be welfare improving for both countries for calibrations in which changes in equilibrium terms of trade movements induced by the controls improve insurance against country specific shocks.
    Date: 2015
  7. By: Kollmann, Robert
    Abstract: This paper analyzes the effects of output volatility shocks and of risk appetite shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country world with recursive preferences and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country’s output volatility triggers a wealth transfer to that country, in equilibrium; this raises its consumption, lowers its trade balance and appreciates its real exchange rate. The effects of risk appetite shocks resemble those of volatility shocks. In a recursive preferences-complete markets framework, volatility and risk appetite shocks account for a noticeable share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption growth and the real exchange rate.
    Keywords: consumption-real exchange rate anomaly; exchange rate; external balance; risk appetite; volatility shock
    JEL: F31 F32 F36 F41 F43
    Date: 2015–11
  8. By: jae sim (Federal Reserve Board); Raphael Schoenle (Brandeis University); Egon Zakrajsek (Federal Reserve Board); Simon Gilchrist (Boston University)
    Abstract: In this paper, we analyze the business cycle and welfare consequences of monetary union among countries that face heterogeneous financial market frictions. We show that facing financial distress in the absence of devaluation, the firms in financially weak countries countries have an incentive to raise their prices to cope with liquidity shortfalls. At the same time, firms in countries with greater financial slack poach from the customer base of the former countries by undercutting their prices, without internalizing the detrimental effects on union-wide aggregate demand. Thus, a monetary union among countries with heterogeneous degrees of financial frictions may create a tendency toward internal devaluation for core countries with greater financial resources, leading to chronic current account deficits of the peripheral countries. A risk-sharing arrangement between the core and the periphery can potentially undo the distortion brought about by the currency union. However, such risk sharing requires unrealistic amounts of wealth transfers from the core to the periphery. We show that unilateral fiscal devaluation carried out by the peripheral countries can substantially improve the situation not only for themselves but also for the core countries if there exists an important degree of pecuniary externality not internalized by the predatory pricing strategies of individual firms.
    Date: 2015
  9. By: Zsolt Darvas (Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Bruegel and Corvinus University of Budapest)
    Abstract: Highlights - Global current account imbalances widened before the 2007/2008 crisis and have narrowed since then. While the post-crisis adjustment of European current account deficits was in line with global developments (though more forceful), European current account surpluses defied global trends and increased. - We use panel econometric models to analyse the determinants of medium-term current account balances. Our results confirm that higher fiscal balances, higher GDP per capita, more rapidly aging populations, larger net foreign assets, larger oil rents and better legal systems increase the medium-term current account balance, while a larger growth differential and a higher old-age dependency ratio reduce it. - European current account surpluses became excessive during the past twelve years according to our estimates, while they were in line with model predictions in the preceding three decades. - Generally, the gap between the actual current account and its fitted value by the model has a strong predictive power for future current account changes. Excess deficits adjust more forcefully than excess surpluses. However, in the 2004-07 period, excess imbalances were amplified, which was followed by a forceful correction in 2008-15, with the exception of European surpluses.
    Keywords: Current account imbalances; Current account adjustment
    JEL: F32 F41
    Date: 2015–08
  10. By: Charles Yuji Horioka; Akiko Terada-Hagiwara; Takaaki Nomoto
    Abstract: In this paper, we find that home bias is still present in all economies and regions, especially in the case of short-term debt securities, but that there are substantial variations among economies and regions in the strength of home bias, with the Eurozone economies, the US, and developing Asia showing relatively weak home bias and advanced Asia, especially Japan, showing relatively strong home bias. We then examine trends over time in foreign holdings of debt securities and find that capital has been flowing from the US and the Eurozone economies to both advanced Asia (especially Japan) and developing Asia and that foreign holdings of debt securities have been increasing in advanced as well as developing Asia but for different reasons. The main reason in the case of advanced Asia (especially Japan) appears to be higher risk-adjusted returns, whereas the main reason in the case of developing Asia appears to be the growth of debt securities markets combined with relatively weak home bias and (in the case of short-term securities) lower exchange rate volatility. Finally, we find that since the Global Financial Crisis, foreign holdings of debt securities have declined (i.e., that home bias has strengthened) in all economies and regions except developing Asia, where they have increased (except for a temporary decline in 2008) but where their share is still much lower than the optimal share warranted by the capital asset pricing market model.
    Date: 2015–11
  11. By: Mariarosaria Comunale (Economics Department, Bank of Lithuania)
    Abstract: Using the IMF Consultative Group on Exchange Rate Issues methodology, we make an assessment of the current account and price competitiveness of the Central Eastern European Countries that joined the EU between 2004 and 2014. We present results for the “Macroeconomic Balance” approach, which provides a measure of current account equilibrium based on its determinants together with misalignments in real effective exchange rates. We believe that a more refined analysis of the misalignments may useful for the Macroeconomic Imbalance Procedure. This is especially the case for these countries, which have gone through a transition phase and boom/bust periods since their independence. Because such a history may have influenced a country’s performance, any evaluation must take account of each country’s particular characteristics. We use a panel setup of 11 EU new member states (incl. Croatia) for the period 1994-2012 in static and dynamic frameworks, also controlling for the presence of cross-sectional dependence and checking specifically for the role of exchange rate regimes, capital flows and global factors. We find that the estimated coefficients of the determinants meet with expectations. Moreover, the foreign capital flows, the oil balance, and relative output growth seem to play a crucial role in explaining the current account balance. Some global factors such as shocks in oil prices or supply might have played a role in worsening the current account balances. Having a pegged exchange rate regime (or being part of the euro zone) affects the current account positively. The real effective exchange rates behave in accord with the current account gaps, which clearly display cyclical behaviour. The current accounts and real effective exchange rates come close to equilibria in 2012 in most of the countries and the rebalancing is completed for some countries that were less misaligned in the past, such as Poland and Czech Republic, but also for Lithuania. When foreign direct investments are introduced as a determinant for these countries, the misalignments are larger in the boom periods (positive misalignments) whereas the negative misalignments are smaller in magnitude.
    Keywords: real effective exchange rate, Central Eastern European Countries, EU new member states, fundamental effective exchange rate, current account.
    JEL: F31 F32 C23
    Date: 2015–11–13
  12. By: Jean-François Rouillard (GREDI, Universite de Sherbrooke)
    Abstract:  A two-country real business cycle model with national endogenous borrowing con- straints and frictionless international financial markets can account for the high level of international co-movements. The borrowing mechanism brings about a wedge be- tween the real interest rate and the expected marginal product of capital, which plays a key role in the international transmission of technology shocks. Moreover, terms of trade are amplified by the effects of these shocks on real interest rates which ultimately lead to greater synchronization of economic activities across countries. Finally, the signs of international co-movements are not sensitive to the structure of international asset markets (incomplete markets or financial autarky). Therefore, in the presence of national financial frictions, international efficiency cannot be assessed from looking at the behavior of aggregate variables.
    Keywords:  borrowing constraints, working capital, international co-movements, terms of trade.
    JEL: E44 F34 F44
    Date: 2015–11
  13. By: William R. Cline (Peterson Institute for International Economics)
    Abstract: The latest semiannual fundamental equilibrium exchange rate (FEER) estimates find that the US dollar is now overvalued by about 10 percent, comparable to levels in 2008 through early 2010 and again in 2011. Unlike then, the current strong dollar does not reflect a weak renminbi kept undervalued by major exchange rate intervention by China. Instead, China’s current account surplus has fallen sharply relative to GDP, and its recent intervention has been to prevent excessive depreciation rather than to prevent appreciation. Additionally, declines in the real effective exchange rates (REERs) for major emerging-market economies and resource-based advanced economies, driven by falling commodity prices in recent months, have strengthened the dollar. Recent increases in the REERs for the euro area and Japan have removed their modest undervaluation identified in the last FEERs estimates in May, and the Chinese renminbi remains consistent with its FEER. The dollar’s rise by nearly 15 percent in real effective terms over the past two years could impose a drag of nearly one-half percent annually on US demand growth over the next five years. As the Federal Reserve moves to normalize US monetary policy, it may need to consider a gentler rise in interest rates than it might otherwise have pursued, both to temper possible further strengthening of the dollar in response to higher interest rates and to help offset the demand compression from falling net exports.
    Date: 2015–11
  14. By: Volha Audzei; Frantisek Brazdik
    Abstract: To understand the potential for forming an optimum currency area it is important to investigate the origins of macroeconomic volatility. We focus on the contribution of exchange rate shocks to macroeconomic volatility in selected Central and Eastern European countries. The contribution of the exchange rate shock relative to other shocks allows us to evaluate whether the Exchange rate is a source of volatility or a buffer against shocks as the theory suggests. The identification of the contributions is based on variance decomposition in two-country structural VAR models, which are identified by the sign restriction method. We identify countries where shocks are predominantly symmetric relative to the effective counterpart and countries where the contribution of real exchange rate shocks is strong. In general, for all the countries considered the results are consistent with the real exchange rate having a shock-absorbing nature. Finally, a significant role of symmetric monetary policy shocks in movements in real exchange rates is found for some of the countries.
    Keywords: Asymmetric shocks, Central and Eastern Europe, monetary union, real exchange rates, sign restrictions method, structural vector autoregression
    JEL: C32 E32 F31 F41
    Date: 2015–09
  15. By: Ridha R. Nouira; Khalid Sekkat
    Abstract: The paper seeks to explain the extent of real exchange rate misalignment, defined as its deviation from its equilibrium level. It enlarges the traditional analysis, which focuses mainly on the role of nominal exchange rate regimes, to consider the role of the quality of institutions and financial development. The results show that the intermediate regime induces higher and more volatile misalignment than both fixed and float. The fixed regime exhibits a pattern of misalignment similar to the float regime. Inflation pressures and dependence on oil exports are associated with more misalignment. More importantly, persistence in misalignment is an important phenomenon that should be taken into account, better quality of institutions is associated with less misalignment, while financial development seems to have no impact on misalignment.
    Keywords: Determinants; Institutions; Misalignment
    Date: 2015–05
  16. By: Ponomarev, Yuri; Trunin, Pavel V.; Uljukaev, Aleksej V.
    Abstract: The article provides estimates of short-run and medium-run exchange rate pass-through into domestic prices in Russia during the period of 2000–2012 using vector error correction model. Exchange rate pass-through asymmetry estimates, its assessments on different sub-periods and exchange rate volatility effect on pass-through are also provided.
    Abstract: В статье приводятся оценки краткосрочной перспективе и обменного курса среднесрочной перспективе сквозной в внутренних цен в России в период 2000-2012 с использованием вектора коррекции ошибок модели. Обменный курс сквозного асимметрия оценкам, его оценки по различным суб-периодов и курсовой волатильности влияния на сквозного также предоставляются.
    Keywords: exchange rate pass-through,asymmetry of exchange rate pass-through,exchange rate volatility,inflation,monetary policy,vector error correction model
    JEL: C32 E31 E52 F31 F41
    Date: 2014–03
  17. By: Jean-François Rouillard (GREDI, Universite de Sherbrooke)
    Abstract:  A canonical two-country real business cycle model with complete international asset markets fails to replicate the sign of the correlation between relative consumptions and real exchange rates—i.e. the consumption–real exchange rate anomaly or Backus-Smith puzzle. When preferences are non-separable between consumption and leisure, the same two-country model augmented by domestic financial frictions and shocks can account for the sign of the Backus-Smith correlation. Specifically, shocks to the firms’ borrowing capacity create important fluctuations in the labor wedge, inducing firms to demand more labor following these positive financial shocks. These procyclical movements in hours worked significantly affect the marginal utility of consumption and explain the Backus-Smith correlation. Moreover, the same model under financial autarky predicts a correlation that is far away from its empirical counterpart. This finding suggests that this correlation is not a good indicator of international risk sharing.
    Keywords: Backus-Smith puzzle, borrowing constraints, labor wedge, working capital, financial shocks, non-separable preferences
    JEL: E44 F34 F44
    Date: 2015–11
  18. By: Hyeongwoo Kim; Jintaek Kim
    Abstract: We empirically investigate dynamic responses of 49 world commodity prices to exchange rate shocks using recursively identified vector autoregressive models. Our major empirical findings are as follows. First, price adjustments toward the new equilibrium tend to be gradual with a few exceptions. We propose two measures of price-stickiness that exhibit a high degree of short-run price rigidity in most commodities. Second, our dynamic elasticity analysis implies that commodity price responses are quite heterogeneous even in the long-run. Some commodity prices over-correct for the exchange rate shock, which implies higher volatility for those prices than the exchange rate. Third, for those commodities that over-react, domestic prices would rise significantly when the US dollar depreciates unexpectedly, perhaps suggesting a role for price stabilization policies.
    Keywords: Commodity Prices; Price Stickiness; Dynamic Elasticity; Vector Autoregression; Impulse-Response Function
    JEL: E31 F31 Q02
    Date: 2015–11
  19. By: Ouyang, Alice; Paul, Saumik
    Abstract: Building on a simple analytical model, we provide cross-country empirical evidence from 67 countries that the net skilled emigration appreciates bilateral real exchange rates in source countries. Channels of causality, when Law of One Price (LOOP) holds, are through "spending effect" and "resource allocation effect", analogous to the remittance-based Dutch disease effect. Pricing-to-market model allows pass-through for both tradable and nontradable prices when LOOP is violated. Internal (relative price of tradable to nontradable) price explains about 60% of the RER appreciation, which is mostly driven by the outcomes on developing countries. The outcomes are robust across different levels of skilled emigration, alternative model specifications and withstand placebo tests with unskilled emigration.
    Keywords: Emigration, Exchange Rate, the Dutch Disease
    JEL: F22 F31
    Date: 2015–03

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