nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒12‒01
twelve papers chosen by
Martin Berka
University of Auckland

  1. Countercyclical Foreign Currency Borrowing:Eurozone Firms in 2007-2009 By Philippe Bacchetta; Ouarda Merrouche
  2. Oil Prices and the Dynamics of Output and Real Exchange Rate By Meenagh, David; Minford, Patrick; Oyekola, Olayinka
  3. Deposit dollarization in emerging markets: modelling the hysteresis effect By Krupkina , Anna; Ponomarenko , Alexey
  4. Risk Sharing in International Economies and Market Incompleteness By Gurdip Bakashi; Mario Cerrato; John Crosby
  5. The Dynamics of the Trade Balance and the Real Exchange Rate: The J Curve and Trade Costs? By Horag Choi; George Alessandria
  6. Exchange Rates and UIP Violations at Short and Long Horizons By Rosen Valchev
  7. Income distribution and the current account: a sectoral perspective By Jan Behringer; Till van Treeck
  8. Exit Expectations and Debt Crises in Currency Unions By Alexander Kriwoluzky; G. J. Müller; M. Wolf
  9. Monetary Policy and Welfare in a Currency Union By D’Aguanno, Lucio
  10. Sharing a Ride on the Commodities Roller Coaster: Common Factors in Business Cycles of Emerging Economies By Andrés Fernández; Andrés González; Diego Rodríguez
  11. External shocks, banks and optimal monetary policy in an open economy By Yasin Mimir; Enes Sunel
  12. Sovereign Debt Restructurings: Preemptive or Post-Default By Asonuma, Tamon; Trebesch, Christoph

  1. By: Philippe Bacchetta; Ouarda Merrouche
    Abstract: Despite international financial disintegration, we document a dramatic increase in dollar borrowing among leveraged Eurozone corporates during the Great Financial Crisis. Using loan-level data, we trace this increase to the twin crisis in the credit market and in funding markets. The reduction in the supply of credit by Eurozone banks caused riskier borrowers to shift to foreign banks, in particular US banks. The coincident rise in the relative cost of euro wholesale funding and the disruptions in the FX swap market caused a rise in dollar borrowing from US banks, especi ally for firms in export-oriented sectors. Although global bank lending is often reported to amplify the international credit cycle, we show that foreign banking acted as a shock absorber that weathered the real consequences of the credit crunch in Europe.
    Keywords: Money market, swaps, credit crunch, corporate debt, foreign banks
    JEL: G21 G30 E44
    Date: 2015–08
  2. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Oyekola, Olayinka
    Abstract: We examine the role of oil price shocks in effecting changes both at the aggregate and sectoral levels using an estimated dynamic stochastic equilibrium open economy model. Our main finding is that energy price shocks are not able directly to generate the magnitude of the economic downturn observed in the data. These shocks, however, do possess a strong indirect transmission link that endogenously spreads their effect through the system such that they account for a considerable portion of the U.S. business cycle movements. This leads us to conclude that previous results that attribute a minimal importance to oil price shocks must be focusing more on the energy cost share of gross domestic product and less on how they affect the intertemporal decisions of economic agents. We also find that external shocks have been responsible for explaining volatility in U.S. economic activities for a long time. This leads us to conclude that modelling the U.S. as a closed economy discounts a sizeable set of very relevant factors.
    Keywords: Two sector; non-stationary DSGE model; Oil price; Relative prices; Domestic shocks; Imported shocks
    JEL: E32 D58 F41 C52 Q43
    Date: 2015–11
  3. By: Krupkina , Anna (BOFIT); Ponomarenko , Alexey (BOFIT)
    Abstract: We apply empirical modelling set-ups developed to capture the hysteresis effect in the data on deposit dollarization in a cross-section of emerging market economies. Specifically, we estimate a nonlinear relationship that determines two equilibrium levels of deposit dollarization depending on the current value of dollarization and previous episodes of sharp depreciation of the national currency over the past five years. When exchange rates are stable, convergence to a higher equilibrium level of dollarization begins when the 45–50% thresh-old of deposit dollarization is exceeded. We estimate the model for short-run dynamics of dollarization and find that the speed of convergence to the higher equilibrium implies quarterly increases of 1.2–3 percentage points in the ratio of foreign currency deposits to total deposits.
    Keywords: dollarization; hysteresis; nonlinear model; emerging markets
    JEL: C23 E41 F31
    Date: 2015–11–10
  4. By: Gurdip Bakashi; Mario Cerrato; John Crosby
    Abstract: We develop an incomplete markets framework to show that international risk sharing can be low, particularly among countries with large interest-rate differentials. Furthermore, risk sharing computed from asset returns can be consistent with that computed from consumption. The key difference from Brandt, Cochrane, and Santa-Clara (2006) is that exchange rate growth need not equal the ratio of stochastic discount factors (SDF), and we develop a restriction that precludes “good deals” in international economies with incomplete markets. We compute the lowest risk sharing consistent with SDFs that (i) are nonnegative, (ii) correctly price returns, and (iii) disallow “good deals.”
    Keywords: International risk sharing, incomplete markets, exchange rates
    JEL: G12 G15 E44 F31 F36
    Date: 2015–10
  5. By: Horag Choi (Monash University); George Alessandria (University of Rochester)
    Abstract: We show that flexible and sticky price multi-country models generate a counterfactual comovement between the trade balance and the real exchange rate and that the dynamics of the US trade balance since 1980 are mostly attributed to declines in trade costs and a gradual response of trade flows to past movements in the real exchange rate. We develop a theoretical model with heterogenous producers, a dynamic export participation decision, pricing to market, and declining trade costs to address these properties of the trade balance. With temporary and permanent shocks to trade costs leading to fluctuations in trade and the observed increases in trade, the model can capture the dynamics of the trade balance and the real exchange rate. With these movements in the trade balance, business cycles are substantially more synchronized and there is much less consumption risk sharing.
    Date: 2015
  6. By: Rosen Valchev (Duke University)
    Abstract: The much-studied Uncovered Interest Rate Parity (UIP) puzzle, the observation that exchange rates do not adjust sufficiently to offset interest rate differentials, is more complicated than commonly understood. It changes nature with the horizon. I confirm existing short-run evidence that high interest rate currencies depreciate less than predicted by the interest rate differential, but, building on Engel (2012), at longer horizons (4 to 7 years) I find a reverse puzzle: high interest rate currencies depreciate too much. Interestingly, the long-horizon excess depreciation leads exchange rates to converge to the UIP benchmark over the long-run. To address the changing nature of the puzzle, I propose a novel model, based on the mechanism of bond convenience yields, that can explain both the short and the long horizon UIP violations. I also provide direct empirical evidence that supports the mechanism.
    Date: 2015
  7. By: Jan Behringer (IMK and University of Wurzburg, Germany); Till van Treeck (University of Duisburg-Essen and IMK, Germany)
    Abstract: We investigate whether changes in income distribution can explain current account developments in a sample of 20 countries for the period 1972-2007. We analyze the relationship between the personal and the functional income distribution in our sample, before disentangling their effects on the household and corporate financial balances and the current account. We find that rising (top-end) personal inequality leads to a decrease of the private household financial balance and the current account, controlling for standard current account determinants. Moreover, an increase in corporate net lending or, alternatively, a fall in the wage share leads to an increase in the current account, ceteris paribus. While we remain agnostic as to the underlying theoretical explanations of our findings, they are consistent with consumption externalities on the one hand and with incomplete piercing of the corporate veil or the underconsumptionist view on the other hand. We show that changes in personal and functional income distribution have contributed considerably to the widening of current account balances, and hence to the instability of the international economic system, prior to the global financial crisis starting in 2007.
    Keywords: Income distribution, current account determinants, sectoral financial balances, global financial crisis.
    JEL: D31 D33 E21 F41 G3
    Date: 2015–10
  8. By: Alexander Kriwoluzky; G. J. Müller; M. Wolf
    Abstract: Membership in a currency union is not irreversible. Exit expectations may emerge during sovereign debt crises, because exit allows countries to reduce their liabilities through a currency redenomination. As market participants anticipate this possibility, sovereign debt crises intensify. 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 currency unions 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 to 2012.
    Keywords: currency union, exit, sovereign debt crisis, fiscal policy, redenomination premium, euro crisis, regime-switching model
    JEL: E52 E62 F41
    Date: 2015–11
  9. By: D’Aguanno, Lucio (Department of Economics University of Warwick)
    Abstract: What are the welfare gains from being in a currency union? I explore this question in the context of a dynamic stochastic general equilibrium model with monetary barriers to trade, local currency pricing and incomplete markets. The model generates a trade off between monetary independence and monetary union. On one hand, distinct national monetary authorities with separate currencies can address business cycles in a countryspecific way, which is not possible for a single central bank. On the other hand, short-run violations of the law of one price and long-run losses of international trade occur if different currencies are adopted, due to the inertia of prices in local currencies and to the presence of trade frictions. I quantify the welfare gap between these two international monetary arrangements in consumption equivalents over the lifetime of households, and decompose it into the contributions of di.erent frictions. I show that the welfare ordering of alternative currency systems depends crucially on the international correlation of macroeconomic shocks and on the strength of the monetary barriers affecting trade with separate currencies. I estimate the model on data from Italy, France, Germany and Spain using standard Bayesian tools, and I find that the trade off is resolved in favour of a currency union among these countries.
    Keywords: Currency union ; Incomplete markets ; Nominal rigidities ; Local currency pricing ; Trade frictions ; Welfare
    JEL: D52 E31 E32 E42 E52 F41 F44
    Date: 2015
  10. By: Andrés Fernández; Andrés González; Diego Rodríguez
    Abstract: Fluctuations in commodity prices are an important driver of business cycles in small emerging market economies (EMEs). We document how these fluctuations correlate strongly with the business cycle in EMEs. We then embed a commodity sector into a multi-country EMEs business cycle model where exogenous fluctuations in commodity prices follow a common dynamic factor structure and coexist with other driving forces. The estimated model assigns to commodity shocks 42 percent of the variance in income, of which a considerable part is linked to the common factor. A further amplification mechanism is a spillover effect from commodity prices to risk premia.
    Keywords: Emerging economies, business cycles, commodity prices, common factors, Bayesian estimation, dynamic stochastic equilibrium models.
    JEL: E32 F41 F44
    Date: 2015–11–18
  11. By: Yasin Mimir; Enes Sunel
    Abstract: We document empirically that the 2007-09 Global Financial Crisis exposed emerging market economies (EMEs) to an adverse feedback loop of capital outflows, depreciating exchange rates, deteriorating balance sheets, rising credit spreads and falling real economic activity. In order to account for these empirical findings, we build a New-Keynesian DSGE model of a small open economy with a banking sector that has access to both domestic and foreign funding. Using the calibrated model, we investigate optimal, simple and operational monetary policy rules that respond to domestic/external financial variables alongside inflation and output. The Ramsey-optimal policy rule is used as a benchmark. The results suggest that such an optimal policy rule features direct and non-negligible responses to lending spreads over the cost of foreign debt, the real exchange rate and the US policy rate, together with a mild anti-inflationary policy stance in response to domestic and external shocks. Optimal policy faces trade-offs in smoothing inefficient fluctuations in the intratemporal and intertemporal wedges driven by inflation, credit spreads and the real exchange rate. In response to productivity and external shocks, a countercyclical reserve requirement (RR) rule used in coordination with a conventional interest rate rule attains welfare levels comparable to those implied by spread- and real exchange rate-augmented rules.
    Keywords: Optimal monetary policy, banks, credit frictions, external shocks, foreign debt
    Date: 2015–11
  12. By: Asonuma, Tamon; Trebesch, Christoph
    Abstract: Sovereign debt restructurings can be implemented preemptively - prior to a payment default. We code a comprehensive new dataset and find that preemptive restructurings (i) are frequent (38% of all deals 1978-2010), (ii) have lower haircuts, (iii) are quicker to negotiate, and (iv) see lower output losses. To rationalize these stylized facts, we build a quantitative sovereign debt model that incorporates preemptive and post-default renegotiations. The model improves the fit with the data and explains the sovereign's optimal choice: preemptive restructurings occur when default risk is high ex-ante, while defaults occur after unexpected bad shocks. Empirical evidence supports these predictions.
    Keywords: crisis resolution; debt restructuring; default; sovereign debt
    JEL: F34 F41 H63
    Date: 2015–11

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