nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2016‒04‒30
twelve papers chosen by
Martin Berka
University of Auckland

  1. Managing sudden stops By Eichengreen,Barry J.; Gupta,Poonam - DECOS
  2. Cables, Sharks and Servers: Technology and the Geography of the Foreign Exchange Market By Eichengreen, Barry; Lafarguette, Romain; Mehl, Arnaud
  3. Optimal Reserves in Financially Closed Economies By Jeanne, Olivier; Sandri, Damiano
  4. One EMU Fiscal Policy for the EURO By Alexandre Lucas Cole; Chiara Guerello; Guido Traficante
  5. Exchange Rate Pass-through in Production Chains: Application of input-output analysis By Huong Le Thu HOANG; SATO Kiyotaka
  6. Evaluation of unconventional monetary policy in a small open economy By Martin Pietrzak
  7. Inertia of the U.S. Dollar as a Key Currency through the Two Crises By OGAWA Eiji; MUTO Makoto
  8. Exchange rates and monetary policy uncertainty By Philippe Mueller; Alireza Tahbaz-Salehi; Andrea Vedolin
  9. Determinants of Equilibrium Real Exchange Rate and its Misalignment in Kenya: A Behavioral Equilibrium Exchange Rate Approach By Kiptui, Moses C.; Ndirangu, Lydia
  10. Monetary Policy and the Current Account: Theory and Evidence By Hjortsoe, Ida; Weale, Martin; Wieladek, Tomasz
  11. The Dilemma or Trilemma Debate: Empirical Evidence By Pablo Anaya. Michael Hachula
  12. Estimating Border Effects: The Impact of Spatial Aggregation By Coughlin, Cletus C.; Novy, Dennis

  1. By: Eichengreen,Barry J.; Gupta,Poonam - DECOS
    Abstract: The recent reversal of capital flows to emerging markets has pointed up the continuing relevance of the sudden stop problem. This paper analyzes the sudden stops in capital flows to emerging markets since 1991. It shows that the frequency and duration of sudden stops have remained largely unchanged, but that the relative importance of different factors in their incidence has changed. In particular, global factors appear to have become more important relative to country-specific characteristics and policies. Sudden stops now tend to affect different parts of the world simultaneously rather than bunching regionally. Stronger macroeconomic and financial frameworks have allowed policy makers to respond more flexibly, but these more flexible responses have not guaranteed insulation or mitigated the impact of the phenomenon. These findings suggest that the challenge of understanding and coping with capital-flow volatility is far from fully met.
    Keywords: Currencies and Exchange Rates,Macroeconomic Management,Debt Markets,Economic Theory&Research,Emerging Markets
    Date: 2016–04–13
  2. By: Eichengreen, Barry; Lafarguette, Romain; Mehl, Arnaud
    Abstract: We analyze the impact of technology on production and trade in services, focusing on the foreign exchange market. We identify exogenous technological changes by the connection of countries to submarine fiber-optic cables used for electronic trading, but which were not laid for purposes related to the foreign exchange market. We estimate the impact of cable connections on the share of offshore foreign exchange transactions. Cable connections between local markets and matching servers in the major financial centers lower the fixed costs of trading currencies and increase the share of currency trades occurring onshore. At the same time, however, they attenuate the effect of standard spatial frictions such as distance, local market liquidity, and restrictive regulations that otherwise prevent transactions from moving to the major financial centers. Our estimates suggest that the second effect dominates. Technology dampens the impact of spatial frictions by up to 80 percent and increases, in net terms, the share of offshore trading by 21 percentage points. Technology also has economically important implications for the distribution of foreign exchange transactions across financial centers, boosting the share in global turnover of London, the world’s largest trading venue, by as much as one-third. JEL Classification: F30
    Keywords: exogeneity, foreign exchange market, geography, submarine fiber-optic cables, technology
    Date: 2016–03
  3. By: Jeanne, Olivier; Sandri, Damiano
    Abstract: Financially closed economies insure themselves against current-account shocks using international reserves. We characterize the optimal management of reserves using an open-economy model of precautionary savings and emphasize several results. First, the welfare-based opportunity cost of reserves differs from the measures often used by practitioners. Second, under plausible calibrations the model is consistent with the rule of thumb that reserves should be close to three months of imports. Third, simple linear rules can capture most of the welfare gains from optimal reserve management. Fourth, policymakers should place more emphasis on how to use reserves in response to shocks than on the reserve target itself.
    Keywords: current account; Official reserves; precautionary savings
    JEL: F32 F41
    Date: 2016–03
  4. By: Alexandre Lucas Cole (LUISS "Guido Carli" University); Chiara Guerello (LUISS "Guido Carli" University); Guido Traficante (European University of Rome)
    Abstract: We build a Two-Country Open-Economy New-Keynesian DSGE model of a Currency Union to study the effects of fiscal policy coordination, by evaluating the stabilization properties of different degrees of fiscal policy coordination, in a setting where the union-wide monetary policy affects fiscal policies and viceversa, because of price rigidities and distortionary taxation. We calibrate the model to represent two groups of countries in the European Economic and Monetary Union and run numerical simulations of the model under a range of alternative shocks and under alternative scenarios for fiscal policy. We also compare welfare under the different scenarios, bringing to policy conclusions for the proper macroeconomic management of a Currency Union. We find that: a) coordinating fiscal policy by targeting net exports, rather than output, produces more stable dynamics, b) consolidating government budget constraints across countries and moving tax rates jointly provides greater stabilization, c) taxes on wage income are exponentially more distortionary than taxes on firm sales. Our policy prescriptions for the Eurozone are then to use fiscal policy to reduce international demand imbalances, either by stabilizing trade fl ows across countries or by creating some form of fiscal union or both, while avoiding the excessive use of labour taxes, in favour of sales taxes.
    Keywords: Fiscal Policy, International Policy Coordination, Monetary Union, New Keynesian.
    JEL: E62 E63 F42 F45 E12
    Date: 2016
  5. By: Huong Le Thu HOANG; SATO Kiyotaka
    Abstract: This study proposes a new empirical approach to the exchange rate pass-through (ERPT) in Japanese imports using input-output (IO) analysis. We analyze how exchange rate changes are transmitted from import prices to domestic producer prices through numerous stages of production by employing the Japanese IO tables of 2000, 2005, and 2011. Specifically, calculating input coefficients among 108 industries at numerous production stages, we demonstrate that, contrary to the stylized fact, the extent of ERPT to domestic producer prices should be significantly higher than empirical results of the conventional ERPT analysis. Conducting a panel estimation of ERPT determinants, we show that a large dependence on intermediate input imports tends to increase the extent of ERPT. More importantly, we reveal that if the manufacturing sectors tend not only to import intermediate inputs from abroad but also to export their products to foreign countries, the degree of import pass-through to producer prices increases significantly. Thus, growing international production sharing will have a positive impact on ERPT to domestic producer prices.
    Date: 2016–03
  6. By: Martin Pietrzak
    Abstract: This paper shows what are the consequences of omitting international dimension issues like international trade and financial channels when modeling the effects of unconventional monetary policy tools. To evaluate the size of discrepancies between consequences of a large-scale asset purchase program in a small open economy and a closed one, we extend one of the existing models analyzing a large-scale asset purchases by adding small open economy features. Finally we compare it with the original version. We find that previous studies might overestimate the extent to what large-scale asset purchases affect real activity. Allowing agents to trade internationally with goods as well as saving via foreign, currency denominated deposits leads to a leakages that result in substantial differences between large-scale asset purchases in a small open economy and an autarky. Moreover, our results show that negative supply side shocks have less severe consequences in a small open economy comparing to an autarky, because they are offset by the real exchange rate depreciation which boosts competitiveness.
    Keywords: unconventional monetary policy, financial frictions, small open economy
    JEL: E52 F41
    Date: 2016–03
  7. By: OGAWA Eiji; MUTO Makoto
    Abstract: The current international monetary system with the U.S. dollar as a key currency is considered as the background of the U.S. dollar liquidity shortage during the global financial crisis. However, once facing a U.S. dollar liquidity shortage or crisis, financial institutions are likely to avoid their overdependence on the U.S. dollar. This implies that the international monetary system with the U.S. dollar as a key currency may be changed, especially during the global financial crisis even though key currencies show inertia due to network externalities in using international currencies. In this paper, we focus on the effects of both the global financial crisis and the euro zone crisis on the position of the U.S. dollar as a key currency in the current international monetary system. We base this on a theoretical framework in Ogawa and Sasaki (1998) in which a money-in-the-utility model is used to take into account the U.S. dollar's functions as both a medium of exchange and a store of value in the international currency competition. A parameter on the real balance of the U.S. dollar or its contribution to utility in the model is focused on, analyzing empirically whether both the global financial crisis and the euro zone crisis have changed its contribution to utility. One of the main empirical results from our models is that the contribution of the U.S. dollar to utility decreased during the global financial crisis. This corresponds to a period when financial institutions faced liquidity shortages from mid 2007 to late 2008. U.S. dollar liquidity shortage may have decreased the contribution of the U.S. dollar to utility.
    Date: 2016–03
  8. By: Philippe Mueller; Alireza Tahbaz-Salehi; Andrea Vedolin
    Abstract: We document that a trading strategy that is short the U.S. dollar and long other currencies exhibits significantly larger excess returns on days with scheduled Federal Open Market Committee (FOMC) announcements. We also show that these excess returns (i) are higher for currencies with higher interest rate differentials vis-à-vis the U.S.; (ii) increase with uncertainty about monetary policy; and (iii) intensify when the Federal Reserve adopts a policy of monetary easing. We interpret these excess returns as a compensation for monetary policy uncertainty within a parsimonious model of constrained financiers who intermediate global demand for currencies.
    Keywords: Monetary policy; foreign exchange; uncertainty
    JEL: J1 F3 G3
    Date: 2016–01–15
  9. By: Kiptui, Moses C.; Ndirangu, Lydia
    Abstract: This paper examines the real exchange rate misalignment in Kenya using quarterly data over the period 2000 – 2014. The Behavioral Equilibrium Exchange Rate (BEER) approach to determine the extent of exchange rate misalignment is adopted. A vector error correction model (VECM) is estimated and the results show that the real exchange rate is largely driven by fundamentals. Thus, the equilibrium real exchange rate has been closely aligned to its long run equilibrium level, save for instances when misalignment occurred due to major economic shock such as the recent global financial crisis and the Euro zone economic crisis. Hence, given the managed float regime in Kenya, exchange rates keep adjusting to changing economic fundamentals.
    Keywords: exchange rate, equilibrium, misalignment, Kenya
    JEL: C32 F31
    Date: 2015–07
  10. By: Hjortsoe, Ida; Weale, Martin; Wieladek, Tomasz
    Abstract: Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of economic regulation in different markets. In particular, financial (product market) liberalisation makes it more likely that the current account deteriorates (improves) following a monetary expansion. We test these theoretical predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976Q1-2006Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit (surplus) in countries with more liberalised financial (product) markets.
    Keywords: Balance of Payments; Current Account; Bayesian Panel VAR; Economic Liberalisation; Monetary Policy. JEL classification: F32; E52
    JEL: C11 C23 E52 F32
    Date: 2016–03
  11. By: Pablo Anaya. Michael Hachula
    Abstract: One of the central results in international economics is that an economy cannot have at the same time independent monetary policy, free capital flows, and a fixed exchange rate. Over the last few years, however, this so-called Mundell-Flemming ‘trilemma’ has increasingly been challenged. It is argued that given the rising importance and synchronization of capital and credit flows across countries and their underlying common driving forces, the ‘trilemma’ has morphed into a ‘dilemma’: an economy cannot have at the same time independent monetary policy and an open capital account, independent of the exchange rate regime. This Roundup provides a brief overview of the debate, reviews recent empirical findings on the topic, and outlines possible directions for future research.
    Date: 2016
  12. By: Coughlin, Cletus C. (Federal Reserve Bank of St. Louis); Novy, Dennis (University of Warwick, UK)
    Abstract: Trade data are typically reported at the level of regions or countries and are therefore aggregates across space. In this paper, we investigate the sensitivity of standard gravity estimation to spatial aggregation. We build a model in which initially symmetric micro regions are combined to form aggregated macro regions. We then apply the model to the large literature on border effects in domestic and international trade. Our theory shows that larger countries are systematically associated with smaller border effects. The reason is that due to spatial frictions, aggregation across space increases the relative cost of trading within borders. The cost of trading across borders therefore appears relatively smaller. This mechanism leads to border effect heterogeneity and is independent of multilateral resistance effects in general equilibrium. Even if no border frictions exist at the micro level, gravity estimation on aggregate data can still produce large border effects. We test our theory on domestic and international trade flows at the level of U.S. states. Our results confirm the model’s predictions, with quantitatively large effects.
    Keywords: Gravity; Geography; Borders; Trade Costs; Heterogeneity; Home Bias; Spatial Attenuation; Modifiable Areal Unit Problem (MAUP)
    JEL: F10 F15 R12
    Date: 2016–04–01

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