nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2016‒06‒18
eight papers chosen by
Martin Berka
University of Auckland

  1. The Sovereign-Bank Diabolic Loop and ESBies By Brunnermeier, Markus K; Garicano, Luis; Lane, Philip R.; Pagano, Marco; Reis, Ricardo; Santos, Tano; Thesmar, David; van Nieuwerburgh, Stijn; Vayanos, Dimitri
  2. The Determinants of Exchange Rate Volatility in South Africa By Trust R. Mpofu
  3. Risk, Selection and Productivity Differences By Wenbiao Cai
  4. Parsing financial fragmentation in the euro area: a multi-country DSGE perspective By Darracq Pariès, Matthieu; Jacquinot, Pascal; Papadopoulou, Niki
  5. Exchange rate forecasting with DSGE models By Ca' Zorzi, Michele; Kolasa, Marcin; Rubaszek, Michał
  6. The Forward Premium Bias, Carry Trade Return and the Risks of Volatility and Liquidity By Shehadeh, Ali; Li, Youwei; Moore, Michael
  7. De facto exchange-rate regimes in Central and Eastern European Countries By Simón Sosvilla Rivero; Maria del Carmen Ramos Herrera
  8. Income Inequality and Macroeconomic Imbalances under EMU By Benedicta Marzinotto

  1. By: Brunnermeier, Markus K; Garicano, Luis; Lane, Philip R.; Pagano, Marco; Reis, Ricardo; Santos, Tano; Thesmar, David; van Nieuwerburgh, Stijn; Vayanos, Dimitri
    Abstract: We propose a simple model of the sovereign-bank diabolic loop, and establish four results. First, the diabolic loop can be avoided by restricting banks' domestic sovereign exposures relative to their equity. Second, equity requirements can be lowered if banks only hold senior domestic sovereign debt. Third, such requirements shrink even further if banks only hold the senior tranche of an internationally diversified sovereign portfolio - known as ESBies in the euro-area context. Finally, ESBies generate more safe assets than domestic debt tranching alone; and, insofar as the diabolic loop is defused, the junior tranche generated by the securitization is itself risk-free.
    Keywords: bailout; bank default; diabolic loop; ESBies; government default; sovereign debt crisis
    JEL: G18 G21 G28 H63
    Date: 2016–06
  2. By: Trust R. Mpofu
    Abstract: This paper investigates the determinants of exchange rate volatility in South Africa for the period 1986-–2013 using the New Open Economy Macroeconomics model by Obstfeld & Rogoff (1996) and Hau (2002). The main focus of the paper is to test the hypothesis that economic openness decreases Rand (ZAR) volatility. This follows South Africa’s liberalisation of its capital account in the mid-1990s and the mixed results in the literature on the relationship between exchange rate volatility and economic openness. Employing monthly time series data, GARCH models are estimated. The study …finds that switching to a fl‡oating exchange rate regime has a signi…ficant positive effect on ZAR volatility. The results also indicate that trade openness significantly reduces ZAR volatility only when bilateral exchange rates are used, but finds the opposite when multilateral exchange rates are used. The study also …finds that volatility of output, commodity prices, money supply and foreign reserves signi…ficantly in‡fluence ZAR volatility.
    Keywords: Exchange Rate Volatility, GARCH
    JEL: F31 C22
    Date: 2016
  3. By: Wenbiao Cai
    Abstract: Two observations about poor countries are puzzling: (1) the majority of their labor force work in agriculture despite significantly higher wage in nonagriculture; (2) labor productivity difference between rich and poor countries is much larger in agriculture than in nonagriculture. This paper argues that these observations are a result of low economy-wide efficiency and incomplete markets to insure against income risk. I formalize this argument in a model that marries two classics: Roy (1951) and Harris and Todaro (1970). The calibrated model generates cross-country difference in labor productivity that is 3 times larger in agriculture than in nonagriculture and account for most of the cross-country variation in nonagriculture wage premium.
    Date: 2016–06
  4. By: Darracq Pariès, Matthieu; Jacquinot, Pascal; Papadopoulou, Niki
    Abstract: The euro area experience during the financial crisis highlighted the importance of financial and sovereign risk factors in macroeconomic propagation, as well as the constraints that bank lending fragmentation would pose for monetary policy conduct in a currency union. We design a 6-region multi-country DSGE model which provides a structural interpretation of the salient features of these developments. The model spans the relevant "financial wedges" at play during the crisis, together with its cross-country heterogeneity within the euro area, focusing on Ger- many, France, Italy, Spain, and rest-of-euro area. We construct three stylised macro-financial scenarios as a synopsis of the euro area financial crisis and argue that the adverse interactions between sovereign, banking and corporate risk, can account to a large extent for the financial repression and poor economic performance observed in some parts of the euro area. JEL Classification: E4, E5, F4
    Keywords: bank lending rates, banking, cross-country spillovers, DSGE models, financial regulation
    Date: 2016–04
  5. By: Ca' Zorzi, Michele; Kolasa, Marcin; Rubaszek, Michał
    Abstract: We run a real exchange rate forecasting "horse race", which highlights that two principles hold. First, forecasts should not replicate the high volatility of exchange rates observed in sample. Second, models should exploit the mean reversion of the real exchange rate over long horizons. Abiding by these principles, an open-economy DSGE model performs well in real exchange rate forecasting. However, it fails to forecast nominal exchange rates better than the random walk. We find that the root cause is its inability to predict domestic and foreign inflation. This shortcoming leads us toward simpler ways to outperform the random walk. JEL Classification: C32, F31, F37
    Keywords: exchange rates, forecasting, mean reversion, new open economy macroeconomics
    Date: 2016–05
  6. By: Shehadeh, Ali; Li, Youwei; Moore, Michael
    Abstract: In this paper, we analyse the relationship between the currency carry return and volatility and liquidity risk factors. We find that both categories of risk factors are relevant to understanding and explaining carry return, with an outperformance for volatility ones especially the global FX volatility risk factor. Consistent with the poor performance of currency carry trades during high FX volatility regime, we also show that the well-established negative slope coefficient in the Fama regression tends to be more positive and even above unity in times of high FX volatility. The paper, overall, contributes to the risk-based solution of the forward premium bias puzzle.
    Keywords: FX rates; Currency carry trade; Forward-bias puzzle; FX risk premium
    JEL: E44 F31 F41 G11 G15
    Date: 2016–06–02
  7. By: Simón Sosvilla Rivero (Departamento de Economía Cuantitativa, Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid.); Maria del Carmen Ramos Herrera (Departamento de Economía Cuantitativa, Facultad de Ciencias Económicas y Empresariales, Universidad Complutense de Madrid.)
    Abstract: This paper attempts to identify implicit exchange rate regimes for currencies of new European Union (EU) countries vis-à-vis the euro. To that end, we apply three sequential procedures that consider the dynamics of exchange rates to data covering the period from 1999:01 to 2012:12. Our results would suggest that implicit bands have existed in many sub-periods for almost all currencies under study. This paper provides new empirical evidence that strengthens the hypothesis of that the implemented policies differ from those announced by the monetary authorities, identifying the existence of de facto fixed monetary systems along large number of sub-periods for different currencies.
    Keywords: Exchange-rate regimes; Implicit fluctuation bands; Exchange rates.
    Date: 2015
  8. By: Benedicta Marzinotto
    Abstract: This paper explains the build-up and reversal of euro area macroeconomic imbalances by considering the interaction between the underlying income distribution in each country and EMU-induced financial liberalization. The argument is that the sharp increase in money supply since the early 1990s had the effect of relaxing collateral constraints for illiquid lower- income groups, whilst having no specific impact on other households. The former started over-borrowing against optimistic expectations about their future income. It follows that unequal countries such as Greece, Ireland, Italy, Portugal and Spain - where the share of lower-income groups is relatively high - had greater private debt burdens and worse external positions than equal countries. Consequently, current account reversal was asymmetric because the crisis forced these indebted households to abruptly reduce consumption not least because they were the first to be pulled out of the labour market and hardly had financial buffers. The hypothesis is tested using a difference-in-difference approach to panel data.
    Keywords: current account, income inequality, financial liberalization, debt leverage, difference-in-difference
    JEL: F32 F41 E2
    Date: 2016–05

This nep-opm issue is ©2016 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.