nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2016‒07‒23
fourteen papers chosen by
Martin Berka
University of Auckland

  1. Currency Wars, Coordination, and Capital Controls By Olivier Blanchard
  2. Income Inequality and Sovereign Default By Kiyoung Jeon; Zeynep Kabukcuoglu
  3. Liquidity Traps, Capital Flows By Julien Bengui; Sushant Acharya
  4. A Possible Explanation of the ‘Exchange Rate Disconnect Puzzle’: A Common Solution to Three Major Macroeconomic Puzzles? By Charles Yuji Horioka; Nicholas Ford
  5. Alternative Sources of Dutch Disease: A Survey of the Literature By Nuno Baetas da Silva; João Sousa Andrade; António Portugal Duarte
  6. A Market-based Indicator of Currency Risk: Evidence from American Depositary Receipts By Eichler, Stefan; Roevekamp, Ingmar
  7. Volatility Risk Pass-Through By Yang Liu; Mariano Croce; Ivan Shaliastovich; Ric Colacito
  8. Absorptive Capacity and the Impact of Commodity Terms of Trade Shocks in Resource Export-Dependent Economies By Terada-Hagiwara, Akiko; Villlaruel, Mai Lin; Edmonds, Christopher
  9. Can Countries Rely on Foreign Saving for Investment and Economic Development? By Eduardo Cavallo; Barry Eichengreen; Ugo Panizza
  10. Determinants of Consumer Price Inflation versus Producer Price Inflation in Asia By Jongwanich, Juthathip; Wongcharoen, Petchtharin; Park, Donghyun
  11. Exchange Rates and Monetary Policy Uncertainty By Andrea Vedolin; Alireza Tahbaz-Salehi; Philippe Mueller
  12. Exit Expectations and Debt Crises in Currency Unions By Kriwoluzky, Alexander; Müller, Gernot J.; Wolf, Martin
  13. Nonlinearity between RER and Trade Balance: A Case Study of Pakistan By Qayyum, Abdul; Nazir, Sidra; Jawad, Muhammad
  14. Germany's Benefit from the Greek Crisis By Dany, Geraldine; Gropp, Reint E.; Littke, Helge; von Schweinitz, Gregor

  1. By: Olivier Blanchard (Peterson Institute for International Economics)
    Abstract: The strong monetary policy actions undertaken by advanced economies' central banks have led to complaints of "currency wars" by some emerging-market economies and to widespread demands for more macroeconomic policy coordination. This paper reviews cross-border effects of advanced economies' monetary policies on emerging economies, through goods markets, foreign exchange markets, and financial markets, and examines the scope for coordination. Blanchard concludes that, while advanced economies' monetary policies indeed have had substantial spillover effects on emerging-market economies, there was and still is little room for coordination. He argues that, given the limits on fiscal policy, restrictions on capital flows (i.e., capital controls) were and still are the appropriate macroeconomic instrument to advance the objectives of both macro and financial stability.
    Keywords: Exchange Rates, Capital Controls, Capital Flows, Monetary Policy, Macroeconomic Policy Coordination
    JEL: F3 F36 F42
    Date: 2016–07
  2. By: Kiyoung Jeon (Research Department, Bank of Korea); Zeynep Kabukcuoglu (Department of Economics, Villanova School of Business, Villanova University)
    Abstract: In this paper, we study the role of income inequality in government's borrowing and default decisions. We consider a standard endogenous sovereign debt default model and extend it to allow for heterogeneous agents. In addition to shocks to the average income level, we consider the effect of shocks to income distribution. Consistent with the data, income dispersion across individuals increases during a recession and decreases during an expansion. The model is calibrated to match a number of stylized facts for Argentina. We show that (i) rising income inequality within a country increases the probability of default significantly; (ii) the effect of output shocks is larger than the effect of inequality shocks; (iii) the joint effect of these two shocks can generate a high default probability consistent with the Argentine data; (iv) the model can match the high volatility of consumption of the poor relative to the rich; (v) progressive income taxes can reduce the default risk.
    Keywords: Sovereign Debt; Default; Income Inequality; Redistribution
    JEL: F3 F4 E5 D5
    Date: 2016–07
  3. By: Julien Bengui (Université de Montréal); Sushant Acharya (Federal Reserve Bank of New York)
    Abstract: This paper explores the role of capital flows and exchange rate dynamics in shaping the global economy’s adjustment in a liquidity trap. Using a multi-country model with nominal rigidities, we shed light on the global adjustment since the Great Recession, a period when many advanced economies were pushed to the zero bound on interest rates. We establish three main results. First, when the North hits the zero bound, downstream capital flows alleviate the recession by reallocating demand to the South and switching expenditure toward North goods. Second, a free capital flow regime falls short of supporting efficient demand and expenditure reallocations and induces too little downstream (upstream) flows during (after) the liquidity trap. And third, when it comes to capital flow management, individual countries’ incentives to manage their terms of trade conflict with aggregate demand stabilization and global efficiency. This underscores the importance of international policy coordination in liquidity trap episodes.
    Date: 2016
  4. By: Charles Yuji Horioka; Nicholas Ford
    Abstract: Meese and Rogoff (1983) and subsequent studies find that economic fundamentals are apparently not able to explain exchange rate movements, but we argue that this so-called “Exchange Rate Disconnect Puzzle” arose because researchers such as Meese and Rogoff (1983) did not use the right fundamentals and because they did not allow for the forward-looking nature of exchange rate determination. Further, because they apparently were not aware that financial markets by themselves could not equalise interest rates across countries, they did not properly appreciate that the exchange rate is strongly influenced by agents’ expectations of aggregated differences in local returns. Thus, we believe that the same underlying explanation provided by Ford (2015) and Ford and Horioka (2016a and 2016b) for the Feldstein-Horioka (1980) Puzzle and the PPP Puzzle--namely that financial markets alone cannot achieve net transfers of financial capital and cannot equalise real interest rates across countries--also helps explain why previous attempts to connect changes in the exchange rate to economic fundamentals have not been successful, and so can also be said to contribute to solving the Exchange Rate Disconnect Puzzle.
    Date: 2016–07
  5. By: Nuno Baetas da Silva (Faculdade de Economia da Universidade de Coimbra, Grupo de Estudos Monetários e Financeiros (GEMF)); João Sousa Andrade (Faculdade de Economia da Universidade de Coimbra, Grupo de Estudos Monetários e Financeiros (GEMF)); António Portugal Duarte (Faculdade de Economia da Universidade de Coimbra, Grupo de Estudos Monetários e Financeiros (GEMF))
    Abstract: This work reviews the literature on the alternative sources of Dutch Disease. We discuss the so-called Core Model of Dutch Disease, its limitations, extensions and the main contributions to the most recent theoretical and empirical methodologies of the Dutch Disease Economics applied to alternative capital inflows. By analyzing the effects associated with foreign aid, remittances, foreign direct investment and tourism on the real exchange rate and on the manufacturing sector, we set the stage both on the theoretical ground and on empirical evidence for a wider application of Dutch Disease classical approach. While the core model of Dutch Disease makes unambiguously predictions regarding the negative effects of a resource boom on the manufacturing sector, the empirical literature on the alternative sources of the disease that has followed has not clearly identified such effects.
    Keywords: Dutch Disease, De-industrialization, Resource Boom, Capital Inflows. JEL Classification: F2, F41, O14, Q33
    Date: 2016–07
  6. By: Eichler, Stefan; Roevekamp, Ingmar
    Abstract: We introduce a novel currency risk measure based on American Depositary Receipts (ADRs). Using a multifactor pricing model, we exploit ADR investors' exposure to potential devaluation losses to derive an indicator of currency risk. Using weekly data for a sample of 831 ADRs located in 23 emerging markets over the 1994-2014 period, we find that a deterioration in the fiscal and current account balance, as well as higher inflation, increases currency risk. Interaction models reveal that these macroeconomic fundamentals drive currency risk, particularly in countries with managed exchange rates, low levels of foreign exchange reserves and a poor sovereign credit rating.
    Keywords: currency risk,currency crises,American depositary receipts,emerging markets
    JEL: F31 F37 G12 G15
    Date: 2016
  7. By: Yang Liu (University of Pennsylvania); Mariano Croce (University of North Carolina at Chapel H); Ivan Shaliastovich (University of Pennsylvania); Ric Colacito (University of North Carolina, Chapel Hil)
    Abstract: We produce novel empirical evidence on the relevance of output volatility (vol) shocks for both currency and international quantity dynamics. Focusing on G-17 countries, we document that: (1) consumption and output vols are imperfectly correlated within countries; (2) across countries, consumption vol is more correlated than output vol; (3) the pass-through of relative output vol shocks onto relative consumption vol is significant, especially for small countries; and (4) consumption differentials vol and exchange rate vol are disconnected. We rationalize these findings in a frictionless model with multiple goods and recursive preferences featuring a novel and rich risk-sharing of vol shocks.
    Date: 2016
  8. By: Terada-Hagiwara, Akiko (Asian Development Bank); Villlaruel, Mai Lin (Asian Development Bank); Edmonds, Christopher (Asian Development Bank)
    Abstract: This paper investigates the role of “absorptive capacity” to manage unexpected shocks to their real economy, with a focus on small, open, natural resource-dependent economies. A quarterly panel data series for 45 countries is constructed, including 23 developing Asian countries for empirical investigation. For the entire sample, the analysis finds that absorptive capacity, choice of exchange rate regime, presence of wealth funds, level of foreign reserves, or degree of resource dependency alone, does not matter when real shocks are introduced to output. However, levels of absorptive capacity or ability to use resource windfalls effectively, and foreign reserves begin to matter when the sample is restricted to resource-dependent countries. Case studies from Papua New Guinea and Timor-Leste support this claim highlighting the challenges they face with a sudden influx of natural resource revenues when capacity to effectively use fiscal revenues is limited.
    Keywords: absorptive capacity; economic growth; natural resources; real exchange rate; terms of trade
    JEL: F14 F43 H11
    Date: 2016–06–21
  9. By: Eduardo Cavallo (Inter-American Development Bank); Barry Eichengreen (University of California, Berkeley); Ugo Panizza (IHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: A surprisingly large number of countries have been able to finance a significant fraction of domestic investment using foreign finance for extended periods. While many of these episodes are in low-income countries where official finance is more important than private finance, we also identify a number of episodes where a substantial fraction of domestic investment was financed via private capital inflows. That said, we find that foreign savings are not a good substitute for domestic savings. More often than not, episodes of large and persistent current account deficits do not end happily. Rather, they end abruptly with compression of the current account, real exchange rate depreciation, and a sharp slowdown in investment. We conclude that financing growth and investment out of foreign savings, while not impossible, is risky.
    Keywords: Current account, Growth, Volatility, Savings
    JEL: F32 O16
    Date: 2016–07–15
  10. By: Jongwanich, Juthathip (Thammasat University); Wongcharoen, Petchtharin (Thammasat University); Park, Donghyun (Asian Development Bank)
    Abstract: We empirically examine and compare the determinants of producer and consumer price inflation in 10 Asian economies during 2000–2015. In this connection, we also investigate the pass-through of global oil prices, global food prices, and exchange rates to domestic producer and consumer prices. Overall, we find that cost-push factors such as oil and food prices are more important in explaining producer price inflation than consumer price inflation in the 10 Asian economies. On the other hand, for consumer prices, demand-pull factors still explain much of the inflation. Finally, we find that the pass-through of global oil prices, global food prices, and exchange rates tend to be higher for producer prices than consumer prices in Asia.
    Keywords: Asia; commodity price shocks; consumer price; exchange rate; inflation; monetary policy; pass-through; producer price
    JEL: E31 F43 O53
    Date: 2016–07–14
  11. By: Andrea Vedolin (London School of Economics); Alireza Tahbaz-Salehi (Columbia Business School); Philippe Mueller (London School of Economics)
    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-a`-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.
    Date: 2016
  12. By: Kriwoluzky, Alexander; Müller, Gernot J.; Wolf, Martin
    Abstract: We study the impact of the interaction between fiscal and monetary policy on the low-frequency relationship between the fiscal stance and inflation using cross-country data from 1965 to 1999. In a first step, we contrast the monetary-fiscal narrative for Germany, the U.S. and Italy with evidence obtained from simple regression models and a time-varying VAR. We find that the low-frequency relationship between the fiscal stance and inflation is low during periods of an independent central bank and responsible fiscal policy and more pronounced in times of high fiscal budget deficits and accommodative monetary authorities. In a second step, we use an estimated DSGE model to interpret the low-frequency measure structurally and to illustrate the mechanisms through which fiscal actions affect inflation in the long run. The findings from the DSGE model suggest that switches in the monetary-fiscal policy interaction and accompanying variations in the propagation of structural shocks can well account for changes in the low-frequency relationship between the fiscal stance and inflation.
    Keywords: currency union,exit,sovereign debt crisis,fiscal policy,redenomination premium,euro crisis,regime-switching model
    JEL: E52 E62 F41
    Date: 2015
  13. By: Qayyum, Abdul; Nazir, Sidra; Jawad, Muhammad
    Abstract: Exchange rate is an important factor to bring change in trade balance of any country. In this study the true relationship that is nonlinear; have been examined empirically between trade balance and real exchange rate for Pakistan vs USA. By using monthly data (1980m1 to 2014m2) linear and nonlinear models are estimated by using Johansen cointegration technique (1988). The negative sign of RER2 confirms the nonlinear relationship in case of bilateral trade between these two countries. Existence J-curve in case of Pakistan has been confirmed by long run and short run results, as in long run exchange rate improves the trade balance but in short run it depreciated Hussain and Bashir (2013) and Magee (1973). Finally the nonlinear model showed better forecast performance examined by RMSE and MAE.
    Keywords: Exchange Rate, Trade Balance, Non-Linear Model, Cointegration, J-Curve
    JEL: C4 F1 F31
    Date: 2016–07
  14. By: Dany, Geraldine; Gropp, Reint E.; Littke, Helge; von Schweinitz, Gregor
    Abstract: This note shows that the German public sector balance benefited significantly from the European/Greek debt crisis, because of lower interest payments on public sector debt. This is due to two effects: One, in crisis times investors disproportionately seek out safe investments (“flight to safety“), bidding down the returns on safe-haven assets. We show that German bunds strongly benefited from this effect during the Greek debt crisis. Second, while the European Central Bank (ECB) monetary policy stance was quite close to an “optimal“ monetary policy stance for Germany from 1999 to 2007, during the crisis monetary policy was too accommodating from a German perspective, due to the emerging disparities across the Euro area. As a result of these two effects, our calculations suggest that the German sovereign saved more than 100 billion Euros in interest expenses between 2010 and mid-2015. That is, Germany benefited from the Greek crisis even in case that Greece defaults on all its debt (a total of 90 billions) owed to the German government via diverse channels (European Stability Mechanism [ESM], International Monetary Fund [IMF], or directly).
    Keywords: European Union,Greek crisis,government bonds,German public budget,Greece,Germany
    Date: 2015

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.