nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2016‒10‒30
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Optimal Fiscal Substitutes for the Exchange Rate in a Monetary Union By Christoph Kaufmann
  2. International Financial Adjustment in a Canonical Open Economy Growth Model By Richard H. Clarida; Ildikó Magyari
  3. Capital Controls and Financial Frictions in a Small Open Economy By Shigeto Kitano; Kenya Takaku
  4. A Model of Fickle Capital Flows and Retrenchment: Global Liquidity Creation and Reach for Safety and Yield By Ricardo J. Caballero; Alp Simsek
  5. Macroprudential policies, the long-term interest rate and the exchange rate By Philip Turner
  6. The Output Costs of Hard and Soft Sovereign Default By Trebesch, Christoph; Zabel, Michael
  7. The euro as an international currency By Agnès Benassy-Quere
  8. Real Exchange Rate, Effective Demand, and Economic Growth: Theory and Empirical Evidence for Developed and Developing Countries, 1960-2010 By Francisco A. Martínez-Hernández
  9. Does International Trade Produce Convergence? By Iader Giraldo
  10. Migration and Cross-Border Financial Flows By Maurice Kugler; Oren Levintal; Hillel Rapoport
  11. On the link between current account and oil price fluctuations in diversified economies: The case of Canada By Blaise Gnimassoun; Marc Joëts; Tovonony Razafindrabe
  12. Core and Periphery in the European Monetary Union: Bayoumi and Eichengreen 25 Years Later By Nauro F. Campos; Corrado Macchiarelli
  13. China's Electronics Exports, the Renminbi, and Exchange Rates in Supply Chain Countries By THORBECKE, Willem
  14. The response of euro area sovereign spreads to the ECB unconventional monetary policies By Hans Dawachter; Leonardo Iania; jean-charles wijnandts
  15. Are Exchange Rates Disconnected from Macroeconomic Variables? Evidence from the Factor Approach By Yunjung Kim; Cheolbeom Park

  1. By: Christoph Kaufmann
    Abstract: This paper studies Ramsey-optimal monetary and fiscal policy in a New Keynesian 2-country open economy framework, which is used to assess how far fiscal policy can substitute for the role of nominal exchange rates within a monetary union. Giving up exchange rate exibility leads to welfare costs that depend significantly on whether the law of one price holds internationally or whether firms can engage in pricing-to-market. Calibrated to the euro area, the welfare costs can be reduced by 86% in the former and by 69% in the latter case by using only one tax instrument per country. Fiscal devaluations can be observed as an optimal policy in a monetary union: if a nominal devaluation of the domestic currency were optimal under exible exchange rates, optimal fiscal policy in a monetary union is an increase of the domestic relative to the foreign value added tax.
    Keywords: Monetary union, Optimal monetary and fiscal policy, Exchange rate
    JEL: F41 F45 E63
    Date: 2016–09–21
  2. By: Richard H. Clarida; Ildikó Magyari
    Abstract: Gourinchas and Rey (2007) have shown that international financial adjustment (IFA) in the path of expected future returns on a country’s international investment portfolio can complement or even substitute for the traditional adjustment channel via a narrowing of country’s current account imbalance. In their paper, GR derive this result using a log linearization of a net foreign asset accumulation identity without reference to any specific theoretical model of IFA in expected foreign asset returns or the real exchange rate. In this paper we calibrate the importance of IFA in a standard open economy growth model (Schmitt-Grohe and Uribe, 2003) with a well-defined steady level of foreign liabilities. In this model there is a country specific credit spread which varies as a function of the ratio of foreign liabilities to GDP. We find that allowing for an IFA channel results in a very rapid converge of the current account to its steady state (relative to the no IFA case) so that most of the time that the country is adjusting, all the adjustment is via the IFA channel of forecastable changes in the costs of servicing debt and in the appreciation real exchange rate. By contrast, in the no IFA case, current account adjustment by construction does all the work and current account adjustment is much slower.
    JEL: F3 F32 F41
    Date: 2016–10
  3. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University)
    Abstract: We develop a small open economy model with financial frictions between domestic banks and foreign investors, and examine the welfare-improving effect of capital controls. We show that capital controls are effective in addressing the amplification effect due to financial frictions. As the degree of financial frictions increases, the welfare-improving effect of capital controls becomes larger. The monotonic relationship between the degree of financial frictions and the welfare-improving effect of capital controls is robust for varying degrees of country premium, home bias in goods, and trade elasticity. Comparing two economies, one with and one without "liability dollarization," we also find that the welfare-improving effect of capital controls is larger in the presence of "liability dollarization."
    Keywords: Capital control, Financial frictions, Financial intermediaries, Balance sheets, Small open economy, Liability dollarization, DSGE, Welfare
    JEL: E69 F32 F38 F41
    Date: 2016–10
  4. By: Ricardo J. Caballero; Alp Simsek
    Abstract: Gross capital flows are very large and highly cyclical. They are a central aspect of global liquidity creation and destruction. They also exhibit rich internal dynamics that shape fluctuations in domestic liquidity, such as the fickleness of foreign capital inflows and the retrenchment of domestic capital outflows during crises. In this paper we provide a model that builds on these observations to address some of the main questions and concerns in the capital flows literature. Within this model, we find that for symmetric economies, the liquidity provision aspect of capital flows vastly outweighs their fickleness cost, so that taxing capital flows, while could prove useful for a country in isolation, backfires as a global equilibrium outcome. However, if the system is heterogeneous and includes economies with abundant (DM) and with limited (EM) natural domestic liquidity, there can be scenarios when global liquidity uncertainty is high and EM's reach for safety can destabilize DMs, as well as risk-on scenarios in which DM's reach for yield can destabilize EMs.
    JEL: E3 E4 F3 F4 F6 G1
    Date: 2016–10
  5. By: Philip Turner
    Abstract: The Bernanke-Blinder closed economy model suggests that macroprudential policies aimed at bank lending will affect the domestic long-term interest rate. In an open economy, domestic shocks to long-term rates are likely to influence capital flows and the exchange rate. Currency movements feed back into domestic credit through several channels, which will be influenced by balance sheet positions and not only by income flows. Macroprudential policies aimed at domestic credit and at foreign currency borrowing may be the best option open to small countries facing very low global interest rates and risky domestic credit expansion.
    Keywords: Bernanke-Blinder model, capital flows, interest rate policy, macroprudential policy
    Date: 2016–10
  6. By: Trebesch, Christoph; Zabel, Michael
    Abstract: How costly are sovereign debt crises? In this paper we study output losses during sovereign default and debt renegotiation episodes since 1980. In contrast to previous work, we account for the severity of default and not only for its occurrence. Specifically, we distinguish between "hard" and "soft" defaults, using new data on debtor payment and negotiation behavior and on the size of haircuts towards private external creditors. We show that hard defaults are associated with a much steeper drop in GDP, of up to ten percent, compared to soft defaults, and address concerns of reverse causality and omitted variable bias. The results question the standard assumption that defaults trigger fixed and lump-sum costs. Instead, the findings are consistent with models assuming proportional output costs of default.
    Keywords: debt restructuring; Economic Growth; reputation; Sovereign debt crises
    JEL: F34 F41 G01 H63
    Date: 2016–10
  7. By: Agnès Benassy-Quere (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: The euro, in spite of having many of the required attributes put forward by the theoretical literature and past experience, has failed to fulfill all the criteria that would enable it to rival the dollar as an international currency. This does not mean that the euro cannot achieve a status similar to that of the dollar; however, the window of opportunity may not last much more than a decade before the renminbi overtakes the euro. European monetary unification has never explicitly sought for its currency to gain an international status. This makes sense insofar as the key elements required for the euro to expand internationally are also those to be pursued internally: GDP growth; a fiscal backing to the single currency; a deep, liquid and resilient capital market; and a unified external representation of the euro area.
    Keywords: Euro area
    Date: 2015–04
  8. By: Francisco A. Martínez-Hernández (Department of Economics, State University of New York New Paltz)
    Abstract: This paper seeks to assess the effects of an undervalued currency on economic growth. Based on a reformulation of Rodrik’s undervaluation index, our econometric results suggest that real exchange rate undervaluation has, to differing degrees, been able to enhance the economic growth of developed and developing countries. Nevertheless, when we disaggregate the main components of aggregate demand for different clusters of developed and developing countries using the Stock Flow Consistent approach (SFC), we find that in general, an undervalued currency has expansionary and contractionary effects in the short-run, specifically via the export sector and the level of aggregate consumption, respectively. This paper also estimates the effects of an undervalued currency on the level of investment and the trade balance.
    Keywords: Undervalued Currency, Developed and Developing Countries, Effective Demand Components, Economic Growth, Panel Data Models
    JEL: F50 F31 F41 C32
    Date: 2016–10
  9. By: Iader Giraldo
    Abstract: In spite of increasing globalization around the world, the e¤ects of international trade on economic growth are not very clear. I consider an endogenous economic growth model in an open economy with the Home Market Effect (HME) and non-homothetic preferences in order to identify some determinants of the di¤erent results in this relationship. The model shows how trade between similar countries leads to convergence in economic growth when knowledge spillovers are present, while trade between very asymmetric countries produces divergence and may become trade in a poverty or growth trap. The results for welfare move in the same direction as economic growth since convergence implies increases in welfare for both countries, while divergence leads to increases in welfare for the largest country and the opposite for its commercial partner in the absence of knowledge spillovers. International trade does not implicate greater welfare as is usual in a static context under CES preferences.
    Keywords: International Trade, Economic Growth, Home Market E¤ect, Non-homotheticPreferences.
    JEL: F12 F43 O41 O33
    Date: 2016–09–09
  10. By: Maurice Kugler (The Interdisciplinary Center Herzliya - The Interdisciplinary Center Herzliya); Oren Levintal (Bar-Ilan University [Israël]); Hillel Rapoport (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics)
    Abstract: The gravity model has provided a tractable empirical framework to account for bilateral flows not only of manufactured goods, as in the case of merchandise trade, but also of financial flows. In particular, recent literature has emphasized the role of information costs in preventing larger diversification of financial investments. This paper investigates the role of migration in alleviating information imperfections between home and host countries. We show that the impact of migration on financial flows is strongest where information problems are more acute (that is, for more informational sensitive investments, between culturally more distant countries, and when the source country of migrants is a developing country) and for the type of migrants that are most able to enhance the flow of information on their home country, namely, skilled migrants. We interpret these differential effects as additional evidence pointing to the role of information in generating home-bias and as new evidence of the role of migration in reducing information frictions between countries.
    Keywords: gravity models,information asymmetries,international loans,international financial flows,Migration
    Date: 2015–03
  11. By: Blaise Gnimassoun; Marc Joëts; Tovonony Razafindrabe
    Abstract: This study revisits the important relationship between oil prices and current account for oil exporting countries by paying particular attention to the time-varying nature of this link. To this end, we rely on an innovative method, the time-varying parameter vector autoregressive (TVP-VAR) model with sign restriction. We find that while an oil supply shock has non-significant impact on the current account, an oil demand shock has a positive and significant effect, which tends to increase over time. In addition, by studying the economic factors underlying the evolution of this relation, we show that the propensity to spend oil revenues on imports has a significant negative infuence on the pass-through of oil demand shocks on current account. However, a deepening of the domestic financial market and an accumulation of foreign exchange reserves have a significant positive effect on this relationship.
    Keywords: Current account, Oil prices, Time-varying parameters.
    JEL: F32 Q43 C32
    Date: 2016
  12. By: Nauro F. Campos; Corrado Macchiarelli
    Abstract: Bayoumi-Eichengreen (1993) establish a EMU core-periphery pattern using 1963-1988 data. We use same methodology, sample, window length (1989-2015), and a novel over-identifying restriction test to ask whether the EMU strengthened or weakened the core-periphery pattern. Our results suggest the latter.
    Keywords: Business cycle synchronization, Structural VAR, European Monetary Union, Core-periphery
    JEL: E32 E63 F02
    Date: 2016–09
  13. By: THORBECKE, Willem
    Abstract: China's trade surplus remains huge. Researchers have reported that China's exports decimate manufacturing job abroad and stoke protectionist pressures. China's surplus is concentrated in the electronics sector. Much of the value-added of China's exports of smartphones, tablet computers, and consumer electronics goods comes from processors, sensors, and other parts and components (p&c) produced in Taiwan, South Korea, Japan, and the Association of Southeast Asian Nations (ASEAN). This paper finds that exchange rates in countries supplying p&c are crucial for understanding China's electronics exports. A concerted appreciation of East Asian currencies is needed to rebalance the region's exports. However, because of underdeveloped financial markets, the U.S. dollar remains the most important currency in the currency baskets of many East Asian economies. Countries resist appreciation against the dollar to maintain competitiveness vis-Ã -vis neighboring economies. This paper considers ways to overcome this coordination failure and develop stronger consumption-oriented economies in the region.
    Date: 2016–09
  14. By: Hans Dawachter (Economics and Research Department, NBB, University of Leuven, Center for Economic Studies and CESifo.); Leonardo Iania (University of Louvain, Louvain School of Management.); jean-charles wijnandts (University of Louvain, Louvain School of Management.)
    Abstract: We analyse variations in sovereign bond yields and spreads following unconventional monetary policy announcements by the European Central Bank. Using a two-country, arbitrage-free, shadow-rate dynamic term structure model (SR-DTSM), we decompose countries'yields into expectation and risk premium components. By means of an event study analysis, we show that the ECB's announcements reduced both the average expected instantaneous spread and risk repricing components of Italian and Spanish spreads. For countries such as Belgium and France, the ECB announcements impacted primarily the risk repricing component of the spread.
    Keywords: Triffin, European Payments Union (EPU), international monetary system (IMS)
    JEL: A11 B31 F02 F33 F36 N24
    Date: 2016–10
  15. By: Yunjung Kim (Department of Economics, Korea University, Seoul, Republic of Korea); Cheolbeom Park (Department of Economics, Korea University, Seoul, Republic of Korea)
    Abstract: We use factor-augmented predictive regression to analyze the relation between nominal exchange rates and macroeconomic variables. Using a panel of 127 US macroeconomic time series, we estimate eight factors through principal component analysis. Those estimated factors have significant predictive power and can substantially improve the predictive power of Purchasing Power Parity through both in-sample and out-of-sample analyses. The estimated macroeconomic factor, which comoves with US money supply measures, has strong predictive power for nominal exchange rate fluctuations in the short run, while estimated factors, comoving with interest rate spreads and employment variables, have strong predictive power in the long run. Moreover, optimal factors selected by the BIC in the out-of-sample analysis differ greatly depending on the time points when forecasts are made. Finally, we show that factors extracted from a panel of 127 US time series data and those extracted from a panel of 215 Korean macroeconomic series together can predict a substantial portion of movements in the Korea-US bilateral exchange rate.
    JEL: F31 F37 F47
    Date: 2016

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