nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒03‒12
fifteen papers chosen by
Martin Berka
University of Auckland

  1. Fiscal Unions Redux By Patrick J. Kehoe
  2. Revisiting the Commodity Curse: A Financial Perspective By Alberola, Enrique; Benigno, Gianluca
  3. The Impact of Brexit on Foreign Investment and Production By Ellen R. McGrattan; Andrea Waddle
  4. Monetary Policy and the Predictability of Nominal Exchange Rates By Eichenbaum, Martin; Johannsen, Benjamin; Rebelo, Sérgio
  5. Endogenous Asymmetric Shocks in the Eurozone. The Role of Animal Spirits By De Grauwe, Paul; Ji, Yuemei
  6. Aftershocks of Monetary Unification: Hysteresis with a Financial Twist By Bayoumi, Tamim; Eichengreen, Barry
  7. Investigating First-Stage Exchange Rate Pass-Through: Sectoral and Macro Evidence from Euro Area Countries By Cheikh, Nidhaleddine Ben; Rault, Christophe
  8. New Exporters and Continuing Exporters under Exchange Rate Fluctuations By Tan, Yong; Zhao, Chen
  9. Exchange rate implications of Border Tax Adjustment Neutrality By Buiter, Willem H.
  10. The G7 business cycle in a globalized world By Salzmann, Leonard
  11. A panel VAR analysis of macro-financial imbalances in the EU By Comunale, Mariarosaria
  12. A market-based indicator of currency risk: Evidence from American Depositary Receipts By Rövekamp, Ingmar; Eichler, Stefan
  13. Institutional investors and home bias in Europe’s Capital Markets Union By Zsolt Darvas; Dirk Schoenmaker
  14. Risk sharing and real exchange rates: the role of non-tradable sector and trend shocks By Hüseyin Çağrı Akkoyun; Yavuz Arslan; Mustafa Kılınç
  15. Size and welfare costs of price differences across European countries By Rühl, Christian

  1. By: Patrick J. Kehoe (; Centre for Macroeconomics (CFM))
    Abstract: Before the advent of sophisticated international financial markets, a widely accepted belief was that within a monetary union, a union-wide authority orchestrating fiscal transfers between countries is necessary to provide adequate insurance against country-specific economic fluctuations. A natural question is then: Do sophisticated international financial markets obviate the need for such an active union-wide authority? We argue that they do. Specifically, we show that in a benchmark economy with no international financial markets, an activist union-wide authority is necessary to achieve desirable outcomes. With sophisticated financial markets, however, such an authority is unnecessary if its only goal is to provide cross-country insurance. Since restricting the set of policy instruments available to member countries does not create a fiscal externality across them, this result holds in a wide variety of settings. Finally, we establish that an activist union-wide authority concerned just with providing insurance across member countries is optimal only when individual countries are either unable or unwilling to pursue desirable policies.
    Keywords: Cross-country Externalities, Cross-country Insurance, Cross-country Transfers, Fiscal Externalities, International Financial Markets, International Transfers, Optimal Currency Area
    JEL: E60 E61 F33 F35 F38 F42 G15 G28 G33
    Date: 2017–02
  2. By: Alberola, Enrique; Benigno, Gianluca
    Abstract: We study the response of a three-sector commodity-exporter small open economy to a commodity price boom. When the economy has access to international borrowing and lending, a temporary commodity price boom brings about the standard wealth effect that stimulates demand and has long-run implications on the sectoral allocation of labour. If dynamic productivity gains are concentrated in the traded goods sector, the commodity boom crowds out the traded sector and delays convergence to the world technology frontier. Financial openness by stimulating current demand, amplifies the crowding out effect and may even lead to a growth trap, in which no resources are allocated to the traded sector. From a normative point of view, our analysis suggests that capital account management policies could be welfare improving in those circumstances.
    JEL: F32 F36 F41 F43 O13
    Date: 2017–02
  3. By: Ellen R. McGrattan; Andrea Waddle
    Abstract: In this paper, we estimate the impact of increasing costs on foreign producers following a withdrawal of the United Kingdom from the European Union (popularly known as Brexit). Our predictions are based on simulations of a multicountry neoclassical growth model that includes multinational firms investing in research and development (R&D), brands, and other intangible capital that is used nonrivalrously by their subsidiaries at home and abroad. We analyze several post-Brexit scenarios. First, we assume that the United Kingdom unilaterally imposes tighter restrictions on foreign direct investment (FDI) from other E.U. nations. With less E.U. technology deployed in the United Kingdom, U.K. firms increase investment in their own R&D and other intangibles, which is costly, and welfare for U.K. citizens is lower. If the European Union remains open, its citizens enjoy a modest gain from the increased U.K. investment since it can be costlessly deployed in subsidiaries throughout Europe. If instead we assume that the European Union imposes the same restrictions on U.K. FDI, then E.U. firms invest more in their own R&D, benefiting the United Kingdom. With costs higher on both U.K. and E.U. FDI, we predict a significant fall in foreign investment and production by U.K. firms. The United Kingdom increases international lending, which finances the production of others both domestically and abroad, and inward FDI rises. U.K. consumption falls and leisure rises, implying a negligible impact on welfare. In the European Union, declines in investment and production are modest, but the welfare of E.U. citizens is significantly lower. Finally, if, during the transition, the United Kingdom reduces current restrictions on other major foreign investors, such as the United States and Japan, U.K. inward FDI and welfare both rise significantly.
    JEL: F23 F41 O33 O34
    Date: 2017–03
  4. By: Eichenbaum, Martin; Johannsen, Benjamin; Rebelo, Sérgio
    Abstract: This paper documents two facts about the behavior of floating exchange rates in countries where monetary policy follows a Taylor-type rule. First, the current real exchange rate is highly negatively correlated with future changes in the nominal exchange rate at horizons greater than two years. This negative correlation is stronger the longer is the horizon. Second, for most countries, the real exchange rate is virtually uncorrelated with future inflation rates both in the short and in the long run. We develop a class of models that can account for these and other key observations about real and nominal exchange rates.
    Keywords: currency forecasting; Taylor rule
    JEL: E52 F31 F41
    Date: 2017–02
  5. By: De Grauwe, Paul; Ji, Yuemei
    Abstract: Business cycles among Eurozone countries are highly correlated. We develop a two-country behavioral macroeconomic model in a monetary union setting where the two countries are linked with each other by international trade. The net export of country 1 depends on the output gap of country 2 and on real exchange rate movements. The synchronization of the business cycle is produced endogenously. The main channel of synchronization occurs through a propagation of "animal spirits" , i.e. waves of optimism and pessimism that become correlated internationally. We find that this propagation occurs with relatively low levels of trade integration. We analyze the role of the common central bank in this propagation mechanism. We explore the transmission of demand and supply shocks and we study how the central bank affects this transmission. We verify the main predictions of the model empirically.
    Keywords: animal spirits; behavioral macroeconomics; Business Cycles; monetary union
    Date: 2017–03
  6. By: Bayoumi, Tamim; Eichengreen, Barry
    Abstract: Once upon a time, in the 1990s, it was widely agreed that neither Europe nor the United States was an optimum currency area, although moderating this concern was the finding that it was possible to distinguish a regional core and periphery (Bayoumi and Eichengreen, 1993). Revisiting these issues, we find that the United States is remains closer to an optimum currency area than the Euro Area. More intriguingly, the Euro Area shows striking changes in correlations and responses which we interpret as reflecting hysteresis with a financial twist, in which the financial system causes aggregate supply and demand shocks to reinforce each other. An implication is that the Euro Area needs vigorous, coordinated regulation of its banking and financial systems by a single supervisor - ”that monetary union without banking union will not work.
    Keywords: euro; hysteresis; Monetary Unification
    Date: 2017–02
  7. By: Cheikh, Nidhaleddine Ben (ESSCA School of Management); Rault, Christophe (University of Orléans)
    Abstract: In this paper, we evaluate the first-stage pass-through, namely the responsiveness of import prices to the exchange rate changes, for a sample of euro area (EA) countries. Our study aims to shed further light on the role of microeconomic factors vs. macroeconomic factors in influencing the extent of the exchange rate pass-through (ERPT). As a first step, we conduct a sectoral analysis using disaggregated import prices data. We find a much higher degree of pass-through for more homogeneous goods and commodities, such as oil and raw materials, than for highly differentiated manufactured products, such as machinery and transport equipment. Our results confirm that cross-country differences in pass-through rates may be due to divergences in the product composition of imports. The higher share of imports from sectors with lower degrees of pass-through, the lower ERPT for an economy will be. In a next step, we investigate for the impact of some macroeconomics factors or common events experienced by EA members on the extent of pass-through. Using the System Generalized Method of Moments within a dynamic panel-data model, our estimates indicate that decline of import-price sensitivity to the exchange rate is not significant since the introduction of the single currency. Our findings suggest instead that the weakness of the euro during the first three years of the monetary union significantly raised the extent of the ERPT. This outcome could explain why the sensitivity of import prices has not fallen since 1999. We also point out a significant role played by the inflation in the Eurozone, as the responsiveness of import prices to exchange rate fluctuations tends to decline in a low and more stable inflation environment. Overall, our findings support the view that the extent of pass-through is comprised of both macro- and microeconomic aspects that policymakers should take into account.
    Keywords: exchange rate pass-through, import prices, dynamic panel data
    JEL: E31 F31 F40
    Date: 2017–02
  8. By: Tan, Yong; Zhao, Chen
    Abstract: In this paper we investigate the different behaviors between new and continuing exporters in response to exchange rate shocks. We establish a dynamic model, in which new exporters strategically charge a lower price than continuing exporters in order to increase their current sales and accumulate their consumer base in future periods. The model predicts that new exporters adjust their price more aggressively relative to their continuing counterparts in response to exchange rate fluctuations in order to build future demand stock. Using a transaction-level dataset containing all Chinese exporters over the 2000-2009 period, we find supporting evidence for the model's predictions: new exporters adjust their price 1.5 times more than the continuing exporter. Our findings imply different exchange rate pass-through between new and continuing exporters, and the various ratios of new exporters lead to different degree of exchange rate pass-through across countries at the aggregate level.
    Keywords: New Exporters, Continuing Exporters, Exchange Rate Shocks, Pass-through
    JEL: F14 F31 F33 O19
    Date: 2017–03–02
  9. By: Buiter, Willem H.
    Abstract: A border tax adjustment (BTA) is under consideration for the corporate profit tax in the US. Mainstream economic theory holds that BTAs - a switch from taxing exports and exempting imports to taxing imports and exempting exports - is neutral: it will not affect competitiveness and sectoral profitability in the country implementing the BTA or abroad, through adjustments in the exchange rate and in domestic and foreign prices and costs. Conventional wisdom has it that (real) BTA neutrality is achieved through an appreciation of the currency equal in percentage terms to the tax rate. So, with a 20% US corporate tax rate, a neutral BTA would cause the US dollar to strengthen (appreciate) by 20%. This paper shows that the conventional wisdom is not robust. Alternative assumptions about the behaviour of domestic and foreign nominal prices that are (at least) as plausible as the assumptions that imply a 20% appreciation of the US dollar, would instead result in a 20% strengthening of the foreign currency and a matching depreciation of the US dollar. Two key aspects of rigidities in nominal prices are involved: (1) are prices sticky (constant) in terms of the currency of the country of origin or in terms of the currency of the country of destination (pricing-to-market)?; (2) are prices sticky (constant) net-of-tax or tax-inclusive? The empirical evidence slightly favors pricing-to-market (US import prices constant in dollars and US export prices constant in foreign currency). There is no empirical evidence on whether nominal rigidities apply to tax-inclusive or net-of-tax prices. Pricing-to-market for net-of-tax prices produces the depreciation outcome. So does currency-of-origin pricing for tax-inclusive prices. Pricing-to-market for tax-inclusive prices and currency-of-origin pricing for net-of-tax prices produces the appreciation outcome. Given the lack of robust empirical evidence, I believe it is not possible to have any confidence about even the direction of the response of the dollar to a BTA in the US - let alone about the magnitude. The paper has real BTA neutrality as its maintained hypothesis. This is, however, a disputed empirical issue. This further boosts the uncertainty about the exchange rate implications of a BTA.
    Keywords: Border tax adjustment; equivalence; exchange rate appreciation; neutrality; nominal price and wage rigidities
    JEL: E31 E62 F11 F13 F41 H25 H87
    Date: 2017–03
  10. By: Salzmann, Leonard
    Abstract: Using a factor structural VAR for 14 countries out of the G20 group, we document that output innovations originating outside the G7 account for shares of 10 to 25 percent in the business cycle fluctuations of G7 GDP growth. Using auxiliary regressions, we additionally find that these innovations contribute noticeably, relative to G7 output innovations, to short-term fluctuations in important other national G7 variables such as employment, the current account balance, inflation, and inflation volatility, and in global macroeconomic indicators like the oil price, world stock market returns, and exchange rate volatility. The results indicate that in a globalized world spillovers from emerging markets and industrial countries other than the G7 play a relevant role for major aspects of the G7 and world business cycle.
    JEL: E32 F44 F62
    Date: 2016
  11. By: Comunale, Mariarosaria
    Abstract: We investigate the interactions across current account misalignments, Real Effective Exchange Rate misalignments and financial (or output) gaps within EU countries. We apply panel techniques, including a Bayesian panel VAR, to 27 EU members over the period 1994-2012. We find that, for the euro area, the reaction of current account misalignments to a shock in the Real Effective Exchange Rate misalignments is the largest and the financial gap can influence the current account misalignments more than the output gap. In non-euro area countries and euro periphery an increase in current account misalignments leads to a temporary increase in the Real Effective Exchange Rate misalignments, lowering competitiveness and thus amplifying current account fluctuations. For the core, a raise in the rate or an expansion of the financial gap may help in rebalancing the current account. In the CEE members, an increase in the Real Effective Exchange Rate misalignments may bring larger current account deficits in the medium-long run. JEL Classification: F32, F31, C33
    Keywords: current account, financial gaps, foreign capital flows, panel VAR, real effective exchange rate
    Date: 2017–02
  12. By: Rövekamp, Ingmar; Eichler, Stefan
    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.
    JEL: F31 F37 G15
    Date: 2016
  13. By: Zsolt Darvas; Dirk Schoenmaker
    Abstract: Integrated capital markets facilitate risk sharing across countries. Lower home bias in financial investments is an indicator of risk sharing. We highlight that existing indicators of equity home bias in the literature suffer from incomplete coverage because they consider only listed equities. We also consider unlisted equites and show that equity home bias is much higher than previous studies perceived. We also analyse home bias in debt securities holdings, and euro area bias. We conclude that European Union membership may foster financial integration and reduce information barriers, which sometimes limit cross-country diversification. We calculate home bias indicators for the aggregate of the euro area as if the euro area was a single country and report remarkable similarity between the euro area and the United States in terms of equity home bias, while there is a higher level of debt home bias in the United States than in the euro area as a whole. We develop a new pension fund foreign investment restrictions index to control for the impact of prudential regulations on the ability of institutional investors to diversify geographically across borders. Our panel regression estimates for 25 advanced and emerging countries in 2001-14 provide strong support for the hypothesis that the larger the assets managed by institutional investors (defined as pension funds, insurance companies and investment funds), the smaller the home bias and thereby the greater the scope for risk sharing.
    Date: 2017–03
  14. By: Hüseyin Çağrı Akkoyun; Yavuz Arslan; Mustafa Kılınç
    Abstract: Most of the international macro models, in contrast to the data, imply a very high level of risk sharing across countries and very low real exchange rate (RER) volatility relative to output. In this paper we show that a standard two-country two-good model augmented with conintegrated TFP processes comes closer to matching the data. We first show that the tradable and non-tradable total factor productivity (TFP) processes of the US and Europe have unit roots and can be modelled by a vector error correction model (VECM). Then, we develop a standard two-country and two-good (tradable and non-tradable) DSGE model and study the quantitative implications. Cointegrated TFP shocks, or trend shocks, generate significant income effects and amplify the mechanisms that produce high RER volatility. Moreover, trend shocks can break the tight link between relative consumption and RER for low and high values of trade elasticity parameters.
    Keywords: trends shocks, risk sharing, real exchange rates
    Date: 2017–02
  15. By: Rühl, Christian
    Abstract: Studies employing micro price data suggest that price dispersion is larger between regions in different countries than between regions in the same country. To investigate the strength of this border effect, deviations from the law of one price are used in most studies to provide statistical evidence on the effect of borders on price dispersion. I propose an alternative measure of the economic costs of borders which has an explicitwelfare-theoretic foundation. Employing a unique micro price data set from households in Belgium, Germany and the Netherlands I provide evidence on the economic importance of price differences for households. I find that price dispersion within countries has only small economic importance, but that price dispersion between Belgium andGermany (and Belgium and theNetherlands) has considerable economic importance.
    JEL: D12 F00 F40
    Date: 2016

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