nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒04‒02
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rate Policies at the Zero Lower Bound By Amador, Manuel; Bianchi, Javier; Bocola, Luigi; Perri, Fabrizio
  2. International Inflation Spillovers Through Input Linkages By Auer, Raphael; Levchenko, Andrei A.; Sauré, Philip
  3. Financial Markets and Fiscal Unions By Patrick J. Kehoe; Elena Pastorino
  4. From Financial Repression to External Distress: The Case of Venezuela By Carmen Reinhart; Miguel Angel Santos
  5. The globalisation of inflation: the growing importance of global value chains By Auer, Raphael; Borio, Claudio; Filardo, Andrew J
  6. Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel By Kollmann, Robert
  7. Exposure to international crises: trade vs. financial contagion By Everett Grant
  8. Varieties of Capital Flows: What Do We Know? By Eduardo Levy Yeyati; Jimena Zuniga
  9. Classifying Exchange Rate Regimes: 15 Years Later By Eduardo Levy Yeyati; Federico Sturzenegger
  10. Labor market reforms and current account imbalances - beggar-thy-neighbor policies in a currency union? By Timo Baas; Ansgar Belke
  11. The Currency Composition of International Portfolio Assets By Vahagn Galstyan; Caroline Mehigan; Rogelio Mercado
  12. An estimated two-country EA-US model with limited exchange rate pass-through By Gregory De Walque; Thomas Lejeune; Yuliya Rychalovska; Rafael Wouters
  13. International Transmission of U.S. Monetary Policy Surprises By Kim, Kyunghun

  1. By: Amador, Manuel (Federal Reserve Bank of Minneapolis); Bianchi, Javier (Federal Reserve Bank of Minneapolis); Bocola, Luigi (Northwestern University); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: We study how a monetary authority pursues an exchange rate objective in an environment that features a zero lower bound (ZLB) constraint on nominal interest rates and limits to international arbitrage. If the nominal interest rate that is consistent with interest rate parity is positive, the central bank can achieve its exchange rate objective by choosing that interest rate, a well-known result in international finance. However, if the rate consistent with parity is negative, pursuing an exchange rate objective necessarily results in zero nominal interest rates, deviations from parity, capital inflows, and welfare costs associated with the accumulation of foreign reserves by the central bank. In this latter case, all changes in external conditions that increase inflows of capital toward the country are detrimental, while policies such as negative nominal interest rates or capital controls can reduce the costs associated with an exchange rate policy. We provide a simple way of measuring these costs, and present empirical support for the key implications of our framework: when interest rates are close to zero, violations in covered interest parity are more likely, and those violations are associated with reserve accumulation by central banks.
    Keywords: Capital flows; CIP deviations; Currency pegs; Foreign exchange interventions; International reserves; Negative interest rates
    JEL: F31 F32 F41
    Date: 2017–03–16
  2. By: Auer, Raphael; Levchenko, Andrei A.; Sauré, Philip
    Abstract: We document that observed international input-output linkages contribute substantially to synchronizing producer price inflation (PPI) across countries. Using a multi-country, industry-level dataset that combines information on PPI and exchange rates with international and domestic input-output linkages, we recover the underlying cost shocks that are propagated internationally via the global input-output network, thus generating the observed dynamics of PPI. We then compare the extent to which common global factors account for the variation in actual PPI and in the underlying cost shocks. Our main finding is that across a range of econometric tests, input-output linkages account for half of the global component of PPI inflation. We report three additional findings: (i) the results are similar when allowing for imperfect cost pass-through and demand complementarities; (ii) PPI synchronization across countries is driven primarily by common sectoral shocks and input-output linkages amplify co-movement primarily by propagating sectoral shocks; and (iii) the observed pattern of international input use preserves fat-tailed idiosyncratic shocks and thus leads to a fat-tailed distribution of inflation rates, i.e., periods of disinflation and high inflation.
    Keywords: global value chain; globalisation; inflation; input linkages; input-output linkages; international inflation synchronization; monetary policy; production structure; Supply Chain
    JEL: E31 E52 E58 F02 F14 F33 F41 F42 F62
    Date: 2017–03
  3. By: Patrick J. Kehoe; Elena Pastorino
    Abstract: Do sophisticated international financial markets obviate the need for an active union-wide authority to orchestrate fiscal transfers between countries to provide adequate insurance against country-specific economic fluctuations? 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.
    JEL: E0 E5 E6 E62 F33 F36 F38 F42 F44
    Date: 2017–03
  4. By: Carmen Reinhart (Center for International Development at Harvard University); Miguel Angel Santos (Center for International Development at Harvard University)
    Abstract: Recent work has supported that there is a connection between domestic debt level and sovereign default on external debt. We examine the potential linkages in a case study of Venezuela from 1984 to 2013. This unique example encompasses multiple financial crises, cycles of liberalization and policy reversals, and alternative exchange rate arrangements. The Venezuelan experience reveals a nexus among domestic debt, financial repression, and external vulnerability. Unlike foreign currency-denominated debt, debt in domestic currency may be reduced through financial repression, a tax on bondholders and savers producing negative real interest rates. Using a variety of methodologies we estimate the magnitude of the tax from financial repression. On average, this financial repression tax (as a share of GDP) is similar to those of OECD economies, in spite of much higher domestic debt-to-GDP ratios in the latter. The financial repression "tax rate" is significantly higher in years of exchange controls and legislated interest rate ceilings. In line with earlier literature on capital controls, our comprehensive measures of capital flight document a link between domestic disequilibrium and a weakening of the net foreign asset position via private capital flight. We suggest these findings are not unique to the Venezuelan case.
    Date: 2015–04
  5. By: Auer, Raphael; Borio, Claudio; Filardo, Andrew J
    Abstract: Greater international economic interconnectedness over recent decades has been changing inflation dynamics. This paper presents evidence that the expansion of global value chains (GVCs), ie cross-border trade in intermediate goods and services, is an important channel through which global economic slack influences domestic inflation. In particular, we document the extent to which the growth in GVCs explains the established empirical correlation between global economic slack and national inflation rates, both across countries and over time. Accounting for the role of GVCs, we also find that the conventional trade-based measures of openness used in previous studies are poor proxies for this transmission channel. The results support the hypothesis that as GVCs expand, direct and indirect competition among economies increases, making domestic inflation more sensitive to the global output gap. This can affect the trade-offs that central banks face when managing inflation.
    Keywords: global value chain; globalisation; inflation; input-ouput linkages; international inflation synchronisation; monetary policy; Phillips curve; production structure; Supply Chain
    JEL: E31 E52 E58 F02 F14 F41 F42 F62
    Date: 2017–03
  6. By: Kollmann, Robert
    Abstract: The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country's terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively.
    Keywords: international business cycle synchronization; real exchange rate; recursive preferences; terms of trade; wealth effect on labor supply
    JEL: F31 F32 F36 F41 F43
    Date: 2017–03
  7. By: Everett Grant
    Abstract: I identify new patterns in countries’ economic performance over the 2007-2014 period based on proximity through distance, trade, and finance to the US subprime mortgage and Eurozone debt crisis areas. To understand the causes of the cross-country variation, I develop an open economy model with two transmission channels that can be shocked separately: international trade and finance. The model is the first to include a government and heterogeneous firms that can default independently of one another and has a novel endogenous cost of sovereign default. I calibrate the model to the average experiences of countries near to and far from the crisis areas. Using these calibrations, disturbances on the order of those observed during the late 2000s are separately applied to each channel to study transmission. The results suggest credit disruption as the primary contagion driver, rather than the trade channel. Given the substantial degree of financial contagion, I run a series of counterfactuals studying the efficacy of capital controls and find that they would be a useful tool for preventing similarly severe contagion in the future, so long as there is not capital immobility to the degree that the local sovereign can default without suffering capital flight. JEL Classification: E32, F40, F41, F44, H63
    Keywords: Economic crises, contagion, endogenous costs of default, sovereign default, banking crisis, Great Recession, Eurozone debt crisis
    Date: 2016–11
  8. By: Eduardo Levy Yeyati; Jimena Zuniga
    Abstract: Capital flows have been the subject of key policy concern since the Brady plan launched the emerging markets asset class. Their massive volume, coupled with their volatile and procyclical nature, is often associated with a variety of financial and real risks: excess exchange rate volatility (gradual overvaluation and sharp corrections), dollar liquidity crunches, distressed asset sales, and crisis propensity. These risks have changed over time. Emerging market crises in the 1990s and 2000s were inherently driven by financial dollarization and balance sheet effects, the latter were intimately related with capital inflows in the form of growing foreign liability positions. But, now that financial dollarization has receded in the emerging market word (either through debt deleveraging or international reserve accumulation), the focus shifted to the macroeconomic effects of cross market flows, including extended periods of exchange rate misalignment and the amplification of business cycles in a context of large and persistent terms-of-trade shocks and global liquidity swings. Hence, the difficulty of evaluating capital flows based on data mostly from the 1990s and early 2000s. Hence, also, the emphasis on the recent empirical literature that revisits the issue with fresh data and an open mind. Capital flows cannot be addressed indistinctly or in isolation. Increasingly, academics and practitioners have flagged that different types of capital flows display different behaviors. Conventional wisdom tends to assume that, within portfolio flows, fixed income assets (bonds) are more harmful than equity in that they may introduce currency imbalances that may create deleterious balance sheet effects in the event of sharp exchange rate depreciation. By the same token, it is usually assumed that portfolio flows (including equity securities) are more volatile than foreign direct investment (FDI), because the latter is "sunk" in illiquid instruments that, precisely because of their illiquidity, are not prone to react to speculative motives or short-lived financial distress. However, even this simple order of riskiness deserves some reassessment. Within debt liabilities, a distinction needs to be made between foreign and local currency denominated instruments, at a time when foreign-currency instruments still dominate local-currency ones as emerging market investments; duration is another critical aspect to consider. Is equity "safer" than a long domestic currency bond from a macro prudential perspective?
    Date: 2015–05
  9. By: Eduardo Levy Yeyati; Federico Sturzenegger
    Abstract: Levy Yeyati and Sturzenegger (2001, 2003, 2005) proposed an exchange rate regime classification based on cluster analysis to group countries according to the relative volatility of exchange rates and reserves, thereby shifting the focus from a de jure to de facto approach in the empirical analysis of exchange rate policy. This note extends the classification through 2014 and broadens the country sample, increasing the number of classified country-year observations from 3335 to 5616. Based on this extension, the note documents the main stylized facts in the 2000s, including the behavior of exchange rate policy around the global financial crisis, and the prevalence of floating regimes.
    JEL: F30 F33
    Date: 2016–06
  10. By: Timo Baas; Ansgar Belke
    Abstract: Member countries of the European Monetary Union (EMU) initiated wide-ranging labor market reforms in the last decade. This process is ongoing as countries that are faced with serious labor market imbalances perceive reforms as the fastest way to restore competitiveness within a currency union. Among observers, however,there are fears about a beggar-thy-neighbor policy that leaves non-reforming countries with a loss in competitiveness and an increase in foreign debt. By analyzing the impact of reforms on foreign debt, we contribute to the debate on whether labor market reforms increase or reduce current account imbalances. Using a two-country, two-sector search and matching DSGE model, we analyze the impact of labor market reforms on the transmission of macroeconomic shocks in both, non-reforming and reforming countries.In the case of a positive technology shock hitting a reforming country with the characteristics of a typical EMU member, fears about a beggar-thy-neighbor cannot be corroborated by us for the specic bundle of reforms considered. The positive effect of a reduction in the replacement rate more than compensates negative spillovers from increases in matching ef- ciency and a decrease in vacancy posting costs. This does not hold for a negative productivity shock in the non-reforming country, as the second reform measure, a reduction in vacancy posting costs in the tradable sectors,is dominating the overall impact of labor market reforms and, thus, increasing the foreign debt of the non-reforming country.
    Keywords: Eurozone, Business cycles, Labor market issues
    Date: 2015–07–01
  11. By: Vahagn Galstyan (Trinity College Dublin); Caroline Mehigan (OECD); Rogelio Mercado (Northumbria University)
    Abstract: In this paper, we empirically assess the importance of gravity-type variables and measures of macroeconomic and financial volatilities in explaining portfolio holdings denominated across the main global currencies: US dollar (USD), euro (EUR), Pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF). Our findings underscore the importance of trade ties and common membership euro area. We also find that international positions co-move with the level of macroeconomic and financial uncertainty. Importantly, we identify heterogeneous patterns at a currency level.
    Keywords: currency composition, international portfolio assets, trade, volatility
    JEL: F31 F36 F41 G15
    Date: 2017–03
  12. By: Gregory De Walque (NBB, Economics and Research Department); Thomas Lejeune (NBB, Economics and Research Department); Yuliya Rychalovska (University of Namur); Rafael Wouters (NBB, Economics and Research Department)
    Abstract: We develop a two-country New Keynesian model with sticky local currency pricing,distribution costs and a demand elasticity increasing with the relative price. These features help to reduce the exchange rate pass-through to import price at the border and down the chain towards consumption price, both in the short and the long run. Oil and imported goods enter at the same time as inputs in the production process and as consumption components. The model is estimated using Bayesian full information maximum likelihood techniques and based on real and nominal macroeconomic series for the euro area and the United States together with the bilateral exchange rate and oil prices. The estimated model is shown to perform well in an out-of-sample forecasting exercise and is able to reproduce most of the cross-series co-variances observed in the data. It is then used for forecast error variance decomposition and historical decomposition exercises.
    Keywords: Open-economy macroeconomics, DSGE models, exchange-rate pass through, Bayesian inference, forecasting, policy analysis
    JEL: C11 E32 E37 F41
    Date: 2017–03
  13. By: Kim, Kyunghun (Korea Institute for International Economic Policy)
    Abstract: This paper examines the international transmission of the US monetary policy surprises. The US monetary policy surprises are defined by the gap between the actual fed fund rate and its forecast estimated a quarter ahead. The US monetary policy surprises are used as external shocks to investigate the spillover effects of policy uncertainty on other economies and address the endogeneity problem. The US is the base country where the monetary policy uncertainty shocks take place. I construct the each country's international linkages such as the equity market and debt market linkages vis-à-vis the epicenter, US to investigate how the shocks are transmitted to other countries through those linkages. The empirical result shows that the equity market integration is associated with the business cycle divergence and the debt market integration is associated with the business cycle co-movement when the US policy uncertainty index is low. However, the equity market integration is associated with the business cycle comovement and the debt market integration plays insignificant role in transmitting the monetary policy surprises when the US policy uncertainty index is high.
    Keywords: Business Cycle Co-Movement; Spillover; Monetary Policy; Global Financial Market; Capital Control
    JEL: E52 F33 F42 F44
    Date: 2016–07–29

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