nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒04‒09
twelve papers chosen by
Martin Berka
University of Auckland

  1. Macro policy responses to natural resource windfalls and the crash in commodity prices By Frederick van der Ploeg
  2. The Currency-Plus-Commodity Basket; A Proposal for Exchange Rates in Oil-Exporting Countries to Accommodate Trade Shocks Automatically By Jeffrey Frankel
  3. Macro-financial stability under EMU By Philip R. Lane
  4. Capital controls and foreign currency denomination By Fernando Garcia-Barragan; Guangling Liu
  5. Currency wars or efficient spillovers? By Anton Korinek
  6. Exchange Rates and Trade; A Disconnect? By Daniel Leigh; Weicheng Lian; Marcos Poplawski-Ribeiro; Rachel Szymanski; Viktor Tsyrennikov; Hong Yang
  7. Effects of Consumption Taxes on Real Exchange Rates and Trade Balances By Caroline Freund; Joseph E. Gagnon
  8. Market-preserving fiscal federalism in the European Monetary Union By van Riet, Ad
  9. Cross-country fiscal policy spillovers and capital-skill complementarity in currency unions By Davoine, Thomas; Molnar, Matthias
  10. Exchange Rate Pass-Through in the Euro Area By Davor Kunovac; Mariarosaria Comunale
  11. Cross-country exposures to the Swiss franc By Agustín S. Bénétrix; Philip R. Lane
  12. Regime-dependent sovereign risk pricing during the euro crisis By Anne-Laure Delatte; Julien Fouquau; Richard Portes

  1. By: Frederick van der Ploeg
    Abstract: Policy prescriptions for managing natural resource windfalls are based on the permanent income hypothesis: none of the windfall is invested at home and saving in an intergenerational SWF is dictated by smoothing consumption across different generations. Furthermore, with Dutch disease effects the optimal response is to intertemporally smooth the real exchange rate, smooth public and private consumption, and limit sharp fluctuations in the intersectoral allocation of production factors. We show that these prescriptions need to be modified for the following reasons. First, to cope with volatile commodity prices precautionary buffers should be put in a stabilisation fund. Second, with imperfect access to capital markets the windfall must be used to curb capital scarcity, invest domestically and bring consumption forward. Third, with real wage rigidity consumption must also be brought forward to mitigate transient unemployment. Fourth, the real exchange rate has to temporarily appreciate to signal the need to invest in the domestic economy to gradually improve the ability to absorb the extra spending from the windfall. Fifth, with finite lives the timing of handing back the windfall to the private sector matters and consumption and the real exchange rate will be volatile. Finally, with nominal wage rigidity we show that a Taylor rule is a better short-run response to a crash in commodity prices than a nominal exchange rate peg.
    Keywords: Dutch disease, permanent income, volatility, capital scarcity, domestic investment, absorption constraints, overlapping generations, nominal wage rigidity
    Date: 2017–03
  2. By: Jeffrey Frankel
    Abstract: The paper proposes an exchange rate regime for oil-exporting countries. The goal is to achieve the best of both flexible and fixed exchange rates. The arrangement is designed to deliver monetary policy that counteracts rather than exacerbates the effects of swings in the oil market, while yet offering the day-to-day transparency and predictability of a currency peg. The proposal is to peg the national currency to a basket, but a basket that includes not only the currencies of major trading partners (in particular, the dollar and the euro), but also the export commodity (oil). The plan is called Currency-plus-Commodity Basket (CCB). The paper begins by fleshing out the need for an innovative arrangement that allows accommodation to trade shocks. The analysis provides evidence from six Gulf countries that periods when their currencies were “undervalued”, in the sense that the actual foreign exchange value lay below what it would have been under the CCB proposal, were periods of overheating as reflected in high inflation and of external imbalance as reflected in high balance of payments surpluses. Conversely, periods when the currencies were “overvalued,” in the sense that their foreign exchange value lay above what it would have been under CCB, featured unusually low inflation and low balance of payments. These results are suggestive of the implication that the economy would have been more stable under CCB. The last section of the paper offers a practical blueprint for detailed implementation of the proposal.
    Keywords: basket, commodities, currency, exchange rate, Gulf, oil, peg, Saudi Arabia
    JEL: F3
    Date: 2017–03
  3. By: Philip R. Lane
    Abstract: This paper examines the cyclical behaviour of country-level macro-financial variables under EMU. Monetary union strengthened the covariation pattern between the output cycle and the financial cycle, while macro-financial policies at national and area-wide levels were insufficiently counter-cyclical during the 2003-2007 boom period. We critically examine the policy reform agenda required to improve macro-financial stability. JEL Classification: E52, E65, G28
    Keywords: macroeconomic stabilisation, financial stability, international capital flows, inflation, exchange rate
    Date: 2016–02
  4. By: Fernando Garcia-Barragan; Guangling Liu
    Abstract: This paper studies the effectiveness of capital controls with foreign currency denomination and its welfare implications. To do this, we develop a general equilibrium model with financial frictions and banking, in which assets and liabilities are denominated in both domestic and foreign currencies. We propose a non-pecuniary capital-control policy that limits the gap between foreign-currency denominated loans and deposits to the amount of foreign funds that bankers can borrow from the international credit market. We show that capital controls have a critical impact on the dynamics of assets and liabilities that are denominated in foreign currency. This critical impact works through the capital control constraint on quantitative nancial variables directly, not through the spreads. The non-pecuniary capital controls help to stabilize the nancial sector and, hence, reduces the negative spillovers to the real economy. A more restrictive capital-control policy signicantly attenuates the welfare effect of the foreign monetary policy and exchange rate shocks.
    Keywords: Capital control, Foreign currency denomination, Open economy macroeconomics, Financial friction, Welfare analysis, DSGE
    JEL: E32 E44 E58 F38 F41
    Date: 2017–02
  5. By: Anton Korinek
    Abstract: In an interconnected world, national economic policies regularly lead to large international spillover effects, which frequently trigger calls for international policy cooperation. However, the premise of successful cooperation is that there is a Pareto inefficiency, i.e. if there is scope to make some nations better off without hurting others. This paper presents a first welfare theorem for open economies that defines an efficient benchmark and spells out the conditions that need to be violated to generate inefficiency and scope for cooperation. These are: (i) policymakers act competitively in the international market, (ii) policymakers have sufficient external policy instruments and (iii) international markets are free of imperfections. Our theorem holds even if each economy suffers from a wide range of domestic market imperfections and targeting problems. We provide examples of current account intervention, monetary policy, fiscal policy, macroprudential policy/capital controls, and exchange rate management and show that the resulting spillovers are Pareto efficient, but only if the three conditions are satisfied. Furthermore, we develop general guidelines for how policy cooperation can improve welfare when the conditions are violated.
    Keywords: currency wars, international spillovers, policy cooperation, first welfare theorem
    Date: 2017–03
  6. By: Daniel Leigh; Weicheng Lian; Marcos Poplawski-Ribeiro; Rachel Szymanski; Viktor Tsyrennikov; Hong Yang
    Abstract: We examine the stability and strength of the relationship between exchange rates and trade over time using three alternative approaches, mitigating the endogeneity of the relation. We find that both exchange rate pass-through and the price elasticity of trade volumes are largely stable over time. Economic slack and financial conditions affect the relationship, but there is limited evidence that participation in global value chains has significantly changed the exchange rate–trade relationship over time.
    Date: 2017–03–15
  7. By: Caroline Freund (Peterson Institute for International Economics); Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: This paper examines the effects of border-adjusted consumption taxes (mainly value added taxes or VATs) in a sample of 34 advanced economies from 1970 through 2015. We find that the real exchange rate tends to rise by the full amount of any consumption tax increase, with little effect on the current account balance and modest offsetting effects on the trade and income balances. Case studies suggest that adjustment comes initially through prices. We note that the border-adjusted cash flow tax of the House Republicans differs in important ways from consumption taxes used in our study, which raises the possibility of a slower adjustment process with temporarily larger trade effects.
    Keywords: VAT, border tax adjustment, exchange rate adjustment, current account adjustment
    JEL: F31 F32 H20
    Date: 2017–04
  8. By: van Riet, Ad
    Abstract: Responding to the euro crisis, European leaders have put in place an enhanced economic and financial governance framework for the euro area, including the main pillars of a banking union, while they have initiated work on a capital markets union. This should more effectively secure sound national macroeconomic and fiscal policies, a healthy financial sector and the stability of the euro. This paper poses the question whether the status quo of half-way political integration is sufficient to safeguard the cohesion and integrity of the euro area. National governments still have considerable leeway to circumvent the “hard” budget constraint and the strong market competition implied by the euro area’s “holy trinity” (one market, one currency and one monetary policy). For example, they might target captive sovereign debt markets or take protectionist measures. This economic nationalism would entrench the crisis-related fragmentation of the single market and frustrate the efficient functioning of the monetary union. A higher level of market-preserving fiscal federalism could prevent member countries from encroaching on markets and foster sustainable economic convergence towards an optimal currency area.
    Keywords: European Monetary Union, monetary policy trilemma, protectionism, market fragmentation, fiscal federalism
    JEL: E6 F33 F4 H7
    Date: 2015–10–30
  9. By: Davoine, Thomas (Institute for Advanced Studies (IHS) Vienna, Austria); Molnar, Matthias (Institute for Advanced Studies (IHS) Vienna, Austria)
    Abstract: We investigate cross-country fiscal policy spillovers through the integration of capital markets in a currency union and allow capital use in production to differ across countries. Following empirical evidence, we assume that production exhibits capital-skill complementarity. Using a multi-country overlapping-generations model calibrated for 14 European Union countries, we find that output spillovers are small with standard tax reforms but can be sizeable with large government spending increases financed by taxes: long run output losses in shock-free countries can amount to a quarter of the losses in countries hit by the spending shock. Conditional and temporary relaxing of the EU debt ceiling rule could benefit the Union as a whole.
    Keywords: Spillovers, Fiscal policy, Capital-skill complementarity, Multi-country modeling, Computable general equilibrium
    JEL: C68 E62 F21 F45
    Date: 2017–03
  10. By: Davor Kunovac (The Croatian National Bank, Croatia); Mariarosaria Comunale (Bank of Lithuania, Lithuania)
    Abstract: In this paper we analyse the exchange rate pass-through (ERPT) in the euro area as a whole and for four euro area members - Germany, France, Italy and Spain. For that purpose we use Bayesian VARs with identification based on a combination of zero and sign restrictions. Our results emphasize that pass-through in the euro area is not constant over time - it may depend on a composition of economic shocks governing the exchange rate. Regarding the relative importance of individual shocks, it seems that pass-through is the strongest when the exchange rate movement is triggered by (relative) monetary policy shocks and the exchange rate shocks. Our shock-dependent measure of ERPT points to a large but volatile pass-through to import prices and overall very small pass-through to consumer inflation in the euro area.
    Keywords: Exchange rate pass-through, import prices, consumer prices, inflation, bayesian vector autoregression
    JEL: E31 F3 F41
    Date: 2017–01
  11. By: Agustín S. Bénétrix; Philip R. Lane
    Abstract: "This paper first documents the foreign currency exposures of Switzerland in the 2002-2012 period. We find that the large scale of the Swiss international balance sheet means that movements in the Swiss Franc generate large cross-border valuation effects. Second, we examine the Swiss Franc holdings of the rest of the world and highlight differences in exposures between advanced and emerging economies." JEL Classification: F31, O24
    Keywords: cross-border valuation, foreign currency exposures, swiss frank, emerging economies
    Date: 2016–03
  12. By: Anne-Laure Delatte; Julien Fouquau; Richard Portes
    Abstract: Previous work has documented a greater sensitivity of long-term government bond yields to fundamentals in Euro area stress countries during the euro crisis, but we know little about the driver(s) of regimeswitches. Our estimates based on a panel smooth threshold regression model quantify and explain them: 1) investors have penalized a deterioration of fundamentals more strongly from 2010 to 2012; 2) a key indicator of regime switch is the premium of the financial credit default swap index: the higher the bank credit risk, the higher the extra premium on fundamentals; 3) after ECB President Draghi’s speech in July 2012, it took one year to restore the non-crisis regime and suppress the extra premium. JEL Classification: E44, F34, G12, H63, C23
    Keywords: European sovereign crisis, Panel Smooth Threshold Regression Models, CDS indices
    Date: 2016–05

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