nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒04‒23
eleven papers chosen by
Martin Berka
University of Auckland

  1. Monetary Policy and the Predictability of Nominal Exchange Rates By Martin Eichenbaum; Benjamin K. Johannsen; Sergio Rebelo
  2. Commodity Prices and Labour Market Dynamics in Small Open Economies By Martin Bodenstein; Gunes Kamber; C. Thoenissen
  3. Monetary Policy and Global Banking By Falk Bräuning; Victoria Ivashina
  4. Episodes of War and Peace in an Estimated Open Economy Model By Stéphane Auray; Aurélien Eyquem
  5. Fiscal spillovers in the euro area a model-based analysis By Attinasi, Maria Grazia; Lalik, Magdalena; Vetlov, Igor
  6. A Small Open Economy DSGE Model with Workers’ Remittances By Muhammad Rehman; Sajawal Khan; Zafar Hayat
  7. What Explains Current Account Surplus in Korea? By Han , Chirok; Shin , Kwanho
  8. The implications of global and domestic credit cycles for emerging market economies: measures of finance-adjusted output gaps By Grintzalis, Ioannis; Lodge, David; Manu, Ana-Simona
  9. EAGLE-FLI: A macroeconomic model of banking and financial interdependence in the euro area By Sandra Gomes; Nikola Bokan; Andrea Gerali; Massimiliano Pisani; Pascal Jacquinot
  10. The impact of oil price shocks on exchange rates: A non-linear smooth-transition approach By Alfred Haug; Syed Basher; Perry Sadorsky
  11. Testing the Presence of the Dutch Disease in Kazakhstan By Akhmetov, Almaz

  1. By: Martin Eichenbaum; Benjamin K. Johannsen; Sergio Rebelo
    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: Exchange rates and foreign exchange ; Monetary policy
    JEL: E52 F31
    Date: 2017–02
  2. By: Martin Bodenstein; Gunes Kamber; C. Thoenissen
    Abstract: We investigate the connection between commodity price shocks and unemployment in advanced resource-rich small open economies from an empirical and theoretical perspective. Shocks to commodity prices are shown to influence labour market conditions primarily through the real exchange rate. The empirical impact of commodity price shocks is obtained from estimating a panel vector autoregression; a positive price shock is found to expand the components of GDP, to cause the real exchange rate to appreciate, and to improve labour market conditions. For every one percent increase in commodity prices, our estimates suggest a one basis point decline in the unemployment rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse responses to a commodity price shock from a small open economy model with net commodity exports and search and matching frictions in the labour market to these empirical responses. As in the data, an increase in commodity prices raises consumption demand in the small open economy and induces a real appreciation. Facing higher relative prices for their goods, non-commodity producing firms post additional job vacancies, causing the number of matches between firms and workers to rise. As a result, unemployment falls, even if employment in the commodity-producing sector is negligible. For commodity price shocks, there is little difference between the standard Diamond (1982), Mortensen (1982), and Pissarides (1985) approach of modelling search and matching frictions and the alternating offer bargaining model suggested by Hall (2008).
    Keywords: Commodity prices ; Search and matching ; Unemployment
    JEL: E44 E61 F42
    Date: 2017–04–04
  3. By: Falk Bräuning; Victoria Ivashina
    Abstract: Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often denominated in different currencies. This leads to a foreign exchange (FX) exposure that banks need to hedge. If cross-currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest interest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity.
    JEL: E44 E52 F31 G21
    Date: 2017–04
  4. By: Stéphane Auray (CREST - Centre de Recherche en Économie et Statistique - INSEE - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique); Aurélien Eyquem (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - UJM - Université Jean Monnet [Saint-Etienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We analyze the effects of world wars on the macroeconomic dynamics of the U.S., France, Germany, and the UK, by means of an estimated open-economy model. The model allows wars to affect the economy through capital depreciation, sovereign default, a military draft, household preferences, and spillovers on other exogenous processes (productivity, investment, trade, policy variables). If the bulk of fluctuations during war episodes can be explained by the rise in government spending in the U.S., other factors are crucial in other countries. We also discuss the size and state-dependence of public spending multipliers, and a counterfactual welfare exercise.
    Keywords: Fluctuations, War, Trade, Taxes, Public Debt, Bayesian estimations, Multipliers, Welfare
    Date: 2017
  5. By: Attinasi, Maria Grazia; Lalik, Magdalena; Vetlov, Igor
    Abstract: The fiscal consolidation measures adopted in many euro area countries over 2010–13 reduced excessive domestic fiscal imbalances, but came at the cost of short-term output losses. This simultaneous tightening of fiscal policy raised concerns that such output losses might be exacerbated by negative spillovers from other countries. This paper presents some model-based simulations for the euro area with a view to gauge the cross-country impact of the fiscal measures adopted over 2010–13. The paper finds that the output effects of the fiscal consolidation were heterogeneous across countries, reflecting the different amounts and composition of fiscal measures adopted. We find that the trade channel is able to generate sizeable cross-border fiscal spillovers in the euro area. However, once the analysis takes into account the remaining channels (e.g. monetary policy reaction, exchange rate, and risk premium) total spillovers are estimated to be relatively small. In general, when compared to the growth fallout of domestic fiscal policies, negative fiscal spillovers do not seem to have added much to the economic growth woes of vulnerable countries. JEL Classification: E42, E32, F42, F45
    Keywords: Fiscal consolidation, macroeconomic models, policy spillovers
    Date: 2017–03
  6. By: Muhammad Rehman (State Bank of Pakistan); Sajawal Khan (State Bank of Pakistan); Zafar Hayat (State Bank of Pakistan)
    Abstract: In this paper, we develop and estimate a small open economy Dynamic Stochastic General Equilibrium (DSGE) model with an enriched specification, which enables us to include a variable of high significance for Pakistan viz. workers’ remittances. The results indicate that a positive shock to workers’ remittances help boost real growth via increased consumption and imported investment and helps ease-off the pressure on current account balance and thereby exchange rate. Too much dependence on workers’ remittances to help meet the trade deficits may potentially leave the economy in doldrums in case sizable negative shocks occur to the flow of foreign remittances. Therefore there is a need for structural reforms to help the economy out of the historical trade deficits, and decrease dependence on the workers’ remittances source to allow for a sustainable economic growth.
    Keywords: Business cycles, Workers remittances, Open economy
    JEL: E32 F24 F43
    Date: 2017–02
  7. By: Han , Chirok (Korea University); Shin , Kwanho (Korea University)
    Abstract: Some countries have persistent current account surplus, contributing to global imbalances up to a level that is worrisome. For example, Germany has been continuously experiencing current account surpluses since 2002, amounting to 8.4% of GDP in 2015. China has never experienced current account deficits since 1997, the year that data is first available. Japan's record is even longer; its consecutive current account surplus started from 1981. Recently, Korea joined this large current-account surplus club: since the currency crisis in 1997, Korea's current account balance has been continuously in the black, expanding even more in these recent years. In this paper, we present an empirical methodology that explains how current account balances are determined and by employing it, try to diagnose factors that account for Korea's current account surplus. In fact, the IMF has introduced a methodology, the External Balance Assessment (EBA: Phillips et al., 2013), to assess exchange rate and current account gaps that are defined as the difference between current levels and those consistent with fundamentals. For example, the 2016 External Sector Report, by utilizing this methodology, demonstrates that Korea's real effective exchange rate in 2015 was 4 to 12 percent undervalued than the level consistent with fundamentals. While the IMF's EBA is a state-of-the-art methodology that incorporates major studies in the literature, we feel that it has some limitations when analyzing the movements of Korea's current account balances. The method implicitly assumes that the current account surpluses of these countries will be substantially reduced by changing the exchange rate. However, the current account surpluses of Korea cannot be explained by the exchange rate alone. After the global financial crisis, despite rapid appreciation of the real effective exchange rate, Korea's current account surplus has been continuously increasing. Korea experienced a currency crisis in 1998. Since then it has experienced continuous current account surpluses. The current account surpluses just after the crisis were extremely helpful for the economy to recover from the crisis. Managing a modest level of current account surpluses has also been beneficial for the economy in preventing future crises. However, Korea's current account surplus in 2015 amounted to 7.7% of GDP, causing a concern that it may be too excessive. This exorbitant reliance on external demand can escalate political pressures from trading partners to appreciate the exchange rate. It is also argued that maintaining more balanced demand sources by giving domestic demand a greater role is essential for a sustained growth path. In this paper, we investigated underlying reasons as to why Korea's current account surpluses are widening. We found that the upward trend in Korea's current account surpluses is essentially explained by demographical changes it is currently experiencing. Moreover, we show that since Korea's population is rapidly aging, its current account surplus is expected to disappear by 2042 as it becomes one of the most aged economies in the world. In fact, demographical changes are so powerful that they explain quite successfully the trend of current account balances of other aged economies such as Japan, Germany, Italy, Finland and Greece as well. However, demographics do not explain cross-country differences in the level of current account balances, i.e. the high level of Korea's current account surpluses is mainly explained by a country fixed effect. When we add the real exchange rate as an additional explanatory variable, it is statistically significant with the right sign, but the magnitude explained by it is quite limited. For example, in order to reduce current account surplus by 1 percentage point, a whopping 12% depreciation is needed. Since other economic variables are yet included as explanatory variables, this can be considered to be the maximum estimate of the effect of the exchange rate changes. If it is true that Korea's current exchange rate is 4 to 12 percent undervalued than the level consistent with fundamentals, it is impossible to reduce Korea's current account surplus to a reasonable level by adjusting the exchange rate alone. Another possibility to reduce current account surplus is expanding fiscal policies. We find, however, that the impact of fiscal adjustments on current account surplus is even more limited. According to our estimates, reducing current account surplus by 1 percentage point requires a 5-6 percentage points increase in budget deficits (as a ratio to GDP). The above impacts of exchange rate and fiscal policy adjustments are estimated without considering the endogeneity of these policy variables. If we allow endogenous movements of these variables, the impact of exchange rate adjustment is 1.6 times larger, while that of fiscal policy decreases so that it is no longer statistically significant. When we add other economically fundamental variables such as GDP gap, oil prices, net foreign asset and so on, they contribute to explaining short run fluctuations without much improvement in explaining the trend nor country fixed effects. On the other hand, while the upward trend in Korea's current account surplus since 1997 is mainly explained by demographical changes, the current level of current account surplus, i.e. 7.7% of GDP, is placed quite above the fitted line derived by the economically fundamental variables including demographical changes. This idiosyncrasy of Korea's current account surplus seems to be related to increasing saving propensity of households especially among aged people. However, we will need further detailed analyses for more rigorous evidence to support this argument.
    Keywords: Current Account Surplus; Real Exchange Rate; Budget Surplus; Global Imbalances
    JEL: E17 E62 F32 F42
    Date: 2016–12–16
  8. By: Grintzalis, Ioannis; Lodge, David; Manu, Ana-Simona
    Abstract: We present estimates of finance-adjusted output gaps which incorporate the information on the domestic and global credit cycles for a sample of emerging market economies (EMEs). Following recent BIS research, we use a state-space representation of an HP filter augmented with a measure of the credit gap to estimate finance-adjusted output gaps. We measure the domestic and global credit gaps as the deviation of private-sector real credit growth and net capital flows to EMEs from long-term trends, using the asymmetric Band-Pass filter. Overall, we find that financial cycle information is associated with cyclical movements in output. In the current circumstances, the estimates suggest that if financing and credit conditions were to tighten, it would be associated with a moderation in activity in some EMEs. JEL Classification: C32, E32, F32
    Keywords: Domestic credit cycle, global financial cycle, output gap
    Date: 2017–03
  9. By: Sandra Gomes; Nikola Bokan; Andrea Gerali; Massimiliano Pisani; Pascal Jacquinot
    Abstract: We aim to properly assess domestic and cross-country macroeconomic effects of financial shocks. To do so, we introduce a number of new features in a model previously developed by some of the authors. which together with the full characterization of trade balance and real exchange rate dynamics and with a rich array of financial shocks – allow a detailed analysis of the transmission of financial shocks. We incorporate financial linkages in a multi-country New-Keynesian microfounded general equilibrium model of the euro area by including financial frictions and country-specific banking sectors. The model is non-linear and simulated under perfect foresight. The experiments are run in Dynare. Our results support the views that (1) the business cycles in the euro area can be driven not only by real shocks, but also by financial shocks, (2) the financial sector could amplify the transmission of (real) shocks, and (3) the financial/ banking shocks and the banking sectors can be sources of business cycle asymmetries and spillovers across countries in a monetary union.
    Keywords: Euro area (split into Germany and the rest of the euro area), Modeling: new developments, Macroeconometric modeling
    Date: 2016–07–04
  10. By: Alfred Haug; Syed Basher; Perry Sadorsky
    Abstract: This paper contributes to the literature on the effects of oil price changes for developed and emerging oil-exporting countries by looking at the effects on real exchange rates, which affect a country’s terms of trade and hence its competitiveness. In contrast to previously used Markov-switching models where the adjustment process is abrupt and in a way a “black box,” we employ smooth transition models that specify the functional form of the adjustment process and are explicit about what variables drive the process. These types of smooth transition models have been successfully used to model the time series behaviour of exchange rate movements but have not yet been used to explain how exchange rates react to changes in oil prices, as far as we know. The paper considers logistic (asymmetric) and exponential (symmetric) smooth transition adjustments of real exchange rates for six major oil exporting countries in response to three different shocks affecting oil prices: an oil supply shock, an oil-market specific demand shock, and a global economic demand shock. Preliminary results for Canada only: We detect no statistically significant non-linearities, be they asymmetric or symmetric, for the effects of oil supply shocks and oil-market specific demand shocks on the exchange rate. Instead, the effects are linear in these cases. However, global aggregate demand shocks have non-linear effects on exchange rates.
    Keywords: Canada, Brazil, Mexico, Norway, Russia, and the United Kingdom , Energy and environmental policy, Finance
    Date: 2016–07–04
  11. By: Akhmetov, Almaz
    Abstract: This paper uses Vector Autoregression (VAR) models to test the presence of the Dutch disease in Kazakhstan. It was found that tradable industries and world oil price have immediate effect on domestic currency appreciation. This in return has delayed negative impact on agricultural production and positive delayed effect on non-tradable industries. Prolonged period of low oil prices could hurt Kazakh economy if no effective policies to combat the negative effects of the Dutch disease are implemented.
    Keywords: Kazakhstan, Dutch disease, VAR
    JEL: E6 O13 O53
    Date: 2017–03–27

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