nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒05‒28
ten papers chosen by
Martin Berka
University of Auckland

  1. The Distributional Consequences of Large Devaluations By Javier Cravino; Andrei A. Levchenko
  2. Exporters and Shocks By Fitzgerald, Doireann; Haller, Stephanie
  3. Foreign Exchange Intervention and the Dutch Disease By Julia Faltermeier; Ruy Lama; Juan Pablo Medina
  4. External Adjustment in Oil Exporters: The Role of Fiscal Policy and the Exchange Rate By Alberto Behar; Armand Fouejieu
  5. Resolving International Macro Puzzles with Imperfect Risk Sharing and Global Solution Methods By Jonathan J Adams; Philip Barrett
  6. Current Account Imbalances, Real Exchange Rates, and Nominal Exchange Rate Variability By Adnan Velic
  7. Real Exchange Rate and External Balance; How Important Are Price Deflators? By JaeBin Ahn; Rui Mano; Jing Zhou
  8. Thick vs. Thin-Skinned; Technology, News, and Financial Market Reaction By Barry J. Eichengreen; Romain Lafarguette; Arnaud Mehl
  9. Macroprudential Policy Coordination with International Capital Flows By William Chen; Gregory Phelan
  10. The Role of Stock-Flow Adjustment during the Global Financial Crisis By Katharina Bergant

  1. By: Javier Cravino; Andrei A. Levchenko
    Abstract: We study the impact of large exchange rate devaluations on the cost of living at different points on the income distribution. Poor households spend relatively more on tradeable product categories, and consume lower-priced varieties within categories. Changes in the relative price of tradeables and of lower-priced varieties affect the cost of living of low-income relative to high-income households. We quantify these effects following the 1994 Mexican devaluation and show that they can have large distributional consequences. Two years post-devaluation, the cost of living for the bottom income decile rose 1.48 to 1.62 times more than for the top income decile.
    JEL: F31 F61
    Date: 2017–05
  2. By: Fitzgerald, Doireann (Federal Reserve Bank of Minneapolis); Haller, Stephanie (University College Dublin)
    Abstract: We use micro data for Ireland to estimate how export participation and the export revenue of incumbent exporters respond to tariffs and real exchange rates. Both participation and revenue, but especially revenue, are more responsive to tariffs than to real exchange rates. Our estimates translate into an elasticity of aggregate exports with respect to tariffs of between -3.8 and -5.4, and with respect to real exchange rates of between 0.45 and 0.6, consistent with estimates in the literature based on aggregate data. We argue that forward-looking investment in customer base combined with the fact that tariffs are much more predictable than real exchange rates can explain why export revenue responds so much more to tariffs.
    Keywords: Tariffs; Real exchange rates; International elasticity puzzle
    JEL: F14 F41
    Date: 2017–05–18
  3. By: Julia Faltermeier; Ruy Lama; Juan Pablo Medina
    Abstract: We study the optimal foreign exchange (FX) intervention policy in response to a positive terms of trade shock and associated Dutch disease episode in a small open economy model. We find that during a Dutch disease episode tradable production drops below the socially optimal level, resulting in lower welfare under learningby- doing (LBD) externalities. FX reserves accumulation improves welfare by preventing a large appreciation of the real exchange rate and by inducing an efficient reallocation between the tradable and non-tradable sectors. For an empirically plausible parametrization of LBD externalities, the model predicts that in response to a 10 percent increase in commodity prices FX reserves should increase by 1.5 percent of GDP. We also find that the welfare gains from optimally using FX reserves are twice as high as the gains from relying only on monetary policy. These results suggest that FX intervention is a beneficial policy to counteract the loss of competitiveness during a Dutch disease episode.
    Keywords: Central banks and their policies;Foreign exchange;Dutch Disease; Learning-by-Doing Externalities; Foreign Exchange Intervention, Dutch Disease, Learning-by-Doing Externalities, Foreign Exchange Intervention, Open Economy Macroeconomics
    Date: 2017–03–27
  4. By: Alberto Behar; Armand Fouejieu
    Abstract: After the decline in oil prices, many oil exporters face the need to improve their external balances. Special characteristics of oil exporters make the exchange rate an ineffective instrument for this purpose and give fiscal policy a sizeable role. These conclusions are supported by regression analysis of the determinants of the current account balance and of the trade balance. The results show little or no relationship with the exchange rate and, especially for the less diversified oil exporters, a strong relationship with the fiscal balance or government spending.
    Keywords: Oil exporters; current account; trade balance; fiscal policy; exchange rates; trade volume elasticities; Marshall Lerner conditions
    JEL: F32 F13 F41 E62
    Date: 2017
  5. By: Jonathan J Adams (Department of Economics, University of Florida); Philip Barrett (International Monetary Fund)
    Abstract: Do gross international asset positions matter for macroeconomic outcomes? In this paper, we argue that they do. In particular, we demonstrate that asset market incompleteness which features a meaningful portfolio choice can resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates are negatively correlated. Because income and nominal exchange rates are positively correlated, countries choose a portfolio that features home bias in bond holdings, which is common in the data. We compare our findings to the predictions of alternative asset market structures frequently used in the literature - such as complete markets or restricting assets to a single bond - and show that they cannot solve the Backus-Smith puzzle without further frictions. We also show that local perturbation methods that use endogenous discount factors to stabilize the model are inaccurate, even when they correctly characterize the average portfolio holdings. Instead, we use a novel global solution method to accurately solve the portfolio problem when asset markets are incomplete, using an approach that generalizes Maliar and Maliar (2015) to solve a wide class of models.
    JEL: F30 F41
  6. By: Adnan Velic (Dublin Institute of Technology)
    Abstract: This paper analyzes the bivariate relation between large current account imbalances and the real exchange rate over different degrees of nominal exchange rate variability. Employing both linear and nonlinear panel estimation procedures, we find an inverse link between large imbalances and the real exchange rate at lower nominal exchange rate rigidity levels. This is in contrast to the often non-existent or positive comovement that materializes under regimes entailing lower nominal exchange rate variation. Our results thus suggest that greater nominal exchange rate adjustment can induce a stabilizing current account-real exchange rate relation. Along the cross-section, the most salient findings are i) the striking positive relation between current account persistence and real exchange rate persistence based on country-specific estimates and ii) the inverse correlation between persistence in either the current account or real exchange rate and nominal exchange rate volatility.
    Keywords: external imbalances, current account adjustment, real exchange rate, nominal exchange rate volatility, flexibility, persistence
    JEL: F00 F31 F32 F41
    Date: 2017–05
  7. By: JaeBin Ahn; Rui Mano; Jing Zhou
    Abstract: This paper contrasts real exchange rate (RER) measures based on different deflators (CPI, GDP deflator, and ULC) and discusses potential implications for the link—or lack thereof—between RER and external balance. We begin by documenting patterns in the evolution of different measures of RERs, and confirm that the choice of deflator plays a significant role in RER movements. A subsequent empirical investigation based on 35 developed and emerging market economies over 1995 to 2014 yields comprehensive and robust evidence that only the RER deflated by ULC exhibits contemporaneous patterns consistent with the expenditure-switching mechanism. We rationalize the empirical findings by introducing a simple model featuring nominal rigidity and trade in intermediate goods as the one in Obstfeld (2001) and Devereux and Engel (2007), which is shown to generate qualitatively identical patterns to empirical findings.
    Keywords: Foreign exchange;Real exchange rate; External balance; Expenditure switching; Deflators, Real exchange rate, External balance, Expenditure switching, Deflators, Open Economy Macroeconomics
    Date: 2017–03–30
  8. By: Barry J. Eichengreen; Romain Lafarguette; Arnaud Mehl
    Abstract: We study the impact of technology on the reaction of financial markets to information, focusing on the foreign exchange market. We contrast the “thin-skinned†view that technological improvements cause markets to react more to new information with the “thick-skinned†view that they react less. We pinpoint exogenous technological changes using the timing of the connection of countries via the submarine fiber-optic cables used for electronic trading. Cable connections dampen the response of exchange rates to macroeconomic news, consistent with the “thick-skinned†hypothesis. This is in line with the view that technology eases access to information and reduces trend-following behavior. According to our estimates, cable connections reduce the reaction of exchange rates to U.S. monetary policy news by 50 to 80 percent.
    Keywords: Western Hemisphere;United States;Technology, Submarine Fiber-Optic Cables, Foreign Exchange Market, Macro Announcements, General
    Date: 2017–04–07
  9. By: William Chen (Williams College); Gregory Phelan (Williams College)
    Abstract: We theoretically illustrate how macroprudential policy spillovers through international cap- ital flows can lead to uncoordinated policy choices that are tighter than would occur with coor- dination. We consider a symmetric two-country macro model in which countries have limited ability to issue state-contingent contracts in international markets. Accordingly, output en- dogenously depends on the relative share of wealth held by each country. Because markets are incomplete, welfare can be improved by regulating countries’ borrowing positions. Tighter macroprudential policy in country A (limiting leverage or capital inflows) stabilizes country A and endogenously increases the frequency with which A is relatively more wealthy than coun- try B. Thus, tight policy in A provides incentives for B to choose tight policy as well so that B is not poor on average relative to A. We numerically solve for the coordinated and uncoordinated equilibria when countries choose among countercyclical macroprudential policies.
    Keywords: International Capital Flows, Capital Controls, Macroeconomic Instability, Macroprudential Regulation, Policy Coordination, Spillovers, Financial Crises
    JEL: E44 F36 F38 F42 G15
    Date: 2017–05
  10. By: Katharina Bergant (Department of Economics, Trinity College Dublin)
    Abstract: While the recent contraction of current account imbalances that followed the Global Financial Crisis is well documented, we analyse the increasing divergence of the net international investment position in the post-crisis period. Decomposing the change in the international net investment position into capital flows and valuation effects we find that the increasing stock imbalances are driven by the former. However, valuation changes show a stabilizing pattern. Countries with the largest net foreign liabilities experienced the greatest valuation gains. Analysing this effect by different asset classes shows that this stabilising pattern was mainly driven by debt write-offs and a change in the value of portfolio equity. For the latter, the pro-cyclical movement of the domestic stock markets during the post-crisis period improved international risk sharing through foreign portfolio equity liabilities.
    Keywords: Financial Globalisation, Global Financial Crisis, External Adjustment, Risk Sharing;
    JEL: F32 F36 G15
    Date: 2017–05

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