nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒07‒23
seven papers chosen by
Martin Berka
University of Auckland

  1. Step away from the zero lower bound: small open economies in a world of secular stagnation By Corsetti, Giancarlo; Mavroeidi, Eleonora; Thwaites, Gregory; Wolf, Martin
  2. Shocks versus structure: explaining differences in exchange rate pass-through across countries and time By Forbes, Kristin; Hjortsoe, Ida; Nenova, Tsvetelina
  3. The Macroeconomic Effects of Trade Tariffs; Revisiting the Lerner Symmetry Result By Jesper Lindé; Andrea Pescatori
  4. Effects of commodity price shocks on inflation: A cross-country analysis By Atsushi Sekine; Takayuki Tsuruga
  5. Aggregate Demand Externalities in a Global Liquidity Trap By Luca Fornaro
  6. The Exchange Rate as an Instrument of Monetary Policy By Heipertz, Jonas; Mihov, Ilian; Santacreu, Ana Maria
  7. The Effects of Government Spending on Real Exchange Rates: Evidence from Military Spending Panel Data By Viacheslav Sheremirov; Thuy Lan Nguyen; Wataru Miyamoto

  1. By: Corsetti, Giancarlo (Cambridge University); Mavroeidi, Eleonora (Bank of England); Thwaites, Gregory (Bank of England); Wolf, Martin (University of Bonn)
    Abstract: We study how small open economies can escape from deflation and unemployment in a situation where the world economy is permanently depressed. Building on the framework of Eggertsson et al (2016), we show that the transition to full employment and at-target inflation requires real and nominal depreciation of the exchange rate. However, because of adverse income and valuation effects from real depreciation, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that as long as the economy remains financially open, domestic asset supply policies or reducing the effective lower bound on policy rates may be ineffective or even counterproductive. However, closing domestic capital markets does not necessarily enhance the monetary authorities’ ability to rescue the economy from stagnation.
    Keywords: Small open economy; secular stagnation; capital controls; optimal policy; zero lower bound
    JEL: E62 F41
    Date: 2017–07–17
  2. By: Forbes, Kristin (Bank of England); Hjortsoe, Ida (Bank of England); Nenova, Tsvetelina (Bank of England)
    Abstract: We show that exchange rate pass-through to consumer prices varies not only across countries, but also over time. Previous literature has highlighted the role of an economy’s ‘structure’ — such as its inflation volatility, inflation rate, use of foreign currency invoicing, and openness — in explaining these variations in pass-through. We use a sample of 26 advanced and emerging economies to show which of these structural variables are significant in explaining not only differences in pass-through across countries, but also over time. The ‘shocks’ leading to exchange rate movements can also explain variations in pass‑through over time. For example, exchange rate movements caused by monetary policy shocks consistently correspond to significantly higher estimates of pass-through than those caused by demand shocks. The role of ‘shocks’ in driving pass-through over time can be as large as that of structural variables, and even larger for some countries. As a result, forecasts predicting how a given exchange rate movement will impact inflation at a specific point in time should take into account not just an economy’s ‘structure’, but also the ‘shocks’.
    Keywords: Pass-through; exchange rate; price level; inflation; monetary policy
    JEL: E31 E37 E52 F47
    Date: 2017–07–10
  3. By: Jesper Lindé; Andrea Pescatori
    Abstract: We study the robustness of the Lerner symmetry result in an open economy New Keynesian model with price rigidities. While the Lerner symmetry result of no real effects of a combined import tariff and export subsidy holds up approximately for a number of alternative assumptions, we obtain quantitatively important long-term deviations under complete international asset markets. Direct pass-through of tariffs and subsidies to prices and slow exchange rate adjustment can also generate significant short-term deviations from Lerner. Finally, we quantify the macroeconomic costs of a trade war and find that they can be substantial, with permanently lower income and trade volumes. However, a fully symmetric retaliation to a unilaterally imposed border adjustment tax can prevent any real or nominal effects.
    Date: 2017–07–07
  4. By: Atsushi Sekine; Takayuki Tsuruga
    Abstract: Since the 2000s, large fluctuations in commodity prices have become a concern among policymakers regarding price stability. This paper investigates the effects of commodity price shocks on headline inflation with a monthly panel consisting of 144 countries. We find that the effects of commodity price shocks on inflation virtually disappear within about one year after the shock. While the effect on the level of consumer prices varies across countries, this transitory effect is fairly robust, suggesting a low risk of a persistent second-round effect on inflation. Employing the smooth transition autoregressive models that use past inflation as the transition variable, we also explore the possibility that the effect of commodity price shocks could be persistent, depending on inflation regimes. In this specification, commodity price shocks may not have transitory effects when a country’s currency is pegged to the U.S. dollar. However, the effect remains transitory in countries with exchange-rate flexibility.
    Keywords: Commodity prices, inflation, pass-through, local projections, smooth transition autoregressive models
    JEL: E31 E37 Q43
    Date: 2017–07
  5. By: Luca Fornaro (CREI and Universitat Pompeu Fabra)
    Abstract: A recent literature has suggested that macroprudential policies can act as second-best stabilization tools when monetary policy is constrained by the zero lower bound. In this paper we show that, once their international dimension is taken into account, macroprudential policies can backfire. We provide a tractable multi-country framework of an imperfectly financially integrated world, in which equilibrium interest rates are low and monetary policy is occasionally constrained by the zero lower bound. Idiosyncratic shocks generate capital flows and asymmetric liquidity traps across countries. Due to a domestic aggregate demand externality, it is optimal for governments to implement countercyclical macroprudential policies, taxing borrowing in good times, as a precaution against the risk of a future liquidity trap triggered by a negative shock. The key insight of the paper is that this policy is inefficient from a global perspective, because it depresses global rates and deepens the recession in the countries currently stuck in a liquidity trap. This international aggregate demand externality points toward the need for international cooperation in the design of financial market interventions. Indeed, under the cooperative optimal financial policy countries internalize the fact that a stronger demand for borrowing and consumption from countries at full employment sustains global rates, reducing the recession in liquidity trap economies.
    Date: 2017
  6. By: Heipertz, Jonas; Mihov, Ilian; Santacreu, Ana Maria
    Abstract: Most of the theoretical research in small open economies has typically focused on corner solutions regarding the exchange rate: either the currency rate is fixed by the central bank or it is left to be freely determined by market forces. We build an open-economy model with external habits in consumption to study the properties of a new class of monetary policy rules, in which the exchange rate serves as the instrument for stabilizing business cycle fluctuations. Instead of using a short-term interest rate, the monetary authority announces a path for currency appreciation or depreciation as a reaction to fluctuations in inflation and the output gap. We find that, under a wide range of modeling assumptions, the exchange rate rule outperforms a standard Taylor rule in terms of stabilizing both output and inflation. The reduction in volatility is more pronounced for more open economies and for economies with lower sensitivity to movements in the interest rate. We show that differences between the two rules are driven by two key factors: (i) paths of the nominal exchange rate and the interest rate under each rule, and (ii) the time variation in the risk premium, which leads to deviations from uncovered interest parity.
    Keywords: Exchange rate management; External habit; monetary policy rules; Risk premium
    JEL: E52 F31 F41
    Date: 2017–07
  7. By: Viacheslav Sheremirov (Federal Reserve Bank of Boston); Thuy Lan Nguyen (Santa Clara University); Wataru Miyamoto (Bank of Canada)
    Abstract: Using panel data on military spending for 125 countries, we document new facts about the effects of changes in government purchases on the real exchange rate, consumption, and current accounts in both advanced and developing countries. While an increase in government purchases causes real exchange rates to appreciate and increases consumption significantly in developing countries, it causes real exchange rates to depreciate and decreases consumption in advanced countries. The current account deteriorates in both groups of countries. These findings are not consistent with standard international business-cycle models. We propose potential sources of the differences between advanced and developing countries in the responses to spending shocks.
    Date: 2017

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