nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒09‒10
nine papers chosen by
Martin Berka
University of Auckland

  1. A Note on Risk Sharing versus Instability in International Financial Integration: When Obstfeld Meets Stiglitz By Raouf Boucekkine; Benteng Zou
  2. Global banking and the conduct of macroprudential policy in a monetary union By Jean-Christophe Poutineau; Gauthier Vermandel
  3. Quality Pricing-to-Market By Raphael Auer; Thomas Chaney; Philip Sauré
  4. Dealing with time-inconsistency: Inflation targeting vs. exchange rate targeting By J. Scott Davis; Ippei Fujiwara; Jiao Wang
  5. Cross-border Exchange and Sharing of Generation Reserve Capacity By Baldursson, Fridrik M; Lazarczyk, Ewa; Ovaere, Marten; Proost, Stef
  6. Effects of capital controls on foreign exchange liquidity By Carlos Cantú
  7. The Eurozone Convergence through Crises and Structural Changes By Merih Uctum; Remzi Uctum; Chu-Ping C. Vijverberg
  8. Fixed on Flexible Rethinking Exchange Rate Regimes after the Great Recession By Corsetti, G.; Kuester, K; Müller, G. J.
  9. How Important is the Global Financial Cycle? Evidence from Capital Flows By Eugenio Cerutti; Stijn Claessens; Andrew K. Rose

  1. By: Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille, IMéRA - Institute for Advanced Studies - Aix-Marseille University); Benteng Zou (CREA - Center for Research in Economic Analysis - - Université du Luxembourg)
    Abstract: International risk sharing is one of the main arguments in favor of financial liberalization. The pure risk sharing mechanism highlighted by Obstfeld (1994) implies that liberalization is growth enhancing for all countries as it allows the world portfolio to shift from safe low-yield capital to riskier high yield capital. This result is obtained under the assumption that the volatility figures for risky assets prevailing under autarky are not altered after liberalization. This note relaxes this assumption within the standard two-country model with intertemporal portfolio choices, formally incorporating the instability effect invoked by Stiglitz (2000). We show that putting together the pure risk sharing and instability effects in the latter set-up enriches the analysis and delivers predictions more consistent with the contrasted related empirical literature.
    Keywords: optimal growth,financial liberalization,risk sharing,volatility
    Date: 2017–08
  2. By: Jean-Christophe Poutineau (CREM - Centre de Recherche en Economie et Management - UNICAEN - Université Caen Normandie - UR1 - Université de Rennes 1 - CNRS - Centre National de la Recherche Scientifique); Gauthier Vermandel (LEDa - Laboratoire d'Economie de Dauphine - Université Paris-Dauphine)
    Abstract: This paper questions the role of cross-border lending in the definition of national macroprudential policies in the European Monetary Union. We build and estimate a two-country DSGE model with corporate and interbank cross-border loans, Core-Periphery diverging financial cycles and a national implementation of coordinated macroprudential measures based on Countercyclical Capital Buffers. We get three main results. First, targeting a national credit-to-GDP ratio should be favored to federal averages as this rule induces better stabilizing performances in front of important divergences in credit cycles between core and peripheral countries. Second, policies reacting to the evolution of national credit supply should be favored as the transmission channel of macroprudential policy directly impacts the marginal cost of loan production and, by so, financial intermediaries. Third, the interest of lifting up macroprudential policymaking to the supra-national level remains questionable for admissible value of international lending between Eurozone countries. Indeed, national capital buffers reacting to the union-wide loan-to-GDP ratio only lead to the same stabilization results than the one obtained under the national reaction if cross-border lending reaches 45%. However, even if cross-border linkages are high enough to justify the implementation of a federal adjusted solution, the reaction to national lending conditions remains remarkably optimal.
    Keywords: Macroprudential policy, Global banking, International business cycles, Euro area
    Date: 2017
  3. By: Raphael Auer; Thomas Chaney; Philip Sauré
    Abstract: This paper analyses firm's pricing-to-market decisions in vertically differentiated industries. We first present a model featuring firms that sell goods of heterogeneous quality levels to consumers who are heterogeneous in their income and thus their marginal willingness to pay for quality increments. We derive closed-form solutions for the unique pricing game under costly international trade. The comparative statics highlight how firms' pricing-to-market decisions are shaped by the interaction of consumer income and good quality. We derive two testable predictions. First, the relative price of high qualities compared to low qualities increases with the income of the destination market. Second, the rate of cost pass-through into consumer prices falls with quality if destination market income is sufficiently high. We present evidence in support of these two predictions based on a dataset of prices, sales, and product attributes in the European car industry.
    Keywords: exchange rate pass-through, intra-industry trade, monopolistic competition, pricing-to-market, vertical differentiation
    JEL: E3 E41 F12 F4 L13
    Date: 2017–08
  4. By: J. Scott Davis; Ippei Fujiwara; Jiao Wang
    Abstract: Abandoning an objective function with multiple targets and adopting single mandate can be an effective way for a central bank to overcome the classic time-inconsistency problem. We show that the choice of a particular single mandate depends on an economy’s level of trade openness and the credibility of the central bank. We begin with reduced form empirical results which show that as central banks become less credible they are more likely to adopt a pegged exchange rate, and crucially, the tendency to peg depends on trade openness. Then in a model where the central bank displays “loose commitment” we show that as central bank credibility falls, they are more likely to adopt either an inflation target or a pegged exchange rate. A relatively closed economy would adopt an inflation target to overcome the time-inconsistency problem, but a highly open economy would prefer an exchange rate peg.
    Keywords: Time-inconsistency, Commitment, Inflation target, Exchange rate peg, Tie-one’s-hands
    JEL: E50 E30 F40
    Date: 2017–08
  5. By: Baldursson, Fridrik M (Reykjavik University); Lazarczyk, Ewa (University of Reykjavik); Ovaere, Marten (KU Leuven); Proost, Stef (KU Leuven)
    Abstract: This paper develops a stylized model of cross-border balancing. We distinguish three degrees of cooperation: autarky, reserves exchange and reserves sharing. The model shows that TSO cooperation reduces costs. The gains of cooperation increase with cost asymmetry and decrease with correlation of real-time imbalances. Based on actual market data of reserves procurement of positive and negative automatic frequency restoration reserves in Belgium, France, Germany, the Netherlands, Portugal and Spain, we estimate the procurement cost decrease of exchange to be 160 million euro per year and of sharing to be 500 million euro per year. The model also shows that voluntary cross-border cooperation could be hard to achieve, as TSOs do not necessarily have correct incentives.
    Keywords: Cross-border balancing; Generation reserves; Multi-TSO interactions; Electricity transmission reliability
    JEL: C78 D61 L94
    Date: 2017–08–25
  6. By: Carlos Cantú
    Abstract: The literature on capital controls has focused on their use as tools to manage capital and improve macroeconomic and financial stability. However, there is a lack of analysis of their effect on foreign exchange (FX) market liquidity. In particular, technological and regulatory changes in FX markets over the past decade have had an influence on the effect of capital controls on alternative indicators of FX liquidity. In this paper, we introduce a theoretical model showing that, if capital controls are modelled as entry costs, then fewer investors will enter an economy. This will reduce the market's ability to accommodate large order flows without a significant change in the exchange rate (a market depth measure of liquidity). On the other hand, if capital controls are modelled as transaction costs, they can reduce the effective spread (a cost-based measure of liquidity). Using a panel of 20 emerging market economies and a novel measure of capital account restrictiveness, we provide empirical evidence showing that capital controls can reduce cost-based measures of FX market liquidity. The results imply that capital controls are effective in reducing the implicit cost component of FX market liquidity but can also have a negative structural effect on the FX market by making it more vulnerable to order flow imbalances.
    Keywords: capital flow management policies, foreign exchange market, market liquidity, market depth
    JEL: F31 G11 G15
    Date: 2017–08
  7. By: Merih Uctum; Remzi Uctum; Chu-Ping C. Vijverberg
    Abstract: In light of several economic and financial crises and institutional changes experienced by the Eurozone countries, we examine whether the adoption of the euro led to business cycle synchronization or fostered convergence of growth rates. Controlling for reverse causality, we conduct multiple endogenous break tests and find that while output growth was synchronized for some countries, convergence occurred in a nonlinear way for others: (i) convergence was not triggered by adoption of the euro but by international or idiosyncratic shocks; (ii) in several countries convergence started long before the introduction of the euro, accelerated during the 1990s and continued since then, reflecting persistent influence of the core countries; (iii) convergence has been prevalent among the non-Eurozone economies in our sample.
    Keywords: Convergence, business cycle synchronization, euro, crises, structural breaks.
    JEL: E3 F4
    Date: 2017
  8. By: Corsetti, G.; Kuester, K; Müller, G. J.
    Abstract: The zero lower bound problem during the Great Recession has exposed the limits of monetary autonomy, prompting a re-evaluation of the relative benefits of currency pegs and monetary unions (see e.g. Cook and Devereux, 2016). We revisit this issue from the perspective of a small open economy. While a peg can be beneficial when the recession originates domestically, we show that a float dominates in the face of deflationary demand shocks abroad. When the rest of the world is in a liquidity trap, the domestic currency depreciates in nominal and real terms even in the absence of domestic monetary stimulus (if domestic rates are also at the zero lower bound) - enhancing the country's competitiveness and insulating to some extent the domestic economy from foreign deflationary pressure.
    Keywords: External shock, Great Recession, Exchange rate, Zero lower bound, Exchange rate peg, Currency union, Fiscal Multiplier, Benign coincidence
    JEL: F41 F42 E31
    Date: 2017–08–17
  9. By: Eugenio Cerutti; Stijn Claessens; Andrew K. Rose
    Abstract: This study quantifies the importance of a Global Financial Cycle (GFCy) for capital flows. We use capital flow data dis-aggregated by direction and type between 1990Q1 and 2015Q5 for 85 countries, and conventional techniques, models and metrics. Since the GFCy is an unobservable concept, we use two methods to represent it: directly observable variables in center economies often linked to it, such as the VIX, and indirect manifestations, proxied by common dynamic factors extracted from actual capital flows. Our evidence seems mostly inconsistent with a significant and conspicuous GFCy, in that both methods combined rarely explain more than a quarter of the variation in capital flows. Succinctly, most variation in capital flows does not seem to be the result of common shocks nor stem from observables in a central country like the United States.
    JEL: F32 F36 G15
    Date: 2017–08

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