nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒10‒15
sixteen papers chosen by
Martin Berka
University of Auckland

  1. Dealing with Time-inconsistency: Inflation Targeting vs. Exchange Rate Targeting By Ippei Fujiwara; Scott Davis
  2. Missing Risk Sharing from International Transmission through Product Quality and Variety By Masashige Hamano
  3. Policy Rules for Capital Controls By Gurnain Pasricha
  4. The Imact of Brexit on Foreign Investment and Production By Andrea Waddle; Ellen McGrattan
  5. Equilibrium Exchange Rates and Misalignments: The Case of Homogenous Emerging Market Economies By Christian K. Tipoy; Marthinus C. Breitenbach; Mulatu F. Zerihun
  6. Purchasing Power Parity in the 34 OECD Countries: Evidence from Quantile-Based Unit Root Tests with both Smooth and Sharp Breaks By BAHMANI-OSKOOEE, Mohsen; Wu, Tsung-Pao
  7. Sovereign Bond Prices, Haircuts and Maturity By Tamon Asonuma; Dirk Niepelt; Romain Rancière
  8. Dynamics of net foreign asset components in the EMU By Tatiana Cesaroni; Roberta De Santis
  9. Managing Capital Flows in the Presence of External Risks By Ricardo M. Reyes-Heroles; Gabriel Tenorio
  10. A Macroeconomic Model with Occasional Financial Crises By Paul, Pascal
  11. International credit supply shocks By Cesa-Bianchi, Ambrogio; Ferrero, Andrea; Rebucci, Alessandro
  12. External Imbalances, Gross Capital Flows and Sovereign Debt Crises By Sergio de Ferra
  13. The German current account surplus: where does it come from, is it harmful and should Germany do something about it? By Gabriel Felbermayr; Clemens Fuest; Timo Wollmershäuser
  14. The Future of Eurozone Fiscal Governance By Anne-Laure Delatte; Clemens Fuest; Daniel Gros; Friedrich Heinemann; Martin Kocher; Roberto Tamborini
  15. Real Exchange Rate Policies for Economic Development By Martin Guzman; Jose Antonio Ocampo; Joseph E. Stiglitz
  16. The International Credit Channel of U.S. Monetary Policy and Financial Shocks By Andrej Sokol; Ambrogio Cesa-Bianchi

  1. By: Ippei Fujiwara (Keio University / ANU); Scott Davis (Federal Reserve Bank of Dallas)
    Abstract: Abandoning an objective function with multiple targets and adopting a single mandate is 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 a country's level of trade openness. Both inflation targeting and nominal exchange rate targeting come with their own costs. We show that the costs of inflation targeting are increasing in a country's level of trade openness while the costs of exchange rate targeting are decreasing in trade openness. Thus a relatively closed economy will prefer an inflation targeting mandate and a very open economy will prefer an exchange rate target. Empirical results show that as central banks become less credible they are more likely to adopt a pegged exchange rate, and crucially the empirical link between central bank credibility and the tendency to peg depends on trade openness.
    Date: 2017
  2. By: Masashige Hamano (Waseda University, Tokyo and CREA, Université du Luxembourg)
    Abstract: This paper explores the role played by product quality and variety in interna- tional consumption risk sharing. Turnover in product quality and variety can cause a wealth effect. A reasonable Backus-Smith correlation is driven by the Harrod- Balassa-Samuelson mechanism based on heterogeneous firms. Using panel data, we test the prediction of the theoretical model and find a supportive evidence for a resolution to the Backus-Smith puzzle. The extent of \missing risk sharing" due to unobservable fluctuations in quality and the number of varieties is high in the data.
    Keywords: exchange rate, consumption-real exchange rate anomaly, product quality, firm heterogeneity
    JEL: F12 F41 F43
    Date: 2017
  3. By: Gurnain Pasricha
    Abstract: This paper attempts to borrow the tradition of estimating policy reaction functions in monetary policy literature and apply it to capital controls policy literature. Using a novel weekly dataset on capital controls policy actions in 21 emerging economies over the period 1 January 2001 to 31 December 2015, I examine the mercantilist and macroprudential motivations for capital control policies. I introduce a new proxy for mercantilist motivations: the weighted appreciation of an emerging-market currency against its top five trade competitors. There is clear evidence that past emerging-market policy systematically responds to both mercantilist and macroprudential motivations. The choice of instruments is also systematic: policy-makers respond to mercantilist concerns by using both instruments — inflow tightening and outflow easing. They use only inflow tightening in response to macroprudential concerns. I also find that policy is acyclical to foreign debt but is countercyclical to domestic bank credit to the private non-financial sector. The adoption of explicit financial stability mandates by central banks or the creation of inter-agency financial stability councils increased the weight of macroprudential factors in the use of capital controls policies. Countries with higher exchange rate pass-through to export prices are more responsive to mercantilist concerns.
    Keywords: Exchange rate regimes, Financial stability, Financial system regulation and policies, International topics
    JEL: F3 F4 F5 G0 G1
    Date: 2017
  4. By: Andrea Waddle (University of Richmond); Ellen McGrattan (University of Minnesota)
    Abstract: In this paper, we estimate the impact of increasing costs on foreign producers following a withdrawal of the United Kingdom from the European Union (popularly known as Brexit). Our predictions are based on simulations of a multicountry neoclassical growth model that includes multinational firms investing in research and development (R&D), brands, and other intangible capital that is used nonrivalrously by their subsidiaries at home and abroad. We analyze several post-Brexit scenarios. First, we assume that the United Kingdom unilaterally imposes tighter restrictions on foreign direct investment (FDI) from other E.U. nations. With less E.U. technology deployed in the United Kingdom, U.K. firms increase investment in their own R&D and other intangibles, which is costly, and welfare for U.K. citizens is lower. If the European Union remains open, its citizens enjoy a modest gain from the increased U.K. investment since it can be costlessly deployed in subsidiaries throughout Europe. If instead we assume that the European Union imposes the same restrictions on U.K. FDI, then E.U. firms invest more in their own R&D, benefiting the United Kingdom. With costs higher on both U.K. and E.U. FDI, we predict a significant fall in foreign investment and production by U.K. firms. The United Kingdom increases international lending, which finances the production of others both domestically and abroad, and inward FDI rises. U.K. consumption falls and leisure rises, implying a negligible impact on welfare. In the European Union, declines in investment and production are modest, but the welfare of E.U. citizens is significantly lower. Finally, if, during the transition, the United Kingdom reduces current restrictions on other major foreign investors, such as the United States and Japan, U.K. inward FDI and welfare both rise significantly.
    Date: 2017
  5. By: Christian K. Tipoy (Department of Economics, University of Pretoria, South Africa and School of Accounting, Economics and Finance, University of KwaZulu-Natal, South Africa); Marthinus C. Breitenbach (Department of Economics, University of Pretoria, Pretoria, South Africa); Mulatu F. Zerihun (Department of Economics, Tshwane University of Technology, South Africa)
    Abstract: We compute the exchange rate misalignment for a set of emerging economies between 1980 and 2013 using the behavioural equilibrium exchange rate definition. The real equilibrium exchange rate is constructed using a parsimonious model and estimators that are robust to cross-sectional independence and small sample size bias. We find that these countries tend to intervene to avoid real appreciation of their currencies following a rise in relative productivity, casting doubt on the Balassa-Samuelson effect. East-Asian countries have maintained their currencies at an artificially low level in order to remain competitive and boost economic growth these past years. Length: 26 pages
    Keywords: equilibrium exchange rate, panel cointegration, autoregressive distributed lag
    JEL: F31 C23
    Date: 2017–10
  6. By: BAHMANI-OSKOOEE, Mohsen; Wu, Tsung-Pao
    Abstract: Conventional unit root tests have mostly failed to validate the PPP. Quantile-based unit root test by previous research have provided some support for the PPP. In this paper we take an additional step and incorporate sharp shifts and smooth breaks into the quantile-based unit root test and re-examine the PPP in each of the 34 OECD countries over the period 1994M01 to 2016M03. We find support for the PPP in 18 countries of Austria, Chile, Estonia, Finland, France, Germany, Italy, Korea, Mexico, Netherlands, New Zealand, Poland, Portugal, Slovenia, Sweden, Switzerland, Turkey, and the United Kingdom.
    Keywords: Purchasing Power Parity; OECD Countries; Quantile Unit Root Test; Sharp Shifts; Smooth breaks.
    JEL: F3 F31
    Date: 2017–01–05
  7. By: Tamon Asonuma; Dirk Niepelt; Romain Rancière
    Abstract: Rejecting a common assumption in the sovereign debt literature, we document that creditor losses ("haircuts") during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999-2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.
    JEL: F34 F41 H63
    Date: 2017–09
  8. By: Tatiana Cesaroni; Roberta De Santis
    Abstract: In the last two decades, foreign capital investments have followed different paths in EMU countries. Given their importance for growth and productivity, we analyse the factors underlying the dynamics of foreign direct investments, portfolio debt investments, and portfolio equity investments in EMU countries over the years 1996-2014. We assess how the heterogeneous behavior between core and peripheral countries can be related to macroeconomic factors (business cycle, trade, financial openness and spreads) and institutional quality. Our results show that financial integration as well as interest rates spread had an impact on the main components of foreign assets which was different between core and peripheral countries. In EMU countries as a whole we find a statistical significant relationship between institutional quality and foreign capital components, which is entirely driven by core countries.
    Keywords: Net international investment positions, PEI, FDI and PDI, Institutional quality, Euro area
    JEL: F3 F4
    Date: 2017–09
  9. By: Ricardo M. Reyes-Heroles; Gabriel Tenorio
    Abstract: We introduce external risks, in the form of shocks to the level and volatility of world interest rates, into a small open economy model subject to the risk of sudden stops—large recessions together with abrupt reversals in capital inflows| and characterize optimal macroprudential policy in response to these shocks. In the model, collateral constraints create a pecuniary externality that leads to "overborrowing" and sudden stops that arise when the constraints bind. The typical sudden stop generated by the model replicates existing empirical evidence for emerging market economies: Low and stable external interest rates reinforce "overborrowing" and lead to greater exposure to crises typically accompanied by abrupt increases in interest rates and a persistent rise in their volatility. We solve for the optimal policy and argue that the size of a tax on international borrowing that implements the policy depends on two factors, the incidence and the severity of potential future crises. We show quantitatively that these taxes respond to both the level and volatility of interest rates even though optimal decisions in the competitive equilibrium do not respond substantially to changes in volatility, and that the size of the optimal tax is non-monotonic with respect to external shocks.
    Keywords: Macroprudential policy ; time-varying volatility ; sudden stops ; financial crises ; external interest rates
    JEL: E3 E6 F3 F4 G1 G2
    Date: 2017–09
  10. By: Paul, Pascal (Federal Reserve Bank of San Francisco)
    Abstract: Financial crises are born out of prolonged credit booms and depressed productivity. At times, they are initiated by relatively small shocks. Consistent with these empirical observations, this paper extends a standard macroeconomic model to include financial intermediation, long-term defaultable loans, and occasional financial crises. Within this framework, crises are typically preceded by prolonged boom periods. During such episodes, intermediaries expand their lending and leverage, thereby building up financial fragility. Crises are generally initiated by a moderate adverse shock that puts pressure on intermediaries’ balance sheets, triggering a creditor run, a contraction in new lending, and ultimately a deep and persistent recession.
    JEL: E32 E44 E52 G01 G21
    Date: 2017–09–25
  11. By: Cesa-Bianchi, Ambrogio (Bank of England); Ferrero, Andrea (University of Oxford); Rebucci, Alessandro (John Hopkins University Carey Business School)
    Abstract: House prices and exchange rates can potentially amplify the expansionary effect of capital inflows by inflating the value of collateral. We first set up a model of collateralized borrowing in domestic and foreign currency with international financial intermediation in which a change in leverage of global intermediaries leads to an international credit supply increase. In this environment, we illustrate how house price increases and exchange rates appreciations contribute to fuelling the boom by inflating the value of collateral. We then document empirically, in a Panel VAR model for 50 advanced and emerging countries estimated with quarterly data from 1985 to 2012, that an increase in the leverage of US Broker-Dealers also leads to an increase in cross-border credit flows, a house price and consumption boom, a real exchange rate appreciation and a current account deterioration consistent with the transmission in the model. Finally, we study the sensitivity of the consumption and asset price response to such a shock and show that country differences are associated with the level of the maximum loan-to-value ratio and the share of foreign currency denominated credit.
    Keywords: Cross-border claims; capital flows; credit supply shock; leverage; exchange rates; house prices; international financial intermediation
    JEL: C32 E44 F44
    Date: 2017–10–06
  12. By: Sergio de Ferra (Stockholm University)
    Abstract: The experience of the European monetary union has been characterized by three distinctive facts. First, core and periphery countries ran widening current account surplus and deficit positions, after the inception of the union. Second, core countries intermediated gross capital flows from the rest of the world, which in turn financed deficits in the periphery. Finally, a sovereign debt crisis took place, affecting multiple countries and causing severe recessions. I argue that institutional features of the European Economic and Monetary Union are responsible for the observation of imbalances, intermediation and pervasive crises. First, I show in a theoretical model that subsidies on holdings of euro-denominated assets contribute to all three phenomena. Second, I build a dynamic model of an economic union with trade in goods and financial assets. In the model, the introduction of a subsidy on cross-border asset holdings generates predictions for net and gross asset flows that quantitatively replicate the euro area experience. The model features a novel theoretical mechanism magnifying the severity of a debt crisis in an economic union, due to the joint presence of financial and trade linkages among union members. This mechanism is likely to have exacerbated the recent recession in the euro area periphery.
    Date: 2017
  13. By: Gabriel Felbermayr; Clemens Fuest; Timo Wollmershäuser
    Abstract: In the international economic policy debate Germany is criticized heavily for its current account surplus. This paper describes the factors that have led to the surplus and discusses the policy implications. The current account surplus is mainly a result of higher savings, driven by an ageing population. The claim that the German surplus causes economic damage either in Germany or in other countries is not well founded. But Germany faces growing political pressures related to the threat of protectionism, the risk that a growing creditor position may lead to political backlash, and the fact that European Macroeconomic Imbalances Procedures imply that current account surpluses should not exceed six percent of GDP. To reduce the surplus Germany should focus on a corporate tax reform to boost private investment.
    Date: 2017
  14. By: Anne-Laure Delatte; Clemens Fuest; Daniel Gros; Friedrich Heinemann; Martin Kocher; Roberto Tamborini
    Abstract: This paper discusses various options for reforming fiscal governance in the Eurozone. We focus on two possible reform approaches referred to as the ‘Maastricht model’ and the ‘US model’. The Maastricht model implies that ultimate responsibility for economic and fiscal policy remains at the national level. The US model, by contrast, calls for the development of much stronger European institutions. In both cases some degree of policy coordination, a European Banking Union and insolvency procedures for sovereigns are indispensable. We discuss the challenges and trade-offs involved and argue that certain elements of the two approaches which combine increased risk sharing with increased market discipline and risk reduction could be combined to achieve a more resilient and economically successful Eurozone.
    Date: 2017
  15. By: Martin Guzman; Jose Antonio Ocampo; Joseph E. Stiglitz
    Abstract: This paper analyzes the role of real exchange rate (RER) policies in promoting economic development. Markets provide a suboptimal amount of investment in sectors characterized by learning spillovers. We show that a stable and competitive RER policy may correct for this externality and other related market failures. The resulting development of these sectors leads to overall faster economic growth. A system of effectively multiple exchange rates is required when spillovers across different tradable sectors differ. The impact of RER policies is increased when they are complemented by traditional industrial policies that increase the elasticity of the aggregate supply to the RER. Among the instruments required to implement a stable and competitive RER are interventions in the foreign exchange market and regulation of capital flows. We also discuss the trade-offs associated with alternative stable and competitive RER policies.
    JEL: D62 F13 L52 O24 P45
    Date: 2017–09
  16. By: Andrej Sokol (Bank of England); Ambrogio Cesa-Bianchi (Bank of England)
    Abstract: We provide novel evidence on the existence of an `international credit chan- nel' for the transmission of US shocks across borders. Using a two-country SVAR for the U.S. and the U.K., we show that U.S. monetary policy shocks, identified using high frequency surprises around policy announcements as external instruments, can significantly affect credit spreads in both coun- tries, but less so U.K. economic activity. We then recover a U.S. financial shock, which we identify within the same model using sign restrictions, and show that financial shocks are quickly transmitted internationally, with effects on credit spreads that are similar to the ones of monetary policy shocks. Unlike monetary policy shocks, however, financial shocks have a sizeable impact on economic activity and consumer prices in both coun- tries. Our results are in line with general equilibrium open economy models with credit market imperfections and a high degree of financial integration.
    Date: 2017

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