nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2017‒11‒19
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Overcoming the Original Sin: Gains from Local Currency External Debt By Ricardo Sabbadini
  2. Financial Crises and Lending of Last Resort in Open Economies By Bocola, Luigi; Lorenzoni, Guido
  3. Euro Area Imbalances By Mark Mink; Jan Jacobs; Jakob de Haan
  4. Domestic and External Sovereign Debt By Di Casola, Paola; Sichlimiris, Spyridon
  5. Public Debt Sustainability and Defaults. By Michel Guillard; Hubert Kempf
  6. Central bank transparency and the volatility of exchange rates By Eichler, Stefan; Littke, Helge C. N.
  7. Structure of Capital Flows and Exchange Rate: The Case of Croatia By Maja Bukovšak; Gorana Lukinić Čardić; Nina Ranilović
  8. Misallocation, Selection and Productivity: A Quantitative Analysis with Panel Data from China By Tasso Adamopoulos; Loren Brandt; Jessica Leight; Diego Restuccia
  9. Nonlinear Exchange Rate Pass-Through to Domestic Prices in Ukraine By Oleksandr Fàrynà
  10. Advanced economies and emerging markets: Dissecting the drivers of business cycle synchronization By Aikaterini Karadimitropoulou
  11. Financial Crises and the Role of Debt Maturity for Emerging Economies By Hewei Shen
  12. Debunking the Myth of Southern Profligacy. A DSGE Analysis of Business Cycles in the EMU’s Big Four By Alice, Albonico; Roberta, Cardani; Patrizio, Tirelli
  13. Capital Flows and Sovereign Debt Markets: Evidence from Index Rebalancings By Lorenzo Pandolfi; Tomas Williams

  1. By: Ricardo Sabbadini
    Abstract: Emerging markets increasingly rely on external debt denominated in local currency. In order to understand if this is a better situation than using US dollar denominated debt, I present a small open economy model with two sectors, and endogenous determination of both default risk and real exchange rate. Using a calibrated version of the model that replicates default frequency and debt level of emerging economies, I compare the two possibilities of debt denomination: local or foreign currency. I find that welfare gains from issuing debt in local currency derive from less frequent defaults, higher sustainable debt levels, and less volatile consumption and real exchange rates. However, even an economy issuing debt in local currency still faces counter-cyclical interest rate spread and real depreciations around default episodes.
    Keywords: external debt; sovereign default; debt denomination; real exchange rate.
    JEL: E43 F31 F34 F41
    Date: 2017–10–31
  2. By: Bocola, Luigi (Federal Reserve Bank of Minneapolis); Lorenzoni, Guido (Northwestern University)
    Abstract: We study financial panics in a small open economy with floating exchange rates. In our model, bank runs trigger a decline in domestic wealth and a currency depreciation. Runs are more likely when banks have dollar debt. Dollar debt emerges endogenously in response to the precautionary motive of domestic savers: dollar savings provide insurance against crises; so when crises are possible it becomes relatively more expensive for banks to borrow in local currency, which gives them an incentive to issue dollar debt. This feedback between aggregate risk and savers’ behavior can generate multiple equilibria, with the bad equilibrium characterized by financial dollarization and the possibility of bank runs. A domestic lender of last resort can eliminate the bad equilibrium, but interventions need to be fiscally credible. Holding foreign currency reserves hedges the fiscal position of the government and enhances its credibility, thus improving financial stability.
    Keywords: Financial crises; Dollarization; Lending of last resort; Foreign reserves
    JEL: E44 F34 G11 G15
    Date: 2017–10–24
  3. By: Mark Mink; Jan Jacobs; Jakob de Haan
    Abstract: We argue that if currency union member states have different potential output per capita, output growth rates, or trade balances, the common monetary policy may not be optimal for all of them. Euro area imbalances for potential output and for trade balances are quite large, while output growth imbalances are more modest. Member states with larger imbalances of one type also have larger imbalances of both other types, but a decline of one imbalance need not coincide with a decline of the others. We also show that imbalances are fairly persistent, and are larger in poorer and smaller member states.
    Keywords: euro area macroeconomic imbalances, common monetary policy, economic convergence, business cycle synchronization, euro crisis
    JEL: E30 O47
    Date: 2016
  4. By: Di Casola, Paola (Monetary Policy Department, Central Bank of Sweden); Sichlimiris, Spyridon (Örebro University)
    Abstract: Why do countries tend to repay their domestic and external debt, even though the legal enforcement of the sovereign debt contract is limited? Contrary to conventional wisdom, we argue that temporary market exclusion after default is costly. When the domestic financial market is characterized by a scarcity of private saving instruments, a government can partition its debt market into domestic and external segments, by restricting capital flows, to exploit its market power. The government's market power mitigates the problem of limited commitment, by making default a more costly option. Consequently, it extends the government's external debt capacity. We replicate the domestic and external sovereign debt for non-advanced economies, by unveiling their link to financial repression.
    Keywords: sovereign debt; sovereign default; financial repression; financial development; capital controls
    JEL: E21 E44 E60 F34 G15 G18 H63 O16
    Date: 2017–11–01
  5. By: Michel Guillard; Hubert Kempf
    Abstract: We offer a new methodology for the assessment of public debt sustainability in a stochastic economy when sovereign default taken into account. The default threshold differs from the no-Ponzi condition and depends on the post-default debt recovery rule. We distinguish sustainability and unsustainability conditions, related to alternative scenarios on the future sequence of shocks. We highlight the role of the debt recovery ratio on the whole dynamics of public debt. When a sovereign default occurs, the sustainability of the post-default debt is ensured when the haircut is sufficiently large. Lastly we provide an explanation of serial defaults.
    Keywords: public debt, sovereign default, recovery rate, debt sustainability
    JEL: E60 F40 H63
    Date: 2017
  6. By: Eichler, Stefan; Littke, Helge C. N.
    Abstract: We analyze the effect of monetary policy transparency on bilateral exchange rate volatility. We test the theoretical predictions of a stylized model using panel data for 62 currencies from 1998 to 2010. We find strong empirical evidence that an increase in the availability of information about monetary policy objectives decreases exchange rate volatility. Using interaction models, we find that this effect is more pronounced for countries with a lower flexibility of goods prices, a lower level of central bank conservatism, and a higher interest rate sensitivity of money demand.
    Keywords: central bank transparency,exchange rate volatility,panel model
    JEL: E58 F31
    Date: 2017
  7. By: Maja Bukovšak (The Croatian National Bank, Croatia); Gorana Lukinić Čardić (The Croatian National Bank, Croatia); Nina Ranilović (The Croatian National Bank, Croatia)
    Abstract: The paper analyses the impact of different types of capital flows to Croatia on the kuna exchange rate. SVAR models based on Cholesky decomposition with block exogeneity restrictions are estimated using different types of capital flows and the key finding is that the structure of capital flows matters for their impact on the exchange rate. On the one hand, debt capital inflows lead to kuna appreciation, irrespective of their maturity, while in terms of sectoral structure this is mostly due to corporate and government borrowing. On the other hand, equity capital flows seem to affect it in the opposite direction, which is in line with results from other empirical research. The opposite effects of debt and equity flows could stem from the differences in their relative orientations towards the tradable versus the non-tradable sector, with the latter being more prominent in debt flows. The paper also confirms that capital flows to the banking sector have no effect on the exchange rate, providing support to the intensive use of countercyclical macroprudential measures by the central bank. These findings are relevant for the design of monetary policy, especially in countries like Croatia where central bank uses the exchange rate of the kuna against the euro as the main tool for achieving its primary objective of price stability.
    Keywords: capital inflows, kuna exchange rate, SVAR with block exogeneity
    JEL: F32 F41 C51 C32
    Date: 2017–07
  8. By: Tasso Adamopoulos; Loren Brandt; Jessica Leight; Diego Restuccia
    Abstract: We use household-level panel data from China and a quantitative framework to document the extent and consequences of factor misallocation in agriculture. We find that there are substantial frictions in both the land and capital markets linked to land institutions in rural China that disproportionately constrain the more productive farmers. These frictions reduce aggregate agricultural productivity in China by affecting two key margins: (1) the allocation of resources across farmers (misallocation) and (2) the allocation of workers across sectors, in particular the type of farmers who operate in agriculture (selection). We show that selection can substantially amplify the static misallocation effect of distortionary policies by affecting occupational choices that worsen the distribution of productive units in agriculture.
    Keywords: Agriculture, misallocation, selection, productivity, China.
    JEL: O11 O14 O4 E02 Q1
    Date: 2017–11–13
  9. By: Oleksandr Fàrynà (Monetary Policy and Economic Analysis Department, National Bank of Ukraine)
    Abstract: This paper aims to estimate the degree of exchange rate pass-through (ERPT) to domestic prices in Ukraine considering nonlinearities with respect to the size and direction of exchange rate movements, inflation environment, and business cycles. We use disaggregated consumer price data and employ a panel autoregressive distributed lag model including threshold parameters to account for nonlinearities in the ERPT mechanism. Estimation results suggest that the pass-through effect is higher from currency depreciation than in the case of appreciation for most price groups. We also find that price responsiveness to small, medium, and large exchange rate changes is nonlinear. In particular, we provide evidence that prices are sensitive to small changes, but the pass-through effect is insignificant if exchange rate movements are moderate. Furthermore, the degree of ERPT is higher in periods of extremely large depreciations, high inflationary environment, and economic slumps.
    Keywords: Exchange rate pass-through, inflation, Ukraine, nonlinear ERPT, Autoregressive Distributed Lag model
    JEL: E31 E52 E58 F31
    Date: 2016–12
  10. By: Aikaterini Karadimitropoulou (University of East Anglia)
    Abstract: What are the divers of business cycle synchronization within and between advanced and emerging economies at the sector level? This question is addressed by analysing international co-movements of value added growth in a multi-sector dynamic factor model. The model contains a world factor, region factors, sector factors, country factors, and idiosyncratic components. The model is estimated using Bayesian methods for 9 disaggregated sectors in 5 developed economies (G5) and 19 emerging economies for the 1972-2009 period. The results suggest that, while there exists a common 'regional business cycle' in the G5, fluctuations in sectoral value added growth are dominated by country-specific factors in the emerging markets. Despite that, the international factor (the sum of world and sector factors) is more important than the region factor, suggesting that the emerging markets are more synchronized with the G5. A simple regression shows that (i) the world factor would be more important the larger the share of agriculture in output; (ii) in more open economies the sector factor is more important in explaining sectoral VA growth fluctuations; (iii) the region factors is more important the richer and the less volatile the economy. Finally, a comparison of the variance of sectoral value added growth accounted for by each factor from the pre- to the post-globalization period shows convergence of the business cycles within the G5 and EM, respectively. The changes in the contribution of the world, sector and region factor are due to changes in the importance of those factors within sectors. However, for the emerging markets, the fall in the importance of the country factors is dominated by changes in the structural composition of the economies. Therefore, the evolution of the structural composition in the emerging markets could be an important driver for more synchronised business cycles at the regional and international level.
    Keywords: dynamic factors, disaggregated business cycles, international co-movement, emerging markets
    JEL: C38 E32 F44
    Date: 2017
  11. By: Hewei Shen (Indiana University)
    Abstract: This paper studies the role of debt maturity for small open economies subject to endogenous financial crises. It uses an off-the-shelf two-sector DSGE model featuring collateral constraints and endogenous financial crises but allows the duration of the bond in the economy to vary. This model generates a trade-off between the borrowing cost and insurance benefit of a long-term bond. On one hand, it is more costly for small open economies to borrow through the long-term bond than the short-term bond. On the other hand, a long-term bond also provides an insurance benefit against aggregate shocks and the probability of financial crises declines monotonically in the duration of the bond. As a result, the quantitative analysis shows that the ex-ante welfare is maximized when the duration of the bond in the economy is seven quarters and this result sheds some light on why emerging market economies adopt controls on short-term capital flows.
    Keywords: Bond Duration, Credit Constraints, Financial Crises
    Date: 2016–06
  12. By: Alice, Albonico; Roberta, Cardani; Patrizio, Tirelli
    Abstract: We investigate the drivers of EMU big fours' business cycles in a DSGE model. Our approach allows to disentangle the role of demand and technology shocks, where the latter may generate permanent consequences on national productivity levels. For the years before the financial crisis we cannot find evidence of a demand-driven boom in Spain and Italy relative to what happened in France and Germany. The aftermath of the sovereign bond crisis was characterized by a sequence of adverse permanent technology shocks both in Spain and in Italy. These latter results are consistent with recent theoretical developments that emphasize the adverse supply-side effects of a credit crunch.
    Keywords: Asymmetric Euro crisis, two-country DSGE, Bayesian estimation
    JEL: C11 C13 C32 E21 E32 E37
    Date: 2017–11–05
  13. By: Lorenzo Pandolfi (Università di Napoli Federico II and CSEF); Tomas Williams (George Washington University)
    Abstract: In this paper, we analyze how capital flows into the sovereign debt market affect government bond prices and liquidity. Additionally, we explore whether these flows spill over to the exchange rate. To address endogeneity concerns, we construct a measure of informationless capital Flows Implied by (mechanical) Rebalancings (FIR) in the largest local currency government debt index for emerging countries. We find that FIR is associated with higher returns on bonds and greater depth in the sovereign debt market after the rebalancings. These capital flows also impact the exchange rate market; larger inflows (outflows) are associated with greater currency appreciations (depreciations).
    Keywords: sovereign debt; international capital flows; index rebalancings; mutual funds; benchmark indexes; exchange rate.
    JEL: F32 G11 G12 G15 G23
    Date: 2017–11–12

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