nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒01‒22
sixteen papers chosen by
Martin Berka
University of Auckland

  1. The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules By Charles Engel; Dohyeon Lee; Chang Liu; Chenxin Liu; Steve Pak Yeung Wu
  2. Fiscal unions redux By Kehoe, Patrick J.
  3. Fiscal rules, financial stability and optimal currency areas By de Grauwe, Paul; Foresti, Pasquale
  4. Comment on "external and public debt crises" By Reis, Ricardo
  5. Foreign booms, domestic busts: The global dimension of banking crises By Cesa-Bianchi, Ambrogio; Martin, Fernando Eguren; Thwaites, Gregory
  6. PIIGS in the Euro area: An empirical DSGE model By Alice Albonico; Alessia Paccagnini; Patrizio Tirelli
  7. An Equilibrium Theory of Determinate Nominal Exchange Rates, Current Accounts and Asset Flows By Marcus Hagedorn
  8. When is foreign exchange intervention effective? Evidence from 33 countries By Fratzscher, Marcel; Gloede, Oliver; Menkhoff, Lukas; Sarno, Lucio; Stoerh, Tobias
  9. International Credit Supply Shocks By Cesa-Bianchi, Ambrogio; Ferrero, Andrea; Rebucci, Alessandro
  10. External Adjustment in a Resource-Rich Economy: The Case of Papua New Guinea By Ryota Nakatani
  11. Monetary policy transmission in an open economy:new data and evidence from the United Kingdom By Cesa-Bianchi, Ambrogio; Thwaites, Gregory; Vicondoa, Alejandro
  12. What's News in International Business Cycles By Daniele Siena
  13. 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
  14. Synchronicity of real and financial cycles and structural characteristics in EU countries By Mariarosaria Comunale
  15. Testing Twin Deficits and Saving-Investment Nexus in Turkey By HALICIOGLU, Ferda; EREN, Kasim
  16. Regulating Capital Flows to Emerging Markets: An Externality View By Anton Korinek

  1. By: Charles Engel; Dohyeon Lee; Chang Liu; Chenxin Liu; Steve Pak Yeung Wu
    Abstract: Recent research has found that the Taylor-rule fundamentals have power to forecast changes in U.S. dollar exchange rates out of sample. Our work casts some doubt on that claim. However, we find strong evidence of a related in-sample anomaly. When we include U.S. inflation in the well-known uncovered interest parity regression of the change in the exchange rate on the interest-rate differential, we find that the inflation variable is highly significant and the interest-rate differential is not. Specifically, high U.S. inflation in one month forecasts dollar appreciation in the subsequent month. We introduce a model in which a Taylor rule determines monetary policy, but in which not only monetary shocks but also liquidity shocks drive nominal interest rates. This model can potentially account for the empirical findings.
    JEL: F3 F31 F41
    Date: 2017–11
  2. By: Kehoe, Patrick J.
    Abstract: Before the advent of sophisticated international Önancial markets, a widely accepted belief was that within a monetary union, a union-wide authority orchestrating Öscal transfers between countries is necessary to provide adequate insurance against country-speciÖc economic áuctuations. A natural question is then: Do sophisticated international Önancial markets obviate the need for such an active union-wide authority? We argue that they do. SpeciÖcally, we show that in a benchmark economy with no international Önancial markets, an activist union-wide authority is necessary to achieve desirable outcomes. With sophisticated Önancial markets, however, such an authority is unnecessary if its only goal is to provide cross-country insurance. Since restricting the set of policy instruments available to member countries does not create a Öscal externality across them, this result holds in a wide variety of settings. Finally, we establish that an activist union-wide authority concerned just with providing insurance across member countries is optimal only when individual countries are either unable or unwilling to pursue desirable policies.
    Keywords: Cross-country externalities; Cross-country insurance; Cross-country transfers; Fiscal externalities; international Önancial markets; International transfers; Optimal currency area
    JEL: E60 E61 F33 F35 F42 G15 G28 G33
    Date: 2017–02
  3. By: de Grauwe, Paul; Foresti, Pasquale
    Abstract: In this paper we suggest that Eurozone countries face a policy trade-off between: (1) a common rule imposing co-movements in fiscal policy; (2) financial stability; (3) financial integration. We provide empirical evidence documenting the existence of such a trade-off in the period characterized by the financial crisis and by the sovereign debt crisis. Then, we conclude that the intense fiscal rules that have been introduced in the Eurozone after the emergence of the debt crisis can reduce the capacity of national governments to deal with asymmetric shocks and can be incompatible with either free capital mobility and/or financial stability.
    Keywords: fiscal policy rules; Eurozone; financial stability; policy objectives; optimal currency areas
    JEL: E61 E62 F3
    Date: 2016–08–01
  4. By: Reis, Ricardo
    JEL: E6
    Date: 2016–06–01
  5. By: Cesa-Bianchi, Ambrogio; Martin, Fernando Eguren; Thwaites, Gregory
    Abstract: This paper provides novel empirical evidence showing that foreign financial developments are a powerful predictor of domestic banking crises. Using a new data set for 38 advanced and emerging economies over 1970-2011, we show that credit growth in the rest of the world has a large positive effect on the probability of banking crises taking place at home, even when controlling for domestic credit growth. Our results suggest that this effect is larger for financially open economies, and is consistent with transmission via cross-border capital flows and market sentiment. Direct contagion from foreign crises plays an important role, but does not account for the whole effect.
    Keywords: Financial Crises; Global Credit Cycle; Banking; Financial Stability; Sentiment.
    JEL: E32 E44 E52
    Date: 2017–01–24
  6. By: Alice Albonico; Alessia Paccagnini; Patrizio Tirelli
    Keywords: PIIGS, Euro crisis, two-country DSGE, Bayesian estimation
    JEL: E32 E21 C13 C32 C11 E37
    Date: 2017–10
  7. By: Marcus Hagedorn (University of Oslo)
    Abstract: In standard open economy macro-models, where monetary policy in each country works through setting nominal interest rates, only the expected change but not the level of the nominal exchange rates is determinate. In contrast to this standard result (Kareken+Wallace (1981), in this paper I show determinacy of the level in a large class of heterogenous agents incomplete markets models with aggregate risk. I then characterize the determinants of the nominal exchange rate: assets held by a country, the net foreign asset position, the nominal interest rate and productivity. I also show whether a change in one of the determinants leads to a depreciation or an appreciation. The incompleteness of markets implies that temporary shocks affect the long-run world distribution of assets and exchange rates with interesting feedback effects on the current exchange rate. The determinacy result also enables the researcher to answer many question in open economy macroeconomics within a coherent equilibrium model. I discuss some of these questions, such as how international asset flows affect exchange rates, how a country can divorce itself from these flows and how a country can manage its exchange rate. The model also implies that a country with an exchange rate peg and free asset mobility faces a tetralemma and not a trilemma as it not only loses monetary but also fiscal policy independence. This suggest a new way to think about fiscal coordination in a monetary union as a response to within union asset flows. I also provide some empirical evidence consistent with the theoretical predictions.
    Date: 2017
  8. By: Fratzscher, Marcel; Gloede, Oliver; Menkhoff, Lukas; Sarno, Lucio; Stoerh, Tobias
    Abstract: This paper examines foreign exchange intervention based on novel daily data covering 33 countries from 1995 to 2011. We find that intervention is widely used and an effective policy tool, with a success rate in excess of 80 percent under some criteria. The policy works well in terms of smoothing the path of exchange rates, and in stabilizing the exchange rate in countries with narrow band regimes. Moving the level of the exchange rate in flexible regimes requires that some conditions are met, including the use of large volumes and that intervention is made public and supported via communication.
    Keywords: Foreign exchange intervention; exchange rate regimes; effectiveness measures; communication.
    JEL: E58 F31 F33
    Date: 2017–12
  9. By: Cesa-Bianchi, Ambrogio; Ferrero, Andrea; Rebucci, Alessandro
    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 fueling 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: Capital Flows; Credit Supply Shock; Cross-border claims; Exchange Rates; House Prices; International Financial Intermediation.; leverage
    JEL: C32 E44 F44
    Date: 2017–12
  10. By: Ryota Nakatani
    Abstract: How should resource-rich economies handle the balance of payments adjustment required after commodity price declines? This paper addresses the question theoretically by developing a simple two-period multi-sector model based on Nakatani (2016) to compare different exchange rate policies, and empirically by estimating elasticities of imports and commodity exports with respect to exchange rates using Papua New Guinean data. In the empirical part, using various econometric methods, I find the statistically significant elasticities of commodity exports to real exchange rates. In the theoretical part, by introducing the notion of a shadow exchange rate premium, I show how the rationing of foreign exchange reduces consumer welfare. Using the estimated elasticities and theoretical outcomes, I further discuss policy implications for resource-rich countries with a focus on Papua New Guinea.
    Date: 2017–12–01
  11. By: Cesa-Bianchi, Ambrogio; Thwaites, Gregory; Vicondoa, Alejandro
    Abstract: This paper constructs a new series of monetary policy surprises for the United Kingdom and estimates their effects on macroeconomic and financial variables, employing a high-frequency identification procedure. First, using local projections methods, we find that monetary policy has persistent effects on real interest rates and breakeven inflation. Second, employing our series of surprises as an instrument in a SVAR, we show that monetary policy affects economic activity, prices, the exchange rate, exports, and imports. Finally, we implement a test of overidentifying restrictions, which exploits the availability of the narrative series of monetary policy shocks computed by Cloyne and Huertgen (2014), and find no evidence that either set of shocks contains any ‘endogenous’ response to macroeconomic variables.
    Keywords: Monetary policy transmission; external instrument; high-frequency identification; structural VAR; local projections.
    JEL: E31 E32 E43 E44 E52 E58
    Date: 2016–08–02
  12. By: Daniele Siena (Banque de France)
    Abstract: The role of news shocks in international business cycles is first evaluated using a structural factor-augmented VAR model (FAVAR). An international FAVAR model is shown to be necessary to recover the correct news shocks in open economies, except the US, without incurring in the ‘non-fundamentalness’ problem. Then, a standard two-country, two-good real business cycle model, featuring news shocks, investment adjustment costs and variable wealth elasticity of the labor supply is used to match and explain the empirical evidence. News shocks are only marginal drivers of international business cycles synchronization.
    Date: 2017
  13. By: Corsetti, Giancarlo; Mavroeidi, Eleonora; Thwaites, Gregory; Wolf, Martin
    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: Monetary policy; zero lower bound; deflation; depreciation; beggar-thy-neighbour; capital controls
    JEL: E62 F41
    Date: 2017–05–31
  14. By: Mariarosaria Comunale (Bank of Lithuania)
    Abstract: In this paper, we examine the relationships between real, credit and house price cycles, by using a synchronicity index, and structural characteristics and macroeconomic variables of 17 EU countries. We find that the cycles between credit variables and the real cycle with the property or equity prices cycles seem relatively well synchronised. Credit and GDP fluctuations seem to be less synchronised, mostly because credit volumes tend to lag the real cycle by several quarters. The high rates of private homeownership tend to be associated with larger cycles in GDP, credit, and house prices. Higher Loan-To-Value ratios, seen as a proxy of borrowing constraints, and a higher percentage of flexible rate mortgages, could also indicate that a country is more sensitive to shocks and possibly increase pro-cyclicality and increase cycle volatility. Finally, the pro-cyclicality of the credit and housing market to the GDP cycle can be linked to the fluctuation in current accounts and their misalignments with respect to the theoretical equilibrium value. The synchronicity and the cycles of credit may also be considered for signaling recessions.
    Keywords: cycles, synchronicity, housing market, credit, European Union
    JEL: E32 E44 F36
    Date: 2017–08–18
  15. By: HALICIOGLU, Ferda; EREN, Kasim
    Abstract: This paper provides further evidence on the validity of twin deficits and the Feldstein-Horioka hypotheses for Turkey during the period of 1987-2004 using bounds testing approach to cointegration. In order to explain the main determinants of the current account deficits in the long-run, the fiscal balance and the domestic investments are used in an econometric model.The cointegration tests indicate the presence of a long-run relationship between the current account and budget deficits as well as the domestic investments during the estimation period. As a result, it is concluded that the twin deficits hypothesis and the Feldstein-Horioka puzzle are present and Turkey appeared to be integrated into the world capital market with a low degree of capital mobility as less than 1/5 of its domestic investment is financed through external funds. The augmented Granger-causality tests suggest no causality between the current account and budget deficits, both in the short-run and the long-run. The post-sample variance decompositions suggest that the domestic investments are the main cause of current deficits in the long-run. The paper also discusses the policy implications of the empirical results.
    Keywords: Twin deficits, Feldstein-Horioka hypothesis, cointegration, Turkey
    JEL: C22 F32 F36
    Date: 2017
  16. By: Anton Korinek
    Abstract: We show that capital flows to emerging market economies create externalities that differ by an order of magnitude depending on the state-contingent payoff profile of the flows. Those with pro-cyclical payoffs, such as foreign currency debt, generate substantial negative pecuniary externalities because they lead to large repayments and contractionary exchange rate depreciations during financial crises. Conversely, capital flows with an insurance component, such as FDI or equity, are largely benign. We construct an externality pricing kernel and use sufficient statistics and DSGE model simulations to quantify the externalities that materialized during past financial crises. We find stark differences depending on the payoff profile, justifying taxes of up to 3% for dollar debt but close to zero for FDI. These findings contrast with the existing literature, which has suggested that policymakers should focus on reducing over-borrowing rather than changing the composition of external liabilities.
    JEL: E44 F41 H23
    Date: 2017–12

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