nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒04‒02
eleven papers chosen by
Martin Berka
University of Auckland

  1. Time-consistent monetary policy, terms of trade manipulation and welfare in open economies By Schmidt, Sebastian
  2. Sovereign defaults in court By Schuhmacher, Julian; Trebesch, Christoph; Enderlein, Henrik
  3. Macroprudential FX Regulations: Shifting the Snowbanks of FX Vulnerability? By Ahnert, Toni; Forbes, Kristin; Friedrich, Christian; Reinhardt, Dennis
  4. Debauchery and Original Sin: The Currency Composition of Sovereign Debt By JungJae Park; Charles Engel
  5. Optimal Monetary Policy and Portfolio Choice By Sebastian Fanelli
  6. Oil price shocks, monetary policy and current account imbalances within a currency union By Baas, Timo; Belke, Ansgar
  7. Intra-temporal Substitution between Tradable and Nontradable Goods: Evidence from the Japanese Cross-sectional Survey Data By Jun Nagayasu
  8. Labour tax reforms, cross-country coordination and the monetary policy stance in the euro area: a structural model-based approach By Jacquinot, Pascal; Lozej, Matija; Pisani, Massimiliano
  9. Liquidity and exchange rate volatility By Thi Hong Hanh Pham
  10. Financial Flows, Global Interest Rates, and Political Integration By Jun Nagayasu
  11. BKK the EZ Way. International Long-Run Growth News and Capital Flows. By Colacito, Riccardo; Croce, Mariano Massimiliano; Ho, Steven; Howard, Philip

  1. By: Schmidt, Sebastian
    Abstract: A key insight from the open economy literature is that domestic price stability is in general not optimal for countries that exert some market power over their terms of trade. Under commitment, a national benevolent monetary policymaker improves upon the allocation associated with stable domestic prices by manipulating the terms of trade to her own country’s advantage. In this paper, I study optimal monetary policy in a sticky-price small open economy model when the policymaker lacks a commitment device. Without commitment, the benevolent policymaker’s attempt to improve national welfare by manipulating the terms of trade can be self-defeating. By steering international relative prices the discretionary policymaker induces fluctuations in domestic prices, the costs of which she is unable to fully internalize in her decision-making. Society may thus be better off if it appoints an inward-looking policymaker who aims for domestic price stability and resists the temptation to exploit the country’s monopoly power in trade. Accounting for the effective lower bound on nominal interest rates further strengthens the case for the inward-looking policy objective. JEL Classification: E52, F41
    Keywords: delegation, discretion, optimal monetary policy, small open economy, terms of trade externality
    Date: 2018–02
  2. By: Schuhmacher, Julian; Trebesch, Christoph; Enderlein, Henrik
    Abstract: For centuries, defaulting governments were immune from legal action by foreign creditors. This paper shows that this is no longer the case. Building a dataset covering four decades, we find that creditor lawsuits have become an increasingly common feature of sovereign debt markets. The legal developments have strengthened the hands of creditors and raised the cost of default for debtors. We show that legal disputes in the US and the UK disrupt government access to international capital markets, as foreign courts can impose a financial embargo on sovereigns. The findings are consistent with theoretical models with creditor sanctions and suggest that sovereign debt is becoming more enforceable. We discuss how the threat of litigation affects debt management, government willingness to pay, and the resolution of debt crises.
    Keywords: sovereign default,enforcement,government financing,debt restructuring
    JEL: F34 G15 H63 K22
    Date: 2018
  3. By: Ahnert, Toni; Forbes, Kristin; Friedrich, Christian; Reinhardt, Dennis
    Abstract: Can macroprudential foreign exchange (FX) regulations on banks reduce the financial and macroeconomic vulnerabilities created by borrowing in foreign currency? To evaluate the effectiveness and unintended consequences of macroprudential FX regulation, we develop a parsimonious model of bank and market lending in domestic and foreign currency and derive four predictions. We confirm these predictions using a rich dataset of macroprudential FX regulations. These empirical tests show that FX regulations: (1) are effective in terms of reducing borrowing in foreign currency by banks; (2) have the unintended consequence of simultaneously causing firms to increase FX debt issuance; (3) reduce the sensitivity of banks to exchange rate movements, but (4) are less effective at reducing the sensitivity of corporates and the broader financial market to exchange rate movements. As a result, FX regulations on banks appear to be successful in mitigating the vulnerability of banks to exchange rate movements and the global financial cycle, but partially shift the snowbank of FX vulnerability to other sectors.
    Keywords: Banking flows; FX regulations; International debt issuance; macroprudential policies
    JEL: F32 F34 G15 G21 G28
    Date: 2018–03
  4. By: JungJae Park (National University of Singapore); Charles Engel (University of Wisconsin)
    Abstract: This paper quantitatively investigates the currency composition of sovereign debt in the presence of two types of limited enforcement frictions arising from a government’s monetary and debt policy: strategic currency debasement and default on sovereign debt. Local currency debt has better state contingency than foreign currency debt in the sense that its real value can be changed by a government’s monetary policy, thus acting as a better consumption hedge against income shocks. However, this higher degree of state contingency for local currency debt provides a government with more temptation to deviate from disciplined monetary policy, thus restricting borrowing in local currency more than in foreign currency. The two financial frictions related to the two limited enforcement problems combine to generate an endogenous debt frontier for local and foreign currency debts. Our model predicts that a less disciplined country in terms of monetary policy borrows mainly in foreign currency, as the country faces a much tighter borrowing limit for local currency debt than for the foreign currency debt. Our model accounts for the surge in local currency borrowings by emerging economies in the recent decade and “Mystery of Original Sin” by Eichengreen, Haussman, Panizza (2002)
    Date: 2017
  5. By: Sebastian Fanelli (MIT)
    Abstract: A recent and rapidly increasing literature has documented the presence of sizeable cross-currency mismatches in countries' balance sheets. Yet, existing studies of optimal monetary policy focus on economies with either a single bond or complete markets. We bridge this gap by studying a small open economy with nominal rigidities where home agents are able to borrow abroad in both home- and foreign-currency bonds. In this environment, monetary policy faces a trade-off between providing insurance and doing inflation-targeting. To solve the optimal policy problem, we develop a technique to approximate the solution around the deterministic steady state with locally incomplete markets. When home-currency-bond markets are perfect, the central bank commits to a smooth exchange rate to induce agents to be significantly exposed to currency risk, giving monetary policy firepower to create wealth transfers at low cost. In contrast, if markets are imperfect and agents cannot choose such large positions, a volatile exchange rate is the only way to provide insurance. Finally, we show that despite the presence of aggregate demand externalities, private portfolio choice decisions are efficient in the approximated model.
    Date: 2017
  6. By: Baas, Timo; Belke, Ansgar
    Abstract: For more than two decades now, current-account imbalances are a crucial issue in the international policy debate as they threaten the stability of the world economy. More recently, the government debt crisis of the European Union shows that internal current account imbalances inside a currency union may also add to these risks. Oil price fluctuations and a contracting monetary policy that reacts on oil prices, previously discussed to affect the current account may also be a threat to the currency union by changing internal imbalances. Therefore, in this paper, we analyze the impact of oil price shocks on current account imbalances within a currency union. Differences in institutions, especially labor market institutions and trade result in an asymmetric reaction to an otherwise symmetric shock. In this context, we show that oil price shocks can have a long-lasting impact on internal balances, as the exchange rate adjustment mechanism is not available. The common monetary policy authority, however, can reduce such effects by specifying an optimum monetary policy target. Nevertheless, we also show that there is no single best solution. CPI, core CPI or an asymmetric CPI target all come at a cost either regarding an increase in unemployment or increasing imbalances.
    Keywords: Current account deficit, Oil price shocks, DSGE models, Search and matching labor market, Monetary policy JEL Classifications: E32, F32, F45, Q43
    Date: 2017–12
  7. By: Jun Nagayasu
    Abstract: Using survey-based Japanese household data, this study estimates the elasticity of intra-temporal substitution (EIS) between tradable and nontradable goods. Thus, this research is related to the Backus-Smith puzzle (1993), which states the non- tradable sector and low substitution between these goods are the reasons for non- conformance to the purchasing power parity theory. Among other conclusions, we confirm that consumption behavior differs among households with different social backgrounds. Furthermore, we find that the EIS is overestimated when household characteristics and time dimensions are not taken into account in the consump- tion function. Indeed, the EIS is low and close to zero when properly estimated, thereby confirming a cause of the Backus-Smith puzzle. Based on these findings, we conclude that prices are less decisive factors in determining the consumption composition than what the standard economic theories predict. In contrast, social factors such as age, cohort, and family size are more directly associated with con- sumers' allocation of goods and services.
    Date: 2018–03
  8. By: Jacquinot, Pascal; Lozej, Matija; Pisani, Massimiliano
    Abstract: We evaluate the effects of permanently reducing labour tax rates in the euro area (EA) by simulating a large-scale open economy dynamic general equilibrium model. The model features the EA as a monetary union, split in two regions (Home and the rest of the EA - REA), the US, and the rest of the world, region-specific labour markets with search and matching frictions, and public employment. Our results are as follows. First, a permanent reduction in labour tax rates in the Home region would have stimulating effects on domestic economic activity and employment. Second, reducing labour tax rates simultaneously in both Home and REA would have additional expansionary effects on the Home region. Third, in the short run the expansionary effects on the EA economy of a EA-wide tax reduction are enhanced if the EA monetary policy is accommodative. JEL Classification: E24, E32, E52, E62, F45
    Keywords: DSGE models, labour taxes, monetary union, open-economy macroeconomics, unemployment
    Date: 2018–02
  9. By: Thi Hong Hanh Pham (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - UN - Université de Nantes)
    Abstract: Using a large panel dataset covering both advanced and developing countries over the period 1980-2015, this paper does two things. First, it explores the impacts of liquidity on the dynamics of exchange rate. We find evidence of a significant relationship between liquidity and real exchange rate volatility, which is, however, diverse and strongly depends on the way to measure liquidity level. Second, it investigates whether the nature of the linkage between liquidity and real exchange rate depends on the level of financial development of a country. This hypothesis is empirically validated in our study.
    Keywords: Exchange rate volatility,Liquidity,Financial development
    Date: 2018–02–13
  10. By: Jun Nagayasu
    Abstract: This paper empirically analyzes international financial flows between 2000 and 2016. Cal- culating a proxy for global interest rates using a factor model, we confirm that there are global elements in national real interest rates, particularly those of advanced countries. Con- sequently, interest rate differentials are insignificantly associated with financial flows in these countries. Instead, exchange rates and political integration have been more consistently in- fluencing investors' decisions to form financial portfolios than interest rates.
    Date: 2018–03
  11. By: Colacito, Riccardo; Croce, Mariano Massimiliano; Ho, Steven; Howard, Philip
    Abstract: We study the response of international investment flows to short- and long-run growth news. Among developed G7 countries, positive long-run news for domestic productivity induces a net outflow of investments, in contrast to the effects of short-run growth shocks. We document that a standard Backus, Kehoe, and Kydland (1994) (BKK) model fails to reproduce this novel empirical evidence. We augment this model with Epstein and Zin (1989) preferences (EZ-BKK) and characterize the resulting recursive risk-sharing scheme. The response of international capital flows in the EZ-BKK model is consistent with the data.
    JEL: C62 F31 G12
    Date: 2018–03

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