nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒05‒07
fourteen papers chosen by
Martin Berka
University of Auckland

  1. Inequality and Imbalances : a Monetary Union Agent-Based Model By Alberto Cardacci; Francesco Saraceno
  2. Modelling the G20 By Warwick J. McKibbin; Adam Triggs
  3. Foreign Exchange Intervention Redux By Roberto Chang
  4. Global liquidity and exchange market pressure in emerging market economies By Hossfeld, Oliver; Pramor, Marcus
  5. International Monetary Policy Transmission through Banks in Small Open Economies By Simone Auer; Christian Friedrich; Maja Ganarin; Teodora Paligorova; Pascal Towbin
  6. The behavioral economics of currency unions: Economic integration and monetary policy By Akvile Bertasiute; Domenico Massaro; Matthias Weber
  7. The role of local currency pricing in international transmission effects of corporate tax reduction in an economy with vertical production linkage and foreign direct investment By Dohwa, Kohjiro
  9. Predicting exchange rate with commodity prices: The role of structural breaks and asymmetries By Afees A. Salisu; Wasiu Adekunle; Zachariah Emmanuel; Wasiu A. Alimi
  10. The evolving impact of global, region-specific and country-specific uncertainty By Mumtaz, Haroon; Musso, Alberto
  11. The International Transmission of Monetary Policy By Claudia M. Buch; Matthieu Bussiere; Linda Goldberg; Robert Hills
  12. Puzzling out the Feldstein-Horioka Paradox for Turkey by a Time-Varying Parameter Approach By Dilem Yıldırım; Onur A. Koska
  13. Price Stickiness along the Income Distribution and the Effects of Monetary Policy By Javier Cravino; Ting Lan; Andrei A. Levchenko
  14. Fiscal multipliers and foreign holdings of public debt By Fernando Broner; Daragh Clancy; Alberto Martin; Aitor Erce

  1. By: Alberto Cardacci (Lombardy Advanced School of Economics Milan); Francesco Saraceno (Observatoire français des conjonctures économiques)
    Abstract: Our paper investigates the impact of rising inequality in a two-country macroeconomic model with an agent-based household sector characterised by peer effects in consumption. In particular, the model highlights the role of inequality in determining diverging balance of payments dynamics within a currency union. Inequality may drive the two countries into different growth patterns: where peer effects in consumption interact with higher credit availability, rising income inequality leads to the emergence of a debt-led growth. Where social norms determine weaker emulation and credit availability is lower, an export-led regime arises. Eventually, a crisis emerges endogenously due to the sudden-stop of capital ows from the net lending country, triggered by the excessive risk associated to the dramatic amount of private debt accumulated by households in the borrowing country. Monte Carlo simulations for a wide range of calibrations confirm the robustness of our results.
    Keywords: Inequality; Current Account; Currency Union; Agent -based model
    JEL: C63 D31 E21 F32 F43
    Date: 2017–12
  2. By: Warwick J. McKibbin; Adam Triggs
    Abstract: World leaders have declared the G20 to be the premier forum for economic cooperation. But as its influence and policy agenda has grown, so too has the need to be able to effectively model the G20 and the implications of its policy agenda. The paper introduces the G-Cubed (G20) model: a multi-country, multi-sector, intertemporal general equilibrium model of the G20. The paper gives an overview of the model and highlights its key features through four simulated shocks, all of which relate to the G20’s goal of reducing global current account imbalances: a fiscal shock (reducing the fiscal deficit in the United States), a productivity/fiscal shock (increasing infrastructure investment in Germany), a consumption shock (increasing domestic consumption in China) and the collective impact of all three shocks occurring simultaneously. The results demonstrate that, to be effective, any model of the G20 must reflect the complex trade and financial linkages between countries, the structural differences across G20 economies and the short-term rigidities observed empirically in the data, as well as a high level of disaggregation across economies, markets and sectors. The simulations show that reducing current account imbalances through these policies often comes with a real economic cost. The results also explain some of the shifts in global current account balances observed since 2007.
    Keywords: macroeconomic policy coordination, intertemporal general equilibrium models, econometric modelling, Group of 20, fiscal policy, structural reform
    JEL: F4 C68 C5 C02 E17 D9 D58 E62
    Date: 2018–04
  3. By: Roberto Chang
    Abstract: Received wisdom posits that sterilized foreign exchange intervention can be effective by altering the currency composition of assets held by the public. This paper proposes an alternative channel: sterilized intervention may (or may not) have real effects because it changes the net credit position of the central bank vis a vis financial intermediaries, thereby affecting external debt limits. This argument is developed in the context of an open economy model with domestic banks subject to occasionally binding collateral constraints. Intervention has real effects if and only if it occurs when the constraints bind; at such times, a sterilized sale of official reserves relaxes the constraints by reducing the central bank's debt to domestic banks, freeing resources for the latter to increase the supply of credit to domestic agents. The analysis yields several noteworthy implications for intervention policy, official reserves accumulation, and the interaction between intervention and monetary policy.
    JEL: E58 F33 F41
    Date: 2018–03
  4. By: Hossfeld, Oliver; Pramor, Marcus
    Abstract: We analyse the relationship between global liquidity and exchange market pressure in 32 emerging market economies. Exchange market pressure is a measure of excess currency demand that is applicable across different exchange rate regimes as it accounts for changes in exchange rates, foreign exchange reserves and, optionally, interest rates. Surges in monetary liquidity, credit provision, and short-term funding in advanced economies are shown to be robustly associated with appreciation pressure on emerging market currencies. The underlying transmission mechanism, however, only operates under regular financial market conditions: ample liquidity provision in advanced economies contributes to the build-up of financial stability risks in emerging market economies in tranquil times, but further liquidity injections do not avert the pronounced depreciation pressure on emerging market currencies in times of high market volatility.
    Keywords: global liquidity,emerging markets,exchange market pressure,search for yield,global financial cycle
    JEL: F31 E51 E58 C23
    Date: 2018
  5. By: Simone Auer; Christian Friedrich; Maja Ganarin; Teodora Paligorova; Pascal Towbin
    Abstract: This paper studies the international transmission of monetary policy through banks in small open economies using the examples of Switzerland and Canada. We assess the inward transmission of foreign monetary policy for Switzerland and the outward transmission of domestic monetary policy for Canada. In both country cases, we focus on the international bank lending and the international portfolio channel, which make opposing predictions about how monetary policy transmits internationally through banks. Our results on the inward transmission of foreign monetary policy through banks in Switzerland are consistent with a role for the international portfolio channel, but we find no evidence for the traditional international bank lending channel. The results on the outward transmission of domestic monetary policy in Canada suggest that foreign lending by Canadian banks is affected through both channels, which work as predicted and largely balance each other.
    Keywords: International banking, monetary policy, inward transmission, outward transmission, small open economies, Switzerland, Canada
    JEL: G21 E5 F21 F32
    Date: 2018
  6. By: Akvile Bertasiute (Budget Policy Monitoring Department, National Audit Office of Lithuania); Domenico Massaro (Universita Cattolica del Sacro Cuore & Complexity Lab in Economics); Matthias Weber (CEFER, Bank of Lithuania & Faculty of Economics, Vilnius University)
    Abstract: Currency unions are often modeled as homogeneous economies, although they are fundamentally different. The expectations that impact macroeconomic behavior in any given country are not the expectations of variables at the currency-union level but at the country level. We model these expectations with a behavioral reinforcement learning model. In our model, economic integration is of particular importance in determining whether economic behavior in a currency union is stable. Monetary policy alone is insufficient to guarantee stable economic behavior, as the central bank cannot conduct different monetary policies in different countries. These results are easily overlooked when modeling expectations as rational.
    Keywords: Behavioral Macroeconomics, Monetary Unions, Reinforcement Learning, Expectation Formation
    JEL: E52 D84
    Date: 2018–04–27
  7. By: Dohwa, Kohjiro
    Abstract: By constructing a two-country model with asymmetry in price-setting behavior between home and foreign intermediate goods firms, vertical production and trade, and endogenous entry of three types of final goods firms, we examine the effects of a reduction in the corporate tax rate of the home country. In particular, we focus on the role of asymmetry in price-setting behavior between home and foreign intermediate goods firms. We show that a reduction in home corporate tax rate yields the entry of foreign multinational firms, the exit of home multinational firms, the improvement in home welfare, and the deterioration in foreign welfare. In addition, when the ratio of home and/or foreign intermediate goods firms that set their export prices in the local currency rises, we show that the above effects are weakened.
    Keywords: Local currency pricing, Vertical production and trade, Firm entry, Foreign direct investment, Corporate tax reduction
    JEL: F41 F42
    Date: 2018–04–27
  8. By: Erdal Özmen (Department of Economics, Middle East Technical University, Ankara, Turkey); Fatma Taşdemir (Department of Economics, Middle East Technical University, Ankara, Turkey)
    Abstract: We investigate the long-run relations and equilibrium correction mechanisms between gross capital inflows, outflows and global financial conditions for advanced and emerging market economies. According to our results, the findings of the recent empirical literature, suggesting that twin behaviour of capital inflows and outflows resulting from domestic and foreign investors to behave as distant cousins tend to be the case for the long-run. The short-run relations, however, often appear to be consistent with the conventional theory suggesting that the behaviours of residents and non-residents do not systematically diverge from each other. Consistent with the flight to safety concerns, capital outflows from EME and capital inflows to AE tend to increase in the long-run in response to worsening global financial conditions. We find that, these results essentially hold also for the main components of capital flows.
    Keywords: Advanced economies, Cointegration, Emerging market economies, Equilibrium correction, Foreign direct investments, Gross capital flows, Portfolio flows
    JEL: F21 F30 F32 G01
    Date: 2018–04
  9. By: Afees A. Salisu (Centre for Econometric and Allied Research, University of Ibadan); Wasiu Adekunle (Centre for Econometric and Allied Research, University of Ibadan); Zachariah Emmanuel (Centre for Econometric and Allied Research, University of Ibadan Department of Economics, Federal University Wukari, Taraba State, Nigeria); Wasiu A. Alimi (Centre for Econometric and Allied Research, University of Ibadan)
    Abstract: In this paper, we offer new evidence on the predictability of exchange rate with commodity prices by accounting for the role of asymmetries and structural breaks. In particular, we evaluate whether such considerations matter for the forecast performance of the predictive model for exchange rate. We further account for any possible bias in estimation due to the presence of persistence, endogeneity and conditional heteroscedasticity effects in our predictors. Monthly data of five major tradable currency pairs in the world and disaggregated commodity price indices over the period of 1960 to 2017 are utilized. We find significant improvements in both the in-sample and out-of-sample forecast performance of the predictive model for exchange rate when asymmetries and structural breaks are accommodated. In addition, all the economic models considered with and without asymmetries and structural breaks offer superior forecast performance over the ARFIMA model. Our results are robust to alternative exchange rates and commodity price indices and different breaks, data samples and forecast horizons.
    Keywords: Exchange rate; Commodity prices; Forecast evaluation, Asymmetry, Structural break
    JEL: F31 F37 Q02
    Date: 2018–04
  10. By: Mumtaz, Haroon; Musso, Alberto
    Abstract: We build a dynamic factor model with time-varying parameters and stochastic volatility and use it to decompose the variance of a large set of financial and macroeconomic variables for 22 OECD countries spanning from 1960 onwards into contributions from country-specific uncertainty, region-specific uncertainty and uncertainty common to all countries. We find that common global uncertainty plays a primary role in explaining the volatility of inflation, interest rates and stock prices, although to a varying extent over time. Region-specific uncertainty drives most of the exchange rate volatility for all Euro Area countries and for countries in North-America and Oceania. All uncertainty estimates (global, regional, country-specific and idiosyncratic) play a non-negligible role for real economic activity, credit and money for most countries. We also find that all uncertainty measures display significant recurrent fluctuations, that the recent peaks in uncertainty found for most estimates around 2008/2009 are comparable to those seen in the mid-1970s and early 1980s, and that all uncertainty measures appear to be strongly countercyclical and positively correlated with inflation. JEL Classification: C15, C32, E32
    Keywords: dynamic factor model, global uncertainty, stochastic volatility, time-varying parameters, uncertainty shocks
    Date: 2018–04
  11. By: Claudia M. Buch; Matthieu Bussiere; Linda Goldberg; Robert Hills
    Abstract: This paper presents the novel results from an internationally coordinated project by the International Banking Research Network (IBRN) on the cross-border transmission of conventional and unconventional monetary policy through banks. Teams from seventeen countries use confidential micro-banking data for the years 2000 through 2015 to explore the international transmission of monetary policies of the U.S., euro area, Japan, and United Kingdom. Two other studies use international data with different degrees of granularity. International spillovers into lending to the private sector do occur, especially for U.S. policies, and bank-specific heterogeneity influences the magnitudes of transmission. The effects are supportive of the international bank lending channel and the portfolio channel of monetary policy transmission. They also show that the frictions that banks face matter; in particular, foreign currency funding and hedging considerations can be a key source of heterogeneity. The forms of bank balance sheet heterogeneity that differentiate spillovers across banks are not uniform across countries. International spillovers into lending can be large for some banks, even while the average international spillovers of policies into nonbank lending generally are not large.
    JEL: E4 E5 F30 F4 G15 G21
    Date: 2018–03
  12. By: Dilem Yıldırım (Department of Economics, Middle East Technical University, Ankara, Turkey); Onur A. Koska (Department of Economics, Middle East Technical University, Ankara, Turkey)
    Abstract: This study would like to contribute to the existing literature on the Feldstein-Horioka paradox by focusing on Turkey for the period 1960-2014 and by scrutinizing the correlation between domestic savings and investments within a time-varying parameter approach (which is warranted especially for emerging countries due to their political and economic instability and due to the frequency of policy changes). Our time-varying parameter approach is able to capture the impact of various economic and political interruptions on the correlation between domestic savings and investments, especially the military coups in the early 1960s, 1970s and 1980s, and the economic and financial crises in the mid-1990s, in the late 1990s, and in the early 2000s, as well as the financial crises affecting various countries in the globe in the late 1990s and 2000s. Our empirical analysis suggests a high correlation between domestic savings and investments in the 1960s, which was decreasing (increasing) during the 1970s (1980s), and which was decreasing since the 1990s. Furthermore, in the post-2002 era, with a further decline in the correlation coefficient, the saving-investment nexus has turned out to be statistically insignificant.
    Keywords: Feldstein-Horioka Paradox; Turkey; Economic and financial crises; Structural breaks; Time-varying parameter approach
    JEL: E21 E22 F21 C32 C51 G01
    Date: 2018–04
  13. By: Javier Cravino (University of Michigan and NBER); Ting Lan (University of Michigan); Andrei A. Levchenko (University of Michigan, NBER, and CEPR)
    Abstract: We document that the prices of the goods consumed by high-income households are more sticky and less volatile than those of the goods consumed by middle-income households. This suggests that monetary shocks can have distributional consequences by affecting the relative prices of the goods consumed at different points on the income distribution. We use a Factor-Augmented VAR (FAVAR) model to show that, following a monetary policy shock, the estimated impulse responses of high-income householdsÕ consumer price indices are 22% lower than those of the middle-income households. We then evaluate the macroeconomic implications of our empirical findings in a quantitative New-Keynesian model featuring households that are heterogeneous in their income and consumption patterns, and sectors that are heterogeneous in their frequency of price changes. We find that: (i) the distributional consequences of monetary policy shocks are large and similar to those in the FAVAR model, and (ii) greater income inequality increases the effectiveness of monetary policy, although this effect is modest for realistic changes in inequality.
    Keywords: Inflation, distributional effects, consumption baskets, monetary policy.
    JEL: E31 E52
    Date: 2018–04
  14. By: Fernando Broner; Daragh Clancy; Alberto Martin; Aitor Erce
    Abstract: This paper explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. Thus, these crowding-out effects are likely to be weaker when public debt is purchased by foreigners. We test this hypothesis on (i) post-war US data and (ii) data for a panel of 17 advanced economies from the 1980’s to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for a large set of advanced economies. We combine this data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950’s and 1960’s and Japan today, and larger than one when the foreign share is high, such as in the U.S. and Ireland today.
    Keywords: sovereign debt, fiscal multiplier, foreign holdings of public debt
    JEL: F32 F34 F36 F41 F43 F44 G15
    Date: 2017–12

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