nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒06‒18
ten papers chosen by
Martin Berka
University of Auckland

  1. Uncovered Return Parity: Equity Returns and Currency Returns By Edouard Djeutem; Geoffrey R. Dunbar
  2. Global Financial Cycles and Risk Premiums By Jorda, Oscar; Schularick, Moritz; Taylor, Alan M.; Ward, Felix
  3. Managing Financial Globalization: A Guide for Developing Countries Based on the Recent Literature By Wei, Shang-Jin
  4. International Credit Markets and Global Business Cycles By Patrick Pintus; Yi Wen; Xiaochuan Xing
  5. Designing QE in a fiscally sound monetary union By Bletzinger, Tilman; von Thadden, Leopold
  6. Estimating the effect of the EMU on current account balances: a synthetic control approach By Hope, David
  7. Currency Unions, Trade, and Heterogeneity By Chen, Natalie; Novy, Dennis
  8. The Real Exchange Rate, Innovation and Productivity: Regional Heterogeneity, Asymmetries and Hysteresis By Laura Alfaro; Alejandro Cuñat; Harald Fadinger; Yanping Liu
  9. Trade and currency weapons By Agnès Bénassy-Quéré; Matthieu Bussière; Pauline Wibaux
  10. Foreign Currency Bank Funding and Global Factors By Krogstrup, Signe; Tille, Cédric

  1. By: Edouard Djeutem; Geoffrey R. Dunbar
    Abstract: We propose an uncovered expected returns parity (URP) condition for the bilateral spot exchange rate. URP implies that unilateral exchange rate equations are misspecified and that equity returns also affect exchange rates. Fama regressions provide evidence that URP is statistically preferred to uncovered interest rate parity (UIP) for nominal bilateral exchange rates between the US dollar and six countries (Australia, Canada, Japan, Norway, Switzerland and the UK) at the monthly frequency. An implication of URP is that commodity price changes that affect equity returns thus affect bilateral exchange rates through the equity channel. We find evidence that the Australian, Canadian, Norwegian (post 2001) and UK (post 1992) expected exchange rates increase via the oil-equity channel as oil prices rise, whereas the Japanese and Swiss expected exchange rates decrease.
    Keywords: Asset pricing; Exchange rates; International financial markets
    JEL: E E4 E43 F F3 F31 G G1 G15
    Date: 2018
  2. By: Jorda, Oscar (Federal Reserve Bank of San Francisco); Schularick, Moritz (University of Bonn); Taylor, Alan M. (University of California, Davis); Ward, Felix (University of Bonn)
    Abstract: This paper studies the synchronization of financial cycles across 17 advanced economies over the past 150 years. The comovement in credit, house prices, and equity prices has reached historical highs in the past three decades. The sharp increase in the comovement of global equity markets is particularly notable. We demonstrate that fluctuations in risk premiums, and not risk-free rates and dividends, account for a large part of the observed equity price synchronization after 1990. We also show that U.S. monetary policy has come to play an important role as a source of fluctuations in risk appetite across global equity markets. These fluctuations are transmitted across both fixed and floating exchange rate regimes, but the effects are more muted in floating rate regimes.
    JEL: E50 F33 F42 F44 G12 N10 N20
    Date: 2018–06–11
  3. By: Wei, Shang-Jin (Asian Development Bank Institute)
    Abstract: We seek to draw lessons for developing countries based on a survey of the recent literature on financial globalization. First, while capital account openness holds promises (by potentially generating a lower cost of capital, better risk sharing, and stronger disciplines on policies), they do not always work out that way in the data. Distortions in the domestic financial market, international capital market, domestic labor market, and domestic public governance can make financial globalization less beneficial for developing countries. Second, developing countries sometimes need to insulate themselves from foreign monetary policy shocks. The empirical pattern appears to be somewhere between a trilemma and a dilemma. While nominal exchange rate flexibility is insufficient for policy autonomy, capital flow management may be needed to confer more monetary policy autonomy.
    Keywords: financial globalization; monetary policy autonomy; overborrowing; capital flow management
    JEL: E42 E43 E52
    Date: 2018–01–31
  4. By: Patrick Pintus (InSHS - CNRS - Institut des Sciences Humaines et Sociales - CNRS - INS1640, GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université - EHESS - École des hautes études en sciences sociales); Yi Wen (Federal Reserve Bank of St. Louis, School of Economics and Management, Tsinghua University); Xiaochuan Xing (Department of Economics, Yale University)
    Abstract: This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and foreign economies. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of a world business-cycle component, documented by recent empirical studies through dynamic factor analysis, and the factor’s intimate link to global financial markets.
    Keywords: world interest rate,international co-movement,self-fulfilling equilibria
    Date: 2018–05
  5. By: Bletzinger, Tilman; von Thadden, Leopold
    Abstract: This paper develops a tractable model of a monetary union with a sound fiscal governance structure and shows how in such environment the design of monetary policy above and at the lower bound constraint on short-term interest rates can be linked to well-known findings from the literature dealing with single closed economies. The model adds a portfolio balance channel to a New Keynesian two-country model of a monetary union. If the monetary union is symmetric and the portfolio balance channel is not active, the model becomes isomorphic to the canonical New Keynesian three-equation economy in which central bank purchases of long-term debt (QE) at the lower bound are ineffective. If the portfolio balance channel is active, QE becomes effective and we prove that for sufficiently small shocks there exists an interest rate rule augmented by QE at the lower bound which replicates the equilibrium allocation and the welfare level of a hypothetically unconstrained economy. Shocks large enough to push the whole yield curve to the lower bound require, in addition, forward guidance. We generalise these results to an asymmetric monetary union and illustrate them through simulations, distinguishing between asymmetric shocks and asymmetric structures. In general, asymmetries give rise to current account imbalances which are, depending on the degree of financial integration, funded by private capital imports or through the central bank balance sheet channel. Moreover, our findings support that at the lower bound, as long as asymmetries between countries result from shocks, outcomes under an unconstrained policy rule can be replicated via a symmetric QE design. By contrast, asymmetric structures of the countries which matter for the transmission of monetary policy can translate into an asymmetric QE design. JEL Classification: E43, E52, E61, E63
    Keywords: lower bound, monetary policy, monetary union, quantitative easing
    Date: 2018–06
  6. By: Hope, David
    Abstract: The European sovereign debt crisis wrought major political and economic damage on the European Monetary Union (EMU). This led to a reassessment of the pre-crisis period of economic growth and stability in the EMU, shifting attention to the macroeconomic imbalances that emerged between member states, especially those in current account balances. This paper uses macroeconomic data on OECD economies and a new statistical approach for causal inference in observational studies—the synthetic control method—to estimate the effect of the EMU on the current account balances of individual member states. This ‘counterfactuals’ approach provides strong evidence that the introduction of the EMU was responsible for the divergence in current account balances among member states in the run-up to the euro crisis. The results suggest that the EMU effect operated through multiple channels and that fundamental changes to the institutional framework of the EMU may be required to safeguard the currency union against a reemergence of dangerous external imbalances in the future.
    Keywords: common currency areas; EMU; current control method; synthetic control method; European sovereign debt crisis
    JEL: F3 G3
    Date: 2016–09–01
  7. By: Chen, Natalie; Novy, Dennis
    Abstract: How do trade costs affect international trade? This paper offers a new approach. We rely on a flexible gravity equation that predicts variable trade cost elasticities, both across and within country pairs. We apply this framework to the effect of currency unions on international trade. While we estimate that currency unions are associated with a trade increase of around 38 percent on average, we find substantial underlying heterogeneity. Consistent with the predictions of our framework, we find effects around three times as strong for country pairs associated with small import shares, and a zero effect for large import shares. Our results imply that conventional homogeneous currency union estimates do not provide helpful guidance for countries considering to join a currency union. Instead, countries need to take into account the distribution of their trade shares to assess the impact of trade costs.
    Keywords: Currency Unions; euro; Gravity; Heterogeneity; Trade Costs; Trade Elasticity; Translog.
    JEL: F14 F15 F33
    Date: 2018–05
  8. By: Laura Alfaro; Alejandro Cuñat; Harald Fadinger; Yanping Liu
    Abstract: We evaluate manufacturing firms' responses to changes in the real exchange rate (RER) using detailed firm-level data for a large set of countries for the period 2001-2010. We uncover the following stylized facts: In export-oriented emerging Asia, real depreciations are associated with faster growth of firm-level TFP, higher sales and cash-flow, and higher probabilities to engage in R&D and to export. We find negative effects for firms in other emerging economies, which are relatively more import dependent, and no significant effects for firms in industrialized economies. Motivated by these facts, we build a dynamic model in which real depreciations raise the cost of importing intermediates, affect demand, borrowing-constraints and the profitability of engaging in innovation (R&D). We decompose the effects of RER changes on productivity growth across regions into these channels. We estimate the model and quantitatively evaluate the different mechanisms by providing counterfactual simulations of temporary RER movements and conduct several robustness analyses. Effects on physical TFP growth, while different across regions, are non-linear and asymmetric.
    JEL: F0 O0
    Date: 2018–05
  9. By: Agnès Bénassy-Quéré; Matthieu Bussière; Pauline Wibaux
    Abstract: The debate on trade wars and currency wars has re-emerged since the Great recession of 2009. We study the two forms of non-cooperative policies within a single framework. First, we compare the elasticity of trade flows to import tariffs and to the real exchange rate, based on product level data for 110 countries over the 1989-2013 period. We find that a 1 percent depreciation of the importer's currency reduces imports by around 0.5 percent in current dollar, whereas an increase in import tariffs by 1 percentage point reduces imports by around 1.4 percent. Hence the two instruments are not equivalent. Second, we build a stylized short-term macroeconomic model where the government aims at internal and external balance. We find that, in this setting, monetary policy is more stabilizing for the economy than trade policy, except when the internal transmission channel of monetary policy is muted (at the zero-lower bound). One implication is that, in normal times, a country will more likely react to a trade "aggression" through monetary easing rather than through a tariff increase. The result is reversed at the ZLB.
    Keywords: tariffs;exchange rates;trade elasticities;protectionism
    JEL: F13 F14 F31
    Date: 2018–06
  10. By: Krogstrup, Signe; Tille, Cédric
    Abstract: The literature on drivers of capital flows stresses the prominent role of global financial factors. Recent empirical work, however, highlights how this role varies across countries and time, and this heterogeneity is not well understood. We revisit this question by focusing on financial intermediaries' funding flows in different currencies. A portfolio model shows that the sign and magnitude of the response of foreign currency funding flows to global risk factors depend on the financial intermediary's pre-existing currency exposure. Analysis of data on European banks' aggregate balance sheets lends support to the model predictions, especially in countries outside the euro area.
    Keywords: Capital Flows; cross-border transmission of shocks; currency mismatch; European bank balance sheets.; push factors; Spillovers
    JEL: F32 F34 F36
    Date: 2018–05

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