nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒08‒27
twelve papers chosen by
Martin Berka
University of Auckland

  1. A Theory of Foreign Exchange Interventions By Sebastian Fanelli; Ludwig Straub
  2. The Factor Content of Equilibrium Exchange Rates By Richard H. Clarida
  3. The real exchange rate, innovation and productivity : regional heterogeneity, asymmetries and hysteresis By Alfaro, Laura; Cunat, Alejandro; Liu, Yanping; Fadinger, Harald
  4. Gradual Portfolio Adjustment: Implications for Global Equity Portfolios and Returns By Philippe Bacchetta; Eric van Wincoop
  5. New Marshall-Lerner Conditions for an Economy with Outward and Two-Way Foreign Direct Investment By Paul J.J. Welfens
  6. Reputation and Sovereign Default By Manuel Amador; Christopher Phelan
  7. Fiscal buffers, private debt and recession: the good, the bad and the ugly By Nicoletta Batini; Giovanni Melina; Stefania Villa
  8. The internationalization of the Renminbi and the evolution of China’s monetary policy By Ramaa Vasudevan
  9. Revisiting the Exchange Rate Pass Through: A General Equilibrium Perspective By Mariana García-Schmidt; Javier Garcia-Cicco
  10. The Missing Profits of Nations By Thomas R. Tørsløv; Ludvig S. Wier; Gabriel Zucman
  11. Capital controls spillovers By Valerio Nispi Landi
  12. International Spillovers of Monetary Policy: Evidence from France and Italy By Julia Schmidt; Marianna Caccavaio; Luisa Carpinelli; Giuseppe Marinelli

  1. By: Sebastian Fanelli (MIT); Ludwig Straub (MIT)
    Abstract: This paper develops a theory of foreign exchange interventions in a small open economy with limited capital mobility. Home and foreign bond markets are segmented and intermediaries are limited in their capacity to arbitrage across markets. As a result, the central bank can implement nonzero spreads by managing its portfolio. Crucially, spreads are inherently costly, over and above the standard costs from distorting households’ consumption profiles. The extra term is given by the carry-trade profits of foreign intermediaries, is convex in the spread—as more foreign intermediaries become active carry traders—and increasing in the openness of the capital account—as foreign intermediaries find it easier to take larger positions. Optimal interventions balance these costs with terms of trade benefits. We show that they lean against the wind of global capital flows to avoid excessive currency appreciation. Due to the convexity of the costs, interventions should be small and spread out, relying on credible promises (forward guidance) of future interventions. By contrast, excessive smoothing of the exchange rate path may create large spreads, inviting costly speculation. Finally, in a multi-country extension of our model, we find that the decentralized equilibrium features too much reserve accumulation and too low world interest rates, highlighting the importance of policy coordination.
    Date: 2018
  2. By: Richard H. Clarida
    Abstract: This paper develops framework to estimate and interpret the factor content of equilibrium real exchange rates. The framework – which builds on Backus, Foresi, and Telmer (2001) and Ang Piazzesi (2003) – respects the restrictions imposed by stochastic discount factors that generate standard, no arbitrage, essentially affine term structure models of inflation indexed bond yields in a home and a foreign country. We derive a sufficient set of parameter restrictions on the SDFs that deliver a stationary real exchange rate that is linear in the factors that govern the evolution of the SDFs. Our model implies that both the real exchange rate, and the ex ante real exchange rate risk premium at any horizon are linear functions of a “home” and ”foreign” factors and that inflation indexed bond yields are functions of these factors as well as a “global” factor that accounts for the observed correlation in bond yield levels across countries. Home and foreign factors in turn are simple linear functions of the level slope and curvature factors extracted from home and foreign yield curves a la Litterman and Scheinkman (1991). We find that a real exchange rate risk premium accounts for about half the variance of the dollar – pound real exchange rate and that this risk premium if fully accounted for by the traditional level, slope, and curve curve factors in the UK linkers curve. We find that a home factor accounts for about 40 percent of the variance of the real exchange rate, and that this home factor is fully accounted for by the US specific component of the LS level factor in the US TIPs curve.
    JEL: F3
    Date: 2018–06
  3. By: Alfaro, Laura; Cunat, Alejandro; Liu, Yanping; Fadinger, Harald
    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.
    Keywords: real exchange rate , innovation , productivity , exporting , importing , financial constraints , firm-level data
    JEL: F O
    Date: 2018
  4. By: Philippe Bacchetta (University of Lausanne, Swiss Finance Institute, and CEPR); Eric van Wincoop (University of Virginia)
    Abstract: Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio decisions is stochastic rather than fixed, leading to a smoother response to shocks. Second, rather than only considering asset returns, we also use data on portfolio shares to confront the model to the data. Conditional on reasonable risk aversion, we find that the data is consistent with infrequent portfolio decisions, with a frequency of at most once in 15 months on average.
    Keywords: gradual portfolio adjustment, international portfolio allocation, predictable excess returns
    JEL: F30 F41 G11 G12
    Date: 2017–04
  5. By: Paul J.J. Welfens (Europäisches Institut für Internationale Wirtschaftsbeziehungen (EIIW))
    Abstract: Summary: The international debate about trade imbalances often puts the focus on the role of domestic GDP/foreign GDP and the role of real exchange rate changes – with respect to the latter adjustment channel, the standard question is whether or not the Marshall-Lerner condition is fulfilled. With outward foreign direct investment (FDI) and inward FDI becoming increasingly important, the question about the real exchange rate impact on the trade balance has to be restated as imports are proportionate to real gross national income and this indeed implies a new Marshall-Lerner condition. It is shown that with outward cumulated FDI, the modified condition is stricter than the traditional case and with both outward FDI and inward FDI, the elasticity requirement is ambiguous. “FDI globalization” might go along with unpleasant trade imbalance problems so that additional empirical research is needed as well as stronger international policy cooperation as high trade balance deficits/high trade balance surplus positions could be rather difficult to correct through exchange rate adjustments only. Looking at the import elasticities for all partner countries of the US – or country x – together is quite misleading for policymakers. Zusammenfassung: Die internationale Debatte zu Handelsbilanzungleichgewichten fokussiert häufig auf die Rolle von inländischem oder ausländischem Bruttoinlandsprodukt und die Rolle realer Wechselkursänderungen – dabei ist mit Blick auf letzteren Anpassungskanal ein gewichtige Standardfrage, ob die Marshall-Lerner Bedingung erfüllt ist. Mit der zunehmenden Bedeutung von Direktinvestitionsabflüssen und Direktinvestitionszuflüssen muss die Frage nach der Rolle des realen Wechselkurses mit Blick auf die Handelsbilanzreaktion neu gestellt werden, da die Güterimporte proportional zum realen Brutto-Nationaleinkommen sind; das bedeutet eine neue, veränderte Marshall-Lerner Bedingung. Gezeigt wird, dass bei kumulierten Auslandsdirektinvestitionen die modifizierte Bedingung strikter als die traditionelle Bedingung ist: Die Direktinvestitionsintensität, die ausländische Gewinnquote und die Größe des Landes relative zum Welteinkommen spielen nun zusätzlich eine wichtige Rolle. Hat man sowohl Zuflüsse wie Abflüsse bei Direktinvestitionen wird die Bedingung uneindeutig. “Direktinvestitions-Globalisierung” könnte von daher mit unerfreulichen Handelsbilanz-Ungleichgewichtsproblemen einhergehen, wobei zusätzliche empirische Forschung notwendig ist; ebenso zudem verstärkte international Politikkooperation, da hohe Defizit- oder Überschusspositionen kaum allein durch reale Wechselkursänderung zu korrigieren sind. Protektionismus-Politik, die zu Direktinvestitionen als Mittel zum Überspringen von Zollmauern führt, unterminiert die Handelsbilanzanpassung via reale Wechselkurse. Wenn man die Importelastizitäten für alle Handelspartner zusammen betrachtet, ist das irreführend für die Politik.
    Keywords: Trade balance, foreign direct investment, real exchange rate, macroeconomics, economic policy
    JEL: E22 E61 F10 F21 F31 F40 F41
    Date: 2018–07
  6. By: Manuel Amador; Christopher Phelan
    Abstract: This paper presents a continuous-time model of sovereign debt. In it, a relatively impatient sovereign government's hidden type switches back and forth between a commitment type, which cannot default, and an optimizing type, which can default at any time, and assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. If these beliefs satisfy reasonable assumptions, in any Markov equilibrium, the optimizing type mimics the commitment type when borrowing, revealing its type only by defaulting on its debt at random times. Further, in such Markov equilibria (the solution to a simple pair of ordinary differential equations), there are positive gross issuances at all dates, constant net imports as long as there is a positive equilibrium probability that the government is the optimizing type, and net debt repayment only by the commitment type. For countries that have recently defaulted, the interest rate the country pays on its debt is a decreasing function of the amount of time since its last default, and its total debt is an increasing function of the amount of time since its last default. For countries that have not recently defaulted, interest rates are constant.
    JEL: F3 F34
    Date: 2018–06
  7. By: Nicoletta Batini (International Monetary Fund (IMF)); Giovanni Melina (International Monetary Fund (IMF)); Stefania Villa (Bank of Italy)
    Abstract: Focusing on Euro-Area countries, we show empirically that higher private debt leads to deeper recessions while higher public debt does not, unless its level is especially high. We then build a general equilibrium model that replicates these dynamics and use it to design a policy that can mitigate the recessionary consequences of private deleveraging. In the model, in the aftermath of financial shocks, recessions are milder and public debt is more contained when the government lends directly to those households and firms that face binding borrowing constraints. As a consequence, large fiscal buffers are critical to enhance macroeconomic resilience to financial shocks.
    Keywords: private debt, public debt, financial crisis, financial shocks, borrowing constraints, fiscal limits
    JEL: E44 E62 H63
    Date: 2018–07
  8. By: Ramaa Vasudevan (Colorado State University)
    Abstract: This paper explores the evolution of monetary policy in the context of the distinct path China and the PBoC have adopted in fostering the international role of the renminbi. Instead of focusing on the PBoC’s negotiation of the impossible trinity of flexible exchange rates, capital mobility and independent monetary policy, the paper highlights the challenges the PBoC faces as it promotes the use renminbi, in international lending in particular, while simultaneously seeking to contain and discipline the inherent instability and potentially disruptive logic of finance.
    Keywords: China, monetary policy, internationalization of renminbi, impossible trinity
    JEL: F33 F36 G28
    Date: 2018–08
  9. By: Mariana García-Schmidt; Javier Garcia-Cicco
    Abstract: A large literature estimates the exchange rate pass-through to prices (ERPT) using reducedform approaches, whose results are an important input for analyses at Central Banks. We study the usefulness of these empirical measures for actual monetary policy analysis and decision making, emphasizing two main problems that arise naturally from a general equilibrium perspective. First, while the literature describes a single ERPT measure, in a general equilibrium model the evolution of the exchange rate and prices will differ depending on the shock hitting the economy. Accordingly, we distinguish between conditional and unconditional ERPT measures, showing that they can lead to very different interpretations. Second, in a general equilibrium model the ERPT crucially depends on the expected behavior of monetary policy, but the empirical approaches in the literature cannot account for this and thus provide a misleading guide for policy makers. We first use a simple model of a small and open economy to qualitatively show the intuition behind these two critiques. We then highlight the quantitative relevance of these distinctions by means of a DSGE model of a small and open economy with sectoral distinctions, real and nominal rigidities, and a variety of driving forces; estimated using Chilean data.
    Date: 2018–08
  10. By: Thomas R. Tørsløv; Ludvig S. Wier; Gabriel Zucman
    Abstract: By combining new macroeconomic statistics on the activities of multinational companies with the national accounts of tax havens and the world's other countries, we estimate that close to 40% of multinational profits are shifted to low-tax countries each year. Profit shifting is highest among U.S. multinationals; the tax revenue losses are highest for the European Union and developing countries. We show theoretically and empirically that in the current international tax system, tax authorities of high-tax countries do not have incentives to combat profit shifting to tax havens. They instead focus their enforcement effort on relocating profits booked in other high-tax countries—in effect stealing revenue from each other. This policy failure can explain the persistence of profit shifting to low-tax countries despite the high costs involved for high-tax countries. We provide a new cross-country database of GDP, corporate profits, trade balances, and factor shares corrected for profit shifting, showing that the global rise of the corporate capital share is significantly under-estimated.
    JEL: F23 H26 H87
    Date: 2018–06
  11. By: Valerio Nispi Landi (Bank of Italy)
    Abstract: I built a three-country business cycle model with one AE and two EMEs to analyze the spillover effects arising from capital controls. I find that, following a push-factor shock from the AE, if one EME tightens capital controls, the other EME experiences an additional wave of foreign investments. In addition, the spillover effects are economically meaningful and can be sizable under specific conditions. Moreover, my findings point out that, in the presence of international financial frictions, moderate capital controls may be useful to EMEs to affect the interest rate at which they trade international bonds. Finally, based on my results, coordination among EMEs in setting capital controls seems to deliver relatively small welfare gains compared with the Nash equilibrium.
    Keywords: capital controls, open economy macroeconomics, international business cycles
    JEL: F41 F44
    Date: 2018–07
  12. By: Julia Schmidt; Marianna Caccavaio; Luisa Carpinelli; Giuseppe Marinelli
    Abstract: In this paper we provide empirical evidence on the impact of US and UK monetary policy changes on credit supply of banks operating in Italy and France over the period 2000-2015, exploring the existence of an international bank lending channel. Exploiting bank balance sheet heterogeneity, we find that monetary policy tightening abroad leads to a reduction of credit supply at home, in particular for US monetary policy changes. Our results show that USD funding plays an important role in the transmission mechanism, especially for French banks which rely to a larger extent on USD funding. We also show that banks adjust their euro and foreign currency lending differently, thus implying that funding sources in different currencies are not perfect substitutes. This is especially the case when tensions in currency swap markets are high, thus resulting in costly cross-currency funding.
    Keywords: Spillovers, Monetary Policy, International Banking
    JEL: E52 F42 G21
    Date: 2018

This nep-opm issue is ©2018 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.