nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒10‒15
twelve papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rates, Local Currency Pricing and International Tax Policies By Sihao Chen; Michael B. Devereux; Jenny Xu; Kang Shi
  2. History Remembered: Optimal Sovereign Default on Domestic and External Debt By Pablo D'Erasmo; Enrique G. Mendoza
  3. The Effects of Conventional and Unconventional Monetary Policy on Exchange Rates By Atsushi Inoue; Barbara Rossi
  4. Deviations in real exchange rate levels in the OECD countries and their structural determinants By Martin Berka; Daan Steenkamp
  5. Imported Intermediate Goods and Incomplete Exchange Rate Pass-Through into Export Prices By Firanchuk, Alexander
  6. Commodity Currencies and Monetary Policy By Michael B. Devereux; Gregor W. Smith
  7. Fiscal multipliers and foreign holdings of public debt By Fernando Broner; Daragh Clancy; Alberto Martin; Aitor Erce
  8. Inflation, Debt, and Default By Hur, Sewon; Kondo, Illenin O.; Perri, Fabrizio
  9. Macroprudential FX Regulations: Shifting the Snowbanks of FX Vulnerability? By Toni Ahnert; Kristin Forbes; Christian Friedrich; Dennis Reinhardt
  10. Quantifying the Natural Rate of Interest in a Small Open Economy - The Czech Case By Tibor Hledik; Jan Vlcek
  11. International spillovers of monetary policy: lessons from Chile, Korea, and Poland By Krzysztof Gajewski; Alejandro Jara; Yujin Kang; Junghwan Mok; David Moreno; Dobromił Serwa
  12. Housing Price Cycles, Current Account Imbalances and Institutions By Sariye Akcay

  1. By: Sihao Chen; Michael B. Devereux; Jenny Xu; Kang Shi
    Abstract: Empirical evidence suggests that for many countries, retail prices of traded goods are sticky in national currencies. Movements in exchange rates then cause deviations from the law of one price, and exchange rate ëmisalignmentí, which cannot be corrected by monetary policy alone. This paper shows that a state contingent international tax policy can be combined with monetary policy to eliminate exchange rate misalignment and sustain a fully efficient welfare outcome. But this monetary-fiscal mix cannot be decentralized with non-cooperative determination of monetary and fiscal policy. Non-cooperative use of taxes and subsidies introduces strategic spillovers which opens up a fundamental conflict between the goals of output gap and inflation stabilization and those of terms of trade manipulation in an open economy. The implementation of an efficient monetary-fiscal mix requires effective cooperation in fiscal policy, while leaving monetary policy to be determined non-cooperatively. In addition, while an efficient outcome requires state contingent taxes and subsidies to eliminate exchange rate misalignment, it is still necessary to have flexible exchange rates and independent monetary policy.
    JEL: F3 F4
    Date: 2018–09
  2. By: Pablo D'Erasmo; Enrique G. Mendoza
    Abstract: Infrequent but turbulent overt sovereign defaults on domestic creditors are a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives v. the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency), and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government's lack of commitment reduces sustainable debt sharply.
    JEL: E44 E6 F34 H63
    Date: 2018–09
  3. By: Atsushi Inoue; Barbara Rossi
    Abstract: What are the effects of monetary policy on exchange rates? And have unconventional monetary policies changed the way monetary policy is transmitted to international financial markets? According to conventional wisdom, expansionary monetary policy shocks in a country lead to that country's currency depreciation. We revisit the conventional wisdom during both conventional and unconventional monetary policy periods in the US by using a novel identification procedure that defines monetary policy shocks as changes in the whole yield curve due to unanticipated monetary policy moves and allows monetary policy shocks to differ depending on how they affect agents' expectations about the future path of interest rates as well as their perceived effects on the riskiness/uncertainty in the economy. Our empirical results show that: (i) a monetary policy easing leads to a depreciation of the country's spot nominal exchange rate in both conventional and unconventional periods; (ii) however, there is substantial heterogeneity in monetary policy shocks over time and their effects depend on the way they affect agents' expectations; (iii) we find favorable evidence to Dornbusch's (1976) overshooting hypothesis.
    JEL: C22 C53 F31 F37
    Date: 2018–09
  4. By: Martin Berka; Daan Steenkamp (Reserve Bank of New Zealand)
    Abstract: The most commonly used theoretical framework describing why prices in some countries are higher than in others (i.e. explaining deviations from purchasing power parity) is the Balassa-Samuelson model. The Balassa-Samuelson model implies that stronger productivity growth should tend to cause a country's real exchange rate to appreciate. This paper develops measures of productivity and real exchange rate levels across industries and countries to allow the Balassa-Samuelson hypothesis to be tested. We show that the model finds empirical support in 17 OECD economies: there is a link between real exchanges and sectoral productivity levels both across countries and over time. We then show theoretically and empirically that relaxing the model's assumptions about wage determination and the role of labour market differences across sectors and countries helps improve the performance of the model. However, there remains large unexplained deviations in real exchange rates across countries that the model cannot account for.
    Date: 2018–10
  5. By: Firanchuk, Alexander
    Abstract: This paper analyses the effect of imported inputs and the exporting country share on the degree of exchange rate pass-through (ERPT) into export prices. I present a model where firms set variable markups under oligopoly competition and imported inputs affect marginal cost. It makes two predictions: (i) the imported input share reduces ERPT (ii) the exporting country share in a destination market increases ERPT. Using industry-level data, I test the hypotheses for 57 countries over the period 2000-2015. For trade between advanced economies, imported inputs reduce ERPT, but only in the case of producer currency movements. Controlling for exporting country share, the pass-through elasticity is 39% when imported inputs are not used, but 11% when the share of imported inputs in gross exports rises to one half.
    Keywords: exchange rate pass-through,export prices,global value chains
    JEL: F12 F14 F31 F41
    Date: 2018
  6. By: Michael B. Devereux; Gregor W. Smith
    Abstract: Countries that specialize in commodity exports often exhibit a correlation between the relevant commodity price and the value of their currency. We explore a natural but little-studied explanation for this correlation. An increase in the commodity price leads to increases in the future values of the international differential in policy interest rates. The tightening of expected future monetary policy relative to the US then leads to an immediate appreciation. We show theoretically that this correlation depends on the stance of monetary policy. We then derive a statistical model that embodies this mechanism and test the over-identifying restrictions for Australia, Canada, and New Zealand. For all three countries, controlling for the effect of commodity prices in predicting current and future monetary policy leaves them no significant, remaining role in statistically explaining exchange rates.
    JEL: E52 F31 F41
    Date: 2018–09
  7. By: Fernando Broner (CREI, Universitat Pompeu Fabra, and Barcelona GSE); Daragh Clancy (ESM); Alberto Martin (CREI, Universitat Pompeu Fabra, and Barcelona GSE); Aitor Erce (ESM)
    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 1980s 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 1950s and 1960s 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: 2018–03–28
  8. By: Hur, Sewon (Federal Reserve Bank of Cleveland); Kondo, Illenin O. (University of Notre Dame); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: We study how the co-movement of inflation and economic activity affects real interest rates and the likelihood of debt crises. First, we show that for advanced economies, periods with procyclical inflation are associated with lower real interest rates. Procyclical inflation implies that nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. However, such procyclicality also increases sovereign default risk when the economy deteriorates, since the government needs to make larger (real) payments. In order to evaluate both effects, we develop a model of sovereign default on domestic nominal debt with exogenous inflation risk and domestic risk-averse lenders. Countercyclical inflation is a substitute with default, while procyclical inflation is a complement with it, by increasing default incentives. In good times, when default is unlikely, procyclical inflation yields lower real rates. In bad times, as default becomes more material, procyclical inflation can magnify default risk and trigger an increase in real rates.
    Keywords: inflation risk; domestic nominal debt; interest rates; sovereign default;
    JEL: E31 F34 G12 H63
    Date: 2018–09–28
  9. By: Toni Ahnert; Kristin Forbes; Christian Friedrich; Dennis Reinhardt
    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 regulations, 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.
    JEL: F32 F34 G15 G21 G28
    Date: 2018–09
  10. By: Tibor Hledik; Jan Vlcek
    Abstract: We identify the natural rate of interest in the Czech Republic as the real rate consistent with output at its equilibrium level and inflation at the target. To identify the rate, we use a (semi-)structural model featuring rational expectations and a forward-looking interest rate rule. Compared to the mainstream literature, the model provides a comprehensive set of cross-restrictions with respect to unobserved variables, including that of the natural rate. Furthermore, we argue that the natural rate of interest in a small open economy is a function of equilibrium real growth adjusted for equilibrium real exchange rate appreciation. Our findings suggest that the natural interest rate in the Czech Republic was around 1 percent in 2017. The current decline of the natural rate from its peak in 2015 mainly reflects the renewed appreciation of the equilibrium real exchange rate on the back of robust real GDP growth.
    Keywords: Natural rate of interest, (semi-)structural model
    JEL: C32 E43 E52 O40
    Date: 2018–07
  11. By: Krzysztof Gajewski (Narodowy Bank Polski); Alejandro Jara (Banco Central de Chile); Yujin Kang (Bank of Korea); Junghwan Mok (Bank of Korea); David Moreno (Banco Central de Chile); Dobromił Serwa (Narodowy Bank Polski)
    Abstract: In this paper, we assess evidence on international monetary policy spillovers to domestic bank lending in Chile, Korea, and Poland, using confidential bank-level data and different measures of monetary policy shocks in relevant currency areas. These three emerging market economies are small and open, their banking systems do not have significant presence overseas, and they can be considered as price takers in the world economy. Such features allow for better identification of binding financial constraints and foreign monetary policy shocks. We find that the monetary policy shocks spill over into domestic bank lending, modifying the degree to which financial frictions tighten or relax, and this evidence is consistent with international bank lending and portfolio channels.
    Keywords: monetary policy spillovers, international bank lending channel.
    JEL: E32 F32 F34 G21 G15
    Date: 2018
  12. By: Sariye Akcay
    Abstract: Recorded in history the 2007-2008 crisis is accepted to be the most serious crisis experienced after the 1929 Great Depression. This crisis began in the US. subprime mortgage markets and impacted not only the financial and real sectors in the US, but quickly became a global crisis, especially because of financial liberalization. The financial liberalization lead that the economies are increasingly integrated into international markets. Although it has presented some advantages for the economy (eg. reducing the cost of capital, raising, increasing in credit availability), it has had the role in happening some problems. Starting with the 1990s, many countries experienced an unprecedented increase in current account imbalances. Some countries appear to have current account deficits (eg. Greece, and Portugal), others have current account surplus (eg. Germany and Netherland).On the other hand, there has been an increase in asset prices, especially in housing prices within the same time period. From 2000 to 2006, house prices rose 50% in real terms in the advanced economy while they went up by almost 30% in the developing country. Again around the same time, the ‘housing boom’ has turned into a ‘bust’ in many countries and most of them have experienced deep crisis. The cost of experiencing both housing price boom-bust cycles and high current deficits concurrently has been more severe for some of them. Consequently, it can be suggested that the current account imbalances and housing price boom-bust cycles have become the defining characteristics of the period of pre-global crisis. In addition, it is seen that although the developments in the markets show similar trends in many countries, they have had the distinct characteristics. The institutional features of the economy have potential to contribute to this differentiation. However, based on literature review, there is no study on the role of institutional features in the relationship between house price dynamics and current account imbalances. The aim of the study is to examine the relationship between housing price cycles and current account imbalances as well as the role of the institutional characteristics in this relationship. For this aim, we use a simulataneous equation model. The findings show that there is a positive association between both dynamics and that the institutions affect this relationship.
    Keywords: Current Account Imbalances; European Union; Housing Prices; Institutional Characteristics
    JEL: R3
    Date: 2018–01–01

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