nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒10‒22
eleven papers chosen by
Martin Berka
University of Auckland

  1. Euro Area and U.S. External Adjustment: The Role of Commodity Prices and Emerging Market Shocks By Giovannini, Massimo; Kollmann, Robert; Ratto, Marco; Roeger, Werner; Vogel, Lukas
  2. Exchange rates and prices: evidence from the 2015 Swiss franc appreciation By Raphael Auer; Ariel Burstein; Sarah M Lein
  3. Global Trends in Interest Rates By Marco Del Negro; Domenico Giannone; Marc P. Giannoni; Andrea Tambalotti
  4. Heterogeneity, Rigidity and Convergence of Labor Markets in the Euro Area By Jocelyn Maillard
  5. External debt and real exchange rates’ adjustment in the euro area: New evidence from a non linear NATREX model By Cécile Couharde; Serge Rey; Audrey Sallenave
  6. International Trade in Western Balkan Countries: Analysis Based on the Gravity Model By Eniel Ninka; Engjell Pere
  7. Overcoming the Original Sin: gains from local currency external debt By Ricardo Sabbadini
  8. Cross-Border Credit Intermediation and Domestic Liquidity Provision in a Small Open Economy By Thorvardur T. Olafsson
  9. What inflation measure should a currency union target? By William Barnett; Chan Wang; Xue Wang; Liyuan Wu
  10. Rare Disasters, Financial Development, and Sovereign Debt By Sergio Rebelo; Neng Wang; Jinqiang Yang
  11. Managing Reductions in Aid Inflows: Assessing Policy Choices in Haiti By Ioana Moldovan; Marina V Rousset; Chris Walker

  1. By: Giovannini, Massimo; Kollmann, Robert; Ratto, Marco; Roeger, Werner; Vogel, Lukas
    Abstract: The trade balances of the Euro Area (EA) and of the US have improved markedly after the Global Financial Crisis. This paper quantifies the drivers of EA and US economic fluctuations and external adjustment, using an estimated (1999-2017) three-region (US, EA, rest of world) DSGE model with trade in manufactured goods and in commodities. In the model, commodity prices reflect global demand and supply conditions. The paper highlights the key contribution of the post-crisis collapse in commodity prices for the EA and US trade balance reversal. Aggregate demand shocks originating in Emerging Markets too had a significant impact on EA and US trade balances. The broader lesson of this paper is that Emerging Markets and commodity shocks are major drivers of advanced countries’ trade balances and terms of trade.
    Keywords: EA and US external adjustment,commodity markets,emerging markets
    JEL: F2 F3 F4 F2 F3 F4
    Date: 2018
  2. By: Raphael Auer; Ariel Burstein; Sarah M Lein
    Abstract: The removal of the lower bound on the EUR/CHF exchange rate in January 2015 provides a unique setting to study the implications of a large and sudden appreciation in an otherwise stable macroeconomic environment. Using transaction-level data on non-durable goods purchases by Swiss consumers, we measure the response of border and consumer retail prices to the CHF appreciation and how household expenditures responded to these price changes. Consumer prices of imported goods and of competing Swiss-produced goods fell by more in product categories with larger reductions in border prices and a lower share of CHF-invoiced border prices. These price changes resulted in substantial expenditure switching between imported and Swiss-produced goods. While the frequency of import retail price reductions rose in the aftermath of the appreciation, the average size of these price reductions fell (and more so in product categories with larger border price declines and a lower share of CHF-invoiced border prices), contributing to low pass-through into import prices.
    Keywords: large exchange rate shocks, exchange rate pass-through, invoicing currency, expenditure switching, price-setting, nominal and real rigidities, monetary policy
    JEL: D4 E31 E50 F31 F41 L11
    Date: 2018–10
  3. By: Marco Del Negro; Domenico Giannone; Marc P. Giannoni; Andrea Tambalotti
    Abstract: The trend in the world real interest rate for safe and liquid assets fluctuated close to 2 percent for more than a century, but has dropped significantly over the past three decades. This decline has been common among advanced economies, as trends in real interest rates across countries have converged over this period. It was driven by an increase in the convenience yield for safety and liquidity and by lower global economic growth.
    JEL: E43 E44 F31 G12
    Date: 2018–09
  4. By: Jocelyn Maillard (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824. 93, Chemin des Mouilles, F-69130 Ecully, France)
    Abstract: This paper investigates the welfare consequences of labor market convergence reforms for a large range of calibrations in a two-country monetary union DSGE model with search and matching frictions. The model features trade in consumption and investment goods, price stickiness, firing costs and is calibrated to reflect the structural asymmetries of flexible and rigid countries of the Euro Area in terms of size and labor market variables. Across steady states, convergence brings welfare gains for the rigid country and welfare losses for the flexible country in most situations. The higher the flexibility induced by the convergence, the higher the gains for the rigid country and the lower the losses for the flexible country. Taking into account the transition path brings results that are qualitatively similar, but have a lower magnitude in terms of welfare gains/losses. Indeed, wage bargaining has a short-term negative impact on the rigid country and a short-term positive impact on the flexible country. As such, I conclude that convergence in labor markets can lead to substantial welfare gains in a monetary union, but only if the implementation is carefully designed.
    Keywords: Unemployment, Monetary Union, Labor Market Reform
    JEL: E32 F41 J64
    Date: 2018
  5. By: Cécile Couharde (EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique); Serge Rey (CATT - Centre d'Analyse Théorique et de Traitement des données économiques - UPPA - Université de Pau et des Pays de l'Adour); Audrey Sallenave (LEAD - Laboratoire d'Économie Appliquée au Développement - UTLN - Université de Toulon)
    Abstract: In this paper we revisit medium- to long-run real exchange rate determination within the euro area, focusing on the role of external debt. Accordingly, we rely on the NATREX approach which provides an explicit framework of the external debt-real exchange rates nexus. In particular, given the indebtedness levels reached by the euro area economies, we investigate potential non-linearity in real exchange rates dynamics, according to the level of the external debt. Our results evidence that during the monetary union, gross and net external debt positions of the euro area countries have exerted pressures on real exchange rate dynamics within the area. Moreover, we find that, beyond a threshold reached by the external debt, euro area countries are found to be in a vulnerable position, leading to an unavoidable adjustment process. Nevertheless, the adjustment process, while effective, is found to be low and occurs slowly.
    Keywords: Euro area,External debt,NATREX approach,Panel Smooth Transition Regression models,Real exchanges rates
    Date: 2018–09–24
  6. By: Eniel Ninka; Engjell Pere
    Abstract: Abstract We adopt the gravity model to analyse the international trade relations of Western Balkan (WB) countries and of the WB region as a whole, using WIIW and World Bank data, over a period of 20 years (1995-2014). Data show a tendency toward better integration of WB countries with the world economy, increased openness of their economies, persistence of their trade deficits, and, for most of them, an improvement of the coverage ratio. For the region as a whole, the volume of international trade outpaced that of intra-regional trade reaching, in 2014, a difference of nearly 5 times. The main partner for the region remains the European Union, particularly Germany and Italy. The gravity model of exports of the WB region shows that its exports are positively impacted by the common language and common borders with third countries, by trade with European Union, and large and highly industrialized countries, while distance and region’s level of per capita Gross Domestic Product both have a negative impact. Considering the imports, the model shows that they are positively impacted by existence of common borders and language with the region, and by region’s and partner countries’ level of economic development, while the distance has again a negative impact.
    Keywords: Western Balkans, International trade relations, Gravity model, Economic integration
    JEL: C59 F14 F15
    Date: 2017–11
  7. By: Ricardo Sabbadini
    Abstract: Is it better for emerging countries to issue external debt denominated in local (LC) or foreign currency (FC)? An economy issuing LC debt can avoid an explicit and costly default by inflating away its debt. However, in the hands of a discretionary policymaker, such tool might lead to excessive inflation and negative consequences for welfare. To investigate this question, I develop a quantitative model of sovereign default extended to incorporate real exchange rates and inflation. I find that an economy issuing LC debt defaults less often, sustains slightly lower debt levels, and presents positive average inflation. The net effect is a modest welfare loss when compared to issuing debt in FC. However, if monetary policy is credible, the welfare change is positive, but also of limited size. In this case, the real exchange rate serves as a buffer to accommodate negative output shocks and to prevent defaults
    Date: 2018–09
  8. By: Thorvardur T. Olafsson
    Abstract: This paper develops a small open economy model where global and domestic liquidity is intermediated to the corporate sector through two financial processes. Investment banks intermediate cross-border credit through interlinked debt contracts to entrepreneurs and commercial banks intermediate domestic savings to liquidity constrained final good producers. Both processes are needed to facilitate development of key production inputs. The model captures procyclical investment bank leverage dynamics, global liquidity spillovers, domestic money market pressures, and macrofinancial linkages through which shocks propagate across the two processes, affecting spreads and balance sheets, as well as the real economy through investment and working capital channels.
    Keywords: Financial intermediation;financial frictions, cross-border banking flows, macrofinancial linkages, working capital, credit contracts, General, Financial Markets and the Macroeconomy, International Lending and Debt Problems, Open Economy Macroeconomics
    Date: 2018–09–11
  9. By: William Barnett (Department of Economics, The University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin); Chan Wang (School of Finance, Central University of Finance and Economics, Beijing, China); Xue Wang (Department of Finance, Jinan University, Guangzhou, China); Liyuan Wu (Guanghua School of Management, Peking University, Beijing, China)
    Abstract: What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.
    Keywords: Core inflation; Headline inflation; Optimal monetary policy; Currency union; Welfare.
    JEL: E5 F3 F4
    Date: 2018–05
  10. By: Sergio Rebelo; Neng Wang; Jinqiang Yang
    Abstract: We study the implications of the interaction between rare disasters and financial development for sovereign debt markets. In our model, countries vary in their financial development, by which we mean the extent to which shocks can be hedged in international capital markets. The model predicts that low levels of financial development generate a key feature of sovereign debt in emerging economies known as “debt intolerance”: high credit spreads associated with lower debt-to-output ratios than those of developed countries.
    JEL: G18 H63
    Date: 2018–09
  11. By: Ioana Moldovan; Marina V Rousset; Chris Walker
    Abstract: A low-income country such as Haiti that confronts an environment of diminishing aid inflows must assess tradeoffs among the available policy options: spending cuts, monetization, sales of debt, or use of foreign reserves. To provide the analytical tools for this task, the paper draws from a set of DSGE models recently developed to evaluate policy choices in low-income countries for which external aid flows represent an important revenue source. Two simplified stylized variations of the main model are used to gain intuition and initially assess the trdeaoffs. Subsequenctly a full-scale small open economy DSGE model, calibrated to match conditions in Haiti and in similar low-income countries, is employed. Several key results are common to all model versions. While sales of foreign exchange reserves can compensate for the loss of aid inflows, this strategy is not sustainable. The remaining policy choices entail larger welfare costs, involving lower consumption levels and real depreciation. The results suggest that a mixture of spending cuts and depreciation is the best strategy, when use of foreign reserves is constrained.
    Keywords: General equilibrium models;Fiscal policy;Monetary policy;Public investment;International reserves;Capital inflows;Low-income developing countries;Haiti;Dynamic Stochastic General Equilibrium Model (DSGE); Aid; Fiscal Policy; Monetary Policy; Public Investment; Foreign Reserves; Haiti
    Date: 2018–09–11

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