nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2018‒11‒26
ten papers chosen by
Martin Berka
University of Auckland

  1. FX Trading and Exchange Rate Disconnect Puzzle By Martin D. D. Evans
  2. An Intermediation-Based Model of Exchange Rates By Malamud, Semyon; Schrimpf, Andreas
  3. Macroprudential FX Regulations: Shifting the Snowbanks of FX Vulnerability? By Toni Ahnert; Kristin Forbes; Christian Friedrich; Dennis Reinhardt
  4. Debt Sustainability and the Terms of Official Support By Corsetti, G.; Erce, A.
  5. The Impact of the ECB’s Quantitative Easing Policy on Capital Flows in the CESEE Region By Anita Angelovska–Bezhoska; Ana Mitreska; Sultanija Bojcheva-Terzijan
  6. International Yield Curves and Currency Puzzles By Mikhail Chernov; Drew D. Creal
  7. Sovereign debt crises and cross-country assistance By Christian Grisse; Gisle J. Natvik
  8. Measuring Competitiveness in a World of Global Value Chains By Tamim Bayoumi; Maximiliano Appendino; Jelle Barkema; Diego A. Cerdeiro
  9. Capital Flows in an Aging World By Barany, Zsofia; Coeurdacier, Nicolas; Guibaud, Stéphane
  10. The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma By Paolo Cavallino; Damiano Sandri

  1. By: Martin D. D. Evans (Department of Economics, Georgetown University)
    Abstract: This paper examines how trading in the FX market carries the information that drives movements in currency prices over minutes, days and weeks; and now those movements are connected to interest rates. The paper first presents a model of FX trading in a Limit Order Book (LOB) that identifies how information from outside the market is reflected in FX prices and trading patterns. I then empirically examine this transmission process with the aid of a structural VAR estimated on 13 years of LOB trading data for the EURUSD, the world's most heavily traded currency pair. The VAR estimates reveal several new findings: first, they show that shocks from outside the LOB affect FX prices through both liquidity and information channel; and that the importance of these channels varies according to the source of the shock. Liquidity effects on FX prices are temporary, lasting between two and ten minutes, while information effects of shocks on prices are permanent. Second, the contemporaneous correlation between price changes and order flows varies across the shocks. Some shocks produce a positive correlation (as in standard trading models), while others produce a negative correlation. Third, the model estimates imply that intraday variations in FX prices are overwhelmingly driven by one type of shock, it accounts for 87% of hour-by-hour changes in the FX prices. The second part of the paper examines the connection between the shocks in the trading model and the macroeconomy. For this purpose, I use the VAR estimates to decompose intraday FX price changes and order flows into separate components driven by different shocks. I then aggregate these components into daily and weekly series. I find that one component of daily order flow is strongly correlated with changes in the long-term interest differentials between US and EUR rates. This suggests that the intraday shocks driving this order flow component carry news about future short-term interest rates which is embedded into FX prices. I find that intraday shocks carrying interest-rate information account for on average 56% of the variance in daily EURUSD depreciation rate between 2003 and 2015, but their variance contributions before 2007 and after 2011 are over 80%. These findings indicate that the EURUSD depreciation rate is relatively well-connected to macro fundamentals via a particular component of order flow. Finally, I show that flows embedding liquidity risk have forecasting power for daily and weekly EURUSD depreciation rates.
    Keywords: Foreign Exchange Trading, Microstructure, Order Flow, Exchange-Rate Determination
    JEL: F31 F32 F34
    Date: 2018–11–05
  2. By: Malamud, Semyon; Schrimpf, Andreas
    Abstract: We develop a general equilibrium model with intermediaries at the heart of international financial markets. In our model, intermediaries bargain with their customers and extract rents for providing access to foreign claims. The behavior of intermediaries, by tilting state prices, generates an explicit, non-linear risk structure in exchange rates. We show how this endogenous risk structure helps explain a number of anomalies in foreign exchange and international capital markets, including the safe haven properties of exchange rates and the breakdown of covered interest parity.
    Keywords: covered interest parity deviations; Exchange Rates; Financial Intermediation; safe haven
    JEL: E44 E52 F31 F33 G13 G15 G23
    Date: 2018–09
  3. 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 data set 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.
    Keywords: Financial system regulation and policies, Exchange rates, Financial institutions, International financial markets
    JEL: F32 F34 G15 G21 G28
    Date: 2018
  4. By: Corsetti, G.; Erce, A.
    Abstract: We study theoretically and quantitatively how official lending regimes affect a government's decision to raise saving as opposed to defaulting, and its implication for sovereign bond pricing by investors. We reconsider debt sustainability in the face of both output and rollover risk under two types of institutional bailouts: one based on long-maturity, low-spread loans similar to the ones offered by the euro area official lenders; the other, on shorter maturity and high-spread loans, close to the International Monetary Fund standards. We show that official lending regimes raise the stock of safe debt and facilitate consumption smoothing through debt reduction. However, to the extent that bailouts translates into higher future debt stocks and countercyclical deficits in persistent recessions, they also have countervailing effects on sustainability. Quantitatively, the model is able to replicate Portuguese debt and spread dynamics in the years of the bailout after 2011. We show that, depending on the composition of debt by maturity and official lending, sustainable debt levels can vary between 50% of GDP and 180% of GDP depending on the state of the economy and the conditions for market access. Longer maturities have a stronger effect on sustainability than lower spreads.
    Keywords: Sovereign debt, default, maturity, spread, rollover, bailout
    Date: 2018–10–31
  5. By: Anita Angelovska–Bezhoska (National Bank of Republic of Macedonia); Ana Mitreska (National Bank of Republic of Macedonia); Sultanija Bojcheva-Terzijan (National Bank of Republic of Macedonia)
    Abstract: This paper attempts to empirically assess the impact of the ECB’s quantitative easing policy on capital flows in the countries of the Central and South Eastern region. Given the tight trade and financial linkages of the region with the euro area, one should expect that the buoyant liquidity provided by the ECB might affect the size of the capital inflows. We test this hypothesis by employing panel estimation on a sample of 14 countries CESEE countries for the 2003-2015 period. Contrary to the expected outcome, the results reveal either negative or insignificant impact of the change in the ECB balance sheet on the different types of capital inflows. The results suggest that the magnitude of the crisis, to which the ECB responded to was immense, hence precluding any significant impact of the monetary easing on capital flows in the region. The inclusion of a dummy in the model, to control for the 2008 crisis confirms the findings from the first specification and also does not change the finding on the ECB quantitative easing impact on the capital flows. The impact of the crisis dummy on capital flows is negative and it holds for almost all types of capital inflows, except for the government debt flows, which is consistent with the countercyclical fiscal policies and rising public debt after the crisis.
    Keywords: quantitative easing polices, ECB, capital flows, CESEE countries, panel estimates, mean group estimator
    JEL: E43 F21 C33
    Date: 2018
  6. By: Mikhail Chernov; Drew D. Creal
    Abstract: The depreciation rate is often computed as the ratio of foreign and domestic pricing kernels. Using bond prices alone to estimate these kernels leads to currency puzzles: the inability of models to match violations of uncovered interest parity and the volatility of exchange rates. One cannot use information in bonds alone because exchange rates are not spanned by bonds. This view of the puzzles is distinct from market incompleteness. Incorporating exchange rates into estimation of yield curve models helps with resolving the puzzles. It also allows us to connect the differences between international yield curves to characteristics of exchange rates.
    JEL: F31 G12 G15
    Date: 2018–11
  7. By: Christian Grisse; Gisle J. Natvik
    Abstract: We provide a theoretical study of the interplay between cross-country assistance and expectations-driven sovereign debt crises. A self-interested "safe" country may choose to assist a "risky" country that is prone to default. Investors internalize the potential for assistance when lending to fragile countries. If the safe country is not able to commit to or rule out cross-country transfers, assistance only improves the equilibrium outcomes if the risky country is fundamentally insolvent and cannot handle its debt even at the risk-free interest rate. If a default requires pessimistic expectations, an incentive-compatible assistance policy has adverse side effects.
    Keywords: Sovereign default, self-fulfilling expectations, bailout
    JEL: F34
    Date: 2018
  8. By: Tamim Bayoumi; Maximiliano Appendino; Jelle Barkema; Diego A. Cerdeiro
    Abstract: All common real effective exchange rate indexes assume trade is only in final goods, despite the growing presence of global supply chains. Extending effective exchange rate indexes to include such intermediate goods can imply radically different effective exchange rate weights, depending on the relative substitutability of goods in final demand and in production. Unfortunately, the effect of these shifts in weights are difficult to identify empirically because the two currencies most affected—the dollar and the renminbi—have moved closely together. As the renminbi becomes more flexible, however, it will be important to determine which assumptions are the most realistic.
    Date: 2018–11–01
  9. By: Barany, Zsofia; Coeurdacier, Nicolas; Guibaud, Stéphane
    Abstract: We investigate the importance of worldwide demographic evolutions in shaping capital flows across countries and over time. Our lifecycle model incorporates cross-country differences in fertility and longevity as well as differences in countries' ability to borrow inter-temporally and across generations through social security. In this environment, global aging triggers uphill capital flows from emerging to advanced economies, while country-specific demographic evolutions reallocate capital towards countries aging more slowly. Our quantitative multi-country overlapping generations model explains a large fraction of capital flows across advanced and emerging countries and a substantial portion of the prolonged decline in the world interest rate.
    Keywords: aging; Household Saving; International Capital Flows
    JEL: E21 F21 J11
    Date: 2018–09
  10. By: Paolo Cavallino; Damiano Sandri
    Abstract: We provide a theory of the limits to monetary policy independence in open economies arising from the interaction between capital flows and domestic collateral constraints. The key feature of our theory is the existence of an “Expansionary Lower Bound” (ELB), defined as an interest rate threshold below which monetary easing becomes contractionary. The ELB can be positive, thus acting as a more stringent constraint than the Zero Lower Bound. Furthermore, the ELB is affected by global monetary and financial conditions, leading to novel international spillovers and crucial departures from Mundell’s trilemma. We present two models under which the ELB may arise, the first featuring carry-trade capital flows and the second highlighting the role of currency mismatches.
    Date: 2018–11–02

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