nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒02‒25
twelve papers chosen by
Martin Berka
University of Auckland

  1. The magnitude of euro area misalignments By Bruno Ducoudré; Xavier Timbeau; Sébastien Villemot
  2. Oil Prices, Exchange Rates and Interest Rates By Kilian, Lutz; Zhou, Xiaoqing
  3. Sovereign Bonds since Waterloo By Meyer, Josefin; Reinhart, Carmen M.; Trebesch, Christoph
  4. The Dynamics of the U.S. Trade Balance and Real Exchange Rate: The J Curve and Trade Costs? By George A. Alessandria; Horag Choi
  5. Capital Flows in an Aging World By Zsofia Barany; Nicolas Coeurdacier; Stéphane Guibaud
  6. America First? A US-centric view of global capital flows By McQuade, Peter; Schmitz, Martin
  7. The German undervaluation regime under Bretton Woods: How Germany became the nightmare of the world economy By Höpner, Martin
  8. Can Capital Deepening Explain the Global Decline in Labor’s Share? By Andrew Glover; Jacob Short
  9. International correlation risk By Mueller, Philippe; Stathopoulos, Andreas; Vedolin, Andrea
  10. The Trials of the Trilemma: International Finance 1870-2017 By Eichengreen, Barry; Esteves, Rui
  11. Dynamic Interactions Between Financial and Macroeconomic Imbalances: A Panel VAR Analysis By Amat Adarov
  12. The Term Premium in a Small Open Economy: A Micro-Founded Approach By Alex Ilek; Irit Rozenshtrom

  1. By: Bruno Ducoudré (Observatoire français des conjonctures économiques); Xavier Timbeau (Observatoire français des conjonctures économiques); Sébastien Villemot (Ecole d'Économie de Paris - Paris School of Economics)
    Abstract: Using real equilibrium exchange rate modelling, we quantify adjustments within the euro area compatible with a current account equilibrium and a stabilisation of the net external positions of t he euro area countries. Our estimates indicate that the imbalances have shrunk since 2008, but substantial misalignments remain, and the average (absolute) mismatch relative to the euro price level amounts to 10% in 2017. The imbalances now weigh on the external equilibrium of the euro area and are increasing the risk of a medium -term appreciation in the euro. These results are robust to hypotheses on the horizon of adjustment, potential growth, output gaps and real interest rates.
    Keywords: Equilibrium exchange rate; Trade balance; Price competitiveness
    JEL: E31 F41
    Date: 2018–12
  2. By: Kilian, Lutz; Zhou, Xiaoqing
    Abstract: There has been much interest in the relationship between the price of crude oil, the value of the U.S. dollar, and the U.S. interest rate since the 1980s. For example, the sustained surge in the real price of oil in the 2000s is often attributed to the declining real value of the U.S. dollar as well as low U.S. real interest rates, along with a surge in global real economic activity. Quantifying these effects one at a time is difficult not only because of the close relationship between the interest rate and the exchange rate, but also because demand and supply shocks in the oil market in turn may affect the real value of the dollar and real interest rates. We propose a novel identification strategy for disentangling the causal effects of oil demand and oil supply shocks from the effects of exogenous shocks to the U.S. real interest rate and exogenous shocks to the real value of the U.S. dollar. We empirically evaluate popular views about the role of exogenous real exchange rate shocks in driving the real price of oil, and we examine the extent to which shocks in the global oil market drive the U.S. real exchange rate and U.S. real interest rates. Our evidence for the first time provides direct empirical support for theoretical models of the link between oil prices, exchange rates, and interest rates.
    Keywords: carry trade; commodity; Exchange rate; global real activity; interest rate; oil price
    JEL: E43 F31 F41 Q43
    Date: 2019–01
  3. By: Meyer, Josefin; Reinhart, Carmen M.; Trebesch, Christoph
    Abstract: This paper studies external sovereign bonds as an asset class. We compile a new database of 220,000 monthly prices of foreign-currency government bonds traded in London and New York between 1815 (the Battle of Waterloo) and 2016, covering 91 countries. Our main insight is that, as in equity markets, the returns on external sovereign bonds have been sufficiently high to compensate for risk. Real ex-post returns averaged 7% annually across two centuries, including default episodes, major wars, and global crises. This represents an excess return of around 4% above US or UK government bonds, which is comparable to stocks and outperforms corporate bonds. The observed returns are hard to reconcile with canonical theoretical models and with the degree of credit risk in this market, as measured by historical default and recovery rates. Based on our archive of more than 300 sovereign debt restructurings since 1815, we show that full repudiation is rare; the median haircut is below 50%.
    Keywords: coupons; default; interest rates; investor returns; portfolio; recovery; risk premiums; Sovereign debt; yields
    JEL: E4 F3 F4 G1 N0
    Date: 2019–02
  4. By: George A. Alessandria; Horag Choi
    Abstract: We study how changes in trade barriers contributed to the dynamics of the US trade balance and real exchange rate since 1980 - a period when trade tripled. Using two dynamic trade models, we decompose fluctuations in the trade balance into terms related to trade integration (global and unilateral) and business cycle asymmetries. We find three main results. First, the relatively large US trade deficits as a share of GDP in the 2000s compared to the 1980s mostly reflect a rise in the trade share of GDP. Second, controlling for trade, only about 60 percent of net trade flows are due to business cycle asymmetries. And third, about two-thirds of the contribution of business-cycle asymmetries are a lagged response. For instance, the short-run Armington elasticity is about 0.2 while the long-run is closer to 1.12 with only 6.9 percent of the gap closed per quarter. We show that a two-country IRBC model with a dynamic exporting decision, pricing-to-market, and trade cost shocks can account for the dynamics of the US trade balance, real exchange rate, and trade integration. The model clarifies how permanent and transitory changes in trade barriers affect the trade balance and how to identify changes in trade barriers. We also show the effect of temporary trade policies on the trade balance depends on whether they induce a trade war.
    JEL: E32 F4
    Date: 2019–02
  5. By: Zsofia Barany (Département d'économie); Nicolas Coeurdacier (Département d'économie); Stéphane Guibaud (Département d'économie)
    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 long-term capital flows across advanced and emerging countries.
    Keywords: Aging; Household Saving; International Capital Flows
    JEL: E21 F21 J11
    Date: 2018–12
  6. By: McQuade, Peter; Schmitz, Martin
    Abstract: Both academic researchers and policymakers posit a unique role for the US in the inter-national financial system. This paper investigates the characteristics and determinants of US cross-border financial flows and examines how these contrast with those of the rest of the world. We analyse the relative importance of US, country-specific, and global variables as determinants of aggregate and bilateral US financial flows and as determinants of country-level cross-border financial flows excluding those directly involving the US. Our results indicate that variation in US variables – notably the VIX and US dollar exchange rate – has a quantitatively important influence on global financial flows, but mostly via US cross-border flows. Global and national risk indicators perform better in explaining “rest of the world” flows. Moreover, we find that the correlation between US and rest of the world flows peaks in periods of elevated uncertainty. We interpret our findings as evidence for the existence of a global financial cycle, only some of which is driven by policies and events in the US. JEL Classification: F15, F21, F36, F42, G15
    Keywords: international capital flows, monetary policy spillovers, US dollar exchange rate, US financial system, VIX
    Date: 2019–02
  7. By: Höpner, Martin
    Abstract: Germany is an undervaluation regime, a regime that steers economic behavior towards deterioration of the real exchange rate and thereby towards export surpluses. This regime has brought the eurozone to the brink of collapse. But it is much older than the euro. It was established during the Bretton Woods years and has survived all subsequent European currency orders. The regime operates in two steps: competitive disinflation against trading partners; and resistance against correcting revaluations. The Bretton Woods order provided perfect conditions for the establishment and perpetuation of the regime: it was flexible enough for sufficient macroeconomic policy autonomy to bring about differential inflation rates, and sticky enough to delay and minimize revaluations.
    Keywords: current account surpluses,exchange rate policy,inflation,political economy,undervaluation,varieties of capitalism,Inflation,Leistungsbilanzüberschüsse,Politische Ökonomie,Spielarten des Kapitalismus,Unterbewertung,Wechselkurspolitik
    Date: 2019
  8. By: Andrew Glover; Jacob Short
    Abstract: We estimate an aggregate elasticity of substitution between capital and labor near or below one, which implies that capital deepening cannot explain the global decline in labor's share. Our methodology derives from transition paths in the neo-classical growth model. The elasticity of substitution is identified from the cross-country correlation between trends in the labor share and (a proxy for) the rental rate of capital. Trends in labor's share and the rental rate are weakly correlated across countries, and inversely related in most samples. Previous cross-country estimates of this elasticity were substantially greater than one, which we show was partly due to omitted variable bias: earlier studies used investment prices alone to proxy for the rental rate, whereas the growth model relates rental rates to investment prices and consumption growth.
    Keywords: Firm dynamics; International topics; Labour markets
    JEL: E25 E22 J3 E13
    Date: 2019
  9. By: Mueller, Philippe; Stathopoulos, Andreas; Vedolin, Andrea
    Abstract: We show that the cross-sectional dispersion of conditional foreign exchange (FX) correlation is countercyclical and that currencies that perform badly (well) during periods of high dispersion yield high (low) average excess returns. We also find a negative cross-sectional association between average FX correlations and average option-implied FX correlation risk premiums. Our findings show that while investors in spot currency markets require a positive risk premium for exposure to high dispersion states, FX option prices are consistent with investors being compensated for the risk of low dispersion states. To address our empirical findings, we propose a no-arbitrage model that features unspanned FX correlation risk.
    Keywords: correlation risk; exchange rate; international finance
    JEL: G32 F3 G3
    Date: 2017–11–01
  10. By: Eichengreen, Barry; Esteves, Rui
    Abstract: In this paper we survey the history of international finance spanning a century and a half. We start by characterizing capital flows in the long run, organizing our discussion around six facts relating to the volume and volatility of capital flows, measured in both net and gross terms. We then connect up the discussion with exchange rates and monetary policies. The organizing framework for this section is the macroeconomic trilemma. We describe where countries situated themselves relative to the trilemma over time and consider the political economy of their choices. Finally, we study the connections between international finance and economic and financial stability. We present consistent measures of growth and debt crises over the century and a half covered in this paper and discuss how their incidence is related to those institutional and political circumstances and, more generally, to the nature of the international monetary and financial regime.
    Keywords: Capital Flows; financial crises; Monetary Systems
    JEL: F21 F33 F34 N10
    Date: 2019–01
  11. By: Amat Adarov (The Vienna Institute for International Economic Studies, wiiw)
    Abstract: We use Bayesian and GMM panel VAR frameworks to study interactions between financial cycles and macroeconomic imbalances based on a global sample of 24 countries spanning the period 1998‑2012. We find that financial cycles play an important role in shaping macroeconomic imbalances with expansions inducing economic overheating and a downward pressure on public debt-to-GDP ratios, and vice versa. Bank-based economies exhibit a deeper and faster response of business cycles to financial misalignments, while the impact in market-based economies is milder, but more persistent, as well as more significant for current account and public debt dynamics. Financial cycles invoke a particularly strong reaction of current account balances and especially public debt ratios in the euro area.
    Keywords: financial cycles, macroeconomic imbalances, financial stability, business cycles, panel VAR, Bayesian VAR
    JEL: E44 F32 G15 F4
    Date: 2019–02
  12. By: Alex Ilek (Bank of Israel); Irit Rozenshtrom (Bank of Israel)
    Abstract: We study the term premium on nominal and real government bonds in a small open economy within a micro-founded DSGE model with Epstein- Zin preferences. We solve the model using a third-order approximation to allow for time-varying risk premia. We thus extend previous work on closed economies to the case of a small open economy. We find that tech- nological spillovers from the global economy to the small open economy are essential for the ability of the model to produce concurrently a sub- stantial positive nominal term premium, realistic variability of the main macroeconomic variables, and high correlations between the global and domestic economies as evident in the data. We use the model to study the effect of the openness of the economy on bond risk premia. We identify two opposing effects of the openness of the economy on the nominal term premium. The better ability of the open economy to accommodate domes- tic shocks works to decrease the term premium in the open economy. By contrast, in the presence of technological spillovers from the global econ- omy to the small open economy, the foreign technological shock generates a higher term premium in the open economy compared to a closed one. Quantitatively, in our model these effects roughly offset each other so that the term premium in the open economy is similar to the premium in an otherwise similar economy that is closed to trade in goods and financial assets.
    Date: 2017–07

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