nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒07‒08
ten papers chosen by
Martin Berka
University of Auckland

  1. Precaution Versus Mercantilism: Reserve Accumulation, Capital Controls, and the Real Exchange Rate By Woojin Choi; Alan M. Taylor
  2. A tale of two surplus countries: China and Germany By Yin-Wong Cheung; Sven Steinkamp; Frank Westermann
  3. External debt financing and macroeconomic instability in emerging market economies By Ashima Goyal; Rajeswari Sengupta; Akhilesh Verma
  4. Financial Stability Implications of Policy Mix in a Small Open Commodity-Exporting Economy By Irina Kozlovtceva; Alexey Ponomarenko; Andrey Sinyakov; Stas Tatarintsev
  5. Beggar Thy Neighbor or Beggar Thy Domestic Firms? Evidence from 2000-2011 Chinese Customs Data By Rasmus Fatum; Runjuan Liu; Jiadong Tong; Jiayun Xu
  6. Financial cycles across G7 economies: A view from wavelet analysis By Mandler, Martin; Scharnagl, Michael
  7. Public Support for the Euro and Trust in the ECB. The First Two Decades of the Common Currency By Roth, Felix; Jonung, Lars
  8. Tracking foreign capital: the effect of capital inflows on bank lending in the UK By Christiane Kneer; Alexander Raabe
  9. Does a Big Bazooka Matter? Central Bank Balance-Sheet Policies and Exchange Rates By Luca Dedola; Georgios Georgiadis; Johannes Gräb; Arnaud Mehl
  10. "The Monetary Policy Implications of a Low R-Star: An Update," Joint DNB/ECB Workshop on the Natural Rate of Interest, De Nederlandsche Bank, Amsterdam, Netherlands. By Bullard, James B.

  1. By: Woojin Choi (Korea Development Institute); Alan M. Taylor (University of California, Davis)
    Abstract: We document a new international stylized fact describing the relationship between real exchange rates and external asset holdings. Economists have long argued that the real exchange rate is associated with the net international investment position, appreciating as external wealth increases. This mechanism has been seen as central for international payments equilibrium and relative price adjustments. However, we argue that the effect of external assets held by the public sector—reserve accumulation—on real exchange rates may be quite different from that of privately held external assets, and that capital controls are a critical factor behind this difference. For 1975–2007, controlling for GDP per capita and the terms of trade, we find that a one percentage point increase in external assets relative to GDP (net of reserves) is related to an 0.24 percent real exchange rate appreciation. On the contrary, a one percentage point increase in reserve accumulation relative to GDP has virtually no effect on the real exchange rate in financially open countries (low capital controls), and is related to a 1.65 percent real exchange rate depreciation in financially closed countries (high capital controls). Results are stronger in developing countries and in more recent periods. Gross, rather than net, positions matter. We present a theoretical model to account for the stylized fact. The framework encompasses so-called precautionary and mercantilist motives for reserve accumulation, and also explains how the optimal capital account policy—the mix of reserve accumulation and capital controls—is determined. Further empirical support arises from evidence that reserve accumulation is associated with a trade surplus, along with higher GDP and TFP growth in countries with high capital controls, findings that are consistent with the mechanisms of our model.
    Keywords: international reserves, capital controls, real exchange rates, financial crises, trade, economic growth
    JEL: F31 F41 F43 O24
  2. By: Yin-Wong Cheung; Sven Steinkamp; Frank Westermann
    Abstract: We analyze current account imbalances through the lens of the two largest surplus countries; China and Germany. We observe two striking patterns visible since the 2007/8 Global Financial Crisis. First, while China has been gradually reducing its current account surplus, Germany’s surplus has continued to increase throughout and after the crisis. Second, for these two countries, there is a remarkable reversal in the patterns of exchange rate misalignment: China’s currency has turned from being undervalued to overvalued, Germany’s currency has erased its level of overvaluation and become undervalued. Our empirical analyses show that the current account balances of these two countries are quite well explained by currency misalignment, common economic factors, and country-specific factors. Furthermore, we highlight the global financial crisis effects and, for Germany, the importance of differentiating balances against euro and non-euro countries.
    Keywords: currency misalignment, current account surplus, global imbalances, global financial crisis
    JEL: F15 F31 F32
    Date: 2019
  3. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Rajeswari Sengupta (Indira Gandhi Institute of Development Research); Akhilesh Verma (Indira Gandhi Institute of Development Research)
    Abstract: We study the relationship between external debt financing and risk to macroeconomic stability using a panel vector autoregression model for a sample of ten major emerging market economies. We also focus on the linkages of key channels of external debt financing, namely external debt securities and cross-border loans. We find that external debt securities substantially impact the yield spread and the exchange rate for emerging market economies, both before and after the global financial crisis of 2008. On the other hand, the impact of cross-border flows is found to be relatively subdued for these economies in the post-crisis period. We also find that emerging economies that were already receiving a high level of external debt securities inflows experienced a relatively larger yield compression and greater exchange rate pressure compared to the economies that had a low level of external debt securities flows. It indicates higher risk exposure for EMEs with larger external debt securities flows.
    Keywords: External debt securities, cross border loans, financial stability risk, panel VAR
    JEL: E44 E51 F34 G15
    Date: 2019–05
  4. By: Irina Kozlovtceva (Bank of Russia, Russian Federation); Alexey Ponomarenko (Bank of Russia, Russian Federation); Andrey Sinyakov (Bank of Russia, Russian Federation); Stas Tatarintsev (Bank of Russia, Russian Federation)
    Abstract: In this paper, we study how systematic monetary policy under inflation targeting in a commodity-exporting economy not fully isolated from commodity price volatility by fiscal policy may contribute to financial instability by fueling the credit cycle when commodity prices increase or by amplifying the credit crunch when commodity prices decline. We report several empirical observations that illustrate the potential procyclicality (relative to credit developments) of inflation targeting policy where commodity price fluctuations are the main drivers of macroeconomic developments. Namely, we find that relative prices in commodity-exporting economies are much more volatile than in other countries. The length of periods when relative prices grow or decline is comparable to the monetary policy horizon of most inflation targeters (2-3 years). Note that the central banks that target inflation, including those of the commodity-exporting countries, usually target the headline CPI. This index accommodates relative price changes by design. We proceed with formal statistical testing using panel structural VARs and local projection models. The tests support the procyclicality of inflation targeting, but only in a group of emerging market economies, which in practice have more procyclical fiscal policy than advanced economies: monetary policy eases in response to a higher price of an exported commodity while real credit grows. Counterfactual exercises show that endogenous monetary policy responses to commodity shocks explain around 20% on average of the real credit growth in a group of commodity exporting countries for which the reaction of policy rates to commodity shocks is statistically significant. We cross-check the empirical findings by reviewing a collection of papers with estimated DSGE models and analysing impulse responses of real policy rates to commodity price changes. We also conduct a theoretical analysis and compare stabilization properties (while accounting for financial stability risks) of the inflation-targeting policy rule and the ‘leaning against the wind’ policy rules. Notably, we do this exercise conditionally on the role of commodity price shocks for the economy. For this purpose, we use the DSGE with financial frictions and a banking sector estimated basing for the Russian economy and measure the efficiency of policy results with different sensitivity to credit developments (the ‘leaning against the wind’ rules) under different variance of oil price shocks (which may be interpreted also as different efficiency of fiscal policy in insulating the economy from a given oil price volatility). Results show that when commodity price volatility is relatively high (fiscal policy is not countercyclical), leaning against the wind outperforms pure inflation targeting, thus supporting our empirical findings. Interestingly, even when the financial stability risks associated with the volatility of credit developments are negligible, a moderate leaning against the wind policy is still preferable. As policy implication, we point that a commodity-exporting economy should have countercyclical fiscal policy for inflation targeting to become countercyclical in a commodity cycle.
    Keywords: systematic monetary policy, optimal central bank policy, inflation targeting, macroprudential policy, relative prices, credit cycle, financial frictions, leaning against the wind, commodity prices
    JEL: E31 E52 E58 F41 F47
    Date: 2019–06
  5. By: Rasmus Fatum (University of Alberta); Runjuan Liu (University of Alberta); Jiadong Tong (Nankai University); Jiayun Xu (Nankai University)
    Abstract: A premise of beggar-thy-neighbor policies is that currency depreciations lead to export growth. This premise, however, does not seem validated as there is no consensus in the empirical literature regarding the impact of exchange rate changes on trade flows. We reexamine whether currency fluctuations are systematically associated with trade flows using a rich and unique Chinese customs dataset spanning the universe of bilateral Chinese transaction level trades over the 2000 to 2011 period. This dataset allows us to consider firm-level involvement in processing trade and firm-level dynamics in both export and import markets. Key findings of our firm-level estimations of trade elasticities include that the response of Chinese firms to exchanges rate changes depends strongly on the extent to which firms are involved in processing trade, i.e. heterogeneity in the extent of processing trade is crucial to understanding trade elasticities, and that the Chinese trade balance responds strongly to changes in the relative value of the Chinese Yuan, thereby implying that the influence of exchange rates on trade flows is significant and that currency depreciations do in fact lead to export growth and trade balance improvement.
    Keywords: Exchange Rate Changes, Processing Trade, Firm Dynamics, Trade Balance
    JEL: F14 F31 F41
  6. By: Mandler, Martin; Scharnagl, Michael
    Abstract: We analyse the cross-country dimension of financial cycles by studying cyclical co-movements in credit, house prices, equity prices and interest rates across the G7 economies. We use wavelet-based statistics to assess at which frequencies cyclical fluctuations and their crosscountry co-movements are important and how these change over time. We show cycles in interest rates and equity prices to be at least as synchronised as cycles in real GDP while cycles in credit and house prices are less synchronised. As a result, cross-country common cycles in equity prices and long-term interest rates account for a larger share of the volatility of these variables at the country level than common cycles in credit aggregates and house prices. A cluster analysis shows a high degree of similarity in the spectral characteristics of cycles in interest rates and equity prices across all countries but less similarities for cycles in credit and house price. For credit and house price cycles country-specific developments turn out to be more important than the common cross-country cycles.
    Keywords: financial cycles,wavelet analysis,cluster analysis,cross-country synchronisation
    JEL: C32 C38 E44 E51
    Date: 2019
  7. By: Roth, Felix (Department of Economics, University of Hamburg); Jonung, Lars (Department of Economics, Lund University)
    Abstract: This chapter examines the evolution of public support for the euro and public trust in the European Central Bank (ECB) during the new currency’s first two decades. Using a unique set of opinion poll data that is not available for any other currency, we find that a majority of citizens in every member country of the euro area (EA) support the euro. The economic crisis in the EA following the Great Recession and the euro crisis led to a slight decline in public support for the euro but a sharp fall in trust in the ECB. The recent economic recovery has strengthened support for the euro as well as trust in the ECB. We suggest that support for the euro as a medium of exchange was not strongly affected by the crisis, while trust in the ECB, as the framer of monetary policy, was measurably weakened by the crisis. Our econometric work demonstrates that unemployment is a key driver of support for the euro and its governance. Given these developments, we discuss whether the present levels of support for the euro equip the currency to weather populist challenges in the coming decade.
    Keywords: Euro; public support; trust; unemployment; optimum currency area; monetary union; ECB; EU
    JEL: E42 E52 E58 F33
    Date: 2019–06–14
  8. By: Christiane Kneer; Alexander Raabe
    Abstract: This paper examines how UK banks channel capital inflows to the individual sectors of the domestic economy and to overseas residents. Information on the source country of foreign capital deposited with UK banks allows us to construct a novel Bartik instrument for capital inflows. Our results suggest that foreign funds boost bank lending to the domestic economy. This result is due to the positive effect of capital inflows on bank lending to non-financial firms and to other domestic financial institutions. Banks do not channel capital inflows directly to households or the public sector. Much of the foreign capital is also channeled back abroad, reflecting the role of the UK as a global financial center.
    Keywords: Capital flows, bank lending, credit allocation, international finance, instrumental variables, international financial linkages
    JEL: F21 F30 F32 F34 G00 G21
    Date: 2019–07
  9. By: Luca Dedola (European Central Bank); Georgios Georgiadis (European Central Bank); Johannes Gräb (European Central Bank); Arnaud Mehl (European Central Bank)
    Abstract: We estimate the effects of quantitative easing (QE) measures by the ECB and the Federal Reserve on the US dollar-euro exchange rate at frequencies and horizons rele- vant for policymakers. To do so, we derive a theoretically-consistent local projection regression equation from the standard asset pricing formulation of exchange rate de- termination. We then proxy unobserved QE shocks by future changes in the relative size of central banks’ balance sheets, which we instrument with QE announcements in two-stage least squares regressions in order to account for their endogeneity. We find that QE measures have large and persistent effects on the exchange rate. For example, our estimates imply that the ECB’s APP program which raised the ECB’s balance sheet relative to that of the Federal Reserve by 35 percentage points between September 2014 and the end of 2016 depreciated the euro vis-`a-vis the US dollar by 12%. Regarding transmission channels, we find that a relative QE shock that ex- pands the ECB’s balance sheet relative to that of the Federal Reserve depreciates the US dollar-euro exchange rate by reducing euro-dollar short-term money market rate differentials, by widening the cross-currency basis and by eliciting adjustments in currency risk premia. Changes in the expectations about the future monetary policy stance, reflecting the “signalling” channel of QE, also contribute to the exchange rate response to QE shocks.
    Keywords: Quantitative easing, interest rate parity condition, CIP deviations
    JEL: E5 F3
  10. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Abstract: r* is, in practice, a low-frequency trend measure of a short-term real interest rate, and this talk will take a regime-switching view of this issue.{{p}}Observed low real interest rates are associated with government debt, not necessarily with capital.{{p}}There appears to be a large demand for safe assets globally, and this may be the largest factor driving real interest rates to low levels in the past three decades.{{p}}There is only modest evidence that key trends influencing the natural rate of interest are changing today.
    Date: 2019–05–16

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