nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒07‒15
fifteen papers chosen by
Martin Berka
University of Auckland

  1. The Macroeconomics of the Greek Depression By Chodorow-Reich, Gabriel; Karabarbounis, Loukas; Kekre, Rohan
  2. A Tale of Two Surplus Countries: China and Germany By Yin-Wong Cheung; Sven Steinkamp; Frank Westermann
  3. A framework for debt-maturity management By Saki Bigio; Galo Nuño; Juan Passadore
  4. The Global Business Cycle: Measurement and Transmission By Zhen Huo; Andrei A. Levchenko; Nitya Pandalai-Nayar
  5. Political Animosity in the Global Value Chain: Whether Taiwanese Consumers are willing to Purchase International Brand Made in China Mainland? By ZHANG Geng; SU Shuitian
  6. Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates By Georgios Georgiadis; Feng Zhu
  7. Equilibrium real exchange rate estimates across time and space By Christoph Fischer
  8. Does a Currency Union Need a Capital Market Union? Risk Sharing via Banks and Markets By Joseba Martinez; Thomas Philippon; Markus Sihvonen
  9. Public Debt Dynamics in New Zealand By Melissa Piscetek
  10. Currency Collapses and Output Dynamics in Commodity Dependent Countries By Vincent Bodart; Jean-François Carpantier
  11. Tracking Foreign Capital: The Effect of Capital Inflows on Bank Lending in the UK By Alexander Raabe; Christiane Kneer
  12. Inflation and Exchange Rate Targeting Challenges Under Fiscal Dominance By Rashad Ahmed; Joshua Aizenman; Yothin Jinjarak
  13. Fluctuations in Global Macro Volatility By Danilo Leiva-Leon; Lorenzo Ductor
  14. Ramsey Tax Competition with Real Exchange Rate Determination By Paul Gomme
  15. The Currency Composition of International Reserves, Demand for International Reserves, and Global Safe Assets By Joshua Aizenman; Yin-Wong Cheung; Xingwang Qian

  1. By: Chodorow-Reich, Gabriel (Harvard University); Karabarbounis, Loukas (Federal Reserve Bank of Minneapolis); Kekre, Rohan (University of Chicago)
    Abstract: The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment away from taxes toward spending or away from capital taxes toward other taxes would generate longer-term production and consumption gains. Eliminating the rise in transfers to households during the boom would significantly reduce the burden of tax adjustment in the bust and the magnitude of the depression.
    Keywords: Greek Depression; Productivity; Nominal rigidity; Fiscal policy; Taxes
    JEL: E20 E32 E44 E62 F41
    Date: 2019–06–28
  2. By: Yin-Wong Cheung (City University of Hong Kong); Sven Steinkamp (Osnabrueck University); Frank Westermann (Osnabrueck University)
    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
  3. By: Saki Bigio (UCLA); Galo Nuño (Banco de España); Juan Passadore (EIEF)
    Abstract: We characterize the optimal debt-maturity management problem of a government in a small open economy. The government issues a continuum of finite-maturity bonds in the presence of liquidity frictions. We find that the solution can be decentralized: the optimal issuance of a bond of a given maturity is proportional to the difference between its market price and its domestic valuation, the latter defined as the price computed using the government’s discount factor. We show how the steady-state debt distribution decreases with maturity. These results hold when extending the model to incorporate aggregate risk or strategic default.
    Keywords: debt maturity, debt management, liquidity costs
    JEL: F34 F41 G11
    Date: 2019–06
  4. By: Zhen Huo; Andrei A. Levchenko; Nitya Pandalai-Nayar
    Abstract: This paper uses sector-level data for 30 countries and up to 28 years to provide a quantitative account of the sources of international GDP comovement. We propose an accounting framework to decompose comovement into the components due to correlated shocks, and to the cross-country transmission of shocks. We apply this decomposition in a multi-country multi-sector DSGE model. We provide an analytical solution to the global influence matrix that characterizes every country's general equilibrium GDP elasticities with respect to shocks anywhere in the world. We then provide novel estimates of country-sector-level technology and non-technology shocks to assess their correlation and quantify their contribution to comovement. TFP shocks are virtually uncorrelated across countries, whereas non-technology shocks are positively correlated. These positively correlated shocks account for two thirds of the observed GDP comovement, with international transmission through trade accounting for the remaining one third. However, trade opening does not necessarily increase GDP correlations relative to autarky, because the contribution of trade openness to comovement depends on whether sectors with more or less correlated shocks grow in influence as countries increase input linkages. Finally, while the dynamic model features rich intertemporal propagation, quantitatively these components contribute little to GDP comovement as impact effects dominate.
    JEL: F41 F44
    Date: 2019–06
  5. By: ZHANG Geng; SU Shuitian
    Abstract: This paper explored the impact of political animosity on consumers’ willingness to purchase in the context of the global value chain and found that openness value and familiarity can weaken the negative impact of political animosity on consumers’ willingness to purchase. Thus, this paper expanded the application of the consumer animosity model. The research background of this paper is whether Taiwanese consumers’ willingness to purchase is affected by political animosity when they face international clothing brand made by China Mainland. The empirical results showed that political animosity can significantly lower the willingness of Taiwanese consumers to purchase international brand with China Mainland participation in its value chain. However, if Taiwanese consumers hold higher openness value or increase their familiarity with China Mainland, the negative effect of political animosity can be effectively weakened. The empirical results also brought inspirations to everyone. If Taiwanese consumers can have an open mind to China Mainland and be more proactive in their contacts with China Mainland, their political animosity towards China Mainland will gradually disappear.
    Keywords: Political Animosity; Openness Value; Familiarity; Willing to Purchase; Global Value Chain
    Date: 2019–07–06
  6. By: Georgios Georgiadis (European Central Bank); Feng Zhu (Bank for International Settlements)
    Abstract: We assess the empirical validity of the trilemma (or impossible trinity) in the 2000s for a large sample of advanced and emerging market economies. To do so, we estimate Taylor-rule type monetary policy reaction functions, relating the local policy rate to real-time forecasts of domestic fundamentals, global variables, as well as the base-country policy rate. In the regressions, we explore variations in the sensitivity of local to base-country policy rates across different degrees of exchange rate flexibility and capital controls. We find that the data are in general consistent with the predictions from the trilemma: Both exchange rate flexibility and capital controls reduce the sensitivity of local to base-country pol- icy rates. However, we also find evidence that is consistent with the notion that the financial channel of exchange rates highlighted in recent work reduces the extent to which local policymakers decide to exploit the monetary autonomy in principle granted by flexible exchange rates in specific circumstances: The sensi- tivity of local to base-country policy rates for an economy with a flexible exchange rate is stronger when it exhibits negative foreign-currency exposures which stem from portfolio debt and bank liabilities on its external balance sheet and when base-country monetary policy is tightened. The intuition underlying this finding is that it may be optimal for local monetary policy to mimic the tightening of base-country monetary policy and thereby mute exchange rate variation because a depreciation of the local currency would raise the cost of servicing and rolling over foreign-currency debt and bank loans, possibly up to a point at which finan- cial stability is put at risk.
    Keywords: Trilemma, financial globalisation, monetary policy autonomy, spillovers
    JEL: F42 E52 C50
  7. By: Christoph Fischer (Deutsche Bundesbank)
    Abstract: Equilibrium real exchange rate and corresponding misalignment estimates differ tremendously depending on the panel estimation method used to derive them. Essentially, these methods differ in their treatment of the time-series (time) and the cross-section (space) variation in the panel. The study shows that conventional panel estimation methods (pooled OLS, fixed, random, and between effects) can be interpreted as restricted versions of a correlated random effects (CRE) model. It formally derives the distortion that arises if these restrictions are violated and uses two empirical applications from the literature to show that the distortion is generally very large. This suggests the use of the CRE model for the panel estimation of equilibrium real exchange rates and misalignments.
    Keywords: Equilibrium real exchange rate, panel estimation method, correlated random effects model, productivity approach, BEER, price competitiveness
    JEL: F31 C23
  8. By: Joseba Martinez; Thomas Philippon; Markus Sihvonen
    Abstract: We compare risk sharing in response to demand and supply shocks in four types of currency unions: segmented markets; a banking union; a capital market union; and complete financial markets. We show that a banking union is efficient at sharing all domestic demand shocks (deleveraging, fiscal consolidation), while a capital market union is necessary to share supply shocks (productivity and quality shocks). Using a calibrated model we provide evidence of substantial welfare gains from a banking union and, in the presence of supply shocks, from a capital market union.
    JEL: E5 F02 F3 F40
    Date: 2019–06
  9. By: Melissa Piscetek (The Treasury)
    Abstract: This paper develops a framework to decompose the change in New Zealand’s public debt ratio into four component effects: the primary balance, real GDP growth, real interest rates, and exchange rates. We study New Zealand's debt dynamics over three periods: the decade after the Global Financial Crisis (2008 – 2018), the five-year forecasts (2019 – 2023), and the medium-term projections (2024 – 2033). We find asymmetry between the component effects of the debt dynamics on New Zealand's public debt ratio. The primary balance is the larger contributor to the public debt ratio (either positive or negative), while the automatic debt dynamics (the interest-growth differential and exchange rates) are relatively benign.
    Keywords: Public debt; debt dynamics; fiscal policy, debt sustainability, fiscal sustainability
    Date: 2019–07
  10. By: Vincent Bodart (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Jean-François Carpantier (Aix-Marseille University, CERGAM)
    Abstract: This paper provides new empirical evidence on the relationship between currency collapses (i.e. large nominal depreciations or devaluations) and real output by paying a specific attention to commodity exporting countries. Using a dataset including 108 emerging and developing economies for the period 1970-2016, we document and estimate what happens to output growth during episodes of currency collapses for commodity-dependent and non commodity-dependent countries. One particular feature of our analysis is to control for war events. We find that currency crises occur more frequently in commodity-dependent countries (one crisis every 17 years versus 30 years for non commodity-dependent countries) and with a larger magnitude (median depreciation about 12 percent points larger for commodity-dependent countries). In both groups of countries, output growth declines in response to the currency collapse. It appears however that output growth starts to slowdown earlier in commodity-dependent countries while the impact is more persistent in non commodity-dependent countries. The magnitude of the output growth slowdown is very close between the two groups of countries. Finally, we find that the output growth-currency collapse relationship differs among commodity-dependent countries according to the category of their main exported commodity.
    Keywords: Currency crises, nominal depreciations, commodity currencies, exchange rates, output growth, recovery
    JEL: E32 F31 F32 F41 F43 Q02
    Date: 2019–06
  11. By: Alexander Raabe (IHEID, Graduate Institute of International and Development Studies, Geneva); Christiane Kneer (Bank of England)
    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: 2019–06–30
  12. By: Rashad Ahmed; Joshua Aizenman; Yothin Jinjarak
    Abstract: Countries have increased significantly their public-sector borrowing since the Global Financial Crisis. In this context, we document several potential fiscal dominance effects during 2000-2017 under Inflation Targeting (IT), and non IT regimes. Higher ratio of public debt to GDP are associated with lower policy interest rates in advanced economies. In Emerging Market economies under non-IT regimes, composed mostly of exchange rate targeters, the interest rate effect of higher public debt is non-linear, and depends both on the ratio of foreign-currency to local-currency debt, and on the ratio of hard-currency debt to GDP. For these Emerging Market economies under non-IT regimes, real exchange rate depreciations and a higher international reserves to GDP ratio are significantly associated with higher interest rates. Sorting countries into low, medium and high nominal exchange rate volatility bins, we find that the high nominal exchange rate volatility group of Emerging Market economies, composed mostly of commodity intensive countries, show the most persuasive evidence of debt levels influencing policy interest rates.
    JEL: F31 F33 F34 F36 F41
    Date: 2019–06
  13. By: Danilo Leiva-Leon (Banco de España); Lorenzo Ductor (Universidad de Granada)
    Abstract: We rely on a hierarchical volatility factor approach to estimate and decompose time-varying second moments of countries output growth into global, regional and idiosyncratic contributions. We document a “global moderation” of international business cycles, defined as a persistent decline in macroeconomic volatility across the main world economies. This decline in volatility was induced by a reduction in the underlying global component, uncovering a new level of interconnection of the world economy. After assessing the importance of different economic factors, we find that the reduction in overall countries macroeconomic volatility can be mainly explained by the increasing trade openness exhibited in recent decades. Likewise, the idiosyncratic component of countries volatility is also influenced by domestic monetary policies.
    Keywords: output volatility, factor model, model uncertainty
    JEL: C11 C32 F44 E32
    Date: 2019–07
  14. By: Paul Gomme (Concordia University, CIREQ and CIRANO)
    Abstract: How should governments choose tax rates when they face competition from other jurisdictions? This questions is answered by solving for the Nash equilibrium of the game played between Ramsey planners in a two good, two country open economy macroeconomic model. It is shown, analytically, that the planers do not tax capital income in the long run. Short term results, obtained computationally, reveal that the government of the larger country manages the path of the real exchange rate in order to manipulates its smaller rival's choice of tax rates. Tax competition does not lead to a "race to the bottom."
    Keywords: Optimal fiscal policy; open economy macroeconomics; Ramsey taxation
    JEL: E32 E52 F41
    Date: 2019–07–02
  15. By: Joshua Aizenman; Yin-Wong Cheung; Xingwang Qian
    Abstract: This paper examines determinants of the international reserves (IR) currency composition before and after the Global Financial Crisis (GFC). Applying the annual data of 58 countries, we confirm that countries that trade more with the US, euro zone, UK, and Japan, and issue more debt denominated in the big four currencies (US dollar, euro, pound, yen) hoard more IR in these currencies. We find scale effects in which countries tend to diversify from the big four currencies as they increase their IR/GDP and that a growing shortage of global safe assets (GSAs) induces countries to hold more big four currencies. Countries hold less big four currencies as IR after the 2008 GFC, while they hold more of such currencies since the tapering of the Fed’s quantitative easing. The 2008 GFC and QE tapering weakened and sometimes reversed the effect of several economic factors. We also find that TARGET2 balances matter for the currency composition in the euro zone; commodity-exporting countries tend to diversify their IR from the big four currencies when their terms of trade improve; and that the valuation effects induced by Euro/USD exchange rate changes diminish the significance of the GFC in explaining the currency composition of IR.
    JEL: F15 F3 F31
    Date: 2019–06

This nep-opm issue is ©2019 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.