nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒08‒12
ten papers chosen by
Martin Berka
University of Auckland

  1. Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates By Georgios Georgiadis; Feng Zhu
  2. Growth of international finance and emerging economies: Elements for alternative approach By Alves, C.; Toporowski, J.
  3. Current account dynamics and exchange rate regimes in Central and Eastern Europe By Kersti Harkmann; Karsten Staehr
  4. East Asian Value Chains, Exchange Rates, and Regional Exchange Rate Arrangements By Willem THORBECKE
  5. Has globalization changed the inflation process? By Kristin Forbes
  6. International Fiscal-financial Spillovers: The Effect of Fiscal Shocks on Cross-border Bank Lending By Sangyup Choi; Davide Furceri; Chansik Yoon
  7. Expectations-driven liquidity traps: implications for monetary and fiscal policy By Nakata, Taisuke; Schmidt, Sebastian
  8. The macroeconomic effects of international uncertainty By Cuaresma, Jesús Crespo; Huber, Florian; Onorante, Luca
  9. Medium-term asymmetric fluctuations and EMU as an optimum currency area By Jeroen Hessel
  10. Exchange Rate Driven Balance Sheet Effect and Capital Flows to Emerging Market Economies By Can Kadirgan

  1. By: Georgios Georgiadis; Feng Zhu
    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 policy 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 sensitivity 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 financial stability is put at risk.
    Keywords: Trilemma, financial globalisation, monetary policy autonomy, spillovers
    JEL: F42 E52 C50
    Date: 2019–07
  2. By: Alves, C.; Toporowski, J.
    Abstract: This paper examines the increasing cross-border flows of capital involving developing and emerging economies in the past few decades. The discussion challenges the traditional economic theories based on net capital flows and deficits in current accounts to explain international borrowing by developing countries, and on the current account imbalances approach to explain financial crises. We argue that the increasing involvement of the private sector in developing countries’ external debt and the fact that the public sector, previously reliant almost entirely on official credit, has become able to access private debt markets, reflect the increasing integration of developing countries into the global financial system, and this process has particular features. A closer look at data on gross capital flows reveals that net capital flows neither explain nor capture this global financial integration.
    Keywords: developing and emerging economies, private Non-Guaranteed external debt, cross-border flows, financial globalisation, Borio and Disyatat
    JEL: F3 G1 G3 H6
    Date: 2019–03–25
  3. By: Kersti Harkmann; Karsten Staehr
    Abstract: The paper seeks to determine the factors that drive the current account dynamics of the 11 EU members from Central and Eastern Europe (CEE). Panel data models are estimated on annual data for the period 1997–2017 and both domestic pull factors and external push factors are included. The models are, as a key innovation, estimated separately for floating and fixed exchange rate regimes. The current account exhibits substantial persistence in both cases. For the floaters, the current account has been driven by domestic factors while external factors appear unimportant. For the fixers, the current account has mainly been driven by external factors, suggesting there is substantial vulnerability to external developments. The analysis underscores the importance of the exchange rate regime for the drivers of the current account balance in the CEE countries.
    Keywords: current account balance, exchange rate regime, economic policies, Central and Eastern Europe
    JEL: F32 F33 P33
    Date: 2019–01–23
  4. By: Willem THORBECKE
    Abstract: Tariffs and trade wars threaten East Asian economies. Exchange rate appreciations would be less disruptive than protectionism. This paper reports dynamic ordinary least squares findings indicating that appreciations in Asian supply chain countries reduce exports and increase imports. However, despite large current account surpluses, there has been little exchange rate appreciation outside of China. Modified Frankel-Wei (1994) regressions indicate that Asian countries focus on the U.S. dollar in their implicit currency baskets. These high weights on the dollar imply that regional exchange rates are in a Nash Equilibrium. No Asian country wants its exchange rate to appreciate against the dollar for fear of losing price competitiveness relative to its neighbors. A better equilibrium would occur if they assigned more weight to regional currencies and less to the dollar. This would facilitate a concerted appreciation of Asian currencies against the dollar.
    Date: 2019–06
  5. By: Kristin Forbes
    Abstract: The relationship central to most inflation models, between slack and inflation, seems to have weakened. Do we need a new framework? This paper uses three very different approaches - principal components, a Phillips curve model, and trend-cycle decomposition - to show that inflation models should more explicitly and comprehensively control for changes in the global economy and allow for key parameters to adjust over time. Global factors, such as global commodity prices, global slack, exchange rates, and producer price competition can all significantly affect inflation, even after controlling for the standard domestic variables. The role of these global factors has changed over the last decade, especially the relationship between global slack, commodity prices, and producer price dispersion with CPI inflation and the cyclical component of inflation. The role of different global and domestic factors varies across countries, but as the world has become more integrated through trade and supply chains, global factors should no longer play an ancillary role in models of inflation dynamics.
    Keywords: inflation, Phillips curve, trend-cycle, price dynamics, globalization
    JEL: E31 E37 E52 E58
    Date: 2019–07
  6. By: Sangyup Choi; Davide Furceri; Chansik Yoon
    Abstract: This paper sheds new light on the degree of international fiscal-financial spillovers by investigating the effect of domestic fiscal policies on cross-border bank lending. By estimating the dynamic response of U.S. cross-border bank lending towards the 45 recipient countries to exogenous domestic fiscal shocks (both measured by spending and revenue) between 1990Q1 and 2012Q4, we find that expansionary domestic fiscal shocks lead to a statistically significant increase in cross-border bank lending. The magnitude of the effect is also economically significant: the effect of 1 percent of GDP increase (decrease) in spending (revenue) is comparable to an exogenous decline in the federal funds rate. We also find that fiscal shocks tend to have larger effects during periods of recessions than expansions in the source country, and that the adverse effect of a fiscal consolidation is larger than the positive effect of the same size of a fiscal expansion. In contrast, we do not find systematic and statistically significant differences in the spillover effects across recipient countries depending on their exchange rate regime, although capital controls seem to play some moderating role. The extension of the analysis to a panel of 16 small open economies confirms the finding from the U.S. economy.
    Date: 2019–07–12
  7. By: Nakata, Taisuke; Schmidt, Sebastian
    Abstract: We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents’ confidence can give rise to persistent liquidity trap episodes. Unlike in the case of fundamental-driven liquidity traps, there is no straightforward recipe for mitigating the welfare costs and the systematic inflation shortfall associated with expectations-driven liquidity traps. Raising the inflation target or appointing an inflation-conservative central banker improves inflation outcomes away from the lower bound but exacerbates the shortfall at the lower bound. Using government spending as an additional policy tool worsens stabilization outcomes both at and away from the lower bound. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society can eliminate expectations-driven liquidity traps altogether. JEL Classification: E52, E61, E62
    Keywords: discretion, effective lower bound, fiscal policy, monetary policy, policy delegation, sunspot equilibria
    Date: 2019–08
  8. By: Cuaresma, Jesús Crespo; Huber, Florian; Onorante, Luca
    Abstract: This paper proposes a large-scale Bayesian vector autoregression with factor stochastic volatility to investigate the macroeconomic consequences of international uncertainty shocks in G7 countries. The curse of dimensionality is addressed by means of a global-local shrinkage prior that mimics certain features of the well-known Minnesota prior, yet provides additional flexibility in terms of achieving shrinkage. The factor structure enables us to identify an international uncertainty shock by assuming that it is the joint volatility process that determines the dynamics of the variance-covariance matrix of the common factors. To allow for first and second moment shocks we, moreover, assume that the uncertainty factor enters the VAR equation as an additional regressor. Our findings suggest that the estimated uncertainty measure is strongly connected to global equity price volatility, closely tracking other prominent measures commonly adopted to assess uncertainty. The dynamic responses of a set of macroeconomic and financial variables show that an international uncertainty shock exerts large effects on all economies and variables under consideration. JEL Classification: C30, E52, F41, E32
    Keywords: factor stochastic volatility, global propagation of shocks, global uncertainty, vector autoregressive models
    Date: 2019–07
  9. By: Jeroen Hessel
    Abstract: Recent studies find that short-term fluctuations in EMU have been symmetric. This finding leads to benign views on the functioning of EMU as an optimum currency area (OCA), that are difficult to reconcile with the sovereign debt crisis. We try to solve this puzzle by looking at medium-term fluctuations instead, and reach five conclusions. First, medium-term fluctuations in EMU are much larger and less symmetric than short-term fluctuations. Second, medium-term fluctuations have become larger and less symmetric over time, while short-term fluctuations have become smaller and more symmetric. Third, medium-term fluctuations in EMU are less symmetric than in the US, while short-term fluctuations are more symmetric. Fourth, medium-term fluctuations in the euro area have become more strongly correlated with financial variables like credit and house prices, and less strongly correlated with real variables like productivity. Finally, medium-term fluctuations are more closely related to imbalances in price competitiveness, current accounts and budget deficits than short-term fluctuations. We conclude that our medium-term perspective has become relevant in the monetary union, due to the increasing importance of financial factors. It leads to less benign views on the functioning of EMU and on the endogenous OCA hypothesis.
    Keywords: EMU; optimum currency areas; economic fluctuations; financial cycle
    JEL: E44 E58 F36 G15 G21
    Date: 2019–07
  10. By: Can Kadirgan
    Abstract: Turkish firm-level data suggests that firms borrowing from domestic banks have, on average, a higher degree of currency mismatch than firms with direct access to international financial markets. Higher FX exposure for the former group implies that their balance sheet are more likely to deteriorate when the local currency depreciates. This risk might in turn spillover onto creditors, potentially affecting the financial health of domestic banks. In a set of emerging market economies, I indeed find that when global liquidity tightens, domestic banks are more adversely affected by the above described channel, than firms with direct access to international financial markets. When the US$ index is countercyclical over the global credit cycle, countries whose foreign currency liabilities are heavily weighted in US$ experience a larger valuation effect. Using this variation to identify the exchange rate driven balance sheet effect, I find that banking sectors in countries heavily indebted in US$ have more difficulties accessing foreign funds when global liquidity tightens. In the same countries, this additional hindrance is however absent for firms with direct access to international financial markets. I develop a partial equilibrium model whose predictions are consistent with these results. The results favor the implementation of FX-related macro prudential policies during periods of abundant global liquidity. These policies should reinforce the financial stability of the banking system at a potential reversal of global funds.
    Keywords: FX debt, Balance sheet effect, Capital flows, Banks, Systemic risk, Global liquidity
    JEL: E0 F0 F3
    Date: 2019

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