nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒08‒19
eleven papers chosen by
Martin Berka
University of Auckland

  1. Exchange rate puzzles: evidence from rigidly fixed nominal exchange rate systems By Charles Engel; Feng Zhu
  2. Covered Interest Parity Deviations: Macrofinancial Determinants By Eugenio M. Cerutti; Maurice Obstfeld; Haonan Zhou
  3. China's Overseas Lending By Horn, Sebastian; Reinhart, Carmen M.; Trebesch, Christoph
  4. International Bank Lending Channel of Monetary Policy By Silvia Albrizio; Sangyup Choi; Davide Furceri; Chansik Yoon
  5. Exportweltmeister: The Low Returns on Germany's Capital Exports By Hünnekes, Franziska; Schularick, Moritz; Trebesch, Christoph
  6. Public Sector Balance Sheet Strength and the Macro Economy By Seyed Reza Yousefi
  7. Dutch disease dynamics reconsidered By Hilde C. Bjørnland; Leif Anders Thorsrud; Ragnar Torvik
  8. Global Factors Driving Inflation and Monetary Policy: A Global VAR Assessment By Feldkircher, Martin; Lukmanova, Elizaveta; Tondl, Gabriele
  9. The Euro Crisis and Economic Growth: A Novel Counterfactual Approach By Alessio Terzi
  10. Covered interest rate parity, relative funding liquidity and cross-currency repos By Daniel Kohler; Benjamin Müller
  11. Taming the Global Financial Cycle: Central Banks and the Sterilization of Capital Flows in the First Era of Globalization (1891-1913) By Bazot, Guillaume; Monnet, Eric; Morys, Matthias

  1. By: Charles Engel; Feng Zhu
    Abstract: We examine several major exchange rate puzzles: the excess volatility of real exchange rates; their excess reaction to the real interest rate differentials; the uncovered interest rate parity (UIP) puzzle; the excess persistence of real exchange rates; the exchange rate disconnect puzzle; and the consumption correlation puzzle. We examine the behaviour of real exchange rates among pairs of economies that have rigidly fixed nominal exchange rates, eg countries within the euro area, regions in China and Canada, and Hong Kong SAR vis-à-vis the United States, compared with that among non-euro-area OECD economies. Our results suggest that some of these puzzles are less puzzling under a rigidly fixed exchange rate regime. In particular, real exchange rates appear to have no or little excess volatility; excess reaction of the real exchange rate to real interest rates is less common; there is less disconnect between the real exchange rate and the economic fundamentals; and uncovered interest rate parity appears to hold more frequently in these economies. However, real exchange rates are as persistent in these economies as in the floating rate economies and there appears to be little difference in risk-sharing across countries with fixed versus floating nominal exchange rates. These results may have implications for exchange rate modelling.
    Keywords: consumption correlation puzzle, excess volatility, exchange rate disconnect, exchange rate regime, real exchange rate, purchasing power parity, uncovered interest rate parity
    JEL: E43 F31
    Date: 2019–08
  2. By: Eugenio M. Cerutti; Maurice Obstfeld; Haonan Zhou
    Abstract: For several decades until the Global Financial Crisis (GFC), Covered Interest Parity (CIP) appeared to hold quite closely—even as a broad macroeconomic relationship applying to daily or weekly data. Not only have CIP deviations significantly increased since the GFC, but potential macrofinancial drivers of the variation in CIP deviations have also become significant. The variation in CIP deviations seems to be associated with multiple factors, not only regulatory changes. Most of these do not display a uniform importance across currency pairs and time, and some are associated with possibly temporary drivers (such as asynchronous monetary policy cycles).
    JEL: F31 G15
    Date: 2019–08
  3. By: Horn, Sebastian; Reinhart, Carmen M.; Trebesch, Christoph
    Abstract: Compared with China's dominance in world trade, its expanding role in global finance is poorly documented and understood. Over the past decades, China has exported record amounts of capital to the rest of the world. Many of these financial flows are not reported to the IMF, the BIS or the World Bank. "Hidden debts" to China are especially significant for about three dozen developing countries, and distort the risk assessment in both policy surveillance and the market pricing of sovereign debt. We establish the size, destination, and characteristics of China's overseas lending. We identify three key distinguishing features. First, almost all of China's lending and investment abroad is official. As a result, the standard "push" and "pull" drivers of private cross-border flows do not play the same role in this case. Second, the documentation of China's capital exports is (at best) opaque. China does not report on its official lending and there is no comprehensive standardized data on Chinese overseas debt stocks and flows. Third, the type of flows is tailored by recipient. Advanced and higher middle-income countries tend to receive portfolio debt flows, via sovereign bond purchases of the People's Bank of China. Lower income developing economies mostly receive direct loans from China's state-owned banks, often at market rates and backed by collateral such as oil. Our new dataset covers a total of 1,974 Chinese loans and 2,947 Chinese grants to 152 countries from 1949 to 2017. We find that about one half of China's overseas loans to the developing world are "hidden".
    Keywords: Belt and Road initiative; China; hidden debts; International Capital Flows; official finance; sovereign risk
    JEL: F21 F34 F42 G15 H63 N25
    Date: 2019–07
  4. By: Silvia Albrizio (Bank of Spain); Sangyup Choi (Yonsei University); Davide Furceri (IMF); Chansik Yoon (Princeton University)
    Abstract: How does domestic monetary policy in systemic countries spillover to the rest of the world? This paper examines the transmission channel of domestic monetary policy in the cross-border context. We use exogenous shocks to monetary policy in systemically important economies, including the U.S., and local projections to estimate the dynamic effect of monetary policy shocks on bilateral cross-border bank lending. We find robust evidence that an increase in funding costs following an exogenous monetary tightening leads to a statistically and economically significant decline in cross-border bank lending. The effect is weakened during periods of high uncertainty. In contrast, the effect is found to not vary according to the degree of borrower country riskiness, further weakening support for the international portfolio rebalancing channel.
    Keywords: Monetary policy spillovers; International bank lending channel; Cross-border banking flows; Global financial cycles; Local projections
    JEL: E52 F21 F32 F42
    Date: 2019–08
  5. By: Hünnekes, Franziska; Schularick, Moritz; Trebesch, Christoph
    Abstract: Germany is world champion in exporting capital (\Exportweltmeister"). No other country invests larger amounts of savings outside its borders. However, Germany plays in the third division when it comes to investment performance, as we show in this paper. We study the returns on German foreign investments from 1950 to 2017 and find that: (1) Germany's annual returns on foreign assets were 2 to 5 percentage points lower than those of comparable countries. Germany ranks last among the G7 countries, also in the last decade; (2) Domestic returns on German assets have outperformed foreign returns abroad by about 3 percentage points per year; (3) Germany's external wealth provides very little consumption insurance as foreign returns are highly correlated with domestic activity; (4) The capital exports do little to diversify demographic risks as Germany mainly invests in countries with similar demographics. Taken together, these facts raise substantial doubts whether German households, firms, and banks allocate their savings in a beneficial way.
    Keywords: Foreign Assets; Foreign returns; International Capital Flows
    JEL: F21 F30 F31 F36 G15
    Date: 2019–07
  6. By: Seyed Reza Yousefi
    Abstract: This paper introduces concepts of public sector balance sheet (PSBS) strength, taking into account different aspects of what governments own in addition to what they owe. It develops measures of PSBS strength and investigates their macroeconomic implications. Empirical estimations show that in their pricing of sovereign bonds, financial markets account for government assets and net worth in addition to their liabilities. Furthermore, economies with stronger public sector balance sheets experience shallower recessions and recover faster in the aftermath of economic downturns. This faster return to growth can be explained by the greater space for countercyclical fiscal policy in countries with stronger balance sheets.
    Date: 2019–08–06
  7. By: Hilde C. Bjørnland; Leif Anders Thorsrud; Ragnar Torvik
    Abstract: In this paper we develop the first model to incorporate the dynamic productivity consequences of both the spending effect and the resource movement effect of oil abundance. We show that doing so dramatically alters the conclusions drawn from earlier models of learning by doing (LBD) and the Dutch disease. In particular, the resource movement effect suggests that the growth effects of natural resources are likely to be positive, turning previous growth results in the literature relying on the spending effect on their head. We motivate the relevance of our approach by the example of a major oil producer, Norway. Empirically we find that the effects of an increase in the price of oil may resemble results found in the earlier Dutch disease literature, while the effects of increased oil activity increases productivity in most industries. Therefore, models that only focus on windfall gains due to increased spending potential from higher oil prices, would conclude - incorrectly based on our analysis - that the resource sector cannot be an engine of growth.
    Keywords: Dutch disease, resource movements, learning by doing, analytics of multidimensional dynamic systems, time-varying VAR model
    JEL: C32 E32 F41 Q33
    Date: 2019–08
  8. By: Feldkircher, Martin; Lukmanova, Elizaveta; Tondl, Gabriele
    Abstract: In this paper, we examine international linkages in inflation and short-term interest rates using a global sample of OECD and emerging economies. Using a Bayesian global vector autoregression (GVAR) model, we show that for short-term interest rates both movements in inflation and output play an important role. In advanced countries, however, international factors such as foreign interest rates appear as an important driver of local interest rates. For inflation, we also find evidence for the importance of global factors, such as price developments in other countries, oil prices and the exchange rate. Again, this impact of global factors appears predominately in advanced countries.
    Keywords: Monetary policy, Inflation, Global VAR
    Date: 2019–08
  9. By: Alessio Terzi
    Abstract: Macroeconomic adjustment in the euro area periphery was more recessionary than pre-crisis imbalances would have warranted. To make this claim, this paper uses a Propensity Score Matching Model to produce counterfactuals for the Eurozone crisis countries (Greece, Portugal, Ireland, Cyprus, Spain) based on over 200 past macroeconomic adjustment episodes between 1960-2010 worldwide. At its trough, between 2010 and 2015 per capita GDP had contracted on average 11 percentage points more in the Eurozone periphery than in the standard counterfactual scenario. These results are not dictated by any specific country experience, are robust to a battery of alternative counterfactual definitions, and stand confirmed when using a parametric dynamic panel regression model to account more thoroughly for the business cycle. Zooming in on the potential causes, the lack of an independent monetary policy, while having contributed to a deeper recession, does not fully explain the Eurozone’s specificity, which is instead to be traced back to a sharper-than-expected contraction in investment and fiscal austerity due to high funding costs.
    Keywords: macroeconomic adjustment, financial crisis, Eurozone, growth, propensity score matching
    JEL: E63 E65 F31 F32 F33 F36
    Date: 2019
  10. By: Daniel Kohler; Benjamin Müller
    Abstract: Deviations from the covered interest rate parity (CIP) are considerably smaller or even zero when calculated based on a particular set of repo rates, so-called cross-currency repo rates, instead of standard interest rates, such as overnight indexed swap or Interbank Offered rates. We attribute this (partial) solution of the CIP puzzle to the nearly identical risk characteristics of foreign exchange swaps and cross-currency repos: both are virtually devoid of counterparty credit risk but incorporate a relative funding liquidity premium. In practice, CIP deviations can thus be exploited on a truly riskless basis using cross-currency repo transactions, which is not the case for other interest rates.
    Keywords: Covered interest rate parity, FX swap market, cross-currency repos, funding
    JEL: E43 F31 G12 G14 G15
    Date: 2019
  11. By: Bazot, Guillaume; Monnet, Eric; Morys, Matthias
    Abstract: Are central banks able to isolate their domestic economy by offsetting the effects of foreign capital flows? We provide an answer for the First Age of Globalisation based on an exceptionally detailed and standardized database of monthly balance sheets of all central banks in the world (i.e. 21) over 1891-1913. Investigating the impact of a global interest rate shock on the exchange-rate, the interest rate and the central bank balance sheet, we find that not a single country played by the "rules of the game." Core countries fully sterilized capital flows, while peripheral countries also relied on convertibility restrictions to avoid reserve losses. In line with the predictions of the trilemma, the exchange rate absorbed the shock fully in countries off the gold standard (floating exchange rate): the central bank's balance sheet and interest rate were not affected. In contrast, in the United States, a gold standard country without a central bank, the reaction of the money market rate was three times stronger than that of interest rates in countries with a central bank. Central banks' balance sheets stood as a buffer between domestic economy and global financial markets.
    Keywords: central banking; Federal Reserve System; gold standard; rules of the game; Sterilization; trilemma
    JEL: E42 E50 F30 F44 N10 N20
    Date: 2019–07

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