nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒08‒26
nine papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rate Pass-Through: A Competitive Search Approach By Beverly Lapham; Ayman Mnasri
  2. Global Dimensions of U.S. Monetary Policy By Obstfeld, Maurice
  3. The Yen Exchange Rate and the Hollowing Out of the Japanese Industry By Belke, Ansgar; Volz, Ulrich
  4. Exchange Rate Reconnect By Lilley, Andrew; Maggiori, Matteo; Neiman, Brent; Schreger, Jesse
  5. Covered Interest Parity deviations: Macrofinancial determinants By Cerutti, Eugenio; Obstfeld, Maurice; Zhou, Haonan
  6. Forward-Looking Policy Rules and Currency Premia By Filippou, Ilias; Taylor, Mark P
  7. Effects of QE on sovereign bond spreads through the safe asset channel By Jan Willem van den End
  8. Dominant-currency pricing and the global output spillovers from US dollar appreciation By Georgiadis, Georgios; Schumann, Ben
  9. An investigation of the exchange rate pass-through in the Baltic states By Mariarosaria Comunale

  1. By: Beverly Lapham; Ayman Mnasri (Qatar University)
    Abstract: We develop an open economy monetary model with heterogeneous households which is characterized by incomplete pass-through of exchange rate movements to import prices. Partial pass-through arises in our environment due to the presence of competitive search in international goods' markets. Under competitive search, agents choose a sub-market in which to exchange goods, where different sub-markets are characterized by different price and trading probability combinations. Preference and policy shocks which induce exchange rate movements cause households to choose a different sub-market for their purchases of traded goods--an extensive margin response. These responses mitigate the direct effect of nominal exchange rate changes on equilibrium traded goods' prices, thereby generating incomplete exchange rate pass-through to goods' prices. In the calibrated model, exchange rate pass-through due to foreign shocks ranges between 19% and 62%, which is in the range of import price pass-through estimates for developed economies. Due to risk aversion by households, the magnitude of pass-through depends on the size and direction of the initial shock, making the model consistent with the observed phenomenon of asymmetric pass-through. Importantly, by incorporating household heterogeneity, we are able to examine the role of precautionary savings in affecting pass-through, characterize how pass-through varies across different types of households, and examine the distributional effects of exchange rate movements.
    Keywords: Exchange Rate Pass-Through, Competitive Search, Monetary Policy
    JEL: F31 O24 E58
    Date: 2019–06
  2. By: Obstfeld, Maurice
    Abstract: This paper is a partial exploration of mechanisms through which global factors influence the tradeoffs that U.S. monetary policy faces. It considers three main channels. The first is the determination of domestic inflation in a context where international prices and global competition play a role, alongside domestic slack and inflation expectations. The second channel is the determination of asset returns (including the natural real safe rate of interest, râ??) and financial conditions, given integration with global financial markets. The third channel, which is particular to the United States, is the potential spillback onto the U.S. economy from the disproportionate impact of U.S. monetary policy on the outside world. In themselves, global factors need not undermine a central bank's ability to control the price level over the long term -- after all, it is the monopoly issuer of the numeraire in which domestic prices are measured. Over shorter horizons, however, global factors do change the tradeoff between price-level control and other goals such as low unemployment and financial stability, thereby affecting the policy cost of attaining a given price path.
    Keywords: current account; financial conditions; monetary policy; natural real interest rate; open-economy Phillips curve; spillbacks
    JEL: E52 E58 F36 F41 G15
    Date: 2019–07
  3. By: Belke, Ansgar; Volz, Ulrich
    Abstract: Since the demise of the Bretton Woods system, the yen has seen several episodes of strong appreciation, including in the late 1970s, after the 1985 Plaza Agreement, the early and late 1990s and after 2008. These appreciations have not only been associated with “expensive yen recessions” resulting from negative effects on exports; since the late 1980s, the strong yen has also raised concerns about a de-industrialisation of the Japanese economy. Against this backdrop, the paper investigates the effects of changes to the yen exchange rate on the hollowing out of the Japanese industrial sector. To this end, the paper uses both aggregate and industry-specific data to gauge the effects of yen fluctuations on the output and exports of different Japanese industries, exploiting new data for industry-specific real effective exchange rates. Our findings support the view that the periods of yen appreciation had more than just transitory effects on Japanese manufacturing. The results also provide indication of hysteresis effects on manufacturing. While there are certainly also other factors that have contributed to a hollowing out of Japanese industry, a strong yen played a role, too.
    Keywords: Yen appreciation,exchange rates,Japanese manufacturing,hollowing out,hysteresis
    JEL: F31 O14
    Date: 2019
  4. By: Lilley, Andrew; Maggiori, Matteo; Neiman, Brent; Schreger, Jesse
    Abstract: The failure to find fundamentals that co-move with exchange rates or forecasting models with even mild predictive power â?? facts broadly referred to as "exchange rate disconnect" â?? stands among the most disappointing, but robust, facts in all of international macroeconomics. In this paper, we demonstrate that U.S. purchases of foreign bonds, which did not co-move with exchange rates prior to 2007, have provided significant in-sample, and even some out-of-sample, explanatory power for currencies since then. We show that several proxies for global risk factors also start to co-move strongly with the dollar and with U.S. purchases of foreign bonds around 2007, suggesting that risk plays a key role in this finding. We use security-level data on U.S. portfolios to demonstrate that the reconnect of U.S. foreign bond purchases to exchange rates is largely driven by investment in dollar-denominated assets rather than by foreign currency exposure alone. Our results support the narrative emerging from an active recent literature that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.
    Date: 2019–07
  5. By: Cerutti, Eugenio; Obstfeld, Maurice; Zhou, Haonan
    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).
    Keywords: Covered Interest Parity; forward FX market; Interest Rate Differentials
    JEL: F31 G15
    Date: 2019–07
  6. By: Filippou, Ilias; Taylor, Mark P
    Abstract: We evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.
    Keywords: currency risk premium; data snooping bias; foreign exchange; Taylor rules
    JEL: F31 G11 G15
    Date: 2019–07
  7. By: Jan Willem van den End
    Abstract: We show that through the safe asset channel the excess liquidity created by QE can lead to higher sovereign bond spreads in the euro area. This unintended effect is most likely in stressed markets when excess liquidity spurs demand for tradeable safe assets, pushing down the interest rate of these assets, which widens risk spreads. Outcomes of a panel regression model estimated for individual euro area countries confirm that the excess liquidity created by QE had an upward effect on sovereign bond spreads. It indicates that the safe asset channel dominates the usual portfolio rebalancing channel. For monetary policy the results imply that QE is not an appropriate instrument to address country specific shocks.
    Keywords: interest rates, central banks and their policies, monetary policy
    JEL: E43 E58 E52
    Date: 2019–08
  8. By: Georgiadis, Georgios; Schumann, Ben
    Abstract: Different export-pricing currency paradigms have different implications for a host of issues that are critical for policymakers such as business cycle co-movement, optimal monetary policy, optimum currency areas and international monetary policy co-ordination. Unfortunately, the literature has not reached a consensus on which pricing paradigm best describes the data. Against this background, we test for the empirical relevance of dominant-currency pricing (DCP). Specifically, we first set up a structural three-country New Keynesian dynamic stochastic general equilibrium model which nests DCP, producer-currency pricing (PCP) and local-currency pricing (LCP). In the model, under DCP the output spillovers from shocks that appreciate the US dollar multilaterally decline with an economy’s export-import US dollar pricing share differential, i.e. the difference between the share of an economy’s exports and imports that are priced in the dominant currency. Underlying this prediction is a change in an economy’s net exports in response to multilateral changes in the US dollar exchange rate that arises because of differences in the extent to which exports and imports are priced in the dominant currency. We then confront this prediction of DCP with the data in a sample of up to 46 advanced and emerging market economies for the time period from 1995 to 2018. Specifically, controlling for other cross-border transmission channels, we document that consistent with the prediction from DCP the output spillovers from US dollar appreciation correlate negatively with recipient economies’ export-import US dollar invoicing share differentials. We document that these findings are robust to considering US demand, US monetary policy and exogenous exchange rate shocks as a trigger of US dollar appreciation, as well as to accounting for the role of commodity trade in US dollar invoicing. JEL Classification: F42, E52, C50
    Keywords: dominant-currency pricing, spillovers, US shocks
    Date: 2019–08
  9. By: Mariarosaria Comunale
    Abstract: In this paper, we investigate the Exchange Rate Pass-Through (ERPT) to import and consumer prices in the three Baltic states. We apply reduced form equations first. Then, to look at measures of shock-dependent ERPT, we use Bayesian VARs with zero and sign restrictions and a local projection exercise, using common euro area shocks. We find that results from reduced form equations are in line with the ERPT literature. As for shock-dependent ERPTs, the magnitudes are overall bigger than in the literature in the case of import prices. They get smaller for consumer prices and even smaller if we remove energy and food prices.
    Keywords: Exchange Rate Pass-Through, Baltic states, Shock dependence
    JEL: E31 F3 F41
    Date: 2019–08

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