nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒10‒21
twelve papers chosen by
Martin Berka
University of Auckland

  1. Macroeconomics Challenges and Resilience of Emerging Market Economies By Joshua Aizenman
  2. Cryptocurrencies, Currency Competition, and The Impossible Trinity By Benigno, Pierpaolo; Schilling, Linda Marlene; Uhlig, Harald
  3. The Exchange Rate and Oil Prices in Colombia: A High Frequency Analysis By Julio-Román, Juan Manuel; Gamboa-Estrada, Fredy Alejandro
  4. Exploring The Role of Limited Commitment Constraints in Argentina’s "Missing Capital" By Marek Kapička; Finn Kydland; Carlos Zarazaga
  5. A Macroprudential Theory of Foreign Reserve Accumulation By Arce, Fernando; Bengui, Julien; Bianchi, Javier
  6. REER Imbalances and Macroeconomic Adjustments: evidence from the CEMAC zone By Simplice A. Asongu; Joseph Nnanna
  7. Export Prices, Markups, and Currency Choice after a Large Appreciation By Daniel Kaufmann; Tobias Renkin
  8. Exchange Rate Regimes and Foreign Direct Investment Flow in West African Monetary Zone (WAMZ) By Perekunah B. Eregha
  9. Determinants of real exchange rate movements in 15 emerging market economies By Goda, Thomas; Priewe, Jan
  10. US Monetary Policy and International Risk Spillovers By Kalemli-Ozcan, Sebnem
  11. Estimating the Exchange Rate Pass-Through: A Time-Varying Vector Auto-Regression with Residual Stochastic Volatility Approach By Julio-Román, Juan Manuel
  12. Exchange rate dynamics and monetary policy -- Evidence from a non-linear DSGE-VAR approach By Florian Huber; Katrin Rabitsch

  1. By: Joshua Aizenman
    Abstract: A Growing share of Emerging Markets (EMs) use hybrid versions of inflation targeting (IT) that differ from the IT regimes of OECD countries. Policy interest rates among commodity countries are impacted by real exchange rate and international reserves (IR) changes, aiming at stabilizing their real exchange rate in the presence of volatile terms of trade and heightened exposure to capital inflow/outflow shocks. IT works well with independent central banks; yet, fiscal dominance concerns may hinder the efficacy and independency of central banks. This suggests experimenting with the integration of monetary rules with fiscal rules, possibly linking these rules with the operations of buffers like IR and Sovereign Wealth Funds (SWFs). The Global Financial Crisis validated the benefits of counter-cyclical management of international reserves and SWFs in reducing the volatility of real exchange rates. Macro-prudential policies may complement or even substitute buffer policies by reducing a country’s balance sheet exposure to foreign currency debt, mitigating the risk of costly sudden-stops and capital flight. A growing share of EMs is exposed to new financial technologies (fintech), providing cheaper and faster financial services, deepening financial coverage to previously under-served populations. Deeper fintech diffusion may redirect financial intermediation from regulated banks to emerging fintech shadow banks, some of which may have global reach. These developments, and the diffusion of cryptocurrencies promising anonymized payment systems may hinder the effectiveness of monetary policy, and eventually induce greater financial instability. States may encourage the diffusion of efficient financial intermediation in ways that benefit users, while restricting the use of anonymized exchange and global monies to reduce the threat of a shrinking tax base, and to maintain financial stability.
    JEL: F02 F31 F33 F36 F4 F42
    Date: 2019–10
  2. By: Benigno, Pierpaolo; Schilling, Linda Marlene; Uhlig, Harald
    Abstract: We analyze a two-country economy with complete markets, featuring two national currencies as well as a global (crypto)currency. If the global currency is used in both countries, the national nominal interest rates must be equal and the exchange rate between the national currencies is a risk- adjusted martingale. We call this result Crypto-Enforced Monetary Policy Synchronization (CEMPS). Deviating from interest equality risks approaching the zero lower bound or the abandonment of the national currency. If the global currency is backed by interest-bearing assets, additional and tight restrictions on monetary policy arise. Thus, the classic Impossible Trinity becomes even less reconcilable.
    Keywords: cryptocurrency; currency competition; Exchange Rates; impossible trinity; independent monetary policy; uncovered interest parity
    JEL: D53 E4 F31 G12
    Date: 2019–08
  3. By: Julio-Román, Juan Manuel; Gamboa-Estrada, Fredy Alejandro
    Abstract: We study the relationship between daily oil prices and nominal exchange rates between 1995 and 2019 in Colombia through a Time-Varying Vector Auto-Regressions with residual Stochastic Volatility, TV-VAR-SV, model. For this task we also employ co-integration, Univariate Auto-Regressions with residual Stochastic Volatility, UAR-SVTV, and De-trended Cross Correlation, DCC analyses. We found that a stable lon-grun relationship between the two processes is lacking. We also found significant time variation in residual volatility and co-volatility. More specifically, we found that both periods of time, the international financial crisis and the oil price drop of 2015, behave conspicuously different from other “more normal” times. These results are consistent with a shift in the features of the DCC at the start of the crisis. Before the crises the DCCs are positive but weak for different windows sizes, turning negative and significant after it. The latter DCCs and their significance increase with the window size. These results are concurrent, also, with two clearly differentiated periods of time; one when oil production was not financially feasible, and thus production, exports and oil related currency inflows were small, and the other when oil production became feasible because of the price increase, which led to a boom in exploration, production, exports and oil related currency inflows.
    Keywords: Nominal Exchange Rate; Oil prices; Small Open Economy; Co-Volatility
    JEL: C22 C51 F31 F41 G15
    Date: 2019–10
  4. By: Marek Kapička; Finn Kydland; Carlos Zarazaga
    Abstract: We study why capital accumulation in Argentina was slow in the 1990s and 2000s, despite high productivity growth and low international interest rates. We show that limited commitment constraints introduce two mechanisms. First, the response of investment to a total factor productivity increase is muted and short-lived, while the response to a decrease is large and persistent. Second, unlike in a first-best economy, low international interest rates may reduce capital accumulation, because they increase the relevance of future commitment constraints. A quantitative implementation of the model economy shows that the two mechanisms are quantitatively important for the dynamics of Argentina’s capital accumulation. The model accounts for between 50% and 85% of the capital missing from Argentina in these two periods, relative to what it would be in the absence of the limited commitment frictions.
    JEL: F34 F41 F42 F43 O19 O54
    Date: 2019–10
  5. By: Arce, Fernando; Bengui, Julien; Bianchi, Javier
    Abstract: This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the recent upward trend in international reserves.
    Keywords: financial crises; International Reserves; macroprudential policy
    JEL: D52 D62 F24
    Date: 2019–08
  6. By: Simplice A. Asongu (Yaoundé/Cameroon); Joseph Nnanna (The Development Bank of Nigeria, Abuja, Nigeria)
    Abstract: The EMU crisis holds special lessons for existing monetary unions. We assess the behavior of real effective exchange rates (REERs) of members of the Central African Economic and Monetary Community (CEMAC) zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate (FEER) model is estimated and associated misalignments. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. There is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths.
    Keywords: Exchange rate; Macroeconomic impact; CEMAC zone
    JEL: F31 F33 F42 F61 O55
    Date: 2019–01
  7. By: Daniel Kaufmann; Tobias Renkin
    Abstract: We analyze export price adjustment of Swiss manufacturing firms using a novel data set of matched export, import, and domestic prices. After a large, unexpected, and permanent appreciation of the Swiss franc, export prices set in domestic currency fell less than export prices set in foreign currency. This difference prevails if we control for variation in firms' marginal cost. Through the lens of a structural model, this difference can be traced back to strategic complementarity in price setting for firms pricing in foreign currency. Meanwhile, firms setting prices in domestic currency exhibit no strategic complementarity and follow a constant markup-pricing rule.
    Keywords: Nominal exchange rate, border prices, currency choice, variable markups, pricing-to-market, price rigidity, exchange rate pass through, exchange rate sensitive factor costs.
    JEL: E3 E5 F3 F4
    Date: 2019–10
  8. By: Perekunah B. Eregha (Pan-Atlantic University, Lekki-Lagos, Nigeria)
    Abstract: This study examines the effect of exchange rate regimes on Foreign Direct Investment (FDI) flow for WAMZ. The Arellano Panel Correction for Serial Correlation and Heteroskedaticity option of the Within Estimator for fixed effect panel data model as well as the Dynamic Panel Data Instrumental Variable Approach by Anderson and Hsiao (1981) for the countries selected based on data availability for the period 1980-2016 were used. The fixed exchange rate regime was found to hamper FDI flow in the zone while intermediate policy had a significantly positive effect in facilitating FDI flow during periods of declining foreign reserves and narrowing current account balance in WAMZ. This implies that the transmission of the effect of exchange rate regimes on FDI inflows depends on the positions of the foreign reserves and current account balance in the zone. Consequently, the fixed regime is not a good policy in periods of narrowing current account balance and depleting foreign exchange reserves. The study therefore recommends the need for monetary authorities to be cautious in managing their exchange rates especially in periods of depleting foreign reserves and narrowing current account so as not to deter the much needed FDI inflow.
    Keywords: Exchange Rate Regimes; Inflationary Expectation; Exchange rate uncertainty; Foreign Direct Investment Flow; Panel Data Analysis
    JEL: E31 F21 F31
    Date: 2019–01
  9. By: Goda, Thomas; Priewe, Jan
    Abstract: Previous work has established that an appreciation of the real exchange rate (REER) contributes to premature deindustrialization, less productive investment and dependence on commodity booms and busts in emerging markets economies (EME). From the previous literature, it is less clear however what the most important drivers for the cyclical REER movements in EME are. The main aim of this study is to provide empirical evidence about the determinants of the REER movements of 15 emerging markets during the last two decades, using statistical analysis and a dynamic panel fixed effects model approach. Our analysis shows that although "commodity" and "industrial" EME are heterogeneous, REER volatility tends to be higher among the former. Yet, REER volatility between emerging and advanced countries does not differ very much, apart from a few EME countries. Countries that had more stable REER trend fared better than those that had a depreciating or appreciating trend (with the notable exception of China). As theoretically expected, commodity prices are an important structural driver of REER movements in "commodity EME". Moreover, the results confirm the existence of the Harrod-Balassa-Samuelson effect, and show the importance of financial inflows. Further, exchange rate regimes and the intervention of central banks were partially successful to avoid more substantial appreciations (depreciations). Finally, we find that lower country risk and, at least in some periods, growing broad money has led to REER appreciations.
    Keywords: Real Exchange Rate,Foreign Exchange Rate Policy,Commodity Prices,CapitalInflows,Global Risk
    JEL: F6 F31 F41 O11 O57 P52
    Date: 2019
  10. By: Kalemli-Ozcan, Sebnem
    Abstract: I show that monetary policy divergence vis-a-vis the U.S. has larger spillover effects in emerging markets than advanced economies. The monetary policy of the U.S. affects domestic credit costs in other countries through its effect on global investors' risk perceptions. Capital flows in and out of emerging market economies are particularly sensitive to fluctuations in such risk perceptions and have a direct effect on local credit spreads. Domestic monetary policy is ineffective in mitigating this effect as the pass-through of policy rate changes into short-term interest rates is imperfect. This disconnect between short rates and monetary policy rates is explained by changes in risk perceptions. A key policy implication of my findings is that emerging markets' monetary policy actions designed to limit exchange rate volatility can be counterproductive.
    Date: 2019–10
  11. By: Julio-Román, Juan Manuel
    Abstract: The adoption of a Time-Varying Vector Auto-Regression with residual Stochastic Volatility approach to address the state and time dependency of the exchange rate pass-through, ERPT, is proposed. This procedure is employed to estimate the size, duration and stability of the ERPT to flexible relative price changes in Colombia through a fairly simple Phillips curve. For this, the generalized impulse responses, i.e. pass-throughs, from different periods of time are compared. It was found that the ERPT is bigger and faster than previous estimates for broader price indexes. It was also also found that regardless of the existence of time-varying shock sizes, i.e. time varying standard deviations, the ERPT before full Inflation Targeting, IT, is marked and significantly larger before than during full IT, and also that the ERPT relates to real exchange rate volatility. The second results relates to the benefits derived from the adoption of full IT in this country. It was finally found that the output gap and flexible relative price change residual volatilities drop permanently and importantly at 1998Q3, emphasizing the role of the free float regime adoption in the success of IT in this country.
    Keywords: Pass-Through; Price Stickiness; Phillips Curve
    JEL: C22 F31 F41
    Date: 2019–10
  12. By: Florian Huber (Paris Lodron University of Salzburg, Salzburg Centre of European Union Studies); Katrin Rabitsch (Institute for International Economics and Development, Department of Economics, Vienna University of Economics and Business)
    Abstract: In this paper, we reconsider the question how monetary policy influences exchange rate dynamics. To this end, a vector autoregressive (VAR) model is combined with a two-country dynamic stochastic general equilibrium (DSGE) model. Instead of focusing exclusively on how monetary policy shocks affect the level of exchange rates, we also analyze how they impact exchange rate volatility. Since exchange rate volatility is not observed, we estimate it alongside the remaining quantities in the model. Our findings can be summarized as follows. Contractionary monetary policy shocks lead to an appreciation of the home currency, with exchange rate responses in the short-run typically undershooting their long-run level of appreciation. They also lead to an increase in exchange rate volatility. Historical and forecast error variance decompositions indicate that monetary policy shocks explain an appreciable amount of exchange rate movements and the corresponding volatility.
    Keywords: Monetary policy, Exchange rate overshooting, stochastic volatility modeling, DSGE priors
    JEL: E43 E52 F31
    Date: 2019–10

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