nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒11‒18
eleven papers chosen by
Martin Berka
University of Auckland

  1. The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges By Michael T. Kiley
  2. Globalization and the Geography of Capital Flows By Carol C. Bertaut; Beau Bressler; Stephanie E. Curcuru
  3. Making room for new competitors. A comparative perspective on Italy’s exports in the euro-area market By Silvia Fabiani; Alberto Felettigh; Claire Giordano; Roberto Torrini
  4. Synchronization patterns in the European Union By Mattia Guerini; Duc Thi Luu; Mauro Napoletano
  5. Shifts in Monetary Policy and Exchange Rate Dynamics: Is Dornbusch's Overshooting Hypothesis Intact, After all? By Rüth, Sebastian K.
  6. Trend Fundamentals and Exchange Rate Dynamics By Florian, Huber; Kaufmann, Daniel
  7. Towards a new monetary theory of exchange rate determination By Cesa-Bianchi, Ambrogio; Kumhof, Michael; Sokol, Andrej; Thwaites, Gregory
  8. Attention to the tail(s): global financial conditions and exchange rate risks By Eguren-Martin, Fernando; Sokol, Andrej
  9. The Brexit vote, productivity growth and macroeconomic adjustments in the United Kingdom By Broadbent, Ben; Di Pace, Federico; Drechsel, Thomas; Harrison, Richard; Tenreyro, Silvana
  10. IMF programs and stigma in Emerging Market Economies By Claudia Maurini
  11. Exchange rate dynamics and monetary policy: Evidence from a non-linear DSGE-VAR approach By Huber, Florian; Rabithsc, Katrin

  1. By: Michael T. Kiley
    Abstract: Real interest rates have been persistently below historical norms over the past decade, leading economists and policymakers to view the equilibrium real interest rate as likely to be low for some time. Various definitions and approaches to estimating the equilibrium real interest rate are examined, including approaches based on the term-structure of interest rates and small macroeconomic models. The individual-country approaches common in the literature are extended to allow for global trend and cyclical factors. The analysis finds that global factors dominate the downward trend in the equilibrium interest rate across 13 advanced economies. A corollary of this finding is that the U.S. equilibrium rate may be substantially lower than estimated in U.S.-only studies. The analysis also highlights how the common global trend confounds empirical assessments of the determinants of movements in the equilibrium rate and the need to better integrate term-structure and macroeconomic approaches.
    Keywords: Global Factors ; Natural Rate ; World Interest Rate
    Date: 2019–11
  2. By: Carol C. Bertaut; Beau Bressler; Stephanie E. Curcuru
    Abstract: In this note, we document the large and growing distortions in official capital flows and investment statistics as a result of globalization. We provide a series of stylized facts about the extent and causes of these distortions, and also include data files containing U.S. portfolio holdings restated on a nationality basis to reflect the true exposures of U.S. investors.
    Date: 2019–09–06
  3. By: Silvia Fabiani (Bank of Italy); Alberto Felettigh (Bank of Italy); Claire Giordano (Bank of Italy); Roberto Torrini (Bank of Italy)
    Abstract: Over the last two decades Italy’s intra-euro area export performance has been weak when compared with that of Germany and Spain, but not in relation to France. This paper first tracks the heterogeneous developments in the four countries’ goods exports in the euro-area market across different sub-periods and product categories. It then discusses some potential determinants of these dynamics: price competitiveness and the entry of new competitors, namely China and the Central and Eastern European countries (the “CEE6”), in the euro-area market. By exploiting several datasets and by using different techniques, the paper quantitatively explores the impact of developments in intra-euro area price competitiveness; it analyzes the role played by China and by the CEE6 in displacing the four economies’ exports in the euro-area market and in activating their total exports via the heightened import demand stemming from the new competitors. These effects are found to be heterogeneous across the four countries, and generally more unfavourable for Italy, thereby helping to explain the country’s relative underperformance, at least vis-à-vis Germany.
    Keywords: goods exports, global value chains, competition from low-wage economies, euro area
    JEL: F00 F10 F40 F62
    Date: 2019–11
  4. By: Mattia Guerini (Scuola Superiore Sant'Anna); Duc Thi Luu; Mauro Napoletano (Observatoire français des conjonctures économiques)
    Abstract: We propose a novel approach to investigate the synchronization of business cycles and we apply it to a Eurostat database of manufacturing industrial production time-series in the European Union (EU) over the 2000-2017 period. Our approach exploits Random Matrix Theory and extracts the latent information contained in a balanced panel data by cleaning it from possible spurious correlation. We employ this method to study the synchronization among different countries over time. Our empirical exercise tracks the evolution of the European synchronization patterns and identifies the emergence of synchronization clusters among different EU economies. We find that synchronization in the Euro Area increased during the first decade of the century and that it reached a peak during the Great Recession period. It then decreased in the aftermath of the crisis, reverting to the levels observable at the beginning of the 21st century. Second, we show that the asynchronous business cycle dynamics at the beginning of the century was structured along a East-West axis, with eastern European countries having a diverging business cycle dynamics with respect to their western partners. The recession brought about a structural transformation of business cycles co-movements in Europe. Nowadays the divide can be identified along the North vs. South axis. This recent surge in asynchronization might be harmful for the European Unio because it implies countries’ heterogeneous responses to common policies.
    Keywords: Business cycle synchronization ; Random matrix theory; European Union
    JEL: E32 F4 F45
    Date: 2019–11
  5. By: Rüth, Sebastian K.
    Abstract: How do nominal exchange rates adjust after surprise contractions in monetary policy? While the seminal contribution by Dornbusch provides concise predictions -exchange rates appreciate, i.e., overshoot on impact before depreciating gradually - empirical support for his hypothesis is at best mixed. I argue that the failure to discover overshooting may result from assumptions researchers have imposed to recover structural VARs. Specifically, simultaneous feedback effects between interest rates and exchange rates, which are inherently forward-looking variables, are often excluded or modeled alongside with strong restrictions. In this paper, I identify U.S. monetary policy shocks using surprises in Federal funds futures around policy announcements as external instruments, which recent literature has established to represent the appropriate laboratory in settings encompassing macroeconomic and financial variables. Resulting adjustments of the dollar, conditional on shifts in policy, generally align with Dornbusch's predictions during the post-Bretton-Woods era, including Volcker's tenure as Fed Chair.
    Keywords: Nominal exchange rate; monetary policy shock; external instrument; structural vector autoregression
    Date: 2019–11–13
  6. By: Florian, Huber (University of Salzburg); Kaufmann, Daniel (Université de Neuchâtel)
    Abstract: We estimate a multivariate unobserved components stochastic volatility model to explain the dynamics of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries’ monetary policy strategies may be well described by Taylor rules with a time-varying inflation target, a time-varying natural rate of unemployment, and interest rate smoothing. Compared to the existing literature, our model simultaneously provides estimates of the latent components included in a typical Taylor rule specification and the model-based real exchange rate. Our estimates closely track major movements along with important time series properties of real and nominal exchange rates across all currencies considered, outperforming a benchmark model that does not account for changes in trend inflation and trend unemployment. More precisely, the proposed approach improves upon competing models in tracking the actual evolution of the real exchange rate in terms of simple correlations while it appreciably improves upon simpler competitors in terms of matching the persistence of the real exchange rate.
    Keywords: Exchange rate models; trend inflation; natural rate of unemployment; Taylor rule; unobserved components stochastic volatility model
    JEL: E31 E52 F31 F41
    Date: 2019–10–22
  7. By: Cesa-Bianchi, Ambrogio (Bank of England and Centre for Macroeconomics); Kumhof, Michael (Bank of England, CEPR and Centre for Macroeconomics); Sokol, Andrej (European Central Bank, Bank of England and Centre for Macroeconomics); Thwaites, Gregory (Bank of England)
    Abstract: We study exchange rate determination in a 2-country model where domestic banks create each economy’s supply of domestic and foreign currency. The model combines the UIP-based and monetary theories of exchange rate determination, but the latter with a focus on private rather than public money creation. The model features an endogenous monetary spread or excess return in the UIP condition. This spread experiences sizeable changes when shocks affect the relative supplies (of bank loans) or demands (for bank deposits) of the two currencies. Under such shocks, monetary effects dominate traditional UIP effects in the determination of exchange rates and allocations, and this becomes stronger as domestic and foreign currencies become more imperfect substitutes. With these shocks, the model successfully addresses the UIP puzzle, and it is also consistent with the Meese-Rogoff and PPP puzzles.
    Keywords: Bank lending; money creation; money demand; endogenous money; uncovered interest parity; exchange rate determination; international capital flows; gross capital flows
    JEL: E44 E51 F41 F44
    Date: 2019–08–30
  8. By: Eguren-Martin, Fernando (Bank of England); Sokol, Andrej (European Central Bank, Bank of England and CfM)
    Abstract: We document how the entire distribution of exchange rate returns responds to changes in global financial conditions. We measure global financial conditions as the common component of country-specific financial condition indices, computed consistently across a large panel of developed and emerging economies. Based on quantile regression results, we provide a characterisation and ranking of the tail behaviour of a large sample of currencies in response to a tightening of global financial conditions, corroborating some of the prevailing narratives about safe haven and risky currencies. We then carry out a portfolio sorting exercise to identify the macroeconomic fundamentals associated with such different tail behaviour, and find that currency portfolios sorted on the basis of relative interest rates, current account balances and levels of international reserves display a higher likelihood of large losses in response to a tightening of global financial conditions.
    Keywords: Exchange rates; tail risks; financial conditions indices; global financial cycle; quantile regression
    JEL: F31 G15
    Date: 2019–09–16
  9. By: Broadbent, Ben (Bank of England and Centre for Macroeconomics); Di Pace, Federico (Bank of England); Drechsel, Thomas (London School of Economics and Centre for Macroeconomics); Harrison, Richard (Bank of England and Centre for Macroeconomics); Tenreyro, Silvana (Bank of England, Centre for Macroeconomics, CEPR and London School of Economics)
    Abstract: The UK economy has experienced significant macroeconomic adjustments following the 2016 referendum on its withdrawal from the European Union. This paper develops and estimates a small open economy model with tradable and non-tradable sectors to characterise these adjustments. We demonstrate that many of the effects of the referendum result can be conceptualised as news about a future slowdown in productivity growth in the tradable sector. Simulations show that the responses of the model economy to such news are consistent with key patterns in UK data. While overall economic growth slows, an immediate permanent fall in the relative price of non-tradable output (the real exchange rate) induces a temporary ‘sweet spot’ for tradable producers before the slowdown in tradable sector productivity associated with Brexit occurs. Resources are reallocated towards the tradable sector, tradable output growth rises and net exports increase. These developments reverse after the productivity decline in the tradable sector materialises. The negative news about tradable sector productivity also leads to a decline in domestic interest rates relative to world interest rates and to a reduction in investment growth, while employment remains relatively stable. As a by-product of our analysis, we provide a quantitative analysis of the UK business cycle.
    Keywords: Brexit; small open economy; productivity; tradable sector; UK economy
    JEL: E13 E32 F17 F47 O16
    Date: 2019–08–27
  10. By: Claudia Maurini (Bank of Italy)
    Abstract: This paper investigates the existence and estimates the magnitude of a financial market stigma associated with the International Monetary Fund’s non-concessional programmes. In particular, it focuses on the impact of IMF non-concessional loans on Emerging Markets’ sovereign spreads, using the propensity score matching methodology to deal with the selection bias problem. We find evidence of higher spreads for countries supported by a non-concessional IMF programme with respect to comparable countries that are not supported by such a programme. This effect may be linked to both a pure financial stigma and the (low) probability of the programme succeeding, as it tends to dissipate towards the end of the programme and to be smaller and less significant if we restrict the sample to non-repeated programmes (more likely to be successful). Finally, we find that precautionary programmes (such as the Flexible Credit Line) have a negative impact on sovereign spreads.
    Keywords: International Monetary Fund, propensity score matching, sovereign spreads, emerging market economies
    JEL: E44 F33 F44 F55 G15
    Date: 2019–11
  11. By: Huber, Florian (University of Salzburg); Rabithsc, Katrin (WU Wien)
    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: 2019–10–22

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