nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2019‒12‒09
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Monetary Unions and National Welfare By Cem Gorgun
  2. The global financial cycle and us monetary policy in an interconnected world By Stéphane Dées; Alessandro Galesi
  3. Exchange Rate Risk and Business Cycles By Lloyd, S. P.; Marin, E. A.
  4. A Re-Evaluation of the Choice of an Inflation Target in the Wake of the Global Financial Crisis By Richard T. Froyen; Alfred V. Guender
  5. Footloose global value chains: How trade costs make a difference By Jakubik, Adam; Stolzenburg, Victor
  6. Taming the gobal financial cycle: Central banks and the sterilization of capital flows in the first era of globalization By Bazot, Guillaume; Monnet, Eric; Morys, Matthias
  7. Populism, Political Risk and the Economy: Lessons from Italy By Pierluigi Balduzzi; Emanuele Brancati; Marco Brianti; Fabio Schiantarelli
  8. The Fiscal and Current Account Imbalances: An Empirical analysis of the Twin Deficits Hypothesis in Bangladesh By Murshed, Muntasir; Nijhum, Nawrin Khan
  9. Capital Flow Volatility: The Effects of Financial Development and Global Financial Conditions By Shiyi Wang
  10. Czech BEERs with PEERs: Tackling the Uncertainty By Jaromir Baxa; Pavel Jancovic
  11. Can fiscal rules improve financial markets access for developing countries ? By Pegdéwendé Nestor Sawadogo
  12. Conservation targets might be reducing trust in MPA planning By Wehner, Nicholas; Open Communications for The Ocean, OCTO
  13. Spread the Word: International Spillovers from Central Bank Communication By Hanna Armelius; Christoph Bertsch; Isaiah Hull; Xin Zhang

  1. By: Cem Gorgun (Koc University)
    Abstract: This paper studies monetary regime choice between monetary union and flexible exchange rate regime in a large open economy framework. The classical approach emphasizes that monetary unions are inherently costly because a single interest rate cannot respond effectively to different shocks of members of the union. Therefore, it is argued that countries with similar shocks should establish a monetary union so that the cost of one-size-fits-all monetary policy is minimized. This study reveals that when there are inefficient shocks (namely those which distort the economy asymmetrically and break the 'divine coincidence') and countries are large, the classical approach fails. In that case, monetary regime choice should depend on relative variation (mean preserving spread) of inefficient shocks rather than proximity of shocks. A union implicitly imposes cooperation in monetary policy between its members. This cooperation improves response to foreign inefficient shocks while it worsens responses to domestic inefficient shocks slightly less in terms of domestic welfare. Therefore, a country chooses monetary union over flexible exchange rate regime if variation of foreign shocks is close to or larger than variation of domestic shocks. That is on the condition that losing exchange rate flexibility is not costly or has a small cost. In this way, the domestic country 'ties the hand of the foreign country' and prevents foreign monetary policy actions which hurt domestic welfare. Both countries benefit from cooperation provided by the union, if variances (spreads) of domestic and foreign shocks are close enough. Then, a monetary union becomes Pareto Improvement. How close variances should be so that monetary union is welfare increasing or Pareto Improvement, and welfare loss or gain of losing exchange rate flexibility are contingent upon price rigidity and trade elasticity.
    Keywords: monetary unions, fl exible exchange rate, monetary policy, national welfare.
    JEL: E52 E58 F33 F41 F42
    Date: 2019–11
  2. By: Stéphane Dées (Banque de France and University of Bordeaux); Alessandro Galesi (Banco de España)
    Abstract: We assess the international spillovers of US monetary policy with a large-scale global VAR which models the world economy as a network of interdependent countries. An expansionary US monetary policy shock contributes to the emergence of a Global Financial Cycle, which boosts macroeconomic activity worldwide. We also find that economies with floating exchange rate regimes are not fully insulated from US monetary policy shocks and, even though they appear to be relatively less affected by the shocks, the differences in responses across exchange rate regimes are not statistically significant. The role of US monetary policy in driving these macrofinancial spillovers gets even reinforced by the complex network of interactions across countries, to the extent that network effects roughly double the direct impacts of US monetary policy surprises on international equity prices, capital flows, and global growth. This amplification increases as countries get more globally integrated over time, suggesting that the evolving network is an important driver for the increasing role of US monetary policy in shaping the Global Financial Cycle.
    Keywords: trilemma, Global Financial Cycle, monetary policy spillovers, network effects
    JEL: C32 E52 F40
    Date: 2019–12
  3. By: Lloyd, S. P.; Marin, E. A.
    Abstract: We show that currencies with a steeper yield curve tend to depreciate at business cycle horizons, in violation of uncovered interest parity (UIP), but the yield curve adds no explanatory power over and above interest differentials in explaining the exchange rate at longer horizons. We argue that exchange rate risk premia reallocate returns intertemporally to investors who value them relatively highly, reflecting transitory innovations to their stochastic discount factor consistent with business cycle risk. Using holding period returns, we identify a tent-shape relationship, across horizons, between dollar-bond excess returns for long maturity bonds and the relative slope. In addition, we find that short-horizon UIP deviations switch sign following yield curve inversions, consistent with the interpretation of inversions as indicators of changes in growth and inflation expectations. We show that accounting for liquidity yields does not alter our results, but rather contributes to explaining cross-sectional differences across currencies, consistent with permanent innovations to agents' stochastic discount factor.
    Keywords: Exchange rates, Risk premia, Uncovered interest parity, Yield curves
    JEL: E43 F31
    Date: 2019–12–03
  4. By: Richard T. Froyen; Alfred V. Guender (University of Canterbury)
    Abstract: Through an appropriate choice of inflation objective – a real-exchange-rate-adjusted (REX) inflation target - the central bank can limit fluctuations in real economic activity which have become a cause of great concern in recent years in many small open economies. REX inflation targeting dominates CPI targeting from the standpoint of output gap stabilization. CPI inflation targeting dominates REX inflation targeting from the standpoint of stabilizing inflation, nominal interest rates and real exchange rates. These results help inform ongoing discussions of possible alternatives for the existing flexible inflation targeting framework.
    Keywords: CPI, REX, Domestic Inflation Targets, Broad vs. Narrow Mandate
    JEL: E3 E5 F3
    Date: 2019–11–01
  5. By: Jakubik, Adam; Stolzenburg, Victor
    Abstract: The geography of global value chains (GVCs) depends crucially on trade costs between countries hosting various stages of production. Some stages might be more sensitive to trade costs than others. In this paper, we exploit a value-added decomposition of bilateral trade flows to distinguish low value-added GVC trade typically associated with production stages such as assembly, from high value-added GVC trade associated with stages such as R&D and design. We test the hypothesis that low value-added stages will more easily reroute given changes in trade costs between importing and exporting countries than high value-added stages. The intuition for this hypothesis is that trade costs accumulate with multiple border crossings and are larger relative to the profit margins in low value-added stages. Furthermore, high value-added stages often require larger fixed cost investments which are often highly relationship-specific and knowledge-intensive, making them harder to relocate. We find strong empirical support for our hypothesis. This observation has important implications for development policies and bilateral trade policies aimed at reducing imbalances by repatriating offshored production stages.
    Keywords: value added trade,trade costs,organisation of production
    JEL: C23 L23 F13
    Date: 2019
  6. 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 Globalization 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 ba - lance 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 mar - ket 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.
    JEL: N10 N20 E42 E50 F30 F44
    Date: 2019
  7. By: Pierluigi Balduzzi (Boston College); Emanuele Brancati (Sapienza University of Rome); Marco Brianti (Boston College); Fabio Schiantarelli (Boston College; IZA)
    Abstract: We study the effects on financial markets and real economic activity of changes in risk related to political events and policy announcements in Italy during the 2013-2019 period that saw the rise to power of populist parties. We focus on events that have implications for budgetary policy, debt sustainability and for Euro membership. We use changes in the Credit Default Swaps (CDS) spreads on governments bonds around those dates as an instrument for shocks to policy and institutional risk – political risk for short – in the context of Local Projections - IV. We show that shocks associated with the rise of populist forces or their policies have adverse and sizable effects on financial markets. These negative effects were moderated by the European institutions and domestic constitutional constraints. In addition, Italian political developments generate international spillover effects on the spreads of other eurozone countries. Finally, political risk shocks have a negative impact on the real economy, although the accommodating stance of monetary policy helped in cushioning them.
    Keywords: populism, political risk, policy uncertainty, sovereign debt, fiscal policy, CDS spread
    JEL: E44 G10 H62 H63
    Date: 2019–12–01
  8. By: Murshed, Muntasir; Nijhum, Nawrin Khan
    Abstract: This paper aims to analyze the possibility of the twin deficits hypothesis existing in the context of Bangladesh using annual data from 1980 to 2017. Vector Error-Correction approach is tapped to estimate the short and long run coefficients while the pairwise Granger causality analysis is employed to understand the long run causal associations. The results suggest that budget and current account balances in Bangladesh behave as distant cousins rather than twins as perceived from a reverse causality that is found to be stemming from budget deficit to current account deficit. Moreover, budget deficit is found to deteriorate the national trade balance in Bangladesh.
    Keywords: twin deficits; trade deficit; budget deficit; current account deficit; VEC
    JEL: E62 F32 F41 H62
    Date: 2019
  9. By: Shiyi Wang
    Abstract: Volatile international capital flows increase the risk of financial crises and reduce economic growth. The theoretical literature predicts that financial globalization will make capital flows more volatile. Importantly, the deepening of financial globalization has led to the emergence of the global financial cycle, which makes taming capital flows even more challenging. It is important to measure capital flow volatility and examine what factors affect it. In this paper, I estimate the time-varying capital flow volatility of 39 countries, including both advanced and emerging economies since 2000, and find that bank flows are the most volatile while foreign direct investment flows are the most stable. Panel regressions show that higher local financial development and more volatile and riskier global financial conditions increase capital flow volatility. I also find that there exists a threshold effect: financial volatility and risk in the global financial center are transmitted more strongly to countries that are more financially developed. The impulse responses of state-dependent local projections confirm the threshold effect and indicate that it is stronger for bank flows than for FDI and portfolio flows. These empirical findings provide insights into international capital flow management.
    JEL: E44 E52 F32 F36
    Date: 2019–12–02
  10. By: Jaromir Baxa (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic; The Czech Academy of Sciences, Institute of Information Theory and Automation, Pod Vodarenskou Vezi 4, 182 00, Prague, Czech Republic); Pavel Jancovic (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic)
    Abstract: The alternative specifications of the behavioural equilibrium exchange rate models (the BEERs) and their permanent counterparts (the PEERs) often deliver diverse estimates of the equilibrium exchange rate. In the case of the Czech koruna against the euro exchange rate, the discrepancy among the estimated BEERs often exceeds 10 %, and it had been wide before the introduction of the exchange rate commitment in November 2013 as well. Thus, the BEERs do not provide reliable guidance about the equilibrium exchange rate and the size of the equilibrium. To tackle the model uncertainty, we propose to learn about the BEERs and PEERs from the model combination to retain the information of all individual models. From a policy perspective, our results provide weak support to claims that the Czech koruna had been slightly overvalued before the introduction of the commitment in 2013. However, the koruna became increasingly undervalued since the mid of 2015, and this timing overlaps with the need to support the exchange rate commitment by the exchange rate interventions.
    Keywords: Equilibrium exchange rate, BEER, PEER, exchange rate commitment, model averaging
    JEL: F31 O24 E58 C52
    Date: 2019–10
  11. By: Pegdéwendé Nestor Sawadogo (CERDI - Centre d'Études et de Recherches sur le Développement International - Clermont Auvergne - UCA - Université Clermont Auvergne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Several countries have introduced fiscal rules to deter fiscal profligacy, enhance the credibility of fiscal policy and reduce borrowing costs. In this paper, we examine the strength of fiscal rules in terms of improving financial markets access for developing countries. We use entropy balancing and various propensity score matching as well. We find that the adoption of fiscal rules reduces (increases) sovereign bond spreads (sovereign debt ratings) in a sample of 36 developing countries, which are part of the JP Morgan Emerging Markets Bond Index Global (EMBIG), over the period 1993-2014. We explain this finding by the credibility of fiscal policy channel: more credible governments are rewarded in the international financial markets with low sovereign bond spreads and high sovereign debt ratings. These results are robust to a wide set of alternative specifications. We also show that this favorable effect is sensitive to several country's structural characteristics. Our findings substantiate that the adoption and sound implementation of fiscal rules is a substantial instrument for policy makers to improve developing countries' financial markets access.
    Keywords: Fiscal rules,Bond spreads,Sovereign debt ratings,Entropy balancing
    Date: 2019–11–15
  12. By: Wehner, Nicholas (OCTO (Open Communications for The Ocean)); Open Communications for The Ocean, OCTO
    Abstract: Surveys of northern California-based fishermen indicate that there is a relationship between the trust fishermen have in groups like managers and researchers, and their satisfaction with the outcomes of an MPA planning process. Low levels of trust with managers were tied to low levels of satisfaction with the MPA planning process. Conservation targets may be an impediment for building that trust.
    Date: 2018–05–22
  13. By: Hanna Armelius; Christoph Bertsch; Isaiah Hull; Xin Zhang
    Abstract: We construct a novel text dataset to measure the sentiment component of communications for 23 central banks over the 2002-2017 period. Our analysis yields three results. First, comovement in sentiment across central banks is not reducible to trade or financial flow exposures. Second, sentiment shocks generate cross-country spillovers in sentiment, policy rates, and macroeconomic variables; and the Fed appears to be a uniquely influential generator of such spillovers, even among prominent central banks. And third, geographic distance is a robust and economically significant determinant of comovement in central bank sentiment, while shared language and colonial ties have weaker predictive power.
    Keywords: communication, monetary policy, international policy transmission
    JEL: E52 E58 F42
    Date: 2019–12

This nep-opm issue is ©2019 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.