nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒01‒20
eighteen papers chosen by
Martin Berka
University of Auckland

  1. Monetary Policy in an Era of Global Supply Chains By Shang-Jin Wei; Yinxi Xie
  2. Exchange Rates and Consumer Prices: Evidence from Brexit By Breinlich, Holger; Leromain, Elsa; Novy, Dennis; Sampson, Thomas
  3. The Trade-Comovement Puzzle By Lukasz A. Drozd; Sergey Kolbin; Jaromir B. Nosal
  4. Deterministic Debt Cycles in Open Economies with Flow Collateral Constraints By Stephanie Schmitt-Grohé; Martín Uribe
  5. Markups, Quality, and Trade Costs By Chen, Natalie; Juvenal, Luciana
  6. The Mutable Geography of Firms' International Trade: Evidence and Macroeconomic Implications By Lu Han
  7. Cross-Border flows and the effect of Global Financial shocks in Latin America. By Gondo, Rocío; Pérez, Fernando
  8. "An Empirical Stock-Flow Consistent Macroeconomic Model for Denmark" By Mikael Randrup Byrialsen; Hamid Raza
  9. Exchange Rate Pass-through after a Large Depreciation By Anatoli Colicev; Joris Hoste; Jozef Konings
  10. Safe haven flows, natural interest rates and secular stagnation: Empirical evidence for euro area countries By Belke, Ansgar; Klose, Jens
  11. Coalition-Proof Risk Sharing Under Frictions By Harold L. Cole; Dirk Krueger; George J. Mailath; Yena Park
  12. The Negative Consequences of Loss-Framed Performance Incentives By Lamar Pierce; Alex Rees-Jones; Charlotte Blank
  13. Is the Co-Movement Between Budget Deficit and Current Account Deficit Applicable to South Africa? By Naape, Baneng
  14. Oil Discoveries and Protectionism By Rick Van der Ploeg; Fidel Perez-Sebastian; Ohad Raveh
  15. Global Value Chains and External Adjustment: Do Exchange Rates Still Matter? By Gustavo Adler; Sergii Meleshchuk; Carolina Osorio Buitron
  16. Bank Risk-Taking in a Small Open Economy. By Pozo, Jorge
  17. Cross-Border Currency Exposures By Luciana Juvenal; Deepali Gautam; Agustin Benetrix; Martin Schmitz
  18. Does China's overseas lending favor One Belt One Road countries? By Zhang, Yifei; Fang, Heyang

  1. By: Shang-Jin Wei; Yinxi Xie
    Abstract: We study the implications of global supply chains for the design of monetary policy, using a small-open economy New Keynesian model with multiple stages of production. Within the family of simple monetary policy rules with commitment, a rule that targets separate producer price inflation at different production stages, in addition to output gap and real exchange rate, is found to deliver a higher welfare level than alternative policy rules. As an economy becomes more open, measured by the export share, the optimal weight on the upstream inflation rises relative to that on the final stage inflation. If we have to choose among aggregate price indicators, targeting PPI inflation yields a smaller welfare loss than targeting CPI inflation alone. As the production chain becomes longer, the optimal weight on PPI inflation in the policy rule that targets both PPI and CPI inflation will also rise. A trade cost shock such as a rise in the import tariff can alter the optimal weights on different inflation variables.
    JEL: E52 F4
    Date: 2020–01
  2. By: Breinlich, Holger (University of Surrey); Leromain, Elsa (UC Louvain); Novy, Dennis (University of Warwick); Sampson, Thomas (London School of Economics.)
    Abstract: This paper studies how the depreciation of sterling following the Brexit referendum affected consumer prices in the United Kingdom. Our identification strategy uses input-output linkages to account for heterogeneity in exposure to import costs across product groups. We show that, after the referendum, inflation increased by more for product groups with higher import shares in consumer expenditure. This effect is driven by both direct consumption of imported goods and the use of imported inputs in domestic production. Our results are consistent with complete pass-through of import costs to consumer prices and imply an aggregate exchange rate pass-through of 0.29. We estimate the Brexit vote increased consumer prices by 2.9 percent, costing the average household £870 per year. The increase in the cost of living is evenly shared across the income distribution, but differs substantially across regions.
    Date: 2019
  3. By: Lukasz A. Drozd; Sergey Kolbin; Jaromir B. Nosal
    Abstract: Standard international transmission mechanism of productivity shocks predicts a weak endogenous linkage between trade and business cycle synchronization: a problem known as the trade-comovement puzzle. We provide the foundational analysis of the puzzle, pointing to three natural candidate resolutions: i) financial market frictions; ii) Greenwood–Hercowitz–Huffman preferences; and iii) dynamic trade elasticity that is low in the short run but high in the long run. We show the effects of each of these candidate resolutions analytically and evaluate them quantitatively. We find that, while i) and ii) fall short of the data, iii) goes a long way toward resolving the puzzle.
    Keywords: trade-comovement puzzle; elasticity puzzle; trade elasticity; international comovement
    JEL: E32 F32 F41 F44
    Date: 2020–01–02
  4. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper establishes the existence of deterministic cycles in infinite-horizon open economy models with a flow collateral constraint. It shows that for plausible parameter configurations, the economy has a unique equilibrium exhibiting deterministic cycles in which periods of debt growth are followed by periods of debt deleveraging. In particular, three-period cycles exist, which implies by the Li-Yorke Theorem the presence of cycles of any periodicity and chaos. The paper also shows that deterministic cycles are absent in the Ramsey optimal allocation providing a justification for macroprudential policies even in the absence of uncertainty.
    JEL: E32 F38 F41 H23
    Date: 2020–01
  5. By: Chen, Natalie (University of Warwick); Juvenal, Luciana (International Monetary Fund)
    Abstract: We investigate theoretically and empirically how exporters adjust their markups across destinations depending on bilateral distance, tariffs, and the quality of their exports. Under the assumption that trade costs are both ad valorem and per unit, our model predicts that markups rise with distance and fall with tariffs, but these effects are heterogeneous and are smaller in magnitude for higher quality exports. We find strong support for the predictions of the model using a unique data set of Argentinean firm-level wine exports combined with experts wine ratings as a measure of quality.
    Keywords: Distance; export unit values; heterogeneity; markups; quality; tariffs; trade costs; wine JEL Classification: F12, F14, F31
    Date: 2019
  6. By: Lu Han
    Abstract: Exporters add and drop destination markets in response to a variety of global, national and industry-specific shocks. This paper develops empirical measures of these market changes and documents a set of key stylized facts using the customs databases of China (2000-2006) and the United Kingdom (2010-2016). First, I find within-firm changes in destination markets involve large trade values and 30-40% of all market changes involve simultaneously adding and dropping markets. Second, around 20% of within-firm market changes are driven by fluctuations in bilateral exchange rates and local CPI measures. Taken together, these facts suggest that firms face large destination-specific fluctuations in the demand for their products. Third, while adding and dropping markets, firms simultaneously adjust prices and quantities across all other destinations they serve. I build a multi-country general equilibrium model to investigate the channels that can generate the observed data patterns and study the aggregate implications of mutable markets (within-firm market changes) on the distribution of markups, trade volumes, and welfare. Applying the multi-country model to analysis of a bilateral trade war, I find that aggregate productivity for countries directly involved in the trade war drops more (1-2%) and that of countries not involved rises more (8-10%) when firms endogenously vary their markets in response to the new conditions of competition in local markets induced by the bilateral trade war.
    Date: 2019–09
  7. By: Gondo, Rocío (Banco Central de Reserva del Perú); Pérez, Fernando (Banco Central de Reserva del Perú)
    Abstract: This work quantifies the effect of changes in global financial conditions on cross-border flows and domestic financial and macroeconomic variables for a group of countries in Latin America. Using the BIS database of international banking statistics, we consider heterogeneous effects of different types of international financing (credit from global banks to domestic banks and non-financial firms and bond issuance by non-financial firms), on the behavior of the domestic banking system and the transmission to the real economy through the link between bank credit, investment and output. Consistent with the implications from a DSGE model such as Aoki et al. (2018), our results show that an increase in foreign interest rates translate into lower external funding for banks and thus into lower credit growth and higher domestic interest rates. This effect is amplified through an exchange rate depreciation due to capital outflows. We find evidence of a larger drop in flows from global banks to domestic banks relative to those from global banks to non-financial firms. In terms of the real economy, we observe a reduction in GDP growth, although not significant, and an increase in inflation due to the pass through effect from the exchange rate to prices.
    Keywords: Panel Vector Autoregressions, Exogenous Block, Bayesian Estimation, Cross-Border flows.
    JEL: C23 E44 F21 F32
    Date: 2019–12
  8. By: Mikael Randrup Byrialsen; Hamid Raza
    Abstract: This paper emphasizes the need for understanding the interdependencies between the real and financial sides of the economy in macroeconomic models. While the real side of the economy is generally well explained in macroeconomic models, the financial side and its interaction with the real economy remains poorly understood. This paper makes an attempt to model the interdependencies between the real and financial sides of the economy in Denmark while adopting a stock-flow consistent approach. The model is estimated using Danish data for the period 1995-2016. The model is simulated to create a baseline scenario for the period 2017-30, against which the effects of two standard shocks (fiscal shocks and interest rate shocks) are analyzed. Overall, our model is able to replicate the stylized facts, as will be discussed. While the model structure is fairly simple due to different constraints, the use of the stock-flow approach makes it possible to explain several transmission mechanisms through which real economic behavior can affect the balance sheets, and at the same time capture the feedback effects from the balance sheets to the real economy. Finally, we discuss certain limitations of our model.
    Keywords: Empirical Stock-Flow Consistent Models; Denmark; Open Economy
    JEL: E17 E12 F41
  9. By: Anatoli Colicev; Joris Hoste; Jozef Konings
    Abstract: This paper uses monthly scanner consumer price data to study exchange rate pass-through (ERPT) after the Kazakh Tenge switch from a fixed to a floating exchange rate regime in August 2015. The depreciation of the Tenge was large (50%), triggered overnight and unanticipated. This exchange rate shock allows us to have a clear identification strategy. In particular, we model ERPT to consumer prices using Local Projections estimations, which is especially well-suited to capture price dynamics after large shocks. We find that prices respond fast, yet incomplete. After 12 months the ERPT into consumer prices is between 25% and 34%. We also find that ERPT depends on the type of product, i.e. whether it is foreign sourced and whether the product is an international brand.
    Date: 2019–10
  10. By: Belke, Ansgar; Klose, Jens
    Abstract: This article introduces a new measure to capture safe haven flows for twelve Euro area countries. Since those flows are suspected to alter the natural rate of interest, which is at the heart of the discussion whether certain countries face a period of secular stagnation, we estimate the natural rate including those flows explicitly. It is shown that adding this measure indeed changes the estimated natural rate and thus the degree of evidence of secular stagnation in various countries. It is found that the natural rate tends to decrease in countries with safe haven inflows and increases in countries with safe haven outflows.
    Keywords: safe haven,portfolio flows,natural interest rate,secular stagnation,Euro area member countries
    JEL: E43 F45 C32
    Date: 2019
  11. By: Harold L. Cole (University of Pennsylvania); Dirk Krueger (University of Pennsylvania); George J. Mailath (University of Pennsylvania); Yena Park (University of Rochester)
    Abstract: We analyze e?cient risk-sharing arrangements when coalitions may deviate. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any deviating coalition rely on a belief in future cooperation, and we treat the contracting conditions of original and deviating coalitions symmetrically. We show that better belief coordination (higher social capital) tightens incentive constraints since it facilitates both the formation of the original as well as a deviating coalition. As a consequence, the payo? of successfully formed coalitions might be declining in the degree of belief coordination and equilibrium allocations might feature resource burning or utility burning.
    Keywords: Financial Coalition, Limited Enforcement, Risk Sharing, Coalition-Proof Equi-librium
    JEL: E21 G22 D11 D91
    Date: 2019–01–08
  12. By: Lamar Pierce; Alex Rees-Jones; Charlotte Blank
    Abstract: Behavioral economists have proposed that loss-averse employees increase productivity when bonuses are "loss framed"—prepaid then clawed back if targets are unmet. We theoretically document that loss framing raises incentives for costly risk mitigation and for inefficient multitasking, potentially leading to large negative performance effects. We empirically document evidence of these concerns in a nationwide field experiment among 294 car dealers. Dealers randomized into loss-framed (but financially identical) contracts sold 5% fewer vehicles than control dealers, generating a revenue loss of $45 million over 4 months. We discuss implications regarding the use of behavioral economics to motivate both employees and firms.
    JEL: D03 D81 J22 J31
    Date: 2020–01
  13. By: Naape, Baneng
    Abstract: The idea of the fiscal balance to have a statistically significant impact on the current account is known as the Twin deficits hypothesis, which this study seeks to investigate. We make use of annual macroeconomic data spanning from 1990 – 2017. Additionally, we utilise novel time-series cointegration techniques such as the ARDL Bounds and Granger causality analysis. From empirical tests, we find that a long-run relationship exists between budget deficit and current account deficit. Moreover, the real effective exchange rate, real interest rate and GDP are found to have a negative and statistically significant impact on the current account whereas the budget deficit, on the contrary, is found to have a positive and statistically significant impact on the current account deficit, at least in the short-run. Granger causality test indicates unidirectional causation from budget deficit to current account deficit, lagged one period. Given these findings, we fail to reject the Twin Deficits Hypothesis within the context of South Africa. The policy implication is for the government to fix its fiscus so as to improve the current account stance. This can be achieved through extended fiscal adjustments to bring expenditure in line with revenue, thereby stabilising debt.
    Keywords: Twin deficits, Ricardian equivalence, ARDL Bounds test, Granger causality
    JEL: A1 C5 E2 H6
    Date: 2019–08–30
  14. By: Rick Van der Ploeg; Fidel Perez-Sebastian; Ohad Raveh
    Abstract: Can oil discovery shocks affect the demand for protectionism? A two-period model of Dutch disease indicates that if the tradable sector is politically dominant then an oil discovery induces protectionism. If the economy is also credit constrained, this effect is intensified upon discovery, but partially reversed when oil revenues start to flow. We test these predictions using detailed bilateral tariff data that cover 96 products in 155 countries over the period 1988-2012, and worldwide discoveries of giant oil and gas fields. Our identification strategy rests on the exogeneity of the timing of discoveries. We find that an oil discovery increases tariffs during pre-production years and decreases tariffs in the years to follow yet to a lesser extent, most notably in capital scarce economies with a relatively dominant tradable sector. Our baseline estimates indicate that a giant oil field discovery induces a rise of approximately 15% in the average tariff over the course of 10 years; this increase is about 1.8 times larger during the pre¬production period when the oil discovery represents a pure news shock.
    Keywords: Oil discoveries, protectionism, capital scarcity, Dutch disease, political economy, trade policy, news shocks
    JEL: Q32 F13 O24
    Date: 2019–12–19
  15. By: Gustavo Adler; Sergii Meleshchuk; Carolina Osorio Buitron
    Abstract: The paper explores how international integration through global value chains shapes the working of exchange rates to induce external adjustment both in the short and medium run. The analysis indicates that greater integration into international value chains reduces the exchange rate elasticity of gross trade volumes. This result holds both in the short and medium term, pointing to the rigidity of value chains. At the same time, greater value chain integration is associated with larger gross trade flows, relative to GDP, which tends to amplify the effect of exchange rate movements. Overall, combining these two results suggests that, for most countries, integration into global value chains does not materially alter the working of exchange rates and the benefits of exchange rate flexibility in facilitating external adjustment remain.
    Date: 2019–12–27
  16. By: Pozo, Jorge (Banco Central de Reserva del Perú)
    Abstract: I develop an open economy model with banks facing foreign borrowing limits. The interaction of banks' limited liability and deposit insurance leads banks into socially excessive risk-taking, which involves credit volume and not the type of credit. The novel result is that, under a realistic calibration, a lower foreign interest rate reduces the excessive bank risk-taking. Since the foreign borrowing limit is binding, this lower rate does not boost banks' credit, but rather decreases it, since for a given capital the lower rate reduces the default probability of banks, which diminishes their risk-taking incentives. Through the same mechanism, a greater access to the international credit markets reduces the excessive risk-taking by banks. Hence, less banking regulation to achieve socially efficient risk-taking is required after a foreign rate reduction and a higher foreign borrowing limit.
    Keywords: Macroprudential policies, financial stability, monetary policy and bank risk-taking.
    JEL: E44 E52 F41 G01 G21 G28
    Date: 2019–12
  17. By: Luciana Juvenal; Deepali Gautam; Agustin Benetrix; Martin Schmitz
    Abstract: This paper provides a dataset on the currency composition of the international investment position for a group of 50 countries for the period 1990-2017. It improves available data based on estimates by incorporating actual data reported by statistical authorities and refining estimation methods. The paper illustrates current and new uses of these data, with particular focus on the evolution of currency exposures of cross-border positions.
    Date: 2019–12–27
  18. By: Zhang, Yifei; Fang, Heyang
    Abstract: The One Belt One Road initiative is found to promote China’s overseas lending in the belt road countries, especially for countries along the continental route. Such effect strengthens and persists for at least three years. Our findings show that launching a national strategy could be a decisive determinant of one country’s outbound loans.
    Keywords: International lending, One Belt One Road
    JEL: F34 F42
    Date: 2020–01–03

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