nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒03‒30
five papers chosen by
Martin Berka
University of Auckland

  1. Breaking the UIP: A Model-Equivalence Result By Yakhin, Yossi
  2. Exchange rate shocks and inflation comovement in the euro area By Leiva-Leon, Danilo; Martínez-Martin, Jaime; Ortega, Eva
  3. The Financial Center Leverage Cycle: Does it Spread Around the World? By Graciela L. Kaminsky; Leandro Medina; Shiyi Wang
  4. Labor Market Institutions and the Effects of Financial Openness By Shang-Jin Wei; Jun Nie; Qingyuan Du
  5. The transmission of business cycles: Lessons from the 2004 enlargement of the EU and the adoption of the euro By Hoang Sang Nguyen; Fabien Rondeau

  1. By: Yakhin, Yossi
    Abstract: Breaking the uncovered interest rate parity (UIP) condition is essential to accounting for the empirical behavior of exchange rates, and is a prerequisite for theoretical analysis of sterilized foreign exchange interventions. Gabaix and Maggiori (2015) account for some of the long-standing empirical exchange rate puzzles by introducing financial intermediaries that are willing to absorb international saving imbalances for a premium, thereby deviating from the UIP. In another important contribution, Fanelli and Straub (2019) lay down the principles for foreign exchange interventions. In their model, regulatory exposure limits and participation cost in the international financial markets drive a wedge in the UIP. This paper demonstrates that, to a first order approximation, these models are equivalent to a reduced-form portfolio adjustment cost model, as in Schmitt-Grohé and Uribe (2003). Therefore, to the extent that one is only concerned with first-order dynamics and second moments, there is no gain from adopting the rich microstructure of either models -- a simple portfolio adjustment cost is just as good.
    Keywords: UIP; Financial Frictions; Open Economy Macroeconomics
    JEL: E58 F31 F41
    Date: 2019–11–17
  2. By: Leiva-Leon, Danilo; Martínez-Martin, Jaime; Ortega, Eva
    Abstract: This paper decomposes the time-varying effect of exogenous exchange rate shocks on euro area countries inflation into country-specific (idiosyncratic) and region-wide (common) components. To do so, we propose a flexible empirical framework based on dynamic factor models subject to drifting parameters and exogenous information. We show that exogenous shocks to the EUR/USD exchange rate account for over 50% of nominal EUR/USD exchange rate fluctuations in more than a third of the quarters of the past six years, especially in turning point periods. Our main results indicate that headline inflation in euro area countries, and in particular its energy component, has become significantly more affected by these exogenous exchange rate shocks since the early 2010s, in particular for the region's largest economies. While in the case of headline inflation this increasing sensitivity is solely reliant on a sustained surge in the degree of comovement, for energy inflation it is also based on a higher region-wide effect of the shocks. By contrast, purely exogenous exchange rate shocks do not seem to have a significant impact on the core component of headline inflation, which also displays a lower degree of comovement across euro area countries. JEL Classification: C32, E31, F31, F41
    Keywords: exchange rate, factor model, inflation, structural VAR model
    Date: 2020–03
  3. By: Graciela L. Kaminsky; Leandro Medina; Shiyi Wang
    Abstract: With a novel database, we examine the evolution of capital flows to the periphery since the collapse of the Bretton Woods System in the early 1970s. We decompose capital flows into global, regional, and idiosyncratic factors. In contrast to previous findings, which mostly use data from the 2000s, we find that booms and busts in capital flows are mainly explained by regional factors and not the global factor. We then ask, what drives these regional factors. Is it the leverage cycle in the financial center? What triggers the leverage cycle in the financial center? Is it a change in global investors’ risk appetite? Or, is it a change in the demand for capital in the periphery? We link leverage in the financial center to regional capital flows and the cost of borrowing in international capital markets to answer these questions. Our estimations indicate that regional capital flows are driven by supply shocks. Interestingly, we find that the leverage in the financial center has a time-varying behavior, with a movement away from lending to the emerging periphery in the 1970s to the 1990s towards lending to the advanced periphery in the 2000s.
    JEL: F30 F34 F65
    Date: 2020–02
  4. By: Shang-Jin Wei; Jun Nie; Qingyuan Du
    Abstract: We propose a new channel to explain why developing countries may fail to benefit from financial globalization, based on labor market institutions. In our model, financial openness in a developing country with a rigid labor market leads to capital outflow, and both employment and output fall. In contrast, financial openness in a developing country with a flexible labor market benefits the country. Our model suggests that enhancing labor market flexibility is a complementary reform for developing countries opening capital accounts.
    Keywords: Developing Countries; Capital Account LIberalization; Labor Market Rigidity; Financial Openness; Unemployment
    JEL: E24 F41 F44 J08
    Date: 2019–11–26
  5. By: Hoang Sang Nguyen (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique); Fabien Rondeau (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper evaluates macroeconomic interdependencies of seven Central and Eastern European Countries (CEECs) with the Euro Area (EA) through trade relationship. We estimate a near-VAR model and we simulate responses of activity in those CEECs to output shocks for twelve former members of the EA before and after the 2004 enlargement of the European Union (EU). During both periods, empirical results show that spillover effects come through the main economies of the EA: Germany, France and Italy. Furthermore, CEECs are more responsive to output shocks in the EA after 2004 than before (3.3 times larger on average). Increases in spillover effects are larger for the three CEECs that adopted the Euro early (Slovenia, Slovakia, and Estonia) than the other CEECs (4.9 versus 2.1) but without higher trade intensity with the EA (1.07 versus 1.12). Our results show that trade effects are positive inside the same currency area but negative for the CEECs without the euro. JEL Classifications: F13, F15, F45
    Keywords: OCA,Enlargement,European Union,Trade Spillovers,Euro,Near-VAR
    Date: 2019–03–24

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