nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒04‒27
eleven papers chosen by
Martin Berka
University of Auckland

  1. Attention to the tail(s): global financial conditions and exchange rate risks By Sokol, Andrej; Eguren-Martin, Fernando
  2. Inflation and Exchange Rate Pass-Through By Jongrim Ha; M. Marc Stocker; Hakan Yilmazkuday
  3. Avoiding Sovereign Default Contagion: A Normative Analysis By Sergio De Ferra; Enrico Mallucci
  4. Currency Misalignments and Exchange Rate Regimes in Latin American countries: A Trade-Off issue By Jorge Carrera; Blaise Gnimassoun; Valérie Mignon; Romain Restout
  5. Capital Controls and Income Inequality By Zheng Liu; Mark M. Spiegel; Jingyi Zhang
  6. Switching Volatility in a Nonlinear Open Economy By Benchimol, Jonathan; Ivashchenko, Sergey
  7. The Demand for Trade Protection over the Business Cycle By Stéphane AURAY; Michel B. DEVEREUX; Aurélien EYQUEM
  8. Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime-Switching Approach By Gianluca Benigno; Andrew Foerster; Christopher Otrok; Alessandro Rebucci
  9. The International Spillover Effects of US Monetary Policy Uncertainty By Lakdawala, Aeimit; Moreland, Timothy; Schaffer, Matthew
  10. Growth and instability in a small open economy with debt By Leonor Modesto; Carine Nourry; Thomas Seegmuller; Alain Venditti
  11. International capital flows at the security level: evidence from the ECB’s Asset Purchase Programme By Fidora, Michael; Schmitz, Martin; Bergant, Katharina

  1. By: Sokol, Andrej; Eguren-Martin, Fernando
    Abstract: We document how the 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 (and quantifying) some of the prevailing narratives about safe haven and risky currencies. Our approach delivers a more nuanced picture than one based on standard OLS regression. 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 net foreign asset positions, 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. JEL Classification: F31, G15
    Keywords: exchange rates, financial conditions indices, global financial cycle, quantile regression, tail risks
    Date: 2020–04
  2. By: Jongrim Ha (World Bank); M. Marc Stocker (World Bank); Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper investigates exchange rate pass-through into consumer prices by considering the nature of the shock triggering currency movements. By individually estimating structural factor-augmented vector autoregression models for 55 countries, monetary policy shocks are shown to be associated with higher exchange rate pass-through measures compared to other domestic shocks, while global shocks have widely different effects across countries. Pass-through measures tend to be lower in countries that combine flexible exchange rate regimes and credible inflation targets, where central bank independence can greatly facilitate the task of stabilizing inflation by using the exchange rate as a buffer against external shocks. It is implied that exchange rate pass-through should be investigated by considering the nature of the shock that triggers currency movements and country characteristics that affect the response of prices.
    Keywords: Inflation, Foreign Exchange, Monetary Policy, Exchange Rate Pass Through
    JEL: E31 E42 E52 F31
    Date: 2020–03
  3. By: Sergio De Ferra; Enrico Mallucci
    Abstract: Should debtor countries support each other during sovereign debt crises? We answer this question through the lens of a two-country sovereign-default model that we calibrate to the euro-area periphery. First, we look at cross-country bailouts. We find that whenever agents anticipate their existence, bailouts induce moral hazard an reduce welfare. Second, we look at the borrowing choices of a global central borrower. We find that it borrows less than individual governments and, as such, defaults become less frequent and welfare increases. Finally, we show that central borrower's policies can be replicated in a decentralized setting with Pigouvian taxes on debt.
    Keywords: Sovereign default; Sovereign contagion; Bailouts; Pigouvian taxes
    JEL: F34 F41 F45 H63
    Date: 2020–02–27
  4. By: Jorge Carrera; Blaise Gnimassoun; Valérie Mignon; Romain Restout
    Abstract: This paper conducts an in-depth empirical investigation on the impact of the exchange rate regime (ERR) on real currency misalignments in a panel of 17 Latin American countries over the 1970-2016 period. We consider explicitly the two dimensions of misalignments, size and persistence, and evaluate four different ERR classifications. We also pay attention to cross-sectional dependencies across countries that appear to be important in Latin America, and provide several robustness checks. Our main findings show that, although fixed ERR perform well in limiting the size of misalignments – and in reducing inflation and fiscal deficit – the disequilibria are more persistent. On the contrary, allowing for more flexibility reduces persistence but increases the size of misalignments. Overall, we show that Latin American countries face a crucial trade-off when they have to choose their ERR.
    Keywords: Latin American Countries;Exchange Rate Regimes;Currency Misalignments
    JEL: F31 C23 E42
    Date: 2020–04
  5. By: Zheng Liu; Mark M. Spiegel; Jingyi Zhang
    Abstract: We examine the distributional implications of capital account policy in a small open economy model with heterogeneous agents and financial frictions. Households save through deposits in both domestic and foreign banks. Entrepreneurs finance investment with borrowed funds from domestic banks and foreign investors. Domestic banks engage in costly intermediation of deposits from households and loans to entrepreneurs. Government capital account policy consists of taxes on outflows and inflows. Given policy, a temporary decline in the world interest rate leads to a surge in inflows, benefiting entrepreneurs and hurting households. Raising inflow taxes or reducing outflow taxes mitigate this redistribution. However, in the long run liberalization of either inflows or outflows reduces inequality. The model’s short-run implications are supported by empirical evidence. Based on instrumental variable estimation with a panel of emerging market economies, we demonstrate that increases in private capital inflows raise income inequality, while increases in outflows reduce it. These effects are significant and robust to a wide variety of empirical specifications.
    Keywords: Capital flows; income distribution; heterogeneous agents; financial frictions; small open economy
    JEL: D63 F32 F38
    Date: 2020–04–14
  6. By: Benchimol, Jonathan; Ivashchenko, Sergey
    Abstract: Uncertainty about a regime’s economy can change drastically around a crisis. An imported crisis such as the global financial crisis in the Euro area highlights the effect of foreign shocks. Estimating an open-economy nonlinear dynamic stochastic general equilibrium model for the Euro area and United States including Markov-switching volatility shocks, we show that these shocks were significant during the global financial crisis compared with in calm periods. We describe how US shocks from both the real economy and financial markets affected the Euro area economy and how bond reallocation occurred between short- and long-term maturities during the global financial crisis. Importantly, the estimated nonlinearities when domestic and foreign financial markets influence the economy should not be neglected. The nonlinear behavior of market-related variables highlights the importance of higher-order estimation for providing additional interpretations to policymakers.
    Keywords: DSGE; Volatility Shocks; Markov Switching; Open Economy; Financial Crisis; Nonlinearities
    JEL: C61 E32 F21 F41
    Date: 2020–04
  7. By: Stéphane AURAY (CREST-Ensai and Université du Littoral Côte d'Opale. ENSAI, Campus de Ker-Lann, Rue Blaise Pascal, BP37203, 35172 BRUZ Cedex, France); Michel B. DEVEREUX (Vancouver School of Economics, University of British Columbia 6000, Iona Drive, Vancouver B.C. CANADA V6T 1L4, CEPR and NBER); Aurélien EYQUEM (Univ Lyon, Université Lumière Lyon 2, GATE L-SE UMR 5824, and Institut Universitaire de France. 93 Chemin des Mouilles, BP167, 69131 Ecully Cedex, France)
    Abstract: We build measures of the demand for trade protection, and relate it to permanent productivity and transitory monetary policy shocks identified from the U.S. monthly and quarterly data. The demand for protection is counter-cyclical conditional on productivity shocks and pro-cyclical conditional on monetary policy shocks. We then layout a two-country dynamic general equilibrium model with trade in intermediate and final goods, sticky prices, incomplete financial markets and endogenous monetary policy rules, and propose a repeated non-cooperative policy game that determines tariffs endogenously. These tradepolicies (i) are consistent with small but positive tariffs, as in the data, and (ii) fit empirical evidence about the cyclical pattern of the demand for trade protection under a wide range of plausible model calibrations. We then use the model to quantify the macroeconomic and welfare effects of a change in tariff setters' preferences that induces tariffs to rise in both countries.
    Keywords: Protectionism, Tariffs, Business Cycle.
    JEL: F30 F40 F41
    Date: 2018–07–01
  8. By: Gianluca Benigno; Andrew Foerster; Christopher Otrok; Alessandro Rebucci
    Abstract: We estimate a workhorse DSGE model with an occasionally binding borrowing constraint. First, we propose a new specification of the occasionally binding constraint, where the transition between the unconstrained and constrained states is a stochastic function of the leverage level and the constraint multiplier. This specification maps into an endogenous regime-switching model. Second, we develop a general perturbation method for the solution of such a model. Third, we estimate the model with Bayesian methods to fit Mexico's business cycle and financial crisis history since 1981. The estimated model fits the data well, identifying three crisis episodes of varying duration and intensity: the Debt Crisis in the early-1980s, the Peso Crisis in the mid-1990s, and the Global Financial Crisis in the late-2000s. The crisis episodes generated by the estimated model display sluggish and long-lasting build-up and stagnation phases driven by plausible combinations of shocks. Different sets of shocks explain different variables over the business cycle and the three historical episodes of sudden stops identified.
    Keywords: Financial Crises; Endogenous Regime-Switching; Bayesian Estimation; Business Cycles; Mexico; Occasionally Binding Constraints
    JEL: C11 E3 F41 G01
    Date: 2020–03–30
  9. By: Lakdawala, Aeimit (Michigan State University, Department of Economics); Moreland, Timothy (Michigan State University, Department of Economics); Schaffer, Matthew (UNC Greensboro)
    Abstract: An extensive literature studies the international transmission of US monetary policy surprises (shifts in expected path of the policy rate). In this paper we show that changes in uncertainty around the expected path constitute an important additional dimension of spillover effects to global bond yields. In advanced countries, it is the term premium component of yields that responds to uncertainty. We find that this can be explained by an international portfolio balance mechanism. In contrast, for emerging countries it is the expected component of yields that reacts to uncertainty. This can be rationalized from a flight to safety channel. We find heterogeneity in the country-level response to uncertainty only in emerging economies and it is driven by the degree of financial openness. Finally, equity markets in both advanced and emerging countries also respond to US monetary policy uncertainty, but only since the financial crisis.
    Keywords: monetary policy uncertainty; international spillover; international portfolio balance; flight to safety
    JEL: E43 E58 G12 G15
    Date: 2020–04–17
  10. By: Leonor Modesto (UCP, Catolica Lisbon School of Business and Economics, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics); Carine Nourry (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Thomas Seegmuller (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Alain Venditti (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, EDHEC - EDHEC Business School)
    Abstract: The relationship between public debt, growth and volatility is investigated in a Barro-type (1990) endogenous growth model, with three main features: we consider a small open economy, international borrowing is constrained and households have taste for domestic public debt. Therefore, capital, public debt and the international asset are not perfect substitutes and the economy is characterized by an investment multiplier. Whatever the level of the debt-output ratio, the existing BGP features expectation-driven fluctuations. If the debt-output ratio is low enough, there is also a second BGP with a lower growth rate. Hence, lower debt does not stabilize the economy with credit market imperfections. However, a high enough taste for domestic public debt may rule out the BGP with lower growth. This means that if the share of public debt hold by domestic households is high enough, global indeterminacy does not occur.
    Keywords: small open economy,public debt,credit constraint,indeterminacy
    Date: 2020–04
  11. By: Fidora, Michael; Schmitz, Martin; Bergant, Katharina
    Abstract: We analyse euro area investors' portfolio rebalancing during the ECB's Asset Purchase Programme at the security level. Based on net transactions of domestic and foreign securities, we observe euro area sectors' capital flows into individual securities, cleaned from valuation effects. Our empirical analysis – which accounts for security-level characteristics – shows that euro area investors (in particular investment funds and households) actively rebalanced away from securities targeted under the Public Sector Purchase Programme and other euro-denominated debt securities, towards foreign debt instruments, including ‘closest substitutes’, i.e. certain sovereign debt securities issued by non-euro area advanced countries. This rebalancing was particularly strong during the first six quarters of the programme. Our analysis also reveals marked differences across sectors as well as country groups within the euro area, suggesting that quantitative easing has induced heterogeneous portfolio shifts. JEL Classification: F21, F42, E52, G15
    Keywords: capital flows, international investment patterns, investor heterogeneity, quantitative easing, sovereign debt
    Date: 2020–04

This nep-opm issue is ©2020 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.