nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒06‒15
thirteen papers chosen by
Martin Berka
University of Auckland

  1. High order openness By Jean Imbs; Laurent L. Pauwels
  2. Monetary policy and its transmission in a globalised world By Ca' Zorzi, Michele; Dedola, Luca; Georgiadis, Georgios; Jarociński, Marek; Stracca, Livio; Strasser, Georg
  4. The global effects of global risk and uncertainty By Bonciani, Dario; Ricci, Martino
  5. Shock dependence of exchange rate pass-through: A comparative analysis of BVARs and DSGEs By Mariarosaria Comunale
  6. The prospect of the proposed Currency Union on intra-regional trade in East African Community By Stanley, Abban
  7. Switching Volatility in a Nonlinear Open Economy By Jonathan Benchimol; Sergey Ivashchenko
  8. Asset home bias in debtor and creditor countries By Ning Zhang
  9. The Macroeconomic Effects of a European Deposit (Re-) Insurance Scheme By Marius Clemens; Stefan Gebauer; Tobias König
  10. Global financial cycles since 1880 By Potjagailo, Galina; Wolters, Maik H
  11. The Hedging Channel of Exchange Rate Determination By Gordon Y. Liao; Tony Zhang
  12. International effects of euro area forward guidance By Maximilian Bock; Martin Feldkircher; Pierre L. Siklos
  13. COVID-19 and Emerging Markets: An Epidemiological Multi-Sector Model for a Small Open Economy with an Application to Turkey By Cem Çakmaklı; Selva Demiralp; Ṣebnem Kalemli-Özcan; Sevcan Yesiltas; Muhammed A. Yildirim

  1. By: Jean Imbs; Laurent L. Pauwels
    Abstract: Conventional measures of openness are based on direct trade. They imply foreign shocks are irrelevant to sectors that do not trade directly across borders, e.g., services. But shocks propagate via the supply chain: Sectors that trade indirectly across borders via downstream linkages are affected by foreign shocks. We introduce a measure of openness based on indirect trade, computing the fraction of downstream linkages that cross a border. The measure, labeled “High Order Trade” (HOT), is computed using recently released data on international input-output linkages for 50 sectors in 43 countries, including services. HOT correlates positively with conventional trade measures across countries, much less across sectors as many more are open according to our measure. Some services are among the most open sectors in some economies, and services generally rank at the middle of the distribution. HOT correlates significantly with sector productivity, growth, and synchronization; conventional measures of trade do not. We introduce an instrument for HOT using network theory. We show HOT causes productivity and synchronization, but not growth.
    Keywords: Measuring Openness, Global supply chains, Growth, Productivity, Synchronisation
    JEL: E32 F44
    Date: 2020–05
  2. By: Ca' Zorzi, Michele; Dedola, Luca; Georgiadis, Georgios; Jarociński, Marek; Stracca, Livio; Strasser, Georg
    Abstract: This paper estimates and compares the international transmission of European Central Bank (ECB) and Federal Reserve System monetary policy in a unified and methodologically consistent framework. It identifies pure monetary policy shocks by purging them of the bias stemming from contemporaneous central bank information effects. The results suggest that there is a hierarchy in the global spillovers from ECB and Federal Reserve monetary policy: while the spillovers to consumer prices are relatively small in both directions, Federal Reserve monetary policy shocks have a larger impact on euro area financial markets and real activity. Federal Reserve monetary policy also has a significantly larger impact than ECB monetary policy on real and financial variables in the rest of the world. JEL Classification: E44, E52, F3, E58, F42
    Keywords: international monetary policy coordination, international shock transmission, monetary policy shocks, monetary policy spillovers
    Date: 2020–05
  3. By: Pippenger, John
    Abstract: Exchange-rate economics is filled with puzzles. The asset approach has failed. Purchasing Power Parity is useful at best in the long run. There is no clear link between exchange rates and fundamentals. With no empirically supported theory for exchange rates, open-economy macro models are built on sand. This paper shows for the first time how recognizing differences between retail, wholesale and auction markets helps solve the puzzles, provides a theory of exchange rates based on auction markets for assets and commodities, and suggests a link between fundamentals and exchange rates.
    Keywords: Social and Behavioral Sciences, exchange rates, arbitrage, trade, LOP, PPP, transaction costs, retail, wholesale, auction, CI
    Date: 2020–06–01
  4. By: Bonciani, Dario (Bank of England); Ricci, Martino (European Central Bank)
    Abstract: In this paper, we analyse the effects of a shock to global financial uncertainty and risk aversion on real economic activity. To this end, we extract a common factor from the realised volatilities of about 1,000 risky asset returns from around the world. We then study how shocks to the factor affect economic activity in 44 advanced and emerging small open economies by estimating local projections in a panel regression framework. We find that the output responses are quite heterogeneous across countries but, in general, negative and persistent. Furthermore, the effects of shocks to the global factor are stronger in countries with a higher degree of trade and/or financial openness, as well as in countries with a higher level of vulnerabilities.
    Keywords: Global uncertainty; global risk aversion; global financial cycle; small open economies
    JEL: E32 F41 F65
    Date: 2020–05–22
  5. By: Mariarosaria Comunale
    Abstract: In this paper, we make use of the results from Structural Bayesian VARs taken from several studies for the euro area, which apply the idea of a shock-dependent Exchange Rate Pass-Through, drawing a comparison across models and also with respect to available DSGEs. On impact, the results are similar across Structural Bayesian VARs. At longer horizons, the magnitude in DSGEs increases because of the endogenous response of monetary policy and other variables. In BVARs particularly, shocks contribute relatively little to observed changes in the exchange rate and in HICP. This points to a key role of systematic factors, which are not captured by the historical shock decomposition. However, in the APP announcement period, we do see demand and exogenous exchange rate shocks countribute significantly to variations in exchange rates. Nonetheless, it is difficult to find a robust characterization across models. Moreover, the modelling challenges increase when looking at individual countries, because exchange rate and monetary policy shocks (also taken relative to the US) are common to the whole euro area. Hence, we provide a local projection exercise with common euro area shocks, identified in euro area-specific Structural Bayesian VARs and in DSGE, extrapolated and used as regressors. For common exchange rate shocks, the impact on consumer prices is the largest in some new member states, but there are a wide range of estimates across models. For core consumer prices, the coefficients are smaller. Regarding common relative monetary policy shocks, the impact is larger than for exchange rate shocks in any case. Generally, euro area monetary policy plays a big role for consumer prices, and this is especially so for new member states and the euro area periphery.
    Keywords: euro area, exchange rate pass-through, Bayesian VAR, local projections, monetary policy
    JEL: E31 F31 F45
    Date: 2020–04
  6. By: Stanley, Abban
    Abstract: Currency union with a common policy is welfare superlative to the use of sovereign currencies even if a member of the East African Community uses a convertible currency. In this background, the study evaluates whether adopting a common currency will lead to trade using an augmented gravity model of international trade. Additionally, the study investigates the effect of tariffs and nontariff on trade in EAC. The results show that adopting a common currency will lead to trade. Also, the study showed that trade will be enhanced by six-folds when tariffs and nontariff is eliminated. The study concludes that a currency union with a common policy could serve as a panacea when the appropriate institutional policy framework is adopted to ensure transparency by reducing trade and non-trade barriers.
    Keywords: Currency union, Sovereign currencies, tariff, nontariff, gravity model of international trade, panacea, Optimal Currency Area, intra-regional trade
    JEL: E6 F1 F15 F4 F45
    Date: 2020–04–11
  7. By: Jonathan Benchimol; Sergey Ivashchenko
    Abstract: Uncertainty about an economy’s regime 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 the United States including Markov-switching volatility shocks, we show that these shocks were significant during the global financial crisis compared with periods of calm. We describe how U.S. 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: 2020–05–28
  8. By: Ning Zhang
    Abstract: Emerging and developing countries have a less diversified international portfolio than developed countries (Coeurdacier and Rey, 2013). This paper explores the hypothesis that this actually reflects a stronger preference of a creditor country for the local asset than of a debtor country. We first document a significantly positive relation between a country’s NFA and its degree of portfolio home bias, and then develop an asymmetric two-country model to show that: (1) when net external positions are unbalanced, countries have an incentive to hedge against the risk associated with international interest payments; (2) depending on their status on external payments, the hedging works the opposite way in the two countries; and (3) taking the local asset as an example, the hedging is positive in the creditor country while negative in the debtor country so the creditor country will demand more local asset than the debtor country.
    Keywords: International portfolio choices, Global imbalances, Asset home bias
    JEL: F32 F41
    Date: 2018–12
  9. By: Marius Clemens; Stefan Gebauer; Tobias König
    Abstract: While the first two pillars of the European Banking Union have been implemented, a European deposit insurance scheme (EDIS) is still not in place. To facilitate its introduction, recent proposals argue in favor of a reinsurance scheme. In this paper, we use a regime-switching open-economy DSGE model with bank default and bank-government linkages to assess the relative efficiency of such a scheme. We find that reinsurance by both a national fiscal backstop and EDIS is efficient in stabilizing the macro economy, even though welfare gains are slightly larger with EDIS and debt-to-GDP ratios rise under the fiscal reinsurance. We demonstrate that risk-weighted contributions to EDIS are welfare-beneficial for depositors and discuss trade-offs policy makers face during the implementation of EDIS. In a counterfactual exercise, we find that EDIS would have stabilized economic activity in Germany and the rest of the euro area just as well as a fiscal backing of insured deposits during the financial crisis. However, the debt-to-GDP ratio would have been lower with EDIS.
    Keywords: Banking Union, Deposit Insurance, Risk-Sharing
    JEL: E61 F42 F45 G22 G28
    Date: 2020
  10. By: Potjagailo, Galina (Bank of England); Wolters, Maik H (University of Wuerzburg, Kiel Institute, and IMFS at Goethe University Frankfurt)
    Abstract: With the aim to provide a detailed understanding of global financial cycles and their relevance over time, we analyse co-movement in credit, house prices, equity prices, and interest rates across 17 advanced economies over 130 years. Using a time-varying dynamic factor model, we observe global co-movement across financial variables as well as variable-specific global cycles of different lengths and amplitudes. Global cycles have gained relevance over time. For equity prices, they now constitute the main driver of fluctuations in most countries. Global cycles in credit and housing have become much more pronounced and protracted since the 1980s, but their relevance increased for a sub-group of financially open and developed economies only. Panel regressions indicate that a country’s susceptibility to global financial cycles tends to increase with financial openness and financial integration, the extent of mortgage-related lending, and the efficiency of stock markets. Understanding the cross-country heterogeneity in financial market characteristics therefore matters for the design of appropriate financial stabilization policies across countries and sectors.
    Keywords: Financial cycles; financial crisis; global co-movement; dynamic factor models; time-varying parameters; macro-finance
    JEL: C32 C38 E44 F44 F65 G15 N10 N20
    Date: 2020–05–29
  11. By: Gordon Y. Liao; Tony Zhang
    Abstract: We document the exchange rate hedging channel that connects country-level measures of net external financial imbalances with exchange rates. In times of market distress, countries with large positive external imbalances (e.g. Japan) experience domestic currency appreciation, and crucially, forward exchange rates appreciate relatively more than the spot after adjusting for interest rate differentials. Countries with large negative foreign asset positions experience the opposite currency movements. We present a model demonstrating that exchange rate hedging coupled with intermediary constraints can explain these observed relationships between net external imbalances and spot and forward exchange rates. We find empirical support for this currency hedging channel of exchange rate determination in both the conditional and unconditional moments of exchange rates, option prices, large institutional investors' disclosure of hedging activities, and central bank swap line usage during the COVID-19 market turmoil.
    Keywords: Global imbalance; Exchange rate; Forward; Hedging; Covered interest rate parity; Currency options; COVID19
    JEL: E44 F31 F32 F41 G11 G15 G18 G20
    Date: 2020–05–28
  12. By: Maximilian Bock; Martin Feldkircher; Pierre L. Siklos
    Abstract: This paper explores the domestic and international effects of an increase in observed interest rates (conventional monetary policy) and expected interest rates (forward guidance). We find significant spillovers to a broad range of countries when both are subject to a tightening shock: Output growth and inflation decelerate and equity returns decline. Currencies of euro area neighboring countries tend to depreciate against the euro. A tightening forward guidance shock triggers more persistent effects on euro area and international interest rates. We find that international effects vary over the sample period when either interest rates are shocked.
    Keywords: Spillovers, interest rate expectations, forward guidance, GVAR
    JEL: E5 F3 C11 C30
    Date: 2020–05
  13. By: Cem Çakmaklı; Selva Demiralp; Ṣebnem Kalemli-Özcan; Sevcan Yesiltas; Muhammed A. Yildirim
    Abstract: The COVID-19 crisis has the potential to turn into the biggest emerging market (EM) crisis since 1980s. We quantify the macroeconomic effects of COVID-19 for a small open economy by calibrating a SIR-multi-sector-macro model to Turkey. We measure sectoral supply shocks utilizing teleworking and physical job proximity, and sectoral demand shocks with credit card purchases. Both shocks are also affected from changing infection rates under different lockdown scenarios. Our results show that the optimal policy, which yields the lowest economic cost and saves the maximum number of lives, can be achieved under a full lockdown. Being an open economy amplifies the economic costs through two main channels. First, the demand shock has domestic and external components. Second, the initial shock is magnified due to domestic and international input-output linkages. The policy options are limited given the low fiscal space to fight the pandemic and urgent external finance needs to rollover the foreign currency debt. We draw parallels between the policies employed during 2001 crisis in Turkey and discuss pros and cons of policy options to deal with the economic fallout from COVID-19.
    JEL: E01 F23 F41
    Date: 2020–05

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.