nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒06‒22
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Monetary Policy Independence and the Strength of the Global Financial Cycle By Christian Friedrich; Pierre Guérin; Danilo Leiva-Leon
  2. Asset home bias in debtor and creditor countries By Ning Zhang
  3. Exchange rate pass-through in the euro area and EU countries By Eva Ortega; Chiara Osbat
  4. The effectiveness of macroprudential policies and capital controls against volatile capital inflows By Jon Frost; Hiro Ito; René van Stralen
  5. Monetary Unions of Small Currencies and a Dominating Member: What Policies Work Best for Benefiting from the CMA? By Wörgötter, Andreas; Brixiova, Zuzana
  6. The effectiveness of currency intervention in a commodity-exporter: Evidence from Mongolia By Victor Pontines; Davaajargal Luvsannyam; Enkhjin Atarbaatar; Ulziikhutag Munkhtsetseg
  7. Questioning the puzzle: Fiscal policy, exchange rate and inflation By Laurent Ferrara; Luca Metelli; Filippo Natoli; Daniele Siena
  8. Deadly Debt Crises: COVID-19 in Emerging Markets By Cristina Arellano; Yan Bai; Gabriel Mihalache
  9. When the Fed sneezes, the whole world catches the cold, when the ECB - only Europe By Walerych, Małgorzata; Wesołowski, Grzegorz
  10. Global Trade and GDP Co-Movement By de Soyres, Francois; Gaillard, Alexandre
  11. Trade, Growth, and the International Transmission of Financial Shocks By Ohdoi, Ryoji
  12. Le Pont de Londres: interactions between monetary and prudential policies in cross-border lending By Matthieu Bussière; Robert Hills; Simon Lloyd; Baptiste Meunier; Justine Pedrono; Dennis Reinhardt; Rhiannon Sowerbutts
  13. The Role of Real Exchange Rates in Export Price Determination By M. Faruk Aydin; Selcuk Gul

  1. By: Christian Friedrich; Pierre Guérin; Danilo Leiva-Leon
    Abstract: We propose a new strength measure of the global financial cycle by estimating a regime-switching factor model on cross-border equity flows for 61 countries. We then assess how the strength of the global financial cycle affects monetary policy independence, which is defined as the response of central banks' policy interest rates to exogenous changes in inflation. We show that central banks tighten their policy rates in response to an unanticipated increase in the inflation gap during times when global financial cycle strength is low. During times of high financial cycle strength, however, the responses of the same central banks to the same unanticipated changes in the inflation gap appear muted. Finally, by assessing the impact of different policy tools on countries' sensitivities to the global financial cycle, we show that using capital controls, macroprudential policies, and the presence of a flexible exchange rate regime can increase monetary policy independence.
    Keywords: Business fluctuations and cycles; Exchange rate regimes; Financial system regulation and policies; International financial markets; Monetary policy
    JEL: E4 E5 F3 F32 F4 F42 G1 G15 G18
    Date: 2020–06
  2. 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
  3. By: Eva Ortega (Banco de España); Chiara Osbat (European Central Bank)
    Abstract: Aggregate exchange rate pass-through (ERPT) to import and consumer prices in the EU is currently lower than it was in the 1990s and is non-linear. Low estimated aggregate ERPT to consumer prices does not at all mean that exchange rate movements do not have an impact on inflation, as aggregate rules of thumb mask substantial heterogeneities across countries, industries and time periods owing to structural, cyclical and policy factors. Looking also at new micro evidence, four key structural characteristics explain ERPT across industries or sectors: (i) import content of consumption, (ii) share of imports invoiced in own currency or in a third dominant currency, (iii) integration of a country and its trading partners in global value chains, and (iv) market power. In the existing literature there is also a robust evidence across models showing that each shock which causes the exchange rate to move has a different price response, meaning that the combination of shocks that lies behind the cycle at any point in time has an impact on ERPT. Finally, monetary policy itself affects ERPT. Credible and aggressive monetary policy reduces the observed ex post ERPT, as agents expect monetary policy to counteract deviations of inflation from target, including those relating to exchange rate fluctuations. Moreover, under the effective lower bound, credible non-standard monetary policy actions result in greater ERPT to consumer prices. This paper recommends moving away from rule-of-thumb estimates and instead using structural models with sufficient feedback loops, taking into account the role of expectations and monetary policy reactions, to assess the impact of exchange rate changes when forecasting inflation.
    Keywords: exchange rates, import prices, consumer prices, inflation, pass-through, euro area, monetary policy
    JEL: C50 E31 E52 F31 F41
    Date: 2020–06
  4. By: Jon Frost; Hiro Ito; René van Stralen
    Abstract: This paper compares the effectiveness of macroprudential policies (MaPs) and capital controls (CCs) in influencing the volume and composition of capital inflows, and the probability of banking and currency crises. We distinguish between foreign exchange (FX)-based MaPs, which may be similar to some types of CCs, and non-FX-based MaPs. Using a panel of 83 countries over the period 2000-17, and a propensity score matching model to control for selection bias, we find that capital inflow volumes are lower where FX-based MaPs have been activated. The imposition of CCs does not have a significant effect on the volume or composition of capital inflows. Further, we find that the activation of MaPs is associated with a lower probability of banking crises and surges in capital inflows in the following three years.
    Keywords: capital account openness; capital flows; capital controls; macroprudential policy; banking crises; currency crises
    JEL: F38 G01 G28
    Date: 2020–06
  5. By: Wörgötter, Andreas (Vienna University of Technology); Brixiova, Zuzana (University of Economics Prague)
    Abstract: This policy paper underscores the importance of credible currency regimes and their macroeconomic underpinnings for stability in financial systems and long-term economic convergence of developing and emerging market economies. It suggests that for developing regions such as Sub-Saharan Africa, taking steps toward fixed exchange rate frameworks, as a milestone on the path to monetary union, could provide credibility that individual countries struggle to attain on their own. Specifically, fixed arrangements, can restrain unsustainable policies among small economies and enable them to achieve greater stability at lower costs. The paper provides successful examples in this area. Moreover, while it is well-understood that monetary unions and fixed exchange rate regimes among countries with heterogeneous economies are difficult to sustain, the paper notes that heterogeneity can be accommodated in regimes with one dominant member and diverse countries that enhance the flexibility of their labour and product markets and have flexible internal pricing systems. This opens up the question of what might work for African economies, which are heterogeneous and do not meet the optimal currency criteria. The paper examines the convergence performance of small current and past members of the Common Monetary Area (CMA) against the benchmark of South African provinces. The results confirm that a monetary union alone is no guarantee for good outcomes: Among the three small CMA members one (Namibia) is overperforming, one (Eswatini) is average and Lesotho is underperforming. The paper concludes with country-specific and CMA-wide policy recommendations for higher growth of the CMA member countries.
    Keywords: asymmetric monetary union, flexibility, regional convergence, Africa
    JEL: F02 F45 O11
    Date: 2020–06
  6. By: Victor Pontines; Davaajargal Luvsannyam; Enkhjin Atarbaatar; Ulziikhutag Munkhtsetseg
    Abstract: Although EME central banks actively intervene in currency markets, there is a long-running debate as to its effectiveness in affecting exchange rates. In this study, we use unique daily data on currency interventions in Mongolia to analyze the impact of these interventions on the changes in the MNT/USD exchange rate. The results indicate that currency intervention is effective in Mongolia, although it differs in certain ways. Currency sales are effective in moving changes in the MNT/USD in the correct direction, especially when carried out in larger amounts and when implemented frequently. This effect can last from one to three weeks, although we find the magnitude of the daily effect to be relatively small. We do not find evidence, however, that currency purchases are effective. These findings are comparable to the existing literature on the effectiveness of intervention in EMEs.
    Keywords: Currency intervention, exchange rate, treatment effect, causal effect, local projection, Mongolia
    JEL: C14 C32 E58 F31
    Date: 2020–03
  7. By: Laurent Ferrara; Luca Metelli; Filippo Natoli; Daniele Siena
    Abstract: The paper re-investigates the effects of government spending shocks on the real exchange rate and inflation. In contrast with some previous puzzling results, we find that an increase in government spending appreciates the real exchange rate and is inflationary; besides, it induces a trade balance deficit and a decrease in consumption. The discrepancy with the existing literature lies in the identification of fiscal shocks: embedding a narrative approach in a proxy-SVAR is what makes the difference. Empirical findings are then well explained by a standard estimated open real business cycle model.
    Keywords: : Fiscal Shocks, Real Exchange Rate, Inflation, Proxy SVAR, Narrative Shocks.
    JEL: E62 F41
    Date: 2020
  8. By: Cristina Arellano; Yan Bai; Gabriel Mihalache
    Abstract: The COVID-19 epidemic in emerging markets risks a combined health, economic, and debt crisis. We integrate a standard epidemiology model into a sovereign default model and study how default risk impacts the ability of these countries to respond to the epidemic. Lockdown policies are useful for alleviating the health crisis but they carry large economic costs and can generate costly and prolonged debt crises. The possibility of lockdown induced debt crises in turn results in less aggressive lockdowns and a more severe health crisis. We find that the social value of debt relief can be substantial because it can prevent the debt crisis and can save lives.
    Keywords: Default risk; Pandemic mitigation; Sovereign debt; Partial default; Debt relief; COVID-19
    JEL: E52 F34 F41
    Date: 2020–05–22
  9. By: Walerych, Małgorzata; Wesołowski, Grzegorz
    Abstract: This paper presents evidence that the international spillovers of Fed's conventional monetary policy to emerging markets are global, while their ECB's counterparts are local. The result comes from panel Bayesian Vector Autoregressive model estimated separately for two groups of countries: Central Eastern Europe (CEE) and Latin America (LA). In this setup, we investigate the impact of unanticipated and anticipated Fed and ECB montetary policy shocks, showing that the former affect both regions, while the latter are important for CEE and insignificant for LA.
    Keywords: Monetary policy spillovers, international business cycles, emerging economies
    JEL: E32 E58 F44
    Date: 2020–06–05
  10. By: de Soyres, Francois; Gaillard, Alexandre
    Abstract: We revisit the association between trade and GDP comovement for 135 countries from 1970 to 2009. Guided by a simple theory, we introduce two notions of trade linkages: (i) the usual direct bilateral trade index and (ii) new indexes of common exposure to third countries capturing the role of similarity in trade networks. Both measures are economically and statistically associated with GDP correlation, suggesting an additional channel through which GDP fluctuations propagate through trade linkages. Moreover, high income countries become more synchronized when the content of their trade is tilted toward inputs while trade in final goods is key for low income countries. Finally, we present evidence that the density of the international trade network is associated with an amplification of the association between global trade flows and bilateral GDP comovement, leading to a significant evolution of the trade comovement slope over the last two decades.
    Keywords: International Trade, International Business Cycle Comovement, Networks, Input-Output Linkages.
    JEL: F15 F4 F44 F62
    Date: 2020–01–30
  11. By: Ohdoi, Ryoji
    Abstract: This study develops a two-country model to explore how financial shocks in one country affect its partner country's business cycles through international trade. Unlike existing studies, I introduce the mechanism of endogenous trade patterns, by which a shock can affect both the intensive and extensive margins of trade. I also embed the mechanism of endogenous growth into the model to indicate the potential for prolonged recessions, even for a transitory shock. I obtain the following four main findings. First, an adverse financial shock in one country induces a global recession, even in the absence of international financial transactions. Second, although the downward shift of real GDP in the partner country is not so large, it can be very prolonged. Third, the real value of exports in the partner drops more seriously than its real GDP. Finally, this drop is caused mainly by a change at the intensive margin rather than the extensive margin.
    Keywords: Eaton–Kortum model; Endogenous growth; Financial frictions; Financial shocks; International business cycles; Margins of trade
    JEL: E22 E32 E44 F11 F44 O4 O41
    Date: 2020–05
  12. By: Matthieu Bussière; Robert Hills; Simon Lloyd; Baptiste Meunier; Justine Pedrono; Dennis Reinhardt; Rhiannon Sowerbutts
    Abstract: We examine how euro area (EA) monetary policy and recipient-country prudential policy interact to influence cross-border lending of French banks. We find that monetary spillovers via cross-border lending can be partially offset by prudential measures in receiving countries. We then explore heterogeneities, specifically by bank size and location of the affiliate (French HQ vs. affiliates based in the UK). We find that the response of lending from French HQ to EA monetary policy is less sensitive to recipient-country prudential policy for systemic banks (GSIBs) than for non-GSIBs’. In contrast, the response of lending from GSIBs’ affiliates in the UK is sensitive to recipient-country prudential policy. French GSIBs’ crossborder lending from French HQ responds differently than lending from international financial centres. We also find evidence that French GSIBs channel funds towards the UK in response to EA monetary policy, in a manner dampened by global prudential policy setting. These findings suggest the existence of a ‘London Bridge’: conditional on EA monetary policy, French GSIBs adjust their funds in the UK depending on global prudential policies and, from there, lend to third-party countries according to local prudential policies. Finally, we have similar findings for all EA-owned banks UK affiliates, suggesting a broader relevance for the London Bridge.
    Keywords: : Monetary Policy, Prudential Policy, Policy Interactions, Spillovers, Financial Centre.
    JEL: E52 F34 F36 F42 G18 G21
    Date: 2020
  13. By: M. Faruk Aydin; Selcuk Gul
    Abstract: [EN] This study investigates the determinants of Turkey's export prices measured in foreign currency for the 1994Q1:2019Q3 period. Estimates from separate models using nominal and real exchange rates indicate that movements of the exchange rate have a long-run impact on export prices measured in foreign currency. However, the exchange rate pass-through to export prices in foreign currency is relatively low. This finding indicates that the exchange rate pass-through into export prices measured in local currency is almost complete. Results suggest that low exchange rate pass-through to export prices measured in foreign currency limits the expansionary impact of local currency depreciation, but increases the firms' profitability when the local currency depreciates. Besides, the most significant determinant of export prices measured in foreign currency in the short and long term is the world export prices. [TR] Bu calismada, 1994C1:2019C3 donemi icin Turkiye'nin yabanci para cinsinden ihracat fiyatlarinin belirleyicileri incelenmektedir. Nominal ve reel doviz kurlarinin kullanildigi ayri modellerden elde edilen tahminler, uzun donemde doviz kurundaki hareketlerin yabanci para cinsinden ihracat fiyatlarini etkiledigini gostermektedir. Bununla birlikte, doviz kurunun yabanci para birimi cinsinden ihracat fiyatlarina geciskenligi gorece dusuktur. Soz konusu bulgu, doviz kuru degisimlerinin Turk lirasi cinsinden ihracat fiyatlarina guclu bir sekilde tasindigina isaret etmektedir. Sonuclar yabanci para cinsinden ihracat fiyatlarina zayif doviz kuru geciskenliginin, yerel para birimindeki deger kaybinin yarattigi genisleyici etkiyi sinirladigini, ancak yerel paranin deger kaybi durumunda firma karliligini arttirdigini ima etmektedir. Ayrica, yabanci para cinsinden ihracat fiyatlarinin kisa ve uzun donemde en onemli belirleyicisinin dunya ihracat fiyatlari oldugu gozlenmektedir.
    Date: 2020

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