nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒06‒29
seven papers chosen by
Martin Berka
University of Auckland

  1. A Century of Arbitrage and Disaster Risk Pricing in the Foreign Exchange Market By Corsetti, G.; Marin, E. A.
  2. The Open-Economy ELB: Contractionary Monetary Easing and the Trilemma By Cavallino, Paolo; Sandri, Damiano
  3. High Order Openness By Imbs, Jean; Pauwels, Laurent
  4. Modeling the Global Effects of the COVID-19 Sudden Stop in Capital Flows By Ozge Akinci; Gianluca Benigno; Albert Queraltó
  5. The Vanishing Procyclicality of Labour Productivity By GalÌ, Jordi; van Rens, Thijs
  6. Interest Rate Uncertainty as a Policy Tool By Ghironi, Fabio; Ozhan, Galip Kemal
  7. Global Supply Chains in the Pandemic By Barthélémy Bonadio; Zhen Huo; Andrei A. Levchenko; Nitya Pandalai-Nayar

  1. By: Corsetti, G.; Marin, E. A.
    Abstract: A long-standing puzzle in international finance is that a positive interest rate differential systematically forecasts an exchange rate appreciation - the Uncovered Interest Parity (UIP) puzzle. Hence, a carry trade portfolio long in high yield currency bonds funded by borrowing in low yield currencies can be expected to yield positive profits. Following the Great Financial Crisis, however, the sign of the puzzle has changed - positive differentials forecast excessive depreciation - and carry trade has withered after the large losses suffered by investors in 2007-2008. In this paper, we use a century-long time series for the GBP/USD exchange rate to show that a sign switch is neither new, nor, arguably, a new puzzle. First, it is not new in the data|by virtue of a long sample featuring infrequent, non-overlapping currency crashes, we document that switches systematically occur in crises such as the Great Depression in the 1930s and the exchange rate turmoil of the 1990s. However, UIP deviations, sharp in either direction for short - to medium-horizon portfolios, remain small to almost negligible for long-horizon investment portfolios. Second, we argue that our century-long evidence is consistent with models featuring a time-varying probability of disasters or 'Peso events,' specified so to account for the difference in UIP deviations in crisis and normal times, as well as for a decreasing term structure of carry trade returns that on average characterize the data.
    Keywords: Uncovered Interest Parity, Peso Problem, Great Depression, Currency Crises, Carry Trade, Fama Puzzle
    JEL: F31 F41 G15
    Date: 2020–03–24
  2. By: Cavallino, Paolo; Sandri, Damiano
    Abstract: Contrary to the trilemma, we show that international financial integration can undermine the transmission of monetary policy even in countries with flexible exchange rates due to an open-economy Effective Lower Bound. The ELB is an interest rate threshold below which monetary easing becomes contractionary due to the interaction between capital flows and collateral constraints. A tightening in global monetary and financial conditions increases the ELB and may prompt central banks to hike rates despite output contracting. We also show that the ELB gives rise to a novel inter-temporal trade-off for monetary policy and calls for supporting monetary policy with additional policy tools.
    Keywords: carry trade; Collateral constraints; Currency mismatches; monetary policy; Spillovers
    JEL: E5 F3 F42
    Date: 2020–04
  3. By: Imbs, Jean; Pauwels, Laurent
    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: Global supply chains; growth; Measuring Openness; productivity; Synchronisation
    JEL: E32 F44
    Date: 2020–04
  4. By: Ozge Akinci; Gianluca Benigno; Albert Queraltó
    Abstract: The COVID-19 outbreak has triggered unusually fast outflows of dollar funding from emerging market economies (EMEs). These outflows are known as “sudden stop” episodes, and they are typically followed by economic contractions. In this post, we assess the macroeconomic effects of the COVID-induced sudden stop of capital flows to EMEs, using our open-economy DSGE model. Unlike existing frameworks, such as the Federal Reserve Board’s SIGMA model, our model features both domestic and international financial constraints, making it well-suited to capture the effects of an outflow of dollar funding. The model predicts output losses in EMEs due in part to the adverse effect of local currency depreciation on private-sector balance sheets with dollar debts. The financial stresses in EMEs, in turn, spill back to the U.S. economy, through both trade and financial channels. The model-predicted output losses are persistent (consistent with previous sudden stop episodes), with financial effects being a significant drag on the recovery. We stress that we are only tracing out the effects of one particular channel (the stop of capital flows and its associated effect on funding costs) and not the totality of COVID-related effects.
    Keywords: sudden stops; COVID-19; spillovers and spillbacks
    JEL: E2 F1
    Date: 2020–05–18
  5. By: GalÌ, Jordi (CREI, UPF and Barcelona GSE); van Rens, Thijs (University of Warwick)
    Abstract: We document two changes in postwar US macroeconomic dynamics: the procyclicality of labour productivity vanished, and the relative volatility of employment rose. We propose an explanation for these changes that is based on reduced hiring frictions due to improvements in information about the quality of job matches and the resulting decline in turnover. We develop a simple model with hiring frictions and variable e§ort to illustrate the mechanisms underlying our explanation. We show that our model qualitatively and quantitatively matches the observed changes in business cycle dynamics
    Keywords: labour hoarding, hiring frictions, e§ort choice JEL Classification: E24; E32
    Date: 2020
  6. By: Ghironi, Fabio; Ozhan, Galip Kemal
    Abstract: We study a novel policy tool-interest rate uncertainty-that can be used to discourage inefficient capital inflows and to adjust the composition of external accounts between short-term securities and foreign direct investment (FDI). We identify the trade-offs faced in navigating between external balance and price stability. The interest rate uncertainty policy discourages short-term inflows mainly through portfolio risk and precautionary saving channels. A markup channel generates net FDI inflows under imperfect exchange rate pass-through. We further investigate new channels under different assumptions about the irreversibility of FDI, the currency of export invoicing, risk aversion of outside agents, and effective lower bound in the rest of the world. Under every scenario, uncertainty policy is inflationary.
    Keywords: international financial policy; Short-Term and Long-Term Capital Movements; stochastic volatility; Unconventional Monetary Policy
    JEL: E32 F21 F32 F38 G15
    Date: 2020–04
  7. By: Barthélémy Bonadio; Zhen Huo; Andrei A. Levchenko; Nitya Pandalai-Nayar
    Abstract: We study the role of global supply chains in the impact of the Covid-19 pandemic on GDP growth for 64 countries. We discipline the labor supply shock across sectors and countries using the fraction of work in the sector that can be done from home, interacted with the stringency with which countries imposed lockdown measures. Using the quantitative framework and methods developed in Huo, Levchenko and Pandalai-Nayar (2020), we show that the average real GDP downturn due to the Covid-19 shock is expected to be -31.5%, of which -10.7% (or one-third of the total) is due to transmission through global supply chains. However, “renationalization” of global supply chains does not in general make countries more resilient to pandemic-induced contractions in labor supply. The average GDP drop would have been -32.3% in a world without trade in inputs and final goods. This is because eliminating reliance on foreign inputs increases reliance on the domestic inputs, which are also subject to lockdowns. Whether renationalizing supply chains insulates a country from the pandemic depends on whether it plans to impose a more or less stringent lockdown than its trading partners. Finally, unilateral lifting of the lockdowns in the largest economies can contribute as much as 6-8% to GDP growth in some of their smaller trade partners.
    JEL: F41 F44
    Date: 2020–05

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