nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒07‒27
sixteen papers chosen by
Martin Berka
University of Auckland

  1. Monetary Union and Financial Integration By Fornaro, Luca
  2. Global macroeconomic cooperation in response to the COVID-19 pandemic: a roadmap for the G20 and the IMF By Warwick McKibbin; David Vines
  3. The Global Transmission of U.S. Monetary Policy By Riccardo Degasperi; Seokki Simon Hong; Giovanni Ricco
  4. Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies By Kollmann, Robert
  5. Macro-financial interactions in a changing world By Eddie Gerba; Danilo Leiva-Leon
  6. The Elusive Gains from Nationally-Oriented Monetary Policy By Bodenstein, Martin; Corsetti, Giancarlo; Guerrieri, Luca
  7. The Financial Center Leverage Cycle: Does it Spread Around the World? By Graciela Laura Kaminsky; Leandro Medina; Shiyi Wang
  8. REER Imbalances and Macroeconomic Adjustments: evidence from the CEMAC zone By Asongu, Simplice; Nnanna, Joseph
  9. Robustness of the Balassa-Samuelson effect: evidence from developing and emerging economies By Florian Morvillier
  10. High Order Openness By Jean Imbs; Laurent L. Pauwels
  11. The Micro and Macro Dynamics of Capital Flows By Felipe Saffie; Liliana Varela; Kei-Mu Yi
  12. Exchange rate risk and business cycles By Lloyd, Simon; Marin, Emile
  13. Dominant Currencies and External Adjustment By Gustavo Adler; Camila Casas; Luis M. Cubeddu; Gita Gopinath; Nan Li; Sergii Meleshchuk; Carolina Osorio Buitron; Damien Puy; Yannick Timmer
  14. International Business Cycles in Emerging Markets By Jacek Rothert
  15. International Portfolio Choice with Frictions: Evidence from Mutual Funds By Philippe Bacchetta; Simon Tièche; Eric van Wincoop
  16. Global macroeconomic scenarios of the COVID-19 pandemic By Warwick McKibbin; Roshen Fernando

  1. By: Fornaro, Luca
    Abstract: Since the creation of the euro, capital flows among member countries have been large and volatile. Motivated by this fact, I provide a theory connecting the exchange rate regime to financial integration. The key feature of the model is that monetary policy affects the value of collateral that creditors seize in case of default. Under flexible exchange rates, national governments can expropriate foreign investors by depreciating the exchange rate. Anticipating this, investors impose tight limits on international borrowing. In a monetary union this source of exchange rate risk is absent, because national governments do not control monetary policy. Forming a monetary union thus increases financial integration by boosting borrowing capacity toward foreign investors. This process, however, does not necessarily lead to higher welfare. The reason is that a high degree of financial integration can generate multiple equilibria, with bad equilibria characterized by inefficient capital flights. Capital controls or fiscal transfers can eliminate bad equilibria, but their implementation requires international cooperation.
    Keywords: capital flights; Euro Area; Exchange Rates; International financial integration; monetary union; Optimal Currency Area
    JEL: E44 E52 F33 F34 F36 F41 F45
    Date: 2019–12
  2. By: Warwick McKibbin; David Vines
    Abstract: The COVID-19 crisis has caused the greatest collapse in global economic activity since 1720. Some advanced countries have mounted a massive fiscal response, both to pay for disease-fighting action and to preserve the incomes of firms and workers until the economic recovery is under way. But there are many emerging market economies which have been prevented from doing what is needed by their high existing levels of public debt and—especially—by the external financial constraints which they face. We argue in the present paper that there is a need for international cooperation to allow such countries to undertake the kind of massive fiscal response that all countries now need, and that many advanced countries have been able to carry out. We show what such cooperation would involve. We use a global macroeconomic model to explore how extraordinarily beneficial such cooperation would be. Simulations of the model suggest that GDP in the countries in which extra fiscal support takes place would be around two and a half per cent higher in the first year, and that GDP in other countries in the world be more than one per cent higher. So far, such cooperation has been notably lacking, in striking contrast with what happened in the wake of the Global Financial Crisis in 2008. The necessary cooperation needs to be led by the Group of Twenty (G20), just as happened in 2008–9, since the G20 brings together the leaders of the world’s largest economies. This cooperation must also necessarily involve a promise of international financial support from the International Monetary Fund, otherwise international financial markets might take fright at the large budget deficits and current account deficits which will emerge, creating fiscal crises and currency crises and so causing such expansionary policies which we advocate to be brought to an end.
    Keywords: COVID-19, risk, macroeconomics, DSGE, CGE, G-Cubed (G20)
    JEL: C54 C68 E27 E61 E62 F41 F42
    Date: 2020–07
  3. By: Riccardo Degasperi; Seokki Simon Hong; Giovanni Ricco
    Abstract: This paper studies the transmission of US monetary shocks across the globe by employing a high-frequency identification of policy shocks and large VAR techniques, in conjunction with a large macro- financial dataset of global and national indicators covering both advanced and emerging economies. Our identification controls for the information effects of monetary policy and allows for the separate analysis of tightenings and loosenings of the policy stance. First, we document that US policy shocks have large real and nominal spillover effects that affect both advanced economies and emerging markets. Policy actions cannot fully isolate national economies, even in the case of advanced economies with exible exchange rates. Second, we investigate the channels of transmission and find that both trade and financial channels are activated and that there is an independent role for oil and commodity prices. Third, we show that effects are asymmetric and larger in the case of contractionary US monetary policy shocks. Finally, we contrast the transmission mechanisms of countries with different exchange rates, exposure to the dollar, and capital control regimes.
    Keywords: Monetary policy, Trilemma, exchange rates, Foreign Spillovers
    JEL: E5 F3 F4 C3
    Date: 2020–03
  4. By: Kollmann, Robert
    Abstract: This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term 'rational bubbles' refers to multiple equilibria arising from the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an overlapping generations structure. Rational bubbles reflect self-fulfilling fluctuations in agents' expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here are stable and bounded. Bounded bubbles can generate persistent fluctuations of real activity, and capture key business cycle stylized facts. Both closed and open economies are analyzed. In a non-linear two-country model with integrated financial markets, bubbles must be perfectly correlated across countries.
    Keywords: Boom-bust cycles; business cycles in closed and open economies; Dellas model; Long-Plosser model; non-linear DSGE models; Rational bubbles
    JEL: C6 E1 E3 F3 F4
    Date: 2020–01
  5. By: Eddie Gerba (Danmarks Nationalbank); Danilo Leiva-Leon (Banco de España)
    Abstract: We measure the time-varying strength of macro-financial linkages within and across the US and euro area economies by employing a large set of information for each region. In doing so, we rely on factor models with drifting parameters where real and financial cycles are extracted, and shocks are identified via sign and exclusion restrictions. The main results show that the euro area is disproportionately more sensitive to shocks in the US macroeconomy and financial sector, resulting in an asymmetric cross-border spillover pattern between the two economies. Moreover, while macro-financial interactions have steadily increased in the euro area since the late 1980s, they have oscillated in the US, exhibiting very long cycles of macro-financial interdependence.
    Keywords: macro-financial linkages, dynamic factor models, TVP-VAR
    JEL: E44 C32 C55 F44 E32 F41
    Date: 2020–07
  6. By: Bodenstein, Martin; Corsetti, Giancarlo; Guerrieri, Luca
    Abstract: The consensus in the recent literature is that the gains from international monetary cooperation are negligible, and so are the costs of a breakdown in cooperation. However, when assessed conditionally on empirically-relevant dynamic developments of the economy, the welfare cost of moving away from regimes of explicit or implicit cooperation may rise to multiple times the cost of economic fluctuations. In economies with incomplete markets, the incentives to act non-cooperatively are driven by the emergence of global imbalances, i.e., large net-foreign-asset positions; and, in economies with complete markets, by divergent real wages.
    Keywords: global imbalances; monetary policy cooperation; open-loop Nash games
    JEL: E44 E61 F42
    Date: 2020–01
  7. By: Graciela Laura Kaminsky (George Washington University and NBER); Leandro Medina (Strategy Policy and Review Department, International Monetary Fund); Shiyi Wang (George Washington University)
    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.
    Keywords: International Borrowing Cycles, Global and Regional Factors, Push and Pull Factors of Capital Flows, Financial Center Leverage Cycles
    JEL: F30 F34 F65
    Date: 2020–02
  8. By: Asongu, Simplice; Nnanna, Joseph
    Abstract: The EMU crisis holds special lessons for existing monetary unions. We assess the behavior of real effective exchange rates (REERs) of members of the Central African Economic and Monetary Community (CEMAC) zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate (FEER) model is estimated and associated misalignments. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. There is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths.
    Keywords: Exchange rate; Macroeconomic impact; CEMAC zone
    JEL: F31 F33 F42 F61 O55
    Date: 2019–01
  9. By: Florian Morvillier
    Abstract: This paper aims at investigating the robustness of the Balassa-Samuelson (BS) effect to alternative proxies for a panel of 38 developing and emerging economies over the period 1980-2016. We examine the internal and external versions of the BS hypothesis using a total of five different measures. Relying on the Cross Sectional-Distributed Lag (CS-DL) approach, we show that the internal version of the BS hypothesis holds only if the labor productivity differential between the tradable and non-tradable sectors is used rather than the Gross Domestic Product Per worker. We also find evidence of a positive and robust effect of the relative price of the non-traded to traded goods on the real exchange rate. Overall, our findings highlight that while the verification of the internal version of the BS effect depends on the proxy considered for productivity, the validity of the external version is a general and robust result.
    Keywords: Balassa–Samuelson effect, real exchange rate, relative prices
    JEL: F31 F41
    Date: 2020
  10. By: Jean Imbs (NYU Abu Dhabi, PSE (CNRS),CEPR); Laurent L. Pauwels (University of Sydney)
    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: 2020–04–29
  11. By: Felipe Saffie; Liliana Varela; Kei-Mu Yi
    Abstract: We empirically and theoretically study the effects of capital flows on resource allocation within sectors and cross-sectors. Novel data on service firms – in addition to manufacturing firms – allows us to assess two channels of resource reallocation. Capital inflows lower the relative price of capital, which promotes capital-intensive industries – an input-cost channel. Second, capital inflows increase aggregate consumption, which tilts the demand towards goods with high income elasticities – a consumption channel. We provide evidence for these two channels using firm-level census data from the financial liberalization in Hungary, a policy reform that led to capital inflows. We show that firms in capital intensive industries expand, as do firms in industries producing goods with high income elasticities. In the short-term, the consumption channel dominates and resources reallocate towards high income elasticity activities, such as services. We build a dynamic, multi-sector, heterogeneous firm model with multiple sectors of an economy transitioning to its steady-state. We simulate a capital account liberalization and show that the model can rationalize our empirical findings. We then use the model to assess the permanent effects of capital flows and show that the long-term allocation of resources and, thus, aggregate productivity depend on degree of long-term financial openness of the economy. Larger liberalizations trigger long-run debt pushing the country to a permanent trade surplus. This tilts long-run production towards manufacturing exporters, which also increases aggregate productivity.
    JEL: F15 F41 F43 F63
    Date: 2020–06
  12. By: Lloyd, Simon (Bank of England); Marin, Emile (University of Cambridge)
    Abstract: We show that currencies with a steeper yield curve tend to depreciate at business cycle horizons, in violation of uncovered interest parity. The yield curve adds no explanatory power over and above spot yield differentials in explaining exchange rates at longer horizons. Analysing bond holding period returns, we identify a tent-shaped relationship between the exchange rate risk premium and the relative slope across horizons. We derive this relationship analytically within an asset pricing framework and show it is driven by differences in transitory innovations to investors’ stochastic discount factor, captured by the relative yield curve slope and consistent with business cycle risk. Our mechanism is robust to the inclusion of liquidity yields, which instead contribute to explaining cross-sectional differences across currencies and reflect permanent innovations to investors’ stochastic discount factor.
    Keywords: Business cycle risk; exchange rates; risk premia; stochastic discount factor; uncovered interest parity; yield curves
    JEL: E43 F31 G12
    Date: 2020–06–12
  13. By: Gustavo Adler; Camila Casas; Luis M. Cubeddu; Gita Gopinath; Nan Li; Sergii Meleshchuk; Carolina Osorio Buitron; Damien Puy; Yannick Timmer
    Abstract: The extensive use of the US dollar when firms set prices for international trade (dubbed dominant currency pricing) and in their funding (dominant currency financing) has come to the forefront of policy debate, raising questions about how exchange rates work and the benefits of exchange rate flexibility. This Staff Discussion Note documents these features of international trade and finance and explores their implications for how exchange rates can help external rebalancing and buffer macroeconomic shocks.
    Keywords: Currency exchange rates;External trade;trade pricing;trade invoicing;exchange rate;external adjustment
    Date: 2020–07–20
  14. By: Jacek Rothert (United States Naval Academy)
    Abstract: This paper documents cyclical behavior of real exchange rates (RERs) in emerging and developed economies: RERs are pro-cyclical in emerging markets and mildly counter-cyclical in developed economies. RER pro-cyclicality coincides with excess volatility of consumption and counter-cyclicality of the trade balance. The paper then re-evaluates the role of trend shocks and interest rate shocks in emerging economies, by incorporating these features into a standard international business cycle model where domestic and foreign goods are imperfect substitutes. In the model, estimated to match the behavior of the RERs, trend shocks play no role in TFP or GDP fluctuations in Mexico. Conversely, exogenous country risk shocks, without any frictions that would create supply-side effects, account for 78% of GDP fluctuations. The key is that domestic and foreign goods are imperfect substitutes, which dampens the impact of trend shocks and accentuates the impact of interest rate shocks on output and consumption.
    Date: 2019–10
  15. By: Philippe Bacchetta (University of Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute); Simon Tièche (University of Lausanne); Eric van Wincoop (University of Virginia - Department of Economics; National Bureau of Economic Research (NBER))
    Abstract: Using data on international equity portfolio allocations of US mutual funds, we estimate a simple portfolio expression derived from a standard Markowitz mean-variance portfolio model extended with portfolio frictions. The optimal portfolio depends on two benchmark portfolios, the previous month and the buy-and-hold portfolio shares, and a present discounted value of expected future excess returns. We show that equity return differentials are predictable and use the expected return differentials in the mutual fund portfolio regressions. The estimated reduced form parameters are related to the structural model parameters. The estimates imply significant portfolio frictions and a modest rate of risk-aversion. While mutual fund portfolios respond significantly to expected returns, portfolio frictions lead to a weaker and more gradual portfolio response to changes in expected returns. We also document heterogeneity across funds. Global and larger funds face bigger portfolio frictions, while more active funds give relatively less weight to the buy-and- hold portfolio (rebalance more aggressively).
    Date: 2020–06
  16. By: Warwick McKibbin; Roshen Fernando
    Abstract: The COVID-19 global pandemic has caused significant global economic and social disruption. In McKibbin and Fernando (2020), we used data from historical pandemics to explore seven plausible scenarios of the economic consequences if COVID-19 were to become a global pandemic. In this paper, we use currently observed epidemiological outcomes across countries and recent data on sectoral shutdowns and economic shocks to estimate the likely impact of COVID-19 pandemic on the global economy in coming years under six new scenarios. The first scenario explores the outcomes if the current course of COVID-19 is successfully controlled, and there is only a mild recurrence in 2021. We then explore scenarios where the opening of economies results in recurrent outbreaks of various magnitudes and countries respond with and without economic shutdowns. We also explore the impact if no vaccine becomes available and the world must adapt to living with COVID-19 in coming decades. The final scenario is the case where a given country is in the most optimistic scenario (scenario 1), but the rest of the world is in the most pessimistic scenario. The scenarios in this paper demonstrate that even a contained outbreak (which is optimistic), will significantly impact the global economy in the coming years. The economic consequences of the COVID-19 pandemic under plausible scenarios are substantial and the ongoing economic adjustment is far from over.
    Keywords: Pandemics, infectious diseases, risk, macroeconomics, DSGE, CGE, G-Cubed
    JEL: C54 C68 F41
    Date: 2020–06

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