nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒08‒17
nine papers chosen by
Martin Berka
University of Auckland

  1. A Behavioral Explanation for the Puzzling Persistence of the Aggregate Real Exchange Rate By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  2. Sectoral Real Effective Exchange Rate and Industry Competitiveness in Russia By Irina Bogacheva; Alexey Porshakov; Natalia Turdyeva
  3. Financial Market and Capital Flow Dynamics During the COVID-19 Pandemic By Beirne, John Beirne; Renzhi, Nuobu; Sugandi, Eric Alexander; Volz, Ulrich
  4. The Portfolio Channel of Capital Flows and Foreign Exchange Intervention in A Small Open Economy By Carlos Montoro; Marco Ortiz
  5. Persistent Current Account Imbalances: Are they Good or Bad for Regional and Global Growth? By Beirne, John; Renzhi, Nuobu; Volz, Ulrich
  6. Destabilizing the Global Monetary System: Germany’s Adoption of the Gold Standard in the Early 1870s By Johannes Wiegand
  7. Financial spillovers to emerging economies: the role of exchange rates and domestic fundamentals By Alessio Ciarlone; Daniela Marconi
  8. Interest Rate Uncertainty and Sovereign Default Risk By Alok Johri; Shahed Khan; Cesar Sosa-Padilla
  9. The Political Economy of a Diverse Monetary Union By Enrico Perotti; Oscar Soons

  1. By: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
    Abstract: At the aggregate level, the evidence that deviations from purchasing power parity (PPP) are too persistent to be explained solely by nominal rigidities has long been a puzzle (Rogoff, 1996). Another puzzle from the micro price evidence of the law of one price (LOP), which is the basic building block of PPP, is that LOP deviations are less persistent than PPP deviations. To reconcile the empirical evidence, we adapt the model of behavioral inattention in Gabaix (2014, 2020) to a simple two-country sticky-price model. We propose a simple test of behavioral inattention and find strong evidence in its favor using micro price data from US and Canadian cities. Calibrating behavioral inattention with our estimates, we show that our model reconciles the two puzzles relating to the PPP and LOP. First, the PPP deviations are more than twice as persistent as PPP deviations explained only by sticky prices. Second, the LOP deviations decrease to less than two-thirds of the PPP deviations in the degree of persistence.
    JEL: D40 E31 F31
    Date: 2020–06
  2. By: Irina Bogacheva (Bank of Russia, Russian Federation); Alexey Porshakov (Bank of Russia, Russian Federation); Natalia Turdyeva (Bank of Russia, Russian Federation)
    Abstract: One of the most popular measures for the economy’s cost competitiveness in foreign trade is the real exchange rate. The common approach to its calculation consists in adjusting the nominal exchange rates for the trade-weighted CPI-based inflation differentials between the domestic economy and its major trade partners. Although such approach is most often used for official statistics, the CPI-based real exchange rate does not accurately capture an economy’s competitiveness in foreign trade. The latter is explained by the fact that the CPI naturally considers price changes for both tradable and non-tradable goods. We aim at constructing a set of alternative indicators of REER that would more extensively account for the structure of the Russian economy and its foreign trade and, hence, provide more reliable estimates of changes in Russian economy's cost competitiveness over time. This is done by taking into an account the structure of the Russian economy combined with the specificities of production processes in industries that are extensively involved in foreign trade, as well as integration of Russian industries into global value chains. Against this background, we also show the importance of distinguishing between the output-based and cost-based real exchange rate concepts when addressing the country’s trade competitiveness issue.
    Keywords: Real Effective Exchange Rate, Global Value Chains, Input-Output Tables, Industry Competitiveness
    JEL: F3 F41 F63
    Date: 2020–07
  3. By: Beirne, John Beirne (Asian Development Bank Institute); Renzhi, Nuobu (Asian Development Bank Institute); Sugandi, Eric Alexander (Asian Development Bank Institute); Volz, Ulrich (Asian Development Bank Institute)
    Abstract: We examine empirically the reaction of global financial markets across 38 economies to the COVID-19 outbreak, with a special focus on the dynamics of capital flow across 14 emerging market economies. Using daily data over the period 4 January 2010 to 30 April 2020 and controlling for a host of domestic and global macroeconomic and financial factors, we use a fixed effects panel approach and a structural VAR framework to show that emerging markets have been more heavily affected than advanced economies. In particular, emerging economies in Asia and Europe have experienced the sharpest impact on stocks, bonds, and exchange rates due to COVID-19, as well as abrupt and substantial capital outflows. Our results indicate that fiscal stimulus packages introduced in response to COVID-19, as well as quantitative easing by central banks, have helped to restore overall investor confidence through reducing bond yields and boosting stock prices. Our findings also highlight the role that global factors and developments in the world’s leading financial centers have on financial conditions in EMEs. Importantly, the impact of COVID-19 related quantitative easing measures by central banks in advanced countries, which helped to lower sovereign bond yields and prop up stock markets at home, extended to EMEs, notably in relation to stabilizing capital flow dynamics. While the ultimate resolution of COVID-19 may be expected to lead to a market correction as uncertainty declines, our impulse response analysis suggests that there may be some permanent effects on financial markets and capital flows as a result of COVID-19, particularly in EMEs.
    Keywords: COVID-19; financial markets; capital flows
    JEL: F32 F41 F62
    Date: 2020–06–26
  4. By: Carlos Montoro (Banco Central de Reserva del Perú); Marco Ortiz (Universidad del Pacífico)
    Abstract: In this paper we extend a new Keynesian small open economy model to include risk-averse FX dealers and FX intervention by the monetary authority. The former ingredients generate deviations from the uncovered interest parity (UIP) condition. More precisely, in this setup portfolio decisions of the dealers add endogenously a time variant risk-premium element to the traditional UIP that depends on FX intervention by the central bank and FX orders by foreign investors. We analyse the effectiveness of different strategies of FX intervention (e.g., unanticipated operations or via a pre-announced rule) to affect the volatility of the exchange rate and the transmission mechanism of the interest rate. Our findings are as follows: (i) FX intervention has a strong interaction with monetary policy in general equilibrium; (ii) FX intervention rules can have stronger stabilisation power than discretion in response to shocks because they exploit the expectations channel; (iii) there are some trade-offs in the use of FX intervention, since it can help to isolate the economy from external financial shocks, but it prevents some necessary adjustments on the exchange rate as a response to nominal and real external shocks; and (iv) the interaction between the portfolio balance channel and current account dynamics reduces the presence of a explosive response of exchange rate volatility, generating more stable equilibria.
    JEL: E4 E5 F3 G15
    Date: 2020–08
  5. By: Beirne, John (Asian Development Bank Institute); Renzhi, Nuobu (Asian Development Bank Institute); Volz, Ulrich (SOAS University of London)
    Abstract: We examine the regional and global growth effects of current account imbalances in Japan, Germany, and the People’s Republic of China (PRC)—the three largest persistent surplus countries—and the United States and United Kingdom, the two largest persistent deficit countries. Controlling for a set of macroeconomic determinants, we use a structural vector autoregression framework to show that positive shocks to current account balances in the PRC, Germany, and Japan transmit positive regional and global growth effects, particularly in the case of spillovers to regional growth from Japan. As expected, the global growth response is lower in magnitude than the regional growth response. In addition, the extent of the effect is amplified by global value chains, pointing to the significant role played by trade in intermediate goods. For current account deficit countries, the magnitudes of the responses of growth to shocks are much lower on average than in the case of current account surplus countries. We find some marginal positive effects on regional and global growth emanating from a positive shock on the UK current account—i.e., a reduction in the deficit. For the US, a positive shock to its persistent current account deficit marginally drags on global growth, possibly reflecting declining import demand and wealth effects linked to the US dollar’s status as the global reserve currency. Our findings have important policy implications at the global level, particularly in light of the re-emergence of discussions on global imbalances in recent years.
    Keywords: current account imbalances; macroeconomic imbalances; economic growth
    JEL: F32 F41 F62
    Date: 2020–03–16
  6. By: Johannes Wiegand
    Abstract: In 1871-73, newly unified Germany adopted the gold standard, replacing the silver-based currencies that had been prevalent in most German states until then. The reform sparked a series of steps in other countries that ultimately ended global bimetallism, i.e., a near-universal fixed exchange rate system in which (mostly) France stabilized the exchange value between gold and silver currencies. As a result, silver currencies depreciated sharply, and severe deflation ensued in the gold block. Why did Germany switch to gold and set the train of destructive events in motion? Both a review of the contemporaneous debate and statistical evidence suggest that it acted preemptively: the Australian and Californian gold discoveries of around 1850 had greatly increased the global supply of gold. By the mid-1860s, gold threatened to crowd out silver money in France, which would have severed the link between gold and silver currencies. Without reform, Germany would thus have risked exclusion from the fixed exchange rate system that tied together the major industrial economies. Reform required French accommodation, however. Victory in the Franco-Prussian war of 1870/71 allowed Germany to force accommodation, but only until France settled the war indemnity and regained sovereignty in late 1873. In this situation, switching to gold was superior to adopting bimetallism, as it prevented France from derailing Germany’s reform ex-post.
    Keywords: Currency reform;Fixed exchange rates;Exchange rate regimes;Currency question;Gold;Bimetallism,Gold Standard,France,Germany,Flandreau,specie,silver specie,gold currency
    Date: 2019–02–15
  7. By: Alessio Ciarlone (Bank of Italy); Daniela Marconi (Bank of Italy)
    Abstract: Financial integration of emerging economies is on the rise and so are financial and monetary spillovers, especially those originating from US economic policy decisions and the (related) evolution of the US dollar. We revisit the “trilemma” vs. “dilemma” hypothesis and assess whether, and to what extent, exchange rate regimes and other relevant country fundamentals affect the sensitivity of domestic financial conditions to global risk aversion and US financial conditions. Results for a sample of 17 emerging economies over the period 1990-2018 suggest that the trilemma hypothesis appears to be still valid, as more flexible exchange rate regimes help in mitigating spillovers to stock market returns, sovereign spreads and real credit growth. However, other country fundamentals such as the current account, trade integration and US dollar debt exposure are also important factors.
    Keywords: trilemma, global financial cycle, financial conditions, emerging market economies, international policy transmission, spillovers
    JEL: E42 E44 E52 F31 F36 F41 G15
    Date: 2020–07
  8. By: Alok Johri; Shahed Khan; Cesar Sosa-Padilla
    Abstract: International data suggests that fluctuations in the level and volatility of the world interest rate (as measured by the US treasury bill rate) are positively correlated with both the level and volatility of sovereign spreads in emerging economies. We incorporate an estimated time-varying process for the world interest rate into a model of sovereign default calibrated to a panel of emerging economies. Time variation in the world interest rate interacts with default incentives in the model and leads to state contingent effects on borrowing and sovereign spreads which resemble those found in the data. The model delivers up to one-half of the positive comovement between the level and volatility of world interest rate and the level of sovereign spreads seen in emerging economies. Moreover, the model also delivers significant positive co-movements between the volatility of the spread and the process for the world interest rate which is also consistent with the data. Our model provides one potential source for the observed bunching in default probabilities observed across nations, namely the world interest rate process. Our model generates a positive and significant correlation (0.51) between the spreads of two nations with uncorrelated income processes. This is close to the observed mean correlation in the data (0.61).
    Keywords: Sovereign Debt; Sovereign Default; Interest Rate Spread; Time-varying Volatility; Uncertainty Shocks
    JEL: F34 F41 E43 E32
    Date: 2020–07
  9. By: Enrico Perotti (University of Amsterdam); Oscar Soons (University of Amsterdam)
    Abstract: We analyze the political economy of monetary unification among countries with different quality of institutions. Countries with stronger institutions have lower public spending and better investment incentives, even under a stronger currency. Governments under weaker institutions spend more so must occasionally devalue. In a MU market prices and flows adjust quickly but institutional differences persist, so a diverse monetary union (DMU) has redistributive effects. The government in the weaker country expands spending, and investment may be reduced by the fiscal and common exchange rate effect. Strong country production benefits from the weaker currency but needs to offer fiscal support in a crisis. In equilibrium the required support is incentive compatible due to the devaluation gain. Some governments may join a DMU even if it depresses productive capacity to expand public spending. Even in a DMU beneficial for all countries, firms in weaker countries and savers in stronger countries may lose.
    Keywords: Monetary unions, institutional quality, fiscal union, political economy, fiscal transfers
    JEL: O47 D72 F33 F45
    Date: 2020–07–27

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.