nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒08‒24
twelve papers chosen by
Martin Berka
University of Auckland

  1. Reviving the Salter-Swan Small Open Economy Model By Stephanie Schmitt-Grohé; Martín Uribe
  2. The worst of both worlds: Fiscal policy and fixed exchange rates By Born, Benjamin; D'Ascanio, Francesco; Müller, Gernot; Pfeifer, Johannes
  3. Liquidity Traps in a Monetary Union By Robert Kollmann
  4. Scarcity of Safe Assets and Global Neutral Interest Rates By Thiago Revil T. Ferreira; Samer Shousha
  5. Working Paper 334 - Oil Price and Exchange Rate Dependence in Selected Countries By Martin Wafula Nandelenga; Anthony Simpasa
  6. Globalization, Time-Preferences, and Populist Voting By Aronsson, Thomas; Hetschko, Clemens; Schöb, Ronnie
  7. Harry Johnson's "case for flexible exchange rates"—50 years later By Maurice Obstfeld
  8. The Political Economy of a Diverse Monetary Union By Enrico Perotti; Oscar Soons
  9. Protectionism and the effective lower bound in the euro area By Pietro Cova; Alessandro Notarpietro; Massimiliano Pisani
  10. Italy in the Eurozone By Christian Keuschnigg; Linda Kirschner; Michael Kogler; Hannah Winterberg
  11. The Sensitivity of Cash Savings to the Cost of Capital By Viral V. Acharya; Soku Byoun; Zhaoxia Xu
  12. Extracting Implicit Country Weights in ECB's Monetary Policy By Pereira, Márcia; Tavares, José

  1. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper provides microfoundations to the Salter-Swan policy framework, a graphical apparatus designed to ascertain the exchange-rate and fiscal stance of a policymaker with internal and external economic targets. The environment is an infinite-horizon small open economy producing tradable and nontradable goods that takes world prices and world interest rates as given and is populated by optimizing households and firms. The economy is subject to terms-of-trade and interest-rate shocks. The internal target of the government is the unemployment rate and the external target is the current account. Downward nominal wage rigidity and financial frictions serve as the rationale for meaningful policy intervention.
    JEL: F41
    Date: 2020–06
  2. By: Born, Benjamin; D'Ascanio, Francesco; Müller, Gernot; Pfeifer, Johannes
    Abstract: Under fixed exchange rates, fiscal policy is an effective tool. According to classical views because it impacts the real exchange rate, according to Keynesian views because it impacts output. Both views have merit because the effects of government spending are asymmetric. A spending cut lowers output but does not alter the real exchange rate. A spending increase appreciates the exchange rate but does not alter output unless there is economic slack. We establish these results in a small open economy model with downward nominal wage rigidity and provide empirical evidence on the basis of quarterly time-series data for 38 countries.
    Keywords: asymmetric adjustment; Downward Nominal Wage Rigidity; Exchange rate peg; Government Spending Shocks; Non-linear effects; output; real exchange rate
    JEL: E62 F41 F44
    Date: 2019–10
  3. By: Robert Kollmann
    Abstract: The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low (Benhabib et al. (2001)). This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, country-specific productivity shocks induce synchronized responses of domestic and foreign output, while country-specific aggregate demand shocks trigger asymmetric domestic and foreign responses. A rise in government purchases in an individual country lowers GDP in the rest of the union. The result here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries would significantly boost GDP in the EA periphery (e.g. Blanchard et al. (2016)).
    Keywords: Zero lower bound; liquidity trap; monetary union; terms of trade; international fiscal spillovers; Euro Area
    JEL: E30 E40 F20 F30 F40
    Date: 2020–08
  4. By: Thiago Revil T. Ferreira; Samer Shousha
    Abstract: We quantitatively evaluate the role of supply and demand of safe assets in determining neutral interest rates. Using an empirical cross-country state-space model, we find that the net supply of sovereign safe assets available to the private sector in secondary markets is an important driver of neutral rates for 11 advanced economies in the period 1970–2018. We also find that the global accumulation of international reserves in sovereign safe assets since the 1990s (the global savings glut) lowered the net supply of these assets and, thus reduced neutral rates by up to 50 basis points in our sample.
    Keywords: Neutral interest rates; Scarcity of safe assets; International reserves; Global savings glut
    JEL: E21 E43 E52
    Date: 2020–07–10
  5. By: Martin Wafula Nandelenga (School of Economics, University of Cape Town); Anthony Simpasa (Nigeria Country Department, African Development Bank)
    Abstract: This paper revisits the bivariate dependence between exchange rate and crude oil price and, volatility spillover in selected emerging and low-income countries. A two-pronged approach is employed in our analysis, namely elliptic copula models and the Hafner and Herwartz (2006) framework using daily data from January 2000 to December 2018. From the copula analysis, we find that the Gaussian models best capture the dependence structure in the selected countries. Moreover, the results show evidence of heterogeneous dependence for both net oil exporters and net oil importers, as well as the type of exchange rate and country classification. The results also reveal significant symmetric dependence structure for all countries. Our results confirm previous findings that an increase (decrease) in oil price in a net oil exporting (importing) country is associated with appreciation (depreciation) of the domestic currency against the US dollar. However, unlike previous studies, we find that the direction of association varies depending on the period with significant increase in degree of dependence after the global financial crisis. This pattern also manifests with risk transmission from oil prices to exchange rates. Using the Hafner and Herwartz framework, our results show significant risk spillover from oil price to foreign exchange market. These results provide important insights that policy makers should factor in the exchange rate in the design and implementation of monetary policy and for investors in their portfolio allocation decisions.
    Keywords: Dependence structure, Oil price, Exchange rates, Copulas, Risk spillover JEL classification: C400, E310, E320, F440
    Date: 2020–06–01
  6. By: Aronsson, Thomas (Department of Economics, Umeå University); Hetschko, Clemens (University of Leeds and CESifo, Munich); Schöb, Ronnie (Freie Universität Berlin and CESifo)
    Abstract: Societies see growing support for populist politicians who advocate an end to globalization. Our behavioral economics model links impatience to voters’ appraisals of an income shock due to globalization that is associated with short-run costs and delayed gains. The model shows that impatient individuals may reject further globalization if they are subject to borrowing constraints. Using German data, we confirm that impatient voters choose right-wing antiglobalist parties. Similarly, we show for the United Kingdom that a preference for immediate gratification increases the support for right-wing anti-globalist parties as well as for Brexit. A policy implication of our study is that governments may use up-front redistribution to gain voters’ support for further globalization.
    Keywords: Globalization; time-preference; impatience; time-inconsistency; populism; Brexit; up-front redistribution
    JEL: D72 D91 F15 F61 F68 H53
    Date: 2020–07–22
  7. By: Maurice Obstfeld (Peterson Institute for International Economics)
    Abstract: Fifty years ago, Harry G. Johnson published "The Case for Flexible Exchange Rates, 1969," its title echoing Milton Friedman’s classic essay of 1953. Though somewhat overlooked today, Johnson’s reprise was an important element in the late 1960s debate over the future of the international monetary system. In this Working Paper, Obstfeld lays out the historical context in which Johnson’s “Case†was written and read and then examines Johnson’s main points and sees how they stand up to nearly five decades of experience with floating exchange rates since the end of the Bretton Woods system. He also reviews the most recent academic critiques of exchange rate flexibility and asks how fatal they are to Johnson’s basic argument. He concludes that the essential case for exchange rate flexibility still stands strong.
    Keywords: Monetary policy, natural rate of interest, Phillips curve, current account, capital flows, policy spillbacks
    JEL: E52 F32 F41
    Date: 2020–07
  8. By: Enrico Perotti (University of Amsterdam, CEPRand Tinbergen Institute); Oscar Soons (University of Amsterdam and Tinbergen Institute)
    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 ows 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; fiscaltransfers
    JEL: O47 D72 F33 F45
    Date: 2020–06
  9. By: Pietro Cova (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: This paper evaluates the macroeconomic impact on the euro area (EA) of the imposition of tariffs by simulating a multi-country New Keynesian model featuring the effective lower bound (ELB) on the EA monetary policy rate. The main results are as follows. First, the bilateral tariff dispute between the United States (US) and China (CH) has positive spillovers on the EA economy, because of favorable trade diversion effects. Second, simultaneous tariff increases between the US and CH and between the US and EA have negative effects on euro-area GDP and (ex-tariff) inflation. The effects are magnified if the ELB binds in the EA. Third, if the elasticity of substitution among tradables is low, the spillovers on euro-area GDP of US-CH trade tensions are negligible if the ELB is not binding, while they become negative if the ELB binds.
    Keywords: euro area, inflation, tariffs, effective lower bound, DSGE models.
    JEL: C54 E52 F13 F41
    Date: 2020–07
  10. By: Christian Keuschnigg; Linda Kirschner; Michael Kogler; Hannah Winterberg
    Abstract: Using a DSGE model with nominal wage rigidity, we investigate two scenarios for the Italian economy. The first considers sustained policy commitment to reform. The results indicate the possibility of ‘growing out of bad initial conditions’, if fiscal consolidation is combined with a program for bank recovery and for competitiveness and growth. The second scenario involves a strong asymmetric recession. It is likely to be very severe under the restrictions of the currency union. A benign exit from the Eurozone with stable investor expectations could substantially dampen the short-run impact. Stabilization is achieved by monetary expansion, combined with exchange rate depreciation. However, investor panic may lead to escalation. Capital market reactions would offset the benefits of monetary autonomy and much delay the recovery.
    Keywords: Italy, competitiveness, sovereign debt, bad loans, bank recapitalization, European crisis
    JEL: E42 E44 E60 F30 F36 F45 G15 G21
    Date: 2020
  11. By: Viral V. Acharya; Soku Byoun; Zhaoxia Xu
    Abstract: We show theoretically and empirically that in the presence of a time-varying cost of capital (COC), firms have a hedging motive to reduce the overall COC over time by saving cash when COC is relatively low. The sensitivity of cash savings to COC is especially pronounced with respect to the cost of equity and for firms with greater correlation between COC and financing needs for future investments. Both financially constrained and unconstrained firms respond to low COC by saving cash out of external capital issuance in excess of current financial needs.
    JEL: G32 G35
    Date: 2020–07
  12. By: Pereira, Márcia; Tavares, José
    Abstract: We propose a new method to estimate implicit country weights in the conduct of monetary policy by the European Central Bank (ECB). We estimate linear and non-linear Taylor rules for 11 countries in the pre-Euro period, and then use the estimated response to produce counterfactual reference interest rates for those same countries in the post-Euro period. The distance between counterfactual interest rates and the ECB's reference rate provides an estimate of a country's implicit weight in Euro area monetary policy, in which the sum of weights adds up to 1. The concept of monetary weight draws on that of monetary stress, initially proposed by Clarida, Gali, and Gertler, 1998, and further developed by Sturm and Wollmershauser, 2008. Our results show that Germany, Belgium and the Netherlands are persistently assigned the largest weights, whereas Greece and Ireland secure the smallest. This is especially so during the Sovereign Debt Crisis (SDC). The estimated country weights increase with the degree of co-movement between each country's and Germany's business cycle.
    Keywords: Aggregate Supply and Demand Shocks; Counterfactual Interest Rates; Monetary Weights; Taylor rule
    JEL: E52 F15 F33 P16
    Date: 2019–10

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.