nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒09‒07
twelve papers chosen by
Martin Berka
University of Auckland

  1. How does international capital flow? By Kumhof, Michael; Rungcharoenkitkul, Phurichai; Sokol, Andrej
  2. Liquidity traps in a monetary union By Robert Kollmann
  3. Interest Rate Uncertainty and Sovereign Default Risk By Alok Johri; Shahed Khan; César Sosa-Padilla
  4. Trade Flows and Fiscal Multipliers By Matteo Cacciatore; Nora Traum
  5. How Do World Commodity Prices Affect Asian Commodity Exporting Economies?: The Role of Financial Frictions By Shigeto KITANO
  6. Domestic Price Dollarization in Emerging Economies By Andres Drenik; Diego Perez
  7. The IMF’s Growth Forecasts for Poor Countries Don’t Match Its COVID Narrative By Justin Sandefur; Arvind Subramanian
  8. One Money, Many Markets: Monetary Transmission and Housing Financing in the Euro Area By Giancarlo Corsetti; Joao B. Duarte; Samuel Mann
  9. To What Extent Are Tariffs Offset By Exchange Rates? By Olivier Jeanne; Jeongwon Son
  10. The Macroeconomic Effects of Macroprudential Policy: Evidence from a Narrative Approach By Diego Rojas; Carlos A. Vegh; Guillermo Vuletin
  11. Capital Flows in Risky Times: Risk-On / Risk-Off and Emerging Market Tail Risk By Anusha Chari; Karlye Dilts Stedman; Christian T. Lundblad
  12. The international dimension of an incomplete EMU By Ioannou, Demosthenes; Stracca, Livio; Pagliari, Maria Sole

  1. By: Kumhof, Michael (Bank of England); Rungcharoenkitkul, Phurichai (Bank for International Settlements); Sokol, Andrej (European Central Bank)
    Abstract: Understanding gross capital flows is increasingly viewed as crucial for both macroeconomic and financial stability policies, but theory is lagging behind many key policy debates. We fill this gap by developing a two-country DSGE model that tracks domestic and cross-border gross positions between banks and households, with explicit settlement of all transactions through banks. We formalise the conceptual distinction between cross-border saving and financing, which often move in opposite directions in response to shocks. This matters for at least four policy debates. First, current accounts are poor indicators of financial vulnerability, because in a crisis, creditors stop financing debt rather than current accounts, and because following a crisis, current accounts are not the primary channel through which balance sheets adjust. Second, we reinterpret the global saving glut hypothesis by arguing that US households do not finance current account deficits with foreigners’ physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. Third, Triffin’s current account dilemma is not in fact a dilemma, because the creation of additional US dollars requires dollar credit creation by US and non-US banks rather than US current account deficits. Finally, we demonstrate that the observed high correlation of gross capital inflows and outflows is overwhelmingly an automatic consequence of double entry bookkeeping, rather than the result of two separate sets of economic decisions.
    Keywords: Bank lending; money creation; money demand; uncovered interest parity; exchange rate determination; international capital flows; gross capital flows
    JEL: E44 E51 F41 F44
    Date: 2020–08–21
  2. 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 countryspecific 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: E3 E4 F2 F3 F4
    Date: 2020–08
  3. By: Alok Johri; Shahed Khan; César 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).
    JEL: E32 E43 F34 F41
    Date: 2020–08
  4. By: Matteo Cacciatore; Nora Traum
    Abstract: We present novel insights on the role of international trade following unanticipated government spending and income tax changes in a flexible exchange rate environment. In a simple two-country, two-good model, we show analytically that fiscal multipliers can be larger in economies more open to trade, even when fiscal expansions imply a trade deficit. Cross-country comovement can be positive or negative. Three factors determine how trade linkages affect fiscal multipliers: the relative import share of public and private goods, how the government finances its budget, and the currency invoicing of exports. A Bayesian prior-predictive analysis shows a quantitative international business-cycle model bears the same predictions. Estimating the model on Canadian and U.S. data, we find support for larger multipliers relative to a counterfactually closed economy and positive cross-country spillovers.
    JEL: E2
    Date: 2020–08
  5. By: Shigeto KITANO (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: This note examines how recent volatile fluctuations of world commodity prices due to the COVID-19 shock affect Asian commodity exporting economies. Our analysis shows that a drop in world commodity prices has a significant negative impact on output, consumption, and investment of sample countries. However, the impact on trade balance is positive in some countries and negative in others. The difference between these two groups is attributable to whether world commodity prices affect each country's interest rate spreads.
    Keywords: Commodity prices; Asian emerging economies; Financial frictions; SVAR; Interest rate spreads; Commodity exporting economies; Trade balances; COVID-19 shock
    JEL: E32 E37 E44 F32 F36 F41 F44 F62 O16 Q43
    Date: 2020–08
  6. By: Andres Drenik; Diego Perez
    Abstract: This paper studies the dollarization of prices in retail markets of emerging economies. We develop a model of the firm’s optimal currency choice in retail markets in inflationary economies. We derive theoretical predictions regarding the optimality of dollar pricing, and test them using data from the largest e-trade platform in Latin America. Across countries, price dollarization is positively correlated with asset dollarization and inflation, and negatively correlated with exchange rate volatility. At the micro level, larger sellers are more likely to price in dollars, and more tradeable goods are more likely to be posted in dollars. We then show that prices are sticky, and hence the currency of prices determines the short-run reaction of both prices and quantities to a nominal exchange rate shock.
    JEL: E31 F41
    Date: 2020–08
  7. By: Justin Sandefur (Center for Global Development); Arvind Subramanian (Peterson Institute for International Economices; Harvard Kennedy School)
    Abstract: The International Monetary Fund’s forecasts of GDP growth in 2020 suggest a substantially muted impact of the COVID crisis—about 3 percentage points smaller—for developing countries compared to advanced economies. Simple cross-country regressions show this discrepancy cannot be explained by external vulnerabilities to trade disruptions, financial crises, or commodity price shocks, which mostly suggest a more severe crisis in the developing world. It also cannot be explained by the domestic shock, because—while current case totals are greater in advanced economies—the policy responses of social distancing and lockdowns which will directly constrain economic activity have been similar across both groups of countries, and fiscal policy responses have been significantly weaker in developing countries. We hope that the relative optimism will not induce complacency and elicit a less-than-forceful response by countries themselves nor legitimize an ungenerous, conditionality-addled response on the part of the international community in the face of an unprecedented calamity.
    Keywords: IMF, coronavirus, covid-19, growth forecasts
    JEL: I15 E37 O47
    Date: 2020–05–14
  8. By: Giancarlo Corsetti; Joao B. Duarte; Samuel Mann
    Abstract: We study the transmission of monetary shocks across euro-area countries using a dynamic factor model and high-frequency identification. We develop a methodology to assess the degree of heterogeneity, which we find to be low in financial variables and output, but significant in consumption, consumer prices, and variables related to local housing and labor markets. Building a small open economy model featuring a housing sector and calibrating it to Spain, we show that varying the share of adjustable-rate mortgages and loan-to-value ratios explains up to one-third of the cross-country heterogeneity in the responses of output and private consumption.
    Date: 2020–06–26
  9. By: Olivier Jeanne; Jeongwon Son
    Abstract: In theory, we should expect tariffs to be partially offset by a currency appreciation in the tariff-imposing country or by a depreciation in the country on which the tariff is imposed. We find, based on a calibrated model, that the tariffs imposed by the US in 2018-19 should not have had a large impact on the dollar but may have significantly depreciated the renminbi. This prediction is consistent with a high-frequency event analysis looking at the impact of tariff-related news on the dollar and the renminbi. We find that tariffs explained at most one fifth of the dollar effective appreciation but around two thirds of the renminbi effective depreciation observed in 2018-19.
    JEL: F31 F41
    Date: 2020–08
  10. By: Diego Rojas; Carlos A. Vegh; Guillermo Vuletin
    Abstract: We analyze the macroeconomic effects of macroprudential policy – in the form of legal reserve requirements – in three Latin American countries (Argentina, Brazil, and Uruguay). To correctly identify innovations in changes in legal reserve requirements, we develop a narrative approach – based on contemporaneous reports from the IMF and Central Banks in the spirit of Romer and Romer (2010) – that classifies each change into endogenous or exogenous to the business cycle. We show that this distinction is critical in understanding the macroeconomic effects of reserve requirements. In particular, we show that output falls in response to exogenous increases in legal reserve requirements but would seem not to be affected (or could even increase!) when using all changes and relying on traditional time-identifying strategies. This bias reflects the practical relevance of the misidentification of endogenous countercyclical changes in reserve requirements. We also push the empirical frontier along two important dimensions. First, in measuring legal reserve requirements, we take into account both the different types of legal reserve requirements in terms of maturity and currency of denomination as well as the structure of deposits. Second, since in practice reserve requirement policy is tightly linked to monetary policy, we also jointly analyze the macroeconomic effects of changes in central bank interest rates. To properly identify exogenous central bank interest rate shocks, we follow Romer and Romer (2004).
    JEL: E32 E52 E58 F31 F41
    Date: 2020–08
  11. By: Anusha Chari; Karlye Dilts Stedman; Christian T. Lundblad
    Abstract: This paper characterizes the implications of risk-on/risk-off shocks for emerging market capital flows and returns. We document that these shocks have important implications not only for the median of emerging markets flows and returns but also for the left tail. Further, while there are some differences in the effects across bond vs. equity markets and flows vs. asset returns, the effects associated with the worst realizations are generally larger than on the median realization. We apply our methodology to the COVID-19 shock to examine the pattern of flow and return realizations: the sizable risk-off nature of this shock engenders reactions that reside deep in the left tail of most relevant emerging market quantities.
    Keywords: Capital flows; Emerging markets; risk-on/risk-off; COVID-19; Tail risk; Quantile regression
    JEL: F32 G15 G23
    Date: 2020–07–01
  12. By: Ioannou, Demosthenes; Stracca, Livio; Pagliari, Maria Sole
    Abstract: This paper quantifies the economic influence that shocks to EMU cohesion, which in turn reflect the incomplete nature of the monetary union, have on the rest of the world. Disentangling euro area stress shocks and global risk aversion shocks based on a combination of sign, magnitude and narrative restrictions in a daily Structural Vector Autoregression (VAR) model with financial variables. We find that the effects of euro area stress shocks are significant not only for the euro area but also for the rest of the world. Notably, an increase in euro area stress entails a slowdown of economic activity in the rest of the world, as well as a fall in imports/exports of both the euro area and the rest of the world. A decrease in euro area stress has somewhat more widespread beneficial effects on both economic performance and global trade activity. JEL Classification: C23, C32, F02, F33
    Keywords: Bayesian SVAR, Economic and Monetary Union, narrative sign restrictions, panel local projections
    Date: 2020–08

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