nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒10‒19
eight papers chosen by
Martin Berka
University of Auckland

  1. A Theory of Foreign Exchange Interventions By Sebastián Fanelli; Ludwig Straub
  2. Gross capital flows and the balance-of-payments: a balance sheet perspective By Karsten Kohler
  3. How does international capital flow? By Michael Kumhof; Phurichai Rungcharoenkitkul; Andrej Sokol
  4. The Economics of Currency Risk By Tarek Alexander Hassan; Tony Zhang
  5. Do commodity price volatilities impact currency misalignments in commodity-exporting countries ? By Cyriac Guillaumin; Salem Boubakri; Alexandre Silanine
  6. The Global Factor Structure of Exchange Rates By Sofonias Korsaye; Fabio Trojani; Andrea Vedolin
  7. A Counterfactual Economic Analysis of Covid-19 Using a Threshold Augmented Multi-Country Model By Alexander Chudik; Kamiar Mohaddes; M. Hashem Pesaran; Mehdi Raissi; Alessandro Rebucci
  8. Long-run dynamics of exchange rates: A multi-frequency investigation By Vo, Duc Hong

  1. By: Sebastián Fanelli; Ludwig Straub
    Abstract: We study a real small open economy with two key ingredients: (i) partial segmentation of home and foreign bond markets and (ii) a pecuniary externality that makes the real exchange rate excessively volatile in response to capital flows. Partial segmentation implies that, by intervening in the bond markets, the central bank can affect the exchange rate and the spread between home- and foreign-bond yields. Such interventions allow the central bank to address the pecuniary externality, but they are also costly, as foreigners make carry-trade profits. We analytically characterize the optimal intervention policy that solves this trade-off: (a) the optimal policy leans against the wind, stabilizing the exchange rate; (b) it involves smooth spreads but allows exchange rates to jump; (c) it partly relies on “forward guidance”, with non-zero interventions even after the shock has subsided; (d) it requires credibility, in that central banks do not intervene without commitment. Finally, we shed light on the global consequences of widespread interventions, using a multi-country extension of our model. We find that, left to themselves, countries over-accumulate reserves, reducing welfare and leading to inefficiently low world interest rates.
    JEL: F31 F32 F41 F42
    Date: 2020–09
  2. By: Karsten Kohler (King’s College London)
    Abstract: Gross capital flows have gained increasing attention in empirical research over the last decade. Due to their effects on current accounts and financial stability, gross flows are highly relevant for key issues in macroeconomics, political economy, and public policy. However, the exact relationship between gross flows, net flows and current accounts is often poorly understood. These notes aim to clarify some basic features and implications of gross capital flows. Balance-of-payments and balance-sheet accounting is utilised to illustrate how different kinds of gross flows play out on domestic balance sheets and in the balance-of-payments. Organised around nine propositions, the notes clarify the relationship between gross flows, net flows, and trade flows; explain some interesting properties of pure financial flows; discuss issues related to exchange rates and currency unions; and clarify the nature of sudden stop crises.
    Keywords: Gross capital flows, balance-of-payments, current account, imbalances, trilemma, TARGET2, sudden stop
    JEL: F31 F32 F36 F41
    Date: 2020–10
  3. By: Michael Kumhof; Phurichai Rungcharoenkitkul; Andrej Sokol
    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.
    JEL: E44 E51 F41 F44
    Date: 2020–10
  4. By: Tarek Alexander Hassan; Tony Zhang
    Abstract: This article reviews the literature on currency and country risk with a focus on its macroeconomic origins and implications. A growing body of evidence shows countries with safer currencies enjoy persistently lower interest rates and a lower required return to capital. As a result, they accumulate relatively more capital than countries with currencies international investors perceive as risky. Whereas earlier research focused mainly on the role of currency risk in generating violations of uncovered interest parity and other financial anomalies, more recent evidence points to important implications for the allocation of capital across countries, the efficacy of exchange rate stabilization policies, the sustainability of trade deficits, and the spillovers of shocks across international borders.
    JEL: E22 E4 F31 F34 F4 G12 G15 G3
    Date: 2020–09
  5. By: Cyriac Guillaumin (CREG - Centre de recherche en économie de Grenoble - UGA [2020-....] - Université Grenoble Alpes [2020-....]); Salem Boubakri (Université Paris Sorbonne Abou Dhabi); Alexandre Silanine (Université Paris Sorbonne Abou Dhabi)
    Abstract: This paper aims to investigate the relationship between misalignments of real effective exchange rates and real commodity price volatilities in a sample of 46 commodity-exporting countries by considering financial development as the transition variable. We first estimate currency misalignments as deviations of the observed real effective exchange rates from their equilibrium values estimated using the behavioural equilibrium exchange rate (BEER) approach. Then, we rely on panel data and a smooth-transition regression model to estimate commodity price volatilities' non-linear impacts on currency misalignments. Our results indicate that the estimated coefficients are highly significant, and demonstrate that real commodity prices' volatility has a non-linear impact on currency misalignments depending on the country's degree of financial development.
    Keywords: financial development level,commodity-exporting countries,panel smooth transition model,currency misalignments,real commodity price volatility
    Date: 2020
  6. By: Sofonias Korsaye; Fabio Trojani; Andrea Vedolin
    Abstract: We provide a model-free framework to study the global factor structure of exchange rates. To this end, we propose a new methodology to estimate international stochastic discount factors (SDFs) that jointly price cross-sections of international assets, such as stocks, bonds, and currencies, in the presence of frictions. We theoretically establish a two-factor representation for the cross-section of international SDFs, consisting of one global and one local factor, which is independent of the currency denomination. We show that our two-factor specification prices a large cross-section of international asset returns, not just in- but also out-of-sample with R2s of up to 80%.
    JEL: F3 F31 G15
    Date: 2020–10
  7. By: Alexander Chudik; Kamiar Mohaddes; M. Hashem Pesaran; Mehdi Raissi; Alessandro Rebucci
    Abstract: This paper develops a threshold-augmented dynamic multi-country model (TGVAR) to quantify the macroeconomic effects of Covid-19. We show that there exist threshold effects in the relationship between output growth and excess global volatility at individual country levels in a significant majority of advanced economies and in the case of several emerging markets. We then estimate a more general multi-country model augmented with these threshold effects as well as long term interest rates, oil prices, exchange rates and equity returns to perform counterfactual analyses. We distinguish common global factors from trade-related spillovers, and identify the Covid-19 shock using GDP growth forecast revisions of the IMF in 2020Q1. We account for sample uncertainty by bootstrapping the multi-country model estimated over four decades of quarterly observations. Our results show that the Covid-19 pandemic will lead to a significant fall in world output that is most likely long-lasting, with outcomes that are quite heterogeneous across countries and regions. While the impact on China and other emerging Asian economies are estimated to be less severe, the United States, the United Kingdom, and several other advanced economies may experience deeper and longer-lasting effects. Non-Asian emerging markets stand out for their vulnerability. We show that no country is immune to the economic fallout of the pandemic because of global interconnections as evidenced by the case of Sweden. We also find that long-term interest rates could fall significantly below their recent lows in core advanced economies, but this does not seem to be the case in emerging markets.
    JEL: C32 E44 F44
    Date: 2020–09
  8. By: Vo, Duc Hong
    Abstract: The empirical observation that purchasing power parity (PPP) holds in the long run but not in the short run has enjoyed a near-consensus status in international finance literature. However, a similar degree of agreement has not been reached with respect to the exact horizon of this “long run” aspect. To shed light on this matter, a novel approach is adopted in this paper to combine conventional time series methodology with insights from multi-frequency analyses. In particular, we simultaneously explore price-exchange-rate dynamics not only through time, but also at various horizons via a wavelet decomposition. Unit root tests applied to wavelet-based decomposed real exchange rates indicates that PPP holds at horizons consistent with the literature. With respect to the predictive value of our approach, we show that our decomposed measures provide guidance to future movements of real change rates. Additionally, we find that nominal exchangerate dynamics are dominated by activities corresponding to low frequencies. Results from this study thus enable researchers and practitioners to establish an exchange-rate modelling framework with increased efficiency
    Keywords: Purchasing power parity Wavelets Multi-frequency analysis
    JEL: F3 F31
    Date: 2019–11–30

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