nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒11‒30
nine papers chosen by
Martin Berka
Massey University

  1. Sudden Stops and Optimal Foreign Exchange Intervention By J. Scott Davis; Michael B. Devereux; Changhua Yu
  2. Foreign shocks as granular fluctuations By Julian di Giovanni; Andrei A. Levchenko; Isabelle Mejean
  3. Central bank digital currency in an open economy By Ferrari, Massimo Minesso; Mehl, Arnaud; Stracca, Livio
  4. Switching Volatility in a Nonlinear Open Economy By Jonathan Benchimol; Sergey Ivashchenko
  6. Inequality and imbalances: a monetary union agent-based model By Alberto Cardaci; Francesco Saraceno
  7. Trade Integration, Global Value Chains and Capital Accumulation By Michael Sposi; Kei-Mu Yi; Jing Zhang
  8. Exchange Rates, Stock Prices, and Stock Market Uncertainty By Fatemeh Salimi Namin
  9. Agricultural Productivity as a Prerequisite of Industrialization: Some New Evidence on Trade Openness and Premature Deindustrialization By Arnaud Daymard

  1. By: J. Scott Davis; Michael B. Devereux; Changhua Yu
    Abstract: This paper shows how foreign exchange intervention can be used to avoid a sudden stop in capital flows in a small open emerging market economy. The model is based around the concept of an under-borrowing equilibrium defined by Schmitt-Grohe and Uribe (2020). With a low elasticity of substitution between traded and non-traded goods, real exchange rate depreciation may generate a precipitous drop in aggregate demand and a tightening of borrowing constraints, leading to an equilibrium with an inefficiently low level of borrowing. The central bank can preempt this deleveraging cycle through foreign exchange intervention. Intervention is effective due to frictions in private international financial intermediation. Reserve accumulation has ex ante benefits by reducing the risk of a sudden stop, while intervention has ex-post benefits by limiting inefficient deleveraging. But intervention itself faces constraints. When the central bank's stock of reserves is low, even foreign exchange intervention cannot prevent a sudden stop.
    Keywords: Central bank; sudden stops; foreign exchange reserves; capital controls
    JEL: E50 E30 F40
    Date: 2020–11–10
  2. By: Julian di Giovanni; Andrei A. Levchenko; Isabelle Mejean
    Abstract: This paper uses a dataset covering the universe of French firm-level sales, imports, and exports over the period 1993-2007 and a quantitative multi-country model to study the international transmission of business cycle shocks at both the micro and the macro levels. The largest firms are both important enough to generate aggregate fluctuations (Gabaix, 2011), and most likely to be internationally connected. This implies that foreign shocks are transmitted to the domestic economy primarily through the largest firms. We first document a novel stylized fact: larger French firms are significantly more sensitive to foreign GDP growth. We then implement a quantitative framework calibrated to the full extent of observed heterogeneity in firm size, exporting, and importing. We simulate the propagation of foreign shocks to the French economy and report one micro and one macro finding. At the micro level heterogeneity across firms predominates: 40 to 85% of the impact of foreign fluctuations on French GDP is accounted for by the "foreign granular residual" - the term capturing the fact that larger firms are more affected by the foreign shocks. At the macro level, firm heterogeneity dampens the impact of foreign shocks, with the GDP responses 10 to 20% larger in a representative firm model compared to the baseline model.
    Keywords: Granularity, shock transmission, aggregate fluctuations, input linkages, international trade
    JEL: E32 F15 F23 F44 F62 L14
    Date: 2020–11
  3. By: Ferrari, Massimo Minesso; Mehl, Arnaud; Stracca, Livio
    Abstract: We examine the open-economy implications of the introduction of a central bank digital currency (CBDC).We add a CBDC to the menu of monetary assets available in a standard two-country DSGE model with financial frictions and consider a broad set of alternative technical features in CBDC design. We analyse the international transmission of standard monetary policy and technology shocks in the presence and absence of a CDBC and the implications for optimal monetary policy and welfare. The presence of a CBDC amplifies the international spillovers of shocks to a significant extent, thereby increasing international linkages. But the magnitude of these effects depends crucially on CBDC design and can be significantly dampened if the CBDC possesses specific technical features. We also show that domestic issuance of a CBDC increases asymmetries in the international monetary system by reducing monetary policy autonomy in foreign economies. JEL Classification: E50, F30
    Keywords: central bank digital currency, DSGE model, international monetary system, open-economy, optimal monetary policy
    Date: 2020–11
  4. By: Jonathan Benchimol (Bank of Israel, Jerusalem, Israel); Sergey Ivashchenko (Russian Academy of Sciences (IREP), Financial Research Institute, and Saint-Petersburg State University, Saint Petersburg, Russia)
    Abstract: Uncertainty about an economy's regime can change drastically around a crisis. An imported crisis such as the global financial crisis in the euro area highlights the effect of foreign shocks. Estimating an open-economy nonlinear dynamic stochastic general equilibrium model for the euro area and the United States including Markov-switching volatility shocks, we show that these shocks were significant during the global financial crisis compared with periods of calm. We describe how US shocks from both the real economy and financial markets affected the euro area economy and how bond reallocation occurred between short- and long-term maturities during the global financial crisis. Importantly, the estimated nonlinearities when domestic and foreign financial markets influence the economy, should not be neglected. The nonlinear behavior of market-related variables highlights the importance of higher-order estimation for providing additional interpretations to policymakers.
    Keywords: DSGE, Volatility Shocks, Markov Switching, Open Economy, Financial Crisis, Nonlinearities
    JEL: C61 E32 F41
    Date: 2020–11
  5. By: Barnett, William A. (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise); Hu, Jingxian (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise)
    Abstract: Will capital controls enhance macroeconomic stability? How will the results be influenced by the exchange rate regime and monetary policy reaction? Are the consequences of policy decisions involving capital controls easily predictable, or more complicated than may have been anticipated? We will answer the above questions by investigating the macroeconomic dynamics of a small open economy. In recent years, these matters have become particularly important to emerging market economies, which have often adopted capital controls. We especially investigate two dynamical characteristics: indeterminacy and bifurcation. Four cases are explored, based on different exchange rate regimes and monetary policy rules. With capital controls in place, we find that indeterminacy depends upon how the central bank’s response to inflation and its response to output gap coordinate with each other in the Taylor rule. When forward-looking, both passive and active monetary policy can lead to indeterminacy. Compared with flexible exchange rates, fixed exchange rate regimes produce more complex indeterminacy conditions, depending upon the stickiness of prices and the elasticity of substitution between labor and consumption. We show the existence of Hopf bifurcation under capital control with fixed exchange rates and current-looking monetary policy. To determine empirical relevance, we test indeterminacy empirically using Bayesian estimation. Fixed exchange rate regimes with capital controls produce larger posterior probability of the indeterminate region than a flexible exchange rate regime. Fixed exchange rate regimes with current-looking monetary policy lead to several kinds of bifurcation under capital controls. We provide monetary policy suggestions on achieving macroeconomic stability through financial regulation.
    Keywords: Capital controls; open economy monetary policy; exchange rate regimes; Bayesian methods; bifurcation; indeterminacy
    JEL: C11 C62 E52 F31 F38 F41
    Date: 2019–10
  6. By: Alberto Cardaci (Lombardy Advanced School of Economics Milan); Francesco Saraceno (Observatoire français des conjonctures économiques)
    Abstract: Our paper investigates the impact of rising inequality in a two-country macroeconomic model with an agent-based household sector characterized by peer effects in consumption. In particular, the model highlights the role of inequality in determining diverging balance of payments dynamics within a currency union. Inequality may drive the two countries into different growth patterns: where peer effects in consumption interact with higher credit availability, rising income inequality leads to the emergence of a debt-led growth. Where social norms determine weaker emulation and credit availability is lower, an export-led regime arises. Eventually, a crisis emerges endogenously due to the sudden-stop of capital flows from the net lending country, triggered by the excessive risk associated with the dramatic amount of private debt accumulated by households in the borrowing country. Monte Carlo simulations for a wide range of calibrations confirm the robustness of our results.
    Keywords: Inequality; Current account; Currency union; Agent-based model
    JEL: C63 D31 E21 F32 F43
    Date: 2019–07
  7. By: Michael Sposi; Kei-Mu Yi; Jing Zhang
    Abstract: Motivated by increasing trade and fragmentation of production across countries since World War II, we build a dynamic two-country model featuring sequential, multistage production and capital accumulation. As trade costs decline over time, global-value-chain (GVC) trade expands across countries, particularly more in the faster growing country, consistent with the empirical pattern. The presence of GVC trade boosts capital accumulation and economic growth and magnifies dynamic gains from trade. At the same time, endogenous capital accumulation shapes comparative advantage across countries, impacting the dynamics of GVC trade: a country becoming more capital abundant concentrates more on the capital-intensive stage of the production.
    Keywords: Multistage production; International trade; Capital accumulation
    JEL: E22 F10 F43
    Date: 2020–11–10
  8. By: Fatemeh Salimi Namin (Aix-Marseille University, CNRS, AMSE, France)
    Abstract: While the reference framework for international portfolio choice emphasizes a mean-variance framework, uncovered parity conditions only involve mean stock or bond returns. We propose to augment the empirical specification by using the relative stock market uncertainty of two countries as an extra determinant of their bilateral exchange rate returns. A rise in the relative uncertainty of one stock market will lead capital to flow to the other stock market and generate an appreciation in the currency of the latter. By focusing on the JPY/USD exchange rate returns during the most recent decade (2009-2019) and relying on a nonlinear framework, we provide evidence that the Japanese-US differential stock market uncertainty affects the JPY/USD returns both contemporaneously and with weekly lags. This finding is robust when we control for the stock returns differential and the differential changes in Japanese and US unconventional monetary policy measures.
    Keywords: exchange rate determination, implied volatility, UEP, flight to safety, flight to quality
    JEL: F31 F32 G15
    Date: 2020–11
  9. By: Arnaud Daymard (Université de Cergy-Pontoise, THEMA)
    Abstract: Most studies of structural transformation assume a closed economy when modeling. Is this assumption justified in a globalized world? I test the relevance of closed versus open economy models of structural transformation using data on the sectoral productivity levels of developed and developing countries over the 1950-2013 period. The empirical findings suggest that trade openness does affect the mechanics of structural transformation in the way predicted by the theory, but that the practical effect of trade is small. Nonetheless, the difficult creation of manufacturing jobs in Latin America and Africa—a trait commonly referred to as ”premature deindustrialization”—suggests that trade might have a significant role on the mechanics of manufacturing employment, a role that it does not play on agriculture and services. As an alternative to the role of trade, I also emphasize that large fixed costs in the formal manufacturing sector might explain the difficult industrialization of Latin America and Africa.
    Keywords: structural transformation, industrialization, agricultural productivity, international trade
    JEL: O11 O13 O14 O41 F41
    Date: 2020

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