nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2020‒12‒14
nine papers chosen by
Martin Berka
University of Auckland

  1. Sudden Stops, Productivity and the Optimal Level of International Reserves for Small Open Economies By Alexander Mihailov; Harun Nasir
  2. Climate Risk and Commodity Currencies By Felix Kapfhammer; Vegard H. Larsen; Leif Anders Thorsrud
  3. Welfare Costs of Bilateral Currency Crises: The Role of International Trade By Hakan Yilmazkuday
  4. The Dutch Disease Revisited: Theory and Evidence By Arsham Reisinezhad
  5. An asymmetrical overshooting correction model for G20 nominal effective exchange rates By Frédérique Bec; Mélika Ben Salem
  6. Asymmetric Shocks, Real Exchange Rate Distortions and Options for the Second Monetary Zone in West Africa By Chukwuma Agu; Uchenna Alexander Nnamani
  7. Short-term determinants of bilateral exchange rates: A decomposition model for the Swiss franc By Fabian Fink; Lukas Frei; Oliver Gloede
  8. Trade Costs and Strategic Investment in Infrastructure in a Dynamic Global Economy with Symmetric Countries By Akihiko Yanase; Ngo Van Long; Ngo Van Long
  9. Sovereign Capital, External Balance, and the Investment-Based Balassa-Samuelson Effect in a Global Dynamic Equilibrium By Alexis Derviz

  1. By: Alexander Mihailov (Department of Economics, University of Reading); Harun Nasir (Department of Economics, Zonguldak Bülent Ecevit University)
    Abstract: This paper contributes to the theory of optimal international reserves by extending the Jeanne and Rancière (2011) endowments mall open economy (SOE) model to a SOE with capital and production that explicitly accounts for the main sources of economic growth. A first version of our set-up considers capital as the sole factor of production in the spirit of the AK model of endogenous growth with constant population, implying increasing returns to scale and justified on the grounds of its ability to generate sustained long-run growth, as observed empirically. Under a plausible calibration for typical emerging market countries facing the risk of sudden stops in capital inflows, we find that the optimal ratio of international reserves to output is 1.7%, which is quite lower than that in Jeanne and Rancière (2011), of 9.1%, even if calibrated to the same sample of 34 middle-income countries. A richer version then introduces also labour as a second factor in a conventional labour- augmenting Cobb-Douglas production function with constant returns to scale and exogenous population growth, consistent with a long-run balanced growth path and the sustained per capita income growth in the data. Under this alternative technology and the same calibration, we similarly find that the optimal reserves-to-output ratio for emerging market SOEs decreases - but not as much, being 5.5% - relative to the endowment case. We conclude that our results are explained by the role of capital accumulation as precautionary saving: the accumulated capital stock can potentially be used as a pledge to external creditors in obtaining borrowing, therefore insuring better a SOE against sudden stops.
    Keywords: optimal international reserves, small open economies, sudden stops,production technology, capital accumulation, precautionary saving, insurance contracts
    JEL: E21 E23 F32 F34 F41 O40
    Date: 2020–12–03
  2. By: Felix Kapfhammer; Vegard H. Larsen; Leif Anders Thorsrud
    Abstract: The positive relationship between real exchange rates and natural resource income is well understood and studied. However, climate change and the transition to a lower-carbon economy now challenges this relationship. We document this by proposing a novel news media-based measure of climate change transition risk and show that when such risk is high, major commodity currencies experience a persistent depreciation and the relationship between commodity price fluctuations and currencies tends to become weaker.
    Keywords: Exchange Rates, Climate, Risk, Commodities
    Date: 2020–12
  3. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper shows that bilateral currency crises reduce bilateral trade up to 50% after controlling for the depreciation rate. Using a trade model, these reductions are connected to the welfare costs of currency crises. The results show that a single currency crisis can result in welfare reductions through changes in international trade corresponding to more than 10% (and up to 41%) of the costs of autarky for 23 different currency crisis episodes between 1960 and 2014. These welfare costs are also shown to be greater than the welfare gains from having free trade agreements and using common currencies for 25 different currency crisis episodes.
    Keywords: Welfare Costs, Currency Crises, International Trade
    JEL: F14 F31 F63
    Date: 2020–11
  4. By: Arsham Reisinezhad (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PSE - Paris School of Economics)
    Abstract: Contrary to empirical evidence, the Dutch disease hypothesis, driven by Learning By Doing (LBD), does not predict the steady-state real exchange rate appreciation and economic growth deceleration due to a resource boom. To do so, I first represent a simple model to fill the theory's gap, and then adopt a dynamic panel data approach for a sample of 132 countries over the period 1970-2014 to re-evaluate both symptoms of the hypothesis in systematic analysis. The main findings are threefold. First, a resource boom appreciates the real exchange rate. Second, the real exchange rate appreciation decelerates the rate of growth in both sectors such that the shrinkage is larger in the manufacturing sector than in the service sector. This, in turn, makes the relative output level of the manufacturing sector to the service sector be smaller and economic growth be slower. Third, these effects are more intensive in resource-rich countries than in resource-poor countries.
    Keywords: Natural resource,The Dutch Disease,Real exchange rate,Growth rate
    Date: 2020–11
  5. By: Frédérique Bec; Mélika Ben Salem (Université de Cergy-Pontoise, THEMA)
    Abstract: This paper develops an asymmetrical overshooting correction autoregressive model to capture excessive nominal exchange rate variation. It is based on the widely accepted perception that open economies might react differently to under-evaluation or over-evaluation of their currency because of the trade-off between fostering their net exports and maintaining their international purchasing power. Our approach departs from existing works by considering explicitly both size and sign effects: the strength of the overshooting correction mechanism is indeed allowed to differ between large and small depreciations and appreciations. Evidence of overshooting correction is found in most G20 countries. Formal statistical tests confirm sign and/or size asymmetry of the overshooting correction mechanism in most countries. It turns out that the overshooting correction specification is heterogeneous among countries, even though most of Emerging Market and Developing Economies are found to adjust to over-depreciation whereas the Euro Area and the US are shown to adjust to over-appreciation only.
    Keywords: nominal exchange rate, asymmetrical overshooting correction.
    JEL: C22 F31 F41
    Date: 2020
  6. By: Chukwuma Agu; Uchenna Alexander Nnamani (University of Nigeria,)
    Abstract: The West African Monetary Zone (WAMZ) has continued to set targets of monetary integration for member states without success. With 2020 set as the new deadline for the attainment of monetary integration in the zone, it is not clear how the feasible this deadline is. It is clear that there are distortions that possibly affect not only the feasibility of enacting the union but also the potential outcome should the leaders decide to ram through the unification without due consideration to these factors. One such factor is exchange rate alignments. This study therefore investigates the presence of real exchange rate misalignments and the effects of such on the macroeconomic stabilities of the WAMZ countries. Due to paucity of data, the study captures only four of the six countries that make up WAMZ – Nigeria, Ghana, The Gambia, and Sierra Leone. It finds that there are misalignments of real exchange rates in all the four countries. These manifest mostly as real exchange rate (RER) overvaluation in two of the four countries, and as RER undervaluation in the other two countries. The RER misalignments and volatilities affect macroeconomic behaviours of the member countries in various ways and to varying degrees. We evaluate the diverse ways these misalignments affect macroeconomic policies and behaviour of the countries and their implications on the integration effort. The study concludes that efforts at stabilizing the macroeconomic fundamentals that determine RER in the WAMZ member states, beginning with monetary policy tools, will be important steps towards instituting a sustainable monetary union
    Date: 2019
  7. By: Fabian Fink; Lukas Frei; Oliver Gloede
    Abstract: This paper develops an FX factor model to decompose short-term bilateral exchange rate dynamics into different global factors and local uniqueness. We apply the model to the Swiss franc exchange rates against the US dollar (USDCHF) and the euro (EURCHF) between 2006 and 2018 and decompose daily dynamics into three global factors: risk, US dollar, and euro. The model captures daily dynamics well, explaining approximately 73% of the variation in USDCHF and 37% of the variation in EURCHF. The risk factor contributes the most to Swiss franc dynamics, especially in times of a worsening risk environment, highlighting the role of the Swiss franc as a safe-haven currency. Global FX factors had been almost completely reflected in USDCHF dynamics before the euro area debt crisis, but once that crisis began, they also became important for EURCHF. Furthermore, momentum is present in daily Swiss franc returns, especially before the introduction of the EURCHF minimum exchange rate.
    Keywords: Factor model, variance decomposition, safe haven, carry trade, momentum
    JEL: F31 G15 C38
    Date: 2020
  8. By: Akihiko Yanase; Ngo Van Long; Ngo Van Long
    Abstract: This paper develops a two-country model of intraindustry trade with trade costs, which can be reduced by public investment in an international infrastructure capital, the stock of which accumulates over time. Depending on the trade costs and international distribution of manufac-turing firms, equilibrium patterns of trade are determined, and national welfare in each country is affected by these trade patterns. Taking the relationship between trade costs and national welfare into consideration, the governments carry out a dynamic game of public investment. We show that the dynamic equilibrium of the policy game may exhibit history dependency; if the initial stock of international infrastructure is smaller (larger) than a certain level, the infrastructure stock decreases (increases) over time, and the world economy will end up in autarky (two-way free trade) in the long-run. We also show that international cooperation is beneficial in the sense that it may enable the world economy to escape from a “low development trap.”
    Keywords: public infrastructure capital, intraindustry trade, differential game, multiple equilibria.
    JEL: C61 C73 F12 H54 H87 O18
    Date: 2020
  9. By: Alexis Derviz
    Abstract: We develop a two-country dynamic optimization model with investment and labor mobility and calculate its full-distribution Markov solution without relying on non-stochastic steady-state shortcuts. Agents have access to so-called sovereign capital (an extension of the inside equity notion) as well as the usual outside equity in their own country, but only to outside equity in the other country. This friction creates two distinct categories of partially non-tradable investment goods. Their price ratio can be viewed as an analogue of the real exchange rate in the Balassa-Samuelson model, but with consumption goods replaced by assets. In equilibrium, this asset-based real exchange rate is more sensitive to the stock ownership split between residents and non-residents in each country's production capacity than to the ratio of national physical capital stocks. In a similar model without sovereign capital exclusivity, the order of the sensitivity is reversed. Along with the real exchange rate, we also analyze equilibrium net investment positions and financial account levels as functions of the physical capital ratio and the stock ownership splits. This allows us, in the dynamic equilibrium environment modeled, to point at the underlying regularities behind the seemingly irregular interplay between the external balance and the exchange rate.
    Keywords: Capital, dynamic optimization, real exchange rate, sovereignty, tradability
    JEL: C61 C63 F36 F41 F65
    Date: 2020–11

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