nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒01‒11
eleven papers chosen by
Martin Berka
University of Auckland

  1. Divided We Fall: International Health and Trade Coordination During a Pandemic By Viral V. Acharya; Zhengyang Jiang; Robert J. Richmond; Ernst-Ludwig von Thadden
  2. The Global Factor Structure of Exchange Rates By Sofonias A. Korsaye; Fabio Trojani; Andrea Vedolin
  3. Real exchange rate misalignment in developing countries: the role of exchange rate flexibility and capital account openness By Wishnu Mahraddika
  4. Exchange Rate Fluctuations and Firm Leverage By Ilhyock Shim; Sebnem Kalemli-Ozcan; Xiaoxi Liu
  5. Common Trade Exposure and Business Cycle Comovement By ; Carter Mix
  6. Causal and Frequency Analyses of Purchasing Power Parity By Jun Nagayasu
  7. Incentive compatible relationship between ERMII and Close-Cooperation in the Banking Union: The case of Bulgaria and Croatia By María J Nieto; Dalvinder Singh
  8. Using purchasing power parities to compare countries: Strengths and shortcomings By Patrick Honohan
  9. Natural Disasters, Climate Change, and Sovereign Risk By Enrico Mallucci
  10. THE SIGNS OF DUTCH DISEASE IN CROATIA By Marija Beg; Martina Basarac Serti?

  1. By: Viral V. Acharya; Zhengyang Jiang; Robert J. Richmond; Ernst-Ludwig von Thadden
    Abstract: We analyze the role of international trade and health coordination in times of a pandemic by building a two-economy, two-good trade model integrated into a micro-founded SIR model of infection dynamics. Uncoordinated governments with national mandates can adopt (i) containment policies to suppress infection spread domestically, and (ii) (import) tariffs to prevent infection coming from abroad. The efficient, i.e., coordinated, risk-sharing arrangement dynamically adjusts both policy instruments to share infection and economic risks internationally. However, in Nash equilibrium, uncoordinated trade policies robustly feature inefficiently high tariffs that peak with the pandemic in the foreign economy. This distorts terms of trade dynamics and magnifies the welfare costs of tariff wars during a pandemic due to lower levels of consumption and production as well as smaller gains via diversification of infection curves across economies.
    JEL: F1 F4 H87 I1
    Date: 2020–12
  2. By: Sofonias A. Korsaye (University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute); Fabio Trojani (Swiss Finance Institute; University of Geneva); Andrea Vedolin (Boston University - Department of Finance & Economics)
    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%.
    Keywords: International asset pricing, stochastic discount factor, factor models, financial frictions, market segmentation, incomplete markets, capital flows, regularization, lasso
    JEL: F31 G15
    Date: 2020–10
  3. By: Wishnu Mahraddika
    Abstract: This paper examines the association between the real exchange rate (RER) misalignment, exchange rate flexibility, and capital account openness using a panel dataset for 60 developing countries over the period 1980 – 2014. The analysis is based on an alternative measure of RER that is more consistent with the theoretical concept of RER than the commonly used index, and misalignment estimates that account for country-specific underlying factors. The results suggest that the exchange rate regime and capital account policy are significantly related to the degree of persistence and the magnitude of RER misalignment.
    Keywords: Real exchange rate; exchange rate regime; capital account openness
    JEL: F31 F38 F41 O24
    Date: 2020
  4. By: Ilhyock Shim; Sebnem Kalemli-Ozcan; Xiaoxi Liu
    Abstract: We quantify the effect of exchange rate fluctuations on firm leverage. When home currency appreciates, firms who hold foreign currency debt and local currency assets observe higher net worth as appreciation lowers the value of their foreign currency debt. These firms can borrow more as a result and increase their leverage. When home currency depreciates, the reverse happens as firms have to de-lever with a negative shock to their balance sheets. Using firm-level data for leverage from 10 emerging market economies during the period from 2002 to 2015, we show that firms operating in countries whose non-financial sectors hold more of the debt in foreign currency, increase (decrease) their leverage relatively more after home currency appreciations (depreciations). Combining the leverage data with firm-level FX debt data for 4 emerging market countries, we further show that our results hold at the most granular level. Our quantitative results are asymmetric: the effects of depre-ciations, that are generally associated with sudden stops, are quantitatively larger than those of appreciations, which take place at a slower pace over time during capital inflow episodes. As our exercise compares depreciations and appreciations of similar size, these results are suggestive of financial frictions being more binding during depreciations than a possible relaxation of such frictions during appreciations.
    Date: 2020–12–11
  5. By: ; Carter Mix
    Abstract: A large empirical literature has shown that countries that trade more with each other have more correlated business cycles. We show that previous estimates of this relationship are biased upward because they ignore common trade exposure to other countries. When we account for common trade exposure to foreign business cycles, we find that (1) the effect of bilateral trade on business cycle comovement falls by roughly 25 percent and (2) common exposure is a significant driver of business cycle comovement. A standard international real business cycle model is qualitatively consistent with these facts but fails to reproduce their magnitudes. Past studies have used models that allow for productivity shock transmission through trade to strengthen the relationship between trade and comovement. We find that productivity shock transmission increases business cycle comovement largely because of a country-pair's common trade exposure to other countries rather than because of bilateral trade. When we allow for stronger transmission between small open economies than other country-pairs, comovement increases both from bilateral trade and common exposure, similar to the data.
    Keywords: Trade; Business cycles; Open economy macroeconomics
    JEL: E32 F10 F41 F44
    Date: 2020–12–29
  6. By: Jun Nagayasu
    Abstract: A century after its development, the purchasing power parity theorem, which links exchange rates with prices, remains one of the most popular and influential economic theories. This study examines the relationship between exchange rates and prices from the perspectives of causality and spillovers. Using a panel of countries and advanced statistical methods, we estimate spillovers for all combinations of origins and destinations at di erent frequency bands, and show that their relationship is time-varying and multidirectional and has some validity at short and long time horizons. Furthermore, using exchange rate regimes, economic structures, currency crises, and trade openness, we identify economic conditions influencing the size and direction of spillovers.
    Date: 2021–01
  7. By: María J Nieto; Dalvinder Singh
    Abstract: The ambition to expand participation in the European Banking Union was to allow the ‘outs’ to enter in to close cooperation, however, it did not include the simultaneous joining of ERM II. Focusing on the cases of Bulgaria and Croatia, this paper attempts to respond to a number of questions: What is the rationale behind the double requirement of having to simultaneously apply to become a member of the ERM II and to prepare to become a member of the Banking Union via rule based “close cooperation†mechanism of coordination between the EU non-euro area NCAs and the ECB? Does the integration of close cooperation countries' banking systems with the euro area banking systems support the decision to join ERM II and ¨opting-in¨ to the SSM? Do the existing “close cooperation†arrangements guarantee greater coordination of resource-allocating decisions on prudential supervision and improved internalization of financial stability decisions? What are the advantages of the preparation to become a full member of the euro area and the SSM (e.g. coordination of macro and micro-prudential regulation; coordination of micro-prudential supervision and bank resolution)? It is evident from the research undertaken in this paper that there are clear benefits from close cooperation for the respective Member States whose domestic currencies are already linked to the euro in view of the dominant position eurozone banks have in their respective domestic markets.
    Keywords: Banking Union, Close Cooperation, ERM II
    JEL: E02 E44 F15 G15 G21 H12 K23
    Date: 2020
  8. By: Patrick Honohan (Peterson Institute for International Economics)
    Abstract: Good international economic policy requires good comparative data on national economic performance. In May 2020, the World Bank published the latest comprehensive update of purchasing power parities (PPPs), as part of the International Comparison Program. Produced for 176 countries, these PPPs are used to convert data (especially GDP and other quantities based on national income accounts) from national currencies to a common basis in a way that is meaningful for economic analysis. PPP-adjusted data are essential because the distortions caused by sharp exchange rate movements are significant, especially for times of macroeconomic turbulence. The newly released PPP data contain fewer surprises than those published in previous updates and are an invaluable tool, but Honohan explains why PPPs should be used with caution and an understanding of their limitations. Apart from removing distortions caused by market exchange rate movements, PPPs remove the impact of other factors affecting relative prices, especially productivity differences, which Honohan argues should not be removed if one wishes to compare the overall economic size or strength of a country or region. Adjusting for productivity, he finds that the United States retains its position as the world’s largest economy for the time being, and the European Union (even without the United Kingdom) is just ahead of China.
    Date: 2020–12
  9. By: Enrico Mallucci
    Abstract: Unexpected shocks may tip countries with elevated fiscal vulnerabilities into default. The literature has emphasized the role of macroeconomic and financial shocks, such as a decline of commodity prices (Reinhart et al., 2016) or banking crises (Baltenau and Erce, 2018) in shaping sovereign risk.
    Date: 2020–12–18
  10. By: Marija Beg (Faculty of Economics & Business, University of Zagreb); Martina Basarac Serti? (Croatian Academy of Sciences and Arts)
    Abstract: Croatia is the EU member specific by the highest share of tourism in GDP, making one-fifth of it. As tourism is prone to various external factors that are out of state control (clearly visible in the current coronavirus pandemic), along with its growing share in Croatia, the question of Dutch disease arises. The Dutch disease phenomenon refers to the state where one booming sector (e.g. natural resources, which are impersonated by tourism in this case) causes adverse effects on other sectors (e.g. manufacturing sector, industry) which finally leads to the decline in the economy's international competitiveness and deindustrialization. A core model of Dutch disease explains that a large inflow of foreign money will appreciate real exchange rate and cause both the spending and reallocation of resources between non-tradable and tradable sectors thus causing deindustrialization. The aim of this paper is to investigate whether the increasing tourism sector in Croatia has caused resource movement from other sectors towards the tourism sector which would confirm the presence of Dutch disease. Based on Croatian data in period 1995-2019 we conclude that (i) Croatia is highly specialized in tourism with (ii) tourism being a more important growth factor than industry and (iii) a highly important export category; also, (iv) there is a positive relationship between the tourism revenues growth and a number of employees in the tradable sector, and negative between the tourism revenues growth and a number of employees in the non-tradable sector; finally (v) the growth of tourism revenues did not lead to an appreciation of the real effective exchange rate. We conclude that Croatia is not sick with the Dutch disease but if the rapid growth of the tourism sector in Croatia continues, there could be negative effects of the Dutch disease in the future.
    Keywords: Dutch disease, Tourism, Exchange rate, Croatia
    JEL: F31 L83 P28
  11. By: Joanna Wolszczak-Derlacz (Gdansk University of Technology, Gdansk, Poland)
    Abstract: This study examines the potential effects of China’s “One-Belt One-Road” initiative (OBOR) on trade flows and global value chain connections. The empirical analysis is based on the augmented gravity model of international trade, which comprises 186 reporters and 199 partners in the period 2000-2018. We also estimate the gravity model for involvement in global value chains (domestic and foreign value added in exports and the value contributed by a partner to a reporter’s exports). OBOR proves to be positively correlated with international trade and global value chains (GVC), while some of the corridors seem to be more beneficial than others (e.g. China-Pakistan, China-Mongolia-Russian Federation, and Bangladesh-China-India-Myanmar).
    Keywords: One-belt one-road, China, gravity trade models, global value chains
    JEL: F13 F14 C23
    Date: 2020–12

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