nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒02‒22
thirteen papers chosen by
Martin Berka
University of Auckland

  1. The Role of Fiscal Policies for External Imbalances: Evidence from the European Union By António Afonso; José Carlos Coelho
  2. Optimal Bailouts in Banking and Sovereign Crises By Sewon Hur; César Sosa-Padilla; Zeynep Yom
  3. The Future of Healthcare around the World: Four indices integrating Technology, Productivity, Anti-Corruption, Healthcare and Market Financialization By Julia M. Puaschunder; Dirk Beerbaum
  4. External Vulnerabilities and Exchange Rate Pass-Through: The Case of Emerging Markets By Abdullah Kazdal; Muhammed Hasan Yilmaz
  5. Stress-testing net trading income: the case of European banks By Giglio, Carla; Shaw, Frances; Syrichas, Nicolas; Cappelletti, Giuseppe
  6. The evolution of debtor-creditor relationships within a monetary union: Trade imbalances, excess reserves and economic policy By Gräbner, Claudius; Heimberger, Philipp; Kapeller, Jakob; Landesmann, Michael; Schütz, Bernhard
  7. Asymmetric Information and Sovereign Debt: Theory Meets Mexican Data By Harold L. Cole; Daniel Neuhann; Guillermo Ordoñez
  8. Effective Exchange Rate Regimes and Inflation By Philipp Harms; Jakub Knaze
  9. 50 years of capital mobility in the Eurozone: breaking the Feldstein-Horioka Puzzle By Mariam Camarero; Alejandro Muñoz; Cecilio Tamarit
  10. Global Value Chains and the transmission of exchange rate shocks to consumer prices By Hadrien Camatte; Guillaume Daudin; Violaine Faubert; Antoine Lalliard; Christine Rifflart
  11. Peripherical Financialization and Premature Deindustrialization: A Theory and the Case of Brazil (2003-2015) By José Luis Oreiro; Carmem Aparecida Feijó; Lionelo Franco Punzo; João Pedro Heringer Machado
  12. Implications of the Slowdown in Trend Growth for Fiscal Policy in a Small Open Economy By Beames, Alexander; Kulish, Mariano; Yamout, Nadine
  13. Dominant Currency Dynamics: Evidence on Dollar-Invoicing from UK Exporters By Meredith Crowley; Lu Han; Minkyu Son

  1. By: António Afonso; José Carlos Coelho
    Abstract: We revisit the relation between budget deficits and current account deficits for 28 European Union countries from 1996 to 2019. We find that an increase in budget deficit of 1pp of GDP results in a deterioration of the current account deficit of 0.318 ppof GDP, which supports the Twin Deficits Hypothesis. On the other hand, dynamic panel estimates partially corroborate the Equivalence Ricardian Hypothesis in the presence of a fiscal rules index. In addition: i)the relation between the two deficits is asymmetric and the negative impact of the recent Eurozone banking and sovereign debt crisis on the current account balance is observed; ii) after 2010, the budget balance positively affectsthe current account balance;and iii) the positive impact of the budget balance on the current account balance is higherin the cases of non-Eurozone countries, high budget deficit countries,and low exports countries, whereas it is lower in the cases of Eurozone countries, low budget deficit countries, and high exports countries.
    Keywords: budget deficit; external deficit; European Union; fiscal rules; panel data
    JEL: F32 F41 H62 C33
    Date: 2021–02
  2. By: Sewon Hur (Federal Reserve Bank of Dallas); César Sosa-Padilla (University of Notre Dame and NBER); Zeynep Yom (Department of Economics, Villanova School of Business, Villanova University)
    Abstract: We study optimal bailout policies in the presence of banking and sovereign crises. First, we use European data to document that asset guarantees are the most prevalent way in which sovereigns intervene during banking crises. Then, we build a model of sovereign borrowing with limited commitment, where domestic banks hold government debt and also provide credit to the private sector. Shocks to bank capital can trigger banking crises, with government sometimes finding it optimal to extend guarantees over bank assets. This leads to a trade-off: Larger bailouts relax domestic financial frictions and increase output, but also imply increasing government fiscal needs and possible heightened default risk (i.e., they create a 'diabolic loop'). We find that the optimal bailouts exhibit clear properties. Other things equal, the fraction of banking losses that the bailouts would cover is: (i) decreasing in the level of government debt; (ii) increasing in aggregate productivity; and (iii) increasing in the severity of the banking crisis. Even though bailouts mitigate the adverse effects of banking crises, we find that the economy is ex ante better off without bailouts: the 'diabolic loop' they create is too costly.
    Keywords: Bailouts; Sovereign Defaults; Banking Crises; Conditional Transfers; Sovereign-bank diabolic loop
    JEL: E32 E62 F34 F41 G01 G15 H63
    Date: 2021–01
  3. By: Julia M. Puaschunder (The New School, USA); Dirk Beerbaum (Frankfurt School of Finance and Management, Frankfurt am Main)
    Abstract: The currently ongoing COVID-19 crisis has challenged healthcare around the world. The global solution against global pandemic spreads but also to provide essential healthcare is likely to feature components of technological advancement and economic productivity as a starting ground for vital solution finding. Anti-corruption is a necessary prerequisite for access to and quality of healthcare provision in the public sphere. Market innovation financialization of a society raises private sector funds for research and development but also funds the market-oriented implementation of healthcare, which appears beneficial and efficient in combating future healthcare crises. Technology-driven growth, corruption free-healthcare and well-funded markets fostering innovation account for the most prospective public and private sector remedies of the global COVID-19 crisis. These ingredients differ vastly around the world. This paper innovatively combines the mentioned facets in four indices. Highlighting international differences in economic starting positions as well as public and private sector healthcare provision potential around the world serves as indicator where in the world global pandemic medical solutions may thrive in the future. Reflecting the different pandemic crisis alleviation ingredients concurrently allows to capture unknown interaction effects. Pegging remedy credentials to certain regions of the world also holds invaluable insights on what territories of the world should take the lead in different sectors when bundling our common world efforts to overcome the COVID-19 pandemic together. Index 1 highlights the connectedness of Artificial Intelligence (AI) – as operationalized by internet connectivity – with economic productivity – measured in Gross Domestic Products (GDP) – around the world. Index 2 captures the degree of anti-corruption in its relation with a strong public healthcare sector over an entire world sample. Index 3 integrates internet connectivity with anti-corruption and promising healthcare internationally. Index 4 shows the impact of internet connectivity, GDP, anti-corruption, healthcare in light of market capitalization prospects with special attention to technological innovations in the digital age. In its entirety, the four indices highlight different facets of the future of medical care in order to bundle our common efforts strategically in overcoming COVID-19 and thriving in a healthier and more digitalized world to come.
    Keywords: Access to healthcare, Advancements, AI-GDP Index, Apps, Artificial Intelligence (AI), Coronavirus, Corruption-free maximization of excellence and precision, Corruption Perception
    Date: 2020–08
  4. By: Abdullah Kazdal; Muhammed Hasan Yilmaz
    Abstract: This study investigates the differentiation of exchange rate-inflation nexus in emerging markets (EM) in the context of external vulnerabilities for the period 2010-2018. In the empirical setting, EM countries are classified into two subgroups as “more vulnerable” and “less vulnerable” according to vulnerability indicators to identify how exchange rate pass-through (ERPT) dynamics change when the vulnerability is amplified by utilizing the interacted panel vector autoregression (IPVAR) model. Empirical results show that more resilient EM countries are experiencing a lower degree of ERPT during the sample period. Countries facing more prominent dollarization and current account deficit are subject to stronger ERPT, while higher inflation, higher risk premium and higher FX debt levels are associated with increasing ERPT as well. On the other hand, countries with higher reserve adequacy or higher foreign direct investment show lower ERPT compared to lower EM groups.
    Keywords: Exchange rate pass-through, External vulnerabilities, Interacted panel VAR model
    JEL: C23 E31 F31
    Date: 2021
  5. By: Giglio, Carla; Shaw, Frances; Syrichas, Nicolas; Cappelletti, Giuseppe
    Abstract: Net trading income is an important but volatile source of income for many euro area banks, highly sensitive to changes in financial market conditions. Using a representative sample of European banks, we study the distribution of net trading income (normalized by total assets) conditional to changes in key macro-financial risk factors. To map the linkages of net trading income with financial risk factors and capture non-linear effects, we implement a dynamic fixed effects quantile model using the method of moments approach. We use the model to empirically estimate and forecast the conditional net trading income distribution from which we quantify tail risk measures and expected losses across banks. We find a heterogeneous and asymmetric impact of the risk factors on the distribution of net trading income. Credit and interest rate spreads affect lower quantiles of the net trading income distribution while stock returns are an important determinant of the upper quantiles. We also find that the onset of the Covid-19 pandemic resulted in a significant increase in the 5th and 10th percentile expected capital shortfall. Moreover, adverse scenario forecasts show a wide dispersion of losses and a long-left tail is evident especially in the most severe scenarios. Our findings highlight strong inter-linkages between financial risk factors and trading income and suggest that this tractable methodology is ideal for use as an additional tool in stress test exercises. JEL Classification: C21, C23, G21, G28
    Keywords: capital shortfall, net trading income, quantile panel regression, stress testing
    Date: 2021–02
  6. By: Gräbner, Claudius; Heimberger, Philipp; Kapeller, Jakob; Landesmann, Michael; Schütz, Bernhard
    Abstract: This paper analyses the emergence of internal debtor-creditor relationships within a monetary union. Developing a stock- ow consistent model consisting of three regions - North, South, and the Rest of the World (RoW), where North and South form a monetary union - it shows how the simultaneous presence of investment booms, declining export performance and mercantilist policies within a monetary union can interact in order to create Minsky-type boom-bust cycles. Fiscal policy and an internal lender of last resort can help sustain economic life under existing structural imbalances, though without eliminating the root causes of boom-bust patterns.
    JEL: E12 F41 F45 G01 G18
    Date: 2021
  7. By: Harold L. Cole; Daniel Neuhann; Guillermo Ordoñez
    Abstract: Using a novel data set containing all bids by all bidders for Mexican government bonds from 2001 to 2017, we demonstrate that asymmetric information about default risk is a key determinant of primary market bond yields. Empirically, large bidders do not pay more for bonds than the average bidder but their bids are accepted more frequently. We construct a model where investors may differ in wealth, risk aversion, market power and information, and find that only heterogeneous information can qualitatively account for these patterns. Moreover, asymmetric information about rare disasters can quantitatively match key moments of bids and yields, both within and across periods.
    JEL: E5 E6 H63 O23
    Date: 2021–02
  8. By: Philipp Harms (Johannes Gutenberg University); Jakub Knaze (Johannes Gutenberg University)
    Abstract: This paper introduces a new effective exchange rate regime classification. Traditional classifications define the stability or flexibility of a currency with respect to one (“anchor”) currency, thus implicitly neglecting information on exchange rate relationships against other currencies. Our new measure is computed as a trade-weighted average of bilateral exchange rate regimes, thus taking into account both direct and indirect relationships against all other currencies. We argue that our “effective” approach is superior when it comes to assessing the impact of exchange rate regimes on inflation, because fixing an exchange rate vis-`a-vis one currency does not completely anchor domestic prices in a world with multiple trading partners. Using our measure of effective exchange rate regimes in a standard empirical analysis of inflation determinants, we find that – compared to freely floating regimes – not only hard pegs, but also narrow and wide soft pegs are associated with significantly lower inflation rates. This challenges the established view that soft pegs do not matter – or are even detrimental – for price stability. We find that the effect of fixing the exchange rate goes significantly beyond the “disciplining effect” on money growth, with the inflation reduction being at least as strong as the effect of an official inflation target.
    Keywords: Exchange rate regimes · Effective exchange rates · Inflation
    JEL: E31 E52 F41
    Date: 2021–01–29
  9. By: Mariam Camarero (University Jaume I and INTECO, Department of Economics, Campus de Riu Sec, E-12080 Castellón (Spain)); Alejandro Muñoz (University of València, Department of Applied Economics II, Av. dels Tarongers, s/n Eastern Department Building E-46022 Valencia, (Spain) de Marcenado, 27, 28015, Madrid (Spain)); Cecilio Tamarit (University of València and INTECO, Department of Applied Economics II, Av. dels Tarongers, s/n Eastern Department Building E-46022 Valencia, (Spain))
    Abstract: This paper assesses capital mobility for the Eurozone countries by studying the long-run relationship between domestic investment and savings for the period 1970-2019. Our main goal is to analyze the impact of economic events on capital mobility during this period. We apply the cointegration methodology in a setting that allows us to identify endogenous breaks in the long-run saving-investment relationship. Specifically, the breaks coincide with relevant economic events. We find a downward trend in the saving-investment retention since the 70s for the so-called “core countries”, whereas this trend is not so clear in the peripheral, where the financial and sovereign crises have had a more substantial impact. Our analysis captures other economic events: the Exchange Rate Mechanism (ERM) crisis, the German reunification, the European financial assistance program, and the post-crisis period. Our results also indicate that the original euro design had some caveats that remain unsolved.
    Keywords: Capital mobility; Feldstein-Horioka puzzle; Multiple Structural Breaks; Cointegration, unit roots
    JEL: F36 F45 O16
    Date: 2021–02
  10. By: Hadrien Camatte (Banque de France - Gaz de France Direction de la Recherche); Guillaume Daudin (LEDa - Laboratoire d'Economie de Dauphine - CNRS - Centre National de la Recherche Scientifique - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres); Violaine Faubert (Banque de France - Gaz de France Direction de la Recherche); Antoine Lalliard (Banque de France - Gaz de France Direction de la Recherche); Christine Rifflart (OFCE - Observatoire français des conjonctures économiques - Sciences Po - Sciences Po)
    Abstract: Following the 2008 financial crisis, inflation rates in advanced economies have been at odds with the prediction of a standard Phillips curve. This puzzle has triggered a debate on the global determinants of domestic prices. We contribute to this debate by investigating the impact of exchange rate shocks on consumer prices from 1995 to 2018. We focus on cost-push inflation through global value chains, using three sectoral world input-output datasets. Depending on countries, the absolute value of the elasticity of the household consumption expenditure (HCE hereafter) deflator to the exchange rate ranges from 0.05 to 0.35, confirming the importance of global value chains in channelling external shocks to domestic inflation. Using data from WIOD on a sample of 43 countries, we find that the mean output-weighted elasticity of the HCE deflator to the exchange rate increased in absolute value from 0.075 in 2000 to 0.094 in 2008. After peaking in 2008, it declined to 0.088 in 2014. World Input-Output tables (WIOT hereafter) are released with a lag of several years and the latest WIOT dates back to 2015. To fill this gap, we approximate the impact of an exchange rate shock on the HCE deflator from 2016 onwards using up-to -date GDP and trade data. Our extrapolations suggest that the decline in the elasticity of the HCE deflator continued until 2016, before reversing in 2017 and 2018. Our findings are robust to using three different datasets.
    Keywords: Inflation,global value chains,Phillips curve,input output tables,international trade,pass through
    Date: 2021–02–08
  11. By: José Luis Oreiro (None); Carmem Aparecida Feijó; Lionelo Franco Punzo; João Pedro Heringer Machado
    Abstract: The main objective of this paper is to discuss the concept of financialization in developing economies, arguing that the broad definition of financialization - understood as a growing role of motivations, markets and financial institutions in the operation of domestic and international economies – does not take into consideration important features of those economies, such as the hierarchy of currencies and the subordination to the principles of the so-called Washington Consensus. The latter imposed the adoption of a foreign savings-driven growth model, which mostly applied to Latin American countries. Hence, the financialization process in LDCs will be denominated peripherical financialization, since it is associated with dependence upon capital inflows from developed countries and with the reduction in the autonomy of their macroeconomic policies, even within flexible exchange rate regimes. Attraction of capital inflows to countries with a subordinate position in international financial markets, requires high interest rate differentials which have as side effect a trend to the overvaluation of real exchange rates. This creates a trap, high interest rates with an associated overvalued exchange rate. This trap reduces policy space, turning procyclical even fiscal policy. Moreover, the overvaluation of real exchange rate reduces price competitiveness of the manufacturing industry, becoming the main drive toward these countries’ premature deindustrialization. It will be shown that the macroeconomic performance of the Brazilian economy in the period 2003-2015 fits almost perfectly this model of peripherical financialization.
    Keywords: Financialization, Premature Deindustrialization, high interest rate-overvalued exchange rate trap
    JEL: O11 O14 O16
    Date: 2021–02
  12. By: Beames, Alexander; Kulish, Mariano; Yamout, Nadine
    Abstract: We set up and estimate a small open economy model with fi scal policy in which trend growth can permanently change. The magnitude and timing of the change in trend growth are estimated alongside the structural and fiscal policy rule parameters. Around 2003:Q3, trend growth in per capita output is estimated to have fallen from just over 2 per cent to 0.6 per cent annually. The slowdown brings about a lasting transition which in the short-run decreases consumption tax revenues but increases them in the long-run changing permanently the composition of tax revenues and temporarily increasing the government debt-to-output ratio..
    Keywords: Open economy, trend growth, scal policy, real business cycles, estimation, structural breaks
    Date: 2020–05
  13. By: Meredith Crowley; Lu Han; Minkyu Son
    Abstract: How do the choices of individual firms contribute to the dominance of a currency in global trade? Using export transactions data from the UK over 2010-2016, we document strong evidence of two mechanisms that promote theuse of a dominant currency: (1) prior experience: the probability that a firm invoices its exports to a new market in a dominant currency is increasing in the number of years the firm has used the dominant currency in its existing markets; (2) strategic complementarity: a firm is more likely to invoice its exports in the currency chosen by the majority of its competitors in a foreign destination market in order to stabilize its residual demand in that market. We show that the introduction of a managerial fixed cost of currency management into a model of invoicing currency choice yields dynamic paths of currency choice that match our empirical findings.
    Keywords: Exchange rate, invoicing currency, firm-level trade, vehicle currency
    JEL: F14 F31 F41
    Date: 2021–01

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