nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒03‒01
ten papers chosen by
Martin Berka
Massey University

  1. World interest rates and macroeconomic adjustments in developing commodity producing countries By Vincent Bodart; François Courtoy; Erica Perego
  2. Optimal Bailouts in Banking and Sovereign Crises By Sewon Hur; César Sosa-Padilla; Zeynep Yom
  3. Measuring the Cost of Living in Mexico and the US By David Argente; Chang-Tai Hsieh; Munseob Lee
  4. Default Costs and Self-fulfilling Fiscal Limits in a Small Open Economy By Sergey Pekarski; Anna Sokolova
  5. A Prudential trade-off? Leakages and Interactions with Monetary Policy By Meunier Baptiste; Pedrono Justine
  6. Globalization, Trade Imbalances and Labor Market Adjustment By ; ; Ricardo M. Reyes-Heroles; Sharon Traiberman
  7. Information in the First Globalization: News Agencies and Trade By Pierre Cotterlaz; Etienne Fize
  8. Bought, Sold and Bought Again: The Impact of Complex Value Chains on Export Elasticities By ; ; Francois de Soyres; Elena Pavlova
  9. Shifts in the portfolio holdings of euro area investors in the midst of COVID-19: looking-through investment funds By Carvalho, Daniel; Schmitz, Martin
  10. Understanding the gains from wage flexibility in a currency union: the fiscal policy connection By Eiji Okano

  1. By: Vincent Bodart (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); François Courtoy (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Erica Perego (CEPII, Paris, France)
    Abstract: With commodities becoming international financial securities, commodity prices are affected by the international financial cycle. With this evidence in mind, this paper reconsiders the macroeconomic adjustment of developing commodity-exporting countries to changes in world interest rates. We proceed by building a model of a small open economy that produces a non-tradable good and a storable tradable commodity. The difference with standard models of small open economies lies in the endogenous response of commodity prices which -due to commodity storage- adjust to variations in international interest rates. We find that the endogenous response of commodity prices amplifies the reaction of commodity exporting countries to international monetary shocks. This suggests that commodity exporting countries are more vulnerable to unfavourable international monetary disturbances than other small open economies. In particular, through the commodity price channel, even those small open commodity-exporting economies that are disconnected from international financial markets can be affected by the international financial cycle.
    Keywords: Storable commodity, International financial shock, Developing economies
    JEL: E32 F41 G15 Q02
    Date: 2021–01–23
  2. By: Sewon Hur; César Sosa-Padilla; Zeynep Yom
    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: 2021–01–29
  3. By: David Argente (Pennsylvania State University - Department of Economics); Chang-Tai Hsieh (University of Chicago - Booth School of Business; University of California, Berkeley - Department of Economics; NBER); Munseob Lee (University of California, San Diego - School of Global Policy and Strategy)
    Abstract: Cross-country price indexes are crucial to compare living standards between countries and to measure global inequality. An accurate measurement of these price indexes has proven to be a difficult task because of the lack of accurate data on the consumption patterns of different countries. In this paper, we construct a unique data on prices and quantities for consumer packaged goods matched at the barcode-level across two countries, United States and Mexico. We estimate that the Mexican real consumption relative to the United States is larger than previously estimated. We identify heterogeneity in shopping behavior, quality of products, and variety availability as important sources of bias in international price comparisons.
    Keywords: Price index, purchasing power parity, international price comparison
    JEL: E01 E31 O47
    Date: 2020
  4. By: Sergey Pekarski (National Research University Higher School of Economics); Anna Sokolova (National Research University Higher School of Economics)
    Abstract: We revisit the link between the risk of sovereign default and default costs. Contrary to prior literature, we show that higher costs of default may result in higher default probabilities, lower bond prices, and fiscal limits that are not pinned down by economic fundamentals. Government debt sustainability depends on private investment behavior, which is affected by expectations about defaults and capital returns. We argue that this feedback loop gives rise to multiple equilibria. In `bad' equilibria, investors expect default and low capital returns; their low capital investment tightens the governments' fiscal constraints and reduces the probability of debt repayment, validating investor pessimism. In `good' equilibria, optimistic investors choose higher capital investment; this results in higher future fiscal surpluses, raises the probability of debt repayment and validates investor optimism.
    Keywords: sovereign default, default costs, fiscal limit, multiple equilibria
    JEL: E62 H30 H60
    Date: 2021
  5. By: Meunier Baptiste; Pedrono Justine
    Abstract: While monetary and prudential policies are generally analysed separately, this paper focuses on how the two interact. Taking an international perspective, we show that monetary policy in a centre economy (Euro Area) spill over its borders through bank lending – therefore inducing volatility in cross-border lending flows. Investigating a sample of 30 advanced and emerging economies, we find evidence that prudential policy in the receiving-country interact with monetary policy so that a tighter prudential stance in the recipient-country mitigates the volatility of banking flows induced by monetary policy abroad. But we also show that a tighter prudential stance – interactions apart – implies a higher growth of cross-border lending. Taken together, these results might suggest a trade-off: while a tighter prudential stance reduces the volatility of cross-border lending flows, it also implies that local borrowers resort more to lending from abroad. Taking advantage of the granularity of our confidential dataset, we finally explore heterogeneities and show that such leakages arise only for financially more open economies and only through the financial sector, with evidence that such leakages are driven by intra-group lending.ion-JEL: O31, L11, L51, J8, L25
    Keywords: Monetary Policy, Prudential Policy, Policy Interactions, Spillovers, Prudential Leakages, Internation Banking.
    JEL: E52 F34 F36 F42 G18 G21
    Date: 2021
  6. By: ; ; Ricardo M. Reyes-Heroles; Sharon Traiberman
    Abstract: We study the role of global trade imbalances in shaping the adjustment dynamics in response to trade shocks. We build and estimate a general equilibrium, multi-country, multi-sector model of trade with two key ingredients: (a) Consumption-saving decisions in each country commanded by representative households, leading to endogenous trade imbalances; (b) labor market frictions across and within sectors, leading to unemployment dynamics and sluggish transitions to shocks. We use the estimated model to study the behavior of labor markets in response to globalization shocks, including shocks to technology, trade costs, and inter-temporal preferences (savings gluts). We find that modeling trade imbalances changes both qualitatively and quantitatively the short- and long-run implications of globalization shocks for labor reallocation and unemployment dynamics. In a series of empirical applications, we study the labor market effects of shocks accrued to the global economy, their implications for the gains from trade, and we revisit the "China Shock" through the lens of our model. We show that the US enjoys a 2.2 percent gain in response to globalization shocks. These gains would have been 73 percent larger in the absence of the global savings glut, but they would have been 40 percent smaller in a balanced-trade world.
    Keywords: Globalization; Labor markets; Trade imbalances
    JEL: F10 F16
    Date: 2021–02–10
  7. By: Pierre Cotterlaz; Etienne Fize
    Abstract: This paper documents the effect of information frictions on trade using a historical large-scale improvement in the transmission of news: the emergence of global news agencies. The information available to potential traders became more abundant, was delivered faster and at a cheaper price between countries covered by a news agency. Exploiting differences in the timing of telegraph openings and news agency coverage across pairs of countries, we are able to disentangle the pure effect of information from the effect of a reduction in communication costs. Panel gravity estimates reveal that bilateral trade increased by 30\% more for pairs of countries covered by a news agency and connected by a telegraph than for pairs of countries simply connected by a telegraph.
    Keywords: Information;International Trade;Economic History;News Agency;First Globalization
    JEL: N70 F14 F15 F10
    Date: 2021–02
  8. By: ; ; Francois de Soyres; Elena Pavlova
    Abstract: Global value chain (GVC) participation affects the relationship between trade volumes and exchange rate movements. Guided by a simple theory, we show that exports react to the exchange rate between the country producing value added contained in exports and the country of final absorption for this value added. Three predictions follow: (i) a higher share of foreign value added in exports reduce the responsiveness of export volumes to exchange rate changes, (ii) a greater share of exports that returns as imports also reduce the responsiveness of export volumes and (iii) a higher share of inputs that are further reexported increase the responsiveness of exports to the trading partner's nominal effective exchange rate. Using a large origin-sector-destination level panel data set covering the period 1995-2009 and around 85% of world GDP, we find strong empirical support for these predictions. We further show that some sectors in some countries can experience a decline in gross exports when their currency depreciates.
    Keywords: Currency unions; Export elasticities; Exchange rate passthrough; Global value chains
    JEL: F14 F40
    Date: 2021–02–04
  9. By: Carvalho, Daniel; Schmitz, Martin
    Abstract: We study the impact of the COVID-19 shock on the portfolio exposures of euro area investors. The analysis “looks-through” holdings of investment fund shares to first gauge euro area investors' full exposures to global debt securities and listed shares by sector at end-2019 and to subsequently analyse the portfolio shifts in the first and second quarters of 2020. We show important heterogeneous patterns across asset classes and sectors, but also across euro area less and more vulnerable countries. In particular, we find a broad-based rebalancing towards domestic sovereign debt at the expense of extra-euro area sovereigns, consistent with heightened home bias. These patterns were strongly driven by indirect holdings – via investment funds – especially for insurance companies and pension funds, but levelled off in the second quarter. On the contrary, for listed shares we find that euro area investors rebalanced away from domestic towards extra-euro area securities in both the first and the second quarter, which may be associated with better relative foreign stock market performance. Many of these shifts were only due to indirect holdings, corroborating the importance of investment funds in assessing investors' exposures via securities, in particular in times of large shocks. We also confirm the important intermediation role played by investment funds in an analysis focusing on the large-scale portfolio rebalancing observed between 2015 and 2017 during the ECB's Asset Purchase Programme. JEL Classification: F30, F41, G15
    Keywords: bilateral portfolio holdings, COVID-19, cross-border investment, investment funds, sovereign debt
    Date: 2021–02
  10. By: Eiji Okano (Birkbeck, University of London)
    Abstract: I investigate two findings in Gali and Monacelli (2016, American Economic Review) which are (i) the effectiveness of labor cost adjustments on employment is much smaller in a currency union and (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union. First, I introduce a distorted steady state in the small open economy model of GM, in which employment subsidies to make the steady state efficient are not available, and replicate their two findings. Second, I introduce an endogenous fiscal policy rule similar to the Bohn rule with a government budget constraint into the model. The results suggest that while the first finding of Gali and Monacelli is still applicable, their second finding is not necessarily applicable. It is, therefore, possible that an increase in wage flexibility reduces welfare loss in an economy that is part of a currency union as long as wage rigidity is high enough. Thus, there is still scope to discuss how wage flexibility is beneficial in a currency union.
    Keywords: Sticky Wages, Nominal Rigidities, New Keynesian Models, Monetary and Fiscal Policy, Exchange Rate Policy, Currency Union, Fiscal Theory of the Price Level, Bohn Rule
    JEL: E32 E52 E60 F41 F47
    Date: 2020–11

This nep-opm issue is ©2021 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.