nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒03‒15
seven papers chosen by
Martin Berka
University of Auckland

  1. Exchange Rate Pass-Through, Monetary Policy, and Real Exchange Rates: Iceland and the 2008 Crisis By Sebastian Edwards; Luis Cabezas
  2. Repricing of risk and EME assets: the behaviour of Irish-domiciled funds during the COVID-19 crisis By Calo, Silvia; Emter, Lorenz; Galstyan, Vahagn
  3. Quantitative Easing in the US and Financial Cycles in Emerging Markets By Marcin Kolasa; Grzegorz Wesołowski
  4. Currency Depreciations in Emerging Economies: A Blessing or a Curse for External Debt Management? By Boris Fisera; Menbere Workie Tiruneh; David Hojdan
  5. Endogenous Immigration, Human and Physical Capital Formation, and the Immigration Surplus By Isaac Ehrlich; Yun Pei
  6. Manufacturing Risk-Free Government Debt By Zhengyang Jiang; Hanno Lustig; Stijn Van Nieuwerburgh; Mindy Z. Xiaolan
  7. Monetary Policy Pass-Through with Central Bank Digital Currency By Janet Hua; Yu Zhu

  1. By: Sebastian Edwards; Luis Cabezas
    Abstract: We use detailed data for Iceland to examine two often-neglected aspects of the “exchange rate pass-through” problem. First, we investigate whether the pass-through coefficient varies with the degree of “international tradability” of goods. Second, we analyze if the pass-through coefficient depends on the monetary policy framework. We consider 12 disaggregated price indexes in Iceland for 2003-2019, a period that includes Iceland’s banking and currency crisis of 2008. We find that the pass-through declined around the time Iceland reformed its “flexible inflation targeting,” and that the coefficients are significantly higher for tradable than for nontradable goods.
    JEL: E31 E52 E58 F31 F41
    Date: 2021–03
  2. By: Calo, Silvia (Central Bank of Ireland); Emter, Lorenz (Central Bank of Ireland); Galstyan, Vahagn (Central Bank of Ireland)
    Abstract: In 2020Q1, emerging market economies (EMEs) experienced significant outflows of portfolio investment capital. Irish-domiciled funds contributed to these portfolio outflows through sales of EME securities in response to heightened redemptions. Consistent with previous evidence around the sensitivity of Irish-resident fund flows to changes in global risk appetite, the retrenchment by Irish-domiciled funds in 2020Q1 was greater for debt, rather than equity, securities. Relative to their initial positions, the retrenchment was bigger for hedge funds, suggesting leverage may have acted as an amplifier of asset sales. Overall, though, Irish-domiciled funds also retrenched by less than might have been expected, given the historical relationship between measures of global risk aversion and fund flows to EMEs. In part, this may be due to the fact that, in the face of large redemptions, Irish funds also sold more liquid advanced economy securities. This points to potential common creditor effects acting as a transmission channel of shocks. The analysis also finds that EME countries with stronger fundamentals were somewhat cushioned from the retrenchment. Finally, valuation effects were strongest vis-à-vis EMEs with more flexible exchange rate regimes, suggesting a major role for currency depreciations in driving the observed reduction in positions.
    Date: 2020–10
  3. By: Marcin Kolasa; Grzegorz Wesołowski
    Abstract: Large international capital movements tend to be associated with strong fluctuations in asset prices and credit, contributing to domestic financial cycles and posing challenges for stabilization policies, especially in emerging market economies. In this paper we argue that these challenges are particularly severe if the global financial cycle is driven by quantitative easing (QE) in the US, and when the local banking sector has large holdings of government bonds, like in many Latin American countries. We first show empirically that a typical round of QE by the US Fed leads to a persistent expansion in credit to households and a significant loss of price competitiveness in this group of economies. We next develop a quantitative macroeconomic model of a small open economy with segmented asset markets and banks, which accounts for these observations. In this framework, foreign QE creates tensions between macroeconomic and financial stability as a contractionary impact of exchange rate appreciation is accompanied by booming credit and house prices. As a consequence, conventional monetary policy accommodation aimed at stabilizing output and inflation would further exacerbate domestic financial cycle. We show that an effective way of resolving this trade-off is to impose a time-varying tax on capital inflows. Combining foreign exchange interventions with tightening of local credit policies can also restore macroeconomic and financial stability, but at the expense of a large redistribution of wealth between borrowers and savers.
    Keywords: quantitative easing, global financial cycle, domestic credit, exchange rate interventions, capital controls, macroprudential policy
    JEL: E44 E58 F41 F42 F44
    Date: 2021–03
  4. By: Boris Fisera (Slovak Academy of Sciences; Charles University, Prague); Menbere Workie Tiruneh (Slovak Academy of Sciences; Webster Vienna Private University); David Hojdan (Webster Vienna Private University)
    Abstract: We investigate the long-term effect of domestic currency depreciation on the external debt for a panel of 41 emerging economies over the years 1999-2019. Using heterogenous panel cointegration methods, we find that domestic currency depreciation leads to an increase in external debt to GDP ratio over the long-term and it reduces the sustainability of external debt. This is particularly the case for larger depreciations, while smaller depreciations might reduce the external debt burden over the long-term for more developed emerging economies. Poorer emerging economies face a greater increase in external debt burden following domestic currency depreciation. We also find that higher exchange rate volatility and the use of floating exchange rates contributes to an increase in external debt burden over the long-term. Consequently, our results suggest that for emerging economies, having more volatile and floating exchange rates reduces the sustainability of external debt. We find asymmetrical effects of exchange rate depreciation on external debt: higher central bank independence limits the effect of currency depreciation on external debt, while higher financial development and illicit financial flows augment the effect of depreciation on external debt.
    Keywords: external debt, exchange rate, currency depreciation, exchange rate volatility, exchange rate regime, DFE estimator, PMG estimator
    JEL: E50 F31 F34
    Date: 2021–03
  5. By: Isaac Ehrlich; Yun Pei
    Abstract: We evaluate the economic consequences of immigration in a two-country, two-skill, overlapping-generations framework, where immigration, population, human and physical capital formation, and economic growth are endogenous variables. We go beyond extant literature by integrating physical capital in our model. This enables the derivation of new insights about the induced-immigration effects of exogenous triggers, including pull and push factors and policy variables, on the dynamic evolution of the “immigration surplus” in the short run versus the long run, in destination vs. source countries and in the global economy. The policy shifts we analyze include the easing of constraints on potential migrants’ labor and physical capital mobility, and the role of physical capital endowments. We also discuss the policy implications of asymmetries in the net benefits from immigration across destination and source countries.
    JEL: F22 F43 J11 J24 O15
    Date: 2021–02
  6. By: Zhengyang Jiang; Hanno Lustig; Stijn Van Nieuwerburgh; Mindy Z. Xiaolan
    Abstract: Governments face a trade-off between insuring bondholders and taxpayers. If the government fully insures bondholders by manufacturing risk-free zero-beta debt, then it cannot also insure taxpayers against permanent macroeconomic shocks over long horizons. Instead, taxpayers will pay more in taxes in bad times. Conversely, if the government fully insures taxpayers against adverse macro shocks, then the debt becomes risky, at least as risky as unlevered equity claim. As the world’s safe asset supplier, the U.S. appears to have escaped this trade-off thus far, whereas the U.K. has not.
    Keywords: fiscal policy, term structure, debt maturity, convenience yield
    JEL: E62 F34 G12
    Date: 2021
  7. By: Janet Hua; Yu Zhu
    Abstract: This paper investigates how the introduction of an interest-bearing central bank digital currency (CBDC) that serves as a perfect substitute for bank deposits as an electronic means of payment affects monetary policy pass-through. When the deposit market is not fully competitive, the CBDC tends to weaken the pass-through of the interest on reserves. The interest on CBDC impacts the deposit market more directly compared with the interest on reserves. The CBDC rate can also have stronger pass-through to the loan market; however, the effect can be dampened by the policy on the interest on reserves. Therefore, coordination between the two policy rates is needed to effectively achieve policy goals.
    Keywords: Digital currencies and fintech; Monetary policy transmission
    JEL: E52
    Date: 2021–03

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