nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒03‒29
ten papers chosen by
Martin Berka
University of Auckland

  1. A Reconsideration of the Failure of Uncovered Interest Parity for the U.S. Dollar By Charles Engel; Ekaterina Kazakova; Mengqi Wang; Nan Xiang
  2. A Behavioral Explanation for the Puzzling Persistence of the Aggregate Real Exchange Rate By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  3. Exchange Rates and Prices: Evidence from the 2015 Swiss Franc Appreciation By Raphael Auer; Ariel Burstein; Sarah M. Lein
  4. Forecasting the U.S. Dollar in the 21st Century By Charles Engel; Steve Pak Yeung Wu
  5. Optimal Bailouts in Banking and Sovereign Crises By Sewon Hur; César Sosa-Padilla; Zeynep Yom
  6. International Debts Flows By Hung Ly-Dai; Hai Anh Bui Thi; Thanh Vo Tri
  7. Globalization, trade imbalances and labor market adjustment By Rafael Dix-Carneiro; Joao Paulo Pessoa; Ricardo Reyes-Heroles; Sharon Traiberman
  8. Real Exchange Rate and the Dynamics of Services Trade Balance in the UK: A Linear and Non-linear ARDL Analysis By Trofimov, Ivan D.
  9. Cross-Country Connectedness in Inflation and Unemployment: Measurement and Macroeconomic Consequences By Pham, Binh Thai; Sala, Hector
  10. Natural real rates of interest across Euro area countries: Are R-stars getting closer together? By Tomas Reichenbachas; Linas Jurkšas; Rokas Kaminskas

  1. By: Charles Engel; Ekaterina Kazakova; Mengqi Wang; Nan Xiang
    Abstract: We re-examine the time-series evidence for failures of uncovered interest rate parity on short-term deposits for the U.S. dollar versus major currencies of developed countries at short-, medium- and long-horizons. The evidence that interest rate differentials predict foreign exchange risk premiums is fragile. The relationship between interest rates and excess returns is not stable over time and disappears altogether when nominal interest rates are near the zero-lower bound. However, we do find evidence that year-on-year inflation rate differentials consistently predict excess returns – when the U.S. dollar y.o.y. inflation rate has been relatively high, subsequent returns on U.S. deposits tend to be high. We interpret this evidence as being consistent with hypotheses that posit that markets do not fully react initially to predictable changes in future monetary policy. Interestingly, the predictive power of relative y.o.y. inflation only begins in the mid-1980s when central banks began to target inflation more consistently and continues in the post-ZLB period when interest rates lose their primacy as a policy instrument. However, we caution not to rule out the possibility that excess returns are not predictable at all.
    JEL: F3 F41
    Date: 2021–01
  2. By: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
    Abstract: At the aggregate level, the evidence that deviations from purchasing power parity (PPP) are too persistent to be explained solely by nominal rigidities has long been a puzzle (Rogoff, 1996). Another puzzle from the micro price evidence of the law of one price (LOP), which is the basic building block of PPP, is that LOP deviations are less persistent than PPP deviations. To reconcile the empirical evidence, we adapt the model of behavioral inattention in Gabaix (2014, 2020) to a simple two-country sticky-price model. We propose a simple test of behavioral inattention and find strong evidence in its favor using micro price data from US and Canadian cities. Calibrating behavioral inattention with our estimates, we show that our model reconciles the two puzzles relating to the PPP and LOP. First, the PPP deviations are more than twice as persistent as PPP deviations explained only by sticky prices. Second, the LOP deviations decrease to less than two-thirds of the PPP deviations in the degree of persistence.
    Date: 2021–03
  3. By: Raphael Auer; Ariel Burstein; Sarah M. Lein
    Abstract: We dissect the impact of a large and sudden exchange rate appreciation on Swiss border import prices, retail prices, and consumer expenditures on domestic and imported non-durable goods, following the removal of the EUR/CHF floor in January 2015. Cross-sectional variation in border price changes by currency of invoicing carries over to consumer prices and allocations, impacting retail prices of imports and competing domestic goods, as well as import expenditures. We provide measures of the sensitivity of retail import prices to border prices and the sensitivity of import shares to relative prices, which is higher when using retail prices than border prices.
    JEL: F0
    Date: 2021–01
  4. By: Charles Engel; Steve Pak Yeung Wu
    Abstract: The level of the (log of) the exchange rate seems to have strong forecasting power for dollar exchange rates against major currencies post-2000 at medium- to long-run horizons of 12-, 36- and 60-months. We find that this is true using conventional asymptotic statistics correcting for serial correlation biases. But correcting for small-sample bias using simulation methods, we find little evidence to reject a random walk. This small sample bias arises because of near-spurious correlation when the predictor variable is persistent and the horizon for exchange rate forecasts is long. Similar problems of spurious correlation may arise when other persistent variables are used to forecast changes in the exchange rate. We find, in fact, using asymptotic statistics, the level of the exchange rate provides better forecasts than economic measures of “global risk”, and the measures of global risk do not improve the (possibly spurious) forecasting power of the level of the exchange rate.
    JEL: F31 F37 G15
    Date: 2021–02
  5. 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 bank- ing 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.
    JEL: E32 F34
    Date: 2021–01
  6. By: Hung Ly-Dai (Vietnam Institute of Economics, Hanoi, Vietnam); Hai Anh Bui Thi; Thanh Vo Tri
    Abstract: We characterize the determinants of the pattern of cross-border debts flows, using a cross-section regression over a sample of 149 economies over 1990-2019. The net debts inflows is associated with a higher sovereign debts rating, a lower fiscal balance or a higher productivity growth. Thus, the flows of debts are underlined by the store of wealth accumulation across economies. Moreover, in comparison with the prediction by the empirical model, the case studies uncover that Vietnam receives more net debts inflows while Thailand and Japan receives less net debts inflows.
    Keywords: Net Debts Inflows,Safe Assets,Productivity Growth
    Date: 2021–02
  7. By: Rafael Dix-Carneiro; Joao Paulo Pessoa; Ricardo 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% gain in response to globalization shocks. These gains would have been 73% larger in the absence of the global savings glut, but they would have been 40% smaller in a balanced-trade world.
    Keywords: global trade imbalances, labor market disruption
    JEL: F16
    Date: 2021–03
  8. By: Trofimov, Ivan D.
    Abstract: The study of the services trade balance dynamics following depreciation is a novel topic in international finance literature, with limited empirical research conducted (principally in the US context). This paper examines the relationship between the real exchange rate and the services trade balance in the UK using the quarterly data for the 2005Q1 - 2019Q4 period. We consider the aggregate as well as disaggregated trade across five services categories and employ linear and non-linear autoregressive distributed lag (ARDL) models. The findings indicate little evidence of a long-term improvement in the trade balance following depreciation, and suggest the absence of J-curve effect. The effects of domestic, ‘rest of the world’ GDP and monetary base on the trade balance were respectively negative, positive, and mixed.
    Keywords: J-curve; cointegration; ARDL; services
    JEL: C22 F14 F31
    Date: 2020–11–04
  9. By: Pham, Binh Thai (University of Economics Ho Chi Minh City); Sala, Hector (Universitat Autònoma de Barcelona)
    Abstract: We bring the notion of connectedness (Diebold and Yilmaz, 2012) to a set of two critical macroeconomic variables as inflation and unemployment. We focus on the G7 economies plus Spain, and use monthly data –high-frequency data in a macro setting– to explore the extent and consequences of total and directional volatility spillovers across variables and countries. We find that total connectedness is larger for prices (58.28%) than for unemployment (41.81%). We also identify asymmetries per country that result in higher short-run Phillips curve trade-offs in recessions and lower trade-offs in expansions. Besides, by exploring time-varying connectedness (resulting from country-specific shocks), we find that volatility spillovers magnify in periods of common economic turmoil such as the Global Financial Crisis. Our results call for an enhancement of international macroeconomic policy coordination.
    Keywords: country-specific shocks, connectedness, Philips curve, G7, common shocks
    JEL: C32 C50 E24 F41 F42
    Date: 2021–03
  10. By: Tomas Reichenbachas (Bank of Lithuania); Linas Jurkšas (Bank of Lithuania); Rokas Kaminskas (Bank of Lithuania)
    Abstract: Using two different methodologies, we estimate time-varying natural real rates of interest for a majority of euro area (EA) countries, including Lithuania. We find that natural real rates have been declining, particularly since 2008, albeit to different extent across EA countries. Lower rates could (at least partly) be explained by lower productivity and population growth. In line with previous literature, we find evidence of a substantial dispersion of the natural interest rate across EA economies. This became especially evident during the financial crisis of 2008-2009 and the sovereign debt crisis of 2010-2012, while estimates of natural rates tend to converge during "calm" periods. Estimates of natural rates for Lithuania were significantly above the estimates of core EA countries over 2002-2008, but this has changed after the crisis. From 2011 the estimates of natural rates for Lithuania tend to be close to the average for EA countries.
    Keywords: LEuro area, natural rate of interest, common monetary policy, fragmentation
    JEL: C32 E32 E43 E52
    Date: 2021–03–10

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