nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒05‒10
fifteen papers chosen by
Martin Berka
University of Auckland

  1. A Reconsideration of the Failure of Uncovered Interest Parity for the U.S. Dollar By Engel, Charles M; Kazakova, Ekaterina; Wang, Mengqi; Xiang, Nan
  2. Exchange Rate Fluctuations and Firm Leverage By Kalemli-Ozcan, Sebnem; Liu, Xiaoxi; Shim, Ilhyock
  3. Forecasting the U.S. Dollar in the 21st Century By Engel, Charles M; Wu, Steve Pak Yeung
  4. Government Policies in a Granular Global Economy By Gaubert, Cécile; Itskhoki, Oleg; Vogler, Maximilian
  5. Country Risk By Tarek A. Hassan; Jesse Schreger; Markus Schwedeler; Ahmed Tahoun
  6. Liquidity Traps in a World Economy By Kollmann, Robert
  7. Portfolio rebalancing in times of stress By Fischer, Andreas M; Greminger, Rafael P.; Grisse, Christian; Kaufmann, Sylvia
  8. Capital Flows at Risk: Taming the Ebbs and Flows By Gelos, Gaston; Gornicka, Lucyna; Koepke, Robin; Sahay, Ratna; Sgherri, Silvia
  9. One Ring to Rule Them All? New Evidence on World Cycles By Monnet, Eric; Puy, Damien
  10. Does the interest parity puzzle hold for Central and Eastern European economies? By Dąbrowski, Marek A.; Janus, Jakub
  11. Global Value Chains By Antràs, Pol; CHOR, HAN PING DAVIN
  12. Trade Imbalances and the Rise of Protectionism By Delpeuch, Samuel; Fize, Etienne; Martin, Philippe
  13. The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models: A Reassessment By Kamalyan, Hayk
  14. The interdependencies between the private and public sectors in open economies By Andersen, Torben M; Sørensen, Allan
  15. The Exchange Rate Insulation Puzzle By Corsetti, Giancarlo; Kuester, Keith; Müller, Gernot; Schmidt, Sebastian

  1. By: Engel, Charles M; Kazakova, Ekaterina; Wang, Mengqi; Xiang, Nan
    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 â?? 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. We address the problems of parameter instability and small-sample bias that plague the conventional Fama (1984) test, while acknowledging these concerns might remain even in our new findings.
    Keywords: Fama regression; foreign exchange risk premium; interest parity
    JEL: F30 F31 G15
    Date: 2021–03
  2. By: Kalemli-Ozcan, Sebnem; Liu, Xiaoxi; Shim, Ilhyock
    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: 2021–03
  3. By: Engel, Charles M; Wu, Steve Pak Yeung
    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.
    Keywords: forecasting exchange rates
    JEL: C53 F30 F31 G15
    Date: 2021–03
  4. By: Gaubert, Cécile; Itskhoki, Oleg; Vogler, Maximilian
    Abstract: We use the granular model of international trade developed in Gaubert and Itskhoki (2021) to study the rationale and implications of three types of government interventions typically targeted at large individual firms - antitrust, trade and industrial policies. We find that in antitrust regulation, governments face an incentive to be overly lenient in accepting mergers of large domestic firms, which acts akin to beggar-thy-neighbor trade policy in sectors with strong comparative advantage. In trade policy, targeting large individual foreign exporters rather than entire sectors is desirable from the point of view of a national government. Doing so minimizes the pass-through of import tariffs into domestic consumer prices, placing a greater portion of the burden on foreign producers. Finally, we show that subsidizing `national champions' is generally suboptimal in closed economies as it leads to an excessive build-up of market power, but it may become unilaterally welfare improving in open economies. We contrast unilaterally optimal policies with the coordinated global optimal policy and emphasize the need for international policy cooperation in these domains.
    Keywords: Antitrust; granular comparative advantage; import tariff; industrial policy
    JEL: F12 F13 L13 L40 L52
    Date: 2021–03
  5. By: Tarek A. Hassan (Boston University); Jesse Schreger (Columbia University); Markus Schwedeler (Boston University); Ahmed Tahoun (London Business School)
    Abstract: We construct new measures of country risk and sentiment as perceived by global investors and executives using textual analysis of the quarterly earnings calls of publicly listed firms around the world. Our quarterly measures cover 45 countries from 2002-2020. We use our measures to provide a novel characterization of country risk and to provide a harmonized definition of crises. We demonstrate that elevated perceptions of a country's riskiness are associated with significant falls in local asset prices and capital outflows, even after global financial conditions are controlled for. Increases in country risk are associated with reductions in firm-level investment and employment. We also show direct evidence of a novel type of contagion, where foreign risk is transmitted across borders through firm-level exposures. Exposed firms suffer falling market valuations and significantly retrench their hiring and investment in response to crises abroad. Finally, we provide direct evidence that heterogeneous currency loadings on global risk help explain the cross-country pattern of interest rates and currency risk premia.
    Keywords: country risk, contagion, investment, employment, textual analysis, earnings calls
    JEL: D21 F23 F30 G15
    Date: 2021–03–31
  6. By: Kollmann, Robert
    Abstract: This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These "expectations-driven" liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a "fundamentals-driven" liquidity trap.
    Keywords: domestic and international shock transmission; Exchange rate; expectations-driven and fundamentals-driven liquidity traps; Net exports; terms of trade; zero lower bound
    JEL: E3 E4 F2 F3 F4
    Date: 2021–01
  7. By: Fischer, Andreas M; Greminger, Rafael P.; Grisse, Christian; Kaufmann, Sylvia
    Abstract: This paper investigates time variation in the dynamics of international portfolio equity flows. We extend the empirical model of Hau and Rey (2004) by embedding a Markov regime-switching model into the structural VAR. The model is estimated using monthly data from 1995 to 2018, on equity returns, exchange rate returns, and equity flows between the United States and advanced and emerging market economies. We find that the data favor a two-state model where coefficients and shock volatilities switch jointly. In the VAR for flows between the United States and emerging market economies, the estimated states match periods of low and high financial stress, both in terms of the timing of regime switching and in terms of their volatility characteristics. Our main result is that for equity flows between the United States and emerging markets rebalancing dynamics differ between episodes of high and low levels of financial stress. A switch from the low- to the high-stress regime is associated with capital outflows from emerging markets. Once in the high-stress regime, the response of capital flows to exchange rates and stock prices is smaller than in normal (low-stress) periods.
    Keywords: Equity Flows; Exchange Rates; financial stress; Portfolio rebalancing; regime switching; sign restrictions; structural VAR
    JEL: F30 G11 G15
    Date: 2021–02
  8. By: Gelos, Gaston; Gornicka, Lucyna; Koepke, Robin; Sahay, Ratna; Sgherri, Silvia
    Abstract: The volatility of capital flows to emerging markets continues to pose challenges to policymakers. In this paper, we propose a new quantile regression framework to predict the entire future probability distribution of capital flows to emerging markets, based on changes in global financial conditions, domestic structural characteristics, and policies. The approach allows us to differentiate between short- and medium-term effects. We find that FX- and macroprudential interventions are effective in mitigating downside risks to portfolio flows stemming from adverse global shocks, while tightening of capital controls in response appears to be counterproductive. Good institutional frameworks are not able to shield countries from the increased volatility of portfolio flows in the immediate aftermath of global shocks. However, they do contribute to a more rapid bounce-back of foreign flows over the medium term.
    Keywords: capital controls; Capital Flows; emerging markets; foreign-exchange intervention; macroprudential policies
    JEL: E52 F32 F38 G28
    Date: 2021–02
  9. By: Monnet, Eric; Puy, Damien
    Abstract: We estimate world cycles using a new quarterly macro-financial dataset assembled using IMF archives, covering a large set of countries since 1950. World cycles, real and financial, exist and US shocks drive them. But their strength is modest for GDP and credit. Global financial cycles are much weaker for credit than for asset prices. We also challenge the view that synchronization has increased with globalization. Although this is true for prices (goods and assets), it is not for quantities (output and credit). World business and credit cycles were as strong during Bretton Woods (1950-1972) as during the Globalization period (1982-2006). We investigate the economic and financial forces driving our results, connect them to the existing literature and discuss important policy implications.
    Keywords: business cycles; financial cycles; Financial Integration; Globalization; trade integration; US Monetary Policy; World Cycles
    JEL: E32 F41 F42
    Date: 2021–03
  10. By: Dąbrowski, Marek A.; Janus, Jakub
    Abstract: This paper examines the uncovered interest parity (or forward premium) puzzle in four Central and Eastern European countries -- Czechia, Hungary, Poland, and Romania -- as well as their aggregates from 1999 to 2019. Because the interest parity is a foundation of open-macroeconomy analyses, with important implications for policymaking, especially central banking, more systematic evidence on interest parities in the CEE economies is needed. In this study, we not only address this need but also add to a broader discussion on the UIP puzzle after the global financial crisis. The UIP is verified vis-à-vis three major currencies: the euro, the U.S. dollar, and the Swiss franc. We start by providing a full set of baseline forward premium regressions for which we examine possible structural breaks and perform a decomposition of deviations from the UIP. Next, we explore augmented UIP models and introduce various factors which potentially account for the UIP puzzle, such as the realized volatility of the exchange rate, a volatility model of the excess returns, and international risk and business cycle measures. The study shows that the choice of the reference currency matters for the outcome of the interest parity tests in the CEE economies. The puzzle prevails for the EUR and the CHF but not for the USD, a regularity that has not been documented in previous studies. Second, we find that structural breaks in the time series used to test the UIP are not an essential reason for the general failure of the parity in the region. Third, we demonstrate that even though the risk-based measures largely improve the baseline testing regression, both from statistical and economic points of view, they do not alter the overall outcomes of our empirical models. Additionally, we show that the exchange rate peg of the Czech koruna to the euro from 2013 to 2017 had a significant impact on the UIP. A detailed case study on Poland, using granular survey data, indicates that the directly measured exchange rate expectations do not seem to be informed by the UIP relationship. Employing data on option-implied risk reversals, we reveal that the limited resilience of CEE economies to rare disasters may plausibly explain deviations from the UIP.
    Keywords: interest parity puzzle; forward premium puzzle; risk premium; Fama regression; Central and Eastern Europe
    JEL: F31 F41 G15
    Date: 2021–05–04
  11. By: Antràs, Pol; CHOR, HAN PING DAVIN
    Abstract: This paper surveys the recent body of work in economics on the importance of global value chains (GVCs) in shaping international trade flows and multinational activity. On the empirical front, we begin reviewing several variants of the "macro approach" to measuring the relevance of global production sharing in the world economy, and we also offer a critical evaluation of the country- and industry-level datasets (or World Input Output Tables) that have been used to date. We next discuss the advantages and disadvantages of a burgeoning alternative "micro approach" that has instead employed firm-level datasets to document the ways in which firms have sliced up their value chains across countries. On the theoretical front, we propose an analogous dissection of the literature. First, we review a vast body of work developing country- and industry-level quantitative frameworks that are easily calibrated with World Input Output Tables, and that open the door for counterfactual exercises with minimal demands on estimation. Second, we overview micro-level frameworks that have treated firms rather than countries or industries as the relevant unit of analysis, and that have unveiled a number of distinctive mechanisms by which GVCs shape the determinants and consequences of international trade flows in ways distinct from traditional models of international trade. We close this survey with a discussion of a still infant literature on the desirability and effects of trade policy in a world of GVCs.
    JEL: F1 F2 F4 F6
    Date: 2021–03
  12. By: Delpeuch, Samuel; Fize, Etienne; Martin, Philippe
    Abstract: We investigate the role of trade imbalances in the rise of protectionism in the past 10 years. Bilateral as well as multilateral trade imbalances are robust predictors of protectionist attacks. This result is partly but not entirely driven by the US and the Trump years. We also find that countries that experience a bilateral real exchange rate appreciation launch more protectionist attacks. The role of trade imbalances in the rise of protectionism is confirmed when we use fiscal policies as instrumental variables for trade imbalances. Countries with more expansionary fiscal policies react to the ensuing trade imbalance by a more protectionist trade policy. The role of trade imbalances in the rise of protectionism is quantitatively important: in the G20, a one standard deviation increase in the bilateral and multilateral trade deficits of a country leads respectively to a 7% and 17% rise of protectionist attacks by this country.
    Keywords: protectionism; trade imbalances
    JEL: F13 F14 F41
    Date: 2021–01
  13. By: Kamalyan, Hayk
    Abstract: In ``The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models'' published in the American Economic Review, Steinsson (2008) argues that a baseline open economy sticky price model with real shocks can rationalize the real exchange rate persistence and hump-shaped dynamics observed in data. The current paper shows that i) the dynamics of the real exchange rate depend upon the parameter values of the Taylor rule, ii) the model cannot simultaneously match the observed dynamics of the real exchange rate and the close co-movement between the real and nominal currency returns. Thus, the baseline framework is not capable of fully capturing the real exchange rate adjustment process.
    Keywords: Real exchange rate adjustment, Nominal-real exchange rate co-movement, New Keynesian model, Monetary policy rule
    JEL: E52 E58 F31 F41
    Date: 2020–11–04
  14. By: Andersen, Torben M; Sørensen, Allan
    Abstract: Empirical evidence shows that countries with larger public sectors also have larger trade shares, also for the manufacturing sector, and a larger share of firms that export. We reconcile these links between the public and private sector in an analytically tractable general equilibrium model. We derive two-way causal relations between size (and composition) of the public sector and openness and industry structure of the private sector. First, an increase in public sector size or a shift in public expenditures toward public employment (away from transfers) increases openness of the private sector (trade share and fraction of firms exporting), and is also associated with higher average productivity, lower average unit labour costs, and improved wage competitiveness and terms of trade. These outcomes are driven by endogenous entry and selection of firms. A quantitative exercise reveals substantial quantitative differences in the effects from public sector reforms between the open and closed economy. Second, international spillovers imply that non-cooperative policies have an upward bias in the overall size of the public sector, but a downward bias in transfers as a share of public expenditures. Trade liberalization and the degree of firm heterogeneity magnify these biases and thereby shape the size and composition of the public sector.
    Keywords: biases in fiscal policies; composition of public expenditures; Globalization; Heterogeneous Firms; Labour taxation; selection; size of public sector
    JEL: F15 F4 H20 H40
    Date: 2021–02
  15. By: Corsetti, Giancarlo; Kuester, Keith; Müller, Gernot; Schmidt, Sebastian
    Abstract: The notion that flexible exchange rates insulate a country from foreign shocks is well grounded in theory, from the classics (Meade, 1951; Friedman 1953), to the more recent open economy literature (Obstfeld and Rogoff, 2000). We confront it with new evidence from Europe. Specifically, we study how shocks that originate in the euro area spill over to its neighboring countries. We exploit the variation of the exchange rate regime across time and countries to assess whether the regime alters the spillovers: it does not---flexible exchange rates fail to provide insulation against euro area shocks. This result is robust across a number of specifications and holds up once we control for global financial conditions. We show that the workhorse open-economy model can account for the lack of insulation under a float, assuming that central banks respond to headline consumer price inflation. However, it remains puzzling that policy makers are ready to forego stabilization of economic activity to the extent we found in the data.
    Keywords: dominant currency pricing; effective lower bound; Exchange rate; external shock; Insulation; International spillovers; monetary policy
    JEL: E31 F41 F42
    Date: 2021–01

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