nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒06‒21
fifteen papers chosen by
Martin Berka
University of Auckland

  1. The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis By Gourinchas, Pierre-Olivier; Martin, Philippe; Messer, Todd
  2. International Portfolio Choice with Frictions: Evidence from Mutual Funds By Bacchetta, Philippe; Tièche, Simon; van Wincoop, Eric
  3. Uncovered Interest Parity, Forward Guidance and the Exchange Rate By Galí, Jordi
  4. Global Banks and Systemic Debt Crises By Juan M. Morelli; Pablo Ottonello; Diego J. Perez
  5. The Relationship between Debt and Output By Yun Jung Kim; Jing Zhang
  6. One Money, Many Markets: Monetary Transmission and Housing Financing in the Euro Area By Corsetti, Giancarlo; Duarte, Joao; Mann, Samuel
  7. Hysteresis and full employment in a small open economy By Timothy Watson; Juha Tervala
  8. Demographics and the Evolution of Global Imbalances By Michael Sposi
  9. Public Capital and Fiscal Constraint in Sovereign Debt Crises By Tamon Asonuma; Hyungseok Joo
  10. Covid 19: a new challenge for the EMU By Delatte, Anne-Laure; Guillaume, Alexis
  11. Supply of Sovereign Safe Assets and Global Interest Rates By Thiago Revil T. Ferreira; Samer Shousha
  12. Debt Crises, Fast and Slow By Corsetti, Giancarlo; Maeng, Seung Hyun
  13. The Global Transmission of Real Economic Uncertainty By Juan M. Londono; Sai Ma; Beth Anne Wilson
  14. A behavioral explanation for the puzzling persistence of the aggregate real exchange rate By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  15. International Capital Flows: Private Versus Public Flows in Developing and Developed Countries By Yun Jung Kim; Jing Zhang

  1. By: Gourinchas, Pierre-Olivier; Martin, Philippe; Messer, Todd
    Abstract: Despite a formal 'no-bailout clause', we estimate significant net present value transfers from the European Union to Cyprus, Greece, Ireland, Portugal and Spain, ranging from roughly 0.5% (Ireland) to 43% (Greece) of 2011 output during the recent Eurozone crisis. We propose a model to analyze and understand bailouts in a monetary union, and the large observed differences across countries. We characterize bailout size and likelihood as a function of the economic fundamentals (economic activity, debt-to-gdp ratio, default costs). Our model embeds a 'Southern view' of the crisis (transfers did not help) and a 'Northern view' (transfers weaken fiscal discipline). While a stronger no-bailout commitment reduces risk-shifting, it may not be optimal from the perspective of the creditor country, even ex-ante, if it increases the risk of immediate insolvency for high debt countries. Hence, the model provides a potential justification for the often decried policy of 'kicking the can down the road'.
    JEL: F34 F45
    Date: 2020–06
  2. By: Bacchetta, Philippe; Tièche, Simon; van Wincoop, Eric
    Abstract: Using data on international equity portfolio allocations of US mutual funds, we estimate a simple portfolio expression derived from a standard Markowitz mean-variance portfolio model extended with portfolio frictions. The optimal portfolio depends on two benchmark portfolios, the previous month and the buy-and-hold portfolio shares, and a present discounted value of expected future excess returns. We show that equity return differentials are predictable and use the expected return differentials in the mutual fund portfolio regressions. The estimated reduced form parameters are related to the structural model parameters. The estimates imply significant portfolio frictions and a modest rate of risk-aversion. While mutual fund portfolios respond significantly to expected returns, portfolio frictions lead to a weaker and more gradual portfolio response to changes in expected returns. We also document heterogeneity across funds. Global and larger funds face bigger portfolio frictions, while more active funds give relatively less weight to the buy-and-hold portfolio (rebalance more aggressively).
    Date: 2020–06
  3. By: Galí, Jordi
    Abstract: Under uncovered interest parity (UIP), the size of the effect on the real exchange rate of an anticipated change in real interest rate differentials is invariant to the horizon at which the change is expected. Empirical evidence using US, euro area and UK data points to a substantial deviation from that invariance prediction: expectations of interest rate differentials in the near (distant) future are shown to have much larger (smaller) effects on the real exchange rate than is implied by UIP. Some possible explanations are discussed.
    Keywords: forward guidance puzzle; open economy New Keynesian model; unconventional monetary policies; uncovered interest rate parity
    JEL: E43 E58 F41
    Date: 2020–06
  4. By: Juan M. Morelli; Pablo Ottonello; Diego J. Perez
    Abstract: We study the role of global financial intermediaries in international lending. We construct a model of the world economy, in which heterogeneous borrowers issue risky securities purchased by financial intermediaries. Aggregate shocks transmit internationally through financial intermediaries' net worth. The strength of this transmission is governed by the degree of frictions intermediaries face in financing their risky investments. We provide direct empirical evidence on this mechanism showing that around Lehman Brothers' collapse, emerging-market bonds held by more distressed global banks experienced larger price contractions. A quantitative analysis of the model shows that global financial intermediaries play a relevant role in driving borrowing-cost and consumption fluctuations in emerging-market economies, during both debt crises and regular business cycles. The portfolio of financial intermediaries and the distribution of bond holdings in the world economy are key to determine aggregate dynamics.
    JEL: E3 F3 F41
    Date: 2021–06
  5. By: Yun Jung Kim; Jing Zhang
    Abstract: In this paper we empirically explore the relationship between debt and output in a panel of 72 countries over the period 1970–2014 using a vector autoregression (VAR). We document two puzzling empirical findings that contrast with what is predicted by a standard small open economy model by Aguiar and Gopinath (2007), where debt and output endogenously respond to total factor productivity (TFP) shocks. First, developing countries’ debt falls after a positive output shock, while the model predicts a debt expansion. Second, output declines in developed and developing countries after a debt shock, while the model predicts higher output. The relationship between debt and output depends on the sector taking on debt (households, firms, or governments) and the source of financing (domestic versus external) and differs across countries with varying degrees of economic development or different exchange rate regimes.
    Keywords: public debt; household debt; firm debt; foreign debt
    JEL: E44 F32 F34 F41
    Date: 2020–11–19
  6. By: Corsetti, Giancarlo; Duarte, Joao; Mann, Samuel
    Abstract: We study the transmission of monetary shocks across euro-area countries using a dynamic factor model and high-frequency identification. We develop a methodology to assess the degree of heterogeneity. We find this to be low in financial variables and output, but significant in consumption, consumer prices, and variables related to local housing and labor markets. We build a small open economy model featuring a housing sector and calibrate it to Spain. We show that varying the share of adjustable-rate mortgages and loan-to-value ratios explains up to one-third of the cross-country heterogeneity in the response of output and private consumption.
    Keywords: Adjustable Mortgage Rates; High-Frequency Identification; housing market; Loan-to-value Ratio; monetary policy; monetary union
    JEL: E21 E31 E44 E52 F44 F45
    Date: 2020–06
  7. By: Timothy Watson; Juha Tervala
    Abstract: We simulate a small open economy Two Agent New Keynesian (TANK) model featuring ‘learning by doing’ in production whereby changes in employment generate hysteresis in productivity and output. Credit constraints and hysteresis amplify the efficacy of Fiscal stimulus in a small open economy with a floating exchange rate and inflation-targeting central bank such that output multipliers can exceed unity; welfare multipliers can be positive; and the degree of hysteresis, output and employment multipliers match empirical evidence well. Fiscal stimulus helps reverse output hysteresis, and price-level targeting provides superior macroeconomic stabilisation compared to other simple monetary rules combined with fiscal stimulus.
    Keywords: Hysteresis, open economy macroeconomics, monetary policy, fiscal policy
    JEL: E32 E63 F41
    Date: 2021–06
  8. By: Michael Sposi (Southern Methodist University)
    Abstract: The age distribution evolves asymmetrically across countries, influencing capital flows through differences in aggregate saving rates and labor supply. I build a general equilibrium model featuring overlapping generations and international trade where dynamics are driven by capital accumulation and borrowing and lending. The equilibrium can be replicated by a model in which every country is inhabited by a representative household that experiences an endogenous, time-varying discount factor reflecting the co-evolution of the entire age distribution and relevant prices. This equivalence affords computation of the exact transitional dynamics. I calibrate the model to match national accounts and bilateral trade data and quantify how demographic forces affected capital flows between 28 countries since 1970. On average, increasing a country's mean age by one year boosts its current account by 0.4 percent of GDP. Observed bilateral trade patterns dictate the cross-country dispersion and magnitude of capital flows in response to changes in any individual country's demographics.
    Keywords: Demographics; Global imbalances; Dynamics; International trade
    JEL: F11 F21 J11
    Date: 2021–03
  9. By: Tamon Asonuma (IMF); Hyungseok Joo (University of Surrey)
    Abstract: Sovereigns' public capital and fiscal constraint influence sovereign debt crises and resolution. We compile a dataset on public expenditure composition around restructurings with private external creditors. We show that during restructurings, public investment (i) experiences severe decline and slow recovery, (ii) differs from public consumption and transfers, and (iii) relates with restructuring delays. We develop a theoretical model of defaultable debt that embeds endogenous public capital accumulation, expenditure composition, production and multi-round debt renegotiations. The model quantitatively shows public investment dynamics and tight fiscal constraint delay debt settlement - †capital accumulation delays" and “fiscal delays†. Data support these theoretical predictions.
    JEL: F34 F41 H63
    Date: 2021–06
  10. By: Delatte, Anne-Laure; Guillaume, Alexis
    Abstract: While the pandemic was an exogenous shock leading to increasing sovereign debt across the board, the dynamics of sovereign risk premiums has been heterogeneous in the Euro Area (EA). We estimate the determinants of sovereign bond spreads in the EA during the pandemic from January 2 2020 to May 25 2020. We find that: 1) resiliency to COVID shock depended on initial fiscal situation, robustness of the banking sector and healthcare capacity; 2) during the crisis, ECB speeches were a game changer and had a much larger contribution than actual securities purchase programs; 3) the coordination of the European Council also contributed to narrow down the spread but the effect was partly compensated by the implementation of financial assistance based on loans which contributed to increase the spreads.
    Keywords: COVID; European Monetary Union; Event studies; sovereign risk
    JEL: F30 F45 H63
    Date: 2020–06
  11. By: Thiago Revil T. Ferreira; Samer Shousha
    Abstract: We estimate that the supply of sovereign safe assets is a major driver of neutral interest rates--real rates consistent with both economic activity and inflation at their trends. We find this result using an empirical cross-country model with many economic drivers for the neutral rates of 11 advanced economies during the 1960-2019 period. The increasing availability of safe assets after 2008 has pushed up neutral rates, preventing them from continuing their previous decline because of other drivers. We also evaluate the "global savings glut" hypothesis. We estimate that since 1994 the global accumulation of international exchange reserves in safe assets has lowered the availability of these assets to the private sector and, thus pushed down neutral rates. Finally, we find that economies' neutral rates are subject to important global spillovers from developments in other economies.
    Keywords: Neutral interest rates; Safe assets; International reserves; Global savings glut
    JEL: E43 E21 E52
    Date: 2021–04–30
  12. By: Corsetti, Giancarlo; Maeng, Seung Hyun
    Abstract: With the Covid-19 pandemic, public debt around the world is rising to unprecedented heights in peacetime. We revisit the mechanisms by which, driven by self-fulfilling expectations, both slow-moving and rollover (fast) crises are pervasive at intermediate and high levels of debt, respectively. In both strategic-default and debt-limit models, belief-driven shifts in market assessment of risk translate into shifts of the market debt tolerance thresholds---to such an extent that sovereigns may lose market access even if they were able to borrow risk free in a ``good equilibrium''. Long debt maturities may/may not shield countries from this adverse scenario. In a sunspot equilibrium, the threat of belief-driven crises may not be enough for the government to deleverage in a recession, and bring debt to default-free levels. Unless the initial debt is close enough to the critical threshold above which the country becomes vulnerable to such crises, the government will keep borrowing, gambling on economic recovery in the future.
    Keywords: debt sustainability; Expectations; Self-fulfilling Crises; sovereign default
    JEL: E43 E62 H50 H63
    Date: 2020–06
  13. By: Juan M. Londono; Sai Ma; Beth Anne Wilson
    Abstract: Using a sample of 30 countries representing about 65% of the global GDP, we find that real economic uncertainty (REU) has negative long-lasting domestic economic effects and transmits across countries. The international spillover effects of REU are (i) additional to those of domestic REUs, (ii) statistically significant, and (iii) economically meaningful. Trade ties play a key role in explaining why uncertainty generated in one country can affect economic outcomes in other countries. Based on this evidence, we construct a novel index for global REU as the trade-weighted average of all countries' REUs. We disentangle the effects of the domestic and foreign components of global REU and find that, on average, innovations to the foreign component can contribute up to 28% of the future variation in domestic industrial production, with the effect being disproportionately larger on its manufacturing component, the component contributing the most to the tradable goods sector, than on its retail sales component.
    Keywords: Economic effects of uncertainty; International transmission; Spillovers
    JEL: G01 E32 F62 F44
    Date: 2021–04–30
  14. 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 twothirds of the PPP deviations in the degree of persistence.
    Keywords: Real exchange rates, Law of one price, Rational inattention, Trade cost
    JEL: E31 F31 D40
    Date: 2021–04
  15. By: Yun Jung Kim; Jing Zhang
    Abstract: Empirically, net capital inflows are pro-cyclical in developed countries and counter-cyclical in developing countries. That said, private inflows are pro-cyclical and public in flows are counter-cyclical in both groups of countries. The dominance of private (public) in flows in developed (developing) countries drives the difference in total net inflows. We rationalize these patterns using a dynamic stochastic two-sector model of a small open economy facing borrowing constraints. Private agents over-borrow because of the pecuniary externality arising from constraints. The government saves abroad to reduce aggregate debt, making the economy resilient to adverse shocks. Differences in borrowing constraints and shock processes across countries explain the empirical patterns of capital inflows.
    Keywords: reserves; pecuniary externality; cyclicality of net capital ows
    JEL: E44 F32 F34 F41
    Date: 2020–11–13

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