nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒06‒28
twelve papers chosen by
Martin Berka
University of Auckland

  1. Five Facts about the UIP Premium By Ṣebnem Kalemli-Özcan; Liliana Varela
  2. Exchange Rates and Monetary Policy with Heterogeneous Agents: Sizing up the Real Income Channel By Adrien Auclert; Matthew Rognlie; Martin Souchier; Ludwig Straub
  3. Fiscal regimes and the exchange rate By Enrique Alberola-Ila; Carlos Cantú; Paolo Cavallino; Nikola Mirkov
  4. Sectoral real exchange rates and manufacturing exports: A case study of Latin America By Thomas Goda; Alejandro Torres García; Cristhian David Larrahondo Dominguez
  6. Exchange rates and the global transmission of equity market shocks By Ojea-Ferreiro, Javier; Reboredo, Juan C.
  9. The Gold Standard and the International Dimension of the Great Depression. By Luca Pensieroso; Romain Restout
  10. Currency Hedging: Managing Cash Flow Exposure By Laura Alfaro; Mauricio Calani; Liliana Varela
  11. Jumpstarting an International Currency By Bahaj, Saleem; Reis, Ricardo
  12. No country is an island: international cooperation and climate change By Ferrari, Massimo; Pagliari, Maria Sole

  1. By: Ṣebnem Kalemli-Özcan; Liliana Varela
    Abstract: We document five novel facts about Uncovered Interest Parity (UIP) deviations vis-à-vis the U.S. dollar for 34 currencies of advanced economies and emerging markets. First, the UIP premium co-moves with global risk aversion (VIX) for all currencies, whereas only for emerging market currencies there is a negative comovement between the UIP premium and capital inflows. Second, the comovement of the UIP premium and the VIX is explained by changes in interest rate differentials in emerging markets, and by expected changes in exchange rates in advanced countries. Third, country risk measured by the degree of policy uncertainty can explain both the negative comovement of the UIP premium with capital inflows and the positive comovement of the UIP premium with VIX going through interest rate differentials in emerging markets. Fourth, there are no overshooting and predictability reversal puzzles—for any currency—when using exchange rate expectations to calculate the UIP premium. Fifth, the classical Fama puzzle disappears in advanced economies in expectations, but it remains for emerging markets. As a result, while global investors expect zero excess returns and earn positive returns in the short-run and negative returns in the long-run by investing in advanced country currencies, the same global investors always expect and earn positive excess returns from emerging market currencies. These results imply that in advanced countries the UIP premium is largely due to deviations from rational expectations and full information, whereas in emerging markets, the UIP premium is a risk premium. Global investors charge an “excess” premium to compensate for policy uncertainty in emerging markets —a premium that is over and above the expected and actual depreciation of these currencies.
    JEL: E0 F0
    Date: 2021–06
  2. By: Adrien Auclert; Matthew Rognlie; Martin Souchier; Ludwig Straub
    Abstract: Introducing heterogeneous households to a New Keynesian small open economy model amplifies the real income channel of exchange rates: the rise in import prices from a depreciation lowers households’ real incomes, and leads them to cut back on spending. When the sum of import and export elasticities is one, this channel is offset by a larger Keynesian multiplier, heterogeneity is irrelevant, and expenditure switching drives the output response. With plausibly lower short-term elasticities, however, the real income channel dominates, and depreciation can be contractionary for output. This weakens monetary transmission and creates a dilemma for policymakers facing capital outflows. Delayed import price pass-through weakens the real income channel, while heterogeneous consumption baskets can strengthen it.
    JEL: E52 F32 F41
    Date: 2021–05
  3. By: Enrique Alberola-Ila; Carlos Cantú; Paolo Cavallino; Nikola Mirkov
    Abstract: In this paper, we argue that the effect of monetary and fiscal policies on the exchange rate depends on the fiscal regime. A contractionary monetary (expansionary fiscal) shock can lead to a depreciation, rather than an appreciation, of the domestic currency if debt is not backed by future fiscal surpluses. We look at daily movements of the Brazilian real around policy announcements and find strong support for the existence of two regimes with opposite signs. The unconventional response of the exchange rate occurs when fiscal fundamentals are deteriorating and markets' concern about debt sustainability is rising. To rationalize these findings, we propose a model of sovereign default in which foreign investors are subject to higher haircuts and fiscal policy shifts between Ricardian and non-Ricardian regimes. In the latter, sovereign default risk drives the currency risk premium and affects how the exchange rate reacts to policy shocks.
    Keywords: exchange rate, monetary policy, fiscal policy, fiscal dominance, sovereign default
    JEL: E52 E62 E63 F31 F34 F41 G15
    Date: 2021–06
  4. By: Thomas Goda; Alejandro Torres García; Cristhian David Larrahondo Dominguez
    JEL: F14 F31 O14
    Date: 2021–06–14
  5. By: Olivier CARDI; Romain RESTOUT
    Abstract: Motivated by recent evidence pointing at an increase in the TFP following higher government spending, we explore how technology affects sectoral fiscal multipliers in open economy. Our estimates for eighteen OECD countries over 1970-2015 reveal that a government spending shock increases significantly the non-traded-goods-sector share of total hours worked while the response of the value added share of non-tradables (at constant prices) is muted at all horizon. The latter finding is puzzling as government spending shocks are strongly biased toward non-tradables. Our empirical findings show that the solution to this puzzle lies in technology which responds endogenously to the government spending shock. By offsetting the effect of the biasedness of the demand shock toward non-tradables, the rise in traded relative to non-traded TFP ensures that real GDP growth is uniformly distributed across sectors (i.e., in accordance with their value added share). Because a government spending shock also leads non-traded firms to bias technological change toward labor and traded firms to bias technological change toward capital, factor-augmenting technological change rationalizes the concentration of the rise in labor in the non-traded sector. Our quantitative analysis shows that a semi-small open economy model with tradables and non-tradables can reproduce the sectoral fiscal multipliers we document empirically once we let the decision on technology improvement vary across sectors and allow firms to change the mix of labor- and capital-augmenting efficiency over time.
    Keywords: Sector-biased government spending shocks; Endogenous technological change; Factor-augmenting efficiency; Open economy; Labor reallocation; CES production function; Labor income share.
    JEL: E25 E62 F11 F41 O33
    Date: 2021
  6. By: Ojea-Ferreiro, Javier (European Commission); Reboredo, Juan C. (Universidade de Santiago de Compostela)
    Abstract: We assess the role played by exchange rates in buffering or amplifying the propagation of shocks across international equity markets. Using copula functions we model the joint dependence between exchange rates and two global equity markets and, from a copula framework, we obtain the conditional expectation and measure the exchange rate contribution to shock propagation between those equity markets. Our estimates for emerging Latin American economies (Argentina, Brazil, Chile and Mexico) and two developed markets (Europe and the USA) document the following: (a) the contribution of exchange rates to the transmission of equity shocks is time varying and asymmetric and differs across countries; and (b) exchange rates diversify shocks from abroad for investors based in emerging economies (particularly Brazil, Chile and Mexico) and echo the effect of shocks from abroad for investors based in developed markets. This evidence has implications for international investors in terms of portfolio and risk management decisions.
    Keywords: Exchange rates; International equity markets; Copulas; Expected shortfall
    JEL: C58 F31 G15
    Date: 2021–04
  7. By: Solikin M. Juhro; Reza
    Abstract: This paper studies the role of macroprudential policy in the insulation properties of flexible exchangerates. To this end, we build a small open economy New Keynesian DSGE model with a bankingsector where, in the model economy, entrepreneurs may take foreign loans, and the exchange rateintervention is undertaken via a modified Taylor-rule. We also add a macroprudential measure,which limits the entrepreneurs’ foreign to domestic loan ratio. From the analysis, three significantresults emerge. First, the responses of aggregate output, consumption, investment, and inflation varywidely concerning the type of foreign shocks and the combinations of macroprudential policy andexchange rate intervention. Second, the flexible exchange rate’s insulation properties seem to dependon the foreign shock hitting the economy. Under a foreign interest rate shock, a higher exchange rateintervention destabilizes output. Whereas under a risk premium shock, it stabilizes output. Finally, under the foreign shocks, tightening the macroprudential measure does not necessarily stabilize output in the economy.
    Keywords: exchange rate, macroprudential policy, credit frictions, external shocks
    JEL: E30 E32 E44 E51 E52 G21 G28
    Date: 2020
  8. By: Ferry Syarifuddin
    Abstract: This paper examines the spatial dependence of foreign portfolio investment (FPI) inflows between ASEAN countries from 2002Q1-2018Q4 utilizing the spatial econometric approach. In particular, to enrich the resultsof our research we also review the relationship between exchange rates and macroeconomic factors on the FPI in Indonesia. The empirical results show that there is a competitive relationship in FPI between ASEAN countries that indicates crowding out of FPI in the host country is most likely to occur when third-country experiences crowding in its FPI inflow. We also show that the exchange rate dynamics in the host and third country do not significantly affect FPI in the host country. Furthermore, the results indicate that interest rate differential, inflation, economic growth, and government debt rating in host countries, also inflation, economic growth, and government debt rating in neighboring countries are responsible for the inflow of FPI into host countries in ASEAN. In the Indonesia case study, our empirical results show that exchange rates affect bond and equity inflows, and also exchange rate volatility affects foreign equity markets and total portfolio inflows inIndonesia. In addition, we find the importance of interest rate differential and the VIX index for Indonesia's portfolios market
    Keywords: foreign portfolio investment, exchange rates, macroeconomics, spatial panel econometrics, spillover effects
    JEL: F21 F31 F41 C21 R12
    Date: 2020
  9. By: Luca Pensieroso; Romain Restout
    Abstract: Was the Gold Standard a major determinant of the onset and protracted character of the Great Depression of the 1930s in the United States and worldwide? In this paper, we model the ‘Gold-Standard hypothesis’ in an open-economy, dynamic general equilibrium framework. We show that encompassing the international and monetary dimensions of the Great Depression is important to understand the turmoil of the 1930s, especially outside the United States. Contrary to what is often maintained in the literature, our results suggest that the vague of successive nominal exchange rate devaluations coupled with the monetary policy implemented in the United States did not act as a relief. On the contrary, they made the Depression worse.
    Keywords: Great Depression, Gold Standard, Open Macroeconomics, Dynamic General Equilibrium.
    JEL: N10 E13 N01
    Date: 2021
  10. By: Laura Alfaro; Mauricio Calani; Liliana Varela
    Abstract: Foreign currency derivative markets are among the largest in the world, yet their role in emerging markets is relatively understudied. We study firms' currency risk exposure and their hedging choices by employing a unique dataset covering the universe of FX derivatives transactions in Chile since 2005, together with firm-level information on sales, international trade, trade credits and foreign currency debt. We uncover four novel facts: (i) natural hedging of currency risk is limited, (ii) financial hedging is more likely to be used by larger firms and for larger amounts, (iii) firms in international trade are more likely to use FX derivatives to hedge their gross --not net-- cash currency risk, and (iv) firms are more likely to pay higher premiums for longer maturity contracts. We then show that financial intermediaries can affect the forward exchange rate market through a liquidity channel, by leveraging a regulatory negative supply shock that reduced firms' use of FX derivatives and increased the forward premiums.
    JEL: F31 F38 G30 G38
    Date: 2021–06
  11. By: Bahaj, Saleem; Reis, Ricardo
    Abstract: Monetary and financial policies that lower the cost of credit for working capital in a currency outside of its country can provide the impetus for that currency to be used in international trade. This paper shows this in theory, by exploring the complementarity in the currency used for financing working capital and the currency used for invoicing sales. Financial policies by a central bank can jump-start the use of its currency outside a country's borders. In the data, the creation of 38 swap lines by the People's Bank of China between 2009 and 2018 provides a test of the theory. Signing a swap line with a country is significantly associated with increases in the use of the RMB in payments to and from that country in the following months.
    JEL: E44 E58 F33 F41 G15
    Date: 2020–05
  12. By: Ferrari, Massimo; Pagliari, Maria Sole
    Abstract: In this paper we explore the cross-country implications of climate-related mitigation policies. Specifically, we set up a two-country, two-sector (brown vs green) DSGE model with negative production externalities stemming from carbon-dioxide emissions. We estimate the model using US and euro area data and we characterize welfare-enhancing equilibria under alternative containment policies. Three main policy implications emerge: i) fiscal policy should focus on reducing emissions by levying taxes on polluting production activities; ii) monetary policy should look through environmental objectives while standing ready to support the economy when the costs of the environmental transition materialize; iii) international cooperation is crucial to obtain a Pareto improvement under the proposed policies. We finally find that the objective of reducing emissions by 50%, which is compatible with the Paris agreement's goal of limiting global warming to below 2 degrees Celsius with respect to pre-industrial levels, would not be attainable in absence of international cooperation even with the support of monetary policy. JEL Classification: F42, E50, E60, F30
    Keywords: climate modelling, DSGE model, open-economy macroeconomics, optimal policies
    Date: 2021–06

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