nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒08‒16
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Reserve Accumulation, Growth and Financial Crises By Gianluca Benigno; Luca Fornaro; Michael Wolf
  2. Exchange rate pass-through, monetary policy, and real exchange rates - Iceland and the 2008 crisis By Sebastian Edwards; Luis Cabezas
  3. Foreign Vulnerabilities, Domestic Risks: The Global Drivers of GDP-at-Risk By Lloyd, S.; Manuel, E.; Panchev, K.
  4. The Mundellian trilemma and optimal monetary policy in a world of high capital mobility By Richard T. Froyen; Alfred V. Guender
  5. Financial Dollarization in Emerging Markets: Efficient Risk Sharing or Prescription for Disaster? By Lawrence Christiano; Hüsnü Dalgic; Armen Nurbekyan
  6. US Spillovers of US Monetary Policy: Information effects & Financial Flows By Santiago Camara
  7. How do exchange rates respond to political rhetoric by populist leaders? By Cem Cakmakli; Selva Demiralp; Gokhan Sahin Gunes
  8. Dominant currencies and the export supply channel By Frohm, Erik
  9. Optimal Monetary Policy and Incomplete Information: Does the Real Exchange Matter? By Rodrigo Caputo; Felipe Leal
  10. The Dynamics of International Exploitation By Jonathan F. Cogliano; Roberto Veneziani; Naoki Yoshihara
  11. The case for a positive euro area inflation target: evidence from France, Germany and Italy By Adam, Klaus; Gautier, Erwan; Santoro, Sergio; Weber, Henning
  12. Risk sharing in the EMU: a time-varying perspective By Foresti, Pasquale; Napolitano, Oreste
  13. The Natural Resource Boom and the Uneven Fall of the Labor Share By Dávila, Andrés O.; Fernandez Sierra, Manuel; Zuleta, Hernando

  1. By: Gianluca Benigno; Luca Fornaro; Michael Wolf
    Abstract: We present a model that reproduces two salient facts characterizing the international monetary system: Fast growing emerging countries i) run current account surpluses, ii) accumulate international reserves and receive net private in flows. We study a two-sector, tradable and nontradable, small open economy. There is a growth externality in the tradable sector and agents have imperfect access to international financial markets. By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth. Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth. The optimal reserve management en- tails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention. The model is also consistent with the negative relationship between in flows of foreign aid and growth observed in low income countries.
    Keywords: foreign reserve accumulation, gross capital flows, growth, financial crises, allocation, puzzle, exchange rate undervaluation
    JEL: F31 F32 F41 F43
    Date: 2021–07
  2. 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 F3 F41
    Date: 2020–02
  3. By: Lloyd, S.; Manuel, E.; Panchev, K.
    Abstract: We study how foreign financial developments influence the conditional distribution of domestic GDP growth. Within a quantile regression setup, we propose a method to parsimoniously account for foreign vulnerabilities using bilateral-exposure weights when assessing downside macroeconomic risks. Using a panel dataset of advanced economies, we show that tighter foreign financial conditions and faster foreign credit-to-GDP growth are associated with a more severe left tail of domestic GDP growth, even when controlling for domestic indicators. The inclusion of foreign indicators significantly improves estimates of ‘GDP-at-Risk’, a summary measure of downside risks. In turn, this yields time-varying estimates of higher GDP growth moments that are interpretable and provide advanced warnings of crisis episodes. Decomposing historical estimates of GDP-at-Risk into domestic and foreign sources, we show that foreign shocks are a key driver of domestic macroeconomic tail risks.
    Keywords: Financial stability, GDP-at-Risk, International spillovers, Local projections, Quantile regression, Tail risk
    JEL: E44 E58 F30 F41 F44 G01
    Date: 2021–07–30
  4. By: Richard T. Froyen; Alfred V. Guender
    Abstract: This paper proposes that the Mundellian Trilemma remains valid despite the emergence of a world financial cycle. A clear distinction must be made between monetary policy independence and insulation of an open economy’s financial system. A flexible exchange rate allows an optimizing central bank to chart an independent course but does not insulate the domestic economy from foreign monetary or financial shocks. The gains from a flexible exchange rate may be considerable and vary in accordance with the mandate of the central bank. The Mundellian Trilemma highlights the acute shortage of policy instruments. We show that macroprudential policy in the form of an interest equalization tax, enhances the ability of an optimizing central bank to effectively stabilize domestic output and inflation in the presence of policy changes abroad and potentially destabilizing capital flows.
    Keywords: Mundellian Trilemma, policy independence, capital mobility, instrument shortage, capital controls
    JEL: E3 E5 F3
    Date: 2021–07
  5. By: Lawrence Christiano; Hüsnü Dalgic; Armen Nurbekyan
    Abstract: This paper pushes back against two views about the effects of dollarization. First, there is a view that the dollar is a device by which rich countries provide business cycle insurance to emerging market (EME) countries. We find that the dollar is important for risk sharing, but the evidence suggests that it is primarily a device to shift business cycle risk across different people within individual EMEs and within rich countries rather than across countries. Second, there is a widespread view that dollarization raises the risk of systemic banking and other crises. Although we identify sources of fragility in some aspects of dollarization, the common view that financial dollarization is a source of fragility is over-stated. Our insurance view about financial dollarization and the lack of risks to financial stability emerges from a study of a large cross-country dataset, as well as case studies for Peru and Armenia. We develop a simple model which formalizes the insurance view, which is consistent with the key cross-country facts on interest rate differentials, deposit dollarization and exchange rate depreciations in recessions.
    JEL: F3 F4 G15
    Date: 2021–07
  6. By: Santiago Camara
    Abstract: This paper presents evidence of an informational effect in changes of the federal funds rate around FOMC announcements by exploiting exchange rate variations for a panel of emerging economies. For several FOMC announcements dates, emerging market economies' exchange rate strengthened relative to the US dollar, in contrast to what the standard theory predicts. These results are in line with the information effect, which denote the Federal Reserve's disclosure of information about the state of the economy. Using Jarocinski \& Karadi 2020's identification scheme relying on sign restrictions and high-frequency surprises of multiple financial instruments, I show how different US monetary policy shocks imply different spillovers on emerging markets financial flows and macroeconomic performance. I emphasize the contrast in dynamics of financial flows and equity indexes and how different exchange rate regimes shape aggregate fluctuations. Using a structural DSGE model and IRFs matching techniques I argue that ignoring information shocks bias the inference over key frictions for small open economy models.
    Date: 2021–08
  7. By: Cem Cakmakli (Department of Economics, Koç University); Selva Demiralp (Department of Economics, Koç University); Gokhan Sahin Gunes (BETAM, Bahcesehir University)
    Abstract: With the global rise in authoritarianism, there has been an increase in political commentaries by the populist leaders that have criticized their central banks in favor of lower interest rates. We analyze the effects of these political pressures on exchange rates. We provide strong empirical evidence where political commentaries affect both the level and the volatility of exchange rate returns. The intensity of political pressures as well as institutional strength play a key role in determining the size of the impact.
    Keywords: Political pressure, exchange rate, time inconsistency, populism.
    JEL: E5 G1 F31
    Date: 2021–08
  8. By: Frohm, Erik
    Abstract: Dominant currency pricing (DCP) weakens the demand-side effects of exchange rate changes on exports (Gopinath et al., 2020). However, adjustment in the export sector can still occur through other supply-side channels. With bilateral trade data at the HS2-product level, panel fixed-effects regressions and an instrumental variables (IV) approach, this paper presents several novel findings: (1), a depreciation of an exporter’s currency against the US-dollar increases total export volumes between non-US countries, whereas bilateral exchange rates matter very little. (2), there is no statistically significant increase in average exports per firm (the intensive margin), while the aggregate export response is mainly driven by an increase in the number of exporting firms (the extensive margin). (3), there is substantial heterogeneity in the export response to exchange rates against dominant currencies. Market concentration, approximated by the Herfindahl-Hirschman Index (HHI), reduces the response of both the extensive and intensive margins to the US-dollar exchange rate. These results highlight an “export supply channel” of exchange rates in a world with dominant currencies, deepen our understanding of aggregate export adjustment and further underline the heterogeneous export response in different sectors to exchange rate changes. JEL Classification: F14, F31, F41
    Keywords: dominant currencies, exchange rates, export heterogeneity, extensive margins of trade, intensive margins of trade
    Date: 2021–08
  9. By: Rodrigo Caputo; Felipe Leal
    Abstract: In a small economy, with complete markets and domestic price stickiness, a monetary policy rule that reacts to domestic inflation implements the efficient allocation, as long as it also reacts to the natural rate of interest. In this case, a policy response to the exchange rate or any other foreign variable is inefficient. We show that, when the central bank is unable to observe the natural rate of interest, a domestic inflation targeting rule that reacts also to the real exchange rate is optimal. This rule is able to fully stabilize domestic inflation and, at the same time, induces efficient movements in relative prices (terms of trade) through nominal devaluations. Indeterminacy can arise, but a stronger policy response to domestic inflation can prevent this from happening.
    Date: 2021–06
  10. By: Jonathan F. Cogliano; Roberto Veneziani; Naoki Yoshihara
    Abstract: This paper develops a theoretical and computational framework to analyse imperialistic international relations and the dynamics of international exploitation. A new measure of unequal exchange across borders -- an exploitation intensity index -- is proposed which can be used to characterise the structure of imperialistic international relations in the current global economy. It is shown that wealthy nations are net lenders and exploiters, whereas endowment-poor countries are net borrowers and suffer from exploitation. Capital flows transfer surplus from countries in the core of the global economy to those in the periphery. However, while international credit markets and wealth inequalities are sufficient to generate unequal exchange, they are proved to be insufficient for it to persist. Various possible factors are considered, including technical change and varying social norms, that may explain the persistence of international inequalities.
    Keywords: international exploitation; imperialism; capital movements; technical change
    JEL: B51 D63 C63 F21 F54
    Date: 2021–08
  11. By: Adam, Klaus; Gautier, Erwan; Santoro, Sergio; Weber, Henning
    Abstract: Using micro price data underlying the Harmonized Index of Consumer Prices in France, Germany and Italy, we estimate relative price trends over the product life cycle and show that minimizing price and mark-up distortions in the presence of these trends requires targeting a significantly positive inflation target. Relative price trends shift the optimal inflation target up from a level of zero percent, as suggested by the standard sticky price literature, to a range of 1.1%- 2.1% in France, 1.2%-2.0% in Germany, 0.8%-1.0% in Italy, and 1.1-1.7% in the Euro Area (three country average). Differences across countries emerge due to systematic differences in the strength of relative price trends. Other considerations not taken into account in the present paper may push up the optimal inflation targets further. The welfare costs associated with targeting zero inflation turn out to be substantial and range between 2.1% and 4.5% of consumption in present-value terms. JEL Classification: E31, E52
    Keywords: micro price trends, optimal inflation target, welfare
    Date: 2021–07
  12. By: Foresti, Pasquale; Napolitano, Oreste
    Abstract: The development of effective risk sharing mechanisms is one of the main passages for the success and longevity of a monetary union. In this paper, we study risk sharing, measured as income and consumption smoothing, in the EMU. As we employ time-varying estimations, we are able to retrieve time patterns of risk sharing for each member country and to compare them with the degree of economic asymmetry within the EMU. Other than documenting the need for stronger risk sharing mechanisms in the EMU, our results also suggest that much more attention should be dedicated to fostering homogeneity in risk sharing across member countries. We document the existence of increasing heterogeneity in the risk sharing capacity between member countries that can potentially exacerbate and amplify the impact of asymmetric shocks and further destabilize the EMU.
    Keywords: consumption smoothing; economic asymmetry; EMU; income smoothing; risk sharing
    JEL: J1 F3 G3
    Date: 2021–07–14
  13. By: Dávila, Andrés O. (Universidad de los Andes); Fernandez Sierra, Manuel (Universidad de los Andes); Zuleta, Hernando (Universidad de los Andes)
    Abstract: We study the effect of the upsurge of natural resources income from the commodity price boom of the 2000s on the functional distribution of income. To do so, we build a general equilibrium model of Dutch disease that characterizes how natural resource windfalls affect equilibrium factor shares. The theory suggests that the response of factor shares to exogenous changes in commodity prices depends on the relative intensity in which factors are used in the tradable and natural resource sectors. We construct estimates of income shares accruing to raw labor, human capital, physical capital, and natural resources, and quantify the effect of the resource boom on factor shares. For identification, we use a two-way fixed effects strategy and a differential exposure design to instrument commodity prices. We find that a natural resource boom negatively impacts the total labor, human capital, and physical capital shares, while the raw labor share remains unchanged. Our estimates suggest that the natural resource boom explains nearly 25.7 percent of the global decline of the total labor share during the 2000s. We also find a redistribution effect within labor income that indicates that the fall of the labor share was unevenly distributed against human capital.
    Keywords: labor share, factor income shares, natural resource boom, commodity price boom, dutch disease, human capital
    JEL: D33 F14 J31 O13
    Date: 2021–07

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