nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒09‒06
ten papers chosen by
Martin Berka
University of Auckland

  1. Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization By Markus Kirchner; Malte Rieth
  2. Sovereign Spreads and the Political Leaning of Nations By Ionut Cotoc; Alok Johri; César Sosa-Padilla
  3. A study on the exchange rate pass-through to consumer prices in Malta By Glenn Abela; Noel Rapa
  4. Fiscal policy in a monetary union with downward nominal wage rigidity By Matthias Burgert; Philipp Pfeiffer; Werner Roeger
  6. The corporate saving glut and the current account in Germany By Klug, Thorsten; Mayer, Eric; Schuler, Tobias
  7. Global Capital, the Exchange Rate, and Policy (In)Effectiveness By Biagio Bossone
  8. Do Central Banks Rebalance Their Currency Shares? By Menzie D. Chinn; Hiro Ito; Robert N. McCauley
  9. Veiled Expectations: The Heterogeneous Impact of Exchange Rate Shocks at the Sectoral-Level By Suah, Jing Lian
  10. The existential trilemma of EMU in a model of fiscal target zone By Pompeo Della Posta,; Roberto Tamborini

  1. By: Markus Kirchner; Malte Rieth
    Abstract: This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilization policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplification between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilization tools than hawkish inflation targeting.
    Keywords: Small open economies, sovereign risk, monetary policy, exchange rates, business cycles, DSGE models
    JEL: E58 E63 F41
    Date: 2021
  2. By: Ionut Cotoc; Alok Johri; César Sosa-Padilla
    Abstract: Using data from 56 nations over 45 years, we find that nations that are more likely to elect left wing governments face higher (and more volatile) sovereign spreads. To explain these facts, we build a sovereign default model in which two policymakers (left and right) alternate in power. The probability of an incumbent staying in power is increasing in the share of government spending. We parametrize the left policymaker as having a higher marginal political gain from increasing government spending than the right does, a feature found in our data. Model economies in which the left is more frequently in power face worse borrowing terms due to higher default risk, a greater reluctance for fiscal austerity in bad times, and a higher share of government spending on average. These features imply large welfare losses for households.
    JEL: F34 F41
    Date: 2021–08
  3. By: Glenn Abela; Noel Rapa (Central Bank of Malta)
    Abstract: Exchange Rate Pass-Through (ERPT), commonly defined as the extent to which exchange rate changes are reflected in the price levels of an economy, has important implications in a number of policy-relevant areas. Despite this, estimates of ERPT in the Maltese economy are scarce and do not take into account changes in the monetary regime pertaining to the adoption of the euro. In this paper, we use local projections (LP) to estimate linear and non-linear ERPT to consumer prices in Malta after its accession to the European Monetary Union. In line with literature, results point at incomplete ERPT to headline consumer prices, peaking at around 20% by the end of the first year after the exchange rate shock. ERPT to overall HICP inflation seems to be largely driven by the goods component while ERPT to services prices is largely insignificant across the horizon considered. Allowing for non-linearities, we find evidence of asymmetric pass-through with larger changes to as well as depreciations in the nominal effective exchange rate being consistent with larger pass-through estimates
    JEL: E31 F31
    Date: 2021
  4. By: Matthias Burgert; Philipp Pfeiffer; Werner Roeger
    Abstract: We estimate an open economy DSGE model to study the fiscal policy implications of downward nominal wage rigidity (DNWR) in a monetary union. DNWR has significantly exacerbated the recession in the southern euro area countries and is important for the design of fiscal policy. We show that a cut in social security contributions paid by employers (equivalent to wage subsidies) is particularly effective in a deep recession with limited wage adjustment. Such cuts strengthen domestic demand and international competitiveness. Compared to government expenditure increases, the reduction in social security contributions provides more persistent growth effects and enhances the fiscal position. Non-linear estimation methods establish a strong state-dependence of policy.
    Keywords: Downward nominal wage rigidity, currency union, fiscal policy, nonlinear estimation
    JEL: E3 F41 F45
    Date: 2021
  5. By: Solikin M. Juhro (Bank Indonesia); Reza Anglingkusumo (Bank Indonesia)
    Abstract: This paper empirical shows that unconventional monetary policy (UMP) in the US after the global financial crisis (GFC) affects capital inflows to SEACEN economies. For open middle income SEACEN economies, such as Indonesia, capital flows volatility induced by the UMP in the US adds to the complexity of managing monetary policy trilemma (MPT). A recent hypothesis states that in post GFC, it is possible for monetary authority in an open emerging market economy to retain monetary policy sovereignty (MPS) if and only if capital flows is managed, directly or indirectly, regardless the degree of exchange rate flexibility. This paper contends that for the case of Indonesia, MPS remains feasible even without a direct capital control. This supports the argument that MPS depends more on the strength of the policy framework to address domestic policy objectives. We argue that the implementation of central bank policy mix by Bank Indonesia provides such strength.
    Keywords: capital inflows, unconventional monetary policy, monetary policy trilemma
    JEL: E22 F32 F36 F41
    Date: 2020
  6. By: Klug, Thorsten; Mayer, Eric; Schuler, Tobias
    Abstract: We investigate, in the case of Germany, the positive correlation between the cyclical components of the corporate saving glut in the non-financial corporate sector and the current account surplus from a capital account perspective. Employing sign restrictions, our findings suggest that mostly labor supply, world demand and financial friction shocks account for the joint dynamics of excess corporate saving and the current account surplus. Household saving shocks, by contrast, cannot explain the correlation. We conclude that, explained through these factors, the corporate saving glut is an important driver of the cyclical component of the current account. JEL Classification: E32, F32, F45
    Keywords: corporate saving, current account, macro shocks
    Date: 2021–08
  7. By: Biagio Bossone
    Abstract: In line with JMK’s liquidity preference theory, this article holds that in a world of highly internationally financially integrated economies the exchange rate between any two currencies is determined by the financial market views as to what its value is expected to be in the future. These views are influenced by the policy credibility that markets themselves attribute to the currency-issuing countries. After briefly reviewing the established theories of the exchange rate, the article proposes a very simple, aggregate model of equilibrium exchange rate determination based on market views and discusses its basic features and policy implications. It shows that whereas macro policy shocks in highly credible countries affect mostly real output with only a moderate impact on the exchange rate, the same shocks in poorly credible countries dissipate almost entirely in exchange rate movements. The exchange rate ultimately reflects the space that markets make available to national authorities for effective macro policies.
    Keywords: Credibility; Exchange rate; Global investors and capital; Inflation; Macroeconomic policy
    JEL: F41 F62 G15
    Date: 2021–09
  8. By: Menzie D. Chinn; Hiro Ito; Robert N. McCauley
    Abstract: Do central banks rebalance their currency shares? The answer matters because the dollar’s predominant role in large official reserve holdings means that widespread rebalancing requires central banks to buy (sell) a depreciating (appreciating) dollar, stabilising its value against other major currencies. We hypothesise that larger reserve holdings have led central banks to approach their investment more systematically and to make rebalancing in the face of exchange rate changes the norm. We illustrate the choice with two polar case studies: the US clearly does not rebalance its small FX reserves; Switzerland does rebalance its very large reserves, so that changes in exchange rates do not move its currency allocation. Our hypothesis finds partial support in global aggregated data. They reject both no rebalancing and full rebalancing and point to emerging market economies as the source of the aggregate result. We also test for rebalancing with panel data and find that our sample economies on average again behave in intermediate fashion, partially but not fully rebalancing. However, when observations are weighted by the size of reserves, the panel analysis finds full rebalancing. A variety of control variables and splits of the panel sample do not alter the thrust of these findings. Central banks rebalance their FX reserves extensively but not uniformly.
    JEL: F31 F42
    Date: 2021–08
  9. By: Suah, Jing Lian
    Abstract: This paper examines the sectoral-level impact of nominal exchange rate shocks. I introduce a model where agents face bounded abilities to form expectations, and agents’ foresight depends directly on the state of financial stress. This leads to differential labour market responses to exchange rate movements. When financial stress is low, absent of shocks, exchange rate movements are minimal and pinned down by agents. When financial stress is salient, agents’ foresight is veiled; they fail to form reliable expectations during episodes of sharp depreciation. Workers and firms fail to adjust expected relative wages and future marginal profits respectively, leading to sub-optimal output. Using monthly sectoral data from Malaysia in Simultaneous Equations and Markov-Switching Models, I find heterogeneous labour market responses. In tradable sectors, labour flows were small and concentrated in the manufacturing sector. Likewise, adjustments in non-tradable sectors were small. On the extensive margin, labour market flows diverge between tradable and non-tradable sectors. On the intensive margin, labour market flows in tradable sectors reverse. In contrast, as the model predicts, non-tradable sectors do not react to substantial terms of trade shocks.
    Keywords: Exchange Rate, Labour Market Frictions, Financial Stress, Expectations Formation, Regime-Switching, Simultaneous Equations Model
    JEL: D84 E44 F31 J20
    Date: 2020–11–01
  10. By: Pompeo Della Posta,; Roberto Tamborini
    Abstract: The lesson of the sovereign debt crises of the 2010s, and of the outbreak of the COVID- 19 pandemic is that EMU irreversibility, if not to remain a wishful statement in the founding treaties, necessitates to be completed by carefully designed ramparts for extraordinary times beside regulations for ordinary times. In this paper we wish to contribute to this line of thought in two points. First, we highlight that when exposed to large, systemic shocks the EMU faces a trilemma: its integrity can only be saved by relaxing either monetary orthodoxy, or fiscal orthodoxy, or both. We elaborate this concept by means of a fiscal target-zone model, where EMU member governments are willing to abide with the commitment to debt stability under the no-bailout clause only up to an upper bound of their feasible fiscal effort. Second, we show that EMU completion means providing a monetary and/or fiscal emergency backstop to the irreversibility principle. Drawing on the target-zone literature, we show how these devices can be designed in a consistent manner hat minimises their extension and mitigates the moral hazard concerns. The alternative to these devices is not retaining both the EMU irreversibility and the twin orthodoxies, but reformulating the treaties with explicit and regulated exit procedures.
    Keywords: COVID-19 pandemic, Fiscal Target Zone, Public Debt, Speculative Attacks, Fiscal Orthodoxy, Monetary Orthodoxy
    JEL: E65 F34 F36
    Date: 2021

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