nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒11‒29
eleven papers chosen by
Martin Berka
University of Auckland

  1. Labor Market Effects of Technology Shocks Biased Toward the Traded Sector By Luisito Bertinelli; Olivier Cardi; Romain Restout
  2. Scrambling for Dollars: International Liquidity, Banks and Exchange Rates By Javier Bianchi; Saki Bigio; Charles Engel
  3. Welfare Costs of Exchange Rate Fluctuations: Evidence from the 1972 Okinawa Reversion By Kano, Kazuko; Kano, Takashi
  4. Limited Asset Market Participation and Monetary Policy in a Small Open Economy By Paul Levine; Stephen McKnight; Alexander Mihailov; Jonathan Swarbrick
  5. Leverage Cycles, Growth Shocks, and Sudden Stops in Capital Inflows By Lorenz Emter
  6. What Shapes Current Account Adjustment During Recessions? By Ms. Christina Kolerus
  7. U.S. Dollar Currency Premium in Corporate Bonds By Ms. Gita Gopinath; John Caramichael; Gordon Y. Liao
  8. The shock absorbing role of cross-border investments: net positions versus currency composition By Agustin S. Benetrix; Beren Demirolmez; Martin Schmitz
  9. Marginal Product of Capital under Financial Frictions By Margarita Lopez Forero
  10. Exchange Rates as Trade Frictions: Estimates and Implications for Policy By James E. Anderson; Praveen Saini
  11. Global models for a global pandemic: the impact of COVID-19 on small euro area economies By Pablo Garcia; Pascal Jacquinot; Crt Lenarcic; Matija Lozej; Kostas Mavromatis

  1. By: Luisito Bertinelli (Department of Economics and Management, Université du Luxembourg); Olivier Cardi (Lancaster University Management School); Romain Restout (Université de Lorraine, Université de Strasbourg, CNRS, BETA)
    Abstract: Motivated by recent evidence pointing at an increasing contribution of asymmetric shocks across sectors to economic fluctuations, we explore the labor market effects of technology shocks biased toward the traded sector. Our VAR evidence for seventeen OECD countries reveals that the non-traded sector alone drives the increase in total hours worked following a technology shock that increases permanently traded relative to non-traded TFP. The shock generates a reallocation of labor toward the non-traded sector which contributes to 35% on average of the rise in non-traded hours worked. Both labor reallocation and variations in labor income shares are found empirically connected with factor-biased technological change. Our quantitative analysis shows that a two-sector open economy model with flexible prices can reproduce the labor market effects we document empirically once we allow for imperfect mobility of labor, gross substitutability between home- and foreign-produced traded goods, and factor- biased technological change. When calibrating the model to country-specific data, its ability to account for the cross-country reallocation and redistributive effects we esti- mate increases once we let factor-biased technological change vary between sectors and across countries.
    Keywords: Sector-biased technology shocks; Factor-augmenting efficiency; Open economy; Labor reallocation; CES production function; Labor income share
    JEL: E25 E32 F11 F41
    Date: 2021
  2. By: Javier Bianchi; Saki Bigio; Charles Engel
    Abstract: We develop a theory of exchange rate fluctuations arising from financial institutions’ demand for dollar liquid assets. Financial flows are unpredictable and may leave banks “scrambling for dollars.” Because of settlement frictions in interbank markets, a precautionary demand for dollar reserves emerges and gives rise to an endogenous convenience yield on the dollar. We show that an increase in the dollar funding risk leads to a rise in the convenience yield and an appreciation of the dollar, as banks scramble for dollars. We present empirical evidence on the relationship between exchange rate fluctuations for the G10 currencies and the quantity of dollar liquidity, which is consistent with the theory.
    JEL: F41 F44 G20
    Date: 2021–11
  3. By: Kano, Kazuko; Kano, Takashi
    Abstract: The main tenet of the New Keynesian (NK) paradigm is that price dispersion caused by nominal price stickiness is the primary source of allocative inefficiency. This study empirically evaluates the welfare implications of NK models by observing how internal and external price dispersion responds to two types of large aggregate shocks: high inflation and sharp currency depreciation. For this purpose, we consider the history of US military deployment on a small southern island in Japan called Okinawa following the Pacific War. We investigate unique data variations in micro-level retail prices surveyed in Okinawa and mainland Japan before and after the Okinawan reversion to Japanese sovereignty in May of 1972. By considering the Okinawan experience of three currency regimes during the high inflation period of the early 1970s as valid quasi-natural experiments, we identify statistically significant deteriorations of currency misalignment associated with the sudden exogenous large USD depreciation versus the JPY following the Nixon Shock. Furthermore, we observe that these massive aggregate shocks left the average absolute size of price changes mostly unchanged, but significantly increased the average frequency of price changes in Okinawa. Because a calibrated small open-economy menu cost model fits these empirical findings better than the Calvo model, the welfare costs of exchange rate fluctuations may be more elusive than suggested by the openeconomy NK literature.
    Keywords: Currency regime, Currency misalignment, Welfare cost, Okinawan reversion, Menu cost model
    JEL: F31 F41 F45
    Date: 2021–11
  4. By: Paul Levine (University of Surrey); Stephen McKnight (El Colegio de Mexico); Alexander Mihailov (University of Reading); Jonathan Swarbrick (University of St Andrews)
    Abstract: Limited asset market participation (LAMP) and trade openness are crucial features that characterize all real-world economies. We study equilibrium determinacy and optimal monetary policy in a model of a small open economy with LAMP. With low enough participation in asset markets, the conventional wisdom concerning the stabilizing benefits of policy inertia can be overturned irrespective of the constraint of a zero lower bound on the nominal interest rate. In contrast to recent studies, in LAMP economies trade openness can play an important stabilizing role. We also show that the central bank must balance the opposing influence of openness and LAMP on the aggressiveness of optimal policy, and that the equivalence between efficient and equitable optimal allocation found in closed economies breaks down in open economies. We derive targeting rules and demonstrate the superiority of commitment over discretion in implementable optimal interest rate rules.
    JEL: E31 E44 E52 E58 E63 F41
    Date: 2021–10
  5. By: Lorenz Emter (Central Bank of Ireland and Department of Economics, Trinity College Dublin)
    Abstract: Using a quarterly panel of 98 advanced as well as emerging and developing countries from 1990 to 2017 this paper shows that domestic variables are significantly related to the probability of incurring sharp reversals in capital inflows controlling for global push factors. In particular, negative growth shocks combined with high levels of leverage in the domestic private sector are a significant determinant of sudden stops. This is in line with real business cycle models including an occasionally binding credit constraint and income trend shocks.
    Keywords: international capital flows, sudden stops, financial stability
    JEL: E32 F30 F32 F34 G15
    Date: 2020–07
  6. By: Ms. Christina Kolerus
    Abstract: This paper studies the dynamics of external accounts during 278 economic recession events in the past 60 years and sheds light on key factors that shape these patterns. Economic recessions trigger highly-persistent increases in the current account, driven by an initial, sharp decline in investment and fueled by medium term deleveraging, more so in advanced economies than in emerging markets. The strengthening of the current account is more pronounced when internal and external imbalances are present, and less when recessions are synchronized across countries. During severe natural disasters or epidemics, however, current accounts tend to weaken in the short term. Consistent with these findings, the COVID-19 shock, with comparatively moderate pre-existing imbalances yet high synchronization, had a muted effect on current account balances. The compositional changes, however, were unique and driven by unprecedented policy intervention, with record public dissaving more than offsetting exceptional private saving.
    Keywords: response to recession; synchronized recession; current account sensitivity; current account response; Non-commodity EMs; Economic recession; Current account; Credit booms; Private savings; Natural disasters; Global
    Date: 2021–07–30
  7. By: Ms. Gita Gopinath; John Caramichael; Gordon Y. Liao
    Abstract: We isolate a U.S. dollar currency premium by comparing corporate bonds issued in the dollar and the euro by firms o utside t he U .S. a nd e uro a rea. We make s everal empirical observations that dissect the perceived advantage of borrowing in the dollar. First, while the dollar dominates global debt issuance, borrowing costs in the dollar are more expensive without a currency hedge and about the same with a currency hedge when compared to the euro. This observed parity in currency-hedged corporate borrowing stands in contrast to the persistent deviation from covered interest parity in risk-free rates. Second, we observe a dollar safety premium in relative hedged borrowing costs, found in the subset of bonds with high credit ratings and short maturities, attributes similar to those of safe sovereigns. Finally, we find that firms flexibly adjust the currency mix of their debt issuance depending on the relative borrowing cost between dollar and euro debt. In sum, the disproportionate demand for U.S. dollar debt is reflected in higher issuance volumes that drive up the currency hedged dollar borrowing costs such that at the margin they equate to euro borrowing costs.
    Keywords: U.S. Dollar Dominance, Exorbitant Privilege, Exchange Rate, Global Corporate Debt, Covered Interest Rate Parity Deviation; U.S. Dollar currency premium; premium in corporate bonds; U.S. Dollar dominance; currency hedge; euro borrowing costs; currency mix; Bonds; Currencies; Corporate bonds; Bond yields; Interest rate parity; Global
    Date: 2021–07–12
  8. By: Agustin S. Benetrix (Department of Economics, Trinity College Dublin); Beren Demirolmez (Department of Economics, Trinity College Dublin); Martin Schmitz (European Central Bank)
    Abstract: We present a comprehensive analysis of the shock absorption role of external positions using the currency exposures dataset by Bénétrix, Gautam, Juvenal, and Schmitz (2020). While the literature has frequently studied how the net international investment position and its currency composition determine the direction and scale of valuation effects, we focus on their amplitude. This is of central importance for global financial stability given the large and increasing scale of external balance sheets. To that end, we propose an indicator showing the extent to which external positions absorb or amplify exchange rate shocks. Analysing a set of 50 countries over the period 1990-2017, we find the external shock absorption role to be present for advanced economies, while this was initially not the case for emerging markets economies (EMEs). In recent years, however, EMEs' external positions increasingly showed a shock absorption capacity. Our regression-based analysis reveals that the level of economic and financial development is associated with a greater capacity to absorb exchange rate shocks.
    Keywords: Currency composition, international investment position, foreign currency exposures, valuation effects, global imbalances
    JEL: F21 F31 F32 F41
    Date: 2021–06
  9. By: Margarita Lopez Forero (Université d'Evry and Université Paris-Saclay, France)
    Abstract: We link the Lucas' Paradox to the interaction between sector and countrylevel financial frictions. First, we compute proper measures of the aggregate marginal product of capital (MPK), accounting for natural capital and relative capital prices, for a panel of 50 developed and developing countries over 1995-2008. Our aggregate MPK measures imply there are little incentives for capital to flow to capital-poor economies over the sample period. Next, we examine how sector and country-level financial frictions interact to shape the aggregate MPK of a country. To do so, we use industry-level data to construct an annual country-level measure of external financial dependence and assess its effects on aggregate MPK conditional on the level of financial development and alternatively, on legal origins, our instrumental variable. We find that external financial dependence positively relates to MPK in developed countries, regardless of their level of financial development while it negatively relates to MPK in developing economies. Financial development appears to be a necessary condition in order for production in financially dependent sectors to positively affect aggregate MPK in developing countries. Our results taken altogether suggest that sector and country level financial frictions act as inefficiencies precluding improvements of MPK in developing economies despite large differences in capital-to-labor rations with respect to developed countries.
    Keywords: Financial Dependence, Financial Development, Marginal Product of Capital, Financial Frictions, Legal Origins, Lucas Paradox
    JEL: E22 F11 F21 F32 F41 F63 O11 O16 O47
    Date: 2021
  10. By: James E. Anderson; Praveen Saini
    Abstract: This paper improves on current treatment of exchange rate variation in quantitative trade models. Exchange rate changes with heterogeneous passthrough to buyers are embedded in the structural gravity model. Quantification on two digit annual bilateral trade data reveals real effects of exchange rate changes on producers that are substantial for some country-sector-time period observations. Real national income effects are small but not always negligible. Effective exchange Rates with Gravitas (ERGs) are introduced as theory-consistent indexes to guide potential policy remedies.
    JEL: F1 F13 F14 F3
    Date: 2021–10
  11. By: Pablo Garcia; Pascal Jacquinot; Crt Lenarcic; Matija Lozej; Kostas Mavromatis
    Abstract: This paper analyses the effects of the COVID-19 pandemic shock on small open economies in a monetary union with an application to the euro area. Accounting for a high degree of openness and a strong dependence on intra and extra union trade, we focus on the size and the direction of international spillovers – both from the shock itself and from the ensuing fiscal response. To do so, we use a unified modelling framework: The Euro Area and the Global Economy (EAGLE) model. Furthermore, within this general framework, we assess the extent to which specific modelling features shape the dynamic responses to the COVID-19 pandemic. The main messages are as follows. First, fiscal spillovers from the rest of the monetary union do matter. Second, the effective lower bound amplifies the size of the spillovers. Third, the design of wage negotiations leads to wage subsidies having negative international fiscal policy spillovers. Fourth, import content of government spending interacts with the effective lower bound, strongly affecting the size and sign of spillovers. Fifth, when households have finite lifetimes, the responses of output and inflation are amplified compared to the case with infinitely lived households. Finally, a next generation EU instrument is more effective when financed using a tax on consumption.
    Keywords: DSGE Modelling, International Spillovers, Monetary Union, Euro Area, COVID-19
    JEL: C53 E32 E52 F45
    Date: 2021–10

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