nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒12‒06
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Heterogeneity in Exchange Rate Pass-through to Import Prices in Thailand: Evidence from Micro Data By Tosapol Apaitan; Pym Manopimoke; Nuwat Nookhwun; Jettawat Pattararangrong
  2. What Types of Capital Flows Help Improve International Risk Sharing? By Ergys Islamaj; M. Ayhan Kose
  3. Macroeconomic Impact of Foreign Exchange Intervention: Some Cross-country Empirical Findings By Mr. Zhongxia Jin; Haobin Wang; Yue Zhao
  4. 60%, -4% And 6%, a Tale of Thresholds for EU Fiscal and Current Account Developments By António Afonso; José Carlos Coelho
  5. Cross-Border Currency Exposures. New evidence based on an enhanced and updated dataset. By Agustin S. Benetrix; Deepali Gautam; Luciana Juvenal; Martin Schmitz
  6. Choosing the European Fiscal Rule By Ginters Buss; Patrick Gruning; Olegs Tkacevs
  7. Open Economy Secular Stagnation and Financial Integration By Jean-Baptiste Michau
  8. Heterogeneity, convergence and imbalances in the Euro area By Stéphane Auray; Aurélien Eyquem
  9. Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rates? By Jin Cao; Valeriya Dinger; Tomas Gomez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovana; Yaz Terajima
  10. Do term premiums matter? Transmission via exchange rate dynamics By Mitsuru Katagiri; Koji Takahashi
  11. On the Validity of Purchasing Power Parity (PPP): The Case of Sierra Leone By Jabbie, Mohamed; Jackson, Emerson Abraham
  12. “Impossible Trinity” Hypothesis: The causal Relation between Trilemma and Macro Policy Performance By Zhai, Weiyang
  13. Policy Uncertainty Shocks and Small Open Economies in Monetary Union: a Case Study of Ireland By Jonathan Rice

  1. By: Tosapol Apaitan; Pym Manopimoke; Nuwat Nookhwun; Jettawat Pattararangrong
    Abstract: We use transaction-level customs data and show that there is significant heterogeneity in exchange rate pass-through (ERPT) to import prices at the Thai border. Our findings uncover significant variations in ERPT across time as well as across disaggregated sectors. By studying several structural determinants of ERPT, we find that (i) prices of homogenous goods are more sensitive to exchange rate changes compared to differentiated goods; (ii) firms with a higher degree of market power face lower ERPT; and (iii) ERPT crucially hinges upon the currency of invoice in the trade transaction. For goods invoiced in a foreign currency, the effect of ERPT is significantly higher than those priced in Thai baht. We also find that for the large majority of Thai imports that are invoiced in the US dollar under the dominant currency pricing (DCP) paradigm, price responses to the US dollar are much higher than those associated with the bilateral exchange rate vis-Ã -vis the exporters' currency, but only in the short run. In the medium run, both exchange rates become equally relevant. Finally, by investigating state-dependent properties of ERPT, we find that while Thai import prices are equally sensitive to small versus large exchange rate changes, the degree of pass-through is stronger during episodes of depreciations rather than appreciations, particularly for goods that practice DCP.
    Keywords: Invoice Currency; Exchange Rate Pass-through; Directional Asymmetry; Differentiated Products; Firm Market Power; Local Currency Pricing; Producer Currency Pricing; Dominant Currency Pricing
    JEL: E31 F14 F31 L11
    Date: 2021–11
  2. By: Ergys Islamaj (World Bank); M. Ayhan Kose (World Bank, Brookings Institution, CAMA, and CEPR)
    Abstract: Cross-border capital flows are expected to lead to increased international risk sharing by facilitating borrowing and lending in global financial markets. This paper examines risk-sharing outcomes of various types of capital flows (foreign direct investment, portfolio equity, debt, remittance, and aid flows) in a large sample of emerging market and developing economies. The results suggest that remittances and aid flows are associated with increased international risk sharing. Other types of capital flows are not consistently correlated with better risk-sharing outcomes. These findings are robust to the use of different econometric specifications, country-specific characteristics, and other controls.
    Keywords: Capital flows; remittances; aid flows, international risk sharing.
    JEL: E1 F02 F4 G01
    Date: 2021–11
  3. By: Mr. Zhongxia Jin; Haobin Wang; Yue Zhao
    Abstract: Based on VAR analyses across 26 countries, we show that, although foreign exchange intervention (FXI) is effective in stabilizing the nominal exchange rate in the short run, its impacts on the real exchange rate are less significant: Limitations on nominal exchange rate flexibility may induce adjustments to the real exchange rate through domestic prices. We find that countries that intervene more heavily in response to external shocks experience greater general and asset price volatility, which is not conducive to countering the impact of external shocks. We show that China’s macroeconomic responses to external shocks are broadly consistent with international experiences among intervening countries. The simple methodological framework adopted in this paper is meant to examine a broad set of macroeconomic variables and bears limitations; our findings serve to motivate more structural analysis on FXI’s macroeconomic impacts going forward.
    Keywords: nominal exchange rate IRF; asset price volatility; housing price IRF; floaters IRF; stock price IRF; Real exchange rates; Nominal effective exchange rate; Asset prices; Real interest rates; Exchange rates; Global
    Date: 2021–04–30
  4. By: António Afonso; José Carlos Coelho
    Abstract: We study the relationship between the budget balance and the current account balance for European Union (EU) countries, using quarterly data from 1995 to 2020. Through the use of panel Granger causality tests and a panel SUR model, we conclude that the relationship is bi-directional for the EU panel as a whole. Furthermore, we find that in Eurozone countries, before 2010, for those countries with an average current account balance-toGDP ratio outside the range of -4 to 6%, and also in countries whose average debt-toGDP ratio is greater than 60%, the impact of the budget balance on the current account balance is greater. Conversely, in non-Eurozone countries, after 2010, in countries with a current account balance-to-GDP ratio of -4 to 6%, and also in countries with an average debt-to-GDP ratio of less than 60%, the impact of the fiscal balance on the current account balance is less relevant.
    Date: 2021
  5. By: Agustin S. Benetrix (Department of Economics, Trinity College Dublin); Deepali Gautam (International Monetary Fund); Luciana Juvenal (International Monetary Fund); Martin Schmitz (European Central Bank)
    Abstract: This paper provides a dataset on the currency composition of the international investment position for a group of 50 countries for the period 1990-2017. It improves available data based on estimates by incorporating actual data reported by statistical authorities and refining estimation methods. The paper illustrates current and new uses of these data, with particular focus on the evolution of currency exposures of cross-border positions.
    Keywords: currency composition, foreign currency exposures
    JEL: F20 F31 F41
    Date: 2020–01
  6. By: Ginters Buss (Latvijas Banka); Patrick Gruning (Latvijas Banka, Vilnius University); Olegs Tkacevs (Latvijas Banka)
    Abstract: Contributing to the ongoing discussions at the European Union level about the potential simplification of its fiscal framework, we evaluate the economic and public finance stabilization properties of two benchmark fiscal rules – the structural balance rule and the expenditure growth rule – using a New Keynesian small open economy model. If these fiscal rules are implemented one at a time, having just an expenditure growth rule tends to yield more stable macroeconomic outcomes, but more volatile public finances, as compared to having only a structural balance rule. Much of the quantitative differences in relative volatilities can be accounted for by the modifications of the public expenditure definition in the expenditure growth rule, in particular, the removal of debt service payments. Accounting for debt service payments in fiscal rules strengthens the monetary-fiscal policy interaction but it may turn vicious to macroeconomic stability at business cycle frequencies. Strong-enough debt correction for either fiscal rule contains public debt volatility at little expense to macroeconomic stability in the long run. The households' welfare gain from having the expenditure growth rule instead of the structural balance rule is 4% for a small country in a monetary union and 5% for a country with sovereign monetary policy.
    Keywords: fiscal policy, DSGE, small open economy, fiscal-monetary policy interaction
    JEL: E0 E2 E3 E6 F4 H2 H3 H6
    Date: 2021–11–17
  7. By: Jean-Baptiste Michau (Ecole Polytechnique, France)
    Abstract: What is the optimal policy response to secular stagnation within a small open economy? Secular stagnation is characterized by a persistent lack of demand, resulting in under-employment. Within a small open economy, the degree of fi nancial integration determines the nature of the secular stagnation equilibrium. Under perfect capital mobility, stagnation is due to downward nominal wage rigidities; while under financial autarky, it is due to an excessively high real interest rate. I characterize the planners optimal allocation of resources and solve for the tax policy that implements it within a stagnating economy. Under perfect fi nancial integration, payroll taxes should be falling and labor income taxes rising such as to relax the downward nominal wage rigidity; while under fi nancial autarky, the opposite policy should be implemented such as to generate inflation. Alternatively, full employment can be achieved by setting a sufficiently inflation target and by relying on an exchange rate policy to import inflation from abroad. Policy options are more limited under a fixed exchange rate regime, where effciency can either be reached through a coordinated policy response or by abandoning the peg.
    Keywords: Financial integration, Liquidity trap, Secular stagnation
    JEL: E31 E63 F38 F41
    Date: 2021–11–02
  8. By: Stéphane Auray; Aurélien Eyquem (UL2 - Université Lumière - Lyon 2)
    Abstract: The inception of the euro allowed countries from the periphery to experience a large fall in the cost of borrowing. Lower nominal rates were only partially offset by lower inflation rates. We rationalize this real interest rate reversal using a two-region model of a monetary union where, consistently with real interest rate data, discount factors are initially heterogeneous, leading the periphery to be borrowing-constrained. We model the inception of the euro as a partial convergence process in inflation rates and a slow rise in the discount factor of the periphery, relaxing the borrowing constraint. This simple setup accounts for the bulk of post-euro fluctuations in both regions. In particular, it replicates very well the observed joint dynamics of current accounts and terms of trade.
    Keywords: monetary union,inflation convergence,current account imbalances,borrowing constraints
    Date: 2021–06
  9. By: Jin Cao; Valeriya Dinger; Tomas Gomez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovana; Yaz Terajima
    Abstract: We explore the impact of low and negative monetary policy rates in core world economies on bank lending in four small open economies - Canada, Chile, the Czech Republic and Norway - using confidential bank-level data. Our results show that the impact on lending in these small open economies depends on the interest rate level in the core. When interest rates are high, monetary policy cuts in core economies can reduce credit supply in small open economies. In contrast, when interest rates in core economies are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel. These results have important policy implications, suggesting that central banks in small open economies should watch for the impact of potential regime switches in core economies' monetary policy when rates shift to and from the very low end of the distribution.
    Keywords: Cross-border monetary policy spillover, international bank lending channel, low and negative interest rate environment (LNIRE), portfolio channel
    JEL: E43 E52 E58 F34 F42 G21 G28
    Date: 2021–11
  10. By: Mitsuru Katagiri; Koji Takahashi
    Abstract: The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing on the empirical observation that uncovered interest parity holds better for longer-term interest rate differentials. A quantitative exercise using Japanese and U.S. data shows that changes in term premiums, particularly those made by the central bank's bond purchases, have sizable effects on Japanese inflation rates via exchange rate dynamics.
    JEL: E31 E52 E58
    Date: 2021–10
  11. By: Jabbie, Mohamed; Jackson, Emerson Abraham
    Abstract: This paper attempts to empirically validate the purchasing power parity (PPP) theory in the context of Sierra Leone. To achieve this objective, cointegration and error correction techniques were utilised to account for both long and short-run dynamics over the period 2007Q1 to 2019Q1. The Engel-Granger cointegration technique was utilised to ascertain the long-run relationship between the exchange rate and the price differential between Sierra Leone and the United States of America, while the redundant variable test was used to attain the parsimonious short-run error correction model. The results indicated a cointegrating relationship, while the coefficient on the price differential was greater than one (1), reflecting that the PPP does not hold for Sierra Leone. Moreover, the short-run results showed a rejection of the theory and rather endorses the presence of depreciation inertia, where past depreciation of the exchange rate is a major determinant of its current depreciating trend.
    Keywords: Purchasing Power Parity, Exchange Rate, Inflation, Cointegration, Sierra Leone
    JEL: C32 E41 F31
    Date: 2020–01–01
  12. By: Zhai, Weiyang
    Abstract: This paper investigates how trilemma policy and economic performance mutually affected each other in developing and emerging countries between 1990 and 2017. We find that higher capital openness lowers output volatility and the inflation rate. However, trilemma policy decisions are also affected by economic performance. Under a high inflation regime, a country is pressured to reduce its financial integration by restricting its capital openness. During periods of heightened global risk and financial crisis, a country is pressured to reduce its exchange rate stability.
    Keywords: financial crisis; financial liberalization; impossible trinity; trilemma policy
    JEL: F15 F31 F36 O24
    Date: 2021–11–14
  13. By: Jonathan Rice (Department of Economics, Trinity College Dublin)
    Abstract: This paper explores the implications of policy uncertainty shocks for Ireland, a small open economy operating within monetary union. Exogenous domestic uncertainty shocks foreshadow persistent declines in Irish investment and employment, with no clear response by the ECB. On the other hand, no such decline in demand is observed following global uncertainty shocks, largely resulting from an accommodative monetary policy stance by the ECB. Results from this paper suggest that policy uncertainty shocks have negative and persistent effects on Irish real activity, only when monetary policy does not counteract these shocks. Common identification problems in the literature are also discussed and suggestions are made for future work in the area.
    Keywords: Small Open Economy, Uncertainty, Investment, Consumption, Interest Rates, Monetary Policy.
    JEL: E2 E3 E4
    Date: 2020–01

This nep-opm issue is ©2021 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.