nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2021‒12‒13
eight papers chosen by
Martin Berka
University of Auckland

  1. Beyond Incomplete Spanning: Convenience Yields and Exchange Rate Disconnect By Jiang, Zhengyang; Krishnamurthy, Arvind; Lustig, Hanno
  2. Methodologies for the Assessment of Real Effective Exchange Rates By Leonor Coutinho; Nuria Mata Garcia; Alessandro Turrini; Goran Vukšić
  3. Optimal Monetary Policy in a Small Open Economy with Non-tradable Goods By Jia, Pengfei
  4. Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rates? By Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
  5. Commodity Shocks and Exchange Rate Regimes: Implications for the Caribbean Commodity Exporters By Ms. Inci Ötker; Mr. Ali J Al-Sadiq
  6. The Effects of Demographic Change on Current Account and Foreign Asset Accumulation By Kim, Hyo Sang; Yang, Da Young; Kang, Eunjung
  7. Financial Instability and Banking Crises in a small open economy By Grytten, Ola Honningdal
  8. Bond Convenience Yields in the Eurozone Currency Union By Jiang, Zhengyang; Lustig, Hanno; Van Nieuwerburgh, Stijn; Xiaolan, Mindy Z.

  1. By: Jiang, Zhengyang (Northwestern University); Krishnamurthy, Arvind (Stanford University); Lustig, Hanno (Stanford University)
    Abstract: We introduce convenience yields on dollar bonds into an incomplete-market equilibrium model of exchange rates and interest rates. The convenience yield enters as a stochastic wedge in the Euler equation for exchange rate determination. The model identifies a novel safe-asset convenience yield channel by which quantitative easing impacts the dollar exchange rate. Our model addresses three exchange rate puzzles. (1) The model can rationalize the low pass-through of SDF shocks to exchange rates and hence low exchange rate volatility. (2) It helps address but does not fully resolve the exchange rate disconnect puzzle. (3) The model generates an unconditional log currency expected return on the dollar that is in line with the data.
    Date: 2021–07
  2. By: Leonor Coutinho; Nuria Mata Garcia; Alessandro Turrini; Goran Vukšić
    Abstract: This paper develops benchmarks to assess relative price developments based on the so-called behavioural equilibrium exchange rate (BEER) empirical models. Predictions from these empirical models for the determinants of real effective exchange rates allow estimating REER benchmarks consistent with the fundamentals of the economy. While relative price assessments are commonly based on REER indexes, index numbers do not permit comparisons across countries, so that benchmarks based on indexes cannot account for cross-country relations in economic fundamentals, including catching-up effects. To account for this, complementary benchmarks are also developed for the REER in levels. To this purpose, REER measures comparable across countries are constructed using purchasing power parities from the World Bank International Comparison Program, following a regression framework akin to that in Cubeddu et al. (2018), performed on a larger panel of countries and following a different criterion for the definition of the economic fundamentals to compute REER benchmarks. These benchmarks complement those based on current account gaps, already used in economic surveillance under the Macroeconomic Imbalance Procedure, to enrich the overall assessment of exchange rate positions and dynamics.
    JEL: F31 F32 F41
    Date: 2021–10
  3. By: Jia, Pengfei
    Abstract: This paper studies optimal monetary policy in a small open economy DSGE model with non-tradable goods and sticky prices. The introduction of non-traded goods is shown to have important implications for the transmission of shocks and monetary policy arrangements. First, the results show that positive technology shocks need not lead to deflation. In response to technology shocks, real exchange rates and the terms of trade depreciate. The relative price of tradable to non-tradable goods may increase or decrease, depending on the shocks. Second, based on welfare analysis, this paper evaluates the performance of different interest rate rules. The results show that if monetary policy is not very aggressive, the Taylor-type interest rate policy that targets CPI inflation performs the best. However, as monetary policy becomes relatively aggressive, the policy that targets domestic inflation is shown to yield the highest level of welfare. Third, this paper studies the Ramsey policy and optimal allocations. The results indicate that the Ramsey optimal policy stabilizes the inflation rates in both production sectors, while allowing for volatilities in CPI inflation, real exchange rates, the terms of trade, and the relative price of tradable goods. This suggests that the interest rate rules targeting CPI inflation or exchange rates are suboptimal. The results also show that in response to sector specific shocks, the Ramsey planner only cares about the inflation rate in the sector where the shock originates.
    Keywords: Optimal monetary policy; Small open economy; Non-tradable goods, Business cycles; Exchange rates
    JEL: E31 E32 E52 F31 F41
    Date: 2021–11–23
  4. By: Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; 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: Financial institutions; Monetary policy transmission; International topics
    JEL: E43 E58 F34 F42 G28
    Date: 2021–11
  5. By: Ms. Inci Ötker; Mr. Ali J Al-Sadiq
    Abstract: Declining commodity prices during mid-2014-2016 posed significant challenges to commodity-exporting economies. The severe terms of trade shock associated with a sharp fall in world commodity prices have raised anew questions about the viability of pegged exchange rate regimes. More recently, the COVID-19 pandemic and the measures needed to contain its spread have been associated with a significant disruption in several economic sectors, in particular, travel, tourism, and hospitality industry, adding to the downward pressure on commodity prices, a sharp fall in foreign exchange earnings, and depressed economic activity in most commodity exporters. This paper reviews country experiences with different exchange rate regimes in coping with commodity price shocks and explores the role of flexible exchange rates as a shock absorber, analyzing the macroeconomic impact of adverse term-of-trade shocks under different regimes using event study and panel vector autoregression techniques. It also analyzes, conceptually and empirically, policy and technical considerations in making exchange rate regime choices and discusses the supporting policies that should accompany a given regime choice to make that choice sustainable. It offers lessons that could be helpful to the Caribbean commodity-exporters.
    Keywords: commodity shock; commodity exporter; regime choice; Caribbean commodity-exporter; I. commodity terms-of-trade Index; Exchange rate arrangements; Exchange rate flexibility; Exchange rates; Exchange rate adjustments; Caribbean; Global; Africa
    Date: 2021–04–23
    Abstract: The current account surplus of Korea mainly comes from its export-driven trade surplus. The current account surplus can be interpreted as foreign savings for future consumption, which is ultimately accumulated in a net foreign asset position. Net foreign assets can contribute to the current account surplus with income balances such as profits, dividends and interest. Korea has maintained its current account surplus since 1998 due to the demographic structure, but only entered into a net foreign assets surplus country in 2014. Under Korea’s rapid demographic change, it is necessary to construct a positive feedback-loop structure between the current account surplus and net foreign assets.
    Keywords: demographic; current account; foreign asset; surplus
    Date: 2020–12–09
  7. By: Grytten, Ola Honningdal (Dept. of Economics, Norwegian School of Economics and Business Administration)
    Abstract: The present paper seeks to investigate the importance of financial instability during four banking crises, with focus on the small open economy of Norway. The crises elaborated on are the Post First world war crisis of the early 1920s, the mid 1920s Monetary crisis, the Great Depression of the 1930s and the Scandinavian banking crisis of 1987-1993. <p> The paper firstly offers a brief description of the financial instability hypothesis as applied by Minsky, Kindleberger, and in a new explicit dynamic financial crisis model. Financial instability creation basically happens in times of overheating, overspending and over lending, i.e., during significant booms, and have devastating effects after markets have turned into a state of crises. <p> Thereafter, the paper tests the validity of the financial instability hypothesis by using a quantitative structural time series model. The test reveals upheaval of financial and macroeconomic indicators prior to the crises, making the economy overheat and create asset bubbles due to huge growth in debt. These conditions caused the following banking crises. <p> Finally, the four crises are discussed qualitatively. The conclusion is that significant increase in money supply and debt caused overheating, asset bubbles and finally financial and banking crises which spread to the real economy.
    Keywords: Financial crises; banking crises; financial stability; macroeconomic; economic history; monetary expansion
    JEL: E44 E51 E52 F34 G15 N24
    Date: 2021–11–11
  8. By: Jiang, Zhengyang (Northwestern Kellogg); Lustig, Hanno (Stanford GSB, NBER, SIEPR); Van Nieuwerburgh, Stijn (Columbia Business School, NBER, CEPR); Xiaolan, Mindy Z. (UT Austin McCombs)
    Abstract: This paper analyzes bond convenience yields in a currency union. The intertemporal government budget constraint requires member countries’ bond convenience yields and default spreads to adjust in response to shocks to their government surpluses. In the data, adjustments to convenience yields explain a larger fraction of the variation in Eurozone bond yields than default spreads. Higher convenience yields are correlated with stronger fiscal conditions both in the cross-section and in the time series. These findings imply large fiscal costs especially on the peripheral countries. If all Eurozone countries could have issued sovereign bonds at the same convenience yields as Germany, they would have raised an extra 281 billion euros in cumulative revenues from bond issuance between 2003 and 2020, representing 2.6% of 2020 Eurozone GDP.
    Date: 2021–07

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