nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒01‒10
twelve papers chosen by
Martin Berka
University of Auckland

  1. The exchange rate insulation puzzle By Corsetti, Giancarlo; Kuester, Keith; Müller, Gernot J.; Schmidt, Sebastian
  2. Capital Controls and Foreign Reserves against External Shocks: Combined or Alone? By Rafael Cezar; Eric Monnet
  3. Sectoral exchange rate pass-through in the euro area By Osbat, Chiara; Sun, Yiqiao; Wagner, Martin
  4. Fiscal and current account imbalances: the cases of Germany and Portugal By Antonio Afonso; Jose Carlos Coelho
  5. Permanent and temporary monetary policy shocks and the dynamics of exchange rates By Alexandre Carvalho; João Valle e Azevedo; Pedro Pires Ribeiro
  6. Global risk and the dollar By Georgiadis, Georgios; Müller, Gernot J.; Schumann, Ben
  7. The Quadrilemma of a Small Open Circular Economy Through a Prism of the 9R Strategies By Patrick Grüning; Justina Banionienė; Lina Dagilienė; Michael Donadelli; Marcus Jüppner; Renatas Kizys; Kai Lessmann
  8. The Political Economy of Currency Unions By Kai Arvai
  9. Fostering cyclical convergence in the Euro Area By Filippo Gori
  10. A Theoretical Foundation for Prudential Authorities Decision Making By Cristina Badarau; Corentin Roussel
  11. Analyzing Capital Flow Drivers Using the ‘At-Risk’ Framework: South Africa’s Case By Mr. Ken Miyajima; Rohit Goel
  12. Mathematical Model of International Trade and Global Economy By N. S. Gonchar; O. P. Dovzhyk; A. S. Zhokhin; W. H. Kozyrski; A. P. Makhort

  1. By: Corsetti, Giancarlo; Kuester, Keith; Müller, Gernot J.; Schmidt, Sebastian
    Abstract: We confront the notion that flexible rates insulate a country from external disturbances with new evidence on spillovers from euro-area shocks to neighboring countries. We find that in response to euro-area shocks, spillovers are not smaller, and currency movements not significantly larger, in countries that float their currency, relative to those that peg to the euro—the insulation puzzle. Unconditionally, however, currency volatility is significantly higher for floaters. A state-of-the-art open-economy model can fit our conditional evidence on lack of insulation, provided monetary policy targets headline inflation, but only at the cost of missing the unconditional evidence on currency volatility. JEL Classification: F41, F42, E31
    Keywords: exchange-rate disconnect, exchange-rate regime, external shock, insulation, international spillovers
    Date: 2021–12
  2. By: Rafael Cezar; Eric Monnet
    Abstract: Long considered suboptimal, capital controls and FX interventions are now recognized as prudential measures. Yet, whether they should be used in combination remains an open question. Thanks to a rich dataset from 1950, we investigate how the response of FX reserves to an exogenous US monetary shock depends on capital controls. The response is insignificant with a very close capital account. By contrast, for a significant number of countries, FX interventions and capital controls are combined to tame the effects of an international financial shock. Yet, as countries open up financially, FX interventions replace capital controls. There is no one-sizes-fits-all recipe.
    Keywords: Capital Controls ; Foreign Exchange Interventions ; Foreign Exchange Reserves ; GlobalvFinancial Cycle
    JEL: F31 F32 F38
    Date: 2021
  3. By: Osbat, Chiara; Sun, Yiqiao; Wagner, Martin
    Abstract: We study exchange rate pass-through (ERPT), i.e., the impact of exchange rate movements on inflation, focusing on euro area import prices at a sectorally disaggregated level. Our estimation strategy is based on VAR-X models, thus incorporating both endogenous and exogenous explanatory variables. The impulse response functions not only allow to study the extent but also the dynamics of ERPT. We find that ERPT is heterogeneous in terms of magnitude across sectors. We further investigate what industry-specific characteristics affect the heterogeneity of ERPT. Across various model specifications including import penetration, market integration, competition and value chain integration, we find that higher market concentration and higher backward integration in global value chains decrease pass-through, in line with previous findings in the literature. JEL Classification: C50, F30, F40
    Keywords: euro area, exchange rates, import prices, pass-through, sectoral disaggregation
    Date: 2021–12
  4. By: Antonio Afonso (Universidade de Lisboa); Jose Carlos Coelho (Universidade de Lisboa)
    Abstract: We investigate the bilateral relationship between government budget balances and current account balances for Portugal and Germany. We find that the response of the current account balance to the budget balance is greater in Portugal than in Germany. On the other hand, the response of the budget balance to the current balance is higher in Germany than in Portugal. In Portugal and Germany, a fiscal rules index has a negative impact on the current account balance and the government effectiveness index has a positive impact on the government balance. The public debt as a percentage of GDP positively affects the current account balance in Portugal, and in Germany it does not. During the period of implementation of the external assistance programme in Portugal, the current account balance improved, while the government balance did not.
    Keywords: budget deficit; external deficit; Portugal; Germany; fiscal rules; time-series
    JEL: F
    Date: 2021
  5. By: Alexandre Carvalho; João Valle e Azevedo; Pedro Pires Ribeiro
    Abstract: Over the short run contractionary monetary policy shocks tend to be associated with domestic currency appreciations, which goes against standard interest rate parity conditions. How can this be reconciled with the fact that these conditions tend to be restored over the long run? We show the distinction between permanent and temporary monetary policy shocks is helpful to understand the impacts of monetary policy on exchange rates in the short as well as over the long run. Drawing on monthly data for the United States, Germany, France, Great Britain, Japan, Australia, Switzerland and the euro area from 1971 to 2019, and resorting to a simple structural vector error correction (SVEC) model and mild identifying restrictions, we find that a shock leading to a temporary increase in U.S. nominal interest rates leads to a temporary appreciation of the USD against the other currencies, in line with the literature on the exchange rate effects of monetary shocks and that on the forward premium puzzle. In turn, a monetary policy shock leading to a permanent rise in nominal interest rates - e.g. one associated with a normalisation of monetary policy after a long period at the zero lower bound - has the opposite impact, i.e., in line with interest parity conditions, in the short as well as over the long run. The ensuing depreciation may also contribute to higher (not lower) inflation, also in the short run. We thus confirm, in a simpler setting and for more economies, the results of Schmitt-Grohé and Uribe (2021). This highlights the relevance of differentiating between temporary and permanent monetary policy shocks in interpreting short-run exchange rate movements.
    JEL: C32 E52 E58 F31
    Date: 2021
  6. By: Georgiadis, Georgios; Müller, Gernot J.; Schumann, Ben
    Abstract: How does global risk impact the world economy? In taking up this question, we focus on the dollar’s role in the international adjustment mechanism. First, we rely on high-frequency surprises in the price of gold to identify the effects of global risk shocks in a Bayesian Proxy VAR model. They cause a synchronized contraction of global economic activity and appreciate the dollar. Other key financial indicators adjust in line with pre-dictions of recent theoretical work. Second, we illustrate through counterfactuals that the dollar appreciation amplifies the adverse impact of global risk shocks outside of the US via a financial channel. JEL Classification: F31, F42, F44
    Keywords: Bayesian proxy structural VAR, counterfactual, global risk shocks, minimum relative entropy, US dollar exchange rate
    Date: 2021–12
  7. By: Patrick Grüning (Latvijas Banka & Vilnius University); Justina Banionienė (Kaunas University of Technology); Lina Dagilienė (Kaunas University of Technology); Michael Donadelli (University of Brescia); Marcus Jüppner (Deutsche Bundesbank, Goethe University); Renatas Kizys (University of Southampton); Kai Lessmann (Potsdam Institute for Climate Impact Research)
    Abstract: The Circular Economy (CE) challenges the traditional linear economy model to arrive at a sustainable economy that minimizes resource use, its negative environmental impact, and dependency on resource imports. We develop a multi-sector dynamic stochastic general equilibrium small open economy model with endogenous adoption of exogenous foreign technology innovations, endogenous environmental quality, and CE elements, comprising recyclable waste as well as recycling and refurbishing sectors. We analyze the model-implied impulse response functions with respect to several economic shocks and conduct a rich scenario-based analysis, for which the scenarios are derived from the 9R strategies. We find important trade-offs to be considered by the economy with respect to circularity, trade, environment, and growth – the four dimensions of the quadrilemma of a small open circular economy. We find that none of the six shocks considered and in none of the eight scenarios analyzed the quadrilemma can be resolved. However, a positive shock to the price of energy or a lower energy share in one of the two intermediate goods sectors provide benefits to three out of four dimensions of the quadrilemma.
    Keywords: Circular economy, Small open economy, Recycling, Refurbishing, Endogenous economic growth, Technology adoption, General equilibrium, Energy
    JEL: E2 F4 O3 O4 Q4 Q5
    Date: 2021–11–24
  8. By: Kai Arvai
    Abstract: How can a currency union be sustained when member states have an exit option? This paper derives how fiscal and monetary policies can ensure the survival of a common currency, i countries want to leave the union. A union-wide central bank can prevent a break-up by setting interest rates in favor of the country that wants to exit. I show how a central bank does this by following a monetary rule with state-dependent country weights. The paper then demonstrates in a simulation that a central bank can only sustain the union for a while with this rule, but not permanently and that the best way to sustain the union is through fiscal transfers.
    Keywords: Currency union, Monetary policy, Lack of commitment, Exit option, Fiscal Policy
    JEL: E42 E52 E61 F33 F45
    Date: 2021
  9. By: Filippo Gori
    Abstract: During the first decade of the currency union, business cycle fluctuations among Euro Area countries were relatively synchronised and similar in magnitude. This concordance disappeared during the 2008 financial turmoil and the following European sovereign debt crisis, a time when key flaws in the architecture of the euro area became apparent. The recovery helped reduce cross-country differences in unemployment and output gaps, but countries worst hit by the crisis took much longer to recover, and in some cases negative consequences of shocks became entrenched. The COVID-19 crisis could lead to a resurgence in euro area cyclical di-synchronisation, risking to exacerbate economic divergence among member states and putting to the test the macroeconomic stability of the currency union. Diverging cyclical paths among euro area countries originate from differences in economic structures and domestic institutions. However, such differences are compounded by features in the economic policy architecture of the currency union – such as the lack of a common fiscal stabilisation tool – and by remaining frictions in the functioning of the common labour and financial markets. Reforms to the common euro area economic policy framework combined with those to improve labour and capital mobility across euro area members are needed to foster cyclical convergence in the currency union.
    Keywords: Capital markets union, European deposit insurance, financial integration, labour market reforms, macroeconomic stabilisation
    JEL: E61 F42 E62 E32 H87
    Date: 2021–12–17
  10. By: Cristina Badarau (Université de Bordeaux); Corentin Roussel (Université de Bordeaux)
    Abstract: In the aftermath of the Global Financial Crisis, financial regulation uses micro- and macro-prudential rules, most of the time motivated by empirical studies. This article suggests a theoretical explanation for countercyclical and progressive capital requirements that incorporate micro- and macro-prudential stabilization objectives. The Capital Adequacy Ratio (CAR) imposed to individual banks by a Prudential Authority (PA) would thus represent an optimal regulation whose aim is to avoid individual and systemic risk accumulation by imposing minimal constraints to financial institutions. This corresponds to the implementation of optimal time-varying prudential capital requirements to banks, with non-linear structure, that allows PA to take progressive countercyclical actions in order to insure financial stability. We also test the mechanism in a DSGE model and show that it would be more suitable for the financial and real stability compared to the existing fixed prudential ratios.
    Keywords: prudential regulation model, optimal CAR, time-varying capital requirements, DSGE model
    JEL: E
    Date: 2021
  11. By: Mr. Ken Miyajima; Rohit Goel
    Abstract: Cross-border capital flows are important for South Africa. They fund the nation’s relatively large external financing needs and have important financial stability implications evidenced by the large capital outflows and asset price selloffs during the COVID-19 pandemic. This paper adds to the literature on the drivers of South Africa’s capital flows by applying the ‘at-risk’ framework––which differentiates between the likelihood of “extreme” inflows (surges) and outflows (reversals) and of “typical” flows––to both nonresident and resident capital flows. Estimated results show that among nonresident flows, the portfolio debt component is most sensitive to changes in external risk sentiment particularly during reversals. This applies to flows to the sovereign sector. Nonresident equity flows, both portfolio and FDI, are most sensitive to domestic economic activity especially during surges. This applies to flows to the corporate and banking sectors. Results also suggest that resident flows, in particular the FDI component, tend to offset nonresident flows, thus acting as buffers against funding withdrawal during periods of global risk aversion.
    Keywords: Capital flows, capital flows at risk, COVID-19 pandemic, emerging markets, financial stability, quantile regression, South Africa.; portfolio debt component; flow cycle; flow distribution; flow reversal; IMF staff calculation; capital-flows-at-risk framework; Capital flows; Foreign direct investment; Portfolio investment; Capital outflows; Capital inflows; Global; Africa
    Date: 2021–10–22
  12. By: N. S. Gonchar; O. P. Dovzhyk; A. S. Zhokhin; W. H. Kozyrski; A. P. Makhort
    Abstract: This work was partially supported by the Program of Fundamental Research of the Department of Physics and Astronomy of the National Academy of Sciences of Ukraine "Mathematical models of non equilibrium processes in open systems" N 0120U100857.
    Date: 2021–12

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