nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒01‒24
thirteen papers chosen by
Martin Berka
University of Auckland

  1. Exchange rate disconnect and the general equilibrium puzzle By Yu-chin Chen; Ippei Fujiwara; Yasuo Hirose
  2. The aftermath of debt surges By M. Ayhan Kose; Franziska Ohnsorge; Carmen Reinhart; Kenneth Rogoff
  3. Welfare gains in a small open economy with a dual mandate for monetary policy By Punnoose Jacob; Murat Özbilgin
  4. Monetary Policy, External Finance and Investment By James Cloyne; Clodomiro Ferreira; Maren Froemel; Paolo Surico
  5. Better out than in? Regional disparity and heterogeneous income effects of the euro By Sang-Wook (Stanley) Cho; Sally Wong
  6. Time-Varying Relationship Between Exports and Real Exchange Rate in Turkey: A Recent Analysis at Sectoral Level By Selcuk Gul; Abdullah Kazdal
  7. Real Exchange Rates and Primary Commodity Prices: Mussa Meets Backus-Smith By Joao Ayres; Constantino Hevia; Juan Pablo Nicolini
  8. What types of capital flows help improve international risk sharing? By Ergys Islamaj; M. Ayhan Kose
  9. Tariffs and Macroeconomic Dynamics By Marco A. Hernández Vega
  10. A mountain of debt: Navigating the legacy of the pandemic By M. Ayhan Kose; Franziska Ohnsorge; Naotaka Sugawara
  11. Learning and Cross-Country Correlations in a Multi-Country DSGE Model By Volha Audzei
  12. Endogenous Fluctuations and International Business Cycles By Stephen McKnight; Laura Povoledo
  13. Does uncertainty matter for trade flows of emerging economies? By Nicolas Groshenny; Benedikt Heid; Tayushma Sewak

  1. By: Yu-chin Chen; Ippei Fujiwara; Yasuo Hirose
    Abstract: This paper conducts general equilibrium (GE) estimation to evaluate the empirical contributions of macroeconomic shocks in explaining the exchange rate disconnect, excess volatility, and the uncovered interest parity (UIP) puzzles. We embed stochastic volatilities and limits-to-international arbitrage in a two-country New Keynesian model and estimate the GE system for the US and Euro area using higher-order approximation and full-information Bayesian methods. Assessing the roles of level vs. volatility shocks and linear vs. higher-order approximations, we find that shocks to macroeconomic fundamentals together with their uncertainties can account for a sizable portion—over 40%—of the observed exchange rate variations. Using the GE estimates, we then evaluate whether the fundamental shocks in our model can deliver the UIP relationship observed in the data, and more importantly, whether the results may differ conditionally vs. unconditionally. In line with findings in previous literature, several fundamental shocks individually can indeed generate patterns consistent with data. However, their contributions unconditionally in the GE setting are quantitatively insufficient to resolve the UIP puzzle. The presence of multiple shocks, their potential interactions, and the need for estimators to fit empirical dynamics of all observables beyond just the exchange rate are all likely reasons behind this “General Equilibrium Puzzle,” which underscores the importance of GE estimation beyond simulations or partial-equilibrium analyses.
    Keywords: Exchange rate, risk premium, international risk sharing, stochastic volatility, nonlinear estimation.
    JEL: E52 F31 F41
    Date: 2021–10
  2. By: M. Ayhan Kose; Franziska Ohnsorge; Carmen Reinhart; Kenneth Rogoff
    Abstract: Debt in emerging market and developing economies (EMDEs) is at its highest level in half a century. In about nine out of 10 EMDEs, debt is higher now than it was in 2010 and, in half of the EMDEs, debt is more than 30 percentage points of gross domestic product higher. Historically, elevated debt levels increased the incidence of debt distress, particularly in EMDEs and particularly when financial market conditions turned less benign. This paper reviews an encompassing menu of options that have, in the past, helped lower debt burdens. Specifically, it examines orthodox options (enhancing growth, fiscal consolidation, privatization, and wealth taxation) and heterodox options (inflation, financial repression, debt default and restructuring). The mix of feasible options depends on country characteristics and the type of debt. However, none of these options comes without political, economic, and social costs. Some options may ultimately be ineffective unless vigorously implemented. Policy reversals in difficult times have been common. The challenges associated with debt reduction raise questions of global governance, including to what extent advanced economies can cast their net wider to cushion prospective shocks to EMDEs.
    Keywords: Debt restructuring, growth, inflation, fiscal consolidation, financial repression, wealth taxes
    JEL: F62 F34 F44 E32 E63 H6 H63
    Date: 2021–09
  3. By: Punnoose Jacob; Murat Özbilgin
    Abstract: In March 2019, the Reserve Bank of New Zealand was entrusted with a new employment stabilisation objective, that complements its traditional price-stability mandate. Against this backdrop, we assess whether the central bank’s stronger emphasis on the stabilisation of employment, and more broadly, resource utilisation, enhances social welfare. We calibrate an open-economy growth model to New Zealand data. In a second order approximation of the model, we evaluate how lifetime household utility is affected by a wide range of simple and implementable monetary policy rules that target both inflation and resource utilisation. We find that additionally stabilising resource utilisation always improves social welfare at any given level of inflation stabilisation. However, the welfare gains from stabilising resource utilisation get milder as the central bank is increasingly sensitive to inflation.
    Keywords: Optimal simple rules, welfare analysis, monetary policy, dual mandate
    JEL: F41 E52
    Date: 2021–10
  4. By: James Cloyne (University of California Davis/NBER/CEPR); Clodomiro Ferreira (Bank of Spain); Maren Froemel (Bank of England); Paolo Surico (London Business School/CEPR)
    Abstract: In response to a change in interest rates, younger firms not paying dividends adjust both their capital expenditure and borrowing significantly more than older firms paying dividends. The reason is that the debt of younger non-dividend payers is far more sensitive to fluctuations in collateral values, which are significantly affected by monetary policy. The results are robust to a wide range of possible confounding factors. Other channels, including movements in interest payments, product demand, profitability and mark-ups, are also significant but seem unlikely to explain the heterogeneity in the response of capital expenditure. Our findings suggest that financial frictions play a significant role in the transmission of monetary policy to investment.
    Keywords: monetary policy, investment, firm’s debt, collateral, financial frictions
    JEL: E22 E32 E52
    Date: 2021–11
  5. By: Sang-Wook (Stanley) Cho; Sally Wong
    Abstract: This paper conducts a counterfactual analysis on the effect of adopting the euro on regional income and disparity within Denmark and Sweden. Using the synthetic control method, we find that Danish regions would have experienced small heterogeneous effects from adopting the euro in terms of GDP per capita, while all Swedish regions are better off without the euro with varying magnitudes. Adopting the euro would have decreased regional income disparity in Denmark, while the effect is ambiguous in Sweden due to greater convergence among noncapital regions but further divergence with Stockholm. The lower disparity observed across Danish regions and non-capital Swedish regions as a result of eurozone membership is primarily driven by losses suffered by high-income regions rather than from gains to low-income regions. These results highlight the cost of foregoing stabilisation tools such as an independent monetary policy and a floating exchange rate regime. For Sweden in particular, macroeconomic stability outweighs the potential efficiency gains from a common currency.
    Keywords: currency union, euro, synthetic control method, regional income disparity
    JEL: C21 E65 F45 O52 R1
    Date: 2021–10
  6. By: Selcuk Gul; Abdullah Kazdal
    Abstract: Previous evidence on the impact of real exchange rate developments on Turkey's exports suggests that the effect is weak while the key determinant of exports is foreign income. Using recent data, this study provides rolling estimates that indicate an increase in the statistical significance and absolute magnitude of the real exchange rate elasticity of exports after the real depreciation of the Turkish lira in recent years. In this context, the cumulative decline in the real exchange rate in recent years is considered one of the factors that boosted Turkish exports. However, the findings confirm that the main determinant of Turkey’s exports is the changes in the incomes of trading partners and real exchange rate movements have a relatively limited effect on exports compared to that of the foreign income. Given that the sectors have quite different structures, the significance of the real exchange rate elasticities and their absolute size differ; yet, the effect of the real exchange rate on exports has increased more recently in most sectors. Finally, while interpreting the findings of the study, it should be taken into account that, in addition to trade channel, real exchange rate movements have effects on the economy through firm and household balance sheet channels.
    Keywords: Export, Real exchange rate elasticity, ARDL, Rolling estimates
    JEL: C22 F14 F31 F41
    Date: 2021
  7. By: Joao Ayres (Inter-American Development Bank); Constantino Hevia (Universidad Torcuato Di Tella); Juan Pablo Nicolini (Federal Reserve Bank of Minneapolis / Universidad Torcuato Di Tella)
    Abstract: We show that explicitly modeling primary commodities in an otherwise totally standard incomplete markets open economy model can go a long way in explaining the Mussa puzzle and the Backus-Smith puzzle, two of the main puzzles in the international economics literature.
    Keywords: primary commodity prices, Mussa puzzle, Backus-Smith puzzle.
    JEL: F31 F41
    Date: 2021–10
  8. By: Ergys Islamaj; M. Ayhan Kose
    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
  9. By: Marco A. Hernández Vega
    Abstract: This paper studies the macroeconomic impact of higher tariffs using a two-country DSGE model with endogenous trade and heterogeneous firms. The analysis consists of two scenarios. First, we assume that one country increases tariffs while the other does not. Second, both countries raise tariffs. In the first case, the country that did not raise tariffs suffers an economic contraction due to lower external demand. In turn, the one that imposed higher tariffs ends with a slight gain in output triggered by a surge in internal consumption originated from the transfer of tariff revenue to households. In the second case, however, both countries suffer a significant drop in exports, reducing dividends and wages paid, and decreasing consumption and output.
    JEL: F12 F13 F17 F41 F62
    Date: 2021–12
  10. By: M. Ayhan Kose; Franziska Ohnsorge; Naotaka Sugawara
    Abstract: The COVID-19 pandemic has triggered a massive increase in global debt levels and exacerbated the trade-offs between the benefits and costs of accumulating government debt. This paper examines these trade-offs by putting the recent debt boom into a historical context. It reports three major findings. First, during the 2020 global recession, both global government and private debt levels rose to record highs, and at their fastest single-year pace, in five decades. Second, the debt-financed, massive fiscal support programs implemented during the pandemic supported activity and illustrated the benefits of accumulating debt. However, as the recovery gains traction, the balance of benefits and costs of debt accumulation could increasingly tilt toward costs. Third, more than two-thirds of emerging market and developing economies are currently in government debt booms. On average, the current booms have already lasted three years longer, and are accompanied by a considerably larger fiscal deterioration, than earlier booms. About half of the earlier debt booms were associated with financial crises in emerging market and developing economies.
    Keywords: COVID-19, fiscal policy, sovereign debt, private debt, deficits
    JEL: E32 E62 G01 H63
    Date: 2021–10
  11. By: Volha Audzei
    Abstract: International spillovers in estimated multi-country DSGE models with trade are usually limited. The correlation of nominal and real variables across countries is small unless correlation of exogenous shocks is imposed. In this paper, I show that introducing adaptive learning (AL) with time-varying coefficients as in Slobodyan and Wouters (2012b and 2012a) increases the international correlation. I use an estimated large-scale model as in de Walque et al. (2017), which has reasonable forecasting performance under rational expectations (RE). The model features the euro area, the US, and an exogenous rest of the world, with endogenous exchange rate determination. I show that the increase in international correlation stems from the varying coefficients and the use of simple forecasting models. The increase in the correlation of international variables goes through two channels: larger shock spillovers through the exchange rate, and correlated adjustment of agents' forecasting model coefficients.
    Keywords: Adaptive learning, Bayesian estimation, Multi-Country DSGE
    JEL: D83 D84 E17 E31
    Date: 2021–12
  12. By: Stephen McKnight (El Colegio de México); Laura Povoledo (University of the West of England)
    Abstract: We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition to analyze the role of self-fulfilling expectations or beliefs in explaining international business cycles. We find that when self-fulfilling beliefs are correlated with tecnology shocks, the model can account for the counter-cyclical behavior observed for the terms of trade and real net exports, while simultaneously generating higher volatilities relative to output, as in the data. The choice of the labor supply elasticity is shown to be critical for generating a negative correlation between the real exchange rate and relative consumption, thereby resolving the Backus-Smith puzzle.
    Keywords: Indeterminacy, Sunspots and Self-Fulfilling Expectations, International Business Cycles, Net Exports, Terms of Trade, Consumption-Real Exchange Rate Anomaly, Combined Impulse Responses
    JEL: E32 F41 F44
    Date: 2021–11
  13. By: Nicolas Groshenny; Benedikt Heid; Tayushma Sewak
    Abstract: Uncertainty shocks have been shown to affect the real economy, but uncertainty remains about their trade effects and whether effects are similar across different types of uncertainty. We investigate how global economic, financial, and trade policy uncertainty affect the trade flows of the seven largest emerging economies (EM-7) using a panel structural vector autoregressive model. We find that: (1) Global economic and trade policy uncertainty shocks induce a protracted decline of about 4 to 5% in EM-7’s imports and exports. (2) Global economic and trade policy uncertainty act as trade barriers, reducing the EM-7’s degree of openness and their trade balance to GDP ratio. (3) Financial uncertainty only has a short-term impact on EM-7’s trade flows. (4) Trade policy uncertainty is the most important type of uncertainty affecting trade flows, explaining 11% of the variation in trade flows.
    Keywords: International trade, trade policy, uncertainty, emerging economies, panel VAR
    JEL: F13 F41 F62
    Date: 2021–09

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