nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒03‒14
eight papers chosen by
Martin Berka
University of Auckland

  1. Monetary policy shocks and exchange rate dynamics in small open economies By Firmin Doko Tchatoka; Qazi Haque; Madison Terrell
  2. Welfare costs of exchange rate fluctuations: Evidence from the 1972 Okinawa reversion By Kazuko Kano; Takashi Kano
  3. External and Internal Real Exchange Rates and the Dutch Disease in Africa: Evidence from a Panel of Nine Oil-Exporting Countries By Edouard Mien
  4. Original sin redux: a model-based evaluation By Boris Hofmann; Nikhil Patel; Steve Pak Yeung Wu
  5. Devaluations, Deposit Dollarization, and Household Heterogeneity By Francesco Ferrante; Nils Gornemann
  6. Comparing Monetary Policy Tools in an Estimated DSGE model with International Financial Markets By Gelfer, Sacha; Gibbs, Christopher
  7. Risk Sharing Revisited By Patrick C. Harms
  8. Central bank digital currency: A review and some macro-financial implications By Hongyi Chen; Pierre Siklos

  1. By: Firmin Doko Tchatoka; Qazi Haque; Madison Terrell
    Abstract: In this paper we provide new insights on the dynamics between monetary policy shocks and real exchange rates in small open economies using a time-varying structural vector autoregression model with stochastic volatility. Identification is achieved using a combination of short-run and long-run restrictions while preserving the contemporaneous interaction between monetary policy and the exchange rate. For several small open economies, we find no evidence of the ‘exchange rate puzzle’ or the ‘delayed overshooting puzzle,’ in line with recent studies on this topic (see e.g. Bj rnland, 2009). However, there is evidence of the ‘forward discount puzzle’ in some countries, suggesting that the uncovered interest parity (UIP) is violated. In addition, a substantial decrease in the volatility of monetary policy shocks is evident in most countries, accompanied by a decline in the importance of policy shocks in explaining the volatility of exchange rates and other macroeconomic variables since the 1990s.
    Keywords: Monetary policy shocks, Exchange rate, TVP-VARs, UIP
    JEL: C32 E52 F31 F41
    Date: 2022–01
  2. By: Kazuko Kano; Takashi Kano
    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 open economy NK literature.
    Keywords: Currency regime, Currency misalignment, Welfare cost, Okinawan reversion, Menu cost model
    JEL: F31 F41 F45
    Date: 2022–01
  3. By: Edouard Mien (CERDI - Centre d'Études et de Recherches sur le Développement International - UCA [2017-2020] - Université Clermont Auvergne [2017-2020] - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Despite a large number of empirical studies on Dutch disease in developing countries and the evidence that oil revenues tend to appreciate the real exchange rate, there remains little discussion about the definition of real exchange rates. This article intends to fill this gap by using four different proxies of the real exchange rate, differentiating the internal and the external real exchange rates for agricultural and manufacturing sectors. Using Pooled-Mean-Group and Mean-Group estimates on a panel of nine African net oil-exporting countries, results show a clear appreciation of the RER generated by oil revenues except for the internal real exchange rate for manufacturing goods. This could imply that oil revenues more clearly affect agricultural compared to manufacturing competitiveness in these African countries.
    Keywords: Dutch disease,Africa,Equilibrium real exchange rate,Pooled Mean Group Estimator,Oil revenues
    Date: 2020–11
  4. By: Boris Hofmann; Nikhil Patel; Steve Pak Yeung Wu
    Abstract: Many emerging markets (EMs) have graduated from "original sin" and are able to borrow from abroad in their local currency. Using a two-country model, this paper shows that the shift from foreign currency to local currency external borrowing does not eliminate the vulnerability of EMs to foreign financial shocks but instead results in "original sin redux" (Carstens and Shin (2019)). Even under local currency borrowing from foreign lenders, a monetary tightening abroad is propagated to EM financial conditions through a tightening of foreign lenders' financial constraints. Moreover, local currency borrowing does not eliminate currency mismatches, but shifts them from the balance sheets of EM borrowers to the balance sheets of financially constrained global lenders, so that amplifying financial effects of exchange rate fluctuations remain. We provide empirical evidence in line with this prediction of the model using data on currency composition of external debt of emerging and advanced economies. Our model-based analysis further suggests that foreign exchange intervention and capital flow management measures can mitigate the adverse effects of capital flow swings in the short run and that a larger domestic investor base can reduce the vulnerability to such swings in the longer run.
    Keywords: emerging market, capital flows, exchange rate, currency mismatch.
    JEL: E3 E5 F3 F4 F6 G1
    Date: 2022–02
  5. By: Francesco Ferrante; Nils Gornemann
    Abstract: We study the aggregate and re-distributive effects of currency devaluations in a small open economy heterogeneous households model with leverage-constrained banks. Our framework captures three stylized facts about liability dollarization in emerging economies: i) banks and firms borrow in foreign currency; ii) households save in dollar-denominated local bank deposits; and iii) such deposits are mainly held by wealthier households. The resulting currency mismatch causes an erosion of banks' net worth during a devaluation, depressing credit supply. The ensuing macroeconomic downturn is amplified by a strong reduction of consumption among poorer households in response to rising borrowing costs and falling labor income. Richer households are partially insured, as they are holding a larger share of their wealth in foreign currency denominated assets. We show that a larger currency hedging by wealthier households deepens the recession and amplifies the negative spillovers for poorer agents. When deposit dollarization is high, welfare gains can arise if monetary policy dampens a depreciation.
    Keywords: Dollarization; Currency Depreciation; Household Heterogeneity; Redistribution
    JEL: E21 F32 F41
    Date: 2022–02–16
  6. By: Gelfer, Sacha; Gibbs, Christopher
    Abstract: We evaluate the dynamics of conventional and unconventional monetary policy using an estimated two-region dynamic stochastic general equilibrium (DSGE) model. In addition to traditional nominal frictions the open-economy model also includes financial frictions, international portfolio balance effects, and correlated global financial shocks. We find that both conventional and unconventional monetary policy is effective in stimulating output and in inflation. However, the type of expansionary monetary policy used has heterogeneous effects on domestic investment, imports, exports and hours worked. Further, including a financial accelerator to the DSGE model significantly dampens the impact of aggregate investment that is expected to occur with quantitative easing. This is because unconventional monetary policy in the model is associated with an expansion in banking deposits and a minimal impact on loan demand, thus creating a fall in the loan to deposit ratio as was seen after the global financial crisis. Using historical decompositions, we find that unconventional monetary policy had a significant positive impact on output and hours worked during the global financial crisis and the preceding years after, but becomes negligible after 2014. Yet, its impact on equity and bond markets remained through 2019.
    Keywords: Unconventional Monetary Policy; Quantitative Easing; International Bond Portfolio; DSGE; Financial accelerator
    Date: 2021–12
  7. By: Patrick C. Harms
    Abstract: The paper adds to the literature as follows: starting from the benchmark model of Asdrubali et al. (1996), we reproduce the original specification with a data set obtained from the authors as well as possible. In a second step, this specification is brought to euro area data. Again, the results are broadly in line with the existing literature (Furceri and Zdzienicka, 2015). We report rolling window and recursive estimates and show high time variation in the coefficients. The parameter estimates are related to a recession dummy in the euro area (confirmed by structural break tests) and very sensitive to the exclusion of countries like Ireland and Luxembourg. Granger causality analysis in a VAR approach also points to a strong dependence on the macroeconomic environment. Last but not least we discuss shortcomings of the approach. All in all the high time variability of the results in a benchmark model in the spirit of Asdrubali et al. (1996) makes it difficult to draw robust policy recommendations for the euro area.
    Keywords: Economic and Monetary Union, Risk Sharing Mechanismus
    JEL: F41 F32 F36
    Date: 2021
  8. By: Hongyi Chen; Pierre Siklos
    Abstract: Central Bank Digital Currency (CBDC) has attracted considerable interest and its deployment on a global scale is imminent. However, digital currencies face several challenges. They include: legal, technological, and political considerations. We summarize those challenges and add a few more that have not received much attention in the literature. We then consider two forms of CBDC: a narrow version that only replaces notes and coins and a broader form with a deposit feature. The narrow CBDC is the most likely one to be first introduced. Next, relying on evidence of past episodes of financial innovation, and using cross-country data, we explore the hypothetical impact of CBDC on inflation and financial stability, based on the historical behaviour of the velocity of circulation and incorporating a CBDC’s impact in McCallum’s policy rule which defines the stance of monetary policy based on money growth. Our simulations suggest that CBDC need not produce higher inflation, but financial stability remains at risk. We provide some policy implications.
    Keywords: Central Bank Digital Currency, Velocity, Money Demand, Monetary Policy, McCallum Rule
    JEL: O31 O33 E41 E42 E51 E52
    Date: 2022–01

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