nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒03‒28
twelve papers chosen by
Martin Berka
University of Auckland

  1. Trade Wars, Currency Wars By Stéphane Auray; Michael B. Devereux; Aurélien Eyquem
  2. "Financial Barriers to Structural Change in Developing Economies: A Theoretical Framework" By Giuliano Toshiro Yajima; Lorenzo Nalin
  3. Can a country borrow forever? The unsustainable trajectory of international debt: the case of Spain By Vicente Esteve; María A. Prats
  4. The Dispersion of Mark-ups in an Open Economy By Stéphane Auray; Aurélien Eyquem
  5. A DSGE model with partial euroization: the case of the Macedonian economy By Mihai Copaciu; Joana Madjoska; Mite Miteski
  6. The international financial system after COVID-19 By Maurice Obstfeld
  7. Fiscal sustainability, fiscal reactions, pitfalls and determinants By António Afonso; José Carlos Coelho
  8. Yield Curve Dynamics and Fiscal Policy Shocks By Adam Kucera; Evzen Kocenda; Ales Marsal
  9. Financial Transaction Tax, macroeconomic effects and tax competition issues: a two-country financial DSGE model By Olivier Damette; Karolina Sobczak; Thierry Betti
  10. The welfare-maximizing discount rate in a small open economy By Asplund, Disa
  11. Asymmetric Information and Sovereign Debt Disclosure By Bulent Guler; Yasin Kursat Onder; Temel Taskin
  12. Monetary and fiscal policy in a nonlinear model of public debt By Gian Italo Bischi; Germana Giombini; Giuseppe Travaglini

  1. By: Stéphane Auray (CREST-Ensai and Université du Littoral Côte d’Opale, France); Michael B. Devereux (Vancouver School of Economics, University of British Columbia, Canada); Aurélien Eyquem (Université Lumière Lyon2, France)
    Abstract: Countries distort trade patterns (‘trade wars’) to gain strategic advantage relative to one another. At the same time, monetary policies are set independently and have spillover effects on partner countries (‘currency wars’). We combine these two scenarios, and show that they interact in deep and interesting ways. The stance of monetary policy has substantial effects on the equilibrium degree of protection in a Nash equilibrium of the monetary and trade policy game. Trade wars lead to higher equilibrium inflation rates. Cooperation in monetary policy leads to both higher inflation and greater degree of trade protection. By contrast, when monetary policy is constrained by pegged exchange rates or the zero lower bound on interest rates, equilibrium tariffs are lower. Finally, when one country has the dominant currency in trade, it gains a large advantage in a trade war.
    Keywords: Protectionism, Currency Wars, Trade Wars
    JEL: F30 F40 F41
    Date: 2021–09–19
  2. By: Giuliano Toshiro Yajima; Lorenzo Nalin
    Abstract: Liabilities denominated in foreign currency have established a permanent role on emerging market firms' balance sheets, which implies that changes in both global liquidity conditions and in the value of the currency may have a long-lasting effect for them. In order to consider the financial conditions that may encourage (discourage) structural change in a small, open economy, we adopt the framework put forward by the "monetary theory of distribution" (MTD). More specifically, we follow the formulation adopted by Dvoskin and Feldman (2019), whereby the financial system is intended as a basic sector that promotes innovation (Schumpeter 1911). In accordance with this, financial conditions are binding only for the innovative entrepreneurs, whose methods of production are not dominant and hence they need to borrow from banks to kickstart their production. Through this device, our model offers an explanation of the technological lock-in experienced by a small, open economy that takes international prices as given.
    Keywords: Foreign Exchange Policy; Currency Mismatches; Structural Change
    JEL: F37 F31 E7
    Date: 2022–03
  3. By: Vicente Esteve (Universidad de Valencia and Universidad de Alcalá, Spain); María A. Prats (Universidad de Murcia, Spain)
    Abstract: We address the issue of the sustainability Spain's external debt, using data for the period 1970-2020. To detect episodes of potentially explosive behavior of the Spanish net foreign assets over GDP ratio and the current account balance over GDP ratio, as well as episodes of external adjustments over this long period, we employ a recursive unit root test approach. Our empirical analysis leads us to conclude that there is some evidence of bubbles in the ratio between Spanish net foreign assets and the GDP. In contrast, the evidence that the ratio between the Spanish current account balance and the GDP had explosive subperiods is very weak.The episode of explosive behavior identified in the position of net foreign assets during the period 2002-2015 was the result of the country's economic expansion 1995-2007. The results also show an external adjustment during the period 2008-2019 after the start of a cyclical economic recession.
    Keywords: external imbalances; sustainability; intertemporal external budget constraint; explosiveness; recursive unit root test
    JEL: F32 F36 F37 F41 C22
    Date: 2022–03
  4. By: Stéphane Auray (CREST-Ensai and ULCO, France); Aurélien Eyquem (Université Lumière Lyon2, France)
    Abstract: We introduce heterogeneous mark-ups through Bertrand competition in a two-country model with endogenous firms' entry and tradability à la Ghironi and Melitz (2005). Bertrand competition generates a distribution of mark-ups according to which firms that are larger and more productive charge lower prices, attract larger market shares and extract larger mark-ups. First, we characterize first-best allocations and their implementation. We find that they are independent from the degree of mark-ups' heterogeneity, suppress the dispersion of mark-ups and imply zero distortions on labor as well as substantial subsidies to preserve firm's incentives to enter. Second, second-best alternative policies with a restricted number ofi nstruments and a balanced budget significantly reduce the potential welfare gains from fiscal policies. Third, the total welfare losses from passive policies are lower under heterogeneous mark-ups than under homogeneous mark-ups: while th edispersion of mark-ups has negative effects on the intensive margin, output per firm, it also raises expected profits for potential entrants and raises the extensive margin, the number of firms in both domestic and export markets, pushing them closer to their efficient levels. Fourth, we also investigate the dynamic properties of allocations under passive and optimal policies considering aggregate productivity shocks and trade liberalization experiments.
    Keywords: Heterogeneous firms, Endogenous Entry, Open economy, Strategic pricing, Optimal taxation
    JEL: D4 E20 E32
    Date: 2021–06–15
  5. By: Mihai Copaciu (National Bank of Romania); Joana Madjoska; Mite Miteski (National Bank of the Republic of North Macedonia)
    Abstract: This paper describes the theoretical structure and estimation results for a DSGE model for the Macedonian economy. Having as benchmark the model of Copaciu et al. (2015), modified to allow for a fixed exchange rate, we are able to match relatively well the volatility observed in the data. Given the monetary policy regime in place, the debt deflation channel is more important relative to the financial accelerator one when compared to the flexible exchange rate case. The lack of balance sheet effects results in no significant differences in terms of net worth evolution across the two types of entrepreneurs when impulse response functions are evaluated. However, the shocks related to the financial sector appear to be especially important for investment, for the domestic interest rate and interest rate spreads, illustrating the relevance of including financial frictions in the model. With the exchange rate not acting as a shock absorber, the external shocks are more relevant for the CPI inflation and the domestic interest rate. The drop in GDP associated with the pandemic mainly reflects the negative innovations to the consumption preference shock and to the permanent technology shock.
    Keywords: DSGE model, Financial frictions, Partial euroization, Small open economy, Bayesian estimation
    JEL: E0 E3 F0 F4 G0 G1
    Date: 2022
  6. By: Maurice Obstfeld (Peterson Institute for International Economics)
    Abstract: In March 2020, international markets seized up with a violence unequaled since the global financial crisis nearly a dozen years before. As economies around the world locked down in the face of the potentially deadly but completely novel SARS-CoV-2 virus, stock markets fell, firms and governments scrambled for cash, liquidity strains emerged even in the market for US Treasurys, and capital flows to emerging-market and developing economies (EMDEs) reversed violently. This paper reviews the evolution of global financial markets since the global financial crisis, changes in academic thinking about these markets' domestic impacts, the strains seen during the COVID-19 crisis, and perils that may lie ahead. A key theme is that stability will be enhanced if the global community embraces reforms that elevate market resilience, rather than depending on skillful policymakers wielding aggressive but ad hoc policy interventions to ride to the rescue again.
    Keywords: COVID-19 crisis, emerging markets, capital flows, international finance, global financial cycle, US dollar, Korean economy
    JEL: E58 F32 F33 F36 F42 F44
    Date: 2022–02
  7. By: António Afonso; José Carlos Coelho
    Abstract: We examine the sustainability of public finances and its determinants for 19 Eurozone countries from 1995 to 2020. We conclude for the existence of panel cointegration between government revenues and expenditures; primary government balance and one-period lagged public debt-to-GDP ratio; and public debt-to-GDP ratio and one-period lagged primary government balance. the estimated fiscal reaction functions suggest the existence of a Ricardian fiscal regime. Finally, modelling via time-varying coefficients, we find that fiscal sustainability increases with growth, fiscal balances and fiscal rules indices, and decreases with trade openness, current account balances, government effectiveness index, after 2010, and with sovereign ratings assigned by the main rating agencies.
    Keywords: fiscal sustainability; budget balance; public debt; panel data; time-varying coefficients; Eurozone, sovereign ratings.
    JEL: C23 H61 H63 E62
    Date: 2022–03
  8. By: Adam Kucera (Czech National Bank, Czech Republic); Evzen Kocenda (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic & Institute of Information Theory and Automation, Prague, Czech Republic); Ales Marsal (Slovak National Bank, Slovak Republic & Mendel University in Brno)
    Abstract: We show that government spending does play a role in shaping the yield curve which has important consequences for the cost of private and government financing. We combine government spending shock identification strategies from the fiscal macro literature with recent advancements in no-arbitrage affine term structure modeling, where we account for time-varying macroeconomic trends in inflation and the equilibrium real interest rate. We stress in our empirical macro-finance framework the importance of timing in the response of yields to government spending. We find that the yield curve responds positively but mildly to a surprise in government spending shocks where the rise in risk-neutral yields is compensated by a drop in nominal term premia. The news shock in expectations about future expenditures decreases yields across all maturities. Complementarily, we also analyze the effect of fiscal policy uncertainty where higher fiscal uncertainty lowers yields.
    Keywords: Government Expenditures, Fiscal policy, U.S. Treasury Yield Curve, Affine Term Structure Model
    JEL: C38 C51 C58 E43 E47
    Date: 2022–04
  9. By: Olivier Damette; Karolina Sobczak; Thierry Betti
    Abstract: We document how introducing a financial transaction tax affects real and financial activity in a general equilibrium framework. Our model replicates some interesting stylised facts about financial markets. Informed, or rational, traders follow the standard rational expectations, while exogenous disturbances, such as optimism or pessimism shocks, affect the expectations of noise traders. An entry cost is introduced to endogenise the entry of noise traders in the financial markets. In contrast to the previous literature, financial contagion and international spillovers are considered in a two-country financial DSGE model. A welfare analysis is performed and we show that the effects of the financial transaction tax on welfare are non-linear and mainly depend on the composition of the financial market. In addition, introducing a financial transaction tax allows volatility to be reduced in both the real and financial sectors, and this result is robust to several model specifications. In a context where only one country implements the tax, we identify some externalities, as the country with the tax is likely to export stability or instability through the flows of traders. Like in the Heckscher-Ohlin-Samuelson (HOS) model in which capital and labor move internationally when countries trade, we assume that there are trader flows when traders invest abroad. As a consequence, noise traders can implicitly move to the foreign country to escape the tax, and this means that countries have conflicting interests. When markets are liquid with a large proportion of noise traders, countries do not internalise that they export noise traders and then some instability to the other market and so they set a tax rate that is higher than the optimal. At the opposite end of the scale, when markets are less liquid and the proportion of noise traders is small, some positive externalities (like financial stability) are overlooked, and so the tax rate is set too low and is sub-optimal. A cooperative situation where countries set a common tax rate is the best solution ans is welfare-enhancing. These results have important policy implications, since the existence of the tax competition issues revealed by our two-country framework might explain why the European Commission proposal initially discussed in 2011 is so contested and has been rejected by several countries.
    Keywords: Financial Transaction Tax, DSGE, Welfare, Noise Traders, Tax coordination, EU tax project.
    JEL: E22 E44 E62
    Date: 2022–03–24
  10. By: Asplund, Disa (Swedish National Road & Transport Research Institute (VTI))
    Abstract: The controversy about what approach is best for calculating the social discount rate for public investments is both long standing and heated. Two main approaches are the social time preference and the social opportunity cost approaches. Complicating issues are tax wedges, the question of whether public investments crowd out current private consumption or private saving, and the possibility of myopic behavior among individuals. This study uses a model that takes these issues into account to derive the discount rate that optimizes welfare in a small open economy. The result is that even if individuals have behavioral preferences differing from the normative preferences of the social planner and even if tax wedges exist, the optimal discount rate is the pre-tax market return on capital, as long as individuals are forward looking and consistent in their behavioral preferences, and their choices are not constrained by, for example, liquidity restrictions.
    Keywords: Discounting; Tax wedge; Social time preference; Social opportunity cost
    JEL: E21 F41 H43
    Date: 2022–03–18
  11. By: Bulent Guler (Indiana University Bloomington); Yasin Kursat Onder (Ghent University); Temel Taskin (Bank of Canada)
    Abstract: This paper studies sovereign debt and default dynamics under alternative disclosure arrangements in a sovereign default model incorporated with asymmetric information and long-term debt. Government is assumed to have access to both international bond financing and non-Paris club lending (a hidden and collateralized debt). Our results show that with a shift from partial disclosure to full disclosure regime governments can borrow at more favorable terms conditional on the same levels of debt and income. However, due to lack of commitment, favorable bond prices encourage governments to borrow more and experience higher default rates in the long-run equilibrium of the full disclosure regime. As a result, the switch from partial disclosure to full disclosure generates small welfare losses contrary to conventional wisdom.
    Keywords: Hidden debt, Sovereign debt, Sovereign default, Collateralized debt, Asymmetric information, Debt disclosure
    Date: 2022–03
  12. By: Gian Italo Bischi (Department of Economics, Society & Politics, Università di Urbino Carlo Bo); Germana Giombini (Department of Economics, Society & Politics, Università di Urbino Carlo Bo); Giuseppe Travaglini (Department of Economics, Society & Politics, Università di Urbino Carlo Bo)
    Abstract: In this paper we study the dynamic relationship between the pub- lic debt ratio and the real interest rate. Specifically, by means of a macroeconomic model of simultaneous di erence equations - one for the debt ratio and the other for the real interest rate - we focus on the role of monetary policy, fiscal policy and risk premium in affecting the stability of the debt ratio and the existence of steady states, if any. We show that, in a dynamic framework, fiscal rules may not be enough to control the pattern of the debt ratio, and the adoption of a monetary policy, in the form of an interest rate rule, is necessary to control the pattern of the debt ratio for assuring its sustainability over time. Notably, the creation or disappearance of steady states, or periodic (stable) cycles, can generate scenarios of multistability. While we obtain clear evidence that an active monetary policy has a stabilizing effect on both the real interest rate and the debt ratio, we also find that, in some scenarios, fiscal policy is not sucient to avoid explosive patterns of the debt ratio.
    Keywords: Public debt; Interest rate; Instability; Chaos
    Date: 2022

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