nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒05‒16
eleven papers chosen by
Martin Berka
Massey University

  1. A Preferred-Habitat Model of Term Premia, Exchange Rates, and Monetary Policy Spillovers By Pierre-Olivier Gourinchas; Walker D. Ray; Dimitri Vayanos
  2. Twin Deficits through the Looking Glass: Time-Varying Analysis in the Euro Area By António Afonso; José Carlos Coelho
  3. In Search of Dominant Drivers of the Real Exchange Rate By Wataru Miyamoto; Thuy Lan Nguyen; Hyunseung Oh
  4. European Exchange Rate Adjustments in Response to COVID-19, Containment Measures and Stabilization Policies By Jens Klose
  5. A Minimalist Model for the Ruble During the Russian Invasion of Ukraine By Guido Lorenzoni; Iván Werning
  6. Enough Potential Repudiation: Economic and Legal Aspects of Sovereign Debt in the Pandemic Era By Anna Gelpern; Ugo Panizza
  7. Fiscal Sustainability, Fiscal Reactions, Pitfalls and Determinants By António Afonso; José Carlos Coelho
  8. Country-Based Investing with Exchange Rate and Reserve Currency By Galvani, Valentina
  9. "Why the Feldstein-Horioka "Puzzle" Remains Unsolved" By Jesus Felipe; Scott Fullwiler; Al-Habbyel Yusoph
  10. Does the Twin-Deficits doctrine apply to the Gulf Cooperation Council? A dynamic panel VAR-X model approach By AL-JAHWARI, SALIM AHMED SAID
  11. DO DIFFERENT TYPES OF CAPITAL INFLOWS HAVE DIFFERENTIAL IMPACT ON OUTPUT? Evidence from Time series and Panel Analysis By Bhavesh Garg; Pravakar Sahoo

  1. By: Pierre-Olivier Gourinchas; Walker D. Ray; Dimitri Vayanos
    Abstract: We develop a two-country model in which currency and bond markets are populated by different investor clienteles, and segmentation is partly overcome by global arbitrageurs with limited capital. Our model accounts for the empirically documented violations of Uncovered Interest Parity (UIP) and the Expectations Hypothesis, and for how UIP violations depend on bond maturity, investment horizon, and yield curve slope differentials. Large-scale purchases of long-maturity bonds lower domestic and foreign bond yields, and depreciate the currency. Conventional monetary policy is transmitted to domestic and international bond yields as well, but its international transmission is weaker than for unconventional policy.
    JEL: F31 F41 F42 G11 G12
    Date: 2022–03
  2. By: António Afonso; José Carlos Coelho
    Abstract: Using two measures of the fiscal position, the cyclically adjusted primary budget balance (CAPB) and the total budget balance, we assess the Twin Deficit Hypothesis for the Euro Area in the period 1995-2020. Furthermore, we estimate time-varying coefficients of the current account balance responses to changes in the CAPB and in the government balance and we identify the determinants of these responses. The CAPB and the government balance, in addition to being determinants of the current account balance, are also determinants of the time-varying responses of the current account balance. The levels of government balance, current account balance and public debt, as a percentage of GDP, and the temporal period (before and after 2010) also influence these responses.
    Keywords: CAPB, government balance, current account balance, time-varying coefficients, Eurozone, panel data
    JEL: F32 F41 H62 C33
    Date: 2022
  3. By: Wataru Miyamoto; Thuy Lan Nguyen; Hyunseung Oh
    Abstract: We uncover the major drivers of each macroeconomic variable and the real exchange rate at the business cycle frequency in G7 countries. In each country, the main drivers of key macro variables resemble each other and none of those account for a large fraction of the real exchange rate variances. We then estimate the dominant driver of the real exchange rate and find that (i) the shock is largely orthogonal to macro variables and (ii) the shock generates a significant deviation of the uncovered interest parity condition. We analyze international business cycle models that are consistent with our findings.
    Keywords: real exchange rate; international business cycles; uncovered interest parity
    JEL: E32 F31
    Date: 2022–04–13
  4. By: Jens Klose (THM Business School Giessen)
    Abstract: This paper estimates the effects of nine exchange rates for european countries vis-a-vis the Euro in the COVID pandemic. Using data on COVID cases, three containment and two stabilization measures relative to the euro area counterparts, it is shown that a more severe spread of the virus leads to a depreciation of the domestic currency. The same holds with respect to stricter movement restrictions, health care measures and more supportive monetary policies. More expansionary fiscal policies by the domestic country on the other hand lead to an appreciation of the currency. Two extensions show that the results differ with respect to whether the country is a scandinavian or eastern european country and whether the euro area countries or the other european countries introduce the measures.
    Keywords: Exchange rates, COVID-19, Europe, stabilization policies, containment measures, panel VAR
    JEL: E44 E52 E62
    Date: 2022
  5. By: Guido Lorenzoni; Iván Werning
    Abstract: This note isolates an overlooked economic force for the Ruble to appreciate in response to international sanctions limiting exports to Russia. The economic intuition is that when Russians are unable to buy the mix of foreign goods they wish, then foreign goods becomes less attractive, increasing the demand for domestic goods; to reestablish an equilibrium a real appreciation is needed to raise the relative price of domestic goods and incentivizing the accumulation of foreign assets and the import from non-sanctioning countries. We also review well-known forces for a depreciation (e.g. Russian export reduction). Our analysis emphasizes that the exchange rate is an inadequate signal of welfare impacts and the effectiveness of sanctions.
    JEL: E0 F3 F31 F4 F51
    Date: 2022–04
  6. By: Anna Gelpern (Georgetown University Law Center & Peterson Institute for International Economics); Ugo Panizza (IHEID, Graduate Institute of International and Development Studies, Geneva)
    Abstract: This paper surveys recent economic and legal literature on sovereign debt in light of the COVID-19 shock. Most of the core theoretical contributions we review across the two disciplines hinge on immunity, and the sovereign borrower's consequent inability to commit to repay foreign creditors, as the distinguishing attribute of sovereignty. We highlight a persistent gap between sovereign debt theories grounded in immunity and empirical evidence that low- and middle-income country governments borrow far more than theory would predict. On the other hand, advanced economy governments, generally viewed as outside the scope of this literature before the euro area debt crisis, have shown themselves to be far more commitment challenged than previously supposed. We conclude that the traditional split between a literature concerned with developing economy sovereigns that repudiate, and one concerned with advanced economies that don't, is no longer appropriate (if it ever was). We argue that shifting some attention away from immunity to a different attribute of sovereignty-authority, or the ability to make rules for domestic markets and negotiate market access terms with other sovereigns—could help bridge the gap between the two literatures, and between theory and experience.
    Keywords: Sovereign Debt; Sovereign Default; Public Debt
    JEL: F30 F34 G15 K12
    Date: 2022–04–28
  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
  8. By: Galvani, Valentina (University of Alberta, Department of Economics)
    Abstract: This study examines how style investing impacts correlations in a small and large economy, with exchange rate risk, and a reserve currency. The results show that style investing increases correlations in both economies, but more so in the smaller market. The impact of style investing on either country's correlations depends nonlinearly on the volatility of the exchange rate and the strength of the reserve currency effect. Higher levels of risk aversion amplify the impact of style investing on correlations. Imprecise signals and country preferences increase correlation distortions. The results have risk management implications for portfolio diversification.
    Keywords: Style investing; International Markets; Portfolio Diversification; Return Correlations; International Markets
    JEL: G10 G11 G12
    Date: 2022–03–24
  9. By: Jesus Felipe; Scott Fullwiler; Al-Habbyel Yusoph
    Abstract: This paper argues that the 40-year-old Feldstein-Horioka "puzzle" (i.e., that in a regression of the domestic investment rate on the domestic saving rate, the estimated coefficient is significantly larger than what would be expected in a world characterized by high capital mobility) should have never been labeled as such. First, we show that the investment and saving series typically used in empirical exercises to test the Feldstein-Horioka thesis are not appropriate for testing capital mobility. Second, and complementary to the first point, we show that the Feldstein-Horioka regression is not a model in the econometric sense, i.e., an equation with a proper error term (a random variable). The reason is that by adding the capital account to their regression, one gets the accounting identity that relates the capital account, domestic investment, and domestic saving. This implies that the estimate of the coefficient of the saving rate in the Feldstein-Horioka regression can be thought of as a biased estimate of the same coefficient in the accounting identity, where it has a value of one. Since the omitted variable is known, we call it "pseudo bias."" Given that this (pseudo) bias is known to be negative and less than one in absolute terms, it should come as no surprise that the Feldstein-Horioka regression yields a coefficient between zero and one.
    Keywords: Accounting Identity; Feldstein-Horioka Paradox; Investment; Pseudo Bias; Saving
    JEL: E01 F21 F32 F36 F41 G15
    Date: 2022–04
    Abstract: Economies around the world tend to show a strong link from fiscal to current accounts deficits. The phenomenon is recognized as the twin-deficits doctrine, which stipulates the presence of a uni-directional causal relationship from the fiscal account deficit (FD) to the current account deficit (CD). This relationship is also apparent for the commodity-based economies of the Gulf Cooperation Council States (GCC). The region is well-documented to rapidly succumb to deteriorating fiscal and current account deficits with any prolonged decline in international crude oil prices. This study extends the research of Granger non-causality between budget deficits by employing a macro-panel in a two-dimensional vector autoregression model with an exogenous variable (VAR-X) process where oil is included as the exogenous control variable. The study uses a homogeneous model in the generalized method of moments framework to conduct a comprehensive investigation between the two deficits and analyze if the twin-deficits doctrine applies to the GCC. A heterogeneous model with fixed time coefficients is then used as a robustness check to assess if the twin-deficits phenomenon applies to any of the GCC States. The results indicate that the pooling of data from six GCC States and the inclusion of international oil prices, as the third latent element, leads to the dismissal of the twin-deficits doctrine for the GCC as an integrated unit of analysis, and, for each member State of the GCC individually. Interestingly, the analysis uncovers a reverse direction of causality running from CD to FD.
    Keywords: Twin-Deficits; Granger non-causality; Gulf Cooperation Council; Macro-panels; VAR-X.
    JEL: C23 E62 F32 F41
    Date: 2021–07–31
  11. By: Bhavesh Garg; Pravakar Sahoo (Institute of Economic Growth, Delhi)
    Abstract: Emerging market economies have experienced an unprecedented rise in cross-border capital flows and the existing literature provides us evidence of both expansionary and contractionary effects of inflows on domestic output. In this context, we make an attempt to answer the following questions: (1) Do capital inflows lead to expansionary or contractionary effect on emerging countries? (2) Do different types of capital inflows have different impacts? and (3) Do absorptive capacities influence the effect of capital flows on the host countries? To answer these questions, we carry out a comparative analysis for India and China using quarterly data for the period 1998Q1 to 2020Q1. The results reveal that total gross capital inflows as well as disaggregated capital inflows exhibit expansionary effect on domestic output in case of both India and China. We supplement the time series data with panel analysis for the top ten capital flows recipient EMEs over the period 1998-2019. We find that capital inflows a t aggregate level and also at the disaggregate level except debt flows have an expansionary effect on output.
    Keywords: Gross capital inflows, FDI, Emerging economies, Structural breaks
    JEL: F21 F32 F43 C22 C23
    Date: 2021–09

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