nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒06‒13
seventeen papers chosen by
Martin Berka
Massey University

  1. The Global Financial Cycle and Capital Flows During the COVID-19 Pandemic By J. Scott Davis; Andrei Zlate
  2. Uncertainty Shocks, Capital Flows, and International Risk Spillovers By Ozge Akinci; Sebnem Kalemli-Ozcan; Albert Queraltó
  3. Sanctions and the Exchange Rate By Oleg Itskhoki; Dmitry Mukhin
  4. On Wars, Sanctions and Sovereign Default By Javier Bianchi; César Sosa-Padilla
  5. Causal Effects of Countercyclical Interest Rates: Evidence from the Classical Gold Standard By Kris James Mitchener; Gonçalo Pina
  6. The Financial Resource Curse Revisited: The Supply-Side Effect of Low Interest Rates By Simon Hildebrandt; Jochen Michaelis
  7. International Portfolio Rebalancing and Fiscal Policy Spillovers By Sami Alpanda; Uluc Aysun; Serdar Kabaca
  8. Output Divergence in Fixed Exchange Rate Regimes: Is the Euro Area Growing Apart? By Yao Chen; Felix Ward
  9. International Risk Sharing for Food Staples By Scott C. Bradford; Digvijay Singh Negi; Bharat Ramaswami
  10. The Fed's International Dollar Liquidity Facilities: New Evidence on Effects By Linda S. Goldberg; Fabiola Ravazzolo
  11. The Implication of Exchange Rate Volatility on Nigeria’s External Reserves: 1980-2020 By Soro, Garbobiya Tuwe; Aras, Osman Nuri
  12. Hot off the press: News-implied sovereign default risk By Dim, Chukwuma; Koerner, Kevin; Wolski, Marcin; Zwart, Sanne
  13. Monetary and macroprudential policy interactions in a model of the European Union By Richard Dennis; Pelin Ilbas
  14. The WB Constant Dollar Income Concept: An Interpretation By Syed M. Ahsan; S. Quamrul Ahsan
  15. The Impossible Quartet in a Demand Led Growth-Supermultiplier Model for a Small Open Economy By Jose Luis Oreiro; Julio Fernando Costa Santos
  16. Alternative Measures for the Global Financial Cycle: Do They Make a Difference? By Xin Tian; Jan Jacobs; Jakob de Haan
  17. The Chronology of Brexit and UK Monetary Policy By Martin Geiger; Jochen Güntner

  1. By: J. Scott Davis; Andrei Zlate
    Abstract: We estimate the heterogeneous effect of the global financial cycle on exchange rates and cross-border capital flows during the COVID-19 pandemic, using weekly exchange rate and portfolio flow data for a panel of 48 advanced and emerging market economies. We begin by estimating the global financial cycle at a weekly frequency with data through 2021 and observe the two standard deviation fall in our global financial cycle index over a period of four weeks in March 2020. We then estimate the country-specific sensitivities of exchange rates and capital flows to fluctuations in the global financial cycle. We show how during the pandemic crisis, high-frequency COVID-19 fundamentals like infection and vaccination rates—which differed in timing and intensity across our sample countries—were just as important as traditional, slow-moving macroeconomic fundamentals, such as the net external asset position and the current account balance, in explaining the cross-country heterogeneity in exchange rates and capital flows.
    Keywords: COVID-19; global financial cycle; capital flows; exchange rates
    JEL: F3 F4
    Date: 2022–05–13
  2. By: Ozge Akinci; Sebnem Kalemli-Ozcan; Albert Queraltó
    Abstract: Foreign investors’ changing appetite for risk-taking has been shown to be a key determinant of the global financial cycle. Such fluctuations in risk sentiment also correlate with the dynamics of uncovered interest parity (UIP) premia, capital flows, and exchange rates. To understand how these risk sentiment changes transmit across borders, we propose a two-country macroeconomic framework. Our model features cross-border holdings of risky assets by U.S. financial intermediaries that operate under financial frictions and act as global intermediaries in that they take on foreign asset risk. In this setup, an exogenous increase in U.S.-specific uncertainty, modeled as higher volatility in U.S. assets, leads to higher risk premia in both countries. This occurs because higher uncertainty leads to deleveraging pressure on U.S. intermediaries, triggering higher global risk premia and lower global asset values. Moreover, when U.S. uncertainty rises, the exchange rate in the foreign country vis-a-vis the dollar depreciates, capital flows out of the foreign country, and the UIP premium increases in the foreign country and decreases in the U.S., as in the data.
    Keywords: financial frictions; risk premia; time-varying uncertainty; intermediary asset pricing; financial spillovers; global financial cycle
    JEL: E32 E44 F41
    Date: 2022–05–01
  3. By: Oleg Itskhoki; Dmitry Mukhin
    Abstract: We show that the exchange rate may appreciate or depreciate depending on the specific mix of sanctions imposed, even if the underlying equilibrium allocation is the same. Sanctions that limit a country's imports tend to appreciate the country’s exchange rate, while sanctions that limit exports and/or freeze net foreign assets tend to depreciate it. Increased precautionary household demand for foreign currency is another force that depreciates the exchange rate, and it can be offset with domestic financial repression of foreign currency savings. The overall effect depends on the balance of currency demand and currency supply forces, where exports and official reserves contribute to currency supply and imports and foreign currency precautionary savings contribute to currency demand. Domestic economic downturn and government fiscal deficits are additional forces that affect the equilibrium exchange rate. The dynamic behavior of the ruble exchange rate following Russia's military invasion of Ukraine in February 2022 and the resulting sanctions is entirely consistent with the combined effects of these mechanisms.
    JEL: E50 F31 F32 F41 F51
    Date: 2022–04
  4. By: Javier Bianchi; César Sosa-Padilla
    Abstract: This paper explores the role of restrictions on the use of international reserves as economic sanctions. We develop a simple model of the strategic game between a sanctioning (creditor) country and a sanctioned (debtor) country. We show how the sanctioning country should impose restrictions optimally, internalizing the geopolitical benefits and the financial costs of a potential default from the sanctioned country.
    JEL: F3 F34 F41 F42 F51
    Date: 2022–04
  5. By: Kris James Mitchener; Gonçalo Pina
    Abstract: We estimate the causal impact of countercyclical interest rates on macroeconomic outcomes in open economies. To identify countercyclical interest rates, we construct a new database of short-term interest rates, principal exports, and international commodity prices for 40 economies from 1870 to 1913. This era of capital mobility, nominal anchors, specialization and trade integration, exposed economies to multiple exogenous demand-side shocks. Specialization and trade integration subjected economies to a “commodity lottery” in the form of price fluctuations in world markets. Capital mobility and a currency peg exposed them to interest-rate movements originating in the U.K., the largest economy and linchpin of the classical gold standard. We identify (i) positive effects of commodity-export prices on real GDP and the domestic price level and (ii) negative effects of exogenous changes in short-term interest rates on the same variables. We then show that countercyclical interest rates, defined relative to export-price shocks, stabilized both output and the domestic price level. This stabilization was more effective for the price level than for output.
    Keywords: countercyclical interest rates, stabilization, gold standard, commodity lottery
    JEL: E52 E32 F33 F41 F62 N10
    Date: 2022
  6. By: Simon Hildebrandt (University of Kassel); Jochen Michaelis (University of Kassel)
    Abstract: Benigno and Fornaro (2014) show that an episode of low interest rates may harm an economy. Low interest rates trigger a consumption boom, labor shifts away from the tradable sector, learning spillovers from foreign technology decline and so do domestic total factor productivity, consumption and welfare. In this paper, we show that their conclusion of a financial resource curse does not hold in a world with capital as production factor. Low interest rates now trigger an investment boom, there is no shift of labor between sectors, total factor productivity remains unaffected. Our model confirms “textbook wisdom†, i.e., an episode of low interest rates enhances welfare in a small open economy.
    Keywords: capital accumulation, endogenous growth, macroeconomic integration
    JEL: E22 F36 F43
    Date: 2022
  7. By: Sami Alpanda (University of Central Florida, Orlando, FL); Uluc Aysun (University of Central Florida, Orlando, FL); Serdar Kabaca (Bank of Canada, Ottawa, Canada)
    Abstract: We theoretically and empirically evaluate the spillover effects of debt-financed fiscal policy interventions of the United States on other economies. We first consider a two-country dynamic stochastic general equilibrium model with international portfolio rebalancing effects arising from an imperfect substitutability between short- and long-term domestic and foreign bonds. The model shows that US fiscal expansions financed by long-term debt issuance would, on net, hinder economic activity in the rest of the world (ROW). This is despite the standard trade channel’s net positive effect on the ROW economy given the depreciation in the ROW currency. The fall in ROW output occurs mainly due to the increase in the ROW term premia and long-term rates through the portfolio rebalancing channel, as the relative demand for ROW long-term bonds decreases following the increase in the supply of US long-term bonds accompanying the fiscal expansion. Testing the predictions of our theoretical model by using panel regressions and vector autoregressions, we find empirical support for the negative relationship between ROW output and US fiscal spending. The data also confirm the positive relationship between ROW term spreads and US fiscal spending.
    Keywords: International portfolio rebalancing, international spillover effects of fiscal policy, preferred habitat, DSGE.
    JEL: E62 F41 F42
    Date: 2022–05
  8. By: Yao Chen (Erasmus University Rotterdam); Felix Ward (Erasmus University Rotterdam)
    Abstract: Can fixed exchange rate regimes cause output divergence among member states? We show that such divergence is a long-run equilibrium characteristic of a two-region model with fixed exchange rates, heterogeneous labor markets, and endogenous growth. Under flexible exchange rates, monetary policy closes output gaps and realizes the associated maximum TFP growth in both regions. Upon fixing exchange rates, the region with higher structural wage inflation falls into a low-growth trap. When calibrated to the euro area, the model implies a slowdown in the TFP growth rate of the euro areaÕs periphery relative to its core. An empirical analysis confirms that the peripheryÕs higher structural wage inflation rate contributed to its lower TFP growth in the aftermath of joining the euro.
    Keywords: Exchange rate, growth, monetary policy
    JEL: E50 F31 O40
    Date: 2022–04–28
  9. By: Scott C. Bradford (Brigham Young University); Digvijay Singh Negi (Indira Gandhi Institute of Development Research); Bharat Ramaswami (Ashoka University)
    Abstract: The global output of food staples is far more stable than most individual nations’ outputs, but does this lead to consumption risk sharing? This paper applies tools from the risk sharing literature to address this question for rice, wheat, and maize, using a multilateral risk sharing model that, unlike the canonical model, accounts for trade costs. While the data show that optimal risk sharing does not occur, the wheat market comes closest to the idealized model. Our analysis also implies that both trade and storage play significant roles in smoothing domestic output shocks. Further, we find that risk sharing tends to rise with a nation’s income.
    Keywords: food markets; risk sharing; international trade; supply shocks
    Date: 2022–02–21
  10. By: Linda S. Goldberg; Fabiola Ravazzolo
    Abstract: In March 2020, the Federal Reserve eased the terms on its standing swap lines in collaboration with other central banks, reactivated temporary swap agreements, and then introduced the new Foreign and International Monetary Authorities (FIMA) repo facility. We provide new evidence on how the central bank swap lines and FIMA repo facility reduce strains in global dollar funding markets and US Treasury markets during extreme stress events. These facilities are found to contribute to the narrowing of foreign exchange swap basis spreads and to reduce the sensitivity of global funding strain metrics to risk sentiment deterioration. Cross border flows through banks for excess liquidity support purposes are reduced in the near term, and the risk sensitivity of equity and bond fund flows declines. However, access to these facilities leave longer-term patterns of liquidity and capital flows across borders broadly unchanged. While official sector liquidity hoarding and “dash for cash” type of activity is expected to be lower with access to these facilities, initial evidence does not show general differential changes in foreign exchange reserve holdings by foreign central banks in line with the type of liquidity access.
    JEL: F31 F33 F42 G01 G15
    Date: 2022–04
  11. By: Soro, Garbobiya Tuwe; Aras, Osman Nuri
    Abstract: Given the volatile nature of the exchange rate in Nigeria and the dynamics in the external reserves of the nation which are kept in foreign currency (dollar), this paper examined the impact of exchange rate shocks on the Nigerian external reserves using annual data from 1980 to 2019. Employing the Autoregressive Distributed Lag model, the results of the study indicates that exchange rate has an asymmetric impact on reserves, suggesting that the partial sum of exchange rate differ in magnitude and size relative to reserves in both positive and negative direction. The impact of a positive shock in exchange rate on reserves is statistically significant while the effect of a negative shock in exchange on reserve is statistically insignificant in the long-run. The same relationship holds for the short-run effect, although, both the positive and the negative short-run effects are statistically insignificant. The study therefore recommends that monetary authority should strengthens the exchange rate by adopting a flexible exchange floating and making it to thrives in order to boost reserves. Some of these policies could include allowing the market forces to determine the exchange rate and harmonizing the exchange rate position of the country.
    Keywords: Exchange Rate, External Reserves, Non-Linear Autoregressive Distributed Lag Model, Nigeria.
    JEL: F31
    Date: 2021–05–01
  12. By: Dim, Chukwuma; Koerner, Kevin; Wolski, Marcin; Zwart, Sanne
    Abstract: We develop a sovereign default risk index using natural language processing techniques and 10 million news articles covering over 100 countries. The index is a highfrequency measure of countries' default risk, particularly for those lacking marketbased measures: it correlates with sovereign CDS spreads, predicts rating downgrades, and reflects default risk information not fully captured by CDS spreads. We assess the influence of sovereign default concerns on equity markets and find that spikes in the index are negatively associated with same-week market returns, which reverses over the next week, indicating that investors might overreact to default concerns. Equity markets' reaction to default concerns is more pronounced and persistent for countries with tight fiscal constraints. The response to global, compared to country-specific, default concerns is much stronger, underlining the relevance of global "push" factors for local asset prices.
    Keywords: Sovereign default,Credit risk,Equity returns,Machine learning,Naturallanguage processing,Early warning indicators
    JEL: F30 G12 G15
    Date: 2022
  13. By: Richard Dennis; Pelin Ilbas
    Abstract: We use the two-country euro-area model developed by Quint and Rabanal (2014) to study policymaking in the European Monetary Union (EMU). We focus on strategic interactions: 1) between an EMU-level monetary authority and an EMU-level macro-prudential authority, and; 2) between an EMU-level monetary authority and regional macro-prudential authorities. In the former, price stability and financial stability are pursued at the EMU level, while in the latter each macro-prudential authority adopts region-specific objectives. We compare cooperative and non-cooperative equilibria in simultaneous-move and leadership environments, each obtained assuming discretionary policymaking. Further, we assess the effects on policy performance of assigning shared objectives across policymakers and of altering the relative importance attached to different policy objectives. In the three-policymaker setting, we find that regional macro-prudential policymakers play an important role in achieving regional stability.
    Keywords: Monetary policy, macro-prudential policy, policy coordination
    JEL: E42 E44 E52 E58 E61
    Date: 2022–04
  14. By: Syed M. Ahsan; S. Quamrul Ahsan
    Abstract: The present note raises the issue of how best to interpret the World Bank’s (WB) much used ‘constant USD per capita income’ concept and similar series. We find that the guide to its construction appearing on the WB data portal to be sketchy. The procedures essentially convert all host-country national accounts data, in USD terms, to a common base year, currently 2015. Laudably, this renders all data internationally comparable, though one may question its cardinality. We show that the concept relies on the market exchange rate of a host-country in the base year, and hence whenever the WB alters its base year as it does every few years, the ‘constant USD’ values are directly affected by the shift in a host country’s market exchange rate during the interim period. The latter feature injects an element of randomness in the resulting income concept to the extent the observed exchange rates deviate even temporarily from what one may consider their equilibrium level. Consequently, we recommend replacing the market rate by its ‘smoothed’ version to render the resulting income series more reliable.
    Keywords: per capita income, constant USD income, current USD income, GDP deflator
    JEL: E31 F31 O11
    Date: 2022
  15. By: Jose Luis Oreiro; Julio Fernando Costa Santos
    Abstract: The aim of this paper is to investigate the long run sustainability of a growth path led by multiple non-creating capacity autonomous expenditures in a demand led-supermultiplier model for a small open economy. Using two different models the results show that it is impossible to have in the same model long-term economic growth driven by the non-capacity creating component of domestic demand, exogenous income distribution, long-run balance between productive capacity and aggregate demand and balance of payments equilibrium. Economic viability of the balanced-growth path demands growth to be led by exports, at least for small open economies.
    Keywords: Post-Keynesian Economics, Growth and Distribution, Srafian Supermutiplier, Simulation Models
    JEL: E12 E37 P10
    Date: 2022–05
  16. By: Xin Tian; Jan Jacobs; Jakob de Haan
    Abstract: We construct several measures for the global financial cycle using dynamic factor models and data for 25 advanced and emerging countries over 1980-2019. Our results suggest that global cycles in asset prices and capital flows are highly similar and synchronized, especially during crisis episodes. Our measures for asset-specific global cycles suggest that cycles in credit and house prices are less volatile and have a longer duration than cycles in equity and bond prices. Finally, we find significant co-movement of our global financial cycle measures and two measures as suggested in the literature that are based on top-down and bottom-up approaches.
    Keywords: global financial cycle, national financial cycle, dynamic factor analysis, capital flows, asset prices
    JEL: E44 F32 F36
    Date: 2022
  17. By: Martin Geiger (Liechtenstein Institute); Jochen Güntner
    Abstract: The outcome of the referendum on the UK’s membership of the European Union in June 2016 was largely unanticipated by politicians and pundits alike. Even after the “Leave†vote, the uncertainty surrounding the withdrawal process might have affected the UK economy. We draw on an official list of political events published by the House of Commons Library and daily data on UK stock prices, exchange rates, and economic policy uncertainty to construct a novel instrument for Brexit shocks. Including a monthly aggregate of this time series into a vector-autoregressive model of the UK economy, we find that Brexit shocks were quantitatively important drivers of the business cycle in the aftermath of the referendum that lowered gross domestic product, consumer confidence, and monetary policy rates while raising CPI inflation. A counterfactual experiment, in which we shut down the endogenous response of UK monetary policy to Brexit shocks, reveals that the Bank of England fended off a stronger contraction of output in 2016 and 2018.
    Keywords: Brexit, business cycle, economic policy uncertainty, high-frequency identification, monetary policy
    JEL: E02 E31 E32 E44 E58 F15
    Date: 2022–05

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