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on Open Economy Macroeconomics |
| By: | Pawel Zabczyk; Marcin Kolasa; Sahil Ravgotra |
| Abstract: | We develop an extension of the open economy New Keynesian model in which agents are boundedly rational à la Gabaix (2020). Our setup nests rational expectations (RE) as a special case and it can successfully mitigate many “puzzling” aspects of the relationship between exchange rates and interest rates. Since the model implies an uncovered interest rate parity (UIP) condition featuring behavioral expectations, our results are also consistent with recent empirical evidence showing that several UIP puzzles vanish when actual exchange rate expectations are used (instead of realizations implicitly coupled with the RE assumption). We find that cognitive discounting dampens the effects of current monetary shocks and lowers the efficacy of forward guidance (FG), but its relative importance in mitigating the so-called FG puzzle is decreasing in openness. Finally, we show that accounting for myopia exacerbates the small open economy unit-root problem, makes positive monetary spillovers more likely, and increases the persistence of net foreign assets and the real exchange rate. |
| Keywords: | Monetary Policy; Exchange Rates; Bounded Rationality |
| Date: | 2022–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/112&r= |
| By: | Bušs, Ginters; Grüning, Patrick; Tkačevs, Oļegs |
| Abstract: | In order to contribute to the ongoing discussions at the European Union level about the potential simplification of its fiscal framework, we evaluate the economic and public finance stabilization properties of two benchmark fiscal rules using a New Keynesian small open economy model. If these fiscal rules are implemented one at a time, having just an expenditure growth rule tends to yield more stable macroeconomic outcomes but more volatile public finances, as compared to having only a structural balance rule. Much of the quantitative differences in relative volatilities can be accounted for by using a modified public expenditure definition in the expenditure growth rule, in particular the removal of debt service payments. Strong-enough debt correction for either fiscal rule contains public debt volatility at little expense to long-run macroeconomic stability. There is also a welfare gain for households from having only an expenditure growth rule. |
| Keywords: | Fiscal policy; DSGE; Small open economy; Fiscal-monetary policy interaction |
| JEL: | E27 E32 E62 E63 F41 H63 |
| Date: | 2022–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:075&r= |
| By: | Mr. Alberto Behar; Ramin Hassan |
| Abstract: | In terms of size, the net income balance (IB) is comparable to the trade balance (TB) for many countries. Yet the role of the IB in mitigating external vulnerabilities or complicating external adjustment remains underexplored. This paper studies the role of the IB in stabilizing or destabilizing the current account over the cycle and in crises. Our results show that, due to a negative correlation with the TB, the IB significantly dampens the time series volatility of the current account for most countries. However, the IB generally does not improve during crisis episodes, so current account adjustment occurs entirely through improvements in the TB. The paper also estimates IB semi-elasticities with respect to the exchange rate (ER). Semi-elasticities are small for most countries, so the IB is generally not a significant channel through which the ER stabilizes the current account, and trade-based semi-elasticities are, with some important exceptions, good proxies for current account semi-elasticities used in external sector assessments. |
| Keywords: | Income balance; Exchange rate elasticity; Global imbalances; Crisis; Sudden stop; Fixed-effects counterfactual estimators; B. estimation methodology; D. estimation procedure; current account adjustment; Income; Current account; Exchange rates; Credit; Global |
| Date: | 2022–05–27 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/106&r= |
| By: | Lisack, Noemie (Banque de France); Lloyd, Simon (Bank of England); Sajedi, Rana (Bank of England) |
| Abstract: | We study the implications of trade aggregation in an infinite-horizon economy with multiple countries. Specifically, we ask whether there is a role for alternatives to the Armington aggregator in the workhorse open-economy macroeconomics model. We show analytically that the first-order dynamics of the model are entirely captured by a few sufficient statistics, so that the precise choice of functional form for the trade aggregator is irrelevant. This irrelevance result has the following implications. For given steady-state trade elasticities and expenditure shares, any aggregator that is homogeneous of degree one is equivalent to the Armington aggregator at first order. Similarly, aggregators that are homogeneous of arbitrary degree are equivalent to a simple generalisation of the Armington aggregator, for given steady-state trade elasticities and expenditure shares. In models with more than two countries, alternative aggregators can play a role by allowing for steady-state differences in bilateral trade elasticities across different country pairs, which the Armington aggregator rules out. |
| Keywords: | International trade; open-economy macroeconomics; Armington aggregator; elasticity of trade. |
| JEL: | F00 F10 F41 |
| Date: | 2022–05–20 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0982&r= |
| By: | Mr. Selim A Elekdag; Maxwell Tuuli |
| Abstract: | This paper assesses the stabilization properties of fixed versus flexible exchange rate regimes and aims to answer this research question: Does greater exchange rate flexibility help an economy’s adjustment to weather shocks? To address this question, the impact of weather shocks on real per capita GDP growth is quantified under the two alternative exchange rate regimes. We find that although weather shocks are generally detrimental to per capita income growth, the impact is less severe under flexible exchange rate regimes. Moreover, the medium-term adverse growth impact of a 1 degree Celsius increase in temperature under a pegged regime is about –1.4 percentage points on average, while under a flexible regime, the impact is less than one half that amount (–0.6 percentage point). This finding bolsters the idea that exchange rate flexibility not only helps mitigate the initial impact of the shock but also promotes a faster recovery. In terms of mechanisms, our findings suggest that the depreciation of the nominal exchange rate under a flexible regime supports real export growth. In contrast to standard theoretical predictions, we find that countercyclical fiscal policy may not be effective under pegged regimes amid high debt, highlighting the importance of the policy mix and precautionary (fiscal) buffers. |
| Keywords: | Exchange rate regimes; Economic growth; Climate change; weather shock; growth impact; regime s; decline in government expenditure growth; peg exchange rate regime; temperature shock; government consumption growth; regime window; Exchange rate arrangements; Exchange rate flexibility; Conventional peg; Exchange rate adjustments; Emerging and frontier financial markets; Global |
| Date: | 2022–05–13 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/093&r= |
| By: | William Gatt; Germano Ruisi (Central Bank of Malta) |
| Abstract: | This paper develops a two-block Structural Vector Autoregression (SVAR) to estimate the spillover of external shocks to the Maltese economy. The model focuses on five broad macroeconomic shocks hitting the euro area; an aggregate demand shock, two aggregate supply shocks which respectively proxy better overall productivity and more favourable conditions on the global market for oil, a generic monetary policy shock encompassing both conventional and unconventional interventions, and a financial stress shock. The model is estimated using Bayesian methods over a sample that goes from 2003Q1 to 2019Q4 and considers a number of Maltese variables that are representative of both the real and the financial side of the economy. The results point toward a relevant role of the identified shocks in explaining the fluctuations of the Maltese economy with particular regard to the aggregate demand and financial stress shocks. Overall, shocks hitting the euro area are estimated to contribute to around one third of the fluctuations of the Maltese output and prices in the long run. |
| JEL: | C11 C32 E32 F41 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:mlt:wpaper:0322&r= |
| By: | Davide Furceri; Pietro Pizzuto; Emilio Colombo; Patrizio Tirelli |
| Abstract: | This paper investigates the role of informality in affecting the magnitude of the fiscal multiplier in a panel of 141 countries, using the local projections method. We find a strong negative relationship between the degree of informality and the size of the fiscal multiplier. This result holds irrespective of the levels of economic development and institutional quality and is robust to additional country characteristics such as trade, financial openness and exchange rate regime. In a two-sector new- Keynesian model, we rationalize this result by showing that fiscal shocks raise the relative price of official goods, shifting demand towards the informal sector. This reallocation effect increases with the level of informality, because a larger informal sector is associated with a stronger appreciation of relative prices in response to fiscal shocks. Thus, informality raises the size of the unofficial multiplier. A higher degree of non-separability between public and private goods also contributes to rationalize the lower multipliers in high-informality countries. |
| Keywords: | Fiscal multiplier; local projection methods; informality; DSGE model; TANK model.; high-informality country; role of informality; unofficial multiplier; government spending shock; investment goods producer; shadow economy variable; depreciation rate; Fiscal multipliers; Informal economy; Consumption; Global |
| Date: | 2022–05–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/082&r= |
| By: | Breinlich, Holger; Leromain, Elsa; Novy, Dennis; Sampson, Thomas |
| Abstract: | This paper studies how voting to leave the European Union affected living standards in the United Kingdom. Using heterogeneity in exposure to import costs across product groups, we analyze how the depreciation of sterling caused by the referendum affected consumer prices. We find the Brexit depreciation led to higher inflation in product groups with greater import shares in consumer expenditure. Our results are consistent with complete pass-through of the cost of imports to consumer prices and imply aggregate exchange rate pass-through of 0:29. We estimate the Brexit depreciation increased consumer prices by 2:9 percent, costing the average household £870 per year. |
| Keywords: | Brexit; economic disintegration; import costs; inflation; trade policy |
| JEL: | N0 L81 |
| Date: | 2021–09–03 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:111602&r= |