nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒08‒15
eighteen papers chosen by
Martin Berka
Massey University

  1. Information Spillovers and Sovereign Debt: Theory Meets the Eurozone Crisis By Harold L. Cole; Guillermo Ordoñez; Daniel Neuhann
  2. Trade policies and fiscal devaluations By Christopher J. Erceg; Andrea Prestipino; Andrea Raffo
  3. Foundation of the Small Open Economy Model with Product Differentiation By Lorenzo Caliendo; Robert C. Feenstra
  4. Global Stagflation By Ha, Jongrim; Kose, Ayhan M.; Ohnsorge, Franziska
  5. Monetary policy in the open economy with digital currencies By Pietro Cova; Alessandro Notarpietro; Patrizio Pagano; Massimiliano Pisani
  6. Good-Bye Original Sin, Hello Risk On-Off, Financial Fragility, and Crises? By Joshua Aizenman; Yothin Jinjarak; Donghyun Park; Huanhuan Zheng
  7. COVID-19 and Exchange Rates: Spillover Effects of U.S. Monetary Policy By Hakan Yilmazkuday
  8. The Role of the Euro in Southern Neighbourhood Countries By Juan José Almagro Herrador; Mihai Macovei; Moritz Bizer
  9. The Global Distributive Impact of the US Inflation Shock By Gautam Nair; Federico Sturzenegger
  10. Sanctions and the exchange rate By Itskhoki, Oleg; Mukhin, Dmitry
  11. Foreign monetary policy and domestic inflation in emerging markets By Marco Flaccadoro; Valerio Nispi Landi
  12. Capital Control and Heterogeneous Impact on Capital Flows By Sanyal, Anirban
  13. Global Supply Chain Pressures, International Trade, and Inflation By Julian di Giovanni; Ṣebnem Kalemli-Özcan; Alvaro Silva; Muhammed A. Yildirim
  14. Capital account openness in India and a comparison with China: Then versus now By Nidhi Aggarwal; Sanchit Arora; Rajeswari Sengupta
  15. Global shocks and international policy coordination By Ashima Goyal; Rupayan Pal
  16. SONOMA: a Small Open ecoNOmy for MAcrofinance By Mariano Croce; Mohammad R. Jahan-Parvar; Samuel Rosen
  17. Exchange rate pass-through in small, open, commodity-exporting economies: lessons from Canada By Marco Flaccadoro

  1. By: Harold L. Cole; Guillermo Ordoñez; Daniel Neuhann
    Abstract: We develop a theory of information spillovers in sovereign bond markets in which investors can acquire information about default risk before trading in primary and secondary markets. If primary markets are structured as multi-unit discriminatory-price auctions, an endogenous winner’s curse leads to strategic complementarities in information acquisition. As a result, shocks to default risk in one country may trigger crisis episodes with widespread information acquisition, sharp increases in the level and volatility of yields in risky countries, falling yields in safe countries, endogenous market segmentation, and arbitrage profits between primary and secondary markets. These predictions are consistent with the behavior of primary and secondary market yields, market segmentation, and measures of information acquisition during the Eurozone sovereign debt crisis.
    JEL: D44 E6 F34 G15
    Date: 2022–07
  2. By: Christopher J. Erceg; Andrea Prestipino; Andrea Raffo
    Abstract: Fiscal devaluations—an increase in import tariffs and export subsidies (IX) or an increase in value-added taxes and payroll subsidies (VP)—have been shown to provide as much stimulus under fixed exchange rates as a currency devaluation. We find that if agents expect policies to be reversed and the tax pass-through is large, VP is contractionary and IX provides a modest boost. In our medium-scale DSGE model, both features are crucial in accounting for Germany’s underperformance in response to VP in 2007. These findings cast doubt on fiscal devaluations as a cyclical stabilization tool when monetary policy is constrained.
    Keywords: Trade Policy; Fiscal Policy; Exchange Rates; Fiscal Devaluation
    JEL: E32 F30 H22
    Date: 2022–06–22
  3. By: Lorenzo Caliendo; Robert C. Feenstra
    Abstract: We derive a small open economy (SOE) as the limit of an economy as the number or size of its trading partners goes to infinity and trade costs also go to infinity. We obtain this limit in the Armington, Eaton-Kortum, Krugman, and Melitz models. In all cases, the trade of the SOE with the foreign countries approaches a finite limit, and the domestic expenditure share for the SOE approaches a limit that is not zero or unity. The foreign countries can be either infinitely many SOEs, or alternatively, one or many large countries with domestic expenditure shares that approach unity. We illustrate the usefulness of this framework by obtaining a formula for the optimal tariff in the SOE -- depending on the elasticity of domestic wages with respect to the tariff -- that is consistent with all models.
    JEL: F12 F13
    Date: 2022–07
  4. By: Ha, Jongrim; Kose, Ayhan M.; Ohnsorge, Franziska
    Abstract: Global inflation has risen sharply from its lows in mid-2020, on rebounding global demand, supply bottlenecks, and soaring food and energy prices, especially since the Russian Federation’s invasion of Ukraine. Markets expect inflation to peak in mid-2022 and then decline, but to remain elevated even after these shocks subside and monetary policies are tightened further. Global growth has been moving in the opposite direction: it has declined sharply since the beginning of the year and, for the remainder of this decade, is expected to remain below the average of the 2010s. In light of these developments, the risk of stagflation—a combination of high inflation and sluggish growth—has risen. The recovery from the stagflation of the 1970s required steep increases in interest rates by major advanced-economy central banks to quell inflation, which triggered a global recession and a string of financial crises in emerging market and developing economies. If current stagflationary pressures intensify, they would likely face severe challenges again because of their less well-anchored inflation expectations, elevated financial vulnerabilities, and weakening growth fundamentals.
    Keywords: Inflation; growth; COVID-19; global recession; monetary policy; fiscal policy; disinflation
    JEL: E31 E32 E52 Q43
    Date: 2022–06–07
  5. By: Pietro Cova (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Patrizio Pagano; Massimiliano Pisani (Bank of Italy)
    Abstract: We assess the transmission of a monetary policy shock in a two-country New Keynesian model featuring a global private stablecoin and a central bank digital currency (CBDC). In the model, cash and digital currencies are imperfect substitutes that differ as to the liquidity services they provide. We find that in a digital-currency economy, where the stablecoin is a significant means of payment, the domestic and international macroeconomic effects of a monetary policy shock can be smaller or larger than in a (benchmark) mainly-cash economy, depending on how the assets backing the stablecoin supply respond to the shock. The benchmark transmission of the monetary policy shock can nonetheless substantially be restored in the digital-currency economy 1) if the stablecoin is fully backed by cash or 2) if the CBDC is a relevant means of payment.
    Keywords: digital currency, CBDC, monetary policy, international finance.
    JEL: E51 E52 F30
    Date: 2022–04
  6. By: Joshua Aizenman; Yothin Jinjarak; Donghyun Park; Huanhuan Zheng
    Abstract: We analyze the sovereign bond issuance data of eight major emerging markets (EMs) - Brazil, China, India, Indonesia, Mexico, Russia, South Africa and Turkey from 1970 to 2018. Our analysis suggests that (i) EM local currency bonds tend to be smaller in size, shorter in maturity, or lower in coupon rate than foreign currency bonds; (ii) EMs are more likely to issue local-currency sovereign bonds if their currencies appreciated before the global financial crisis of 2008 (GFC); (iii) inflation-targeting monetary policy increases the likelihood of issuing local-currency debt before GFC but not after; and (iv) EMs that offer higher sovereign yields are more likely to issue local-currency bonds after GFC. Future data will allow us to test and identify structural changes associated with the COVID-19 pandemic and its aftermath.
    Date: 2022–06
  7. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper investigates the spillover effects of U.S. monetary policy on exchange rates of 11 emerging markets and 12 advanced economies during the pre-COVID-19 period of 2019 versus the COVID-19 period of 2020. The investigation is achieved by a structural vector autoregression model, where year-on-year changes in weekly measures of economic activity, exchange rates and policy rates are used. The empirical results suggest evidence for the spillover effects of U.S. monetary policy for several countries during the pre-COVID-19 period, whereas they have been effective only for certain countries during the COVID-19 period that can be explained by the disease outbreak channel. It is implied that policies keeping the pandemic under control may help mitigate the unforeseen economic effects of the COVID-19 crisis.
    Keywords: COVID-19, Coronavirus, Exchange Rates, Monetary Policy, Spillover Effects
    JEL: E52 E58 F31 F42
    Date: 2022–06
  8. By: Juan José Almagro Herrador; Mihai Macovei; Moritz Bizer
    Abstract: This paper explores the role of the euro in the Southern neighbourhood of the EU, notably in Algeria, Egypt, Israel, Jordan, Lebanon, Libya, Morocco and Tunisia. Our analysis is based on a survey conducted by the European Commission in 2021 on the use of the euro and other currencies in these countries, as well as other relevant sources and is performed across five main dimensions: cross-border trade transactions, remittances, foreign exchange reserves, external public debt and the commercial banking sector. It finds that the use of the euro in Southern Neighbourhood countries is higher, on average, than in the world and in the EU’s Eastern Neighbours (Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine), although the US dollar remains the foreign currency of reference in the region. The US dollar’s continued strong role reflects historical developments and monetary arrangements, as well as the greater liquidity and dominant role of the US dollar in global financial markets. The region remains a heterogeneous group, with the euro playing a more prominent role than the US dollar in Maghreb countries (i.e. Algeria, Morocco and Tunisia). The extensive use of the euro for trade invoicing across countries seems highly correlated with the depth of economic and trade relations with euro area countries and the EU at large. Around one third of inward remittances are denominated in euro and over one third of the external public debt stock is denominated in euro on average, higher than the global average. The banking sector and foreign reserves remain heavily dollarised across countries. Based on these findings, the paper highlights new areas, such as green finance and NextGenerationEU bond issuance, which together with other policy initiatives could foster a higher use of the euro in the region.
    JEL: E41 E42 E52 E58
    Date: 2022–06
  9. By: Gautam Nair (John F. Kennedy School of Government, Harvard University); Federico Sturzenegger (Universidad de San Andres and Harvard Kennedy School)
    Abstract: We study the global distributive consequences of the 'Great Reflation.' The conventional wisdom holds that the increases in interest rates resulting from high inflation in the United States will have a negative impact on the rest of the world (and developing countries in particular) due to the reversal of capital flows and higher financing costs. We show that the standard view fails to take into account an important countervailing force: the effect of higher US inflation on the changing real value of nominal US dollar assets and liabilities across countries. Decades of low inflation led to widespread use of dollar-denominated financial instruments with fixed interest rates and long maturities. Unanticipated inflation in the US diminishes the real value of dollar-denominated sovereign debt, both in the US and abroad. For sovereigns other than the US, the gains are equivalent to a debt relief that exceeds $100 billion. On the other hand, the US government benefited from the dilution of non-residents' holdings of US treasuries and dollar cash by an amount close to $600 billion.
    Date: 2022–07
  10. By: Itskhoki, Oleg; Mukhin, Dmitry
    Abstract: Stabilising the exchange rate allows the Russian government to anchor inflation expectations and support consumption but comes at the cost of the financial repression of domestic savers.
    Keywords: F31; F41; F51
    JEL: J1
    Date: 2022–06–07
  11. By: Marco Flaccadoro (Bank of Italy); Valerio Nispi Landi (Bank of Italy)
    Abstract: We estimate the response of domestic inflation to a US interest rate shock in a sample of 27 emerging economies, using local projection methods. Our results point out that the sign of the inflation response crucially depends on the monetary policy framework: after a US monetary policy tightening, inflation decreases in peggers; inflation increases in floaters that do not target inflation; the inflation response is not statistically different from zero in floaters that are committed to an inflation target. We rationalize this outcome using a standard DSGE model. We show that pegging the exchange rate yields larger welfare losses compared to the other two monetary policy frameworks, even assuming dominant currency pricing.
    Keywords: inflation stabilization, inflation targeting, monetary policy, open economy macroeconomics
    JEL: E31 E52 F41
    Date: 2022–04
  12. By: Sanyal, Anirban
    Abstract: Capital control is used as policy toolkit for safeguarding domestic economy from the volatility of capital flows. However, the effect of capital control is rather far fetched as the signaling effect of capital control can moderate investor's outlook about domestic economy and thereby outweighs the intended effect. The spillover effect, on the other hand, modulates the capital flows to other countries when one country increases capital account restrictions. Further, the effect of capital control can have varying impact on capital inflows to different sectors as recent studies indicate heterogeneity in the drivers and nature of capital inflows to different institutional sectors. With the background, the paper analyzes the heterogeneous direct and spillover effect of capital control on gross capital flows across three major institutional sectors namely public, banks and corporate. The paper validates the possible heterogeneity in the effect of capital control on the capital inflows to these institutional sectors using spatial econometric models. The paper observes that the direct effect of capital control moderates portfolio inflows to public sector whereas the effect is insignificant on portfolio inflows to banks and corporate sector. Further, the paper observes that the spillover effect of capital control is broad-based i.e. equally prevalent on all sectors. The paper explains the heterogeneity in the capital control effects by introducing signaling effect in a portfolio choice model. The paper argues that the heterogeneous direct effect is driven by private signals of capital control received by the investors about the state of economy whereas the spillover effect of capital control is mainly driven by the hedging and search for better returns. The paper extends the existing literature of capital controls by reviewing the sectoral heterogeneity in the capital flows.
    Keywords: Capital control,Spillover effect,Portfolio Choice,Signaling effect,Spatial Durbin Model
    Date: 2022
  13. By: Julian di Giovanni; Ṣebnem Kalemli-Özcan; Alvaro Silva; Muhammed A. Yildirim
    Abstract: We study the impact of the Covid-19 pandemic on Euro Area inflation and how it compares to the experiences of other countries, such as the United States, over the two-year period 2020-21. Our model-based calibration exercises deliver four key results: 1) Compositional effects – the switch from services to goods consumption – are amplified through global input-output linkages, affecting both trade and inflation. 2) Inflation can be higher under sector-specific labor shortages relative to a scenario with no such supply shocks. 3) Foreign shocks and global supply chain bottlenecks played an outsized role relative to domestic aggregate demand shocks in explaining Euro Area inflation over 2020-21. 4) International trade did not respond to changes in GDP as strongly as it did during the 2008-09 crisis despite strong demand for goods. These lower trade elasticities in part reflect supply chain bottlenecks. These four results imply that policies aimed at stimulating aggregate demand would not have produced as high an inflation as the one observed in the data without the negative sectoral supply shocks.
    JEL: E00 F10
    Date: 2022–07
  14. By: Nidhi Aggarwal (Indian Institute of Management, Udaipur); Sanchit Arora (Ernst and Young); Rajeswari Sengupta (Indira Gandhi Institute of Development Research)
    Abstract: Existing evidence shows that over the years, India's capital account has become relatively more open, while the same cannot be said for China. However, with its rising share in the world economy, China has increasingly been pursuing its goal of RMB internationalisation, which concurrently relies on an open capital account. In this paper, we revisit the question and examine the openness of capital accounts of both India and China, the two largest emerging economies. Using more than 15 years of daily return differentials in the non-deliverable currency forward (NDF) market vis-a-vis the onshore spot market, we find that the somewhat haphazard process of capital account opening undertaken by the Indian authorities is reflected in large variations in covered interest parity (CIP) deviations across the period. In recent years the deviations have become smaller and the no-arbitrage bands have become narrower, implying greater financial integration and lower effectiveness of existing capital controls Applying our methodology to China, we find that though China has liberalised its capital account over time, its capital controls still bind. Our analysis shows that India's capital account continues to remain substantially more open than that of China's.
    Keywords: Capital account openness, Financial integration, Covered interest parity, Capital controls, Foreign exchange market
    JEL: G15 F30 F31 F32
    Date: 2022–05
  15. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Rupayan Pal (Indira Gandhi Institute of Development Research)
    Abstract: We argue emerging markets (EMs) have become large enough to make it in advanced economies (AEs) own interest to reduce negative spillovers to EMs. It follows the potential for international cooperation in macroeconomic and prudential policy increases. But entrenched perceptions and historical advantages are obstacles. These blocks are explored as well as possibilities in macroeconomic policies and in prudential regulation. Export of capital is a major way AEs earn a share in EM income. AE macroeconomic policy and volatile capital outflows from AEs are a source of negative spillovers for EMs, but preventive prudential regulation is not adequate in AEs. More regulation is likely to reduce short-term returns to capital flows but not long-term, since with fewer crises both AE and EM income streams would rise. Moreover, there is some evidence excess capital flow volatility has adverse effects on AEs themselves. It follows universal macro-prudential polices would benefit both country groups. International conventions should be refocused on reducing the probability of crises, instead of protecting creditors by ensuring they do not suffer a loss in case a crisis occurs. Major source countries should develop prudential regulation of their non-bank financial sectors, including commodity futures markets. The IMF should remove restrictions on pre-emptive implementation of capital flow management and its use before other measures.
    Keywords: International policy coordination, Covid-19, Quantitative easing, Capital flows, advanced economies, Emerging markets
    JEL: F42 F59 F36
    Date: 2022–06
  16. By: Mariano Croce; Mohammad R. Jahan-Parvar; Samuel Rosen
    Abstract: We develop a new small open economy model (SONOMA) in which domestic corporate debt and equities are affected by shocks to both external credit and equity markets. In a novel empirical analysis of several small-but-developed economies, we show that both external debt and equity shocks are important determinants of domestic economic fluctuations, corporate leverage, and net foreign asset positions. SONOMA replicates our empirical facts about asset prices, financial flows, and economic activity.
    Keywords: External Positions; Credit and Equity Shocks; Asset Pricing
    JEL: F30 F40 G15
    Date: 2022–07–14
  17. By: Marco Flaccadoro (Bank of Italy)
    Abstract: We analyse the pass-through of exchange rates to prices in small, open, commodity-exporting economies, taking Canada as a case study. We estimate pass-through on a wide cross-section of disaggregated import, producer, and consumer prices, conditional on commodity shocks that explain a major share of the volatility in prices and exchange rates. Our pass-through measure is free from endogeneity concerns between prices and exchange rates and leads, in some cases, to opposite inference in reference to the sign of the pass-through compared with standard estimates. By focusing on industry-level producer price indexes, we show that conditional pass-through decreases with industry market power, while it increases with the degree of import penetration and the persistence of industry-specific shocks.
    Keywords: time series, factor analysis, prices, exchange rates, pass-through, commodity prices, oil shocks
    JEL: C32 C38 E31 F31 F4 Q02 Q43
    Date: 2022–04
  18. By: Gabriel Montes-Rojas (Instituto Interdisciplinario de Economía Política de Buenos Aires - UBA - CONICET); Nicolás Bertholet (Instituto Interdisciplinario de Economía Política de Buenos Aires - UBA - CONICET)
    Abstract: This paper presents empirical evidence on the short- and medium-run contractionary effects of exchange rate shocks and currency devaluations for bimonetary (i. e., highly dollarized) countries. In particular, for Argentina for the period January 2004-December 2018. Using a VAR representation with quantile heterogeneity, it implements a multivariate model with four macroeconomic variables: exchange rate variations, inflation, economic activity and nominal wage growth. The empirical results show a 30% price pass-through effects and a bimodal effect on output, with both positive and negative effects. Wages adjust less than prices with the consequent effect that real wages have a negative elasticity of 0.23 with respect to exchange rate shocks. Further analysis on the multivariate responses show that the negative effect on output is associated with a decline in real wages: a 1% fall in real wages after a currency devaluation produces a 2.3% decline in output.
    Keywords: Impulse-response functions, Vector autoregressive models, Multivariate quantiles, Exchange rate, Pass-through Recession
    JEL: C13 C14 C22
    Date: 2022–06

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