nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒08‒29
eighteen papers chosen by
Martin Berka
Massey University

  1. Monetary Union, Asymmetric Recession, and Exit By Keuschnigg, Christian
  2. Cross-border flights to safe assets in bond markets: evidence from emerging market economies By Janus, Jakub
  3. Heterogeneous global booms and busts By Farboodi, Maryam; Kondor, Peter
  4. Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rates? By Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
  5. Leaning-against-the-wind Intervention and the “Carry-Trade” View of the Cost of Reserves By Eduardo Levy Yeyati; Juna Francisco Gómez
  6. Digital Money as a Medium of Exchange and Monetary Policy in Open Economies By Daisuke Ikeda
  7. Debt and Taxes: Optimal Fiscal Consolidation in the Small Open Economy By Carlos Rondón-Moreno
  8. On Foreign Drivers of EMEs Fluctuations By Gent Bajraj; Jorge Lorca; Juan M. Wlasiuk
  9. Financial, Institutional and Macroeconomic Determinants of Cross-Country Portfolio Equity Flows By António Afonso; José Alves; Krzysztof Beck; Karen Jackson
  10. The Global Distributive Impact of the US Inflation Shock By Gautam Nair; Federico Sturzenegger
  11. Fiscal and macroprudential policies in a monetary union By Jose E Bosca; Javier Ferri; Margarita Rubio
  12. Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information By Juan Herreño; Carlos Rondón-Moreno
  13. Market Incompleteness, Consumption Heterogeneity and Commodity Price Shocks By Damian Romero
  14. The Term Structure of Interest Rates in a Heterogeneous Monetary Union By James Costain; Galo Nuño; Carlos Thomas
  15. A boosted HP filter for business cycle analysis: evidence from New Zealand’s small open economy. By Hall, Viv B; Thomson, Peter
  16. Pass-through from monetary policy to bank interest rates: A-symmetry analysis By Juan Francisco Martínez; Daniel Oda; Gonzalo Marivil
  17. Contagion as a Dealmaker? The Effect of Financial Spillovers on Regional Lending Programs By Alexandra Fotiou; Alica Ida Bonk; Georgios Manalis
  18. Inequality and the Structure of Countries’ External Liabilities By Tobias Krahnke; Philipp Harms; Mathias Hoffmann; Miriam Kohl

  1. By: Keuschnigg, Christian
    Abstract: We propose a New Keynesian DSGE model of the Eurozone and analyze an asymmetric recession in a vulnerable member state characterized by a trilemma of high public debt, weak banks, and deteriorating competitiveness. We compare macroeconomic adjustment under continued membership with two exit scenarios that introduce flexible exchange rates and autonomous monetary policy. An exit with stable investor expectations could significantly dampen the short-run impact. Stabilization is achieved by a targeted monetary expansion combined with depreciation. However, investor panic may lead to escalation, aggravate the recession and delay the recovery.
    Keywords: Currency union, exchange rate flexibility, fiscal consolidation, sovereign debt, banks
    JEL: E42 E44 E60 F30 F36 F45 G15 G21
    Date: 2022–08
  2. By: Janus, Jakub
    Abstract: This paper investigates cross-border flights to safety (FTS) in sovereign bond markets from the perspective of emerging market economies (EMEs). Accurate identification of such events provides a detailed picture of sharp changes in prices of international assets and potential sources of EMEs' financial fragility. We construct new measures of the FTS occurrence and magnitude by focusing on extreme movements in long-term bond markets vis-à-vis the US for a diverse group of 21 EMEs. An adaptable time-series anomaly detection algorithm is used to recognize patterns in daily data on bond returns from 2002 to 2021. The paper shows that the FTS episodes in the entire sample of EMEs turn out to be short-lived and map well into periods of international financial and economic downturns. We demonstrate the importance of global uncertainty shocks and the US dollar exchange rate fluctuations in driving FTS, with the relative importance of the latter factor increasing after the Global Financial Crisis. The results from panel data models indicate that a range of country-specific economic, financial, and political factors matter visibly more for the FTS magnitude than their mere occurrence. This supports the notion that flights from bond markets are triggered mainly by shocks originating outside of EMEs, but the magnitude of these events may materially depend on their domestic conditions, including macroeconomic stability and policy factors. However, the role of economic fundamentals in driving FTS seems to subside post-2010 at the expense of financial factors. As a by-product, we present a database on FTS episodes in bond markets.
    Keywords: emerging market economies; flight to safety; safe assets; bond markets; foreign-exchange markets; global risk
    JEL: E42 F32 F41 G15
    Date: 2022–07–25
  3. By: Farboodi, Maryam; Kondor, Peter
    Abstract: We investigate the heterogeneous boom and bust patterns across countries that emerge as a result of global shocks. Our analysis sheds light on the emergence of core and periphery countries, and the joint determination of the depth of recessions and tightness of credit across countries. The model implies that interest rates are similar across core and periphery countries in booms, with larger credit and output growth in periphery countries. However, a common global shock that leads to a credit crunch across the globe gives rise to a sharper spike in interest rates and a deeper recession in periphery countries, while a credit flight to the core alleviates the adverse consequences in these countries.
    Keywords: international credit markets; global cycles; information frictions; (Starting Grant #336585
    JEL: E44 E43 E21 G15 E32
    Date: 2022–07–01
  4. By: Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
    Abstract: We explore the impact of low and negative monetary policy rates in core world economies on bank lending in four small open economies – Canada, Chile, the Czech Republic and Norway – using confidential bank-level data. Our results show that the impact on lending in these small open economies depends on the interest rate level in the core. When interest rates are high, monetary policy cuts in core economies can reduce credit supply in small open economies. In contrast, when interest rates in core economies are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel. These results have important policy implications, suggesting that central banks in small open economies should watch for the impact of potential regime switches in core economies’ monetary policy when rates shift to and from the very low end of the distribution.
    Date: 2022–01
  5. By: Eduardo Levy Yeyati (Universidad Torcuato Di Tella); Juna Francisco Gómez (Universidad de Buenos Aires)
    Abstract: We estimate, for a sample of emerging economies, the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabilization motive (appreciating the exchange rate as a nominal anchor), but are rather small when interventions follow a countercyclical, leaning-against-the-wind (LAW) pattern to contain exchange rate volatility. We document that under LAW, central banks outperform a constant size carry trade, as they additionally benefit from buying against cyclical deviations, and that the cost of reserves under the carry-trade view is generally lower than the one obtained from the credit-risk view (which equals the marginal cost to the country´s sovereign spread).
    Keywords: Exchange rates, foreign exchange intervention, international reserves, selfinsurance
    Date: 2022–07
  6. By: Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies (currently, Financial System and Bank Examination Department), Bank of Japan (E-mail:
    Abstract: The rise of digital money may bring about privately issued money that circulates across borders and coexists with public money. This paper uses an open-economy search model with multiple currencies to study the impact of such global money on monetary policy autonomy -- the capacity of central banks to set a policy instrument. I show that the circulation of global money can entail a loss of monetary policy autonomy, but it can be preserved if government policy that limits the amount or use of global money for transactions is introduced or if the global currency is subject to counterfeiting. The result suggests that global digital money and monetary policy autonomy can be compatible.
    Keywords: Cryptocurrency, Monetary policy autonomy, Currency counterfeiting, Government transaction policy
    JEL: D82 E4 E5 F31
    Date: 2022–07
  7. By: Carlos Rondón-Moreno
    Abstract: In this paper, I argue that the optimal design of a fiscal consolidation plan must consider the transition dynamics of the economy and be chosen such that either welfare (or another given measure of prosperity) is maximized. In the context of a small open economy, I study the optimal design of a fiscal consolidation plan under different monetary policy regimes and, in particular, the implications of reducing debt under a currency peg. Two main lessons are derived from the results. First, consolidation is costly enough regarding welfare, so that the fiscal authority would like to implement it at a very slow pace. If the government is forced to do it by a certain deadline, the welfare maximizing path will reduce the losses but will not be able to offset them. Second, from the output perspective, the optimal consolidation path under an independent monetary regime leads to a positive response of aggregate demand. While, under the currency peg, the optimal path induces an economic recession. Devaluation seems to be a key factor in stabilizing output during fiscal consolidation.
    Date: 2022–03
  8. By: Gent Bajraj; Jorge Lorca; Juan M. Wlasiuk
    Abstract: Global macroeconomic forces such as liquidity fluctuations in the US and commodity price cycles among others have been extensively documented as relevant drivers of economic activity for emerging market economies (EMEs). The dynamics of the interactions between those external forces and their ensuing effect on EMEs business cycles, however, are still relatively less explored. We embed a series of different contemporary interactions between a set of common, external drivers shaping EMEs cycles in order to assess their relative empirical importance through the lens of a dynamic factor model. Our results point toward quantitatively relevant effects induced by shocks to the global factors that we identify. Indeed, while shocks to our financial and commodity factors explain independently about 7 and 21% of GDP fluctuations, respectively, they unload rather differently on long term yields and exchange rates: the financial factor explains about half of exchange rate dynamics and more than a fifth of long rates, where our commodity factor ends up playing a much lesser role.
    Date: 2022–04
  9. By: António Afonso; José Alves; Krzysztof Beck; Karen Jackson
    Abstract: We consider a new dataset that provides a description of the population of financial equity flows between developed countries from 2001 to 2018. We follow the standard practice of controlling for pull and push factors as well as gravity-style variables, while also accounting for the business cycle, public debt and sovereign ratings. Our key findings are as follows: (i) equity flows are more intense between countries at the same stage of the business cycle (ii) increased equity flows to countries with a relatively lower public debt deficit as a ratio of GDP (iii) financial and macroeconomic variables are important for big equity flows, while institutional variables are important for the small flows. Overall, this new dataset provides novel evidence on the importance of the business cycle, government debt and sovereign ratings scores.
    Date: 2022–07
  10. By: Gautam Nair (John F. Kennedy School of Government, Harvard University); Federico Sturzenegger (Harvard University/Universidad de San Andrés)
    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-denominatedsovereign 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. These gains come at the expense of private creditors and other sovereigns.
    Date: 2022–07
  11. By: Jose E Bosca; Javier Ferri; Margarita Rubio
    Abstract: In the European Monetary Union (EMU), monetary policy is decided by the European Central Bank (ECB). This can create some imbalances that can potentially be corrected by national policies. So far, fiscal policy was the natural candidate to adjust those imbalances. Nevertheless, after the global financial crisis (GFC), a new policy candidate has emerged, namely national macroprudential policies, with the mission of reducing financial risks. This issue gives rise to an interesting research question: how do macroprudential and fiscal policies interact? By affecting real interest rates and the level of activity, a discretionary macroprudential policy alters the evolution of public debt and can impose a fiscal cost when the government is forced to increase tax rates to stabilize the public debt-to-GDP ratio. In a monetary union, a domestic macroprudential shock creates substantial crossborder financial effects and also influences the foreign country fiscal stance. Moreover, a discretionary government spending policy affects housing prices, so the strenght with which macroprudential policy reacts to a change in the price of houses has an impact on the fiscal multiplier.
    Keywords: Monetary union, macroprudential policy, fiscal policy, monetary policy
    Date: 2022
  12. By: Juan Herreño; Carlos Rondón-Moreno
    Abstract: We study the interaction between imperfect information and financial frictions and its role in driving financial crises in small open economies. We use a model where households observe income growth but do not perceive whether the underlying shocks are permanent or transitory and borrowing is subject to a collateral constraint. The optimal macroprudential policy helps stabilize the economy by taxing debt procyclically. We show that the combination of imperfect information and borrowing constraints is a significant source of economic instability. The optimal tax under these conditions is six times larger than the tax in the perfect information limit.
    Date: 2022–03
  13. By: Damian Romero
    Abstract: This paper studies how household heterogeneity shapes the response to commodity price shocks. Using data from Chile and other emerging economies, we document that (i) low/high-income households spend relatively more on food/services, and (ii) more than 40 percent of the population is financially constrained. We build a multi-sector New Keynesian model for a small open economy with household heterogeneity and non-homothetic preferences. Non-homothetic preferences dampen the effect of a commodity price shock by inducing a reallocation in the consumption basket towards more income-elastic goods: an economy with non-homothetic preferences generates aggregate responses 29 percent lower.
    Date: 2022–04
  14. By: James Costain (Banco de España); Galo Nuño (Banco de España); Carlos Thomas (Banco de España)
    Abstract: The highly asymmetric reaction of euro area yield curves to the announcement of the ECB’s pandemic emergency purchase programme (PEPP) is hard to reconcile with the standard “duration risk extraction” view of the transmission of central banks’ asset purchase policies. This observation motivates us to build a no-arbitrage model of the term structure of sovereign interest rates in a two-country monetary union, in which one country issues default-free bonds and the other issues defaultable bonds. We derive an affine term structure solution, and we decompose yields into term premium and credit risk components. In an extension, we endogenise the peripheral default probability, showing that the possibility of rollover crises makes it an increasing function of bond supply net of central bank holdings. We calibrate the model to Germany and Italy, showing that it matches well the reaction of these countries’ yield curves to the PEPP announcement. A channel we call “default risk extraction” accounts for most of the impact on Italian yields. The programme’s flexible design substantially enhanced this impact.
    Keywords: sovereign default, quantitative easing, yield curve, affine model, COVID-19 crisis, ECB, pandemic emergency purchase programme
    JEL: E5 G12 F45
    Date: 2022–06
  15. By: Hall, Viv B; Thomson, Peter
    Abstract: We investigate whether the boosted HP filter (bHP) proposed by Phillips and Shi (2021) might be preferred for New Zealand trend and growth cycle analysis, relative to using the standard HP filter (HP1600). We do this for a representative range of quarterly macroeconomic time series typically used in small theoretical and empirical macroeconomic models, and address the following questions. Tradition dictates that business cycle periodicities lie between 6 and 32 quarters (e.g. Baxter and King, 1999) (BK). In the context of more recent business cycle durations, should periodicities up to 40 quarters or more now be considered? Phillips and Shi (2021) propose two stopping rules for selecting a bHP trend. Does it matter which is applied? We propose other trend selection criteria based on the cut-off frequency and sharpness of the trend filter. Are stylised business cycle facts from bHP filtering materially different to those produced from HP1600? In particular, does bHP filtering lead to New Zealand growth cycles which are noticeably different from those associated with HP1600 or BK filtering? HP1600 is commonly used as an omnibus filter across all key macroeconomic variables. Does the greater flexibility of bHP filtering provide better alternatives? We conclude that the 6 to 32 quarter business cycle periodicity is sufficient to reflect New Zealand growth cycles and determine stylised business cycle facts and, for our representative 13-variable macroeconomic data set, using a bHP filter (2HP1600) as an omnibus filter is preferable to using the HP1600 filter.
    Keywords: Boosting, Hodrick-Prescott filter, Business cycles, Transfer function sharpness, New Zealand,
    Date: 2022
  16. By: Juan Francisco Martínez; Daniel Oda; Gonzalo Marivil
    Abstract: This paper analyzes the effect of monetary policy in the credit market, by modeling the dynamics of banks’ interest rates relative to its equilibrium level. We estimate the banks’ equilibrium interest rates, which include latent spreads and/or specific margins. Additionally, we allow a gradual convergence to the target and asymmetric adjustment speeds, as it may be different for active and passive rates and it depends on whether these adjust to higher or lower levels as compared to the current one. The use of regimes based on the relative level of the rate to its objective has advantages over only differentiating between increases and decreases in the monetary policy rate (MPR), since it also recognizes changes in spreads, which exploit the heterogeneity of the banks and include the effects of specific factors. Using Chilean data from January 2004 to September 2019, we find that although there is a direct transmission of MPR on the banks’ interest rates, this is not immediate. In particular, we show that the adjustment of deposits rates to changes in the MPR is faster in a monetary easing, while, for commercial rates, banks adjust their rates more rapidly to a tightening. This result is consistent with international evidence, in particular for larger institutions, but this effect is diluted in a period of less than a year.
    Date: 2022–03
  17. By: Alexandra Fotiou; Alica Ida Bonk; Georgios Manalis
    Abstract: The recent European sovereign debt crisis highlighted the critical role of regional lending arrangements. For the first time, European mechanisms were called to design financing programmes for member countries in trouble. This paper analyses how the risk of contagion, an essential characteristic of interlinked economies, shapes borrowing conditions. We focus on the role of spillovers as a channel of bargaining power that a country might have when asking for financial support from regional lending institutions. We build and present a new database that records both the dates on which official meetings took place, relevant statements were released and the timing of the announcements regarding loan disbursements. This database allows us to assess the defining role that announcements of future actions have in mitigating spillover costs. In addition, we study the design of lending arrangements within a recursive contract between a lender and a sovereign country. When accounting for spillover costs, arising from the borrower to the creditor, we find that it is in the lender's best interest to back-load consumption by giving more weight to future transfers in order to reduce contagion cost. Subsequently, we test and validate our theoretical predictions by assessing the effect of spillovers on loan disbursements to programme-countries and by juxtaposing lending conditions imposed by the IMF and the European mechanisms.
    Keywords: Regional lending mechanisms; currency-union; spillovers
    Date: 2022–07–08
  18. By: Tobias Krahnke; Philipp Harms; Mathias Hoffmann; Miriam Kohl
    Abstract: In this paper, we present empirical evidence that higher income inequality is associated with a greater equity share in countries' external liabilities, and we develop a theoretical model that can explain this observation: In a small open economy with traded and nontraded goods, entry barriers depress entrepreneurial activity in nontraded industries and raise income inequality. The small number of domestic nontraded-goods firms leaves room for foreign firms to operate on the domestic market, and it reduces external borrowing. The model suggests that barriers to entrepreneurial activity could be conducive to attract equity-type capital inows. Our empirical results lend some support to this conjecture.
    Keywords: Portfolio Equity; Foreign direct investment; External debt; External liabilities; Income Inequality
    Date: 2022–07–08

This nep-opm issue is ©2022 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.