nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒09‒05
eighteen papers chosen by
Martin Berka
Massey University

  1. Production Networks and International Fiscal Spillovers By Michael B. Devereux; Karine Gente; Changhua Yu
  2. Financial, Institutional, and Macroeconomic Determinants of Cross-Country Portfolio Equity Flows By António Afonso; José Alves; Krzysztof Beck; Karen Jackson
  3. Domestic Linkages and the Transmission of Commodity Price Shocks By Damian Romero
  4. Fear of Appreciation and Current Account Adjustment By Paul Bergin; Kyunghun Kim; Ju H. Pyun
  5. Risk capacity, portfolio choice and exchange rates By Boris Hofmann; Ilhyock Shim; Hyun Song Shin
  6. Is globalization the root cause of declining inflation? By Juhana Hukkinen; Matti Viren
  7. When is Sovereign Debt Odious? A Theory of Government Repression, Growth Traps, and Growth Boosts By Viral V. Acharya; Raghuram Rajan; Jack Shim
  8. Export-Led Takeoff in a Schumpeterian Economy By Chu, Angus C.; Peretto, Pietro; Xu, Rongxin
  9. International Sovereign Spread Differences and the Poverty of Nations By Farzana Alamgir; Alok Johri
  10. Sovereign Debt By Mr. Leonardo Martinez; Mr. Francisco Roch; Francisco Roldán; Mr. Jeromin Zettelmeyer
  11. Thick borders in Franco’s Spain: the costs of a closed economy By Rodolfo G. Campos; Iliana Reggio; Jacopo Timini
  12. Capital flows and monetary policy trade-offs in emerging market economies By Paolo Cavallino; Boris Hofmann
  13. Exchange arrangements and economic growth. What relationship is there? By Cruz-Rodríguez, Alexis
  14. Cross-border financial centres By Pamela Pogliani; Philip Wooldridge
  15. Aggregate Properties of Open Economy Models with Expanding Varieties By Saroj Bhattarai; Konstantin Kucheryavyy
  16. The End of Privilege: A Reexamination of the Net Foreign Asset Position of the United States By Andrew Atkeson; Jonathan Heathcote; Fabrizio Perri
  17. On Wars, Sanctions and Sovereign Default By Javier Bianchi; César Sosa-Padilla
  18. The Term Structure of Interest Rates in a Heterogeneous Monetary Union By James Costain; Galo Nuño; Carlos Thomas

  1. By: Michael B. Devereux (Vancouver school of economics, University of British Columbia, NBER and CEPR.); Karine Gente (Aix-Marseille Universite, CNRS, AMSE, Marseille, France.); Changhua Yu (China Center for Economic Research, National School of Development, Peking University, China.)
    Abstract: This paper analyzes the impact of fiscal spending shocks in a dynamic, multi-country model with international production networks. We first derive a decomposition of the effects of a fiscal spending shock on the GDP of any country. This decomposition defines the response as the sum of a Direct, Income, and Price effect. The Direct Effect depends only on structural parameters and is independent of assumptions about monetary policy, wage setting, or capital mobility, while the Price Effect is zero in the aggregate across countries. We apply this decomposition to an analysis of fiscal spillovers in the Eurozone, using the production network structure from the World Input Output Database (WIOD). We find that fiscal spillovers from Germany and some other large Eurozone countries may be large, and within the range of empirical estimates. Without international production network linkages, spillovers would be only a third as large as predicted by the baseline model. Finally, we explore the diffusion of identified government spending shocks at the sectoral level, both within and across countries, using an empirical measure of the response, based on the theoretical decomposition. The empirical estimates are strongly consistent with the theoretical model.
    Keywords: production network, fiscal policy, spillovers, Eurozone, nominal rigidities
    JEL: E23 E62 F20 F42 H50
    Date: 2022–07
  2. 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.
    Keywords: cross-country equity flows, stock market returns, panel data, quantile regression, business cycle
    JEL: C23 E44 F44 G15
    Date: 2022
  3. By: Damian Romero
    Abstract: This paper studies the role of input-output (IO) linkages in the transmission of commodity price fluctuations. Empirically, the positive correlation between commodity prices and GDP decreases in the degree of IO linkages. In a model of a commodity-exporting economy where international markets set the commodity price, IO linkages reduce the demand for inputs by the commodity sector, dampening the level of income of the country after a positive commodity price shock. In a calibrated version of the model, the elasticity of GDP to commodity prices would be at least 7% higher if the commodity sector had been 10% less connected.
    Date: 2022–01
  4. By: Paul Bergin; Kyunghun Kim; Ju H. Pyun
    Abstract: This paper finds that limited exchange rate flexibility in the form of “fear of appreciation” significantly slows adjustment of current account imbalances, providing novel support for Friedman’s conjecture regarding exchange-rate flexibility. We present a new stylized fact: floaters have faster convergence than peggers for current account deficits, but not so for surpluses. A striking implication is that current account surpluses are more persistent than deficits on average. We provide evidence that this asymmetry is associated with a one-sided muting of exchange rate appreciations. We develop a multi-country DSGE model augmented with an asymmetric exchange rate policy to represent fear of appreciation; when solved to a third-order approximation, it can explain greater persistence of current account surpluses compared to deficits.
    JEL: F31 F33 F44
    Date: 2022–07
  5. By: Boris Hofmann; Ilhyock Shim; Hyun Song Shin
    Abstract: We lay out a model of risk capacity for global portfolio investors in which swings in exchange rates can affect their risk-taking capacity in a Value-at-Risk framework. Exchange rate fluctuations induce shifts in portfolio holdings of global investors, even in the absence of currency mismatches on the part of the borrowers. A currency appreciation for an emerging market borrower that is part of a broad-based appreciation of emerging market currencies leads to larger bond portfolio inflows than the equivalent appreciation in the absence of a broad-based appreciation. As such, the broad dollar index emerges as a global factor in bond portfolio flows. The empirical evidence strongly supports the predictions of the model.
    Keywords: bond spread, capital flow, credit risk, emerging market, exchange rate
    JEL: G12 G15 G23
    Date: 2022–07
  6. By: Juhana Hukkinen (Monetary Policy and Research Department of Bank of Finland); Matti Viren (Monetary Policy and Research Department of Bank of Finland & Economics Department of University of Turku)
    Abstract: This paper examines the reasons for the declining path of inflation since the 1970s. In particular, it focusses on the role of globalization â covering both changes in the global market structure and technical and structural developments in trade and production. In addition, the paper deals with changes in the basic transmission mechanisms of price and wage inflation. The paper makes use of different data from individual countries and panel of countries. These data show that the dispersion of inflation and the behavior of relative prices follow a pattern that is consistent with several globalization indicators. Also estimation results show that these indicators are useful in tracing the developments of trend inflation after the 1960s. Moreover, it is shown that the basic relationships between prices and costs are nonlinear depending on the level of inflation.
    Keywords: Inflation, globalization, Phillips curve, trade unions
    JEL: E31 E52 E58 F02 F41 F42 F62
    Date: 2022–08
  7. By: Viral V. Acharya; Raghuram Rajan; Jack Shim
    Abstract: We examine the dynamics of a country’s growth, consumption, and sovereign debt, assuming that the government is myopic and wants to maximize short-term, self-interested spending. Surprisingly, government myopia can increase a country’s access to external borrowing. In turn, access to borrowing can extend the government’s effective horizon; the government’s ability to borrow hinges on it convincing creditors they will be repaid, which gives it a stake in generating future revenues. In a high-saving country, the lengthening of the government’s effective horizon can incentivize it to tax less, resulting in a “growth boost", with higher steady-state household consumption than if it could not borrow. However, in a country that saves little, the government may engage in more repressive policies to enhance its debt capacity. This could lead to a “growth trap” where household steady-state consumption is lower than if the government had no access to debt. We discuss the effectiveness of alternative debt policies, including declaring debt odious, debt forgiveness, and debt ceilings. We also analyse the impact of unanticipated shocks on the country’s welfare.
    JEL: A0 A1 A11 A13 A14 F0 F02 G0 G00 L0 O0 P0
    Date: 2022–07
  8. By: Chu, Angus C.; Peretto, Pietro; Xu, Rongxin
    Abstract: This study develops an open-economy Schumpeterian growth model with endogenous takeoff to explore the effects of exports on the transition of an economy from stagnation to innovation-driven growth. We find that a higher export demand raises the level of employment, which causes a larger market size and an earlier takeoff along with a higher transitional growth rate of domestic output per capita but has no effect on long-run economic growth. These theoretical results are consistent with empirical evidence that we document using cross-country panel data in which the positive effect of exports on economic growth becomes smaller, as countries become more developed, and eventually disappears. We also calibrate the model to data in China and find that its export share increasing from 4.6% in 1978 to 36% in 2006 causes a rapid growth acceleration, but the fall in exports after 2007 causes a growth deceleration that continues until recent times.
    Keywords: international trade; innovation; endogenous takeoff
    JEL: F43 O3 O4
    Date: 2022–07
  9. By: Farzana Alamgir; Alok Johri
    Abstract: We find that national poverty head-count ratios and country default risk (measured as sovereign bond spreads) are positively correlated. For example, a nation with 40 percent of the population below the poverty line faces an average spread that is 120 basis points higher than a nation with 10 percent of extremely poor households. This correlation is robust to the inclusion of a number of country specific variables including the country’s Gini coefficient and its per capita GDP. We build a sovereign default model that can help explain this correlation that incorporates two types of households – those earning average income and those at the poverty line. The government runs a social safety net which taxes the average income household in order to transfer consumption to the poor. A political constraint that ensures that all households wish to participate in the safety net program constrains the fiscal choices of the government. The novel aspects of the model are calibrated using South African data on household income dynamics, its poverty line and aggregate social transfer rate while the usual calibration targets in the literature are also deployed. A variant of this benchmark economy with a more poor households displays higher default risk than the benchmark economy. The interaction of international borrowing terms with the social safety net and with the political constraint account for this result. Defaults occur when too large a fraction of taxes will be needed for debt repayment and this occurs more often in economies with a larger proportion of the poor. We show that the correlation between the proportion of poor and level of spreads survives even after controlling for the increase in inequality implied by increasing the proportion of poor households. This is achieved by simultaneously increasing the income of the poor. We show that the worse borrowing terms faced by the benchmark economy with higher poverty come with welfare losses due to the lower debt that it can afford and that it would default much less frequently if it faced the same terms as the low-poverty economy.
    Keywords: sovereign default; country spreads; poverty rates
    JEL: F34 F41 G15 H63
    Date: 2022–08
  10. By: Mr. Leonardo Martinez; Mr. Francisco Roch; Francisco Roldán; Mr. Jeromin Zettelmeyer
    Abstract: This paper surveys the literature on sovereign debt from the perspective of understanding how sovereign debt differs from privately issue debt, and why sovereign debt is deemed safe in some countries but risky in others. The answers relate to the unique power of the sovereign. One the one hand, a sovereign has the power to tax, making debt relatively safe; on the other, it also has control over its territory and most of its assets, making debt enforcement difficult. The paper discusses debt contracts and the sovereign debt market, sovereign debt restructurings, and the empirical and theoretical literatures on the costs and causes of defaults. It describes the adverse impact of sovereign default risk on the issuing countries and what explains this impact. The survey concludes with a discussion of policy options to reduce sovereign risk, including fiscal frameworks that act as commitment devices, state-contingent debt, and independent and credible monetary policy.
    Keywords: Sovereign Debt; Safe Debt; Debt Default; Debt Restructuring; Costs of Sovereign Default; Political Defaults; Fiscal Frameworks; State Contingent Debt; Original Sin; debt contract; short-term debt; market value; sovereign default; capital market exclusion; default decision; default event; payment terms; liquid asset; Securities markets; Fiscal rules; Global
    Date: 2022–06–17
  11. By: Rodolfo G. Campos (Banco de España); Iliana Reggio (Universidad Autónoma de Madrid); Jacopo Timini (Banco de España)
    Abstract: Between the 1940s and 1970s, Spain used a variety of economic policies that hindered international trade. Because the mix of tariffs, quotas, administrative barriers, and exchange rate regimes varied greatly over time, the quantification of the effect of the various trade policies on international trade in this period is particularly elusive. In this paper, we use historical bilateral trade flows and a structural gravity model to quantify the evolution of Spain’s border thickness, a summary measure of its barriers to international trade. We find that Spain’s borders in the period 1948-1975 were thicker than those of any other country in Western Europe, even after the liberalization of trade that started in 1959. These comparatively higher impediments to international trade implied substantial negative effects on consumer welfare. We estimate that accumulated welfare costs over the period 1948-1975 exceed 20% of a year’s total consumption.
    Keywords: Spain, Stabilization Plan, international trade, autarky
    JEL: F13 F14 F62 N74
    Date: 2022–03
  12. By: Paolo Cavallino; Boris Hofmann
    Abstract: We lay out a small open economy model incorporating key features of EME economic and financial structure: high exchange rate pass-through to import prices, low pass-through to export prices and shallow domestic financial markets giving rise to occasionally binding leverage constraints. As a consequence of the latter, a sudden stop with large capital outflows can give rise to a financial crisis. In the sudden stop, the central bank faces an intratemporal trade-off as output declines while inflation rises. In normal times, there is an intertemporal trade-off as the risk of a future sudden stop forces the central bank to factor financial stability considerations into its policy conduct. The optimal monetary policy leans against capital flows and domestic leverage. Macroprudential, capital flow management and central bank balance sheet policies can help to mitigate both intra- and intertemporal trade-offs. Fiscal policy also plays a key role. A higher level of public debt and a weaker fiscal policy imply greater leverage and hence greater tail risk for the economy.
    Keywords: capital flows, monetary policy trade-offs, emerging market economies
    JEL: E5 F3 F4
    Date: 2022–07
  13. By: Cruz-Rodríguez, Alexis
    Abstract: This article provides empirical support for the hypothesis that different exchange rate regimes have an impact on economic growth in advanced, emerging and developing countries. The effects of different exchange rate arrangements on economic growth are examined through least squares dummy variable regressions using panel data on 125 countries during the post-Bretton Woods period (1974-1999). Also, this article addresses the issue of measurement errors in the classification of exchange rate regimes by using four different classification schemes. Three de facto and one de jure classifications are used. Consequently, the sensitivity of these results to alternative exchange rate classifications is also tested. The empirical findings indicate that developing countries with fixed regimes tend to have a higher economic growth.
    Keywords: Exchange rate regimes, economic growth
    JEL: F31 F33 O47
    Date: 2022–07–25
  14. By: Pamela Pogliani; Philip Wooldridge
    Abstract: Financial centres that cater predominantly to non-residents – which we refer to as cross-border financial centres (XFCs) –are important intermediaries of cross-border financial flows. For analysing capital flows and international interconnectedness, it can be useful to distinguish countries that are home to XFCs from other countries. We improve on previous methodologies for identifying such centres by constructing a measure focussed on the intermediation activity inherent to XFCs and explicitly taking into account the non-normal distribution of this measure across countries when detecting outliers. We also minimise volatility in the set of countries identified as XFCs over time by de-trending the data and pooling years. Our methodology identifies a core set of 12 countries as XFCs over the 1995-2020 period, but the countries vary with time and different measures of activity.
    Date: 2022–07
  15. By: Saroj Bhattarai; Konstantin Kucheryavyy
    Abstract: We present a unified dynamic framework to study the interconnections between international trade and business cycle models. We prove an aggregate equivalence between a competitive, representative firm model that has aggregate production externalities and dynamic trade models that feature monopolistic competition, endogenous entry, and heterogeneous firms. The production externalities in the representative firm model have to be introduced in the intermediate and final good sectors so that the model is isomorphic to dynamic trade models that embody love-of-variety and selection effects. In a quantitative exercise with multiple shocks, we show that to improve the fit of the dynamic trade models with the data, the most important ingredient is negative capital externality in the intermediate good sector. We conclude that this presents a puzzle for the literature as standard dynamic trade models provide micro-foundations for positive capital externality.
    Keywords: international business cycle, dynamic trade models, heterogeneous firms, production externalities, monopolistic competition, export costs, entry costs
    JEL: F12 F41 F44 F32
    Date: 2022
  16. By: Andrew Atkeson; Jonathan Heathcote; Fabrizio Perri
    Abstract: The US net foreign asset position has deteriorated sharply since 2007 and is currently negative 65 percent of US GDP. This deterioration primarily reflects changes in the relative values of large gross international equity positions, as opposed to net new borrowing. In particular, a sharp increase in equity prices that has been US-specific has inflated the value of US foreign liabilities. We develop an international macro finance model to interpret these trends, and we argue that the rise in equity prices in the United States likely reflects rising profitability of domestic firms rather than a substantial accumulation of unmeasured capital by those firms. Under that interpretation, the revaluation effects that have driven down the US net foreign asset position are associated with large, unanticipated transfers of US output to foreign investors.
    Keywords: Global imbalances; Current account; Equity markets
    JEL: F30 F40
    Date: 2022–04–25
  17. 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.
    Keywords: Wars; International reserves; Financial sanctions; Sovereign default
    JEL: F51 F50 F30
    Date: 2022–04–26
  18. By: James Costain; Galo Nuño; Carlos Thomas
    Abstract: We build a no-arbitrage model of the yield curves in a heterogeneous monetary union with sovereign default risk, which can account for the asymmetric shifts in euro area yields during the Covid-19 pandemic. We derive an affine term structure solution, and decompose yields into term premium and credit risk components. In an extension, we endogenize the peripheral default probability, showing that it decreases with central bank bond-holdings. Calibrating the model to Germany and Italy, we show that a “default risk extraction” channel is the main driver of Italian yields, and that flexibility makes asset purchases more effective.
    Keywords: sovereign default, quantitative easing, yield curve, affine model, Covid-19 crisis, ECB, pandemic emergency purchase programme
    JEL: E50 G12 F45
    Date: 2022

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