nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒09‒12
twelve papers chosen by
Martin Berka
Massey University

  1. Portfolio shocks and the financial accelerator in a small open economy By Ortiz, Marco; Miyahara, Ken
  2. Origins of International Factor Structures By Zhengyang Jiang; Robert J. Richmond
  3. The current account and monetary policy in the euro area By Schuler, Tobias; Sun, Yiqiao
  4. Reserve Accumulation and Capital Flows: Theory and Evidence from Non-Advanced Economies By Juan Pablo Ugarte
  5. Better two eyes than one: A synthesis classification of exchange rate regimes By Carl Grekou
  6. Oil Discovery, Boom-Bust Cycle and Manufacturing Slowdown: Evidence from a Large Industry Level Dataset By Nouf Alsharif; Sambit Bhattacharyya
  7. Changing anchor of the renminbi: A Bayesian learning approach to the decade-long transition By Chen Zhang; Ying Fang; Linlin Niu
  8. Exchange Rates and the Speed of Economic Recovery: The Role of Financial Development By Boris Fisera
  9. Procyclical fiscal policy and asset market incompleteness By Andrés Fernández; Daniel Guzmán; Ruy E. Lama; Carlos A. Vegh
  10. Sovereign Debt By Leonardo Martinez; Francisco Roch; Francisco Roldan; Jeromin Zettelmeyer
  11. A Portfolio Approach to Global Imbalances By Zhengyang Jiang; Robert J. Richmond; Tony Zhang
  12. Rightsizing Bank Capital for Small, Open Economies By McInerney, Niall; O'Brien, Martin; Wosser, Michael; Zavalloni, Luca

  1. By: Ortiz, Marco; Miyahara, Ken
    Abstract: We study a small open economy with two salient properties: an entrepreneurial sector that borrows in foreign currency and is subject to costly state-verification and risk averse FX market intermediaries. This economy thus features a financial accelerator, an endogenous expected cost of capital, and foreign exchange dynamics dependent on the open position of financial intermediaries. we aim to quantitatively assess the extent to which portfolio shocks can reproduce contractionary depreciations and how central bank's optimal simple rules can improve welfare in a stylized economy.
    Keywords: Exchange rate dynamics, exchange rate intervention, financial accelerator, incomplete financial markets
    JEL: F3 F31 F34 F41 G15
    Date: 2022–08–15
  2. By: Zhengyang Jiang; Robert J. Richmond
    Abstract: We show that exchange rate correlations tend to be explained by the global trade network while consumption correlations tend to be explained by productivity correlations. Sharing common trade linkages with other countries increases exchange rate correlations beyond bilateral linkages. We explain these findings using a model of the global trade network with market segmentation. Interdependent global production generates international comovements, while market segmentation disconnects the drivers of exchange rate correlations from the drivers of consumption correlations. Moreover, we show that the trade network generates common factors found in exchange rates. Our findings offer a trade-based account of the origins of international comovements and shed light on important frictions in international markets.
    JEL: F31 G15
    Date: 2022–08
  3. By: Schuler, Tobias; Sun, Yiqiao
    Abstract: We investigate the factors driving current account and monetary policy developments in the euro area. We estimate an open-economy structural vector autoregression (VAR) model with zero and sign restrictions derived from a multi-country dynamic stochastic general equilibrium (DSGE) model to identify relevant shocks and analyse their impact on the current account and interest rate. Examining the VAR impulse responses for Germany, Italy and Spain we find that investment shocks and preference shocks drive the current account and interest rates in the opposite directions. By contrast, external demand shocks and productivity shocks cause both the current account balance and interest rate to move in the same direction. We also provide evidence for spillovers to the euro area from US preference shocks and US interest rate policy shocks. JEL Classification: E32, F32, F45
    Keywords: current account, macroeconomic shocks, monetary policy
    Date: 2022–08
  4. By: Juan Pablo Ugarte
    Abstract: Capital flows can have destabilizing effects in economies connected to the global financial system. Research has shown that external factors tend to explain most of these movements during episodes of financial turmoil, while country-specific determinants are able to explain heterogeneity throughout the recovery. This paper seeks to understand how reserve accumulations affect real and financial variables. For this purpose, a theoretical framework based on an extended version of the Mundell-Fleming model is presented and its predictions are tested with empirical evidence. Our results suggest that, under a flexible exchange rate regime, an accumulation of reserves generates net capital inflows with limited effects on the real economy. Specifically, we find that an accumulation of reserves of 1% of GDP would increase net capital flows about 0.81%.
    Date: 2021–09
  5. By: Carl Grekou (CEPII)
    Abstract: This presentation proposes a new de facto classification of exchange rate regimes, the synthesis classification. The proposed framework has several advantages over existing de facto classifications. First, it offers a unified framework based on the most divergent classifications, the RR and LYS classifications, leading not only to a broader coverage but also to a broader spectrum of exchange systems. Second, it fits better with the known history of exchange rate regimes developments in the post-Bretton Woods era. Among other things, it brings an interesting nuance to the so-called hollowing-out hypothesis by showing that the evolution of de facto regimes—especially in emerging economies since the late 1990s—has essentially involved movement toward more tightly “managed” intermediate regimes and not a shift away from such regimes. As an illustration of the insightfulness of our classification, I empirically revisit the nexus between currency crises and exchange rate regimes. In addition to associate a higher probability of currency crisis with both intermediate and floating regimes, my classification, also displays better statistical performances than other classifications in predicting currency crises.
    Date: 2022–08–01
  6. By: Nouf Alsharif (Department of Economics, University of Sussex, BN1 9SL Falmer, United Kingdom); Sambit Bhattacharyya (Department of Economics, University of Sussex, BN1 9SL Falmer, United Kingdom)
    Abstract: We investigate the effects of giant oil discovery and boom-bust price cycle on manufacturing using a large dataset of up to 49481 two-digit industry-years across 136 countries over the period 1962 to 2012. We find that oil discovery reduces growth in manufacturing value added and wages. The effect on employment is insignificant. We also find strong association between oil discovery and manufacturing slowdown episodes. Oil price boom and bust both negatively affects manufacturing perhaps due to increasing input cost (boom) and declining demand (bust). We do not find any evidence in favor of a real exchange rate appreciation driven effect as outlined in standard Dutch Disease models. We speculate that the effect is primarily driven by an increase in the cost of locally sourced manufacturing input.
    Keywords: Oil discovery; Boom-Bust; Manufacturing growth
    JEL: D72 O11
  7. By: Chen Zhang; Ying Fang; Linlin Niu
    Abstract: China’s exchange rate reform, initiated in 2005, had the goal of switching from a fixed U.S. dollar (USD) peg to a floating mechanism with reference to a trade-weighted currency basket. Over a decade of gradual transition, the renminbi (RMB) has gained importance in the international monetary system and has shown higher flexibility in its dollar value. However, previous studies have demonstrated the inertia of the RMB in maintaining a de facto dollar peg, with little evidence of the up-to-date effectiveness of the official currency basket. We present a Bayesian time-varying coefficient regression on the currency peg or basket weight suitable for studying transition process. We show that the “8.11” reform in 2015 triggered an eventual anchor switching, driving down the dollar weight from 1 to around 0.3. Since 2016, the weight of the official basket has been double that of the USD. SVAR and TVP-VAR analysis, controlling for endogeneity, provide consistent evidence of this regime change, which has important implications for China and the global economy.
    Keywords: Renminbi, exchange rate regime, dollar peg, currency basket
    JEL: F31 F41 C11
    Date: 2022–08–24
  8. By: Boris Fisera (Faculty of Social Sciences, Charles University, Prague & Institute of Economic Research, Slovak Academy of Sciences, Bratislava)
    Abstract: We study the influence of the exchange rate on the speed of economic recovery in a sample of 67 developed and developing economies over the years 1989-2019. First, using a cross-sectional sample of 341 economic recoveries, we study the effect of nominal depreciation and real undervaluation on the length of economic recovery. Our findings indicate that both nominal depreciation and real undervaluation increase the speed of economic recovery. However, this finding only holds for smaller depreciations/ undervaluations. Second, we use an interacted panel VAR (IPVAR) model to investigate the effect of real undervaluation on the speed of economic recovery after external shock. While we once again find evidence that undervalued domestic currency increases the speed of economic recovery, its positive effect seems limited in size. Furthermore, we also explore the role of financial development in influencing the effectiveness of undervalued domestic currency in stimulating the economic recovery. We find that the higher level of financial development seems to limit the negative effect of an overvalued currency on the speed of economic recovery, but not to influence the effect of an undervalued currency on economic recovery.
    Keywords: Economic recovery, exchange rate, currency depreciation, real undervaluation, financial development, interacted panel VAR (IPVAR)
    Date: 2022–08
  9. By: Andrés Fernández; Daniel Guzmán; Ruy E. Lama; Carlos A. Vegh
    Abstract: To explain the fact that government spending and tax policy are procyclical in emerging and developing countries, we develop a model for the joint behavior of optimal tax rates and government spending over the business cycle. Our set-up relies on financial frictions, which have been shown to be critical features of emerging markets, captured by various degrees of asset market incompleteness as well as varying levels of debt-elastic interest rate spreads. We first uncover a novel theoretical result within a simple static framework: incomplete markets can account for procyclical government spending but not necessarily procyclical tax policy. Explaining procyclical tax policy also requires that the ratio of private to public consumption comoves positively with the business cycle, which leads to larger fluctuations in the tax base. We then show that the procyclicality of tax policy holds in a more realistic DSGE model calibrated to emerging markets. Finally, we illustrate how larger financial frictions which amplify the business cycle through more procyclical fiscal policies, have sizeable Lucas-type welfare costs.
    Date: 2021–09
  10. By: Leonardo Martinez (International Monetary Fund); Francisco Roch (International Monetary Fund); Francisco Roldan (International Monetary Fund); Jeromin Zettelmeyer (International Monetary Fund)
    Abstract: This paper surveys the literature on sovereign debt from the perspective of understanding how overeign 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
    JEL: F34 F36 G01 G11
    Date: 2022–08
  11. By: Zhengyang Jiang; Robert J. Richmond; Tony Zhang
    Abstract: We use a portfolio-based framework to understand what drives the decline of the U.S. net foreign asset (NFA) position and the reversal in returns earned on the US NFA (exorbitant privilege). We show that global savings gluts and monetary policies widened the U.S. NFA position, while investor demand shifts partially offset this widening. Moreover, U.S. privilege declined after 2010, in accordance with increasing foreign demand for U.S. equity. We also highlight a quantity dimension of the U.S. privilege: the U.S. can issue substantially more debt than other countries for a given yield increase.
    JEL: E44 F32 G15
    Date: 2022–07
  12. By: McInerney, Niall (Central Bank of Ireland); O'Brien, Martin (Central Bank of Ireland); Wosser, Michael (Central Bank of Ireland); Zavalloni, Luca (Central Bank of Ireland)
    Abstract: In a macroeconomic cost versus benefit framework, we determine the appropriate Tier 1 capital ratio for the banking system of advanced economies. Of particular interest is the appropriate bank capital range for countries sharing similar macrofinancial structural characteristics, during times of normal prevailing risk conditions. The characteristics considered include the relative size of the economy, trade and financial openness, the degree to which the country is FDI-dependent and various measures of banking system concentration. We find that, when the prevailing systemic risk environment is neither elevated nor subdued and other critical modelling parameters are set to plausible levels, an appropriate level for the Tier 1 capital ratio in advanced economies can lie in the range of 12% to 20%, with our benchmark estimate being 16%. When considering the additional risk inherent with being a small, open, FDI-reliant economy with a concentrated banking system, this range and benchmark can be up to 1.25 percentage points higher.
    Keywords: optimal bank capital, macroprudential policy, macro-financial structure, systemic risk, financial crises, financial regulation.
    JEL: E5 G01 G17 G28 R39
    Date: 2022–06

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