nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒09‒26
four papers chosen by
Martin Berka
Massey University

  1. The Impacts of Crises on the Trilemma Configurations By Joshua Aizenman; Menzie D. Chinn; Hiro Ito
  2. The Small Open Economy in a Generalized Gravity Model By Svetlana Demidova; Takumi Naito; Andrés Rodríguez-Clare
  3. Capital Control and Heterogeneous Impact on Capital Flows By Sanyal, Anirban
  4. Flexible Average Inflation Targeting: How Much Is U.S. Monetary Policy Changing? By Jarod Coulter; Roberto Duncan; Enrique Martinez-Garcia

  1. By: Joshua Aizenman; Menzie D. Chinn; Hiro Ito
    Abstract: The “monetary trilemma” – the hypothesis that full monetary policy autonomy, exchange rate stability, and financial openness cannot simultaneously be achieved – has long been studied. Recently, holding international reserves (IR) has become an important policy instrument, insuring against liquidity shortages. We find that countries’ policy mixes are diverse, and have varied over time, sometimes in response to crises. We illustrate how the policy combinations changed drastically after the Asian Financial Crisis (AFC). In contrast, the Global Financial Crisis did not lead to a drastic change in the policy arrangements. We find that countries that faced large terms of trade shocks or negative economic growth during the crisis increased IR holding, post-AFC. Countries that had negative growth during the crisis also tended to pursue greater exchange rate flexibility and financial openness. This finding is true for commodity, but not manufactured goods, exporters. Countries with large current account deficits tend to be more sensitive to economic growth at the time of the AFC. Countries that are under IMF stabilization programs or those with sovereign wealth funds tended to hold more IR. In general, countries increased their IR holdings after the GFC, but did not otherwise respond concurrently to crisis conditions.
    JEL: F33 F38
    Date: 2022–08
  2. By: Svetlana Demidova; Takumi Naito; Andrés Rodríguez-Clare
    Abstract: To provide sharp answers to basic questions in international trade, a standard approach is to focus on a small open economy (SOE). Whereas the classic tradition is to define a SOE as an economy that takes world prices as given, in the modern trade literature a SOE is defined instead as one that takes foreign-good prices and export demand schedules as given. In this paper we develop a generalized gravity model that nests all of its standard microfoundations (e.g., Armington and Melitz-Pareto) and show how to take the limit so that an economy that becomes infinitesimally small behaves like a SOE. We then show how the resulting model of a SOE can be used to understand comparative statics and the optimal tariff in a way that is robust across the different microfoundations consistent with the gravity model.
    JEL: F10
    Date: 2022–08
  3. By: Sanyal, Anirban
    Abstract: This paper analyzes the heterogeneous direct and spillover effect of capital control on gross capital flows across three major institutional sectors namely public sector, banks and corporate. The paper examines the possible heterogeneity in the effect of capital control on the capital inflows to these institutional sectors using spatial econometric models. The empirical findings indicate that the direct effect of capital control moderates portfolio inflows to public sector whereas the portfolio inflows to banks and corporate sector does not respond to the capital control measures. The spillover effect of capital control increases capital inflows to all sectors in other countries. The paper explains the observed 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 yield.
    Keywords: Capital control, Spillover effect, Portfolio Choice, Signaling effect, Spatial Durbin Model
    JEL: C21 F32 F42
    Date: 2022–08–15
  4. By: Jarod Coulter; Roberto Duncan; Enrique Martinez-Garcia
    Abstract: One major outcome of the Federal Reserve’s 2019–20 framework review was the adoption of a Flexible Average Inflation Targeting (FAIT) strategy in August 2020. Using synthetic control methods, we document that U.S. inflation rose post-FAIT considerably more than predicted had the strategy not changed (an average of 1.18 percentage points during 2020:M8-2022:M2). To explore the extent to which targeting average inflation delayed the Fed’s response and contributed to post-FAIT inflation, we adopt a version of the open-economy New Keynesian model in Martínez-García (2021) and document the economic consequences of adopting alternative measures of average inflation as policy objectives. We document three additional major findings using this general equilibrium setup: First, depending on how far back and how much weight is assigned to past inflation misses, the policy outcomes under FAIT are similar to those under the pre-FAIT regime. Secondly, we find that the implementation of FAIT can have large effects over short periods of time as it tends to delay action. However, over longer periods of time—such as the 1984:Q1-2019:Q4 pre-FAIT period—its effects wash out and appear negligible. Finally, we find that different average inflation measures explain an average of 0.5 percentage points per quarter of the post-FAIT inflation surge, indicating that targeting average inflation by itself can only explain part of the inflation spike since August 2020.
    Keywords: Open-Economy New Keynesian Model; Monetary Policy; Flexible Average Inflation Targeting; Survey Expectations
    JEL: F41 F42 F47 E52 E58 E65
    Date: 2022–07–30

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.