nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒10‒10
ten papers chosen by
Martin Berka
Massey University

  1. Foreign Reserves Management and Original Sin By Michael B. Devereux; Steve Pak Yeung Wu
  2. Production Networks and International Fiscal Spillovers By Michael B Devereux; Karine Gente; Changhua Yu
  3. How Can Asset Prices Value Exchange Rate Wedges? By Karen K. Lewis; Edith Liu
  4. Climate Policy, Irreversibilities and Global Economic Shocks By Anwesha Banerjee; Stefano Barbieri; Kai A. Konrad
  5. Foreign Demand Shocks to Production Networks: Firm Responses and Worker Impacts By Emmanuel Dhyne; Ayumu Ken Kikkawa; Toshiaki Komatsu; Magne Mogstad; Felix Tintelnot
  6. A Simple Theory of Economic Development at the Extensive Industry Margin By Dario Diodato; Ricardo Hausmann; Ulrich Schetter
  7. Globalisation and the Decoupling of Inflation from Domestic Labour Costs By Emanuel Kohlscheen; Richhild Moessner
  8. Is a Global Recession Imminent? By Justin Damien Guenette; M. Ayhan Kose; Naotaka Sugawara
  9. Exchange-Rate Swings and Foreign Currency Intervention By Andrew Filardo; Thomas McGregor; Mr. R. G Gelos
  10. Enhancing private and public risk sharing: lessons from the literature and reflections on the COVID-19 crisis By Cimadomo, Jacopo; Gordo Mora, Esther; Palazzo, Alessandra Anna

  1. By: Michael B. Devereux; Steve Pak Yeung Wu
    Abstract: This paper studies the interaction between foreign exchange reserves and the currency composition of sovereign debt in emerging countries. Focusing on inflation targeting countries, we find that holdings of foreign reserves are associated with higher local currency sovereign debt, an exchange rate which is less sensitive to global shocks, and a lower exchange rate risk premium in local currency sovereign spreads. We rationalize these findings within a financially constrained model of a small open economy. The Sovereign values local currency debt as a hedge against endowment risk, but since the exchange rate tends to depreciate in times of global downturns, risk averse international investors charge an additional currency risk premium on this debt. When a country optimally uses foreign reserves to lean against the wind in response to global shocks, this dampens the response of the exchange rate, providing insurance for the global investor. By reducing the risk premium on local currency debt, foreign exchange reserves therefore facilitate a higher share of local currency debt in the sovereign portfolio. Quantitatively, we find the welfare benefits for the sovereign from optimal foreign reserves management can be very large.
    JEL: F30 F40
    Date: 2022–09
  2. By: Michael B Devereux (Vancouver school of economics, University of British Columbia, NBER - The National Bureau of Economic Research, CEPR - Center for Economic Policy Research - CEPR); Karine Gente (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Changhua Yu (China Center for Economic Research, National School of Development, Peking University)
    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
    Date: 2022–07–13
  3. By: Karen K. Lewis; Edith Liu
    Abstract: When available financial securities allow investors to optimally diversify risk across countries, standard theory implies that exchange rates should reflect this behavior. However, exchange rates observed in the data deviate from these predictions. In this paper, we develop a framework to value the welfare costs of these exchange rate wedges, as disciplined by asset returns. This framework applies to a general class of asset pricing and exchange rate models. We further decompose the value of these wedges into components, showing that the ability of goods markets to respond to financial markets through exchange rate adjustment has significant implications for welfare.
    JEL: F30 F31 F41 G10 G15
    Date: 2022–09
  4. By: Anwesha Banerjee; Stefano Barbieri; Kai A. Konrad
    Abstract: Global systematic economic shocks may affect the Nash equilibrium contributions to international climate mitigation. We study how this effect depends on the flexibility countries have to adjust to these shocks. The kind of rigidities countries face because of technological irreversibilities plays a crucial role. Under the plausible assumption of “prudence,†higher global uncertainty tends to reduce equilibrium climate contributions if irreversibilities in the level of climate policy choices exist. And, if countries are committed to allocating a proportion of income to climate protection, rigidities may increase welfare. Thus, exercising the option to perfectly adjust oneís contributions to shocks may be another form of free riding.
    Keywords: Global Warming, Climate Protection, Irreversibilities Climate Policy, Global Income Shocks, International Public Goods, Option Value
    JEL: Q54 H41 Q55
    Date: 2022–06
  5. By: Emmanuel Dhyne; Ayumu Ken Kikkawa; Toshiaki Komatsu; Magne Mogstad; Felix Tintelnot
    Abstract: We quantify and explain the firm responses and worker impacts of foreign demand shocks to domestic production networks. To capture that firms can be indirectly exposed to such shocks by buying from or selling to domestic firms that import or export, we use Belgian data with information on both domestic firm-to-firm sales and foreign trade transactions. Our estimates of firm responses suggest that Belgian firms pass on a large share of a foreign demand shock to their domestic suppliers, face upward-sloping labor supply curves, and have sizable fixed overhead costs in labor. Motivated and guided by these findings, we develop and estimate an equilibrium model that allows us to study how idiosyncratic and aggregate changes in foreign demand propagate through a small open economy and affect firms and workers. Our results suggest that the way the labor market is typically modeled in existing research on foreign demand shocks—with no fixed costs and perfectly elastic labor supply—would grossly understate the decline in real wages due to an increase in foreign tariffs.
    JEL: E1 F1 F12 J31 J42 L11
    Date: 2022–09
  6. By: Dario Diodato; Ricardo Hausmann (Center for International Development at Harvard University); Ulrich Schetter (Center for International Development at Harvard University)
    Abstract: We revisit the well-known fact that richer countries tend to produce a larger variety of goods and analyze economic development through (export) diversification. We show that countries are more likely to enter ‘nearby’ industries, i.e., industries that require fewer new occupations. To rationalize this finding, we develop a small open economy (SOE) model of economic development at the extensive industry margin. In our model, industries differ in their input requirements of non-tradeable occupations or tasks. The SOE grows if profit maximizing firms decide to enter new, more advanced industries, which requires training workers in all occupations that are new to the economy. As a consequence, the SOE is more likely to enter nearby industries in line with our motivating fact. We provide indirect evidence in support of our main mechanism and then discuss implications: We show that there may be multiple equilibria along the development path, with some equilibria leading on a pathway to prosperity while others resulting in an income trap, and discuss implications for industrial policy. We finally show that the rise of China has a non-monotonic effect on the growth prospects of other developing countries, and provide suggestive evidence for this theoretical prediction.
    Keywords: economic complexity, economic convergence, export diversification, industrial policy, multiple equilibria, poverty trap, product space, structural change
    JEL: F43 O11 O14
    Date: 2022–09
  7. By: Emanuel Kohlscheen; Richhild Moessner
    Abstract: We provide novel systematic cross-country evidence that the link between domestic labour markets and CPI inflation has weakened considerably in advanced economies during recent decades. The central estimate is that the short-run pass-through from domestic labour cost changes to core CPI inflation decreased from 0.25 in the 1980s to just 0.02 in the 2010s, while the long-run pass-through fell from 0.36 to 0.03. We show that the timing of the collapse in the pass-through coincides with a steep increase in import penetration from a group of 10 major manufacturing EMEs around the turn of the millennium. This signals increased competition and market contestability. Besides the extent of trade openness, we show that the intensity of the pass-through also depends in a non-linear way on the average level of inflation.
    Date: 2022–08
  8. By: Justin Damien Guenette (World Bank); M. Ayhan Kose (World Bank, Brookings Institution, CEPR, CAMA); Naotaka Sugawara (World Bank)
    Abstract: Global growth prospects have deteriorated significantly since the beginning of the year, raising the specter of global recession. This paper relies on insights gleaned from previous global recessions to analyze the recent evolution of economic activity and policies and presents plausible scenarios for the global economy in 2022–24. We report three major findings. First, every global recession since 1970 was preceded by a significant weakening of global growth in the previous year, as has happened recently. Second, the global economy is in the midst of one of the most internationally synchronous episodes of monetary and fiscal policy tightening of the past five decades. The policy actions in many countries are necessary to contain inflationary pressures, but their mutually compounding effects could have larger impacts than envisioned—both in tightening financial conditions and in steepening the global growth slowdown. Third, if the degree of global monetary policy tightening markets now expect is not enough to reduce inflation to targets, experience from previous global recessions suggests that the additional tightening needed could cause significant financial stress and increase the likelihood of a global recession next year. These findings imply that policymakers need to carefully calibrate, clearly communicate, and credibly implement their policy actions while considering potential international spillovers, especially given the globally synchronous withdrawal of monetary and fiscal policies. They also need to pursue supply-side measures to overcome constraints confronting labor markets, energy markets, and trade networks.
    Keywords: Global economy; growth scenarios; monetary policy; fiscal policy; global inflation; synchronization of policies.
    JEL: E17 E32 E37 E58 F44 G01
    Date: 2022–09
  9. By: Andrew Filardo; Thomas McGregor; Mr. R. G Gelos
    Abstract: This paper develops a new approach for exploring the effectiveness of foreign currency intervention, focusing on real exchange cycles. Using band spectrum regression methods, it examines the role of macroeconomic fundamentals in determining the equilibrium real exchange rate at short-, medium-, and low frequencies. Next, it assesses the effectiveness of FX intervention depending on the degree of cycle-specific misalignments for 26 advanced- and emerging market economies, covering the period 1990–2018, and using different techniques to mitigate endogeneity concerns. Evidence supports the hypothesis that central banks can lean effectively against short-run cyclical misalignments of the real exchange rate. The effects are present in quarterly data—i.e., at policy-relevant horizons. The effectiveness of intervention rises with the size of the misalignment, and with the duration of one-sided interventions. FX sales appear to be somewhat more effective than FX purchases, and intervention is less effective in more liquid FX markets.
    Keywords: Foreign exchange intervention; real exchange rates; equilibrium exchange rate; classical cycles; central banking; band spectrum regression.; exchange rate intervention; macro fundamentals; FX sale; FX purchase; FX intervention; measuring exchange rate misalignment; Exchange rates; Real effective exchange rates; Foreign assets; Global
    Date: 2022–07–29
  10. By: Cimadomo, Jacopo; Gordo Mora, Esther; Palazzo, Alessandra Anna
    Abstract: This article surveys the literature on consumption risk sharing, focusing on the findings for the euro area and for the United States, but also presenting evidence for other countries. The literature examined found that risk sharing is higher in more mature federations, such as the United States, than in the euro area. The papers surveyed suggest that state/country-specific output shocks are primarily smoothed out through the capital and credit channel, whereas the fiscal channel as a minor role, especially in the euro area. Overall, about 70% of shocks is smoothed in the United States while just 40% in the euro area. At the same time, our analysis of the response to the COVID-19 crisis indicates that risk sharing in the euro area has been more resilient than it was during the global financial crisis of 2008-09. Overall, our results point to the need for further improvements to the private and public risk-sharing channels in the euro area to ensure more effective cushioning against asymmetric shocks and to boost progress towards the completion of European Monetary Union (EMU). JEL Classification: C23, E62, G11, G15
    Keywords: COVID-19 crisis, EMU reform, Risk sharing
    Date: 2022–09

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