nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒10‒31
five papers chosen by
Martin Berka
Massey University

  1. Foreign currency exposure and the financial channel of exchange rates By Longaric, Pablo Anaya
  2. Sovereign Risk and Financial Risk By Simon Gilchrist; Bin Wei; Vivian Z. Yue; Egon Zakrajšek
  3. Trapped in the Trilemma: When Security Trumps Economics By Michael D. Bordo; Harold James
  4. When are devaluations more contractionary? A Quantile VAR estimation for Argentina By Gabriel Montes-Rojas; Nicolás Bertholet
  5. The Economic Impact of COVID-19 around the World By Fernando M. Martin; Juan M. Sanchez; Olivia Wilkinson

  1. By: Longaric, Pablo Anaya
    Abstract: Exchange rate movements affect the economy through changes in net exports, i.e. the trade channel, and through valuation changes in assets and liabilities denominated in foreign currencies, i.e. the financial channel. In this paper, I investigate the macroeconomic and financial effects of U.S. dollar (USD) exchange rate fluctuations in small open economies. Specifically, I examine how the financial channel affects the overall impact of exchange rate fluctuations and assess to what extent foreign currency exposure determines the financial channel’s strength. My empirical analysis indicates that, if foreign currency exposure is high, an appreciation of the domestic currency against the USD is expansionary and loosens financial conditions, which is consistent with the financial channel of exchange rates. Moreover, I estimate a small open economy New Keynesian model, in which a fraction of the domestic banks’ liabilities is denominated in USD. In line with the empirical results, the model shows that an appreciation against the USD can be expansionary depending on the strength of the financial channel, which is linked to the level of foreign currency exposure. Finally, the model indicates that the financial channel amplifies the effects of foreign monetary policy shocks. JEL Classification: E44, F31, F41
    Keywords: exchange rates, financial and trade channels, local projections - instrumental variable, open economy DSGE model
    Date: 2022–10
  2. By: Simon Gilchrist; Bin Wei; Vivian Z. Yue; Egon Zakrajšek
    Abstract: In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by more than 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effects are strongest when measuring global risk using the excess bond premium, which is a measure of the risk-bearing capacity of US financial intermediaries. The spillover effects of global financial risk are more pronounced for speculative-grade sovereign bonds.
    Keywords: sovereign bonds; CDS; global financial risk; excess bond premium; global financial cycle
    JEL: E43 E44 F33 G12
    Date: 2021–11–24
  3. By: Michael D. Bordo; Harold James
    Abstract: This paper describes the challenges of globalization in terms of the logic underpinning four distinct policy constraints or “trilemmas” and their interrelationship; in particular the disturbances that arise from capital flows and the difficulties of adjusting monetary policies to a global monetary environment. These trilemmas intersect and interlock. The trilemmas are: 1. The traditional Macroeconomic trilemma between capital mobility, fixed exchange rates and monetary autonomy; 2. The International relations trilemma between capital mobility, sovereignty and international order; 3. The Political economy trilemma between capital mobility, democracy and sovereignty; 4. The Financial stability trilemma between capital mobility, financial stability and independent national policies. The four trilemmas offer a way to analyze how domestic monetary, financial, economic and political systems are interconnected within the international system that opens up vulnerabilities. They can be described as the impossible policy choices at the heart of globalization.
    JEL: E52 E60 F30 F40 G28 N1
    Date: 2022–09
  4. By: Gabriel Montes-Rojas (UBA/CONICET); Nicolás Bertholet (IIEP/BAIRES/UBA/CONICET)
    Abstract: This paper presents empirical evidence on the short- and medium-run contractionary effects of exchange rate shocks and currency devaluations for bimonetary (i. e., highly dollarized) countries. In particular, for Argentina for the period January 2004-December 2018. Using a VAR representation with quantile heterogeneity, it implements a multivariate model with four macroeconomic variables: exchange rate variations, inflation, economic activity and nominal wage growth. The empirical results show a 30% price pass-through effects and a bimodal effect on output, with both positive and negative effects. Wages adjust less than prices with the consequent effect that real wages have a negative elasticity of 0.23 with respect to exchange rate shocks. Further analysis on the multivariate responses show that the negative effect on output is associated with a decline in real wages: a 1% fall in real wages after a currency devaluation produces a 2.3% decline in output.
    JEL: C13 C14 C22
    Date: 2022–10
  5. By: Fernando M. Martin; Juan M. Sanchez; Olivia Wilkinson
    Abstract: For over two years, the world has been battling the health and economic consequences of the COVID-19 pandemic. This paper provides an account of the worldwide economic impact of the COVID-19 shock, measured by GDP growth, employment, government spending, monetary policy, and trade. We find that the COVID-19 shock severely impacted output growth and employment in 2020, particularly in middle-income countries. The government response, mainly consisting of increased expenditure, implied a rise in debt levels. Advanced countries, having easier access to credit markets, experienced the highest increase in indebtedness. All regions also relied on monetary policy to support the fiscal expansion. The specific circumstances surrounding the COVID-19 shock implied that the expansionary fiscal and monetary policies did not put upward pressure on prices until 2021. We also find that the adverse effects of the COVID-19 shock on output and prices have been significant and persistent, especially in emerging and developing countries.
    Keywords: COVID-19; government debt; fiscal policy; monetary policy; emerging markets; inflation; international trade; employment
    JEL: E52 E62 F34 F41 G15
    Date: 2022–09

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.