nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2022‒12‒05
twelve papers chosen by
Martin Berka
Massey University

  1. The United States of Europe: A Gravity Model Evaluation of the Four Freedoms By Keith Head; Thierry Mayer
  2. Risk sharing and monetary policy transmission By Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Renault, Théodore
  3. Endogenous Product Adjustment and Exchange Rate Pass-Through By Freitag, Andreas; Lein, Sarah
  4. Just Do IT? An Assessment of Inflation Targeting in a Global Comparative Case Study By Roberto Duncan; Enrique Martinez-Garcia; Patricia Toledo
  5. Dominant Currency Shocks and Foreign Exchange Pressure in the Periphery By Aleksandr V. Gevorkyan; Tarron Khemraj
  6. Financing imports, the Triffin dilemma and more By Saccal, Alessandro
  7. Quantitative Easing in the US and Financial Cycles in Emerging Markets By Marcin Kolasa; Grzegorz Wesołowski
  8. Explaining the volatility of the real exchange rate in emerging markets By Manuel Agosin; Juan D. Diaz-Maureira
  9. How Can Asset Prices Value Exchange Rate Wedges? By Karen K. Lewis; Edith X. Liu
  10. Estimating the elasticity of consumer prices to the exchange rate: an accounting approach By Hadrien Camatte; Guillaume Daudin; Violaine Faubert; Antoine Lalliard; Christine Rifflart
  11. Global Value Chains and the transmission of exchange rate shocks to consumer prices By Hadrien Camatte; Guillaume Daudin; Violaine Faubert; Antoine Lalliard; Christine Rifflart
  12. Interest Rate Shocks and the Composition of Sovereign Debt By Gonzalez-Aguado, Eugenia

  1. By: Keith Head (UBC - University of British Columbia); Thierry Mayer (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique)
    Abstract: One of the pillars of the 1957 Treaty of Rome that ultimately led to the European Union is the commitment to the four freedoms of movement (goods, services, persons, and capital). Over the following decades, as the members expanded in numbers, they also sought to deepen the integration amongst themselves in all four dimensions. This paper estimates the success of these policies based primarily on a gravity framework. Distinct from past evaluations, we augment the traditional equation for international flows with the corresponding intra-national flows, permitting us to distinguish welfare-improving reductions in frictions from Fortress-Europe effects. We complement the gravity approach by measuring the extent of price convergence. We compare both quantity and price assessments of free movement with corresponding estimates for the 50 American states.
    Date: 2021–05–01
  2. By: Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Renault, Théodore
    Abstract: Using regionally disaggregated data on economic activity, we show that risk sharing plays a key role in shaping the real effects of monetary policy. With weak risk sharing, monetary policy shocks trigger a strong and durable response in output. With strong risk sharing, the response is attenuated, and output reverts to its initial level over the medium term. The attenuating impact of risk sharing via credit and factor markets concentrates over a two-year horizon, whereas fiscal risk sharing operates over longer horizons. Fiscal risk sharing especially benefits poorer regions by shielding them against persistent output contractions after tightening shocks. JEL Classification: C32, E32, E52
    Keywords: local projections, monetary policy, quantile regressions, regional heterogeneity, risk sharing
    Date: 2022–11
  3. By: Freitag, Andreas (University of Basel); Lein, Sarah
    Abstract: We document how product quality responds to exchange rate movements and quantify the extent to which these quality changes affect the aggregate pass-through into export prices. We analyze the substantial sudden appreciation of the Swiss franc post removal of the 1.20-CHF-per-euro lower bound in 2015 using export data representing a large share of the universe of goods exports from Switzerland. We find that firms upgrade the quality of their products after the appreciation. Furthermore, they disproportionately remove lower-quality products from their product ranges. This quality upgrading and quality sorting effect accounts for a substantial share of the total pass-through one year after the appreciation. We cross-check our results with the microdata underlying the Swiss export price index, which includes an adjustment factor for quality based on firms' reported product replacements, and obtain similar results.
    Keywords: large exchange rate shocks, exchange rate pass-through, quality adjustment
    JEL: E3 E31 E50 F14 F41
    Date: 2022–11–18
  4. By: Roberto Duncan; Enrique Martinez-Garcia; Patricia Toledo
    Abstract: This paper proposes new measures of the effectiveness of inflation targeting (IT) and evaluates its main drivers in a (large) sample of advanced economies (AEs) and emerging market and developing economies (EMDEs). Using synthetic control methods, we find that IT has heterogeneous effects on inflation across countries. The gains shifting the level of inflation (generally downwards) are modest and smaller in AEs than are those in EMDEs. All such gains are statistically significant in one out of three economies approximately. Second, statistically significant differences in keeping inflation close to target under IT (compared with estimated counterfactuals) can be detected more broadly in nearly half of the economies. Third, IT can be a source of economic resilience that helped cushion inflation fluctuations during the 2007-09 Global Financial Crisis with statistically significant gains mostly found among EMDEs (in two out of three of these economies). Finally, we find that IT effectiveness—measured by the dynamic treatment effect and the absolute deviations of both observed and synthetic inflation from target—is significantly correlated with indices of exchange rate stability and monetary policy independence, especially among EMDEs.
    Keywords: Inflation targeting; Monetary policy; Inflation; synthetic control method
    JEL: C33 E31 E42 E52 E58 E61 N10
    Date: 2022–11–05
  5. By: Aleksandr V. Gevorkyan; Tarron Khemraj (Schwartz Center for Economic Policy Analysis (SCEPA))
    Abstract: The paper assesses the effects of dominant currency shocks (strong US dollar) on emerging markets by studying exchange market pressure (EMP) or foreign exchange (FX) liquidity, GDP growth, external debt, and inflation. The literature emphasizes inflation passthrough, trade volume and GDP growth contraction in the periphery following a strong dollar. Comparing the dollar shock with euro and commodity price shocks and employing pooled mean group estimates and panel VAR across regimes of trade invoicing, this paper shows that bilateral depreciation can decrease FX liquidity and GDP growth in the periphery, failing to achieve the conventional macroeconomic adjustments of a competitive depreciation. A strong dollar reduces external debt, but strong euro has the opposite effect, implying circumvention of the ‘original sin.’ An EMP, FX liquidity, shock from the periphery appreciates the US dollar, affirming dollar’s safehaven status. These findings have implications for balance of payments and exchange rate policy management.
    Keywords: dominant currency pricing, exchange market pressure, international monetary system, nominal spillovers
    JEL: E24 I14 J62 J38 E21 J83 J32
    Date: 2022–04
  6. By: Saccal, Alessandro
    Abstract: This monograph presents a formal proof of the notion by which a country devoid of tradable assets and without access to foreign borrowing and lending must systematically pay for its imports in foreign currency through its exports alone, provided a demand for them to begin with. It likewise sets forth a formal proof of the Triffin dilemma, by which a country whose external currency enjoys the status of an international reserve currency is bound to incur a trade deficit and an attendant excess of extant foreign net borrowing in relation to its tradable assets, meanwhile advancing an innovative, orderly model of the balance of payments. Currency regimes, sudden stops in foreign net borrowing, international reserve currencies and changes in private and public consumption are additionally examined. This monograph completes its study of the dynamics pertaining to exports and foreign borrowing by means of a static deterministic partial equilibrium (SDPE) model, via stability analysis.
    Keywords: balance of payments; exports; imports; international reserve currency; Triffin dilemma; tradable assets.
    JEL: E12 F13 F30 F31 F41 F45 F52 N10
    Date: 2022–10–03
  7. By: Marcin Kolasa (SGH Warsaw School of Economics and International Monetary Fund); Grzegorz Wesołowski (University of Warsaw, Faculty of Economic Sciences)
    Abstract: Large international capital movements tend to be associated with strong fluctuations in asset prices and credit, contributing to domestic financial cycles and posing challenges for stabilization policies, especially in emerging market economies. In this paper we argue that these challenges are particularly severe if the global financial cycle is driven by quantitative easing (QE) in the US, and when the local banking sector has large holdings of government bonds, like in many Latin American (LA) countries. We first investigate empirically the impact of a typical round of QE by the US Fed on LA economies, finding a persistent expansion in credit to households and house prices as well as a significant loss of price competitiveness in this group of economies. We next develop a quantitative macroeconomic model of a small open economy with segmented asset markets and banks, which accounts for these observations. In this framework, foreign QE creates tensions between macroeconomic and financial stability as a contractionary impact of exchange rate appreciation is accompanied by booming credit and house prices. As a consequence, conventional monetary policy accommodation aimed at stabilizing output and inflation would further exacerbate domestic financial cycle. We show that an effective way of resolving this trade-off is to impose a time-varying tax on capital inflows. Combining foreign exchange interventions with tightening of local credit policies can also restore macroeconomic and financial stability, but at the expense of a large redistribution of wealth between borrowers and savers.
    Keywords: quantitative easing, global financial cycle, domestic credit, exchange rate interventions, capital controls, macroprudential policy
    JEL: E44 E58 F41 F42 F44
    Date: 2022
  8. By: Manuel Agosin; Juan D. Diaz-Maureira
    Abstract: This paper shows that the real exchange rate (RER) is more volatile in emerging and developing economies than in advanced countries. This stylized fact is well explained by the correlation coefficient between gross capital inflows (increases in liabilities with the rest of the world) and gross capital outflows (increases in assets held by domestic agents in the rest of the world). This correlation (with increases both in foreign liabilities and assets expressed as positive magnitudes) is much higher in advanced economies than in emerging and developing economies. We find a negative relationship between the correlation coefficient of gross inflows and outflows, on the one hand, and real exchange volatility, on the other. This finding is robust to various estimation procedures and to changes in the definition of RER volatility.
    Date: 2022–11
  9. By: Karen K. Lewis; Edith X. 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.
    Keywords: Exchange rates and foreign exchange; Asset prices; Financial integration; Social costs
    JEL: F31 G15 G10 F41 F30
    Date: 2022–11–07
  10. By: Hadrien Camatte; Guillaume Daudin (DIAL - Développement, institutions et analyses de long terme, OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po, LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique); Violaine Faubert; Antoine Lalliard; Christine Rifflart (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)
    Abstract: We analyse the elasticity of the household consumption expenditure (HCE) deflator to the exchange rate, using world input-output tables (WIOT) from 1995 to 2019. In line with the existing literature, we find a modest output-weighted elasticity of around 0.1. This elasticity is stable over time but heterogeneous across countries, ranging from 0.05 to 0.22. Such heterogeneity mainly reflects differences in foreign product content of consumption and intermediate products. Direct effects through imported consumption and intermediate products entering domestic production explain most of the transmission of an exchange rate appreciation to domestic prices. By contrast, indirect effects linked to participation in global value chains play a limited role. Our results are robust to using four different WIOT datasets. As WIOT are data-demanding and available with a lag of several years, we extrapolate a reliable estimate of the HCE deflator elasticity from 2015 onwards using trade data and GDP statistics.
    Keywords: Input-output linkages,Spillovers,Global value chains,Cost-push inflation
    Date: 2021–11–02
  11. By: Hadrien Camatte (Banque de France - Gaz de France Direction de la Recherche); Guillaume Daudin (LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique); Violaine Faubert (Banque de France - Gaz de France Direction de la Recherche); Antoine Lalliard (Banque de France - Gaz de France Direction de la Recherche); Christine Rifflart (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)
    Abstract: Following the 2008 financial crisis, inflation rates in advanced economies have been at odds with the prediction of a standard Phillips curve. This puzzle has triggered a debate on the global determinants of domestic prices. We contribute to this debate by investigating the impact of exchange rate shocks on consumer prices from 1995 to 2018. We focus on cost-push inflation through global value chains, using three sectoral world input-output datasets. Depending on countries, the absolute value of the elasticity of the household consumption expenditure (HCE hereafter) deflator to the exchange rate ranges from 0.05 to 0.35, confirming the importance of global value chains in channelling external shocks to domestic inflation. Using data from WIOD on a sample of 43 countries, we find that the mean output-weighted elasticity of the HCE deflator to the exchange rate increased in absolute value from 0.075 in 2000 to 0.094 in 2008. After peaking in 2008, it declined to 0.088 in 2014. World Input-Output tables (WIOT hereafter) are released with a lag of several years and the latest WIOT dates back to 2015. To fill this gap, we approximate the impact of an exchange rate shock on the HCE deflator from 2016 onwards using up-to -date GDP and trade data. Our extrapolations suggest that the decline in the elasticity of the HCE deflator continued until 2016, before reversing in 2017 and 2018. Our findings are robust to using three different datasets.
    Keywords: Inflation,global value chains,Phillips curve,input output tables,international trade,pass through
    Date: 2021–02–08
  12. By: Gonzalez-Aguado, Eugenia
    Abstract: There has been a growing concern about the vulnerability of emerging countries to fluc-tuations in international interest rates. Empirical evidence shows that these countries suffer significant output drops when developed countries raise their interest rates. In this paper, I document that an important determinant of the magnitude of this effect is the ability of coun-tries to issue sovereign debt domestically, rather than to external creditors. Moreover, I find that the level of financial development of domestic markets is positively related to the share of total public debt that is domestically held. I build a model that integrates a domestic banking sector into a sovereign default model where governments can issue domestic and external debt and decide whether to default on debt selectively. Due to financial frictions, issuing domestic debt crowds out investment in capital. As financial markets develop, crowding-out costs decrease, and banks demand lower interest rates on domestic bonds. Both effects reduce the relative cost to the government of borrowing domestically, leading to a higher share of domestic debt. The results of the quantitative solution of the model are consistent with the patterns of vulnerabil-ity to world interest rates and sovereign debt composition observed in the data. I show that financial development, through a less costly access to domestic debt, decreases the vulnerability of emerging economies to external shocks.
    Keywords: Sovereign debt; Interest rates; International spillovers; Financial development
    JEL: E44 F34 F42
    Date: 2022–11–04

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