nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒01‒02
seven papers chosen by
Martin Berka
Massey University

  1. Volatility and the Current Account: Extending the Evidence By João Tovar Jalles; Georgios Karras
  2. The Puzzling Change In The International Transmission Of U.S. Macroeconomic Policy Shocks By Ethan Ilzetzki; Keyu Jin
  3. Financial integration, productive development and fiscal policy space in developing countries By Alberto Botta; Gabriel Porcile; Danilo Spinola; Giuliano Toshiro Yajima
  4. The growing importance of investment funds in capital flows By Richard Schmidt; Pinar Yesin
  5. Monetary policy in a two-country model with behavioral expectations By Michał Brzoza-Brzezina; Paweł Galiński; Krzysztof Makarski
  6. Fiscal, Environmental, and Bank Regulation Policies in a Small Open Economy for the Green Transition By Patrick Gruning
  7. Global uncertainty By Caggiano, Giovanni; Castelnuovo, Efrem

  1. By: João Tovar Jalles; Georgios Karras
    Abstract: Consistent with standard theoretical priors, generally based on the precautionary saving motive, the empirical literature has documented that increased macroeconomic volatility is associated with improvements in the current account balance in advanced economies. Using an updated and extended data set, we first confirm this relationship, but also show that it does not hold in developing economies, where macroeconomic volatility is not systematically associated with changes in the current account balance. When we explore potential mechanisms for this asymmetry, we find evidence in favor of precautionary saving in both groups of countries, which allows us to rule this out as the reason behind the observed difference in the current-account/volatility relationship.
    Keywords: current account; uncertainty; volatility
    JEL: F32 F41
    Date: 2022–12
  2. By: Ethan Ilzetzki (London School of Economics (LSE)); Keyu Jin (London School of Economics (LSE))
    Abstract: We demonstrate a dramatic change over time in the international transmission of US monetary policy shocks. International spillovers from US interest rate policy have had a different nature since the 1990s than they did in post-Bretton Woods period. Our analysis is based on a panel of 21 high income and emerging market economies. Prior to the 1990s, the US dollar appreciated, and ex-US industrial production declined, in response to increases in the US Federal Funds Rate, as predicted by textbook open economy models. The past decades have seen a shift, whereby increases in US interest rates depreciate the US dollar but stimulate the rest of the world economy. Results are robust to several identification methods. We sketch a simple theory of exchange rate determination in face of interest-elastic risk aversion that rationalizes these findings.
    Date: 2020–12
  3. By: Alberto Botta; Gabriel Porcile; Danilo Spinola; Giuliano Toshiro Yajima
    Abstract: This paper offers a simple, tractable post-Keynesian model, which highlights the importance of structural change and productive development in defining the dynamics of the Real Exchange Rate (RER) and foreign debt in a small open developing economy. The argument is that in countries that keep the capital account open and rely on austerity policies to induce a notional surplus in the Balance of Payment, the RER can hardly be used as a tool aimed at smoothing the impacts of changes in international financial markets (as argued in the classical macroeconomic trilemma). In our model, capital flows and fluctuations in the RER endogenously feed back into each other and give rise to cyclical macroeconomic volatility. Fiscal austerity supposedly taming external imbalances exacerbates such instability. More diversified productive structures and stronger non-price competitiveness open more space for expansionary fiscal policies, make the economy more resilient to finance-led macroeconomic cycles, and make external debt more sustainable. Capital controls together with stronger price sensitivity of net exports can further stabilize the economy. The paper carries important policy implications, in particular for the combination of industrial and macroprudential policies in peripheral economies, whose pattern of specialization is highly dependent on a few, low-tech commodities. The adoption of industrial policies to foster non-price competitiveness and diversification is critical to sustain macroeconomic stability, both in the short and the long run.
    Keywords: Structural Change; Capital Inflows; Macroprudential Policies
    JEL: F32 F38 O30
    Date: 2022–12
  4. By: Richard Schmidt; Pinar Yesin
    Abstract: In this paper, we first document the growing importance of foreign-domiciled investment funds in countries' portfolio liabilities over time and then show empirical evidence that cross-border fund flows are coincident with asset price movements. To measure the external liabilities of countries to foreign-domiciled funds, we complement conventional balance of payments and international investment position data with granular and real-time fund flows data. We find that the external exposure of countries to investment funds has been steadily increasing both for advanced and emerging market economies. Furthermore, we find that this increased external exposure is coincident with higher exchange rate fluctuations, lower bond yields and higher stock returns. Because sustainability-themed investment funds are growing faster than conventional investment funds, we also focus on Environmental, Social and Governance (ESG) funds and construct an index of sustainable finance that can distinguish between its domestic and cross-border components. Our index reveals that ESG funds domiciled in European countries tend to invest predominantly in domestic markets, whereas ESG investment in emerging market economies to a large extent originates from foreign-domiciled investment funds.
    Keywords: Investment funds, portfolio investment, fund flows, ESG funds, financial markets
    JEL: F32 G15 G23
    Date: 2022
  5. By: Michał Brzoza-Brzezina (Narodowy Bank Polski); Paweł Galiński (Narodowy Bank Polski); Krzysztof Makarski (Narodowy Bank Polski)
    Abstract: We study the working of monetary policy in an estimated two-country model with behavioral expectations(BE). We first show that the data favors this setting compared with the standard rational expectations assumption. Then we document several findings related to monetary policy in the open-economy framework. First, under BE the Taylor principle depends on the size of the economy - determinacy regions are larger for the small country. Second, both in the small and large economies, monetary policy is less powerful when agents are behavioral. Third, the sacrifice ratio faced by the central bank increases with agents becoming more behavioral (more in the small country). Fourth, BE help to partly solve the puzzles of excess foreign currency returns (UIP puzzle) and of international monetary independence.
    Keywords: behavioral agents, monetary policy, open-economy model
    JEL: E30 E43 E52 E70
    Date: 2022
  6. By: Patrick Gruning (Latvijas Banka)
    Abstract: This study develops a small open economy dynamic stochastic general equilibrium model with green and brown intermediate goods, banks subject to capital requirements, and public investment. The domestic economy might face domestic or foreign carbon taxes and an emissions cap. The model is used to analyze which environmental, fiscal, and bank regulation policies are effective facilitators of the domestic economy’s green transition and the costs involved. Among the policies that can generate an exogenously imposed and fixed emissions reduction, most costly is the exogenous world brown energy price increase, followed by the emissions cap reduction, while the introduction of domestic carbon taxes does not change GDP in the long run. The reason for this stark difference is that domestic carbon taxes and emissions cap violation penalties are used to stimulate public green investment. However, only domestic carbon tax revenues are substantial as brown entrepreneurs do not violate theemissions cap in equilibrium. Bank regulation policies and other fiscal policies are not capable of generating large emissions reductions. During the green transition induced by domestic carbon taxes, the first years of the transition are characterized by a run on brown energy in anticipation of higher prices in the future.
    Keywords: small open economy, climate transition risk, energy, environmental policy, bank regulation, public investment
    JEL: E30 F41 G28 H23 H41 Q50
    Date: 2022–12–01
  7. By: Caggiano, Giovanni; Castelnuovo, Efrem
    Abstract: We estimate a novel measure of global Önancial uncertainty (GFU) with a dynamic factor framework that jointly models global, regional, and country-speciÖc factors. We quantify the impact of GFU shocks on global output with a VAR analysis that achieves set-identiÖcation via a combination of narrative, sign, ratio, and correlation restrictions. We Önd that the world output loss that materialized during the great recession would have been 13% lower in absence of GFU shocks. We also unveil the existence of a global Önance uncertainty multiplier: the more global Önancial conditions deteriorate after GFU shocks, the larger the world output contraction is.
    Keywords: Global Financial Uncertainty,dynamic hierarchical factor model,structural VAR,world output loss,global finance uncertainty multiplier
    JEL: C32 E32
    Date: 2021

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