nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒01‒09
seventeen papers chosen by
Martin Berka
Massey University

  1. A Theory of Gross and Net Capital Flows over the Global Financial Cycle By J. Scott Davis; Eric van Wincoop
  2. Optimal Robust Monetary Policy in a Small Open Economy By André Marine Charlotte; Medina Espidio Sebastián
  3. Exchange rate fluctuations and the financial channel in emerging economies By Beckmann, Joscha; Comunale, Mariarosaria
  4. Leaning against the global financial cycle By Ferrero, Andrea; Habib, Maurizio Michael; Stracca, Livio; Venditti, Fabrizio
  5. Capital Controls Checkup: Cases, Customs, Consequences By Goldbach, Stefan; Nitsch, Volker
  6. Foreign Shocks as Granular Fluctuations By Julian Di Giovanni; Andrei A Levchenko; Isabelle Mejean
  7. Effectiveness of Capital Controls: Gates versus Walls By Yang Zhou; Shigeto Kitano
  8. Delayed Overshooting Puzzle: Does Systematic Monetary Policy Matter? By Efrem Castelnuovo; Giovanni Pellegrino; Giacomo Ranzato
  9. External Shocks and FX Intervention Policy in Emerging Economies By Carrasco, Alex; Florian Hoyle, David
  10. Real Exchange Rates and Primary Commodity Prices: Mussa Meets Backus-Smith By Ayres, JoaÞo; Hevia, Constantino; Nicolini, Juan Pablo
  11. A North-South Model of Structural Change and Growth By Maria Aristizabal-Ramirez; John V. Leahy; Linda L. Tesar
  12. Prediction Errors of Macroeconomic Indicators and Economic Shocks for ASEAN Member States, 1990-2021 By Masahito Ambashi; Fusanori Iwasaki; Keita Oikawa
  13. Endogenous Product Adjustment and Exchange Rate Pass-Through By Andreas Freitag; Sarah M. Lein; Sarah Marit Lein
  14. Exchange Rate Predictability Based on Market Sentiments By Kim, Hyo Sang; Kang, Eunjung; Kim, Yuri; Moon, Seongman; Jang, Huisu
  15. Pros and Cons of Globalization: Income-Based Attitudes By Assaf Razin
  16. Currency Concentration in Sovereign Debt, Exchange Rate Cyclicality, and Volatility in Consumption By Eiji Fujii
  17. Real Equilibrium Exchange Rate in Colombia: Thousands of VEC Models Approach By Andrea Salazar-Díaz; Aarón Levi Garavito-Acosta; Sergio Restrepo-Ángel; Leidy Viviana Arcila-Agudelo

  1. By: J. Scott Davis; Eric van Wincoop
    Abstract: We develop a theory to account for changes in gross and net capital flows over the global financial cycle (GFC). The theory relies critically on portfolio heterogeneity among investors within and across countries, related to risky portfolio shares and portfolio shares allocated to foreign assets. A global drop in risky asset prices during a downturn of the GFC changes relative wealth within and across countries due to portfolio heterogeneity. This leads to changes in gross and net capital flows that are consistent with the stylized facts: all countries experience a decline in gross capital flows (retrenchment), while countries that have a net debt of safe assets experience a rise in net outflows of safe assets (reduced accumulation of safe debt). This is accomplished through a rise in total net outflows and a drop in net outflows of risky assets. The model is applied to 20 advanced countries and calibrated to micro data related to within country portfolio heterogeneity, as well as cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for gross and net capital flows are quantitatively consistent with the data.
    JEL: F30 F40
    Date: 2022–12
  2. By: André Marine Charlotte; Medina Espidio Sebastián
    Abstract: We study an optimal robust monetary policy for a small open economy. The robust control approach assumes that economic agents cannot assign probabilities to a set of plausible models and rather focuses on the worst possible misspecification from a benchmark model. Our findings suggest that, first, conducting a global robust optimal monetary policy is limited as deviations from the benchmark model lead to multiple equilibria. Second, when the central bank considers uncertainty only in the IS Curve or in the UIP, the space of unique solutions is expanded. In fact, the central bank reacts more aggressively to demand and real exchange rate shocks when it is robust to misspecifications in the IS curve only. Finally, our results suggest that the global robust optimal monetary policy is limited due to inflation persistency and the low exchange rate pass-through. The importance of anchoring inflation expectations is highlighted.
    Keywords: Robust control;optimal monetary policy;model uncertainty;small open economy
    JEL: C62 D83 D84 E52 E58
    Date: 2022–12
  3. By: Beckmann, Joscha; Comunale, Mariarosaria
    Abstract: This paper assesses the financial channel of exchange rate fluctuations for emerging countries and the link to the conventional trade channel. We analyze whether the effective exchange rate affects GDP growth, the domestic credit and the global liquidity measure as the credit in foreign currencies, and how global liquidity affects GDP growth. We make use of local projections in order to look at the shocks' transmission covering 11 emerging market countries for the period 2000Q1- 2016Q3. We find that foreign denominated credit plays an important macroeconomic role, operating through various transmission channels. The direction of effects depends on country characteristics and is also related to the policy stance among countries. We find that domestic appreciations increase demand regarding foreign credit, implying positive effects on investment and GDP growth. However, this is valid only in the short-run; in the medium-long run, an increase of credit denominated in foreign currency (for instance, due to appreciation) decreases GDP. The financial channel works mostly in the short run except for Brazil, Malaysia, and Mexico, where the trade channel always dominates. Possibly there is a substitution effect between domestic and foreign credit in the case of shocks in exchange rates.
    Keywords: emerging markets,financial channel,exchange rates,global liquidity
    JEL: F31 F41 F43 G15
    Date: 2021
  4. By: Ferrero, Andrea; Habib, Maurizio Michael; Stracca, Livio; Venditti, Fabrizio
    Abstract: We study the role and the interaction of the quality of institutions and of counter-cyclical policies in leaning against the Global Financial Cycle (GFC) in Emerging Economies (EMEs). We show that heteroegeneity in institutional strength is a key determinant of the different effects of the GFC on EME domestic financial conditions. Institutional strength also shapes the response in terms of counter-cyclical policies to sudden changes in global financial conditions as well as the effectiveness of such policies. We illustrate in a simple stylised model that countries may in fact decide to undertake ex ante costly structural reforms that reduce their vulnerability to the GFC or react ex post to the financial s hock. However, we also find that the Covid-19 episode seems to deviate somewhat from the general pattern of EME reaction to shifts in the GFC. JEL Classification: F32, F38, E52, G28
    Keywords: capital controls, emerging markets, foreign-exchange intervention, Global Financial Cycle, institutions., macro-prudential policies, monetary policy
    Date: 2022–12
  5. By: Goldbach, Stefan; Nitsch, Volker
    Abstract: This paper examines the effect of administrative restrictions on cross-border capital transactions. Using highly disaggregated data from the German balance of payments statistics for the period from 1999 through 2017, we document several stylized facts about the effectiveness of such capital control policies introduced by other countries. Capital controls are associated with economically and statistically significant declines in capital flows; they affect bilateral financial relationships along both the extensive and the intensive margin.
    Date: 2022
  6. By: Julian Di Giovanni (Federal Reserve Bank of New York, CEPR - Center for Economic Policy Research - CEPR); Andrei A Levchenko (University of Michigan System, CEPR - Center for Economic Policy Research - CEPR, NBER - National Bureau of Economic Research [New York] - NBER - The National Bureau of Economic Research); Isabelle Mejean (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CEPR - Center for Economic Policy Research - CEPR)
    Abstract: This paper uses a dataset covering the universe of French firm-level value added, imports, and exports over the period 1995-2007 and a quantitative multi-country model to study the international transmission of business cycle shocks at both the micro and the macro levels. Because the largest firms are the most likely to trade internationally, foreign shocks are transmitted to the domestic economy primarily through the large firms. We first document a novel stylized fact: larger French firms are significantly more sensitive to foreign GDP growth. We then implement a quantitative framework calibrated to the full extent of the observed heterogeneity in firm size, exporting, and importing. We simulate the propagation of foreign shocks to the French economy and report one micro and one macro finding. At the micro level heterogeneity across firms predominates: 45 to 75% of the impact of foreign fluctuations on French GDP is accounted for by the "foreign granular residual"-the term capturing the larger firms' greater responsiveness to the foreign shocks. At the macro level, firm heterogeneity attenuates the impact of foreign shocks, with the GDP responses 10 to 20% larger in a representative firm model compared to the baseline model.
    Keywords: Granularity, Shock transmission, Aggregate fluctuations, Input linkages, International trade
    Date: 2022–09–06
  7. By: Yang Zhou (Graduate School of Economics, Kobe University and Junir Research Institute for Economics & Business Administration (RIEB), Kobe University, JAPAN); Shigeto Kitano (Research Institute for Economics and Business Administration(RIEB), Kobe University, JAPAN)
    Abstract: This study analyzes the effectiveness of capital controls on international debt flows using data of 81 economies, including both advanced and emerging economies, over the period from 1995 to 2019. The analysis using the total sample shows that, although they are in the expected directions, the impulse responses of capital controls are statistically insignificant. Making various distinctions among samples (such as advanced and emerging economies and pre- and post-crisis periods), we still find that most results are statistically insignificant. However, the canonical distinction between the "gate" and "wall" economies indicates that the effectiveness of capital controls is relevant for the "wall" emerging economies.
    Keywords: Capital flows; Capital controls; Local projection
    JEL: E69 F32 F38 F41
    Date: 2022–12
  8. By: Efrem Castelnuovo (University of Padova, CESifo, and CAMA); Giovanni Pellegrino (Aarhus University); Giacomo Ranzato (University of Padova)
    Abstract: We propose a novel identification strategy based on a combination of sign, zero, and policy coefficient restrictions to identify the exchange rate response to a US monetary policy shock. Our strategy crucially hinges upon imposing a sign on the policy response to exchange rate fluctuations, i.e., monetary policy tightens after a depreciation of the US dollar. We support this restriction with narrative evidence as well as empirical evidence from the extant literature. We find an unexpected increase in the policy rate to generate an immediate appreciation followed by a persistent depreciation. This evidence is consistent with the overshooting hypothesis. Importantly, we show that our identification strategy implies robust impulse responses across samples characterized by different monetary policy conducts. Differently, restrictions imposed only on impulse responses return evidence that is subsample specific and associate Volcker’s regime with a delayed overshooting.
    Keywords: delayed overshooting, vector autoregressions, monetary policy rule, exchange rate dynamics, Volcker policy regime
    JEL: C32 E44 E52 F31 F41
    Date: 2022–06
  9. By: Carrasco, Alex; Florian Hoyle, David
    Abstract: This paper discusses the role of sterilized foreign exchange (FX) interventions as a monetary policy instrument for emerging market economies in response to external shocks. We develop a model for a commodity-exporting small open economy in which FX intervention is considered as a balance sheet policy induced by a financial friction in the form of an agency problem between banks and their creditors. The severity of banks agency problem depends directly on a bank-level measure of currency mismatch. Endogenous deviations from the standard UIP condition arise at equilibrium. In this context, FX interventions moderate the response of financial and macroeconomic variables to external shocks by leaning against the wind with respect to real exchange rate pressures. Our quantitative results indicate that, conditional on external shocks, the FX intervention policy successfully reduces credit, investment, and output volatility, along with substantial welfare gains when compared to a free-floating exchange rate regime. Finally, we explore distinct generalizations of the model that eliminate the presence of endogenous UIP deviations. In those cases, FX intervention operations are considerably less effective for the aggregate equilibrium.
    Keywords: Foreign exchange intervention;External shocks;Financial dollarization;Monetary policy
    JEL: E32 E44 E52 F31 F41
    Date: 2021–08
  10. By: Ayres, JoaÞo; Hevia, Constantino; Nicolini, Juan Pablo
    Abstract: We show that explicitly modeling primary commodities in an otherwise totally standard incomplete markets open economy model can go a long way in explaining the Mussa puzzle and the Backus-Smith puzzle, two of the main puzzles in the international economics literature.
    Keywords: Mussa puzzle;Backus-Smith puzzle
    JEL: F31 F41
    Date: 2022–01
  11. By: Maria Aristizabal-Ramirez (Federal Reserve Board of Governors); John V. Leahy (University of Michigan & NBER); Linda L. Tesar (University of Michigan & NBER)
    Abstract: This paper is motivated by a set of cross-country observations on growth, structural transformation, and investment rates in a large sample of countries. We observe a hump-shaped relationship between a country's investment rate and its level of development, both within countries over time and across countries. Advanced economies reach their investment peak at a higher level of income and at an earlier point in time relative to emerging markets. We also observe the familiar patterns of structural change (a decline in the agricultural share and an increase in the services share, both relative to manufacturing). The pace of change observed in the 1930 to 1980 period in advanced economies is remarkably similar to that in emerging markets since 1960. We develop a two-region model of the world economy in which regions are isolated from each other up to the point of capital market liberalization in the early 1990s. At that point, capital flows from advanced economies to emerging markets and accelerates the process of structural change in emerging markets. The majority of gains from financial liberalization accrue to emerging economies. We consider the impact of a Òsecond waveÓ of liberalization when China fully opens its economy to capital inflows.
    Keywords: growth, structural change, financial liberalization
    JEL: E2 F62 O10
    Date: 2022–10
  12. By: Masahito Ambashi (Institute of Economic Research, Kyoto University); Fusanori Iwasaki (ERIA); Keita Oikawa (ERIA)
    Abstract: In this study, we analyze how economic shocks affect six ASEAN Member States-Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam-in three dimensions: global, domestic, and uncertainty shocks. We collect macroeconomic indicators for 1990-2021 and calculate macroeconomic shocks based on the prediction errors of real GDP growth rates. First, we demonstrate that countries were significantly subjected to unforeseen negative economic shocks on average. Second, we show high synchronization of economic fluctuations and shocks within these countries and with the world. Third, by conducting regression analyzes separately, we derive the following: (i) positive association between variations of the global real GDP growth rates and countries' economic shocks; (ii) different quantitative significance of previous estimates among countries; (iii) country-specific domestic shocks; and (iv) correlation of global- and country-level uncertainty indices with negative economic shocks in some AMS. Our results highlight the relative importance of global, domestic, and uncertainty shocks in the AMS as 56.3%, 39.6%, and 2.8%, respectively. Finally, based on this dataset and conducted analysis, we also review the effect of the COVID-19 pandemic on these countries.
    Keywords: Prediction error; Economic shock; Uncertainty; Business cycle synchronization
    JEL: E32 F44 N15
    Date: 2022–12
  13. By: Andreas Freitag; Sarah M. Lein; Sarah Marit Lein
    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: E30 E31 E50 F14 F41
    Date: 2022
    Abstract: It is well-known that exchange rates are difficult to forecast using observed macro-fundamental variables. This discrepancy between economic theory and empirical results is called the Meese and Rogoff puzzle. The purpose of this study is to address this puzzle from a new approach. Rather than pursuing a linkage between macro-fundamentals and exchange rates, we focus on the market sentiment index as a factor that could possibly enhance exchange rate predictability. The analysis folds into three phases. First, we conducted an assessment of the traditional exchange rate predictability model, as well as the augmented traditional model incorporating the market sentiment index. Second, we predicted the exchange rate by applying the market sentiment index, based on the contrarian opinion investment strategy commonly used by foreign exchange dealers. Finally, we analyzed if the machine learning model incorporating both economic fundamentals and market sentiment index could enhance the predictability of the exchange rate.
    Keywords: Exchange Rate; Exchange Rate Predictability; Market Sentiments
    Date: 2022–09–30
  15. By: Assaf Razin
    Abstract: Which income group is pro-globalization or anti-globalization—the wealthy skilled-labor or the poor low-skilled labor? How globalization affect income-based attitudes towards globalization? The paper addresses these issues in the framework of a small open economy which trades in goods and financial securities with the rest of the world. Income-based political cleavages analyzed are grounded on trade-related and macro-related fundamentals, familiar from a standard open-economy model. They are: (i) The degree of trade border frictions, (ii) The degree of international finance frictions, (iii) The relative factor abundance that determines the capital intensity of the country’s exports; and, (iv) The domestic savings and productivity of domestic investment, which determines whether the country is a financial capital exporter or importer.
    JEL: F00 F1 F30
    Date: 2022–12
  16. By: Eiji Fujii
    Abstract: For emerging economies, borrowing abroad is a double-edged sword: it can buffer against adverse economic shocks and smooth their domestic consumption; however, it can also amplify volatility in consumption, depending on the currency in which the debt is denominated and cyclicality in the borrower’s exchange rate. We empirically investigate the nexus among external debt portfolios, exchange rate cyclicality, and volatility in consumption of low- and middle-income countries. Since 1980, many countries have concentrated their external debt portfolios’ currency composition. By constructing debt-weighted effective exchange rates, we find that currency concentration magnifies exchange rate pro-cyclicality, making domestic consumption more volatile when national income fluctuates. Our results endorse diversifying the currency composition of external debt to mitigate the negative consequences of “original sin.”
    Keywords: external debt, currency portfolio, original sin, exchange rate cyclicality, volatility in consumption
    JEL: F34 F31
    Date: 2022
  17. By: Andrea Salazar-Díaz; Aarón Levi Garavito-Acosta; Sergio Restrepo-Ángel; Leidy Viviana Arcila-Agudelo
    Abstract: Behavioral Equilibrium Exchange Rate (BEER) models suggest many variables as potential drivers of equilibrium real exchange rates (ERER). This gives rise to model uncertainty issues, as ERER depends and varies, often drastically, on a particular set of chosen variables. We address this issue by estimating thousands of Vector Error Correction (VEC) specifications for Colombian data between 2000Q1-2019Q4. According to an extensive literature review, we employ thirty-five proxies categorized among five fixed groups of economic fundamentals that underlie the ERER: Indebtedness, Fiscal sector, Productivity, Terms-of-Trade, and Interest Rate Differentials. Our approach derives an empirical distribution of ERER that allows us to state with greater certainty, among hundreds of plausible economic specifications, whether the real exchange rate is either misaligned or in equilibrium. **** RESUMEN: La metodología Behavioral Equilibrium Exchange Rate (BEER) sugiere muchas variables como fundamentales de la tasa de cambio real de equilibrio (TCRE). Esto genera incertidumbre en la especificación de los modelos debido a que la TCRE depende y varía, a menudo de manera drástica, del conjunto particular de variables elegidas. Abordamos este problema estimando miles de especificaciones de vectores de corrección de errores (VEC) para datos colombianos entre 2000Q1-2019Q4. De acuerdo con una extensa revisión de la literatura, empleamos treinta y cinco proxies clasificadas entre cinco grupos fijos de fundamentales económicos que subyacen la TCRE: endeudamiento, sector fiscal, productividad, términos de intercambio y diferenciales de tasas de interés. Nuestro enfoque deriva una distribución empírica de la TCRE que nos permite afirmar con mayor certeza, entre cientos de especificaciones económicas plausibles, si el tipo de cambio real está desalineado o en equilibrio.
    Keywords: Real Exchange Rate, Misalignment, VEC, Tasa de cambio real, desalineamiento, VEC
    JEL: F31 F32 F41 C32
    Date: 2022–12

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