nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒01‒30
eleven papers chosen by
Martin Berka
Massey University

  1. Yet it Endures: The Persistence of Original Sin By Barry Eichengreen; Ricardo Hausmann; Ugo Panizza
  2. Monetary policy when export revenues drop By Drago Bergholt; Øistein Røisland; Tommy Sveen; Ragnar Torvik
  3. Leaning-against-the-wind Intervention and the “carry-trade” View of the Cost of Reserves By Eduardo Levy Yeyati; Juan Francisco Gómez
  4. Aggregation Across Each Nation: Aggregator Choice and Macroeconomic Dynamics By Lisack Noëmie; Sajedi Rana; Lloyd Simon
  5. Resurgence of inflation: Assessing the role of Macroeconomic Policies By Hamid Raza; Thibault Laurentjoye; Mikael Randrup Byrialsen; Sebastian Valdecantos
  6. The United States of Europe: A Gravity Model Evaluation of the Four Freedoms By Keith Head; Thierry Mayer
  7. Global Value Chains and Equilibrium Exchange Rate: Evidence from Central European Economies By Kamila Kuziemska-Pawlak; Jakub Mućk
  8. Exchange Rate Pass-Through to Food and Energy Consumer Price Inflation By Richhild Moessner
  9. Current Account Balances’ Divergence in the Euro Area: an Appraisal of the Underlying Forces By Emmanuelle Faure; Carl Grekou; Valérie Mignon
  10. Capital Account Liberalization, Financial Frictions, and Belief-Driven Fluctuations By Takuma Kunieda; Kazuo Nishimura
  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

  1. By: Barry Eichengreen; Ricardo Hausmann (Center for International Development at Harvard University); Ugo Panizza
    Abstract: Notwithstanding announcements of progress, "international original sin" (the denomination of external debt in foreign currency) remains a persistent phenomenon in emerging markets. Although some middle-income countries have succeeded in developing markets in local-currency sovereign debt and attracting foreign investors, they continue to hedge their currency exposures through transactions with local pension funds and other resident investors. The result is to shift the locus of currency mismatches within emerging economies but not to eliminate them. Other countries have limited original sin by limiting external borrowing, passing up valuable investment opportunities in pursuit of stability. We document these trends, analyzing regional and global aggregates and national case studies. Our conclusion is that there remains a case for an international initiative to address currency risk in low- and middle-income economies so they can more fully exploit economic development opportunities.
    Keywords: original sin, currency mismatches, debt crises
    JEL: H63 F34 C82
    Date: 2022–11
  2. By: Drago Bergholt; Øistein Røisland; Tommy Sveen; Ragnar Torvik
    Abstract: We study how monetary policy should respond to shocks which permanently alter the steady state structure of the economy. In such a case monetary policy affects not only the short run misallocations due to nominal rigidities, but also relative prices which stimulate reallocation of capital. We consider a permanent and negative shock to export revenues that requires a larger traded sector and a smaller non-traded sector in the new steady state. This reallocation calls for a change in relative prices during the transition, but may also lead to a period of high unemployment. We show how an appropriate monetary policy could mitigate the welfare costs of the transition by allowing the exchange rate to depreciate, and thereby allowing inflation to increase in the short run. Traditional monetary policy regimes, such as inflation targeting or a fixed exchange rate, would imply high unemployment and inefficiently slow transition. Stabilizing nominal wage growth, in contrast, would be close to the welfare-optimal monetary policy.
    Keywords: Structural Change, Dutch Disease, Monetary Policy
    JEL: E52 F41 O14
    Date: 2022–11
  3. By: Eduardo Levy Yeyati; Juan Francisco Gómez
    Abstract: For a sample of emerging economies, we estimate the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabilization motive (appreciating the exchange rate as a nominal anchor) but are rather small when interventions follow a countercyclical, leaning-against-the-wind (LAW) pattern to contain exchange rate volatility. We document that under LAW, central banks outperform a constant size carry trade, as they additionally benefit from buying against cyclical deviations, and that the cost of reserves under the carry-trade view is generally lower than the one obtained from the credit-risk view (which equals the marginal cost to the country´s sovereign spread).
    Keywords: Exchange rates, foreign exchange intervention, international reserves, self-insurance
    Date: 2022–10
  4. By: Lisack Noëmie; Sajedi Rana; Lloyd Simon
    Abstract: We study the implications of trade aggregation in an infinite-horizon economy with multiple countries, asking whether there is a role for alternatives to the Armington aggregator in a wide range of workhorse open-economy macroeconomics models. We show analytically that the first-order dynamics of the model are entirely captured by a few sufficient statistics. Over and above these statistics, the precise choice of functional form for the trade aggregator is irrelevant. This result has the following implications. For given steady-state trade elasticities and expenditure shares, any aggregator that is homogeneous of degree one is equivalent to the Armington aggregator at first order. Similarly, aggregators that are homogeneous of arbitrary degree are equivalent to a simple generalisation of the Armington aggregator, for given steady-state trade elasticities and expenditure shares. In models with more than two countries, alternative aggregators can play a role by allowing for steady-state differences in bilateral trade elasticities across different country pairs, which the Armington aggregator rules out. <p> Nous étudions les implications de l’agrégation entre biens échangeables dans un modèle multi-pays en horizon infini, et si des alternatives à l’agrégateur Armington ont un rôle à jouer dans les modèles typiques de macroéconomie ouverte. Nous montrons analytiquement que les dynamiques de premier ordre du modèle sont entièrement déterminées par un petit nombre de statistiques suffisantes. Au-delà de ces statistiques, le choix précis de la forme fonctionnelle de l’agrégateur du commerce n’a pas d’effet. Ce résultat a les conséquences suivantes. À élasticités de commerce et parts de dépenses à l’état stationnaire données, tout agrégateur homogène de degré 1 est équivalent à l’agrégateur Armington au premier ordre. De même, les agrégateurs homogènes de degré arbitraire sont équivalents à une simple généralisation de l’agrégateur Armington, étant données les élasticités de commerce et parts de dépenses à l’état stationnaire. Dans les modèles avec plus de deux pays, les agrégateurs alternatifs peuvent jouer un rôle en permettant aux élasticités bilatérales de commerce entre différentes paires de pays de prendre des valeurs différentes à l’état stationnaire, ce qui n’est pas possible avec l’agrégateur Armington.
    Keywords: International Trade, Open-economy Macroeconomics, Armington Aggregator, Elasticity of Trade; commerce international, macroéconomie ouverte, agrégateur Armington, élasticité de commerce
    JEL: F00 F10 F41
    Date: 2022
  5. By: Hamid Raza; Thibault Laurentjoye; Mikael Randrup Byrialsen; Sebastian Valdecantos
    Abstract: After decades of relative consumer price stability, inflation is now making a come-back as a central topic in economic and political discussions, against a backdrop of various policy challenges. The aim of this paper is to provide a nuanced assessment of the different channels through which monetary, fiscal and income policies can affect prices and output in a small open economy, as well as discuss which policy measures are desirable and practically feasible when such an economy experiences inflationary shocks. To do so, we adopt a comprehensive modelling approach and build an empirical stock-flow-consistent model using sectoral national account data for Denmark over the period 2005Q1-2020Q1. We then replicate the inflationary environment in which Denmark and several other countries are currently operating and introduce a monetary policy reaction which leads to a modest reduction in inflation at the cost of further contracting the economy. Taking monetary tightening as a forced policy response in the case of a small open economy with fixed exchange rate, we explore a number of policies that, within the current institutional and legal framework, can potentially mitigate the adverse effects of inflation. Specifically, we introduce fiscal interventions - in the form of tax cuts on income and production - along with wage- and price-based income policies. Our main conclusion is that a close coordination of fiscal and income policies can help reduce the effects of adverse shocks to income without increasing inflation. Finally, we address a question of political relevance by exploring the effects of different policies on public budget and debt. Overall, we find that of all the policies implemented, monetary policy has the most dramatic effects on public debt sustainability.
    Keywords: Inflation, Fiscal policy, Monetary policy, Income policy, Stock-flow consistent model
    JEL: E12 E52 E61 E64
    Date: 2023–01
  6. 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
  7. By: Kamila Kuziemska-Pawlak (Narodowy Bank Polski; University of Lodz); Jakub Mućk (Narodowy Bank Polski; SGH Warsaw School of Economics)
    Abstract: This paper proposes an extension of the fundamental equilibrium exchange rate (FEER) model that accounts for the trade linkages within the Global Value Chains (GVCs). In the modified FEER framework, both backward and forward linkages are taken into consideration. To demonstrate the empirical relevance of the complex nature of existing trade linkages, the proposed FEER model is applied to analyze exchange rate fluctuations of the selected Central and Eastern European countries against the euro. It is documented that in Czechia, Hungary, and Poland the standard FEER framework predicts rapid appreciation of the equilibrium exchange rate after 2010, which implies deepening undervaluation of the actual real exchange rate towards the end of the analysed period. Instead, when the GVCs’ linkages are taken into account in the framework, actual real exchange rates are broadly in line with the fundamental equilibrium exchange rates, and hence the missing real appreciation of the Czech krone, the Hungarian forint and the Polish zloty is to a large extent an equilibrium phenomenon.
    Keywords: exchange rate, current account, foreign trade, Global Value Chains
    JEL: C32 C33 F12 F31 F32
    Date: 2022
  8. By: Richhild Moessner
    Abstract: This paper studies exchange rate pass-through to food and energy consumer price inflation and its dependence on the inflation environment using cross-country panel estimation of Phillips curves. It considers a large panel of OECD member and candidate economies with quarterly data from 1994 to 2021. We find that exchange rate pass-through is largest for energy CPI inflation and also significant for food CPI inflation. A 10% depreciation in the exchange rate leads to an increase in energy CPI inflation of around 2 percentage points (pp) at the quarterly horizon and of 4pp at the yearly horizon; it leads to an increase in food CPI inflation of around 0.3pp and 2pp at the quarterly and yearly horizon, respectively. We also find some evidence that exchange rate pass-through to food and energy CPI inflation depends on the inflation environment, with higher inflation leading to larger pass-through.
    Keywords: inflation, food prices, energy prices, exchange rates
    JEL: E31 E52 E58 F31
    Date: 2022
  9. By: Emmanuelle Faure; Carl Grekou; Valérie Mignon
    Abstract: This paper revisits the crucial issue of current account imbalances and focuses on the determinants of their gaps between eurozone Member States. We conduct robust estimations of the current account balances for a panel of ten founding euro area economies and construct a measure that allows us to diagnose why some countries have started to diverge from the eurozone mean in the last two decades. Our findings show evidence of remaining differences in countries’ economic development, meaning that real macroeconomic convergence has failed in the zone. Price and cost competitiveness, as well as fiscal balances, have also participated in this growing macroeconomic divergence. Overall, while the European authorities cannot influence the part of the current account gaps due to demographic factors, the role of fiscal redistribution and investment at the euro area level could help achieve macroeconomic convergence and thus reduce current accounts’ divergence in the zone.
    Keywords: Current Account;Global Imbalances;Eurozone
    JEL: F32 O52 C33
    Date: 2022–12
  10. By: Takuma Kunieda (School of Economics, Kwansei Gakuin University); Kazuo Nishimura (Kobe University and Research Institute of Economy, Trade and Industry)
    Abstract: To investigate the macroeconomic effects of capital account liberalization, we apply a dynamic general equilibrium model with two production sectors. In contrast to the literature on belief-driven sunspot fluctuations caused by production externalities, our model does not assume any production externalities. In our model, agents face ï¬ nancial constraints and production heterogeneity. The ï¬ nancial constraints and agents’ production heterogeneity are sources of dynamic inefficiency. Although indeterminacy of equilibrium and belief-driven sunspot fluctuations never occur in the closed economy, dynamic inefficiency combined with a negative foreign asset in the steady state produces indeterminacy in the small open economy if ï¬ nancial constraints are fully relaxed under the condition that the investment goods sector is more labor intensive than the consumption goods sector.
    Keywords: Two-sector growth model; small open economy; ï¬ nancial constraints; heterogeneous agents; dynamic inefficiency; indeterminacy.
    JEL: E32 F36 F43 O41
    Date: 2023–01
  11. By: Hadrien Camatte; Guillaume Daudin (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po); Violaine Faubert; Antoine Lalliard; 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. We build on three sectoral world input-output datasets (WIOD and two versions of TiVA). We assume a Cobb-Douglas production framework and work in a partial equilibrium setting. The construction of World Input-Output tables is data-demanding and WIOTs are typically released with a lag of several years. To address this gap, we use more up-to-date GDP and trade data, thus providing a tool for approximating the partial equilibrium impact of an exchange rate shock on consumer prices from 2015 onwards. Depending on countries, the absolute value of the elasticity of the household consumption expenditure (HCE) 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. Extrapolations based on more up-to-date GDP and trade data suggest that the decline continued until 2016, before reversing in 2017 and 2018. Our findings are robust to using three different datasets.
    Keywords: input-output linkages, spillovers, global value chains, cost-push inflation
    Date: 2021–01–01

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