nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒02‒06
nine papers chosen by
Martin Berka
Massey University

  1. The Fiscal Consequences of Missing an Inflation Target By Michele Andreolli; Hélène Rey
  2. Unstable Prosperity: How Globalization Made the World Economy More Volatile By Enrique G. Mendoza; Vincenzo Quadrini
  3. Understanding the Global Drivers of Inflation: How Important are Oil Prices? By Jongrim Ha; M. Ayhan Kose; Franziska Ohnsorge; Hakan Yilmazkuday
  4. Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rate By Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hondula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
  5. The Transmission of International Monetary Policy Shocks on Firms' Expectations By Serafin Frache; Rodrigo Lluberas; Mathieu Pedemonte; Javier Turen
  6. The Dutch disease of the Euro Area peripheral member states By João Alcobia; Ricardo Cabral
  7. Make-up strategies and exchange rate pass-through in a low-interest-rate environment By Alessandro Cantelmo; Pietro Cova; Alessandro Notarpietro; Massimiliano Pisani
  8. The macroeconomic effects of global supply chain disruptions By Finck, David; Tillmann, Peter
  9. Sovereign Debt and International Trade By Charles Serfaty

  1. By: Michele Andreolli; Hélène Rey
    Abstract: The European Central Bank is unique in setting monetary policy for several sovereign states with heterogeneous debt levels and different maturity structures. The monetary-fiscal nexus is central to the functioning of the euro area. We focus on one particular aspect of that nexus, the effect the reliability of the European Central Bank's monetary policy on public finances. We show that when the ECB misses its inflation target this has large heterogeneous fiscal consequences for Euro Area countries. For comparison we also estimate the fiscal consequences of the Federal Reserve and the Bank of England missing their inflation targets. They are also sizeable.
    JEL: E31 E44 E52 E60 F45 H63
    Date: 2023–01
  2. By: Enrique G. Mendoza; Vincenzo Quadrini
    Abstract: The sharp, secular decline in the world real interest rate of the past thirty years suggests that the surge in global demand for financial assets outpaced the growth in their supply. We argue that this phenomenon was driven by: (i) faster growth in emerging markets, (ii) changes in the financial structure of both emerging and advanced economies, and (iii) changes in demand and supply of public debt issued by advanced economies. We then show that the low-interest-rate environment made the world economy more vulnerable to financial crises. These findings are the quantitative predictions of a two-region model in which privately-issued financial assets (i.e., inside money) provide productive services but can be defaulted on.
    JEL: F34 F36 F62 F65
    Date: 2023–01
  3. By: Jongrim Ha (World Bank, Prospects Group); M. Ayhan Kose (World Bank, Prospects Group; Brookings Institution; CEPR, and CAMA); Franziska Ohnsorge (World Bank, Prospects Group; CEPR; CAMA); Hakan Yilmazkuday (Florida International University)
    Abstract: This paper examines the global drivers of inflation in 55 countries over the 1970–2022 period. We estimate a Factor-Augmented Vector Autoregression model for each country and assess the importance of several global (demand, supply, and oil price) and domestic shocks. We report three main results. First, global shocks have explained about 26 percent of inflation variation in a typical economy. Oil price shocks accounted for only about 4 percent of inflation variation, but they had a statistically significant impact on inflation in three quarters of countries. Second, global shocks have become more important in driving inflation variation over time. The share of inflation variance caused by oil price shocks increased from 4 percent prior to 2000 to roughly 9 percent over the 2001–2022 period. They also accounted for some of the steep runup in inflation between mid-2021 and mid-2022. Finally, oil price shocks tended to contribute significantly more to inflation variation in advanced economies; countries with stronger global trade and financial linkages; commodity importers; net energy importers; countries without inflation-targeting regimes; and countries with pegged exchange rate regimes. Our headline results are robust to a wide range of exercises—including alternative measures of global factors and oil prices— and aggregation of countries.
    Keywords: Inflation; oil prices; global shock; domestic shock; FAVAR; exchange rates.
    JEL: E31 E32 Q43
    Date: 2023–01
  4. By: Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hondula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
    Abstract: We explore the impact of low and negative monetary policy rates in core world economies on bank lending in four small open economies – Canada, Chile, the Czech Republic and Norway – using confidential bank-level data. Our results show that the impact on lending in these small open economies depends on the interest rate level in the core. When interest rates are high, monetary policy cuts in core economies can reduce credit supply in small open economies. In contrast, when interest rates in core economies are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel. These results have important policy implications, suggesting that central banks in small open economies should watch for the impact of potential regime switches in core economies’ monetary policy when rates shift to and from the very low end of the distribution.
    Keywords: Low and negative interest rate environment (LNIRE), Cross-border monetary policy spillover, International bank lending channel, Portfolio channel
    JEL: E43 E52 E58 F34 F42 G21 G28
    Date: 2021–11–05
  5. By: Serafin Frache; Rodrigo Lluberas; Mathieu Pedemonte; Javier Turen
    Abstract: Motivated by the dominant role of the US dollar, we explore how monetary policy (MP) shocks in the US can affect a small open economy through the expectation channel. We combine data from a panel survey of firms' expectations in Uruguay with granular information about firms' debt position and total imports on a monthly basis. We show that a contractionary MP shock in the US reduces firms' inflation and cost expectations in Uruguay. This result contrasts with the inflationary effect of this shock on the Uruguayan economy, suggesting uncertainty about the policy regime. We discuss the issues and challenges of this expectation channel.
    Keywords: Firms' Expectations; Global Financial Cycle; Monetary Policy Spillovers
    JEL: E31 E58 F41 D84 E71
    Date: 2023–01–04
  6. By: João Alcobia; Ricardo Cabral
    Abstract: This paper analyzes explanations identified in the literature for the subpar economic performance of the so-called peripheral member states of the Euro Area since the mid-1990s. It argues that a key factor was a Dutch disease-like transmission mechanism, as the adoption of the euro led to a capital inflow shock. This resulted in a structural shift in the productive structure of the peripheral economies away from technologically advanced manufactured goods, which are characterized by higher productivity growth. As a consequence, the peripheral member states specialized in non-tradable sectors, and in low-technology and labor-intensive tradable goods sectors, which largely explains the peripherals’ low economic growth, low productivity growth, and growing macroeconomic imbalances.
    Keywords: Financial Dutch disease; peripheral member states of the Euro Area; non-price competitiveness; Euro Area architecture
    JEL: O11 O14 O20 O41 O52 E12 F15
    Date: 2023–01
  7. By: Alessandro Cantelmo (Bank of Italy); Pietro Cova (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: We evaluate the macroeconomic stabilization properties, with particular reference to the exchange rate pass-through, of price level targeting (PLT), average inflation targeting (AIT) and inflation targeting (IT) strategies when the effective lower bound on the monetary policy rate can be binding. The results of simulating the canonical open-economy New Keynesian model -- in which the assumption of local currency pricing holds and which is calibrated without loss of generality to the euro area -- are as follows. First, make-up strategies (PLT and AIT) stabilize inflation better than IT, by favoring a smaller appreciation (larger depreciation) of the nominal exchange rate in the event of disinflationary demand (supply) shocks. Second, and in connection with this, the exchange rate pass-through to import prices is more limited under make-up strategies than under IT, as the former stabilize the inflation rate of imports to a greater extent. Third, the results are robust to alternative values of import price stickiness and elasticity of substitution between domestic and imported goods. Fourth, the stabilization properties of make-up strategies are qualitatively preserved under partially backward-looking inflation expectations, although the relative gains of make-up strategies with respect to IT are smaller than under model-consistent inflation expectations.
    Keywords: effective lower bound, exchange rate pass-through, local currency pricing, make-up strategies, monetary policy
    JEL: E31 E52 F31 F41
    Date: 2022–12
  8. By: Finck, David; Tillmann, Peter
    Abstract: Highly interconnected global supply chains make countries vulnerable to supply chain disruptions. This paper estimates the macroeconomic effects of global supply chain shocks for the euro area. Our empirical model combines business cycle variables with data from international container trade. Using a novel identification scheme, we augment conventional sign restrictions on the impulse responses by narrative information about three episodes: the Tohoku earthquake in 2011, the Suez Canal obstruction in 2021, and the Shanghai backlog in 2022. We show that a global supply chain shock causes a drop in euro area real economic activity and a strong increase in consumer prices. Over a horizon of one year, the global supply chain shock explains about 30% of inflation dynamics. We also use regional data on supply chain pressure to isolate shocks originating in China. Our results show that supply chain disruptions originating in China are an important driver for unexpected movements in industrial production, while disruptions originating outside China are an especially important driver for the dynamics of consumer prices.
    Keywords: Container Trade, Supply Chain, Inflation, Narrative Identification, Sign Restrictions
    JEL: E32 F14 F62
    Date: 2023
  9. By: Charles Serfaty
    Abstract: Evidence suggests that sovereign defaults disrupt international trade. As a consequence, countries that are more open have more to lose from a sovereign default and are less inclined to renege on their debt. In turn, lenders should trust more open countries and charge them with lower interest rate. In most cases, the country should also borrow more debt as it gets more open. This paper formalizes this idea in a sovereign debt model à la Eaton and Gersovitz (1981), proves these theoretical relations, and quantifies them in a calibrating model. We also provide evidence suggesting a causal relationship between trade and debt or CDS spreads, using gravitational instrumental variables from Frankel and Romer (1999) and Feyrer (2019) as a source for exogenous variation in trade openness.
    Keywords: Sovereign Debt, International Trade and Finance, Economic Integration
    JEL: H63 B17 F15
    Date: 2022

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