nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒05‒22
fifteen papers chosen by
Martin Berka
Massey University

  1. Collateral Advantage: Exchange Rates, Capital Flows and Global Cycles By Michael B. Devereux; Charles Engel; Steve Pak Yeung Wu
  2. On the pass-through of large devaluations By Carlos Casacuberta; Omar Licandro
  3. Improving Sovereign Debt Restructurings By Maximiliano Dvorkin; Juan M. Sanchez; Horacio Sapriza; Emircan Yurdagul
  4. Multilateral Comovement in a New Keynesian World: A Little Trade Goes a Long Way By Paul Ho; Pierre-Daniel G. Sarte; Felipe Schwartzman
  5. Distributional Effects of Exchange Rate Depreciations: Beggar-Thy-Neighbour or Beggar-Thyself? By Boris Fisera
  6. Inequality, Current Account Imbalances and Middle Incomes By Océane Blomme; Jérôme Héricourt
  7. The strange case of Romania’s Nicolae Ceaușescu: when the liquidation of sovereign debt results in country total damaging By Georgescu, George
  8. Sovereign risk and bank lending: evidence from 1999 Turkish earthquake By Yusuf Soner Başkaya; Bryan Hardy; Sebnem Kalemli-Ozcan; Vivian Yue
  9. The Global Financial Cycle and Country Risk in Emerging Markets During Stress Episodes: A Copula-CoVaR Approach By Melo-Velandia, Luis Fernando; Romero-Chamorro, José Vicente; Ramírez-González, Mahicol Stiben
  10. The Art and Science of Monetary and Fiscal Policies in Chile By Medina, Juan Pablo; Toni, Emiliano; Valdes, Rodrigo
  11. UK monetary and fiscal policy since the Great Recession- an evaluation By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wang, Ziqing
  12. Fiscal Transfers and Common Debt in a Monetary Union: A Multi-Country Agent Based-Stock Flow Consistent Model By Alessandro Caiani; Ermanno Catullo
  13. Tackling the fiscal policy-financial stability nexus By Claudio Borio; Marc Farag; Fabrizio Zampolli
  14. Dollar Dominance in Cross-border Bank Loans and Its Response to Uncertainties By ITO Hiroyuki; XU Ying
  15. A Model of the Gold Standard By Jesús Fernández-Villaverde; Daniel R. Sanches

  1. By: Michael B. Devereux; Charles Engel; Steve Pak Yeung Wu
    Abstract: We construct a two-country New Keynesian model in which US government debt has an advantage as a superior collateral asset in the balance sheets of banks. The model can account for the observed response of the US dollar and US bond returns to a global downturn, in particular when the downturn is associated with a global financial crisis. In our model, the U.S. enjoys an “exorbitant privilege” as its government bonds are desired by banks both in the U.S. and abroad as superior collateral. In times of global stress, the dollar appreciates and the “convenience yield” earned by U.S. government bonds increases. There is “retrenchment” - each country reduces its holdings of foreign assets - a critical determinant of which is the endogenous response of prices and returns. In addition, the model displays a U.S. real exchange rate appreciation despite that domestic absorption in the US falls relative to the rest of the world during a global downturn, thus addressing the “reserve currency paradox” highlighted by Maggiori (2017).
    JEL: F30 F40 G15
    Date: 2023–04
  2. By: Carlos Casacuberta; Omar Licandro
    Abstract: In 2002 Uruguay faced a sudden stop of international capital flows, inducing a deep financial crisis and a large devaluation of the peso. The real exchange rate depreciated and exports expanded. Paradoxically, export shares and real exchange rates negatively correlate among Uruguayan exporters around 2002. To unravel this paradox, we develop a small open economy model of heterogeneous firms. Domestic firms are price takers in the international market, operate under monopolistic competition in the domestic market, and face financial constraints when exporting. Confronted to a large nominal devaluation, financial constraints deepen. Financially constrained exporters cannot optimally expand in the export market and react by passing-through the devaluation to the domestic price only partially, expanding domestic sales. As a consequence, the more financially constrained exporters are, the less their export shares expand and the more their firm specific real exchange rates depreciate. As a result, export shares and real exchange rates of exporters are negatively correlated as in the data.
    Date: 2023
  3. By: Maximiliano Dvorkin; Juan M. Sanchez; Horacio Sapriza; Emircan Yurdagul
    Abstract: The wave of sovereign defaults in the early 1980s and the string of debt crises in subsequent decades have fostered proposals involving policy interventions in sovereign debt restructurings. The global financial crisis and the recent global pandemic have further reignited this discussion among academics and policymakers. A key question about these policy proposals for debt restructurings that has proved hard to handle is how they influence the behavior of creditors and debtors. We address this challenge by evaluating policy proposals in a quantitative sovereign default model that incorporates two essential features of debt: maturity choice and debt renegotiation in default. We find, first, that a rule that tilts the distribution of creditor losses during restructurings toward holders of long-maturity bonds reduces short-term yield spreads, lowering the probability of a sovereign default by 25 percent. Second, issuing GDP-indexed bonds exclusively during restructurings also reduces the probability of default, especially of defaults in the five years following a debt restructuring. The policies lead to welfare improvements and reductions in haircuts of similar magnitude when implemented separately. When jointly implemented, they reinforce each other's welfare gains, suggesting good complementarity.
    Keywords: Crises; GDP-indexed Debt; Distribution of Creditor Losses; Default; Sovereign Debt; Maturity; Restructuring; Country Risk; International Monetary Fun
    JEL: F34 F41 G15
    Date: 2022–04–06
  4. By: Paul Ho; Pierre-Daniel G. Sarte; Felipe Schwartzman
    Abstract: We study how international linkages and nominal price rigidities jointly shape the dynamics of inflation and output across multiple large economies. We describe how these features produce a global system of Phillips curves explicitly connected by multilateral trade relationships. In equilibrium, disturbances abroad propagate to domestic variables not only directly, through pairwise trade between countries, but also indirectly through third-country effects arising from the network structure of trade. The combined propagation mechanisms imply that country-specific shocks alone explain almost 90 percent of the observed average pairwise comovement in output growth between countries. These idiosyncratic shocks also explain more than 1/2 the cross-country comovement in inflation, and between output and inflation. We estimate that a European inflationary shock results in significant U.S. inflation accompanied by lower output, and that these responses transpire almost entirely from the network effects of trade. In addition, a tightening of U.S. monetary policy generates a percentage decline in output globally that is comparable to 1/2 the domestic response.
    Keywords: international comovement; multilateral trade; New Keynesian Phillips Curve
    JEL: E31 E32 F41 F44
    Date: 2022–11–16
  5. By: Boris Fisera (Faculty of Social Sciences, Charles University, Prague & Institute of Economic Research, Slovak Academy of Sciences, Bratislava)
    Abstract: While it is often argued that exchange rate depreciation has a beggar-thy-neighbour effect, in this paper, we investigate, whether exchange rate depreciation has a beggarthyself effect. Specifically, we explore the distributional consequences of Exchange rate movements. Using a heterogeneous panel cointegration approach, we find that, on average, small depreciations of the domestic currency decrease income inequality over the long-term. However, large depreciations in excess of 25%, increase income inequality over the long term. Large appreciations of the domestic currency also increase income inequality. Next, we identify 119 episodes of managed depreciations to better capture the distributional consequences of exchange rate movements. Managed depreciations are defined as situations in which the central bank intervenes to depreciate its domestic currency. Using the local projections (LP) approach, we find that managed depreciation shocks decrease income inequality. We find no evidence supporting the idea that exchange rate depreciation has a "beggar-thyself" effect with respect to income inequality, as it does not seem to increase inequality.
    Keywords: exchange rate depreciation, income inequality, competitive devaluation, managed depreciation, distributional effects
    JEL: F10 F30 F31 F43
    Date: 2023–04
  6. By: Océane Blomme; Jérôme Héricourt
    Abstract: This paper investigates the complex relationship between current account balance and income inequality, putting specific emphasis on the potential sources of non-linearities in the latter. Based on a dataset for 52 developed and developing countries over the period 1990-2019, we first show a one-standard-deviation increase in various income inequality indicators generates a decrease in the ratio of current account over GDP by -0.5 to -0.9 percentage points in developed countries, but no significant impact when the sample is expanded to include emerging and developing countries. We then show those average impacts are distorted along the distribution of economic and financial development variables: for those countries displaying low GDP per capita, low levels of financial deregulation and of capital account openness, additional income inequality actually improves the current account balance. Conversely, the impact of income inequality on current account is all the more negative that financial markets are bigger, more deregulated and more open. In addition, the decrease in the current account balance is 1.2 to 1.4 times more important in countries with higher financial development or more open capital account when the increase in inequality is driven by the income of top earners relative to the middle class rather than by the increase in top earners' incomes at the expense of the lowest percentiles of the distribution. Those results are robust to various robustness checks for endogeneity concerns, possible impact of the Great Financial Crisis, and variable definitions.
    Keywords: Current Account;Finance;Inequality;Middle Class
    JEL: D31 E25 E44 F32
    Date: 2023–04
  7. By: Georgescu, George
    Abstract: The study focuses on 1980s sovereign debt crisis in Romania under the impact of internal and external factors, intending to provide a more realistic image of this dramatic episode. The global economy faced a severe economic and financial crisis at the beginning of the 1980s, when more than 30 developing countries entered default or restructured the sovereign debt. In the case of Romania, the impact of the crisis triggered in 1981-1982 has proved extremely hard worsened by the domestic vulnerabilities accumulated in the previous decade and the external shock coming from the major changes in the global economic, financial and geopolitical context at the end of 1979. The FED monetary policy at that time (twenty percent funds rate in order to fight inflation), has led to the explosive rise in interest rates of the outstanding loans contracted from international commercial banks, to which Romania was highly indebted. The decision of simple-minded Nicolae Ceaușescu to liquidate the foreign debt and other errors concerning the crisis management had a destructive impact on the country, which degenerated in a system crisis ended with its implosion in December 1989. Some lessons from this crisis could be learned for the current indebtedness situation of Romania, amid international circumstances characterized by two-digit inflation, high interest rates and government bond yields, energy crisis, climate changes, Ukraine war, global geopolitical tensions.
    Keywords: foreign debt crisis; oil crisis shocks; IMF; FED monetary policy; inflation; interest rates; sovereign debt restructuring; Romania
    JEL: B22 E44 E62 F34 H63 N44
    Date: 2023–04
  8. By: Yusuf Soner Başkaya; Bryan Hardy; Sebnem Kalemli-Ozcan; Vivian Yue
    Abstract: We use an exogenous fiscal shock to identify the transmission of government risk to bank lending due to banks holding government bonds. We illustrate with a theoretical model that for banks with higher exposure to government bonds, a higher sovereign default risk implies lower bank net worth and less lending. Our empirical estimates confirm the model's predictions. The exogenous change in sovereign default risk of Turkish government debt as a result of the 1999 Earthquake impacts banks whose balance sheets were exposed more to government bonds. The resulting lower bank net worth translates into lower credit supply. We rule out alternative explanations. Our estimates suggest this channel can explain half of the decline in bank lending following the earthquake. This underlines the importance of the bank balance-sheet channel in transmitting a higher sovereign default risk to reduced real economic activity.
    Keywords: banking crisis, bank balance sheets, lending channel, public debt, credit supply, sovereign-bank nexus
    JEL: E32 F15 F36 O16
    Date: 2023–04
  9. By: Melo-Velandia, Luis Fernando; Romero-Chamorro, José Vicente; Ramírez-González, Mahicol Stiben
    Abstract: In this paper, we analyze the tail-dependence structure of credit default swaps (CDS) and the global financial cycle for a group of eleven emerging markets. Using a Copula-CoVaR model, we provide evidence that there is a significant taildependence between variables related with the global financial cycle, such as the VIX, and emerging market CDS. These results are particularly important in the context of distressed global financial markets (right tail of the distributions of the VIX) because they provide international investors with relevant information on how to rebalance their portfolios and a more suitable metric to analyze sovereign risk that goes beyond the traditional CoVaR. Additionally, we present further evidence supporting the importance of the global financial cycle in sovereign risk dynamics.
    Keywords: Global financial cycle; Country risk; CDS; Copula-CoVaR
    JEL: G15 G17 C58
    Date: 2023–05
  10. By: Medina, Juan Pablo; Toni, Emiliano; Valdes, Rodrigo
    Abstract: There is consensus that Chile has made substantial progress in its macroeconomic policies during the last 30 years. However, there is no comprehensive and formal quantification of the macroeconomic stabilization gains in terms of the critical dimensions in the conduct of monetary and fiscal policies. In this work, we make an effort to quantify these gains using a structural model that incorporates essential features of the Chilean economy, disentangling the role of changes in policies and shocks in shaping the business cycles. We pay particular attention to two simultaneous and significant policy regime changes. In 2000, Chile moved from a managed exchange rate regime to a floating one coupled with flexible inflation targeting. On fiscal, policy shifted to a more countercyclical budget, changing a the-facto nominal target for a structural one. Policies also deviated from their implicit rules in the old and the new regimes—the ``art" policy component. Fitting the model to the Chilean data through Bayesian techniques in the period 1990-2015, we find that a flexible exchange rate regime and a countercyclical fiscal rule enhance each other in terms of lowering macroeconomic volatility, especially those arising from commodity prices and other critical economic shocks. Together, the monetary and budgetary reforms attenuated both GDP and inflation's volatility considerably in 2000-2015 (compared to the counterfactual based on the 90's policies). The art part also contributed substantially to lowering macro volatility, especially fiscal policy deviations on GDP volatility. For the 90s, the counterfactuals using the new policy framework also show lower volatility and an even more relevant role for policy deviations.
    Keywords: DSGE Model, Fiscal and Monetary Policies, Macroeconomic stabilization, Chile.
    JEL: C54 E32 E37 E52 E62 F41
    Date: 2023–04–28
  11. By: Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wang, Ziqing (Sheffield Hallam University, Sheffield, United Kingdom)
    Abstract: This paper explores the economic impacts of the Bank of England’s quantitative easing policy, implemented as a response to the global financial crisis. Using an open economy Dynamic Stochastic General Equilibrium (DSGE) model, we demonstrate that monetary policy can remain effective even when nominal interest rates have reached the zero lower bound. We estimate and test the model using the indirect inference method, and our simulations indicate that a nominal GDP targeting rule implemented through money supply could be the most effective monetary policy regime. Additionally, our analysis suggests that a robust, active fiscal policy regime with nominal GDP targeting could significantly enhance economic stabilization efforts.
    Keywords: Quantitative easing, Financial friction, SOE-DSGE, Indirect inference, Zero bound
    JEL: E44 E52 E58 C51
    Date: 2023–04
  12. By: Alessandro Caiani; Ermanno Catullo
    Abstract: Using a refined version of the multi-country AB-SFC model of a Monetary Union already presented in Caiani et al. (2018a, 2019) the paper aims at providing a tentative assessment of the economic effects of transforming the European Monetary Union into an Intergovernmental Fiscal Transfer Union (IFTU) with its own fiscal capacity. Countries contribute proportionally to their GDP whereas funds are redistributed according to a mechanism that gives more funds to countries performing worse than the average of the Union in cyclical terms. Our simulations show that an IFTU inspired by such a redistribution principle acts as a stabilizer of international trade, allowing to stabilize and improve the Union GDP performance without affecting the stability of public finances. When the Union is allowed to borrow on capital markets, i.e. in a Fully-Fledged Fiscal Transfer Union (FFFTU), these effects are enhanced and a part of the public debt burden shifts from the national to the Union level, leaving the total burden almost stable. An interesting result to assess the political acceptability of the proposal is that 'core' countries eventually benefit the most from the introduction of this mechanism, despite being more frequently net contributors. Finally, we show that an FFFTU with common debt might help to soften the impact of an exogenous demand shock while, because of the fact that it mainly operates as a stabilizer of aggregate demand, it does not seem to provide beneficial effects when facing a supply shock to production.
    Keywords: Fiscal Transfer Union; Union Bonds; European Integration; Agent Based Macroeconomics; Stock Flow Consistent Models.
    Date: 2023–05–05
  13. By: Claudio Borio; Marc Farag; Fabrizio Zampolli
    Abstract: Tackling the fiscal policy-financial stability nexus is essential to ensure financial and hence macroeconomic stability. In this paper, we review the literature on this topic and suggest how policy could best tackle the link. Doing so involves action on two fronts. First, incorporating financial stability considerations in the design of fiscal policy. This means, in particular, considering the risk of financial crises when assessing fiscal space, recognising the flattering effects of financial booms on fiscal positions and removing or reducing fiscal incentives to private debt accumulation. Second, acknowledging that domestic currency-denominated public debt is not fully risk-free in the design of the prudential regulation of financial institutions. This calls for carefully balanced risk-sensitive capital charges or other measures to limit banks' sovereign exposures with due regard to the special role of government bonds in the financial system and country-specific characteristics. That said, prudent regulation cannot substitute for fiscal prudence.
    Keywords: financial crises; doom loops; sovereign exposures; prudential policy; fiscal policy
    JEL: E6 G2 G3 H1 H3 H6 H8
    Date: 2023–04
  14. By: ITO Hiroyuki; XU Ying
    Abstract: This paper examines whether, and if so, to what extent uncertainty increases the degree of the use of U.S. dollars in cross-country loans. To this end, we investigate what factors affect the choice of currency for denomination of cross-border syndicated loans. Among them, we focus on whether external shocks and global uncertainties, such as uncertainty stemming from U.S. monetary, fiscal, and trade policies, financial instability (measured by VIX), and infectious disease risk affect the choice of international loans. The analysis uses micro firm-level data on syndicated loans agreed between borrowers located in 25 emerging market economies (EMEs) and lenders from 59, from the 1995 to 2019 period. We find that uncertainties driven by U.S. trade policy led to a higher USD share in total international loans from the borrowers’ perspective, indicating the borrowers’ inclination to avert the exchange rate risk or volatility that may arise due to the uncertainty of U.S. trade policy. A rise in the general level of U.S. economic policy and the intensity of financial instability both have a negative impact on the USD share, likely reflecting dollar shortages at the time of increasing economic policy uncertainty and financial instability. The estimation on the currency shares from the lenders’ perspective also confirms these impacts on U.S. economic uncertainties and financial instability. We also test the correlation between currency choice for international loans and the borrowers’ revenue volatility, and find that syndicated loans in the local currency are associated with less revenue volatility compared to USD-denominated loans.
    Date: 2023–04
  15. By: Jesús Fernández-Villaverde; Daniel R. Sanches
    Abstract: The gold standard emerged as the international monetary system by the end of the 19th century. We formally study its properties in a micro-founded model and find that the scarcity of the world gold stock not only results in a suboptimal output of goods that are purchased with money but also subjects the domestic economy of a country to external shocks. The creation of inside money in the form of private credit instruments adds to the money supply, usually resulting in a Pareto improvement, but opens the door to the international transmission of banking crises. These properties of the gold standard can explain the limited adherence by peripheral countries because of the potential risks to their economies. We argue that the gold standard can be sustainable at the core but not at the periphery.
    Keywords: gold standard; specie flows; non-neutrality of money; inside money
    JEL: E42 E58 G21
    Date: 2022–09–21

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