nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒05‒29
fourteen papers chosen by
Martin Berka
Massey University

  1. Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach By KANO, Takashi
  2. A Theory of Net Capital Flows over the Global Financial Cycle By J. Scott Davis; Eric Van Wincoop
  3. Trade Credit and Exchange Rate Risk Pass Through By Bryan Hardy; Felipe E. Saffie; Ina Simonovska
  4. On the pass-through of large devaluations By Carlos Casacuberta; Omar Licandro
  5. In Search of Dominant Drivers of the Real Exchange Rate By Wataru Miyamoto; Thuy Lan Nguyen; Hyunseung Oh
  6. Inflation Surge and Sovereign Borrowing: The Role of Policy Practices in Strengthening Sovereign Resilience By Joshua Aizenman; Huanhuan Zheng
  7. Who holds sovereign debt and why it matters By Xiang Fang; Bryan Hardy; Karen Lewis
  8. The forgotten lender: the role of multilateral lenders in sovereign debt and default By María Bru Muñoz
  9. Self-Fulfilling Debt Crises with Long Stagnations By Joao Ayres; Gaston Navarro; Juan Pablo Nicolini; Pedro Teles
  10. Re-evaluating whether absolute or relative purchasing power parity is being tested when using price indices By Stewart, Chris
  11. From Carry Trades to Trade Credit: Financial Intermediation by Non-Financial Corporations By Bryan Hardy; Felipe Saffie
  12. Sovereign Risk and Bank Lending: Theory and Evidence from a Natural Disaster By Yusuf Soner Başkaya; Bryan Hardy; Ṣebnem Kalemli-Özcan; Vivian Z. Yue
  13. Trade disruptions along the global supply chain By Alejandro G. Graziano; Yuan Tian
  14. The Productivity Slowdown in Advanced Economies: Common Shocks or Common Trends? By John G. Fernald; Robert Inklaar; Dimitrije Ruzic

  1. By: KANO, Takashi
    Abstract: This study examines the exchange rate implications of trend inflation within a two-country New Keynesian (NK) model. An NK Phillips curve generalized by trend inflation makes the inflation differential smoother, more persistent, and less sensitive to the real exchange rate. A Bayesian analysis with post-Bretton Woods data for Canada and the U.S. shows that the model’s equilibrium, which relies on Taylor rules with a persistent trend inflation shock and strong policy inertia, mimics empirical regularities in exchange rates that are difficult to reconcile within a standard NK model. Trend inflation helps explain the empirical puzzles of the exchange rate dynamics.
    Keywords: Real and Nominal Exchange Rates, Trend Inflation, New Keynesian Model, Bayesian analysis
    JEL: E31 E52 F31 F41
    Date: 2023–04
  2. By: J. Scott Davis; Eric Van Wincoop
    Abstract: We develop a theory to account for changes in net capital flows of safe and risky assets over the global financial cycle. We show empirically that countries that have a net debt of safe assets experience a rise in net outflows of safe assets (reduced accumulation of safe debt) during a downturn in the global financial cycle. This is accomplished through a rise in total net outflows and a drop in net outflows of risky assets. We develop a multi-country portfolio choice model that can account for these facts. The theory relies on cross-country heterogeneity in the share of an investor's portfolio invested in risky assets. A global drop in risky asset prices changes relative wealth across countries due to this heterogeneity, which leads to changes in net flows of safe and risky assets. The model is applied to 20 advanced countries and calibrated to reflect observed cross-country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for net capital flows are quantitatively consistent with the data.
    Keywords: global financial cycle; capital flows; current account; Portfolio Heterogeneity
    JEL: F30 F40
    Date: 2023–05–06
  3. By: Bryan Hardy; Felipe E. Saffie; Ina Simonovska
    Abstract: We show that trade credit mitigates exchange rate risk pass through along supply chains. We develop a theory of trade credit provision along supply chains that involve large intermediate-good suppliers and small final-good producers, both of which face bank borrowing constraints. Motivated by empirical findings, we assume that large suppliers borrow in foreign currency, while small final-good producers borrow in domestic currency at higher rates. Trade credit loosens borrowing constraints and allows for higher production scale. Additionally, the model predicts that unconstrained suppliers fully absorb increasing costs of borrowing in foreign currency when domestic currency depreciates: specifically, suppliers settle for lower profits but maintain unchanged trade credit lines with their trade partners. We verify the model's predictions using firm-level data for over 11, 000 large firms in 19 emerging markets over the 2004-2020 period.
    JEL: E30 F2 F3 F4 G15 G3
    Date: 2023–03
  4. 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.
    Keywords: Uruguay; export shares; exchange rates
    Date: 2023
  5. By: Wataru Miyamoto; Thuy Lan Nguyen; Hyunseung Oh
    Abstract: We uncover the major drivers of macro aggregates and the real exchange rate at business cycle frequencies in Group of Seven countries. The estimated main drivers of key macro variables resemble each other and account for a modest fraction of the real exchange rate variances. Dominant drivers of the real exchange rate are orthogonal to main drivers of business cycles, generate a significant deviation of the uncovered interest parity condition, and lead to small movements in net exports. We use these facts to evaluate international business cycle models accounting for the dynamics of both macro aggregates and the real exchange rate.
    Keywords: Real exchange rate; International business cycles; Uncovered interest parity
    JEL: E32 F31
    Date: 2023–03–31
  6. By: Joshua Aizenman; Huanhuan Zheng
    Abstract: Sovereign borrowing during inflation surges is a litmus test of a government’s ability to withstand and navigate macroeconomic shocks. Based on transaction-level bond issuance data, we explore how sovereign financing strategies respond to inflation surges and how policy practices affect their ability to weather inflation shocks. We find that governments rely more on foreign-currency debt from foreign investors during periods of high inflation. This pattern is particularly prevalent in emerging markets (EMs), especially when the inflation surge is prolonged and severe. We further show that good practices of fiscal discipline, credibly pegged exchange regime, open capital account, and monetary dependence alleviate the need to borrow foreign capital in foreign currency during periods of inflation surges.
    JEL: F21 F31
    Date: 2023–04
  7. By: Xiang Fang; Bryan Hardy; Karen Lewis
    Abstract: This paper studies the impact of investor composition on the sovereign debt market. We construct a data set of sovereign debt holdings by foreign and domestic bank, non-bank private, and official investors for 95 countries over 20 years. Private non-bank investors absorb disproportionately more sovereign debt supply than other investors. Moreover, non-bank investor demand is most responsive to the yield. Counterfactual analysis of emerging market sovereigns shows a 10% increase in debt leads to a 6.7% increase in costs, but an outsize 9% increase if non-bank investors are absent. We conclude that these sovereigns are vulnerable to losing non-bank investors.
    Keywords: new borrowing, debt service, financial cycle, financial flows and real effects
    JEL: F34 G11 G15 F41
    Date: 2023–05
  8. By: María Bru Muñoz (Banco de España)
    Abstract: The role of multilateral lenders in sovereign default has been traditionally overlooked by the literature. However, these creditors represent a significant share of lending to emerging markets and feature very distinct characteristics, such as lower interest rates and seniority. By including these creditors in a traditional DSGE model of sovereign default, I reproduce the high debt levels found in the data while maintaining default probabilities within realistic values. Additionally, I am able to analyze the role of multilateral debt in emerging economies. Multilateral loans complement private financing and reduce the incompleteness of international financial markets. Also, multilateral funding acts as an insurance mechanism in bad times, providing countries with some degree of consumption smoothing, opposite to the role of front-loading consumption fulfilled by private financing.
    Keywords: sovereign debt and default, IFIs, multilateral institutions, seniority, consumption smoothing, emerging markets
    JEL: F34 F35 G15
    Date: 2023–01
  9. By: Joao Ayres; Gaston Navarro; Juan Pablo Nicolini; Pedro Teles
    Abstract: We assess the quantitative relevance of expectations-driven sovereign debt crises, focusing on the Southern European crisis of the early 2010’s and the Argentine default of 2001. The source of multiplicity is the one in Calvo (1988). Key for multiplicity is an output process featuring long periods of either high growth or stagnation that we estimate using data for those countries. We find that expectations-driven debt crises are quantitatively relevant but state dependent, as they only occur during stagnations. Expectations are a major driver explaining default rates and credit spread differences between Spain and Argentina.
    Keywords: Self-fulfilling debt crises; Sovereign default; Multiplicity; Stagnations
    JEL: E44 F34
    Date: 2023–02–14
  10. By: Stewart, Chris (Kingston University London)
    Abstract: A growing body of research suggests that the literature applying unit root, stationarity and cointegration tests of long run purchasing power parity (PPP) and the law of one price (LOP) with price index data test relative PPP/LOP and not absolute PPP/LOP. We argue that such tests cannot determine when long run relative PPP/LOP is rejected and therefore are not tests of relative PPP/LOP. These are not tests of strong absolute PPP/LOP either. We contend that they are tests of weaker forms of absolute PPP/LOP and that determining which form of absolute PPP/LOP is useful in terms of, for example, establishing the form of long run flexible-price monetary exchange rate model that it implies.
    Keywords: absolute purchasing power parity; relative purchasing power parity; the law of one price; price indices; unit root tests; cointegration tests; flexible-price monetary exchange rate models.
    JEL: C32 C43 F31
    Date: 2023–04–28
  11. By: Bryan Hardy; Felipe Saffie
    Abstract: We use unique firm-level data from Mexico to document that non-financial corporations engage in carry trades by borrowing in foreign currency (FX) and lending in domestic currency, largely in the form of trade credit, accumulating currency risk in the process. We show at a quarterly frequency that the practice of borrowing in FX and extending trade credit is more prevalent when foreign currency borrowing is relatively cheaper than local currency borrowing, and it is associated with expansions in both gross trade credit and sales. Firms that were more active in carry-trades, accumulating currency risk, experienced larger reductions in investment and profits following a large depreciation event. Nevertheless, their extension of trade credit remained stable, insulating their trading partners from the shock. A firm-level panel for 20 emerging countries provide external validity for the link between carry trades and trade credit.
    JEL: E44 F30 G15 G30
    Date: 2023–04
  12. By: Yusuf Soner Başkaya; Bryan Hardy; Ṣebnem Kalemli-Özcan; Vivian Z. Yue
    Abstract: We quantify the sovereign-bank doom loop by using the 1999 Marmara earthquake as an exogenous shock leading to an increase in Turkey’s default risk. Our theoretical model illustrates that for banks with higher exposure to government securities, a higher sovereign default risk implies lower net worth and tightening financial constraint. Our empirical estimates confirm the model’s predictions, showing that the exogenous change in sovereign default risk tightens banks’ financial constraints significantly for banks that hold a higher amount of government securities. The resulting tighter bank financial constraints translate into lower credit provision, suggesting that there is a significant balance-sheet channel in transmitting a higher sovereign default risk toward real economic activity.
    Keywords: banking crisis; bank balance sheets; lending channel; public debt; credit supply
    JEL: E32 F15 F36 O16
    Date: 2023–02–09
  13. By: Alejandro G. Graziano; Yuan Tian
    Abstract: In 2020, a pandemic generated by a novel virus caused a large and abrupt decline in world trade, only comparable within the last half-century to the Great Trade Collapse during the 2008-09 Financial Crisis. This collapse followed naturally from the difficulty of locally producing, transporting, and consuming goods in the affected regions worldwide. In this paper, we study the impact of these disruptive local shocks on international trade flows during the COVID-19 pandemic. Using rich product-level import data from Colombia, we first show that import collapse at the onset of the pandemic was due to a decrease in import quantities, and the import recovery in later periods was partially explained by a rise in both foreign export prices and shipping costs. Using smartphone data tracking local human mobility changes to identify local shocks, we decompose the trade effects into shocks originating from exporter cities, seaports, and importer cities. We find that while the decline in quantity was driven by both changes in exporter and importer shocks, the increase in price was entirely driven by exporter shocks. Using data on port calls made by container ships, we document a decline in port productivity during the pandemic. We show that mobility changes at port locations induced a decline in port efficiency and a rise in freight costs. We also document a positive correlation between product-level domestic inflation and mobility shocks to foreign exporters.
    Keywords: International trade, local shocks, COVID-19 pandemic, shipping costs, mobility, supply chain, inflation
    Date: 2023
  14. By: John G. Fernald; Robert Inklaar; Dimitrije Ruzic
    Abstract: This paper reviews advanced-economy productivity developments in recent decades. We focus primarily on the facts about, and explanations for, the mid-2000s labor-productivity slowdown in large European countries and the United States. Slower total factor productivity growth was the proximate cause of the slowdown. This conclusion is robust to measurement challenges including the role of intangible assets, rankings of productivity levels, and data revisions. We contrast two main narratives for the stagnating productivity frontier: The shock of the Global Financial Crisis; and a common slowdown in productivity trends. Distinguishing these two empirically is hard, but the pre-recession timing of the U.S. slowdown suggests an important role for the common-trend explanation. We also discuss the unusual pattern of productivity growth since the start of the Covid-19 pandemic. Although it is early, there is little evidence so far that the large pandemic shock has changed the slow pre-pandemic trajectory of productivity growth.
    Keywords: productivity growth; Great Recession; convergence
    JEL: D24 E23 E44 F45 O47
    Date: 2023–02–26

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