nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒06‒19
fourteen papers chosen by
Martin Berka
Massey University

  1. Neoclassical Growth in an Interdependent World By Benny Kleinman; Ernest Liu; Stephen J. Redding; Motohiro Yogo
  2. Dollarization Dynamics By Tomás E. Caravello; Pedro Martinez-Bruera; Iván Werning
  3. Can Small Economies Act Strategically? The Case of Consumption Pollution and Non-tradable Goods By Michael S. Michael; Panos Hatzipanayotou; Nikos Tsakiris
  4. Stress Relief?: Funding Structures and Resilience to the Covid Shock By Kristin Forbes; Christian Friedrich; Dennis Reinhardt
  5. Transmission of recent shocks in a labour-DSGE model with wage rigidity By Obstbaum, Meri; Oinonen, Sami; Pönkä, Harri; Vanhala, Juuso; Vilmi, Lauri
  6. Financial Stability and Interest Rates By Ozge Akinci; Gianluca Benigno; Marco Del Negro; Ethan Nourbash; Albert Queraltó
  7. State-Dependent Exchange Rate Pass-Through By Carrière-Swallow, Yan; Firat, Melih; Furceri, Davide; Jiménez, Daniel
  8. The politics of redistribution and sovereign default By Scholl, Almuth
  9. On the Pass-Through of Large Devaluations By Carlos Casacuberta; Omar Licandro
  10. A Financial Stress Index for a Small Open Economy: The Australian Case By Pedro Gomis-Porqueras; Romina Ruprecht; Xuan Zhou
  11. State-Dependent Exchange Rate Pass-Through By Mr. Yan Carriere-Swallow; Melih Firat; Davide Furceri; Daniel Jimenez
  12. To What Degree and through Which Channel Do Central Banks Other Than the Federal Reserve Cause Spillovers? By Christopher D. Cotton
  13. Trade Disruptions Along the Global Supply Chain By Alejandro G. Graziano; Yuan Tian
  14. It’s Never Different: Fiscal Policy Shocks and Inflation By Mr. Serhan Cevik; Fedor Miryugin

  1. By: Benny Kleinman (Princeton University); Ernest Liu (Princeton University and NBER); Stephen J. Redding (Princeton University, CEPR, and NBER); Motohiro Yogo (Princeton University and NBER)
    Abstract: We generalize the closed-economy neoclassical growth model (CNGM) to allow for open goods and capital markets with imperfect substitutability between countries. We simultaneously model international trade, gross and net capital holdings at a point in time, and intertemporal savings decisions over time, and hence the current account. We show that our framework rationalizes the observed gravity equation relationships for trade and capital holdings in the data. We find a substantially slower speed of convergence to steady-state than in the CNGM. Furthermore, goods and capital market integration interact in non-trivial ways. With either free trade or free capital, convergence is faster than in CNGM. In contrast, under both free trade and free capital, convergence is slower than in CNGM. In response to counterfactual changes in bilateral trade frictions, reallocations of capital across countries lead to a substantially different incidence of static and dynamic welfare gains and losses than a world of capital market autarky.
    Keywords: Economic Growth, International Trade, Capital Flows
    JEL: F10 F21 F60
    Date: 2023–05
  2. By: Tomás E. Caravello; Pedro Martinez-Bruera; Iván Werning
    Abstract: This study explores the consequences of dollarizing an economy with an initial dollar shortage. We show that the resulting transitional dynamics are tantamount to that of a “sudden stop”: consumption of tradable goods fall, the real exchange rate depreciates abruptly by a discrete drop in domestic prices and wages followed by a gradual appreciation from positive inflation. With nominal rigidities the economy first falls into a recession. This is true even if all prices and wages are allowed to adjust flexibly on impact. The subsequent recovery in activity always “overshoots” the steady state: the non-tradable sector transitions from the initial recession to a boom, then asymptotes to its steady state.
    JEL: E10 F30
    Date: 2023–06
  3. By: Michael S. Michael; Panos Hatzipanayotou (Athens University of Economics and Business); Nikos Tsakiris
    Abstract: We develop a model of two small open asymmetric economies with two tradable and one non-tradable goods, capital mobility and consumption generated cross border pollution. We show that the Nash equilibrium calls for a consumption tax and capital tax (subsidy) when the consumption of the tradable (non-tradable) good pollutes. In this model, the consumption tax causes pollution leakages between the two countries which is partly offset by the capital tax or subsidy. Thus, the existence of non-tradable goods and international capital mobility induce the small countries to act strategically. In the absence of capital taxes, consumption taxes are lower to their rates when capital taxes are also present since are used strategically to mitigate the pollution leakage.
    Keywords: Pollution Leakage, Non-tradable Goods, Capital Mobility, Capital and Consumption Taxes, Consumption-generated Cross-border Pollution
    JEL: F15 F18 F20 H20
    Date: 2023–05–08
  4. By: Kristin Forbes; Christian Friedrich; Dennis Reinhardt
    Abstract: This paper explores the relationship between different funding structures—including the source, instrument, currency, and counterparty location of funding—and the extent of financial stress experienced in different countries and sectors during the sharp risk-off shock in early 2020 when Covid-19 spread globally. We measure financial stress using a new dataset on changes in credit default swap spreads for sovereigns, banks, and corporates. Then we use country-sector and country-sector-time panels to assess how different funding structures are related to financial stress. A higher share of funding from non-bank financial institutions (NBFIs) or in US dollars was correlated with significantly greater stress, while a higher share of funding in debt instruments (instead of loans) or cross-border (instead of domestically) was not significantly related to financial stress. The results suggest that macroprudential regulations should broaden their current focus to take into account exposures to NBFI and dollar funding, with less priority for regulations focused on residency (i.e., capital controls). After the sharp increase in financial stress in early 2020, policy responses targeting these structural vulnerabilities (i.e., US$ swap lines and focused on NBFIs) were more effective at mitigating stress related to these funding structures than policies supporting banks, even after controlling for macroeconomic policy responses.
    JEL: E44 E65 F31 F36 F42 G18 G23 G38
    Date: 2023–05
  5. By: Obstbaum, Meri; Oinonen, Sami; Pönkä, Harri; Vanhala, Juuso; Vilmi, Lauri
    Abstract: In this paper we analyze features of the recent business cycle with a New Keynesian small open economy DSGE model with labour market frictions and wage rigidity. The model complements the existing analytical tools of the Bank of Finland by enabling detailed analysis of labour markets in a DSGE framework. We illustrate the properties of the model by presenting how recent shocks explain in flation and economic recovery in the euro area and Finland, with a specifi c emphasis on factors that are critical to explaining current labour market tightness.
    Keywords: DGSE model, labour market frictions, wage rigidity
    JEL: E24 E32 E37 F41
    Date: 2023
  6. By: Ozge Akinci; Gianluca Benigno; Marco Del Negro; Ethan Nourbash; Albert Queraltó
    Abstract: In a recent research paper we argue that interest rates have very different consequences for current versus future financial stability. In the short run, lower real rates mean higher asset prices and hence higher net worth for financial institutions. In the long run, lower real rates lead intermediaries to shift their portfolios toward risky assets, making them more vulnerable over time. In this post, we use a model to highlight the challenging trade-offs faced by policymakers in setting interest rates.
    Keywords: financial stability; monetary policy; Dynamic Stochastic General Equilibrium (DSGE) models; rates; nonlinear responses; shocks; fire sale
    JEL: E2 E5 E4 G2
    Date: 2023–05–23
  7. By: Carrière-Swallow, Yan; Firat, Melih; Furceri, Davide; Jiménez, Daniel
    Abstract: We estimate how the rate of pass-through from the exchange rate to domestic prices varies across states of the economy and depends on the shocks that drive fluctuations in the exchange rate. We confirm several results from the literature and uncover new facts. Drawing on the experience of a large sample of advanced and emerging market economies over the past 30 years, we document that exchange rate pass-through is significantly larger during periods of high inflation and elevated uncertainty. Using a novel identification strategy, we also show that pass-through is higher when exchange rate fluctuations are driven by U.S. monetary policy.
    Keywords: Exchange rate; Pass Through; Inflation
    JEL: E31 E52 F31 F44
    Date: 2023–05
  8. By: Scholl, Almuth
    Abstract: This paper studies how distributional and electoral concerns shape sovereign default incentives within a quantitative model of sovereign debt with heterogeneous agents and non-linear income taxation. The small open economy is characterized by a two-party system in which the left-wing party has a larger preference for redistribution than the right-wing party. Political turnover is the endogenous outcome of the electoral process. Fiscal policy faces a tradeoff: On the one hand, the government has incentives to fi- nance redistribution via external debt to avoid distortionary income taxation. On the other hand, the accumulation of external debt raises the cost of borrowing. Quanti- tative findings suggest that the left-wing party implements a more progressive income tax, is more prone to default, and has a lower electoral support than the right-wing party due to worse borrowing conditions and the distortionary effects of income taxa- tion. In equilibrium, electoral uncertainty raises sovereign default risk.
    Keywords: sovereign debt and default, inequality, redistribution, political economy
    JEL: F34 H63 E62 F41 D72
    Date: 2023
  9. 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: 2023–05
  10. By: Pedro Gomis-Porqueras; Romina Ruprecht; Xuan Zhou
    Abstract: We construct a Financial Stress Index (FSI) for a small open economy, which aims to provide clear and timely signals of financial market strains. This can be used in developing appropriate responses to address these adverse events. To do so, we use the principal component framework and apply it to Australian monthly data on interest rates, spreads, exchange rates, house price growth and inflation expectations. Decomposing the index into foreign and domestic components, we find that the foreign factors can explain more than half (57.4%) of our Australian Financial Stress Index (AFSI). To determine the information content of our index, we run a series of Granger causality tests on several economic and financial observables. We also estimate whether including the AFSI can improve the prediction of the different economic and financial outcomes relative to a specification that uses only its own previous data. We find that including the AFSI improves the forecasts for future retail sales growth and bank credit growth. Finally, we show that financial stress can have non-linear effects on bank credit growth. In particular, an increase in financial stress affects credit growth more adversely if AFSI is high. This result further highlights the importance of an accurate and timely measure of financial stress in an economy for researchers and policy makers.
    Keywords: Financial stress index; Financial stability; Small open economies
    JEL: F30 G01 G15
    Date: 2023–05–05
  11. By: Mr. Yan Carriere-Swallow; Melih Firat; Davide Furceri; Daniel Jimenez
    Abstract: We estimate how the rate of pass-through from the exchange rate to domestic prices varies across states of the economy and depending on the shocks that drive fluctuations in the exchange rate. We confirm several results from the literature and uncover new facts. Drawing on the experience of a large sample of advanced and emerging market economies over the past 30 years, we document that exchange rate pass-through significantly larger during periods of high inflation and elevated uncertainty. Using a novel identification strategy, we also show that pass-through is higher when exchange rate fluctuations are driven by U.S. monetary policy.
    Keywords: Exchange rate; pass-through; inflation; state-dependence
    Date: 2023–04–28
  12. By: Christopher D. Cotton
    Abstract: Spillovers play a crucial role in driving monetary policy around the world. The literature focuses predominantly on spillovers from the Federal Reserve. Less attention has been paid to spillovers from other central banks. I measure the degree to which 20 central banks cause spillovers. I show that central banks in medium- to high-income countries cause spillovers to medium- to long-term interest rates in similar countries through a bond-pricing channel. These effects are narrower than spillovers from the Federal Reserve, which also affect emerging markets, short-term interest rates, and other assets. However, they are still pronounced. Fourteen central banks other than the Federal Reserve cause significant spillovers: the central banks of Australia, Canada, Czechia, the eurozone, Japan, Mexico, Norway, New Zealand, Poland, Romania, South Korea, Sweden, Switzerland, and the United Kingdom. Consequently, the Federal Reserve causes only one-fifth of the spillovers to 10-year interest rates, and the United States is the recipient of large spillovers. My results imply that central banks, especially the Federal Reserve, are affected by greater spillovers than is commonly believed, and that non-Fed central banks cause spillovers through a bond-pricing channel.
    Keywords: monetary policy spillovers; central bank; global financial cycle
    JEL: F42 E43 E52
    Date: 2022–09–01
  13. By: Alejandro G. Graziano (University of Nottingham); Yuan Tian (University of Nottingham)
    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 inport 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.
    JEL: F10 F14 F16 I12 O18
    Date: 2023–05
  14. By: Mr. Serhan Cevik; Fedor Miryugin
    Abstract: This paper investigates the impact of fiscal shocks on inflation, using a large panel of 139 countries over the period 1970–2021. First, both headline and core measures of inflation increase in response to expansionary shifts in the fiscal policy stance. Second, we split the sample and observe an intriguing pattern that fiscal policy shocks are primarily significant in developing countries. Third, the inflationary impact of fiscal policy shocks is dependent on fiscal space and economic conditions, as well as monetary policy type, exchange rate regimes and fiscal rules, at the time of the shock. We confirm these results by using the narrative approach and forecast errors, as well as cyclically- adjusted data on government revenues and non-interest expenditures, to identify exogenous changes in fiscal policy. The analysis has several important policy implications: (i) fiscal policy is a critical anchor of macroeconomic stability; (ii) fiscal policy should be used with care in aggregate demand management as it has significant effects on inflation, which are highly dependent on fiscal space and economic conditions; and (iii) flexible exchange rates and rule-based policymaking provide greater resilience to inflationary shocks.
    Keywords: Inflation; fiscal policy; public debt; output gap; local projections
    Date: 2023–05–12

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