nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒06‒26
fourteen papers chosen by
Martin Berka
Massey University

  1. Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response? By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  2. External Balance Sheets and the COVID-19 Crisis. By Hale, Galina; Juvenal, Luciana
  3. China as an international lender of last resort By Horn, Sebastian; Parks, Bradley; Reinhart, Carmen M.; Trebesch, Christoph
  4. Debt crises, fast and slow Giancarlo By Giancarlo Corsetti
  5. Export impact on dividend policy for big Colombian exporting firms, 2006-2014 By Merchan Alvarez, Federico Alberto
  6. EOn the Effectiveness of Foreign Exchange Reserves during the 2021-22 U.S. Monetary Tightening Cycle. By Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
  7. The shape of business cycles: a cross-country analysis of Friedman s plucking theory By Emanuel Kohlscheen; Richhild Moessner; Daniel Rees
  9. Original sin and the CFA Franc: A case study of the West African Economic and Monetary Union By Peist, Moritz Manuel
  10. The Global Financial Cycle and Us Monetary Policy in An Interconnected World By Stéphane Dées; Alessandro Galesi
  11. Exchange rate pass-around By Crozet, Matthieu; Hinz, Julian; Trionfetti, Federico
  12. An Investigation into the Effects of Border Carbon Adjustments on the Canadian Economy By Y.-H. Henry Chen; Hossein Hosseini Jebeli; Craig Johnston; Sergey Paltsev; Marie-Christine Tremblay
  13. The Macroeconomic Stabilization of Tariff Shocks: What is the Optimal Monetary Response? By Giancarlo Corsetti; Paul Bergin
  14. On the Pass-Through of Large Devaluations By Carlos Casacuberta; Omar Licandro

  1. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: How should monetary policy respond to excessive capital inflows that appreciate the currency, widen the external deficit and cause overheating? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation. The optimal monetary stance is expansionary if the exchange rate pass-through (ERPT) on import prices is complete, contractionary if nominal rigidities reduce the ERPT. Excessive capital inflows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand.
    Keywords: Currency misalignments, trade imbalances, asset markets and risk sharing, optimal targeting rules, international policy cooperation, exchange rate pass-through
    Date: 2022–11
  2. By: Hale, Galina; Juvenal, Luciana
    Abstract: At the onset of the COVID-19 economic crisis, as in other crisis episodes, we observed a rapid appreciation of "safe haven" currencies. We quantify currency-induced balance sheet valuation effects for aggregate external positions as well as for broadly defined asset classes for the first quarter and the full year 2020. To do so, we use new data on the currency composition of cross-border assets and liabilities for 46 countries. In contrast with past financial crises, many emerging markets did not experience losses on their aggregate external balance sheets despite facing a domestic currency depreciation. This was partly due to currency-induced valuation gains on equity positions offsetting losses on debt positions, and partly due to reduced currency mismatch on their external debt positions. We conduct the stock-flow reconciliation of net international investment positions to measure overall valuation effects and compute the proportion that is due to changes in currency values. For about half of the countries in our sample, currency-induced valuation effects were substantial, representing over 50 percent of total valuation effects in 2020Q1 and the full year 2020.
    Keywords: Balance sheet effects, COVID-19, Currency mismatch, Valuation effects, Applied Mathematics, Economic Theory, Banking, Finance and Investment, Finance
    Date: 2023–02–01
  3. By: Horn, Sebastian; Parks, Bradley; Reinhart, Carmen M.; Trebesch, Christoph
    Abstract: This paper shows that China has launched a new global system for cross-border rescue lending to countries in debt distress. We build the first comprehensive dataset on China's overseas bailouts between 2000 and 2021 and provide new insights into China's growing role in the global financial system. A key finding is that the global swap line network put in place by the People's Bank of China is increasingly used as a financial rescue mechanism, with more than USD 170 billion in liquidity support extended to crisis countries, including repeated rollovers of swaps coming due. The swaps bolster gross reserves and are mostly drawn by distressed countries with low liquidity ratios. In addition, we show that Chinese state-owned banks and enterprises have given out an additional USD 70 billion in rescue loans for balance of payments support. Taken together, China's overseas bailouts correspond to more than 20 percent of total IMF lending over the past decade and bailout amounts are growing fast. However, China's rescue loans differ from those of established international lenders of last resort in that they (i) are opaque, (ii) carry relatively high interest rates, and (iii) are almost exclusively targeted to debtors of China's Belt and Road Initiative. These findings have implications for the international financial and monetary architecture, which is becoming more multipolar, less institutionalized, and less transparent.
    Keywords: China, financial crises, sovereign debt crises, bailouts, rescue loans, external debt, official lending, hidden debts, sovereign risk, Belt and Road initiative
    JEL: F21 F33 F42 F65 G15 H63 N25
    Date: 2023
  4. By: Giancarlo Corsetti
    Abstract: We build a dynamic model where the economy is vulnerable to belief-driven slowmoving debt crisesat intermediate debt level, and rollover crises at both low and high debt levels. Vis-à-vis the threatof slow-moving crises, countercyclical deficits generally welfare-dominate debt reduction policies.In a recession, optimizing governments only deleverage if debt is close to the threshold below whichbelief-driven slow-moving crises can no longer occur. The welfare benefits from deleveraging insteaddominate if governments are concerned with losing market access even at low debt levels. Longbond maturities may fully eliminate belief-driven rollover crises but not slow-moving ones.
    Keywords: Sovereign default, Self-fulfilling crises, Expectations, Debt sustainability
    Date: 2023–02
  5. By: Merchan Alvarez, Federico Alberto
    Abstract: This paper studies the impact of exogenous export demand shocks on firms' dividend policy using firm specific real exchange rate variation as instrumental variable. IV exclusion restriction is plausibly satisfied because real exchange rate shocks were unanticipated -partly explained because of international oil price fluctuation-, and first stage results confirm relevance condition fulfillment. The results indicate that big private Colombian exporting firms decree dividends as a way to mitigate the agency cost generated by exogeneous exports variation via higher free cash flow and cash flow volatility, especially in poor managerial quality firms. Evidence supports agency cost theory and denies signaling.
    Keywords: dividends, exports, agency cost, free cash flow, volatility
    JEL: F14 F10 G30 G32 G14 G35
    Date: 2023
  6. By: Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
    Abstract: This paper examines whether levels of foreign exchange (FX) reserves and other fundamental factors explain cross-country differences in foreign currency depreciation observed over the 2021- 22 Federal Reserve monetary policy tightening that led to a sharp appreciation of the US dollar. Considering a broad cross-section of countries, we document that an additional 10 percentage points of FX reserves/GDP held ex-ante were associated with 1.5 to 2 percent less exchange rate depreciation and this buffer effect was larger among less financially developed economies. Higher ex-ante policy rates were also associated with less depreciation, especially among financially open economies. Taken together, these results support the buffering role of FX reserves and their potential to promote monetary policy independence in the presence of international spillovers.
    Keywords: International Reserves, Trilemma, Global Financial Cycle, Currency Risk, Spillovers
    JEL: F3 F31 F32 F36
    Date: 2023
  7. By: Emanuel Kohlscheen; Richhild Moessner; Daniel Rees
    Abstract: We test the international applicability of Friedman s famous plucking theory of the business cycle in 12 advanced economies between 1970 and 2021. We find that in countries where labour markets are flexible (Australia, Canada, United Kingdom and United States), unemployment rates typically return to pre-recession levels, in line with Friedman s theory. Elsewhere, unemployment rates are less cyclical. Output recoveries differ less across countries, but more across episodes: on average, half of the decline in GDP during a recession persists. In terms of sectors, declines in manufacturing are typically fully reversed. In contrast, construction-driven recessions, which are often associated with bursting property price bubbles, tend to be persistent.
    Date: 2023–06
  8. By: Wahyoe Soedarmono (Sampoerna University); Iman Gunadi (Bank Indonesia); Fiskara Indawan (Bank Indonesia); Carla Sheila Wulandari (Bank Indonesia)
    Abstract: This paper investigates the determinants of foreign capital inflows and analyzes whether such inflows affect bond market and banking in the Indonesian context. We document that exchange rate depreciation and domestic interest rate benchmark tend to boost foreign capital inflows. Likewise, higher fiscal deficit reduces foreign capital inflows regardless capital inflows measurement. Moreover, higher foreign ownership in government bond is also driven by foreign capital inflows directly or through an increase in the current account. Regarding implications for banking, higher foreign capital inflows mitigate bank credit risk. Global factors such as the US interest rate benchmark and the volatility index indeed affect foreign capital inflows, although their impacts differ according to the measures of capital inflows. Eventually, in order to mitigate foreign capital reversals, this paper advocates the importance of policy mix such as fiscal deficit management, prudent monetary policy to maintain the interest rate differential between the US and domestic interest rate benchmark, as well as flexible exchange rate or inflation management. Nevertheless, identifying types of foreign capital outflows is also essential to understand what policy mix is necessary to deal with certain challenges.
    Keywords: capital flows, current account balance, financial stability, macroeconomies policies, bond market, banking
    JEL: F32 G0 F4 G1
    Date: 2022
  9. By: Peist, Moritz Manuel
    Abstract: This paper investigates Original Sin in the West African Economic and Monetary Union in the framework of regional integration and cooperation initiatives. The phenomenon describes the inability of countries to borrow in their currency. The central hypothesis is that smaller South-South Coordination schemes do not possess the necessary magnitude to overcome Original Sin. The paper first substantiates the existence of Original Sin in West Africa. It then examines the influence of economic, fiscal, and monetary factors on the time variance of Original Sin in the region using a Tobit model. The results delivered mixed outcomes but confirm Original Sin's negative correlation with country size. The results uphold the hypothesis that financial and monetary integration and cooperation alone are not a panacea for Original Sin.
    Keywords: Original Sin, WAEMU, CFA Franc, Tobit
    JEL: C33 C34 F3 F4 F6
    Date: 2023
  10. By: Stéphane Dées (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - UB - Université de Bordeaux); Alessandro Galesi
    Abstract: We assess the international spillovers of US monetary policy with a large-scale global VAR which models the world economy as a network of interdependent countries. An expansionary US monetary policy shock contributes to the emergence of a Global Financial Cycle, which boosts macroeconomic activity worldwide. We also find that economies with floating exchange rate regimes are not fully insulated from US monetary policy shocks and, even though they appear to be relatively less affected by the shocks, the differences in responses across exchange rate regimes are not statistically significant. The role of US monetary policy in driving these macro-financial spillovers gets even reinforced by the complex network of interactions across countries, to the extent that network effects roughly double the direct impacts of US monetary policy surprises on international equity prices, capital flows, and global growth. This amplification increases as countries get more globally integrated over time, suggesting that the evolving network is an important driver for the increasing role of US monetary policy in shaping the Global Financial Cycle.
    Keywords: Trilemma, Global financial cycle, Monetary policy spillovers, Network effects
    Date: 2021–07
  11. By: Crozet, Matthieu; Hinz, Julian; Trionfetti, Federico
    Abstract: In January 2015, The Swiss Franc (CHF) appreciated unexpectedly against the Euro by approximately 15%. We document a new fact: French firms that exported to both the Swiss market and the Eurozone also exhibited a sudden change in their export prices to the Eurozone. We coin this the 'exchange rate pass-around' effect. We rationalise this fact with a simple model based on the endogenous decision of some firms to give up pricing-to-market and opt for single-pricing to all markets. An important implication of this finding is that single-pricing may be one of the causes of the incomplete pass-through. This mechanism has so far remained unexplored in the literature, which may have led to overestimating the importance of other factors. Based on monthly French export data, our empirical analysis confirms the existence of the pass-around. Firms directly affected by the CHF exchange rate shock increased their prices in neighboring markets by 0.8% compared to other exporters. The effect was stronger for firms with lower ex-ante price heterogeneity across markets and for firms with smaller trade costs to Switzerland. However, the effect was short-lived. As time passed, exporters tended to decouple the prices they set on the Swiss market from those for the Eurozone, and the pass-around effect faded.
    Keywords: Exchange rate pass-through, International trade, Pricing-to-market
    JEL: F14 F31 D61 D62
    Date: 2023
  12. By: Y.-H. Henry Chen; Hossein Hosseini Jebeli; Craig Johnston; Sergey Paltsev; Marie-Christine Tremblay
    Abstract: This paper examines how border carbon adjustments (BCAs) may address the unintended consequences of uncoordinated global climate action, focusing on the economic implications for Canada. We investigate these implications under different BCA design features and by considering a coalition of countries and regions that adopt BCAs. We find that BCAs, in the form of import tariffs, reduce Canada’s carbon leakage to the rest of the world and improve its domestic and foreign competitiveness when Canada is part of a coalition of countries and regions that implement BCAs that includes the United States. We show that these results may change if Canada imposes BCAs on a different set of sectors than the rest of the coalition or includes export rebates and free emissions allowances to firms. When the United States is not part of the coalition, we show that Canada’s carbon leakage increases, domestic competitiveness dampens and foreign competitiveness improves. Compared with a case where no countries have BCAs, welfare improves in Canada if revenues from BCAs, in the form of import tariffs, are transferred to households. This finding holds regardless of the United States’ participation in the coalition.
    Keywords: Climate change; International topics; Trade integration
    JEL: C68 F1 H2 Q5 Q37
    Date: 2023–05
  13. By: Giancarlo Corsetti; Paul Bergin
    Abstract: In the wake of Brexit and Trump trade war, central banks face the need to reconsider the role ofmonetary policy in managing the inflationary-recessionary effects of hikes in tariffs. Using a NewKeynesian model enriched with global value chains and firm dynamics, we show that the optimalmonetary response is expansionary. It supports activity and producer prices at the expense ofaggravating short-run headline inflation---contrary to the prescription of the standard Taylor rule. Thisholds all the more when the home currency is dominant in pricing of international trade.
    Keywords: Tariff shock, tariff war, optimal monetary policy, production chains
    Date: 2023–03
  14. 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

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