nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒10‒02
thirteen papers chosen by
Martin Berka, Massey University

  1. Liquidity and Exchange Rates: An Empirical Investigation By Engel, Charles; Wu, Steve Pak Yeung
  2. From Dominant to Producer Currency Pricing: Dynamics of Chilean Exports By José De Gregorio; Pablo García; Emiliano Luttini; Marco Rojas
  3. Exchange Rate Elasticities of International Tourism and the Role of Dominant Currency Pricing By Ding Ding; Yannick Timmer
  4. Monetary Policy in Small Open Economies and the International Zero Lower Bound By Marco Rojas
  5. The Importance of Sound Monetary Policy: Some Lessons for Today from Canada’s Experience with Floating Exchange Rates Since 1950 By Michael D. Bordo; Pierre Siklos
  6. Hard Commodities Hit Harder: Global Financial Risk and Commodity Exporters By Gabriela Contreras
  7. Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies By Philippe Bacchetta; Kenza Benhima; Brendan Berthold
  8. Commodity Price Shocks and Production Networks in Small Open Economies By Alvaro Silva; Petre Caraiani; Jorge Miranda-Pinto; Juan Olaya-Agudelo
  9. Global monetary policy surprises and their transmission to emerging market economies: an external VAR analysis By Felipe Beltrán
  10. Real Exchange Rates and the Earnings of Immigrants By Christian Dustmann; Hyejin Ku; Tanya Surovtseva
  11. The Impact of Bretton Woods International Capital Controls on the Global Economy and the Value of Geopolitical Stability: A General Equilibrium Analysis By Lee E. Ohanian; Paulina Restrepo-Echavarria; Diana Van Patten; Mark L.J. Wright
  12. A HANK2 Model of Monetary Unions By Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich
  13. Exchange rate volatility and the effectiveness of FX interventions: the case of Chile By Alejandro Jara; Marco Piña

  1. By: Engel, Charles; Wu, Steve Pak Yeung
    Abstract: Abstract: We find strong empirical evidence that the liquidity yield on government bonds in combination with standard economic fundamentals can well account for nominal exchange rate movements. We find impressive evidence that changes in the liquidity yield are significant in explaining exchange rate changes for all the G10 countries, and we stress that the US dollar is not special in this relationship. We show how these relationships arise out of a canonical two-country New Keynesian model with liquidity returns. Additionally, we find a role for sovereign default risk and currency swap market frictions.
    Keywords: Economics, Applied Economics, Econometrics, Applied economics, Economic theory
    Date: 2023–09–05
  2. By: José De Gregorio; Pablo García; Emiliano Luttini; Marco Rojas
    Abstract: We revisit a central question for international macroeconomics: The response of export prices and quantities to movements in the exchange rate (ER). We use a comprehensive dataset for Chile and study how the effects vary over time with the currency of invoicing and the destination of exports. For prices, we find that the short-run effects of bilateral ER movements vanish when we control for U.S. dollar ER, which supports the dominant currency paradigm. The longer the horizon, the larger the role is played by bilateral ER movements, which lends support to producer currency pricing. The dynamics do not depend on the invoicing currency. We find consistent results for quantities, supporting the view that bilateral exchange rate movements contribute to macroeconomic adjustment through exports. We also find that U.S. dollar fluctuations, holding bilateral exchange rates constant, show results suggestive of relevant supply and demand effects.
    Date: 2023–01
  3. By: Ding Ding; Yannick Timmer
    Abstract: In this paper, we estimate exchange rate elasticities of international tourism. Both the bilateral exchange rate and the U.S. dollar exchange rate relative to tourism origin countries are important drivers of tourism flows. The U.S. dollar exchange rate is more important for tourism destination countries with higher U.S. dollar borrowing, pointing toward a complementarity between U.S. dollar pricing and financing. Country-specific dominant currencies (CSDCs) play only a minor role on average but are important for tourism-dependent countries and those with a high concentration of foreign tourists. Consistent with dominant currency pricing, we also find that local hotel prices do increase strongly when the domestic currency depreciates against the U.S. dollar. The importance of the U.S. dollar exchange rate represents a strong piece of evidence of dominant currency pricing (DCP) in the international trade of services. The results suggest that the benefits of exchange rate flexibility for tourism-dependent countries may be weaker than previously thought and that a broad appreciation of the U.S. dollar is associated with a significant decline in tourism flows globally.
    Keywords: Exchange rates; Trade flows; Tourism; Dominant currency pricing
    JEL: F31 F14 F41
    Date: 2023–08–15
  4. By: Marco Rojas
    Abstract: How does the zero lower bound (ZLB) on the international interest rate affect monetary policy in small open economies (SOE)? When the Fed’s rate was at the ZLB (2008-2015), data for several SOE show a significantly lower correlation between interest rates and inflation, which is at odds with the empirical regularity. This is explained in a model where the distribution of shocks that affect SOE changes when the international interest rate hits the ZLB. Two opposing channels affect the exchange rate. At the ZLB, the depreciating channel is amplified, while the appreciating channel is attenuated. Then, the SOE currency depreciates more than in a scenario without ZLB. This passes through to inflation, which affects SOE’s ability to stabilize the economy as it cannot lower its interest rate as much. In an estimated model, this mechanism by itself can explain 26 percent of the lower correlation observed in the data.
    Date: 2022–12
  5. By: Michael D. Bordo; Pierre Siklos
    Abstract: In this paper we revisit the Canadian experience with floating exchange rates since 1950. Canada was a pioneer in successfully adopting a floating exchange rate during the Bretton Woods pegged exchange rate regime. Since then, most advanced countries have followed the Canadian example. A key finding of our paper based on historical narrative and econometric analysis is that economic performance under floating depended on its monetary policy performance as Milton Friedman originally argued in his seminal 1953 article. Canadian monetary policy achieved low and stable inflation once it adopted inflation targeting as a nominal anchor. Also, as Friedman argued, Canada’s floating exchange rate provided it with a modicum of insulation from external shocks, especially commodity price shocks that influenced both the level and volatility of the real exchange rate over the past three decades. The Canadian experience with floating (along with that of other small open economies such as Australia, New Zealand and Sweden) and inflation targeting became a model for the conduct of monetary policy in emerging countries.
    JEL: E32 E52 F31 F32 N1
    Date: 2023–09
  6. By: Gabriela Contreras
    Abstract: In this study, I investigate the response of commodity exporters to the global financial cycle and how it depends on the type of commodity exported. I first show that following an upsurge in global financial risk, the prices of hard commodities (such as energy, metals, and minerals) decline considerably more than soft commodities. Through a panel SVAR analysis, I compare the reactions of hard and soft commodity exporters to an unexpected increase in global financial risk. My findings reveal that hard commodity exporters experience a more significant decline in their commodity terms of trade, a higher increase in their country spread, and a more substantial reduction in output. I set up a small open economy model to explore the effects of global risk shocks on country spreads, depending on the type of commodities an economy exports. The results of this model suggest that global risk shocks are primarily transmitted through commodity prices, which means that hard commodity exporters are impacted more severely due to the composition of their exports.
    Date: 2023–08
  7. By: Philippe Bacchetta (University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)); Kenza Benhima (University of Lausanne; Centre for Economic Policy Research (CEPR)); Brendan Berthold (University of Lausanne)
    Abstract: We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both CIP and UIP deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that there may be a benefit, rather than a cost, of FX reserves if international intermediaries value the safe haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.
    Date: 2023–08
  8. By: Alvaro Silva; Petre Caraiani; Jorge Miranda-Pinto; Juan Olaya-Agudelo
    Abstract: We study the role of domestic production networks in the transmission of commodity price shocks in small open economies. We provide empirical evidence of a strong propagation of commodity price shocks to quantities produced in domestic sectors that supply intermediate inputs to commodity sectors (upstream propagation) and a muted propagation to sectors using commodities as intermediate inputs (downstream propagation). We develop a small open economy production network model to explain these transmission patterns. We show that the domestic production network is crucial in shaping the propagation of commodity prices. The two key mechanisms that rationalize the evidence are i) the foreign demand channel and ii) the input-output substitution channel. These two channels amplify the upstream propagation of commodity price changes, by increasing the demand for noncommodity inputs, and, at the same time, they mitigate the downstream cost channel by allowing firms to use relatively cheaper primary inputs in production.
    Date: 2023–04
  9. By: Felipe Beltrán
    Abstract: This paper analyzes how monetary policy surprises in the U.S. affects emerging market economies (EMs) focusing on the transmission through the real exchange rate (RER) and country spreads (EMBI). To do so, we disentangle U.S. interest rate movements between both a pure monetary policy shock and an information shock: while the former is constructed based on high-frequency movements of the interest rate around FOMC announcements, the latter builds from major macroeconomic releases. We quantify their relative impacts through an SVAR model with external instruments. The results suggest that a pure monetary policy shock produces a persistent appreciation of the RER in the U.S. coupled with an increase of the EMBI that induces contractionary effects in the real sector of EMs. In contrast, an information shock does not necessarily produce such contractionary effects in EMs. These results contribute to the literature in identifying the specific drivers behind each movement in Fed announcements and its transmission to EMs.
    Date: 2023–04
  10. By: Christian Dustmann; Hyejin Ku; Tanya Surovtseva
    Abstract: We relate origin-destination real price differences to immigrants’ reservation wages and their career trajectories, exploiting administrative data from Germany and the 2004 enlargement of the European Union. We find that immigrants who enter Germany when a unit of earnings from Germany allows for larger consumption at home settle for lower entry wages, but subsequently catch up to those arriving with less favourable exchange rates, through transition to better-paying occupations and firms. Similar patterns hold in the US data. Our analysis offers one explanation for the widespread phenomenon of immigrants’ downgrading, with new implications for immigrant cohort effects and assimilation profiles.
    Keywords: real exchange rate, reservation wage, immigrant downgrading, earnings assimilation
    JEL: J24 J31 J61 O15 O24
    Date: 2023
  11. By: Lee E. Ohanian; Paulina Restrepo-Echavarria; Diana Van Patten; Mark L.J. Wright
    Abstract: This paper quantifies the positive and normative impact of Bretton Woods capital controls on global and regional economic activity. A three-region DSGE capital flows accounting framework consisting of the U.S., Western Europe, and the Rest of the World (ROW) is developed to quantify capital controls and evaluate their impact on the world economy. We find these controls had large effects. Counterfactual analysis show world output would have been 0:5 percent higher had there been perfect capital mobility, with substantial capital flowing from the ROW to the U.S. Bretton Woods capital controls raised welfare substantially in the ROW, but at the expense of much lower U.S. welfare. Given the U.S.’s goal of keeping capital within these countries to preserve their stability during this period, we interpret lower U.S. welfare due to Bretton Woods as the implicit value the U.S. placed on preserving geopolitical stability in ally countries during the Cold War.
    JEL: E0 F30 P0
    Date: 2023–08
  12. By: Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich
    Abstract: How does a monetary union alter the impact of business cycle shocks at the household level? We develop a Heterogeneous Agent New Keynesian model of two countries (HANK2) and show in closed form that a monetary union shifts the adjustment to a shock horizontally—across countries—within the brackets of the union-wide wealth distribution rather than vertically—that is, across the brackets of the union-wide wealth distribution. Calibrating the model to the euro area reveals that a monetary union alters the impact of shocks most strongly in the tails of the wealth distribution but leaves the middle class almost unaffected.
    Keywords: HANK2, OCA theory, Two-country model, monetary union, spillovers, monetary policy, heterogeneity, inequality, households
    JEL: F45 E52 D31
    Date: 2023
  13. By: Alejandro Jara; Marco Piña
    Abstract: In this paper, we study the effectiveness of FX interventions in Chile since adopting a fully flexible exchange rate regime in the late 1990s. In particular, we ask whether these interventions have dumped excess exchange rate volatility and reduced its probability of being in a high volatility state. To do so, we rely on a high-frequency GARCH(1, 1) volatility model with Markov-Switching regimes (Haas et al., 2004) and evaluate the effectiveness of FX interventions within a Local Projection setting (Jordà, 2005). We show that FX interventions in Chile tend to occur during high exchange rate volatility periods, which correlate with domestic and foreign financial factors. Moreover, we show that the FX intervention that started by the end of 2019–the latest intervention included in our study–effectively reduced the exchange rate volatility and the probability of being at a high volatility state.
    Date: 2022–09

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