nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2023‒11‒06
eleven papers chosen by
Martin Berka, Massey University

  1. Monetary policy shocks and exchange rate dynamics in small open economies By Madison Terrell; Qazi Haque; Jamie L. Cross; Firmin Doko Tchatoka
  2. The accumulation of income balance and its relationship with real exchange rate: Evidence from Japan By Takahiro Hattori; Ayako Tomita; Kohei Asao
  3. Chronicle of a Dollarization Foretold: Inflation and Exchange Rates Dynamics By Tomás E. Caravello; Pedro Martinez-Bruera; Iván Werning
  4. Negative Externalities of Financial Dollarization By Valida Pantsulaia; Ana Jangveladze; Shalva Mkhatrishvili
  5. The Impact of Dollarisation on Economic Growth, Investment, and Trade By Fisnik Bajrami
  6. Liquidity premia: the PPP puzzle's missing piece? By Olk, Christopher
  7. Sudden Stops in Latin America and the Caribbean during COVID-19 By Cavallo, Eduardo A.; González Jaramillo, María José; Hernández, Juan; Powell, Andrew
  8. Exchange rate shocks and foreign trade of Russian manufacturers By Kuznetsov, Dmitry (Кузнецов, Дмитрий)
  9. Changing patterns of risk-sharing channels in the United States and the euro area By Cimadomo, Jacopo; Giuliodori, Massimo; Lengyel, Andras; Mumtaz, Haroon
  10. Bridging the Gap: Mobilization of Multilateral Development Banks in Infrastructure By Avellán, Leopoldo; Galindo, Arturo; Lotti, Giulia; Rodríguez Bonilla, Juan Pablo
  11. Price setting on the two sides of the Atlantic: evidence from supermarket-scanner data By Karadi, Peter; Amann, Juergen; Bachiller, Javier Sánchez; Seiler, Pascal; Wursten, Jesse

  1. By: Madison Terrell; Qazi Haque; Jamie L. Cross; Firmin Doko Tchatoka
    Abstract: This paper investigates the relationship between monetary policy shocks and real exchange rates in several small open economies. To that end, we develop a novel identification strategy for time-varying structural vector autoregressions with stochastic volatility. Our approach combines short-run and long-run restrictions to preserve the contemporaneous interaction between the interest rate and the exchange rate. Using this framework, we find that the volatility of monetary policy shocks has substantially decreased in all countries. This leads to a considerable reduction in the significance of policy shocks in explaining exchange rate and macroeconomic fluctuations since the 1990s. However, we find that the dynamic effects of the policy shocks have remained stable over time. Finally, while we do identify violations of uncovered interest parity (UIP) in some countries, we find no evidence of the ‘exchange rate puzzle’ or the ‘delayed overshooting puzzle’ in any country.
    Date: 2023–06
  2. By: Takahiro Hattori (Project Assistant Professor, University of Tokyo and Visiting Scholar, Policy Research Institute, Ministry of Finance, Japan); Ayako Tomita (Former Senior Economist, Policy Research Institute, Ministry of Finance, Japan); Kohei Asao (Visiting Scholar, Policy Research Institute, Ministry of Finance, Japan)
    Abstract: Recently, income balance has been gaining importance in current accounts among many countries. We assess the effect of the real effective exchange rate (REER) on income balance using Japan-specific data and multi-country data. Our results show that the REER does not affect income balance, both on gross and net basis. We also show that accumulation of net foreign assets, driven by the glocalization h of Japanese manufacturing firms, has fostered the income balance surplus in Japan.
    Keywords: Current account; Income account; International investment position; Exchange rates; Japan
    JEL: F1 F32
    Date: 2023–01
  3. By: Tomás E. Caravello; Pedro Martinez-Bruera; Iván Werning
    Abstract: We study the effects of an anticipated dollarization, announced today but planned to be implemented at some future date, in a simple open-economy model. Motivated by the profile of countries considering dollarization we make the following assumptions. First, the government faces a scarcity of dollars to pledge for the future conversion of domestic currency. Second, without dollarization monetary policy finances a deficit via seignorage. We focus on the pre-dollarization period. Our results are as follows. First, the announcement leads to a discrete devaluation on impact. Second, after this jump the devaluation rate also rises relative to the no dollarization benchmark. Finally, the devaluation and inflation rate may rises over time.
    JEL: E0 F3 F31 F33
    Date: 2023–10
  4. By: Valida Pantsulaia (Financial Stability Analysis and Macro-financial Modeling Division, National Bank of Georgia); Ana Jangveladze (Financial Stability Analysis and Macro-financial Modeling Division, National Bank of Georgia); Shalva Mkhatrishvili (Head of Macroeconomics and Statistics Department, National Bank of Georgia)
    Abstract: Dollarization (usage of a foreign currency in place of a domestic one) is a widely observed phenomenon that historically emerged as a result of extended macro-financial instability and extreme price and nominal exchange rate fluctuations. Complete loss of public confidence in a local currency pushed lenders and borrowers to seek more stable foreign currencies like the US dollar and euro. What is more puzzling though is that in many countries dollarization remained at an elevated level even after taking care of its root cause (i.e. after achieving price stability). There have been several explanations of this phenomenon (the so-called dollarization hysteresis). In this short paper, we propose additional explanations in the form of several dollarization-induced negative externalities, including an amplification of credit procyclicality and exchange rate pass-through or a worsening of credit ratings of dollarized economies. We also offer some back-of-the-envelope calculations showing that these externalities could be economically significant (about 1 pp impact on real GDP growth per year) for a small and highly dollarized country like Georgia. This type of market failures underline the importance of prudential policies that internalize negative externalities and, hence, level the playing field for the local currency.
    Keywords: Financial dollarization; Negative externality
    JEL: E44 E58 F34
    Date: 2023–04
  5. By: Fisnik Bajrami (Charles University, Institute of Economic Studies, Faculty of Social Sciences, Prague, Czech Republic)
    Abstract: Dollarisation has been extensively debated and is often promoted as a viable monetary and exchange rate policy alternative for emerging economies. While most arguments for and against dollarisation are grounded in theory, there is a recognized scarcity of empirical evidence on the topic. This study evaluates over two decades of dollarisation experience in emerging economies. Our results suggest that dollarisation is associated with similar economic growth levels as other exchange rate regimes. However, it comes with the cost of more negative current account balance growth rates and heightened growth volatility, especially in the past decade. Nevertheless, dollarised countries benefit from higher levels of investment and trade. Contrary to a significant part of the existing literature, our findings challenge the perceived benefits of dollarisation in terms of economic growth. Additionally, we demonstrate that dollarised countries differ in various macroeconomic indicators when compared to individual exchange rate regimes, even against other fixed exchange rate regimes - which are often assumed to be homogenous.
    Keywords: dollarisation, GDP growth, growth volatility, trade, investment, exchange rate, empirical evaluation
    JEL: E42 E52 F31 F45
    Date: 2023–09
  6. By: Olk, Christopher
    Abstract: The purchasing power of a given currency varies across countries. Countries’ price levels, measured in USD, diverge significantly. The theoretical literature in Minsky’s tradition explains divergences in the other prices of money (the exchange rate, the interest rate and par) with reference to liquidity premia and monetary hierarchy. This argument has not been connected to the price level, which can be defined as the relationship between exchange rates and purchasing power parity rates. This essay presents a hypothesis for that missing connection: Different currencies with different degrees of liquidity are used as a store of value and international means of payment to different degrees. The resulting divergence between the demand for money in the foreign exchange market and the demand for money in the market for commodities moves the market exchange rate away from a level that would equalize purchasing power rates across countries. Based on a review of the Post-Keynesian literature on the links between interest rates and exchange rates, I develop an empirical measure for currencies’ liquidity premia in the foreign exchange market. I use it to empirically test my hypothesis, which I formalize as a simple regression model. My results suggest that the hypothesized effect is small, but significant. This finding points to a causal link between currency hierarchy and ecologically unequal exchange.
    Date: 2023–10–04
  7. By: Cavallo, Eduardo A.; González Jaramillo, María José; Hernández, Juan; Powell, Andrew
    Abstract: External capital accounts suffered during the COVID-19 crisis in Latin America and the Caribbean, but perhaps surprisingly the impacts were less severe than in previous crises. Gross capital inflows offset the outflows of residents, in sharp contrast to the global financial crisis of 2008/09 when residents repatriation of capital countered withdrawals from non-residents. In general, the result was relatively stable net capital inflows and modest current account adjustments. Still, some countries that had seen inflows fall prior to the crisis, reflecting weaker fundamentals, suffered Sudden Stops in net capital flows. Given accommodating global monetary policy, sound fundamentals ensured access to liquid international capital markets, reducing the impacts of Sudden Stops during the pandemic.
    Keywords: External account
    JEL: F30 F32 F40
    Date: 2022–02
  8. By: Kuznetsov, Dmitry (Кузнецов, Дмитрий) (The Russian Presidential Academy of National Economy and Public Administration)
    Abstract: The goal of this paper is to empirically assess the impact of exchange rate shocks on prices and quantities of Russian exports and imports. The relevance of the work is dictated by the sanctions imposed on Russia in 2022, which can complicate international payments in the dominant currencies in international trade, and by subsequent economic policy measures aimed at reducing the role of the dollar and the euro in Russian foreign trade. Modern studies consider the currency of the contract as one of the most important factors influencing the magnitude of the exchange rate pass-through effect on prices and quantities of exports and imports. The main assumption of such models – short-term price rigidity in terms of contract currency – matches the behavior of real data. These models also predict the dependence of the pass-through effect on the firm's share of the product-country market. In this paper, based on econometric analysis of detailed data from customs statistics of the Russian Federation, it is shown that the key to the dynamics of exports and imports is not bilateral exporter-importer rates, but exporter and importer rates to the dominant currencies in world trade (US dollar and euro), and prices are rigid in the contract currency. Because of the asymmetry in the response between importer currency shocks and exporter currency shocks to the contract currency, there is a statistically and economically significant effect of a uniform appreciation of the dominant currency. This means that Russia's foreign trade prices and quantities respond to the dynamics of the contract currency even if neither the exporter nor the importer is a country issuing the contract currency. This response persists in the long run, and therefore cannot be explained solely by short-term price rigidity. The pass-through effect depends on the value of exports and imports, which is consistent with the predictions of the theory. The main conclusion of the paper is that diversification of the currency structure of foreign trade contract payments will contribute to the sustainability of Russian foreign trade, but the question of the costs of such a transition remains beyond the scope of this study.
    Keywords: exports, imports, exchange rate, dominant currencies, contract currency, microdata
    JEL: L23 F14
    Date: 2022–11–10
  9. By: Cimadomo, Jacopo; Giuliodori, Massimo; Lengyel, Andras; Mumtaz, Haroon
    Abstract: In this paper, we assess how risk-sharing channels have evolved over time in the United States and the Euro Area, and whether they have operated as ‘complements’ or ‘substitutes’. In particular, we focus on the capital channel (income from cross-border ownership of productive assets), the credit channel (interstate or cross-country bank lending), and the fiscal channel (federal or international fiscal transfers). We offer three main contributions. First, we propose a time-varying parameter panel VAR model, with stochastic volatility, which allows us to formally quantify time variation in risk-sharing channels. Second, we develop a new test of the complementarity vs. substitutability hypothesis of the three risk-sharing channels, based on the correlation between the impulse responses of these channels to idiosyncratic output shocks. Third, for the United States, we explain time variation in the risk-sharing channels based on some key macroeconomic and financial variables. JEL Classification: C11, C33, E21, E32
    Keywords: complementarity, risk-sharing channels, substitutability, time variation
    Date: 2023–10
  10. By: Avellán, Leopoldo; Galindo, Arturo; Lotti, Giulia; Rodríguez Bonilla, Juan Pablo
    Abstract: We explore how Multilateral Development Banks (MDBs) can help to fill a large infrastructure financing gap in developing countries by indirectly mobilizing resources from other entities. The analysis focuses on more than 6, 500 transactions in 2005-2020 to developing and emerging markets from the Infrastructure Journal database. Using granular data, we analyze the dynamics of flows from different actors to infrastructure at the country-subsector level, and control for a wide range of fixed effects. MDB lending significantly increases the inflows from other sources. Cross-border and domestic resources are mobilized from both the public and the private sectors. Effects exhibit country heterogeneity. Mobilization occurs in countries of all income levels, though it is stronger in low and lower-middle income countries. In countries that use capital controls frequently mobilization effects are undermined. When the global financial crisis of 2008 hit, no difference in mobilization effects was found, unlike the COVID-19 pandemic when mobilization effects were weakened. The findings survive a long battery of robustness checks, and no evidence of anticipation effects is found.
    Keywords: Catalytic finance;Infrastructure
    JEL: F21 F34 G15 H81 O19
    Date: 2022–02
  11. By: Karadi, Peter; Amann, Juergen; Bachiller, Javier Sánchez; Seiler, Pascal; Wursten, Jesse
    Abstract: We compare supermarket price setting in the US and the euro area and assess its impact on food inflation. We introduce a novel scanner dataset of Germany, the Netherlands, France, and Italy (EA4) and contrast it with an equivalent dataset from the US. We find that both higher frequency and stronger state dependence of price changes contribute to higher flexibility of supermarket inflation in the US relative to the euro area. We argue that the driving force behind both factors is higher cross-sectional volatility in the US. Larger product-level fluctuations both force retailers to adjust prices more frequently and increase price misalignments, which increase the selection of large price changes. [...] JEL Classification: E31, E32, E52, F44
    Keywords: COVID-19, duration hazard, food inflation, generalized hazard, state-dependent price setting, US and euro-area comparison
    Date: 2023–10

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