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on Open Economy Macroeconomics |
| By: | Oleg Itskhoki; Dmitry Mukhin |
| Abstract: | We use a general open-economy wedge-accounting framework to characterize the set of shocks that can account for major exchange rate puzzles. Focusing on a near-autarky behavior of the economy, we show analytically that all standard macroeconomic shocks — including productivity, monetary, government spending, and markup shocks — are inconsistent with the broad properties of the macro exchange rate disconnect. News shocks about future macroeconomic fundamentals can generate plausible exchange rate properties. However, they show up prominently in contemporaneous asset prices, which violates the finance exchange rate disconnect. International shocks to trade costs, terms of trade and import demand, while potentially consistent with disconnect, do not robustly generate the empirical Backus-Smith, UIP and terms-of-trade properties. In contrast, the observed exchange rate behavior is consistent with risk-sharing (financial) shocks that arise from shifts in demand of foreign investors for home-currency assets, or vice versa. |
| JEL: | F31 F41 F44 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:32008&r=opm |
| By: | Oleg Itskhoki; Dmitry Mukhin |
| Abstract: | We develop a general policy analysis framework for an open economy that features nominal rigidities and financial frictions giving rise to endogenous PPP and UIP deviations. The efficient allocation can be implemented with monetary policy closing the output gap and FX interventions eliminating UIP deviations. When the “natural” real exchange rate is stable, both goals can be achieved solely by monetary policy that fixes the exchange rate — an open-economy divine coincidence. More generally, optimal policy features a managed float/crawling peg complemented with FX forward guidance and macroprudential accumulation of FX reserves, in line with the “fear of floating” observed in the data. Capital controls are not necessary to achieve the frictionless allocation, but they facilitate the extraction of rents in the currency market. Constrained unilateral policies are not optimal from the global perspective, and international cooperation features a complementary use of FX interventions across countries. |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10837&r=opm |
| By: | Ashima Goyal (Indira Gandhi Institute of Development Research) |
| Abstract: | While the basic exchange rate regime has stayed the same since the liberalizing reforms of the nineties, its implementation has varied over the years. The paper assesses the evolution of India's nominal exchange rate regime and its suitability under inflation targeting. It also examines the evolving impact on trade, inflation, on currency and financial markets, country risk premium and the cost of borrowing. The analysis suggests a flexible exchange rate with intervention to prevent excess volatility as well as misalignment from competitive real exchange rates, while allowing some volatility to aid price discovery in foreign exchange markets, would work best in inflation targeting emerging markets. |
| Keywords: | India, exchange rate regime, capital flows, inflation targeting |
| JEL: | F41 F31 E52 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:ind:igiwpp:2023-015&r=opm |
| By: | Marcin Kolasa (SGH Warsaw School of Economics; International Monetary Fund); Grzegorz Wesołowski (University of Warsaw, Faculty of Economic Sciences) |
| Abstract: | We investigate the domestic and international consequences of three types of Fed monetary policy instruments: conventional interest rate (IR), forward guidance (FG) and large scale asset purchases (LSAP). We document empirically that they can be seen as close substitutes when used to meet macroeconomic stabilization objectives in the US, but have markedly different spillovers to other countries. This is because each of the three monetary policy instruments transmits differently to asset prices and exchange rates of small open economies. The LSAP by the Fed lowers the term premia both in the US and in other countries, and results in bigger exchange rate adjustments compared to conventional policy. Importantly for international spillovers, LSAP is typically associated with a more accommodative reaction of other countries' monetary authorities, especially in emerging market economies. We demonstrate how these findings can be rationalized within a stylized dynamic theoretical framework featuring a simple form of international bond market segmentation. |
| Keywords: | monetary policy, forward guidance, quantitative easing, international spillovers |
| JEL: | E44 E52 F41 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2024-01&r=opm |
| By: | Ho Sy-Hoa (VNU - Vietnam National University [Hanoï]); Idir Hafrad; Viet-Dung Tran |
| Abstract: | In this paper, we study the measure of exchange rate pass-through on consumer price for Vietnam using the Nonlinear Autoregressive Dynamic Lag from 2000Q4 to 2018Q2. Our findings can be summarized as follows: (i) we demonstrate the existence of the asymmetric effect of the exchange rate to domestic price in both short run and long run; (ii) the exchange rate pass-through is high; (iii) the impact of exchange rate depreciation on domestic price is stronger than appreciation; (iv) the exchange rate pass-through is higher in the long run than in the short run; and (v) foreign competitor price plays an important role in domestic price movement. |
| Keywords: | Exchange rate pass-through, Asymmetric Exchange Rate, ARDL models, NARDL models, Vietnam |
| Date: | 2022–08–26 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-04313127&r=opm |
| By: | Ashima Goyal (Indira Gandhi Institute of Development Research) |
| Abstract: | Stylized business cycle facts for South Asia are similar and differ from other regions. They show the dominance of supply shocks, often amplified by macroeconomic policies and procyclical current accounts. Interest and exchange rate volatility rose initially on liberalization, but fell as markets deepened. A gradual middling through approach to openness and market development with flexible exchange rates worked well initially. But a combination of excessive government/foreign borrowing and inadequate reserves made it difficult for smaller countries to withstand the multiple external shocks that began with the global pandemic. Domestic ability to smooth shocks and global safety nets are both essential. India benefitted from growing diversity, evolution to countercyclical macroeconomic policy better suited to structure, a good coordination of monetary and fiscal policies with balance between demand stimulus and continuing supply-side reforms. Reserves and capital flow management policies helped insulate from global shocks. Intervention damped excess exchange rate volatility reducing risk premiums. |
| Keywords: | South Asia, supply shocks, flexible exchange rates, diversity, smoothing |
| JEL: | E3 E63 O11 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:ind:igiwpp:2023-013&r=opm |
| By: | Moro, Alessandro; Zaghini, Andrea |
| Abstract: | We propose a model with mean-variance foreign investors who exhibit a convex disutility associated to brown bond holdings. The model predicts that bond green premia should be smaller in economies with a closer financial account and highly volatile exchange rates. This happens because foreign intermediaries invest relatively less in such economies, and this lowers the marginal disutility of investing in polluting activities. We find strong empirical evidence in favor of this hypothesis using a global bond market dataset. Exchange rate volatility and financial account openness are thus able to explain the higher financing costs of green projects in emerging markets relative to advanced economies, especially when green bonds are denominated in local currency: a disadvantage that we can call the "green sin" of emerging economies. |
| Keywords: | Green bonds, Greenium, Exchange rate volatility, Financial openness, Original sin |
| JEL: | F21 F30 F31 G11 G12 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfswop:280929&r=opm |
| By: | Javier Bianchi; Louphou Coulibaly |
| Abstract: | Financial integration generates macroeconomic spillovers that may require international monetary policy coordination. We show that individual central banks may set nominal interest rates too low or too high relative to the cooperative outcome. We identify three sufficient statistics that determine whether the Nash equilibrium exhibits under-tightening or over-tightening: the output gap, sectoral differences in labor intensity, and the trade balance response to changes in nominal rates. Independently of the shocks hitting the economy, we find that under-tightening is possible during economic expansions or contractions. For large shocks, the gains from coordination can be substantial. |
| JEL: | E21 E23 E43 E44 E52 E62 F32 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:32009&r=opm |
| By: | Jing Lian Suah |
| Abstract: | The unemployment rates (u-rates) of 19 economies (10 advanced and 9 emerging) demonstrate properties consistent with the plucking model. That the amplitude of expansions and subsequent contractions are unrelated, but that the deeper the contraction, the greater the subsequent expansion. The plucking model, which suggests that the u-rate hovers at or above a theoretical floor, has implications for the unemployment-inflation trade-off as well as shock propagation mechanisms, including the effects of policy shocks. This paper does three things. First, building on existing empirics, it demonstrates a straightforward way to estimate the u-rate floor based on identified peaks in the business cycle and interpolation methods. Second, it analyses the empirical relationship between the u-rate and core inflation, and the effect of a binding u-rate floor on this. Third, it analyses the threshold effects of the u-rate gap on the propagation of macroeconomic shocks, with special attention given to interest rates, using a threshold panel local projections model. The paper finds that: (i) the u-rate hovers at or above the floor and converges towards the floor after each downturn; (ii) the relationship between core inflation and the u-rate weakens when the u-rate is further from the floor; and (iii) the propagation of interest rate, price and output shocks display threshold effects, while exchange rate and debt shocks do not. |
| Keywords: | plucking model, unemployment rate, nonlinear Phillips curve, threshold effects |
| JEL: | E24 E31 E32 E52 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1159&r=opm |
| By: | Awdeh, Ali |
| Abstract: | The Arab region contains several countries that suffer high levels of indebtedness, resulting from decades of weak (if not failing) macroeconomic, fiscal, monetary and trade policies. This indebtedness was further exacerbated by political and security unrest, and lastly by the repercussions of Covid-19 crisis. By end 2019, i.e. before the eruption of Covid-19 pandemic, the government debt-to-GDP ratio reached 200 percent in Sudan, which ranked the country third globally in this indicator. Two other Arab countries recorded government debt-to-GDP ratio above 100 percent, namely Lebanon and Bahrain. Several other Arab countries also record considerably high debt ratios, in particular Yemen, Egypt, Jordan, Morocco, and Tunisia. Among other factors, the persistent budget deficit, which is determined by the fiscal policies, is in turn a major determinant of the mounting debt in the Arab region. This high indebtedness resulted in high debt service burden in the Arab countries, which is financed via increased borrowing, higher taxes, and leading to lower government spending, thus imposing liquidity challenges and limits fiscal space which could have otherwise been invested in essential public services, and in financing the Sustainable Development Goals in the Arab countries. Several Arab countries rely heavily on banks to meet their borrowing needs and banks across the Arab region invest considerably in the government securities and dedicate large sums of their resources to finance government budget. The end-2022 data show that approximately 10 percent of the consolidated assets of the Arab banking sector is invested in government debt. The fiscal policies in the Arab countries are indeed responsible for the level of debt held by banks. In particular, budget balance, government debt levels, and interest paid on government debt, are all factors that determine the investment of banks in the domestic sovereign debt. The interconnectedness between fiscal position and bank lending to the government results in the sovereign-bank nexus phenomenon in the Arab region, which poses risks for fiscal sustainability and financial stability. Moreover, the high levels of bank holdings of government debt in several Arab countries may result in two repercussions: firstly, a high exposure of banks to sovereign risk and ratings downgrade following sovereign downgrade; and secondly, a crowding out effects for private sector and depriving businesses from the needed funding. To avoid such scenarios, proper macroprudential and microprudential framework aiming to mitigate the sovereign-bank nexus must be put in place. |
| Keywords: | Sovereign Debt; Financial Sector Stability. |
| JEL: | E58 G21 H6 H63 H68 |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119425&r=opm |
| By: | Bratanova, Alexandra; Cameron, Alicia; Thavat, Maylee; Fyfield, Amelia; Hajkowicz, Stefan |
| Abstract: | We demonstrate a use case of Multiple Criteria Decision Analysis (MCDA) in collaboration with industry stakeholders in forums as a way in which governments can undertake a 'soft' industry policy in international trade given the complex and changing global environment, and facilitate, rather than steer, the prioritisation of sector-specific facilitation. International trade is increasingly a balancing act with multiple competing objectives including security with open competition, economic growth with inclusion, and social and environmental protection. Post-pandemic, government efforts to stimulate export-led recovery and refine trade priorities within the rule bound by members of the World Trade Organisation are set to ramp up. To assist governments, guide their limited resources we advocate for the use of MCDA to assist with greater trade policy transparency and enable strategic decision making between multiple stakeholders While MCDA is often used in areas such as healthcare and environmental resourcing, it is not widely used in international trade. We demonstrate the use of MCDA to determine potential trade priorities in the healthcare sector under the Indonesia-Australia Comprehensive Economic Partnership Agreement. MCDA was applied in real-time during online workshops hosted by Australia's Department of Foreign Affairs and Trade with 38 industry stakeholders. The pilot determined clear priorities for trade promotion in a transparent process. These are discussed along with the potential to further develop and apply MCDA and the limitations of the analysis for effective use in international trade. |
| Keywords: | multiple criteria decision analysis; international trade; Australia; Indonesia; healthcare |
| JEL: | F1 F14 F15 F63 I10 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119407&r=opm |