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on Open Economy Macroeconomics |
| By: | Rong Li (School of Finance, Renmin University of China); Dongzhou Mei (School of International Economics and Trade, Central University of Finance and Economics); Bing Tong (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan) |
| Abstract: | We introduce gradual adjustment costs for both domestic and foreign bonds in a New Keynesian small open economy model, unifying the theories of foreign exchange intervention and the liquidity effect. With gradual adjustment for foreign bonds, interest rate differentials lead to persistent capital flows. With adjustment costs for domestic bonds, open market operations generate a stronger liquidity effect, which has real effects in an environment with costly intermediation. Furthermore, under gradual portfolio adjustment, nominal interest rates change temporarily in response to asset transactions, so that the model can restore equilibrium when the steady-state asset ratios have changed. |
| Keywords: | Gradual portfolio adjustment, Foreign Exchange intervention, Open market operations, Capital flows, Liquidity effect, Small open economy, New Keynesian model |
| JEL: | E44 E58 E63 F31 F32 F41 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:fds:dpaper:202406&r=opm |
| By: | Beckmann, Joscha; Czudaj, Robert L. |
| Abstract: | This paper provides a new perspective on the expectations building mechanism in foreign exchange markets. We analyze the role of expectations regarding macroeconomic fundamentals for expected exchange rate changes. In doing so, we assess real-time survey data for 29 economies from 2002 to 2023 and consider expectations regarding GDP growth, inflation, interest rates, and current accounts. Our empirical findings show that fundamentals expectations are more important over longer horizons compared to shorter horizons. We find that an expected increase in GDP growth relative to the US leads to an expected appreciation of the domestic currency while higher relative inflation expectations lead to an expected depreciation, a finding consistent with purchasing power parity. Our results also indicate that the expectation building process differs systematically across pessimistic and optimistic forecasts with the former paying more attention to fundamentals expectations. Finally, we also observe that fundamentals expectations have some explanatory power for forecast errors, especially for longer horizons. |
| Keywords: | Exchange rates, Expectations, Forecast errors, Fundamentals, Survey data |
| JEL: | F31 F37 G17 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:120648&r=opm |
| By: | Matías Moretti (University of Rochester); Lorenzo Pandolfi (Università di Napoli Federico II and CSEF); Sergio L. Schmukler (World Bank); Germán Villegas Bauer (International Monetary Fund); Tomás Williams (George Washington University) |
| Abstract: | We present evidence of inelastic demand in the market for risky sovereign bonds and examine its interplay with government policies. Our methodology combines bond-level evidence with a structural model featuring endogenous bond issuances and default risk. Empirically, we exploit monthly changes in the composition of a major bond index to identify flow shocks that shift the available bond supply and are unrelated to country fundamentals. We find that a 1 percentage point reduction in the available supply increases bond prices by 33 basis points. Although exogenous, these shocks might influence government policies and expected bond payoffs. We identify a structural demand elasticity by feeding the estimated price reactions into a sovereign debt model that allows us to isolate endogenous government responses. We find that these responses account for a third of the estimated price reactions. By penalizing additional borrowing, inelastic demand acts as a commitment device that reduces default risk. |
| Keywords: | emerging markets bond index, inelastic financial markets, institutional investors, international capital markets, small open economies, sovereign debt |
| JEL: | F34 F41 G11 G15 |
| Date: | 2024–03–26 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:713&r=opm |
| By: | Antonio Afonso; Valérie Mignon; Jamel Saadaoui |
| Abstract: | We assess the impact of China’s bilateral political relations with three main trading partners—the US, Germany, and the UK—on current account balances and exchange rates, over the 1960Q1- 2022Q4 period. Relying on the lag-augmented VAR approach with time-varying Granger causality tests, we find that political relationships with China strongly matter in explaining the dynamics of current accounts and exchange rates, supporting the “trade follows the flag” view. Such relationships cause the evolution of the exchange rate (except in the UK) and the current account; these causal links being time-varying for the US and the UK and robust over the entire period for Germany. These findings suggest that policymakers should account for bilateral political relationships to understand the global macroeconomic consequences of political tensions. |
| Keywords: | Political relations; time-varying causality; lag-augmented vector autoregression; China. |
| JEL: | C22 F51 Q41 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2024-17&r=opm |
| By: | Amador, João; Mehl, Arnaud; Schmitz, Martin; Garcia, Joana |
| Abstract: | We analyze, for the first time, how firms choose the currency in which they price transactions in international trade of services and investigate, using direct evidence, whether the US dollar (USD) plays a dominant role in services trade. Drawing on a new granular dataset on extra-European Union exports of Portuguese firms broken down by currency, we show that currency choices in services trade are active firm-level decisions. Firms that are larger and rely more on inputs priced in foreign currencies are less likely to use the domestic currency to export services. Importantly, we show that the USD has a dominant role as a vehicle currency in trade of services – but to a lesser extent than in trade of goods – and that this is not just due to differences in the geography of trade. An external validity test based on macro data available for Portugal and six other European countries confirms this finding. In line with predictions from recent theoretical models, our results are consistent with the lower prevalence of USD in services trade arising from a lower openness of services markets and a stronger reliance of services on domestic inputs. JEL Classification: F14, F31, F41 |
| Keywords: | dominant currency paradigm, international trade, services |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242932&r=opm |
| By: | Leslie Sheng Shen; Tony Zhang |
| Abstract: | We develop a structural model of the global banking network and analyze its role in facilitating risk sharing and amplifying shocks across countries and over time. Using bilateral international lending data, we uncover significant heterogeneity in the willingness and capacity of banks to provide cross‐border interbank and corporate loans. This heterogeneity explains variation in risk sharing and amplification across countries. Moreover, we show that cross‐border loan supply has become less elastic overtime, resulting in a decline in risk sharing. While shock amplification has also declined on average, some countries may experience greater amplification in response to foreign funding shocks. |
| Keywords: | global economy; risk sharing; shock propagation; capital flows |
| JEL: | F34 G21 |
| Date: | 2024–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbwp:98178&r=opm |
| By: | Elizabeth Bucacos (Banco Central del Uruguay); Javier García-Cicco (Universidad de San Andrés (Argentina)); Miguel Mello (Banco Central del Uruguay) |
| Abstract: | We study the effects of exchange rate interventions in Uruguay on relevant macroeconomic variables such as the exchange rate, inflation, activity, and interest rates. Instead of attempting to identify exogenous variations in the intervention policy (a frequent strategy in the related literature, that raises many endogeneity concerns), we investigate the effect of interventions in dampening the impact of external shocks that are relevant determinants of exchange rate movements. This estimation is carried out through a novel econometric tool called constrained impulse response functions, which allows to construct counterfactual scenarios that are locally valid (i.e. marginal effects around average responses). Moreover, we exploit a detailed data on Central Bank’s operations in the exchange-rate market, leading to a clean measure of interventions that is not contaminated from other factors affecting the foreign reserves position (thus improving over most related studies). We find that interventions can help dampen exchange rate effects, and may have non-trivial effects on inflation as well, but generally the consequences in terms of activity are limited. Crucially, these effects depend on the type and sign of the external shock under consideration. |
| Keywords: | Exchange rate intervention, flotation, currency, monetary policy, local projections |
| JEL: | F31 E58 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:bku:doctra:2023008&r=opm |
| By: | Jean-Guillaume Sahuc; Grégory Levieuge; José Garcia-Revelo |
| Abstract: | The European Central Bank and the Federal Reserve introduced new policy instruments and made changes to their operational frameworks to address the global financial crisis (2008) and the Covid-19 pandemic (2020). We study the macroeconomic effects of these monetary policy evolutions on both sides of the Atlantic Ocean by developing and estimating a tractable two-country dynamic stochastic general equilibrium model. We show that the euro area and the United States faced shocks of different natures, explaining some asynchronous monetary policy measures between 2008 and 2023. However, counterfactual exercises highlight that all conventional and unconventional policies implemented since 2008 have appropriately (i) supported economic growth and (ii) maintained inflation on track in both areas. The exception is the delayed reaction to the inflationary surge during 2021-2022. Furthermore, exchange rate shocks played a significant role in shaping the overall monetary conditions of the two economies. |
| Keywords: | Monetary policy, real exchange rate dynamics, two-country DSGE model, Bayesian estimation, counterfactual exercises |
| JEL: | E32 E52 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2024-13&r=opm |
| By: | Masashige Hamano (Waseda University); Yuki Murakami (Waseda University) |
| Abstract: | This paper investigates the stabilization role of government spending in a collateral constrained small open economy. The economy is characterized by inefficiencies in borrowing decisions, resulting from pecuniary externalities and the amplification mechanism of the debt-deflation spiral. In this context, government spending serves to maintain financial stability, extending beyond the efficient provision of public goods. When the economy borrows up to its limit, the optimal response is fiscal stimulus, which mitigates the amplification of the debt-deflation mechanism. The optimal time-consistent policy prevents recessionary shocks from leading to a financial crisis accompanied by a drastic reversal of the current account. We show that an implementable government spending policy, which maintains a constant ratio to GDP, approximates the optimal policy and achieves a second-best outcome. |
| Keywords: | Small open economy; financial crises; optimal government spending |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2401&r=opm |
| By: | Timothy Meyer |
| Abstract: | U.S. equity outperformance and sustained dollar appreciation have led to large valuation gains for the rest of the world on the U.S. external position. I construct their global distribution, carefully accounting for the role of tax havens. Valuation gains are concentrated and large in developed countries, while developing countries have been mostly bypassed. To assess the welfare implications of these capital gains, I adopt a sufficient statistics approach. In contrast to the large wealth changes, most countries so far did not benefit much in welfare terms. This is because they did not rebalance their portfolios and realize their gains, while they were further hurt by rising import prices from the strong dollar. |
| Keywords: | Foreign Assets, Global Imbalances, Valuation Effects |
| JEL: | F21 F32 F40 G15 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_534&r=opm |
| By: | Corentin Roussel |
| Abstract: | Output floor has emerged as a possibly important tool to ensure financial stability within the banking system. This paper proposes to assess the quantitative potential of output floor to ensure financial stability through the lens of a general equilibrium model for the Euro Area. We get three main results. First, implementation of output floor entails macrofinancial stabilization benefits for Euro Area activities in the long run, which confirms results found by financial European regulators. Second, along financial and economic cycles, output floor activation reduces volatility of banks capital to risk-weighted-asset ratio and the dispersion of this ratio between core and periphery banks, consistently with the desired outcome defined by financial regulators. Third, moderate banking openness in Euro Area limits cross-border credit flows spillovers, which does not affect output floor efficiency. However, full banking openness (i.e. banking union) produces high spillovers and erodes this efficiency. |
| Keywords: | Output Floor, Credit Risk, Banking System, Euro Area, DSGE. |
| JEL: | G21 F36 F41 E44 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2024-18&r=opm |
| By: | William Ginn; Jamel Saadaou |
| Abstract: | How do geopolitical risk shocks impact monetary policy? Based on a panel of 20 economies, we develop and estimate an augmented panel Taylor rule via linear and nonlinear local projections (LP) regression models. First, the linear model suggests that the interest rate remains relatively unchanged in the event of an uncertainty shock. Second, the result turns out to be different in the nonlinear model, where the policy reaction is muted during an expansionary state, which is operating in a manner proportional to the transitory shock. However, geopolitical risks can amplify the policy reaction during a non-expansionary period. |
| Keywords: | Monetary Policy, Linear and Nonlinear Local Projections, Geopolitical Risk, Economic Policy Uncertainty. |
| JEL: | F44 E44 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2024-16&r=opm |
| By: | Altavilla, Carlo; Gürkaynak, Refet S.; Quaedvlieg, Rogier |
| Abstract: | We establish basic facts about the external finance premium. Tens of millions of individual loan contracts extended to euro area firms allow studying the determinants of the external finance premium at the country, bank, firm, and contract levels of disaggregation. At the country level, the variance in the premium is closely linked to sovereign spreads, which are important in understanding financial amplification mechanisms. However, country-level differences only explain half of the total variance. The rest is predominantly attributed to variances at the bank and firm levels, which are influenced by the respective balance sheet characteristics. Studying the response of the external finance premium to monetary policy, we find that balance sheet vulnerabilities of banks and firms strengthen the transmission of policy measures to financing conditions. Moreover, our findings reveal an asymmetrical effect contingent upon the sign and type of the policies. Specifically, policy rate hikes and quantitative easing measures exert a more pronounced impact on lending spreads, further magnified through their repercussions on the external finance premium. JEL Classification: E44, E58, F45, G15, G21 |
| Keywords: | euro area, external finance premium, financial accelerator, loan pricing |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242934&r=opm |