|
on Open Economy Macroeconomics |
| By: | Paul Castillo; Mr. Ruy Lama; Juan Pablo Medina |
| Abstract: | Financial dollarization is considered a source of macroeconomic instability in many emerging economies. Dollarization constrains the ability of central banks to stimulate output during economic downturns. In contrast to the conventional monetary transmission mechanism, a monetary policy loosening in a dollarized economy leads to a currency depreciation, adverse balance sheet effects, and a contraction in investment and output growth. In this paper we evaluate the role of foreign exchange reserves in facilitating macroeconomic stabilization in a financially dollarized economy. We first show empirically that foreign exchange intervention in response to capital outflows can largely reduce the volatility of output and the real exchange rate in dollarized economies. We then develop a small open economy model with foreign currency debt and balance sheets effects. Our quantitative model shows that an active foreign exchange intervention policy is sufficient for offsetting the output volatility associated with financial dollarization. These results can explain the prevalence of low macroeconomic volatility in some dollarized economies (Christiano et al., 2021) and they highlight the role of foreign exchange reserves in reducing the welfare costs of dollarization. |
| Keywords: | Foreign Exchange Intervention; Global Financial Cycle; Financial Dollarization; Balance Sheet Effects; Emerging Economies. |
| Date: | 2024–06–21 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/127 |
| By: | Raphael Auer; Mathieu Pedemonte; Raphael Schoenle; Raphael A. Auer |
| Abstract: | Is inflation (still) a global phenomenon? We study the international co-movement of inflation based on a dynamic factor model and in a sample spanning up to 56 countries during the 1960-2023 period. Over the entire period, a first global factor explains approximately 58% of the variation in headline inflation across all countries and over 72% in OECD economies. The explanatory power of global inflation is equally high in a shorter sample spanning the time since 2000. Core inflation is also remarkably global, with 53% of its variation attributable to a first global factor. The explanatory power of a second global factor is lower, except for select emerging economies. Variables such as a broad dollar index, the US federal funds rate, and a measure of commodity prices positively correlate with the first global factor. This global factor is also correlated with US inflation during the 70s, 80s, the GFC, and COVID. However, it lags these variables during the post-COVID period. Country-level integration in global value chains accounts for a significant proportion of the share of both local headline and core inflation dynamics explained by global factors. |
| Keywords: | globalization, inflation, Phillips curve, monetary policy, global value chain, international inflation synchronization |
| JEL: | E31 E52 E58 F02 F41 F42 F14 F62 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11148 |
| By: | Efrem Castelnuovo; Lorenzo Mori; Gert Peersman |
| Abstract: | We employ a structural VAR model with global and US variables to study the relevance and transmission of oil, food commodities, and industrial input price shocks. We show that commodities are not all alike. Industrial input price changes are almost entirely endogenous responses to other shocks. Exogenous oil and food price shocks are relevant drivers of global real and financial cycles, with food price shocks exerting the greatest influence. We then conduct counterfactual estimations to assess the role of systematic monetary policy in shaping these effects. The results reveal that pro-cyclical policy reactions exacerbate the real and financial effects of food price shocks, whereas counter-cyclical responses mitigate those of oil shocks. Finally, we identify distinct mechanisms through which oil and food shocks affect macroeconomic variables, which could also justify opposing policy responses. Specifically, along with a sharper decrease in nondurable consumption, food price shocks raise nominal wages and core CPI, intensifying inflationary pressures. Conversely, oil price shocks act more like adverse aggregate demand shocks absent monetary policy reactions, primarily through a decrease in durable consumption and spending on goods and services complementary to energy consumption, which are amplified by financial frictions. |
| Keywords: | commodity price shocks, transmission mechanisms, monetary policy |
| JEL: | E32 E52 F44 G15 Q02 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11140 |
| By: | Han, Wontae (KOREA INSTITUTE FOR INTERNATIONAL ECONOMIC POLICY (KIEP)); Kim, Hyo-Sang (KOREA INSTITUTE FOR INTERNATIONAL ECONOMIC POLICY (KIEP)); Song, Saerang (KOREA INSTITUTE FOR INTERNATIONAL ECONOMIC POLICY (KIEP)); Kim, Junhyong (Korea Development Institute (KDI)) |
| Abstract: | This study analyzed the effects of uncertainty and interest rate hike shocks on capital flows, as well as the effectiveness of economic stabilization policies. When comparing the impacts of global economic policy uncertainty shocks and individual country economic policy uncertainty shocks, empirical analysis showed that global economic policy uncertainty shocks had a significant effect on capital flows. This suggests that global factors are more closely associated with capital flows than country-specific factors, relating to discussions on the global financial cycle. Although classified as an advanced economy, Korea has a shallow foreign exchange market and its financial markets are sensitive to external shocks, so the spillover effects of uncertainty shocks need to be analyzed through various channels like trade, capital transactions, industrial structure, and monetary policy. As financial globalization progresses with Fintech and digital finance, the spillover effects of external shocks through capital transactions are expected to increase, especially requiring close monitoring of shocks from countries with similar industrial structures to Korea. An integrated policy framework analysis found that for emerging economies without anchored inflation expectations and shallow foreign exchange markets, a combination of monetary policy and foreign exchange intervention was effective for economic stabilization. Recently, major international organizations like the IMF, BIS, and OECD have shifted towards allowing some foreign exchange intervention and capital flow management measures to reduce exchange rate and capital flow volatility and achieve financial stability. Since there is a general consensus that Korea does not have a deep foreign exchange market, an appropriate combination of monetary policy, foreign exchange intervention, and capital flow management measures can help reduce exchange rate volatility. As Korea's foreign exchange market advances and if Korea succeeds to join major global bond indices, its sensitivity to external factors may increase, so measures to assess the depth and maturity of Korea's foreign exchange and financial markets are needed to determine the optimal policy mix. |
| Keywords: | external shocks; capital flow response; policy effectiveness |
| Date: | 2024–06–14 |
| URL: | https://d.repec.org/n?u=RePEc:ris:kiepwe:2024_017 |
| By: | Henri Ker\"anen; Sakari L\"ahdem\"aki |
| Abstract: | We propose a novel instrumental variable to identify fiscal shocks in small open economies. Under the assumptions that unexpected changes in trading partners correlate with output of an open economy and unexpected fiscal shocks of a small economy are unrelated to its trading partners' forecast errors, we use forecast errors of trading partner economies to proxy unexpected shocks in domestic output. We show that this instrument is relevant and find evidence that supports its exogeneity. Using this IV strategy, we find that the two-year cumulative spending multiplier is around 1 for Canada and 0.5 for euro area small open economies. |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2406.14382 |
| By: | Fueki, Takuji; Hürtgen, Patrick; Walker, Todd B. |
| Abstract: | Financial institutions, especially in Europe, hold a disproportionate amount of domestic sovereign debt. We examine the extent to which this home bias leads to capital misallocation in a real business cycle model with imperfect information and fiscal stress. We assume banks can hold sovereign debt according to a zero-risk weight policy and contrast this scenario to one in which banks weight the sovereign debt according to default probabilities. Banks are assumed to miscalculate the probability of a disaster state due to moral hazard and imperfect monitoring. This distortion pushes the economy away from the first-best allocation. We show that the zero risk weight policy exacerbates these distortions while a non-zero risk-weight improves allocations. The welfare costs associated with zero-risk weight policies are large. Households are willing to give up 3.2 percent of their consumption to move to the first-best allocation, whereas in the economy with non-zero risk-weights households are willing to give up only 1.2 percent of their consumption to move to the first-best allocation. |
| Keywords: | Zero-Risk Weight, Fiscal Limit, Macroprudential Regulation, Sovereign-Bank Nexus, Fiscal Stress |
| JEL: | E61 E62 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:299238 |
| By: | Clemens M. Graf von Luckner; Mr. Robin Koepke; Ms. Silvia Sgherri |
| Abstract: | This paper shows how cryptocurrency markets can fuel cross-border capital flight by serving as marketplaces that match counterparts with and without (illicit) access to FX. In countries where international transactions are restricted, crypto exchanges effectively allow domestic agents to pay a premium to buy foreign currency. The counterparts to these transactions are agents with access to FX, who sell crypto holdings purchased abroad. A stylized model illustrates that restricted foreign currency amid economic imbalances incentivizes these transactions via persistent crypto premia in local relative to global markets. We analyze relative crypto pricing data in several country case studies, providing empirical support that crypto markets serve as marketplaces for capital flight that already took place, rather than a novel channel for capital flight. We make available a novel dataset on crypto market premia, which we propose as indicators of excess demand for foreign currency and capital control intensity. The dataset will be posted along with this paper and updated periodically. |
| Keywords: | Capital flows; digital money; capital controls |
| Date: | 2024–06–28 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/133 |
| By: | Costas Milas (University of Liverpool, UK; Rimini Centre for Economic Analysis); Theodore Panagiotidis (University of Macedonia, Greece); Georgios Papapanagiotou (University of Macedonia, Greece) |
| Abstract: | This paper uses time-varying Bayesian models to assess the impact of the shifting, and progressively more volatile (especially since the EU Referendum vote in 2016) macroeconomic landscape on Foreign Direct Investment (FDI) inflows to the UK. FDI inflows are depressed in response to higher UK-specific economic and geopolitical uncertainty. A stronger real exchange rate and a higher interest rate also have a negative effect. It benefits from lower UK corporate tax rates and higher US uncertainty, the latter creating investment opportunities in the UK. Rising economic policy uncertainty since the EU Referendum, has led to FDI losses of up to 0.5% of GDP. |
| Keywords: | Foreign Direct Investment, economic policy uncertainty, Brexit |
| JEL: | C11 C32 F21 F23 F30 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:rim:rimwps:24-09 |
| By: | Jesús Fernández-Villaverde; Tomohide Mineyama; Dongho Song |
| Abstract: | After decades of rising global economic integration, the world economy is now fragmenting. To measure this phenomenon, we introduce an index of geopolitical fragmentation derived from various empirical indicators. This index is developed using a flexible dynamic factor model with time-varying parameters and stochastic volatility. We then employ structural vector autoregressions and local projections to assess the causal effects of changes in fragmentation. Our analysis demonstrates that increased fragmentation negatively impacts the global economy, with emerging economies suffering more than advanced ones. Notably, we document a key asymmetry: fragmentation has an immediate negative effect, while the benefits of reduced fragmentation unfold gradually. A sectoral analysis within OECD economies reveals that industries closely linked to global markets—such as manufacturing, construction, finance, and wholesale and retail trade—are adversely affected. Finally, we examine the interaction between fragmentation and the economic dynamics of regional economic blocs, highlighting significant differences in the impacts across various geopolitical blocs. |
| JEL: | C11 C31 E00 F01 F2 F4 F6 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32638 |
| By: | Annie Soyean Lee; Charles Engel |
| Abstract: | Empirical work finds that flows of investments from the U.S. and other high income countries to emerging markets increase during times of quantitative easing by the U.S. Federal Reserve, and the reverse movement occurs under quantitative tightening. We offer new evidence to confirm these findings, and then propose a theory based on the liquidity of U.S. government liabilities held by the public. We hypothesize that QE, by increasing liquidity, offers greater flexibility for investors that might be concerned their funds will be tied up when shocks to income or investment opportunities arise. With the assurance that some of their portfolio can be readily sold in liquid markets, rich country investors are more willing to increase investments in illiquid loans to emerging markets. The effect of increasing the liquidity of U.S. government liabilities on investments in EMs may even be stronger during times of greater uncertainty. |
| JEL: | E5 F30 F40 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32572 |
| By: | Ken-ichi Hashimoto; Kaz Miyagiwa; Yoshiyasu Ono; Matthias Schlegl |
| Abstract: | This paper first presents a dynamic model that features both real and monetary aspects of international trade and is capable of dealing with both full employment and secular unemployment. The model is then utilized to examine the effect of a tariff on the terms of trade, the trade pattern, real consumption and employment of labor. It is shown that with full employment in both countries, a tariff by the home country improves its terms of trade and increases its national welfare at the expense of the foreign country. These results however are reversed in the presence of unemployment in both countries. We also examine the asymmetric cases and calibrate our model to evaluate numerically the effect of large tariff changes. The main finding is that the tariff only worsens the economy when it is already stagnant. |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:dpr:wpaper:1245 |
| By: | Ling Cen; Lauren Cohen; Jing Wu; Fan Zhang |
| Abstract: | Using both the onset of the US-China trade war in 2018 and the most recent Russia-Ukraine war and associated trade tensions, we show a counterintuitive pattern in global trade. Namely, while the average firm trading with these nations significantly decreases their trade with these jurisdictions following sanctions, government-linked firms show a marked contrast. In particular, government-linked firms actually significantly increase their trading activity following the onset of formal sanctions. The increase is large - roughly 33% (t=4.01). We find no increase broadly to other countries (even countries in the same regions) at the same time, nor of these same firms in these same regions at other times. In terms of mechanism, government-linked supplier firms are nearly twice as likely to receive tariff exemptions. More broadly, these effects are increasing in the level of government connection. For instance, firms geographically closer to the government agencies they supply increase their imports more acutely. Using micro-level data, government-supplying firms recruiting more employees with past government work experience also increase trading activity more – particularly when the past employee worked in a government-contracting role. Lastly, this results in sizable accrued benefits in terms of firm-level profitability, market share gains, and outsized stock returns. |
| JEL: | F42 F51 G15 G38 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32621 |