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on Open Economy Macroeconomics |
| By: | Douglas A. Irwin (Peterson Institute for International Economics); Maurice Obstfeld (Peterson Institute for International Economics) |
| Abstract: | Korea's real exchange rate has displayed a mild downward trend since the 1980s, with fluctuations of ±20 percent around that trend. This pattern is surprising because the classic Harrod-Balassa-Samuelson framework suggests that countries experiencing rapid growth in the productivity of their tradable industries should experience real currency appreciation over time. The paper decomposes the sources of change behind the Korean won's real exchange rate into internal price drivers (the relative price of nontradable goods) and external price drivers (the international relative price of tradable consumption goods, which is heavily dependent on the nominal exchange rate). The paper finds that, on average, the variability in Korea's real exchange rate, even over long periods, is overwhelmingly due to external price factors. Given the persistent medium-term effects of nominal exchange rate changes on the real exchange rate, the Korean policy of intervening in foreign exchange markets to smooth exchange rate fluctuations appears prudent. However, the paper also find that over the entire period 1985-2023, internal price factors are the main explanator of the won's real depreciation. This finding poses a puzzle for standard accounts of the linkage between productivity growth and real exchange rates. |
| Keywords: | Korean won, real exchange rate, Harrod-Balassa-Samuelson model, Baumol-Bowen effect, terms of trade |
| JEL: | F31 F41 F63 N15 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:iie:wpaper:wp24-17 |
| By: | Martin Bodenstein; Pablo A. Cuba-Borda; Nils M. Gornemann; Ignacio Presno |
| Abstract: | We propose a model with costly international financial intermediation that links exchange rate movements to shifts in the demand for domestically produced goods relative to the demand for imported goods (trade rebalancing). Our model is consistent with stylized facts of exchange rate dynamics, including those related to the trade balance, which is typically overlooked in the literature on exchange rate determination. In a quantitative assessment, trade rebalancing explains nearly 50 percent of exchange rate fluctuations over the business cycle, whereas exogenous deviations from the uncovered interest rate parity—the primary source of exchange rate fluctuations in the literature—account for just above 20 percent. Using data on trade flows or the trade balance is key to properly identifying the determinants of the exchange rate. Thus, our model overcomes the sharp dichotomy between the real exchange rate and the macroeconomy embedded in other models of exchange rate determination. |
| Keywords: | Exchange Rates; Risk Sharing; Financial Intermediation; Trade Balance |
| JEL: | F31 F32 F41 |
| Date: | 2024–07–11 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgif:1391 |
| By: | Cosimo Petracchi (DEF, University of Rome "Tor Vergata") |
| Abstract: | I characterize exchange-rate regime breaks for thirty countries between 1960 and 2019, and I establish that while they affect the volatilities of nominal and real exchange rates they do not change the volatilities of other real macroeconomic variables (output, consumption, investment, and net exports). This is true even in countries in which exports and imports represent a large component of gross domestic product. I propose a model with exporter-importer firms which matches the behavior of nominal and real exchange rates and real macroeconomic variables across exchange-rate regimes, even for economies in which the sum of exports and imports exceeds gross domestic product. |
| Date: | 2024–07–15 |
| URL: | https://d.repec.org/n?u=RePEc:rtv:ceisrp:580 |
| By: | Maeng, F. S. |
| Abstract: | The share of debt denominated in domestic national currency issued by emerging economies has been rising sharply over time—progress away from the “original sin†of invoicing sovereign debt in foreign currencies. Yet this progress has been partial and subject to fluctuations. This paper develops a New Keynesian model with sovereign default where the government can manipulate expected inflation through debt issuance and default policies. High levels of national currency debt incentivize governments to reduce debt repayment by escalating (expected) inflation. Governments tilt the currency denomination of debt towards foreign currency to avoid distortions from escalating (expected) inflation, at the cost of giving up hedging consumption fluctuations of national currency debt. The model highlights default risk as a key factor driving a higher share of debt in foreign currency when expected inflation rises—a pattern observed in inflation-targeting emerging economies. Quantitatively, default risk explains up to 37 percentage points of the share of debt in foreign currency. Optimal debt management contains inflation, default frequency, and spreads. |
| Keywords: | Sovereign Default, Inflation, Currency Denomination, New Keynesian Theory |
| JEL: | E32 E52 E63 F34 H63 |
| Date: | 2024–07–02 |
| URL: | https://d.repec.org/n?u=RePEc:cam:camdae:2438 |
| By: | Purva Gole; Erica Perego; Camelia Turcu |
| Abstract: | In this paper, we reconsider the role of uncertainty in explaining uncovered interest rate parity (UIP) deviations by focusing on 60 emerging and developing (EMDE) and advanced (AE) economies, over the period 1995M1--2023M3. We show that differentiating between EMDE currencies and AE currencies is crucial for understanding UIP deviations as the behaviour of excess returns differs in the two groups in periods of uncertainty: deviations become wider for EMDEs and narrow for AEs. These new results are consistent with the idea that in periods of uncertainty, global investors might change their risk preferences and move from high currency-risk investments in EMDEs towards less risky ones in AEs. This evidence holds for both the short-run and long-run UIP, and becomes stronger since the Global Financial Crisis (GFC). |
| Keywords: | Uncertainty;Uncovered Interest Rate Parity;Risk Premia;Emerging Countries |
| JEL: | F21 F30 F31 F41 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:cii:cepidt:2024-09 |
| By: | Blaise Gnimassoun; Carl Grekou; Valérie Mignon |
| Abstract: | Premature deindustrialization in most emerging and developing economies is one of the most striking stylized facts of the recent decades. In this paper, we provide solid empirical evidence supporting that the choice of a fixed exchange rate regime accelerates this phenomenon. Relying on a panel of 146 developed, emerging, and developing countries over the 1974-2019 period, we show that fixed exchange rate regimes have had a negative, significant, and robust effect on the size of the manufacturing sector —developing countries being the most affected by the industrial cost of such a regime. Additional gravity model regressions show that the impact of fixed regimes passes through the trade channel. In particular, this regime has kept countries with low relative productivity in a state of structural dependence on imports of manufactured products to the detriment of the emergence of a strong local manufacturing sector. |
| Keywords: | Exchange Rate Regimes;(De)industrialization;Manufacturing;Developing Countries;Emerging Economies |
| JEL: | E42 F43 F45 F6 O14 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:cii:cepidt:2024-07 |
| By: | Diego Alejandro Martínez Cruz (Banco de la República de Colombia); Philip Rory Symington Alzate (Bloomberg) |
| Abstract: | Foreign portfolio flows constitute a key component of economic activity in small open economies such as Colombia. The dynamics of these flows are subject to the influence of both external (push) factors and domestic (pull) factors. Consequently, economic crises and episodes of financial distress can severely undermine investor confidence, leading to a sharp decline in foreign capital inflows and the subsequent liquidation of local assets, commonly referred to as a sudden stop and sudden start. Such events can have lasting adverse effects on various facets of the economy, including GDP growth, employment rates, financial stability, and investor sentiment. This paper delves into the dynamics of portfolio external investment and which factors can explain them on major Latin American economies and quantifies the potential reduction in foreign investors' holdings of local assets under high external risk scenarios. For the Colombian case, we estimate a potential liquidation of 43.8% of total foreign investors portfolio under the most severe assumed scenario. Our work provides insights to be integrated into various exercises aimed at formulating precautionary policy measures, such as those entailed in the evaluation of adjustments to foreign exchange reserves and other external buffers by the central banks. |
| Keywords: | Foreign Portfolio Flows; Small Open Economies; Economic Crises; Sudden Stop; Sudden Start; Financial Distress; Pull Factors; Push Factors |
| JEL: | F21 F31 F32 F34 G15 G17 E44 |
| Date: | 2024–07–25 |
| URL: | https://d.repec.org/n?u=RePEc:gii:giihei:heidwp15-2024 |
| By: | Victor Almeida; Carlos Esquivel; Timothy J. Kehoe; Juan Pablo Nicolini |
| Abstract: | We develop a sovereign default model with debt renegotiation in which interest-rate shocks affect default incentives through two mechanisms. The first mechanism, the standard mechanism, depends on how a higher interest rate tightens the government’s budget constraint. The second mechanism, the renegotiation mechanism, depends on how a higher rate increases lenders’ opportunity cost of holding delinquent debt, which makes lenders accept larger haircuts and makes default more attractive for the government. We use the model to study the 1982 Mexican default, which followed a large increase in U.S. interest rates. We argue that our novel renegotiation mechanism is key for reconciling standard sovereign default models with the narrative that U.S. monetary tightening triggered the crisis. |
| Keywords: | Renegotiation; Sovereign default; Interest rate shocks |
| JEL: | G28 F34 F41 |
| Date: | 2024–06–17 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedmwp:98598 |
| By: | Donato, Giovanni; Tille, Cédric |
| Abstract: | Financial globalization has led to a large increase in international asset holdings. While the rise of associated dividend and interest flows has until now been muted by the decreasing trend in interest rates, this pattern could change, leading to a larger role of investment income flows in the balance of payments. We use a broad sample of countries to document the heterogeneous evolution of the various components of investment income flows, with a rising role of FDI and equity income, especially in advanced economies. We then assess the impact of various variables on yields with a panel analysis. Various drivers have highly heterogeneous effects across investment categories and country groups, often impacting the yields on both assets and liabilities. This translates into substantial heterogeneity in the response of countries' income balance, due to different compositions of asset and liabilities. This heterogeneity is amplified if we consider country-specific estimates in complement to the panel ones. Focusing on the impact of changes in interest rates, we find that higher rates only had a limited impact in the 2013 taper tantrum, investment income balances are likely to benefit from higher US rates in the current phase of higher rates, with offsetting effects of higher domestic rates. |
| Keywords: | Financial integration, primary investment income flows, interest rates, exchange rates |
| JEL: | F32 F36 F40 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:ifwkwp:300562 |
| By: | Naohisa Hirakata (General Manager, Niigata Branch, Bank of Japan (E-mail: naohisa.hirakata@boj.or.jp)); Mitsuru Katagiri (Associate Professor, Faculty of Business Administration, Hosei University (E-mail: mitsuru.katagiri@hosei.ac.jp)) |
| Abstract: | This paper investigates the role of foreign direct investment (FDI) in accounting for the long-term trend of capital flows under demographic changes. For this purpose, we incorporate horizontal FDI under the proximity-concentration trade-off into a two-country DSGE model and conduct a quantitative analysis using long-term Japanese data for capital flows since the 1960s. The quantitative analysis finds that the transition dynamics solely driven by demographic changes well account for the long-term trend of capital flows and that multinational firms' endogenous decision on FDI in response to population aging is key to explaining the long-term trend. |
| Keywords: | Capital flows, Demographic changes, Foreign direct investment (FDI) |
| JEL: | F12 F23 F32 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:ime:imedps:24-e-05 |