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on Open Economy Macroeconomics |
| By: | Ippei Fujiwara (Keio University); Yasuo Hirose (Keio University) |
| Abstract: | This paper establishes the connection of exchange rates to macroeconomic fundamentals by estimating a small open-economy model for Canada. The model incorporates an endogenous interest rate spread on foreign bond holdings, enabling the modified uncovered interest rate parity (UIP) condition to exhibit a negative relationship between expected exchange rate depreciation and interest rate differentials, as observed in the data. Given the model's susceptibility to equilibrium indeterminacy, we estimate it using Bayesian methods that allow for both determinacy and indeterminacy of equilibrium. The results reveal that preference shocks to the household utility function are the primary drivers of exchange rate fluctuations, highlighting the connection between exchange rates and macroeconomic fundamentals. We further demonstrate that both allowing for indeterminacy and selecting a specific equilibrium representation from the data are essential for achieving this finding. |
| Keywords: | Exchange rate disconnect; UIP puzzle; Indeterminacy; Bayesian estimation |
| JEL: | C62 E32 F31 F41 |
| Date: | 2024–12–19 |
| URL: | https://d.repec.org/n?u=RePEc:keo:dpaper:2024-024 |
| By: | Rochet, Jean-Charles; Collard, Fabrice; Habib, Michel; Panizza, Ugo |
| Abstract: | We study the sustainability of sovereign debt under the assumption of involuntary and costly default: governments do their utmost to avoid default, which reduces the resources available for debt service. We show that costly default tightens Blanchard’s g > r condition. We derive a formula for a government’s maximum sustainable debt (MSD), which depends on the mean and the volatility of the country’s growth rate, the government’s maximum primary surplus, the risk-free rate, and the fraction of resources available to the government in default. We compute MSD for 12 Eurozone countries and examine the role of the European Stability Mechanism in increasing MSD. |
| Keywords: | Sovereign Debt; Default; Maximum Sustainable Debt |
| JEL: | E62 F34 H63 |
| Date: | 2024–12–05 |
| URL: | https://d.repec.org/n?u=RePEc:tse:wpaper:129958 |
| By: | Horn, Sebastian; Mihalyi, David; Nickol, Philipp; Sosa Padilla, César |
| Abstract: | How reliable are public debt statistics? This paper quantifies the magnitude, characteristics, and timing of hidden debt by tracking ex post data revisions across a comprehensive new database of more than 50 vintages of World Bank debt statistics. In a sample of debt data covering 146 countries and 53 years, the paper establishes three new stylized facts: (i) debt statistics are systematically under-reported; (ii) hidden debt accumulates in boom years and tends to be revealed in bad times, often during IMF programs and sovereign defaults; and (iii) in debt restructurings, higher hidden debt is associated with larger creditor losses. The novel data is used to numerically discipline a quantitative sovereign debt model with hidden debt accumulation and an endogenous monitoring decision that triggers revelations. Model simulations show that hidden debt has adverse effects on default risk, debt-carrying capacity and asset prices and is therefore welfare detrimental. |
| Abstract: | Wie verlässlich sind Schuldenstatistiken? Diese Studie quantifiziert den Umfang, die Charakteristika und das Timing versteckter Staatsverschuldung (Hidden Debt), indem sie ex-post Datenrevisionen in einer umfassenden, neuen Datenbank erfasst, die über 50 Jahrgänge der Schuldenstatistiken der Weltbank beinhaltet. Die erhobenen Daten umfassen die Staatsschulden von 146 Ländern und einen Zeitraum von 53 Jahren und zeigen drei neue empirische Fakten: (i) Schuldenstatistiken werden systematisch zu niedrig ausgewiesen; (ii) versteckte Staatsverschuldung entsteht in wirtschaftlichen Aufschwungphasen, während sie tendenziell in Abschwungphasen sichtbar wird; und (iii) höhere versteckte Schulden sind in Restrukturierungen mit höheren Gläubigerverlusten verbunden. Wir nutzen die neue Datenbank um ein quantitatives Theoriemodell zu kalibrieren, welches versteckte Schulden sowie endogene Monitoring-Entscheidungen berücksichtigt, die zur Aufdeckung dieser Schulden (Hidden Debt Revelations) führen. Die Modellsimulationen zeigen, dass versteckte Staatsschulden negative Auswirkungen auf das Ausfallrisiko, die Schuldentragfähigkeit und die Bewertung von Vermögenswerten haben und somit wohlfahrtsmindernd wirken. |
| Keywords: | Hidden debt, sovereign debt, default |
| JEL: | F34 H63 G01 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:rwirep:306833 |
| By: | Bruno Merlevede (UGent); Bernhard Michel (Federal Planning Bureau) |
| Abstract: | This paper documents a trend towards deglobalization in European-based multinational networks for the period 2010-2019. In the second half of the decade, the number of foreign contraction episodes shows an increasing trend, while the number of foreign expansions decreased substantially. Foreign expansions also increasingly resulted in a reduced geographic scope of networks (nearshoring) and a higher concentration of activity in geopolitically aligned host countries (friendshoring). We estimate home-country effects of foreign network restructuring by analyzing the number of domestic affiliates and different outcomes for parents and domestic affiliates. We find no evidence of increased home country activity in the wake of foreign contraction episodes, but foreign expansion yields benefits for the domestic economy both along the domestic extensive and intensive margins. A reduced geographic scope and geopolitical reorientation do not induce systematic differences in the home-country effects neither for expansion nor for contraction episodes. |
| Keywords: | on episodes.; International Organization of Production, Multinational Networks, Restructuring, Home Country Effects, Deglobalization |
| JEL: | F14 F23 F44 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:nbb:reswpp:202410-465 |
| By: | Kuokštis, Vytautas (Vilnius University); Asali, Muhammad (College of Management Academic Studies); Spurga, Simonas Algirdas (Vilnius University) |
| Abstract: | The effect of exchange rate regimes on economic performance is one of the key questions in international economics, both academically and policy-wise. Based on the theory of Optimum Currency Areas (OCA), we examine how labor market regulations affect the relationship between exchange rate regimes and economic growth during global recessions and recoveries. Using a global panel dataset, we show that the negative influence of fixed exchange rate regimes during global shocks identified in earlier literature only manifests itself in countries with high labor market regulation. Conversely, fixers with less labor market regulation recover faster from global recessions than floaters. |
| Keywords: | exchange rate regimes, labor market regulation, growth, global recessions, recovery |
| JEL: | G01 G18 J08 O24 P17 |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:iza:izadps:dp17590 |
| By: | Mitchener, Kris James (Santa Clara University, CAGE, CESifo, CEPR & NBER); Wandschneider, Kirsten (University of Vienna) |
| Abstract: | The Great Depression is the canonical case of a widespread currency war, with more than 70 countries devaluing their currencies relative to gold between 1929 and 1936. What were the currency war’s effects on trade flows? We use newly-compiled, high- frequency bilateral trade data and gravity models that account for when and whether trade partners had devalued to identify the effects of the currency war on global trade. Our empirical estimates show that a country’s trade was reduced by more than 21% following devaluation. This negative and statistically significant decline in trade suggests that the currency war destroyed the trade-enhancing benefits of the global monetary standard, ending regime coordination and increasing trade costs. |
| Keywords: | currency war, monetary regimes, gold standard, competitive devaluations, “beggar thy neighbor, †gravity model JEL Classification: F14, F33, F42, N10, N70 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:cge:wacage:740 |
| By: | Cormun, Vito; Ristolainen, Kim |
| Abstract: | Leveraging Wall Street Journal news, recent developments in textual analysis, and generative AI, we estimate a narrative decomposition of the dollar exchange rate. Our findings shed light on the connection between economic fundamentals and the exchange rate, as well as on its absence. From the late 1970s onwards, we identify six distinct narratives that explain changes in the exchange rate, each largely non-overlapping. U.S. fiscal and monetary policies play a significant role in the early part of the sample, while financial market news becomes more dominant in the second half. Notably, news on technological change predicts the exchange rate throughout the entire sample period. Finally, using text-augmented regressions, we find evidence that media coverage explains the unstable relationship between exchange rates and macroeconomic indicators. |
| Keywords: | Exchange rates, big data, textual analysis, macroeconomic news, Wall Street Journal, narrative retrieval, scapegoat |
| JEL: | C3 C5 F3 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bofrdp:306349 |
| By: | J. Scott Davis; Andrei Zlate |
| Abstract: | This paper looks at the effect of fluctuations in the global financial cycle on real exchange rates (RER). We show that, on average, a downturn in the global financial cycle leads to RER depreciation relative to the U.S. dollar. However, quantitatively there is considerable heterogeneity in the RER responses among advanced, emerging and developing economies; between net creditor and net debtor countries; and also over time. Prior to 2007, the global financial cycle had less effect on advanced than on emerging market economies' RER, whereas post-2007 the effect was about the same in the two groups of countries. Finally, we decompose the RER changes into changes in the nominal exchange rate and changes in aggregate price levels. We find that in advanced economies, nearly all RER adjustment occurred through nominal exchange rates throughout the sample period. In the emerging and developing economies, the RER adjustment was mixed prior to 2007, when changes in the RER were driven by both nominal exchange rate changes and inflation differentials, whereas nominal exchange rate adjustments dominated post-2007. |
| Keywords: | global financial cycle; real exchange rates |
| JEL: | F3 F4 |
| Date: | 2024–11–26 |
| URL: | https://d.repec.org/n?u=RePEc:fip:feddwp:99214 |
| By: | Mr. Bas B. Bakker |
| Abstract: | This paper addresses a key puzzle in international finance: whether exchange rates follow a random walk or exhibit predictable patterns. We demonstrate that exchange rates can possess a unit root while maintaining substantial predictability over certain horizons. Our model combines a stochastic trend—representing the slowly moving equilibrium exchange rate—and a stationary cyclical component capturing temporary deviations, reconciling long-term random walk behavior with medium-term predictability. This dual-component framework is essential for capturing three key features of exchange rate dynamics: expected exchange rate changes are not zero, they are highly persistent, and there is a strong relationship between exchange rate levels and expected future changes. Without the stationary component, expected exchange rate changes would be zero, and if the stochastic trend evolved too quickly, this relationship would break down. To illustrate, we extend the Bacchetta and van Wincoop (2021) framework (which generates a stationary component of the exchange rate) with a stochastic trend. Our model generates an inverted U-shaped pattern where forecast accuracy peaks at intermediate horizons and predicts that multi-year exchange rate changes are increasing multiples of one-year changes. Using data from 2000–2024 for nine inflation-targeting countries with freely floating exchange rates, we find strong empirical support for these predictions, with our model consistently outperforming the random walk benchmark in out-of-sample tests. |
| Keywords: | Exchange rate dynamics; Random walk hypothesis; Medium-term predictability; Unit root; Stationary component; Stochastic trend; Mean reversion; Forecasting accuracy; Exchange rate modeling; Exchange rate puzzles |
| Date: | 2024–12–13 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/252 |
| By: | Beck, Roland; Schmitz, Martin; Coppola, Antonio; Lewis, Angus; Maggiori, Matteo; Schreger, Jesse |
| Abstract: | We assess Euro Area financial integration correcting for the role of “onshore offshore financial centers” (OOFCs) within the Euro Area. The OOFCs of Luxembourg, Ireland, and the Netherlands serve dual roles as both hubs of investment fund intermediation and centers of securities issuance by foreign firms. We provide new estimates of Euro Area countries’ bilateral portfolio investments which look through both roles, attributing the wealth held via investment funds to the underlying holders and linking securities issuance to the ultimate parent firms. Our new estimates show that the Euro Area is less financially integrated than it appears, both within the currency union and vis-à-vis the rest of the world. While official data suggests a sharp decline in portfolio home bias for Euro Area countries relative to other developed economies following the introduction of the euro, we demonstrate that this pattern only remains true for bond portfolios, while it is artificially generated by OOFC activities for equity portfolios. Further, using new administrative evidence on the identity of non-Euro Area investors in OOFC funds, we document that the bulk of the positions constituting missing wealth in international financial accounts are now accounted for by United Kingdom counterparts. JEL Classification: F3, F4, G2, G3, H26 |
| Keywords: | Capital Markets Union, financial integration, home bias |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20243007 |
| By: | Ms. Nan Li; Sergii Meleshchuk |
| Abstract: | This paper estimates, for the first time, the exchange rate elasticity of bilateral trade in services, providing indirect evidence of both producer currency pricing and dominant currency pricing in services trade. We developed a novel dataset of bilateral trade flows in services, covering twelve broad service sectors across 245 countries from 1985 to 2022. We find that, similar to manufacturing trade, the value of services trade is more closely associated with US dollar exchange rates than with bilateral exchange rates, although this relationship varies by service category. Zeroing in on tourism, where proxies for trade volume (such as tourist arrivals and hotel stays) are available, we find that bilateral exchange rates play a larger role on tourism volume compared to the dollar exchange rates. In addition, in the context of global supply chain, we find that downstream dollar exchange rate movements, rather than downstream bilateral exchange rates, affect the demand for service imports via forward linkages. |
| Keywords: | trade in services; exchange rates; dominant currency pricing; producer currency pricing; global value chain; dollar exchange rate movement; pricing in service; exchange rate elasticity; currency pricing; Currencies; Trade balance; Exports; Global |
| Date: | 2024–11–22 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/242 |
| By: | Viral V. Acharya; Zhengyang Jiang; Robert J. Richmond; Ernst-Ludwig von Thadden |
| Abstract: | The paper analyzes international trade and health policy coordination during a pandemic by developing a two-economy, two-sector trade model integrated into a micro-founded SIR model of infection dynamics. Disease transmission intensity can differ by goods (manufactured versus services and domestic versus foreign). Governments can adopt containment policies to suppress infection spread domestically, and levy import tariffs to prevent infection from abroad. The globally coordinated policy dynamically adjusts both policy instruments heterogeneously across sectors. The more-infected country aggressively contains the pandemic, raising tariffs and tilting the terms of trade in its favor, while the less-infected country lowers tariffs to share its economic pain. In contrast, in the Nash equilibrium of uncoordinated policies the more infected country does not internalize the global spread of the pandemic, lowering tariffs and its terms of trade, especially in the contact-intensive services sector, while the less infected coun- try counters the spread by raising tariffs. Coordination therefore matters: the health-cum-trade war leads to less consumption and production, as well as smaller health gains due to inadequate global diversification of infection curves. |
| Keywords: | Trade War, Terms of Trade, Pandemics, Health Policy |
| JEL: | E61 F13 F42 H12 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_612 |
| By: | Zhesheng Qiu (The Hong Kong University of Science and Technology); Yicheng Wang (Peking University, HSBC Business School); Le Xu (Shanghai Jiao Tong University); Francesco Zanetti (University of Oxford; Centre for Economic Policy Research) |
| Abstract: | This paper studies the design of monetary policy in small open economies with domestic and cross-border production networks and nominal rigidities. The monetary policy that closes the domestic output gap is nearly optimal and is implemented by stabilizing the aggregate inflation index that weights sectoral inflation according to the sector’s roles as a supplier of inputs and a net exporter of products within the international production networks. To close the output gap, monetary policy should assign large weights to inflation in sectors with small direct or indirect (i.e., via the downstream sectors) import shares and failing to account for the cross-border production networks overemphasizes inflation in sectors that export intensively directly and indirectly (i.e., via the downstream sectors). We validate our theoretical results using the World Input-Output Database and show that the monetary policy that closes the output gap outperforms alternative policies that abstract from the openness of the economy or the input-output linkages. |
| Keywords: | Production networks, small open economy, monetary policy |
| JEL: | C67 E52 F41 |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:cfm:wpaper:2501 |
| By: | Susie McKenzie (The Treasury) |
| Abstract: | This paper estimates a Structural Vector Autoregressive (SVAR) model to investigate the impacts of global shocks on four key New Zealand macroeconomic variables: gross domestic product (GDP), interest rates, the consumer price index (CPI), and the exchange rate, and also reports the forecast error variance decomposition. The model is used to assess New Zealand’s vulnerability to cyclical shocks in its major trading partners: China, the United States, and Australia. Results show that New Zealand’s GDP responds positively to positive GDP shocks from China and the world block, with effects that feed through the economy having an impact on price levels, interest rates and exchange rates. New Zealand’s CPI responds differently to shocks depending on the country of origin, and interest rates respond strongly to most foreign interest rate and foreign GDP shocks with persistent effects. The impact of most foreign shocks on New Zealand’s exchange rate cannot be accurately determined in the model developed in this paper. The analysis shows some of the risks New Zealand faces if it concentrates its trade too heavily on a small number of key economies, and provides a useful lens for thinking about the macroeconomic relationships between New Zealand and the rest of the world. |
| JEL: | E32 F41 F15 F44 |
| Date: | 2024–04–30 |
| URL: | https://d.repec.org/n?u=RePEc:nzt:nztans:an24/04 |
| By: | Doireann Fitzgerald |
| Abstract: | Static trade models imply modest gains from trade. I quantify the gains from trade in a multi-country dynamic stochastic environment, taking into account the contributions to welfare of trade across states of the world, and over time, as well as trade within dates and states (3-D gains). For developing countries, which have volatile productivity, standard risk aversion implies that 3-D gains from trade are at least twice as big as static gains, even under financial autarky. Because productivity is less volatile for developed countries, their 3-D gains from trade are only modestly bigger than static gains, even under complete markets. |
| Keywords: | Gains from Trade; International risk sharing |
| JEL: | F11 F41 |
| Date: | 2024–12–24 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedmwp:99350 |
| By: | Yoshihiko Hogen (Bank of Japan); Naoya Kishi (Bank of Japan) |
| Abstract: | The real effective exchange rate (RER) is inherently a general equilibrium variable and its fluctuations are influenced by various factors. In addition to supply factors such as productivity, demand factors, home bias, risk sharing, fiscal and monetary policies also affect the RER. In this context, the "Balassa-Samuelson effect" (B-S effect) focuses on the role of productivity differentials in the tradable sector in explaining the long-run trend of the RER. In this paper, we quantitatively examine the extent to which the B-S effect has been observed in Japan's RER since the 1970s by constructing and estimating a two-country (Japan and the United States), two sector (tradable and non-tradable), dynamic stochastic general equilibrium (DSGE) model. In addition, we also examine cases where the law of one price does not hold in tradables (dominant currency pricing and local currency pricing) and restrictions on labor mobility across sectors. Our results indicate that the long-run trend of the RER in Japan and the United States can be explained to a considerable extent by the B-S mechanism. In other words, according to the model analysis, the yen's appreciation trend in the RER from the 1970s to the mid-1990s can be explained by the rising relative productivity of Japan's tradable sector relative to the U.S., as pointed out in previous studies, and the effects of the Plaza Accord in 1985. In addition, the depreciation of the yen in real terms since the mid-1990s can be explained by a decline in the relative productivity of Japan's tradable sector relative to the United States; the "reverse B-S effect" from Japan's perspective. |
| Keywords: | Balassa-Samuelson effect; productivity; real exchange rate |
| JEL: | F41 F42 C51 |
| Date: | 2024–12–26 |
| URL: | https://d.repec.org/n?u=RePEc:boj:bojwps:wp24e22 |