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on Open Economy Macroeconomics |
| By: | Stéphane Auray (ESC [Rennes] - ESC Rennes School of Business); Michael B Devereux (Vancouver school of economics, University of British Columbia - UBC - University of British Columbia [Canada]); Aurélien Eyquem (UNIL - Université de Lausanne = University of Lausanne) |
| Abstract: | This paper shows that the outcome of trade wars for tariffs and welfare will be affected by the monetary policy regime. The key message is that trade policy interacts with monetary policy in a way that magnifies the welfare costs of discretionary monetary policy in an international setting. If countries follow monetary policies of flexible inflation targeting, trade wars are relatively mild, with low equilibrium tariffs and small welfare costs. Discretionary monetary policies imply much higher tariffs, high inflation rates, and substantially larger welfare costs. We quantify the effects of a global trade war among major economies using estimates of trade elasticities, economic size, net foreign assets, and trade openness. We find large welfare benefits of an inflation targeting monetary policy for all countries. |
| Keywords: | Protectionism, Trade wars, Inflation targeting, Discretionary monetary policy, Trade imbalances F30, F40, F41 |
| Date: | 2025–07–08 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-05151249 |
| By: | Mai Dao; Pierre-Olivier Gourinchas; Oleg Itskhoki |
| Abstract: | We offer a unifying empirical model of covered and uncovered currency premia, interest rates and spot and forward exchange rates, both in the cross section and time series of currencies. We find that the rich empirical patterns are in line with a partial equilibrium model of the currency market, where hedged and unhedged currency is supplied by intermediary banks subject to value-at-risk balance-sheet constraints, emphasizing the frictional nature of equilibrium currency premia and exchange rate dynamics. In the cross section, the excess supply of local-currency savings is the key determinant of low relative interest rates, negative covered and uncovered currency premia, cheap forward dollars; and vice versa. In the time series, covered currency premia change infrequently and in concert across currencies, driven by aggregate financial market conditions. In contrast, uncovered currency premia move frequently in response to currency-specific demand shocks, which we capture with the dynamics of net currency futures positions of dealer banks. Sharp exchange rate depreciations in response to negative shifts in currency demand are followed by small persistent predictable appreciations that generate future positive expected currency returns necessary to ensure intermediation of currency demand shocks, irrespective of their financial or macroeconomic origin. Changes in net futures positions of dealer banks account for most of the variation in the spot exchange rate for every currency. |
| Keywords: | exchange rates; uncovered interest parity; covered interest parity; currency markets; futures market; intermediation frictions |
| Date: | 2025–08–01 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/153 |
| By: | Sangyup Choi (Yonsei University); Kimoon Jeong (University of Virginia); Jiseob Kim (Yonsei University) |
| Abstract: | Despite extensive research, there is little consensus on whether common monetary policy generates systematically asymmetric effects within the euro area. We argue that this ambiguity arises from failing to account for heterogeneity in local cyclical conditions at the time of policy changes, which leads state-dependent responses to obscure underlying cross-country differences. To address this, we construct a measure of country-specific monetary policy that internalizes local cyclical conditions. This adjustment reveals systematic asymmetries in policy transmission between core and periphery euro area countries that conventional methods overlook. We find that macroeconomic and financial variables respond more strongly in periphery countries. In contrast, credit and housing booms are largely absent in core countries. This differential response is consistent with the bank lending channel of monetary policy: banks in periphery countries ease mortgage lending standards following an expansionary shock, while those in core countries tighten them. Cross-border banking flow patterns further corroborate the importance of credit supply in explaining regional heterogeneity. |
| Keywords: | Monetary Union; Country-specific monetary policy gap; Mortgage credit; Bank lending survey; Cross-border banking flows. |
| JEL: | E21 E32 E44 F52 G21 |
| Date: | 2025–08 |
| URL: | https://d.repec.org/n?u=RePEc:yon:wpaper:2025rwp-256 |
| By: | Volha Audzei; Jan Bruha; Ivan Sutoris |
| Abstract: | In this paper, we study domestic and foreign monetary policy transmission in a small open economy in which firms can decide to hold foreign currency loans (FCLs). In a workhorse two-country DSGE model, firms borrow in advance to cover production costs and choose the share of FCLs based on interest rate differentials and expected exchange rate movements. In this framework, we further examine how FCL holdings affect the transmission of exogenous shocks and monetary policy. The results indicate that FCLs impact the effectiveness of domestic policy depending on the shock type: they strengthen monetary policy transmission in response to domestic shocks, while weakening it in response to asymmetric foreign and exchange rate shocks. Symmetric global supply shocks reduce domestic policy efficacy, requiring higher rates to curb inflation but causing larger output losses. In contrast, global demand shocks allow for less aggressive domestic policy responses under large FCL holdings. |
| Keywords: | Cost channel of monetary policy, dynamic stochastic general equilibrium models, foreign currency loans, small open economy |
| JEL: | E32 E44 E52 F41 |
| Date: | 2025–06 |
| URL: | https://d.repec.org/n?u=RePEc:cnb:wpaper:2025/10 |
| By: | Tian, Xin (University of Groningen) |
| Abstract: | This paper examines whether a flexible exchange rate regime, capital controls, and foreign reserves are effective tools to reduce BRICS countries’ exposure toglobal financial cycle (GFCy) shocks. Based on local projections in which we allow the response of national financial cycles (NFCys) to the GFCy to vary, we observe that flexible exchange rate regime absorbs GFCy shocks in BRICS countries, as do tighter capital controls and larger international reserves. We also find thatthe responses of NFCys to GFCy shocks are heterogeneous across countries, withstronger effects observed in countries with higher inflation and GDP growth. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:gro:rugfeb:2024007-gem |
| By: | Gnocato, Nicolò; Montes-Galdón, Carlos; Stamato, Giovanni |
| Abstract: | What are the macroeconomic impacts of tariffs on final goods versus intermediate inputs? We set up a two-region, multi-sector model with production networks, sticky prices and wages, and trade in consumption, investment, and intermediate goods. We show that import tariffs on final goods have a smaller negative impact on GDP compared to tariffs on intermediate inputs, as final goods can be more readily substituted with domestic alternatives. In contrast, tariffs on intermediate inputs lead to larger GDP losses, given the limited substitutability of foreign inputs and their role in global supply chains. Moreover, inflation persistence is lower under tariffs on final goods, whereas tariffs on intermediate goods amplify cost pressures through production linkages. The results imply that a revenue-equivalent approach to import tariffs, targeting only final goods, can cushion the adverse effects of trade wars. JEL Classification: E31, E32, F12, F13, F41 |
| Keywords: | inflation, production networks, tariffs |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20253081 |
| By: | Lorenzo Caliendo; Samuel S. Kortum; Fernando Parro |
| Abstract: | We develop a dynamic multi-country Ricardian trade model with aggregate uncertainty, where countries trade goods and assets, leading to trade imbalances. We introduce a method for computing counterfactuals in this setting without specifying the stochastic process of shocks or solving for asset prices. Applying the model to tariff shocks, we quantify their effects on prices, income, expenditure, and trade imbalances. We find that higher U.S. tariffs reduce the U.S. trade deficit through general equilibrium adjustments, but raise domestic prices and lower real consumption. Our findings highlight that movements in trade imbalances are shaped by the structure of global trade and finance, and that attempts to influence external balances through changes in trade barriers carry significant implications for real economic outcomes. |
| JEL: | F10 F11 F13 F40 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:34003 |
| By: | Ioana Moldovan; Shu-Chun S. Yang; Luis-Felipe Zanna |
| Abstract: | This paper examines Ramsey-optimal policies related to fiscal spending and international reserve accumulation in response to volatile aid flows in Low-Income Countries (LICs). We develop a real Dynamic Stochastic General Equilibrium (DSGE) model of a small open economy, incorporating government transfers and public investment as fiscal spending components, along with two prominent characteristics of LICs: Dutch disease (DD) externalities and financially constrained households. Driven by considerations of precautionary saving, Ramsey-optimal policies involve partial reserve accumulation and partial fiscal spending of aid. Stronger DD externalities necessitate greater reserve ac- cumulation to stabilize future output, thereby mitigating consumption volatility. While transfers directly support private consumption smoothing, public investment also con- tributes to this goal by sustaining future income through gradual capital accumulation. Higher aid volatility calls for increased public investment, underscoring the role of public capital accumulation as a precautionary saving instrument, beyond its developmental role discussed in the literature. |
| Keywords: | aid; fiscal policy; reserve policy; foreign exchange intervention; optimal policy; low-income countries |
| Date: | 2025–08–01 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/154 |
| By: | Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich |
| Abstract: | Attitudes toward fiscal policy differ: fiscal conservatism and fiscal liberalism vary in their willingness to tolerate budget deficits. We challenge the view that such attitudes reflect national preferences. Instead, we offer an economic explanation based on a two-country Heterogeneous Agent New Keynesian model, bringing its implicit political economy dimension to the forefront. We compute the welfare implications of alternative fiscal policies at the household level to assess the conditions under which a policy commands majority support. Whether the majority supports fiscal conservatism or liberalism depends on a country’s debt level, its wealth distribution, and the nature of the economic shock. |
| Keywords: | HANK, two-country model, political economy, government debt, fiscal policy, household heterogeneity |
| JEL: | E32 H63 F45 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:diw:diwwpp:dp2132 |