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on Open Economy Macroeconomics |
| By: | Lukasz A. Drozd; Marcin Kolasa; Jaromir B. Nosal |
| Abstract: | We evaluate several leading microfounded pricing-to-market (PTM) mechanisms embedded in a two-country DSGE model with volatile exchange rates driven by real and financial shocks. Across these frameworks, including the reduced-form Kimball specification, we identify a fundamental parameterization trilemma: Models typically struggle to simultaneously match empirically plausible producer markups, muted expenditure switching (low short-run trade elasticity), and the low exchange-rate pass-through needed to account for the business-cycle dynamics of prices and quantities. We provide an analytical characterization of this trilemma and quantitatively assess each model’s performance vis-à-vis a unified set of empirical benchmarks. |
| Keywords: | exchange-rate pass-through; pricing-to-market; real rigidity; international comovements |
| JEL: | F31 E32 F41 |
| Date: | 2026–06–30 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedpwp:103462 |
| By: | Caballero, Ricardo; Simsek, Alp |
| Abstract: | We analyze monetary policy responses to noisy financial conditions in an open economy where exchange rates and domestic asset prices affect aggregate demand. Noise traders operate in both markets, and specialized arbitrageurs have limited risk-bearing capacity. Monetary policy creates cross-market spillovers: by adjusting the interest rate to stabilize one market, the central bank influences volatility in the other. We show that targeting a financial conditions index (FCI) — a weighted average of exchange rates and domestic asset prices — delivers substantial macroeconomic benefits. FCI targeting commits the central bank to respond to unexpected movements in financial conditions beyond what discretionary monetary policy implies. These stronger responses improve diversification across markets: each market becomes more exposed to external shocks but less exposed to its own. This reduces volatility in both markets and activates the recruitment effect from Caballero et al. (2025b) in each market — lower variance induces arbitrageurs to trade against noise, further dampening volatility. Foreign exchange (FX) targeting can also be effective when the exchange rate is the primary source of noise, with benefits that increase as the economy becomes more open. In this case, FX targeting recruits arbitrageurs to stabilize the FX market, reducing volatility and dampening the macroeconomic impact of noise. However, FX targeting also raises volatility in non-targeted markets through anti-recruitment effects, limiting its effectiveness relative to FCI targeting, especially when domestic asset markets also matter for financial conditions and are comparably noisy. |
| Keywords: | Monetary policy; exchange rate; Financial conditions index; Limits to arbitrage |
| JEL: | E32 E40 E44 E52 F30 F41 G12 G15 |
| Date: | 2026–03 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21290 |
| By: | Antrà s, Pol; Kulesza, Adrian |
| Abstract: | We develop a general equilibrium model of international trade in which the temporal structure of production is a key determinant of comparative advantage. Building on Böhm-Bawerk’s theory of capital, the model formalizes the idea that production processes with longer average periods of production (APPs) entail higher financing costs due to the time lag between input payments and revenue realization. We embed this insight into a multi-sector Ricardian framework with endogenous interest rates. Under autarky, countries with more patient consumers or more developed financial markets exhibit lower equilibrium interest rates and higher wage rates. With international trade, these countries typically gain a comparative advantage in sectors with longer APPs, though the model can also generate multiple equilibria and unconventional specialization patterns. We extend the framework to include trade costs (inclusive of shipment delays), global value chains, and international capital-market integration. Empirically, we present evidence showing that countries with more developed financial systems export disproportionately more in sectors with longer APPs, even after controlling for standard neoclassical and institutional determinants of comparative advantage. |
| Keywords: | Global value chains |
| JEL: | F1 F2 F3 F4 F6 |
| Date: | 2026–03 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21304 |
| By: | Chenard, Antonin; Eichengreen, Barry; Monnet, Eric; Morvillier, Florian |
| Abstract: | We analyze an aspect of the international monetary system that has been the subject of little research: the distinction between foreign exchange reserves held as deposits and held as securities. We assemble new data for 109 countries in the period 1950-2022 based on previously unutilized statistics from central bank annual reports. We show that there has been movement since the late 1990s toward holding a larger share of reserves in the form of securities. Securities now account for almost two-thirds of total foreign exchange reserves, up from one-third a quarter century ago. This shift is concentrated in the decade between the emerging market crises of the late 1990s and the 2008 global financial crisis. It is associated with the accumulation of excess reserves, what central bank reserve managers refer to as the †investment tranche†of their reserve portfolios. |
| Keywords: | International monetary system; Foreign exchange reserves |
| JEL: | F30 F31 F33 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21488 |
| By: | Faia, Ester; Shabalina, Ekaterina |
| Abstract: | We study international risk sharing and international transmission in a model with within and between countries incomplete markets (uninsurable risk and borrowing constraints), with one or two assets. We show that incomplete markets induce a wedge in the aggregate risk-sharing condition. When income risk is countercyclical the wealth effects and the precautionary motives induce a time-varying disconnect that can reconcile statistics related to international risk-sharing: high consumption growth leads to expected appreciations, the correlation between the marginal utilities (or consumption) across countries and the real exchange rate is negative and in the same magnitude as in the data, cross-country consumption correlation is lower than that of output, the exchange rate is highly persistent. |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21533 |
| By: | Fernando Arce; Alessandro Villa |
| Abstract: | Why do countries set sovereign debt ceilings if they keep raising them? This paper shows that debt ceilings can serve as intermediate commitment devices that reduce expected dilution, thereby lowering spreads—and their volatility—even without reducing total borrowing. We propose a new sovereign default model with long-term debt in which each government inherits a previously announced ceiling but may revise it by paying a political or institutional deviation cost. This friction generates a state-dependent form of partial commitment. The ceiling mitigates debt dilution at the expense of fiscal flexibility, leading the government to voluntarily adopt a ceiling that limits the discretion of its future selves. Governments choose rules that are costly—but not impossible—to adjust, trading off lower spreads and volatility through reduced dilution against the option value of fiscal flexibility in bad times. Consistent with this mechanism, we show that emerging-market countries operating under fiscal rules exhibit lower sovereign spreads and lower spread volatility, even though breaches and revisions occur. |
| Keywords: | debt ceiling; endogenous commitment |
| JEL: | E32 E44 F41 G01 G28 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedhwp:103455 |
| By: | den Besten, Tamar; Barnichon, Regis; Känzig, Diego; Singh, Aayush |
| Abstract: | We study the macroeconomic effects of tariff policy using U.S. historical data from 1840–2024. We construct a narrative series of plausibly exogenous tariff changes – based on major legislative actions, multilateral negotiations, and temporary surcharges – and use it as an instrument to identify a structural tariff shock. Tariff increases are contractionary: imports fall sharply, exports decline with a lag, and output and manufacturing activity drop persistently. The shock transmits through both supply and demand channels. Prices rise in the full sample but fall post-World War II, a pattern consistent with changes in the monetary policy response and with stronger international retaliation and reciprocity in the modern trade regime. |
| Keywords: | Trade policy |
| JEL: | E30 F13 F14 F41 H20 |
| Date: | 2026–04 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21381 |
| By: | Drechsel, Thomas; Tenreyro, Silvana; McLeay, Michael; Turri, Enrico Duilio |
| Abstract: | We show that the optimal monetary policy and exchange rate framework depend critically on the economy’s commodity exposure. We develop a flexible but tractable model economy with commodity exports and imports, in which international financial conditions may vary with the commodity cycle. Stabilizing domestic prices is optimal for commodity exporters, in line with standard open-economy policy prescriptions. But for economies that use commodities as inputs in production, optimal policy largely ‘looks through’ the direct and indirect effects of commodity shocks on domestic prices; this contrasts with some earlier findings and policy practice (which only ‘looks through’ the direct effect). Exchange-rate pegs perform better for commodity importers because they stabilize wages and employment, though it is not a robustly optimal policy. In emerging and developing economies, where financial conditions are more tied to the commodity cycle, trade-offs are starker and implementing the optimal policy may be challenging, since it requires enough credibility to keep inflation expectations anchored amidst greater volatility in some nominal variables. |
| Keywords: | Monetary policy; Exchange rates; Inflation targeting; Commodity prices; Small open economy |
| JEL: | E31 E52 E58 F41 Q02 Q30 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21518 |
| By: | Charles de Beauffort (corresponding author) (National Bank of Belgium, Economics and Research Department.); Ansgar Rannenberg (European Central Bank. Fiscal Policies Division.) |
| Abstract: | Government spending falls disproportionately on non-tradable services. We show empirically that government spending shocks stimulate private consumption along with sizable spillovers to the goods sector and a relative decline in goods prices. We rationalize these findings with a two-sector open economy HANK model. Uninsurable income risk and precautionary savings lead to a persistent income-driven expansion in private consumption. In the tradable sector, import intensity and limited labor reallocation dampen wage pass-through to prices, matching observed co-movements. The resulting expenditure switching produces a positive tradable output response despite deteriorating net exports. Household heterogeneity and trade openness jointly shape sectoral fiscal multipliers. |
| Keywords: | Fiscal policy, Heterogeneous agents, Open economy, Sectoral spillovers, Government spending, Consumption, Trade, SVAR |
| JEL: | E62 F41 E21 C11 C32 |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbb:reswpp:202606-493 |
| By: | Coulibaly, Louphou; Ndiaye, Abdoulaye |
| Abstract: | Hidden public liabilities can reprice sovereign risk abruptly upon revelation. We study optimal default following such a revelation in a quantitative sovereign default model and apply the framework to Senegal’s 2024 debt audit, which revised government debt upward by 50 percentage points of GDP. The revelation enters as an exogenous upward shift in the inherited debt stock within a small open economy with long-duration debt and default costs disciplined by Senegal’s monetary-union constraints. Under our baseline calibration, the corrected debt stock exceeds the model’s repayment region, implying that default would have been optimal from 2023 onward—before the audit was conducted. Since Senegal has continued to repay, we also consider a no-default calibration that matches post-revelation spread dynamics. Rationalizing repayment requires income dynamics more volatile and less persistent than historical estimates, consistent with optimism about mean reversion or gambling for redemption. This calibration places Senegal near the default boundary, where a 3 percent adverse income shock would make restructuring optimal within a year. Both calibrations yield the same conclusion: the hidden-debt revelation moved Senegal from moderate fiscal risk to acute vulnerability. |
| Keywords: | Sovereign default; Senegal |
| JEL: | F34 F41 H63 E44 O55 |
| Date: | 2026–03 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21322 |
| By: | Alice Albonico; Guido Ascari; Qazi Haque; Kostas Mavromatis; Andra Smadu |
| Abstract: | We develop and estimate an open economy DSGE model for the euro area where global energy prices and the exchange rate jointly determine domestic inflation, because imported energy, priced in foreign currency, enters both consumption and production. Energy and exchange-rate disturbances account for the bulk of short-run volatility in headline euro area inflation, with energy price shocks driving most of the post-pandemic surge. Because energy and non-energy goods are poor substitutes, an adverse energy price shock raises import values, deteriorating the trade balance and depreciating the real exchange rate through the net-foreign-asset and UIP channels. The exchange-rate channel strengthens monetary transmission and improves the short-run inflation-output trade-off relative to a non-energy economy. Optimal policy can exploit this channel rather than looking through energy price shocks. The case for looking through such shocks becomes stronger when the central bank assigns a greater weight to output gap stabilization and prices become stickier. |
| Keywords: | Monetary policy, Inflation, Energy, Bayesian estimation. |
| JEL: | E52 E31 E32 |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:mib:wpaper:577 |
| By: | den Besten, Tamar; Känzig, Diego |
| Abstract: | We study the macroeconomic effects of tariff policy using U.S. historical data from 1840–2024. We construct a narrative series of plausibly exogenous tariff changes – based on major legislative actions, multilateral negotiations, and temporary surcharges – and use it as an instrument to identify a structural tariff shock. Tariff increases are contractionary: imports fall sharply, exports decline with a lag, and output and manufacturing activity drop persistently. The shock transmits through both supply and demand channels. Prices rise in the full sample but fall post-World War II, a pattern consistent with changes in the monetary policy response and with stronger international retaliation and reciprocity in the modern trade regime. |
| Keywords: | Trade policy |
| JEL: | E30 F13 F14 F41 H20 |
| Date: | 2026–04 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21354 |
| By: | Erik Frohm; John Hooley; Fatih Ozturk; Łukasz Rawdanowicz; Nivetha Sivakumar |
| Abstract: | Current account imbalances have re-emerged in global policy debates amid renewed widening, persistence and trade tensions. This paper reviews stylised facts on global imbalances, lessons from past rebalancing episodes, and policy implications. It shows that global imbalances remain persistent and concentrated in a few economies, are shaped more by differences in saving than in investment, and that net international investment positions are strongly influenced by valuation and nominal growth effects. Deficit narrowing is typically accompanied by export growth and higher private saving‑investment balances, especially in firms, while surplus narrowing is more often associated with higher imports and lower net lending across sectors. Larger initial imbalances – especially deficits – are associated with a higher probability of subsequent narrowing. Overall, durable rebalancing is unlikely to be achieved through trade measures or any single policy instrument. Instead, it could benefit from domestically grounded reforms, including fiscal adjustment where needed, and structural measures to reduce excess saving and support investment. Stronger prudential oversight, especially of non-bank financial institutions, would mitigate financial risks. Industrial policy may affect trade balances for individual goods but is unlikely to durably alter aggregate current account positions. |
| Keywords: | global imbalances, current account, capital flows, industrial policy |
| JEL: | E20 F32 F41 |
| Date: | 2026–06–30 |
| URL: | https://d.repec.org/n?u=RePEc:oec:ecoaaa:1869-en |
| By: | Dennis Essers; Silvia Marchesi; Nejat G. Okatan |
| Abstract: | This paper shows that the trade costs of sovereign default depend on the identity of defaulted creditors. Comparing external and domestic defaults on privately held debt across 128 developing countries over 1980–2019, and applying both two-way fixed effects and stacked difference-in-differences estimators, we find that external defaults are associated with large and persistent import contractions, while domestic defaults have smaller and short-lived effects. This asymmetry is concentrated in imports of capital goods and is mirrored by declines in international lending to the private sector and in medium-to-long-term export credit insurance after external, but not domestic, defaults. By contrast, exports do not change significantly after either type of default. The results point to disruptions in cross-border trade finance as a key channel linking external defaults to trade, and highlight creditor composition as a central determinant of default-related trade costs. |
| Keywords: | sovereign default; external debt; domestic debt; international trade; international lending; trade finance |
| JEL: | F14 F34 G15 H63 |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:mib:wpaper:575 |
| By: | Horn, Sebastian; Reinhart, Carmen; Trebesch, Christoph |
| Abstract: | States are major international financiers, but their role is poorly understood. We study state-driven cross-border lending over two centuries using a new database covering 1.2 million official loans and grants by 134 governments and 70 multilateral institutions since 1790. We document a dual, state-contingent structure of international credit. In normal times, private creditors dominate cross-border lending. In adverse states of the world, such as wars and financial crises, official creditors step in, at times on a massive scale. These official flows are driven by great powers, are highly subsidized, and are largely absent from canonical models in international macroeconomics. |
| Keywords: | Sovereign debt; Capital flows; Financial crises; Bailouts; War finance; Disaster risk |
| JEL: | E42 F33 F34 F35 F36 G01 G20 N1 N2 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21556 |
| By: | Corsetti, Giancarlo; Kuester, Keith; Müller, Gernot; Schmidt, Sebastian; Schumann, Ben Alexander |
| Abstract: | We confront the notion that flexible exchange rates insulate countries from external disturbances with new evidence for the euro area (EA) and 20 of its neighbors. Using high-frequency data, we first establish that countries with flexible exchange rates (“floats†) let their currencies depreciate in response to EA monetary policy shocks, while “pegs†raise interest rates. Yet at business cycle frequency, these depreciations do not translate into insulation: floats contract just as much as pegs—not only in response to monetary policy shocks but also to other shocks originating in the EA. This result appears puzzling in light of received wisdom, but we show that it can be rationalized within a state-of-the-art HANK model and flesh out the underlying transmission channels. |
| Keywords: | Insulation; External shock |
| JEL: | F41 F42 E31 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21468 |
| By: | Marcos Mac Mullen |
| Abstract: | I study the international transmission of fiscal policy and its impact on the real exchange rate (RER) and net exports. I document that periods of high government debt are strongly associated with a depreciated RER and subsequent increases in net exports. I present causal evidence that debt-financed fiscal expansions transmit primarily through deviations from uncovered interest parity, leading to a depreciated RER and increases in net exports over time. I propose a model in which portfolio rebalancing frictions drive the international transmission of fiscal policy that explains the empirical evidence, and show that this mechanism generates dynamics consistent with the RER disconnect. |
| Keywords: | exchange rates; fiscal policy; international finance; current accounts |
| JEL: | E62 F00 F30 F44 F31 |
| Date: | 2026–06–22 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgif:103468 |
| By: | Rezai, Armon; van der Ploeg, Frederick |
| Abstract: | We develop a small open economy model with overlapping generations to analyse the macroeconomic, distributional, and political economy effects of unilateral climate policy under an emissions cap. Carbon pricing lowers wages and thus human wealth, while financial assets continue to earn the world interest rate. This asymmetry generates sharp generational and cross country differences: in creditor economies the young lose most, whereas in debtor economies the old bear the heaviest burden as they must reduce their debt when incomes fall. We compare constant carbon taxes with efficient Hotelling price paths and show that delayed implementation dramatically raises the carbon price needed to meet a fixed emissions cap, especially in debtor economies. Hotelling pricing yields substantially lower near term welfare losses. Across all policies, carbon pricing depresses wages, reduces consumption and human wealth, and induces capital flight; labour supply responses differ by asset position. Public debt can be used to secure majority support for climate policy by shifting part of the burden to future generations—more easily so in creditor economies than debtor ones. Since labour tax cuts counteract the wage depression caused by climate policy, less debt is needed to obtain a political majority. |
| Keywords: | Decarbonization; Overlapping generations; Carbon pricing; Employment; Capital flight; Current account; Government debt; Double dividend |
| JEL: | F18 F20 F41 H23 H60 Q43 Q52 |
| Date: | 2026–03 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21246 |
| By: | de Groot, Oliver; Skok, Yevhenii |
| Abstract: | Were either the exceptional defense spending needs of the government or the sharp increase in the cost-of-living of poorer households factors that rationalize the National Bank of Ukraine’s temporary fix of the Hryvnia when Russia invaded in 2022? To test the validity of these explanations, we develop a small open-economy two-agent New Keynesian (SOE-TANK) model of Ukraine featuring: 1) a government that finances military imports and 2) low- and high-income households. We find that the surge in foreign-currency-denominated military spending alone does not justify a temporary exchange-rate peg. However, when the consumption of low income households is close to subsistence levels, we find that the optimal exchange rate regime becomes state-contingent: exchange-rate flexibility is desirable for small shocks, whereas for a large-scale invasion shock, a fixed exchange rate dominates a floating regime with a standard Taylor rule. |
| Keywords: | Central banking; Monetary policy; Emerging markets |
| JEL: | E44 E52 F31 F41 G01 |
| Date: | 2026–05 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21509 |