|
on Open Economy Macroeconomics |
| By: | Corsetti, G.; Lloyd, S.; Marin, E.; Ostry, D. |
| Abstract: | We document a rise in investors' assessment of U.S. risk relative to other G.7 economies since the late 1990s, driven by higher permanent risk but not reflected in currency returns. Using a two-country framework with trade in a rich maturity structure of bonds which earn convenience yields, alongside risky assets and currencies, we establish an equilibrium relationship between cross-border convenience yields, relative country risk and carry-trade returns. Empirically, we identify a cointegrating relationship between relative permanent risk and long-maturity convenience yields. Counterfactual experiments show rising relative permanent risk explains around one-third of declining long-maturity convenience yields over 2002-2006 and 2010-2014. |
| Keywords: | Convenience Yields, Exchange Rates, Long-Run Risk, U.S. Safety, Equity Risk Premium |
| JEL: | F30 F31 G12 |
| Date: | 2025–09–16 |
| URL: | https://d.repec.org/n?u=RePEc:cam:camjip:2526 |
| By: | Pasquale Della Corte (Imperial College Business School; Centre for Economic Policy Research (CEPR)); Can Gao (University of St.Gallen; Swiss Finance Institute; Swisss Institute for Banking and Finance); Daniel P. A. Preve (Singapore Management University); Giorgio Valente (Hong Kong Institute for Monetary and Financial Research (HKIMR)) |
| Abstract: | This paper investigates the long-horizon predictive variance of an international bondstrategy where a U.S. investor holds unhedged positions in constant-maturity long-term foreign bonds funded at domestic short-term interest rates. Using over two centuries of data from major economies, the study finds that predictive variance grows with the investment horizon, driven primarily by uncertainties in interest rate differentials and exchange rate returns, which outweigh mean reversion effects. The analysis, incorporating both observable and unobservable predictors, highlights that unobservable predictors linked to shifts in monetary and exchange rate regimes are the dominant source of long-term risk, offering fresh insights into international bond investment strategies. |
| Keywords: | Currency risk, Long-term bonds, Predictability, Long-term investments |
| JEL: | F31 G12 G15 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:chf:rpseri:rp2595 |
| By: | Ángel Estrada García (BANCO DE ESPAÑA); Christian E. Castro (CAIXABANK); Gonzalo Fernández Dionis (GWU) |
| Abstract: | The 2010 sovereign crisis in the euro area brought to light the depth of the monetary union’s structural weaknesses. In particular, it highlighted the dangers of the sovereign-bank nexus – the amplification effect resulting from sovereign debt being held primarily by domestic banks. In response, important changes have been put in place. From a crisis management perspective, new institutions were created, such as the European Stability Mechanism which acts as a lender of last resort for euro area countries in difficulties. From an ex ante perspective, the crisis led to the launch of the banking union, which comprises the Single Resolution Mechanism – including the Single Resolution Fund – and the still-pending European Deposit Insurance Scheme. In addition, a wide array of regulation has been put in place, including Basel III and MREL/TLAC requirements to reduce the need for bailouts during financial crises and therefore limit the use of public funds in resolution processes. Despite this, the regulatory debate on how banking regulation should address this sovereign-bank interdependence continues today. In this paper we review the main regulatory proposals aimed at curtailing both exposure to sovereign risk and ownership concentration - two factors often associated to the broader sovereign-bank nexus. We assess their impact on bank capital and risk-weighted assets and simulate banks’ responses to these measures. We find that these solutions could entail significant side effects for both banks and bond markets, highlighting the importance of completing the monetary union and, in particular, issuing a European safe asset as key measures to mitigate this vulnerability. |
| Keywords: | sovereign debt, banking regulation, safe asset, monetary union |
| JEL: | H63 G21 G28 F45 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2540 |
| By: | Francisco Arizala; Santiago Bazdresch; Tomohide Mineyama; Shiqing Hua |
| Abstract: | This paper analyzes the impact of fiscal policy on inflation expectations across a large sample of advanced economies (AEs) and emerging market economies (EMs). We identify episodes of significant fiscal adjustment using both quantitative thresholds and a narrative approach and find that such episodes are associated with statistically significant changes in inflation expectations in EMs while the responses are muted in AEs. We also document that the relationship between fiscal policy and inflation expectations is more pronounced in high-inflation environments and under weak fiscal positions. Additionally, we explore how market perceptions of sovereign risk, as well as monetary and exchange rate frameworks, influence the transmission of fiscal policy to inflation expectations. Our empirical results suggest that it is especially important for EMs to implement prudent fiscal policy as it may help reduce inflationary pressures and inflation expectations. |
| Keywords: | Fiscal Policy; Fiscal Consolidations; Inflation Expectations; Narrative Approach |
| Date: | 2025–11–07 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/231 |
| By: | Luca Fornaro; Martin Wolf |
| Abstract: | We provide a theory connecting trade policies to innovation and technological hegemony, based on the notion that high-tech clusters generate technological rents for the countries hosting them. We show that tariffs on high-tech imports may be used to steal technological rents from the rest of the world, by redirecting innovation activities from foreign to domestic firms. This strategy may lead to welfare gains, which however come at the expense of even larger welfare losses in the rest of the world. Tariffs may backfire even for the country imposing them if they are not well designed, or if the rest of the world retaliates. |
| Keywords: | tariffs, innovation, endogenous growth, international trade, intangibles, high-tech |
| JEL: | E22 F12 F13 F42 F43 O24 O33 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:upf:upfgen:1925 |
| By: | Mr. Francisco Roldan; Cesar Sosa Padilla |
| Abstract: | We study the interaction between private and official sovereign debts. We develop a quantitative sovereign default model featuring a senior creditor with whom borrowing terms are negotiated. We use this model to evaluate implications of the emergence of new official lenders not bound by the Paris Club framework. The dynamics of bilateral bargaining lead the government to issue more market debt, raising default risk and creating welfare losses. This relational overborrowing effect arises in the model due to an endogenous cross-elasticity of bilateral terms to market debt, which can be assessed in practice to evaluate new forms of bilateral sovereign debt. |
| Keywords: | Sovereign debt; debt dilution; bilateral bargaining; official debt |
| Date: | 2025–11–07 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/235 |
| By: | Mai C. 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. Exchange rate depreciations in response to negative shifts in currency demand are followed by small persistent appreciations that generate predictable expected 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. |
| JEL: | E4 F3 G12 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:34443 |
| By: | Martin Wolf; Luca Fornaro |
| Abstract: | We provide a theory connecting trade policies to innovation and technological hegemony, based on the notion that high-tech clusters generate technological rents for the countries hosting them. We show that tariffs on high-tech imports may be used to steal technological rents from the rest of the world, by redirecting innovation activities from foreign to domestic firms. This strategy may lead to welfare gains, which however come at the expense of even larger welfare losses in the rest of the world. Tariffs may backfire even for the country imposing them if they are not well designed, or if the rest of the world retaliates. |
| Keywords: | endogenous growth, high-tech, innovation, intangibles, international trade, tariffs |
| JEL: | E22 F12 F13 F42 F43 O24 O33 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:bge:wpaper:1530 |
| By: | Bassa, Karolina (The Institute for New Economic Thinking at the Oxford Martin School, University of Oxford); Cont, Rama (Mathematical Institute, University of Oxford) |
| Abstract: | We propose an empirically grounded quantitative framework for modeling sovereign credit risk and evaluating the sustainability of sovereign debt. We study the impact of fiscal and public investment policies on the sovereign's borrowing cost and credit risk in the presence of stochastic output shocks and credit-sensitive funding from investors, with a focus on the dynamics of liquidity flows and the sustainability of sovereign debt. The model is able to replicate a range of empirical observations on sovereign credit risk and sovereign defaults, in particular Argentina's 2001 default and Greece's 2012 debt restructuring events, with realistic dynamics for debt, spreads and credit ratings conditional on output. The framework is useful for debt sustainability analysis and to estimate the impact of fiscal policy on debt and output. Finally, we propose a transparent methodology for sovereign credit ratings based on this approach. |
| Keywords: | sovereign debt, fiscal policy, sovereign credit risk, sovereign default, liquidity risk, debt sustainability analysis, sovereign credit ratings |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:amz:wpaper:2025-24 |
| By: | Ingomar Krohn; Andreas Uthemann; Rishi Vala; Jun Yang |
| Abstract: | We establish an empirical framework that causally identifies how Treasury demand shocks transmit across foreign exchange and global bond markets, providing direct validation of quantity-driven theories of international risk premia. Our identification exploits predetermined auction supply to isolate demand shocks from high-frequency movements in Treasury futures prices around Treasury auctions. A one-standard-deviation increase in Treasury demand causes the U.S. dollar to depreciate by 2 basis points against G9 currencies while generating 10-basis-point increases in foreign bond prices. Effects persist for two weeks, indicating meaningful economic impacts. The transmission mechanism varies systematically across countries: those with lower U.S. short-rate correlations exhibit stronger currency responses but weaker bond effects, while higher-correlation countries show the opposite pattern. This cross-sectional variation provides empirical support for models of segmented markets where global arbitrageurs link exchange rates and bond risk premia. |
| Keywords: | Asset pricing; Exchange rates; International financial markets; Interest rates; Market structure and pricing |
| JEL: | F30 F31 G12 G15 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocawp:25-29 |
| By: | Campos, Maria Manuel; Gomes, Sandra; Jacquinot, Pascal; Cardoso-Costa, José Miguel |
| Abstract: | This paper studies the effect of alternative monetary policy responses and the implementation of different fiscal policy measures to an inflationary shock in a monetary union, through the lens of a global DSGE model calibrated to the euro area. We find that a more aggressive monetary policy response mitigates the inflation surge, but has a detrimental impact on economic activity that imposes a stronger increase of public debt, reducing the fiscal policy space. We also find that some fiscal policy measures may alleviate the negative impact of the shock on households and firms, but do not significantly alter the inflation dynamics: a reduction of consumption taxes reduces inflation only temporarily, while an increase of transfers or of public investment slightly increase inflation initially, even if the latter may have a protracted negative impact. Overall, an appropriate mix of monetary and fiscal policies may be needed to ensure a swift return of inflation to target, while mitigating the impact on consumption. Targeting transfers to support constrained households has a mild impact on inflation, but may be a way to mitigate the impact on the most vulnerable with a less detrimental effect on public debt. JEL Classification: E52, E62, E63, F45 |
| Keywords: | cost-push shock, fiscal policy, inflation, monetary policy, public debt |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20253145 |
| By: | Andrea Ariu; Giulia Rivolta (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore) |
| Abstract: | This paper quantifies the micro- and macro-level consequences of the sudden appreciation of the Swiss franc in 2015, one of the sharpest and most persistent currency movements in recent decades. Using detailed firm-level data on French imports and exports, we show that the Swiss franc appreciation led to a rise in exports, driven mainly by the entry of new firms and new products, while imports increased only briefly due to a spike in prices among continuing firm–product pairs. These dynamics mirror a textbook J-curve adjustment and reveal the firm-level mechanisms underlying this aggregate response. On the macro side, we trace how the shock propagated through supply chains, capturing both direct and indirect exposures through input–output linkages. This network-based perspective uncovers a small but negative overall impact on French GDP, driven by the stronger hit to importers, more reliant on non-euro currencies and more central within domestic production networks, who acted as key conduits transmitting the negative side of the shock across the economy. |
| Keywords: | Exchange rate shocks, international trade, production network. |
| JEL: | F14 F31 F44 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:ctc:serie1:def146 |
| By: | Alfred V Guender; Jacob Greig; Kuntal Das; Jakub Pesek |
| Abstract: | This paper assesses the global reach of US monetary policy over the 2007-2022 period in a sample of 78 countries and currency unions. Our findings show that the zero-lower-bound (ZLB) problem was restricted to advanced economies or those with currencies tied to the US dollar during the Global Financial Crisis (GFC) but became more widespread following the outbreak of COVID-19. The enormous and rapid expansion of the Fed’s balance sheet was not common elsewhere in the GFC period. Only three central banks expanded the size of their real balance sheet by more in relative terms than the Fed during the GFC and its aftermath. In contrast, six central banks did so after hitting the ZLB bound during the COVID-19 pandemic. The strongest support for a leading global role of Fed policy action comes from a pairwise assessment of central bank balance sheet changes during the two crises. Positive comovements, both contemporaneous and lagged, between US balance sheet changes and changes in other countries were common, with correlations being considerably more widespread and higher during the pandemic than the GFC. |
| Keywords: | unconventional monetary policy, zero lower bound, balance sheet management, international spillover effects, economic crises |
| JEL: | E5 E6 F4 F6 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2025-60 |
| By: | J. Scott Davis; Kevin X. D. Huang; Zheng Liu; Mark M. Spiegel |
| Abstract: | We document evidence of a U-shaped relationship between financial development and the adjustments of foreign exchange (FX) reserve holdings in response to a U.S. interest rate increase. Countries with intermediate levels of financial development sell reserves aggressively, while those with low or high development adjust little. Domestic interest rate responses are not systematically related to financial development. A model with borrowing constraints and foreign-currency debt rationalizes these findings: the associated pecuniary externality is maximized at intermediate levels of financial development. Calibrated to match the observed leverage and currency composition, the model reproduces the empirical U-shaped relationship under optimal FX reserve policy, and this relation is robust under a range of conventional interest-rate policy regimes. |
| Keywords: | foreign reserves; financial development; capital flows; optimal policy |
| JEL: | F32 F38 E52 |
| Date: | 2025–11–03 |
| URL: | https://d.repec.org/n?u=RePEc:fip:feddwp:102072 |
| By: | Bobasu, Alina; Ciccarelli, Matteo; Notarpietro, Alessandro; Ambrocio, Gene; Auer, Simone; Bonfim, Diana; Bottero, Margherita; Brázdik, František; Buss, Ginters; Byrne, David; Casalis, André; Conti, Antonio M.; Di Casola, Paola; Dobrew, Michael; Dupraz, Stéphane; Giammaria, Alessandro; Gomes, Sandra; Goodhead, Robert; Grimaud, Alex; Haavio, Markus; Martínez Hernández, Catalina; Imbierowicz, Björn; Jacquinot, Pascal; Kalantzis, Yannick; Kornprobst, Antoine; Kortelainen, Mika; Lozej, Matija; Mandler, Martin; McClung, Nigel; Mogliani, Matteo; Müller, Georg; Odendahl, Florens; Priftis, Romanos; Rannenberg, Ansgar; Reichenbachas, Tomas; Repele, Amalia; Theofilakou, Anastasia; Valderrama, María T.; Vestin, David; Vetlov, Igor; Wacks, Johannes; Zhutova, Anastasia; Zimic, Srečko; Zlobins, Andrejs; Berg, Tim Oliver; Delis, Panagiotis; Gonçalves, Nuno Vilarinho; Izquierdo, Matías Covarrubias; Le Gall, Claire; Nilavongse, Rachatar; Yakut, Dilan Aydın |
| Abstract: | This paper serves as a reference guide on the effects of “standard” monetary policy shocks on output and prices, based on harmonised simulation exercises conducted across models of the European System of Central Banks (ESCB), meta-analysis of existing empirical literature for the euro area, and selected works on heterogeneity and non-linearities in the monetary transmission mechanism as captured by empirical models. Our analysis starts by comparing the effects of monetary policy shocks as estimated by structural, semi-structural and dynamic stochastic general equilibrium (DSGE) models, and identifying the main sources of heterogeneity – most notably via the specification of monetary policy rules, the slope of the Phillips curve, the role of real rigidities and financial frictions, and the expectations formation mechanism. While DSGE models tend to produce sharper responses, semi-structural models often reveal more gradual and persistent effects, in line with backward-looking empirical models. The second chapter presents a meta-analysis of estimated effects based on the empirical literature, which are broadly consistent with the results obtained from the ESCB models, although differences might appear when correcting for publication bias, or accounting for different identification frameworks. The study is then complemented by selected works on heterogeneity and non-linearities in the monetary transmission mechanism as captured by empirical models. Our analysis in the final chapter shows that monetary policy transmission is heterogeneous across countries, sectors, demand components, and time. It also reveals important non-linear and state-dependent dynamics: in high-inflation periods, greater price and wage flexibility amplifies the response of inflation while dampening output effects, thereby lowering the sacrifice ratio. [...] JEL Classification: C22, C52, D58, E31, E52, E58, F45 |
| Keywords: | empirical models, heterogeneity, inflation, meta-analysis, monetary policy, output, semi-structural, structural models |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbops:2025377 |