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on Open Economy Macroeconomics |
| By: | Hilde C. Bjornland; Leif Brubakk; Nicolo Maffei-Faccioli |
| Abstract: | This paper examines the structural determinants of real exchange rates, emphasizing the persistent low-frequency movements that traditional models, such as Purchasing Power Parity (PPP) and Uncovered Interest Parity (UIP), often fail to capture. Building on well-established theoretical exchange rate models, we propose a structural VAR model with common trends, enabling a clear distinction between transitory and long-term effects of structural shocks. Estimated using Bayesian techniques and applied to Canada and Norway — two resource-rich economies — the model reveals that productivity shifts and commodity market trends significantly influence domestic activity and the real exchange rate in both countries. Importantly, the model also avoids the delayed overshooting puzzle commonly associated with recursive VARs in response to monetary policy shocks. Instead, it generates exchange rate dynamics consistent with the UIP hypothesis, characterized by immediate appreciation followed by a gradual depreciation to equilibrium. |
| Keywords: | real exchange rates, long-run equilibrium, productivity differentials, resource movement, Bayesian Time-Series Analysis |
| JEL: | C32 F41 O47 Q3 |
| Date: | 2025–02 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2025-10 |
| By: | Zhesheng Qiu; Yicheng Wang; Le Xu; Francesco Zanetti |
| 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 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11613 |
| By: | Kubitza, Christian; Sigaux, Jean-David; Vandeweyer, Quentin |
| Abstract: | We study the implications of deviations from covered interest rate parity for international capital flows using novel data covering euro-area derivatives and securities holdings. Consistent with a dynamic model of currency risk hedging, we document that investors’ holdings of USD bonds decrease following a widening in the USD-EUR cross-currency basis (CCB). This effect is driven by investors with larger FX rollover risk and hedging mandates, and it is robust to instrumenting the CCB. These shifts in bond demand significantly affect bond prices. Our findings shed light on a new determinant of international capital flows with important consequences for financial stability. JEL Classification: F21, F31, G11, G21, G22, G23, E44 |
| Keywords: | currency hedging, derivatives, foreign exchange, FX swap, institutional investors |
| Date: | 2025–02 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20253017 |
| By: | Alemnew, Teklebirhan; Taffesse, Alemayehu Seyoum |
| Abstract: | In both developing and developed economies, academic and policy discussions have consistently emphasized that achieving stable economic growth and maintaining internal and external balance require an exchange rate aligned with its long-term equilibrium value. This paper examines the impact of real exchange rate misalignment on Ethiopia's economic growth from 1980 to 2022. The study begins by estimating the equilibrium real exchange rate using the Behavioral Equilibrium Exchange Rate (BEER) approach to calculate the misalignments. It then analyzes the effects of these misalignments on economic growth using Vector Autoregressive (VAR) and Hansen's (2000) threshold regression model. The VAR and Impulse Response Function (IRF) analyses reveal that real exchange rate misalignments have an immediate positive impact on economic growth, which diminishes between the eighth and sixteenth years and stabilizes as a permanent long-term effect. The threshold regression results indicate that undervaluation of the Ethiopian Birr enhances economic growth up to a 13.95% deviation from the equilibrium real exchange rate, while overvaluation supports growth up to a 7.15% threshold. Beyond these limits, misalignments hinder growth. The study underscores the importance of avoiding excessive deviations from the equilibrium exchange rate to sustain economic growth. Furthermore, it highlights the need for consistent macroeconomic policies to minimize the gap between the actual and equilibrium real exchange rates. These findings emphasize the critical role of exchange rate policy in promoting sustainable economic development in Ethiopia. |
| Keywords: | ETHIOPIA; EAST AFRICA; AFRICA SOUTH OF SAHARA; AFRICA; economic growth; policies; exchange rate |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:fpr:esspwp:163 |
| By: | Marius Faber; Kemal Kilic; Gleb Kozliakov; Dalia Marin |
| Abstract: | The world economy has become more and more globalized as firms have organized production along global value chains. But more recently, globalization has stalled. This paper shows that higher uncertainty, in combination with better automation technologies, has likely contributed to that trend reversal. We show that plausibly exogenous exposure to uncertainty in developing countries leads to reshoring to high-income countries, but only if industrial robots have made this economically feasible. In contrast, we find no strong evidence of nearshoring or diversification. We address concerns about reverse causality by showing that results hold when using two alternative identification strategies. In a narrative approach, we use only locally generated spikes in uncertainty, for which the narrative around the events suggest that they are plausibly exogenous. In a small open economy approach, we restrict the sample to small developed countries that are unlikely to cause uncertainty in the developing world. Moreover, we show that results are robust to the main threats to identification related to shift-share instruments. |
| Keywords: | Global value chains, Uncertainty, Automation, Reshoring, Shift-share design |
| JEL: | F14 F15 F16 J23 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:snb:snbwpa:2025-02 |
| By: | Francesco Zanetti; Zhesheng Qiu; Yicheng Wang; Le Xu |
| Abstract: | This paper investigates the design of monetary policy in small open economies with domestic and cross-border input-output linkages and nominal rigidities. Aggregate distortions are proportional to the aggregate output gap, which can be expressed as a weighted average of sectoral markup wedges that encapsulate the inefficiency in each sector. Monetary policy can close the output gap and offset the sectoral distortions by stabilizing the aggregate index of inflation that weights inflation in each sector based on the degree of nominal rigidities and the centrality of the sector 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 larger weights to inflation in sectors with small direct or indirect (via the downstream sectors) import shares, and failing to account for the cross-border production networks overemphasizes the inflation in sectors that export intensively directly and indirectly (via the downstream sectors), generating quantitatively significant welfare losses that rise with the degree of openness of the economy. We derive the closed-form solution for the optimal monetary policy that minimizes the welfare losses up to the second-order approximation and show that the OG policy generates welfare losses quantitatively close to the optimal policy and, therefore, is nearly optimal. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:cnn:wpaper:25-004e |
| By: | Kang , Jong Woo (Asian Development Bank); Cabaero , Carlos (Asian Development Bank) |
| Abstract: | Foreign exchange (FX) trading volume is a key factor in exchange rate volatility. Given the important role of volatility in economic growth and stability, this paper investigates the dynamic nature of exchange trading volume on exchange rate volatility using hourly high-frequency data. The estimation results from ordinary least squares, fixed effects and the general autoregressive conditional heteroskedasticity model point to a significant impact of third-party foreign exchange trade volumes on the FX volatilities of original currency pairs. The United States dollar (USD), as the dominant currency, exerts sizeable effect through this third-party channel and the magnitude of the foreign exchange trading volume turns out to be a crucial factor to this effect. However, third-party currency pairs without USD linkages also exert non-negligible impact, calling for renewed attention to the effectiveness of regional financial cooperation in mitigating exchange rate volatility as compared with major foreign exchange trading partners, not only through direct transaction mechanisms but through third party currency channels. |
| Keywords: | FX volatility; third party channel; GARCH model |
| JEL: | F31 G15 G18 |
| Date: | 2025–02–06 |
| URL: | https://d.repec.org/n?u=RePEc:ris:adbewp:0768 |
| By: | António Afonso; José Alves; Sofia Monteiro |
| Abstract: | We assess the relevance of macro rates of return on time-varying fiscal and external sustainability. First, we compute the total public and private macroeconomic rates of return for 16 OECD countries from 1980 to 2022. We find that there is a positive impact of higher investment returns on stimulating higher aggregate demand, therefore resulting in higher tax revenues, which in turn lead to greater fiscal sustainability and more external sustainability by lowering the need for foreign capital and imports of goods and services. Accordingly, we demonstrate that macroeconomic rates of return of both public and private investment positively contribute to fiscal sustainability and that public sector investment also displays the same positive effect on external sustainability. |
| Keywords: | macroeconomic rates of return, fiscal sustainability, external sustainability, time-varying, public investment, private investment |
| JEL: | E22 F41 H54 H61 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11634 |