|
on Open MacroEconomics |
| By: | Carlos Carvalho; Fernanda Nechio |
| Abstract: | We study the purchasing power parity (PPP) puzzle in a multi-sector, two-country, sticky- price model. Across sectors, firms differ in the extent of price stickiness, in accordance with recent microeconomic evidence on price setting in various countries. Combined with local currency pricing, this leads sectoral real exchange rates to have heterogeneous dynamics. We show analytically that in this economy, deviations of the real exchange rate from PPP are more volatile and persistent than in a counterfactual one-sector world economy that features the same average frequency of price changes, and is otherwise identical to the multi-sector world economy. When simulated with a sectoral distribution of price stickiness that matches the microeconomic evidence for the U.S. economy, the model produces a half-life of deviations from PPP of 39 months. In contrast, the half-life of such deviations in the counterfactual one-sector economy is only slightly above one year. As a by-product, our model provides a decomposition of this difference in persistence that allows a structural interpretation of the different approaches found in the empirical literature on aggregation and the real exchange rate. In particular, we reconcile the apparently conflicting findings that gave rise to the "PPP Strikes Back debate" (Imbs et al. 2005a,b and Chen and Engel 2005). |
| Keywords: | Purchasing power parity ; Prices ; Foreign exchange rates |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2010-06&r=opm |
| By: | Yanping Chong; Òscar Jordà; Alan M. Taylor |
| Abstract: | Frictionless, perfectly competitive traded-goods markets justify thinking of purchasing power parity (PPP) as the main driver of exchange rates in the long-run. But differences in the traded/non-traded sectors of economies tend to be persistent and affect movements in local price levels in ways that upset the PPP balance (the underpinning of the Harrod-Balassa-Samuelson hypothesis, HBS). This paper uses panel-data techniques on a broad collection of countries to investigate the long-run properties of the PPP/HBS equilibrium using novel local projection methods for cointegrated systems. These semi-parametric methods isolate the long-run behavior of the data from contaminating factors such as frictions not explicitly modelled and thought to have effects only in the short-run. Absent the short-run effects, we find that the estimated speed of reversion to long-run equilibrium is much higher. In addition, the HBS effects means that the real exchange rate is converging not to a steady mean, but to a slowly to a moving target. The common failure to properly model this effect also biases the estimated speed of reversion downwards. Thus, the so-called "PPP puzzle" is not as bad as we thought. |
| JEL: | F31 F41 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15868&r=opm |
| By: | Se-Eun Jeong (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jacques Mazier (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Jamel Saadaoui (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII) |
| Abstract: | Since the mid-1990s, we observe an increase of world current account imbalances. These imbalances have only been partially reduced since the burst of the crisis in 2007. They reflect, to some extent, exchange rate misalignments, an issue which has been frequently studied in the literature. However, these imbalances, which have reinforced in the 2000s, are also important inside the Euro area. This analysis cannot be reduced to simple estimates of euro misalignment at the world level because of the specific constraints that exist for each member of the Euro area. This article aims to examine to what extent the intra-European imbalances reflect exchange rate misalignments for each “national euro”. |
| Keywords: | Equilibrium Exchange Rate; Current Account Balance; Macroeconomic Balance |
| Date: | 2010–03–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00435836_v4&r=opm |
| By: | A. H. Ahmad (Dept of Economics, Loughborough University); Eric J. Pentecost (Dept of Economics, Loughborough University) |
| Abstract: | The impact of terms of trade shocks on a country’s output and price level are, according to economic theory, expected to vary according to the de facto exchange rate regime. This paper tests this hypothesis how terms of trade shocks impact on 22 African countries, which operate different de facto exchange rate regimes, using a structural VAR with long-run restrictions, over the period from 1980 to 2007. The empirical findings support the view that the exchange rate regime matters as to how countries respond to exogenous external shocks like terms of trade shocks, in that output variation is greater for countries with fixed regimes, while for flexible regime countries real exchange rate variation reduces the need for output variability. |
| Keywords: | Terms of Trade, Exchange Rate Regimes, Structural VARs |
| JEL: | F13 F31 F41 |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:lbo:lbowps:2010_08&r=opm |
| By: | Federico S. Mandelman; Pau Rabanal; Juan F. Rubio-Ramírez; Diego Vilán |
| Abstract: | In this paper, we first introduce investment-specific technology (IST) shocks into an otherwise standard international real business cycle model and show that a thoughtful calibration of them along the lines of Raffo (2009) successfully addresses several of the existing puzzles in the literature. In particular, we obtain a negative correlation of relative consumption and the terms of trade (Backus-Smith puzzle), as well as a more volatile real exchange rate, and cross-country output correlations that are higher than consumption correlations (price and quantity puzzles). Then we use data from the Organisation for Economic Co-operation and Development for the relative price of investment to build and estimate these IST processes across the United States and a "rest of the world" aggregate, showing that they are cointegrated and well represented by a vector error–correction model. Finally, we demonstrate that, when we fit such estimated IST processes into the model, the shocks are actually powerless to explain any of the existing puzzles. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2010-03&r=opm |
| By: | Maurizio Michael Habib (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | This paper studies net foreign assets and the differential returns between gross foreign assets and liabilities for a sample of 49 countries between 1981 and 2007. It shows that investment income is more important than capital gains in imparting a drift to net foreign assets over the long-run, whereas the latter dominate short-term dynamics. Excess returns on net foreign assets of the United States are indeed exorbitant from a global perspective, only occasionally matched by other countries and mainly accounted for by positive valuation effects. The role of the United States as levered investor did not contribute to its exorbitant privilege. The econometric panel analysis also fails to find a robust positive relationship between leverage and excess returns. Notably, instead, real exchange rate depreciations increase excess returns through capital gains, proportionally to the relative foreign currency exposure. Excess yields on investment income are positively associated with the country risk rating. JEL Classification: F30, F31, F36. |
| Keywords: | net foreign assets, excess returns, exorbitant privilege, leverage. |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101158&r=opm |
| By: | Joshua Aizenman; Menzie D. Chinn; Hiro Ito |
| Abstract: | Using the “trilemma indexes” developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma—monetary independence, exchange rate stability, and financial openness—we examine how policy configurations affect macroeconomic performances, with focus on the Asian economies. We find that the three policy choices matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a level higher than a threshold (about 20% of GDP). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation rate. We find that trilemma policy configurations and external finances affect output volatility through the investment or trade channel depending on the openness of the economies. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be offset by holding higher levels of IR. Our results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatility of the real exchange rate. These economies’ sizeable amount of IR holding appears to enhance the stabilizing effect of the trilemma policy choices, and this may help explain the recent phenomenal buildup of IR in the region. |
| JEL: | F15 F21 F31 F36 F41 O24 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15876&r=opm |
| By: | Jarkko Jääskelä (Reserve Bank of Australia); Rebecca McKibbin (Reserve Bank of Australia) |
| Abstract: | Expectations of the future play a key role in the transmission of monetary policy. Over recent years, a lot of theoretical and applied macroeconomic research has been based on the assumption of rational expectations. However, estimated models based on this assumption typically fail to capture the dynamics of the economy unless mechanical sources of persistence, such as habit formation in consumption and/or indexation to past prices, are imposed. This paper develops and estimates a small open economy model for Australia assuming two different types of expectations: rational expectations and learning. Learning – where expectations are formed by extrapolating from the historical data – can be an alternative means to generate the persistence observed in the data. The paper has four key findings. First, learning does not reduce the importance of conventional mechanical forms of persistence. Second, despite this, the model with learning is able to generate real exchange rate dynamics that are consistent with empirical models but which are absent in standard theoretical models. Third, there is some tentative evidence that learning is preferred over rational expectations in terms of fitting the data. Fourth, since the adoption of inflation targeting, agents appear to be using a longer history of data to form their expectations, consistent with greater stability of inflation. |
| Keywords: | Learning; expectations; new Keynesian model; regime shifts |
| JEL: | E32 E52 E63 F41 |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbardp:rdp2010-02&r=opm |
| By: | Novy, Dennis (Department of Economics, University of Warwick and CESifo) |
| Abstract: | This paper derives a micro-founded gravity equation in general equilibrium based on a translog demand system that allows for endogenous markups and rich substitution patterns across goods. In contrast to standard CES-based gravity equations, trade is more sensitive to trade costs if the exporting country only provides a small share of the destination country?s imports. As a result, trade costs have a heterogeneous impact across country pairs, with some trade flows predicted to be zero. I test the translog gravity equation and find strong empirical support in its favor. In an application to the currency union effect, I find that a currency union is only associated with substantially higher bilateral trade if the exporting country provides a small share of the destination country's imports. For other pairs, the currency union effect is modest or indistinguishable from zero. Keywords: Translog ; Trade Costs ; Gravity ; Currency Union ; Monopolistic Competition ; Trade Cost Elasticity ; Heterogeneity ; Zero Trade JEL Codes: F11 ; F12 ; F15 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:929&r=opm |
| By: | Arjana Brezigar-Masten (Institute for Macroeconomic Analysis and Development); Fabrizio Coricelli (Centre d'Economie de la Sorbonne and CEPR); Igor Masten (European University Institute and University of Ljubjana) |
| Abstract: | This papers provides an empirical analysis of the role of financial development and financial integration in the growth dynamics of transition countries. We focus on the role of financial integration in determining the impact of financial development on growth, distinguishing "normal times" from periods of financial crises. In addition to confirming the significant positive effect on growth exerted by financial development and financial integration, our estimates show that a higher degree of financial openness tends to reduce the contractionary effect of financial crises, by cushioning the effect on the domestic supply of credit. Consequently, the high reliance on international capital flows by transition countries does not necessarily increase their financial fragility. This implies that financial protectionism is a self-defeating policy, at least for transition countries. |
| Keywords: | Transition economies, financial integration, financial crises, economic growth, threshold effects. |
| JEL: | F33 F36 G15 |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:10021&r=opm |