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on Open Economy Macroeconomic |
| By: | Philippe Bacchetta (University of Lausanne, Swiss Finance Institute, Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Eric van Wincoop (University of Virginia, National Bureau of Economic Research, and Hong Kong Institute for Monetary Research) |
| Abstract: | While the 2008-2009 financial crisis originated in the United States, we witnessed steep declines in output, consumption and investment of similar magnitudes around the globe. This raises two questions. First, given the observed strong home bias in goods and financial markets, what can account for the remarkable global business cycle synchronicity during this period? Second, what can explain the difference relative to previous recessions, where we witnessed far weaker co-movement? To address these questions, we develop a two-country model that allows for self-fulfilling business cycle panics. We show that a business cycle panic will necessarily be synchronized across countries as long as there is a minimum level of economic integration. Moreover, we show that several factors generated particular vulnerability to such a global panic in 2008: tight credit, the zero lower bound, unresponsive fiscal policy and increased economic integration. |
| Date: | 2013–06 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:092013&r=opm |
| By: | Kyriacos Lambrias |
| Abstract: | We propose a fully flexible, complete-market model of the international business cycle that is consistent with two major empirical facts: positive cross-country co-movement of economic aggregates and a negative correlation between the real exchange rate and relative consumption (the Backus-Smith puzzle). The model features non-tradable goods, zero wealth effects on labour supply, imperfect substitutability of capital across sectors and variable capacity utilisation. The latter can generate strong Balassa-Samuelson effects that drive a low consumption-real exchange rate correlation. Cyclical movements across countries are also positively correlated. The novelty of our paper is to introduce changes in expectations (news-shocks) as an explanation to the Backus-Smith puzzle through the wealth effects of future changes in income, while being consistent with expectations-driven economic expansions. |
| Keywords: | News-Driven Cycles, Backus-Smith Puzzle, Real-Exchange Rates |
| JEL: | F41 F44 |
| Date: | 2013–07 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp083&r=opm |
| By: | Ehsan U. Choudhri (Department of Economics, Carleton University, Canada); Lawrence L. Schembri (Bank of Canada, Canada) |
| Abstract: | The paper examines the Canada-U.S. real exchange rate since the early 1970’s to test two popular explanations of the long-run real exchange rate based on the influence of sectoral productivities and commodity prices. The empirical analysis finds that both variables exert a significant long-run effect. However, the relation for the real exchange rate has shifted as the effect of each variable has become stronger and a positive trend is present since 1990. The effect of productivity, moreover, is opposite to that predicted by the standard Balassa-Samuelson theory. An explanation of these findings is suggested based on a general-equilibrium model that includes differentiated traded manufactures and homogeneous commodities. |
| Keywords: | Real exchange rates; Productivity; Commodity prices; Balassa-Samuelson model |
| JEL: | F41 F31 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:45_13&r=opm |
| By: | George Alessandria; Sangeeta Pratap; Vivian Yue |
| Abstract: | We study the source and consequences of sluggish export dynamics in emerging markets following large devaluations. We document two main features of exports that are puzzling for standard trade models. First, given the change in relative prices, exports tend to grow gradually following a devaluation. Second, high interest rates tend to suppress exports. To address these features of export dynamics, we embed a model of endogenous export participation due to sunk and per period export costs into an otherwise standard small open economy. In response to shocks to productivity, the interest rate, and the discount factor, we find the model can capture the salient features of export dynamics documented. At the aggregate level, the features giving rise to sluggish exports lead to more gradual net export reversals, sharper contractions and recoveries in output, and endogenous stagnation in labor productivity. |
| Keywords: | Exports |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:13-33&r=opm |
| By: | Patricia Gómez-González (Massachusetts Institute of Technology); Daniel Rees (Reserve Bank of Australia) |
| Abstract: | The terms of trade of commodity-producing small open economies are subject to large shocks that can be an important source of economic fluctuations. Alongside times of high volatility, however, these economies also experience periods in which their terms of trade are comparatively stable. We estimate the empirical process for the terms of trade for six small open economies and examine the responses of output, the current account and prices to changes in terms of trade volatility using a vector autoregression (VAR). We find that increased terms of trade volatility, by itself, is associated with a contraction in domestic demand and an increase in the current account. We then set up a small open economy real business cycle model and show that it can broadly replicate the responses to a volatility shock estimated in the VAR. We use this model to explore the sectoral implications of terms of trade volatility shocks and to quantify the importance of these shocks as a source of business cycle fluctuations. Our results suggest that the direct effects of terms of trade volatility shocks on output, consumption and investment are generally small. But, interacted with shocks to the level of the terms of trade, volatility shocks account for around one-quarter of the total impact of the terms of trade on macroeconomic outcomes. |
| Keywords: | terms of trade; small open economy; real business cycle; stochastic volatility |
| JEL: | C32 E32 F41 Q33 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbardp:rdp2013-10&r=opm |
| By: | Kugler, Maurice (United Nations Development Programme (UNDP)); Levintal, Oren (Bar-Ilan University); Rapoport, Hillel (Bar-Ilan University) |
| Abstract: | The gravity model has provided a tractable empirical framework to account for bilateral flows not only of manufactured goods, as in the case of merchandise trade, but also of financial flows. In particular, recent literature has emphasized the role of information costs in preventing larger diversification of financial investments. This paper investigates the role of migration in alleviating information imperfections between home and host countries. We show that the impact of migration on financial flows is strongest where information problems are more acute (that is, for more informational sensitive investments and between more culturally distant countries) and for the type of migrants that are most able to enhance the flow of information, namely, skilled migrants. We interpret these differential effects as additional evidence pointing to the role of information in generating home-bias and as new evidence of the role of migration in reducing information frictions between countries. |
| Keywords: | migration, international financial flows, international loans, gravity models, information asymmetries |
| JEL: | F21 F22 O1 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp7548&r=opm |
| By: | Haddow, Abigail (Bank of England); Mileva, Mariya (Kiel Institute for the World Economy) |
| Abstract: | The aim of this paper is to investigate theoretically how financial factors affect the international transmission mechanism. We build a two-country dynamic stochastic general equilibrium model with sticky prices and financial frictions. To add to the literature we extend the model to include two types of credit spread shocks that are micro-founded; a mean preserving shock to the dispersion of firms idiosyncratic productivity (risk shock) and a shock to financial agents net worth (financial wealth shock). We find that the source of the shock to the credit spread matters; credit spread shocks of equivalent size, but driven by different innovations, have different consequences for output and inflation in the home and foreign economy. In general risk shocks generate more realistic spillovers to activity than a financial wealth shock. |
| Keywords: | International transmission mechanism; financial frictions; financial shocks; DSGE model |
| JEL: | E37 F41 F42 F44 |
| Date: | 2013–08–16 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0479&r=opm |
| By: | Dong He (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); Paul Luk (Hong Kong Institute for Monetary Research) |
| Abstract: | In shaping the evolution of the global financial system in the decade ahead, few events will likely be more significant than capital account liberalisation in China and the internationalisation of the renminbi. This paper provides a theory-based enquiry into the contours of China's international balance sheets after the renminbi becomes convertible under the capital account. We construct a two-country general equilibrium model with trading in equities and bonds and calibrate the model with US and Chinese data. We interpret Chinese capital account liberalisation as a removal of restrictions that prohibit agents from trading Chinese bonds and US equities. We explore how international risk-sharing can be achieved through portfolio diversification in each of these asset market configurations. We also look at how these holdings would change as China gradually rebalances its production with a higher share of labour income, and as the productivity gap between China and the US narrows. We find that both US and Chinese residents would have incentives to increase their holdings in each other's equities, and to issue debt in each other's currency. We interpret the latter observation as the co-existence of the US dollar and the renminbi as major international currencies. |
| Keywords: | China, Country Portfolios, Capital Account Liberalization, Renminbi Internationalization |
| JEL: | F3 F4 G1 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:122013&r=opm |
| By: | Peter Fuleky (UHERO, University of Hawaii at Manoa); Luigi Ventura (Department of Economics and Law, Sapienza, University of Rome); Qianxue Zhao (UHERO, University of Hawaii at Manoa) |
| Abstract: | Existing studies of risk pooling among groups of countries are predicated upon the highly restrictive assumption that all countries have symmetric responses to aggregate shocks. We show that the conventional risk sharing test fails to isolate idiosyncratic fluctuations within countries and produces spurious results. To avoid these problems, we propose an alternative form of the risk sharing test that is robust to heterogeneous country characteristics. In our empirical example, we provide estimates using the proposed approach for various groupings of 158 countries. |
| Keywords: | Panel data, Cross-sectional dependence, International risk sharing, Consumption insurance |
| JEL: | C23 C51 E21 F36 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:hae:wpaper:2013-3r&r=opm |
| By: | Rajesh Singh (Iowa State University) |
| Abstract: | This paper studies optimal monetary policy in a small open economy under flexible prices. The paper's key innovation is to analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). In this environment, we study three rules: the optimal state contingent monetary policy; the optimal non-state contingent money growth rule; and the optimal non-state contingent devaluation rate rule. We compare welfare and the volatility of macro aggegates like consumption, exchange rate, and money under the different rules. One of our key findings is that amongst non-state contingent rules, policies targeting the exchange rate are, in general, welfare dominated by policies which target monetary aggregates. Crucially, we find that fixed exchange rates are almost never optimal. On the other hand, under some conditions, a non-state contingent rule like a fixed money rule can even implement the first-best allocation. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:103&r=opm |
| By: | Vespignania, Joaquin L. (School of Economics and Finance, University of Tasmania); Ratti, Ronald A. (School of Business, University of Western Sydney) |
| Abstract: | It is found that over 1999:1-2012:12 China’s monetary expansion influences Japan through the effect of China’s growth on world commodity prices, increased demand for imports, and exchange rate policy. China’s monetary expansion is associated with significant increases in Japan’s industrial production, exports and inflation, and decreases in the trade-weighted yen. In contrast, U.S. monetary expansion results in contraction in Japan’s industrial production, exports and trade balance (expenditure-switching). Monetary expansion in the Euro area does not significantly affect Japan. Structural vector error correction models are estimated. Results are robust to various contemporaneous restrictions for the effect of international monetary variables, the interaction of foreign and domestic variables and to factor augmented VAR to identify monetary shocks |
| Keywords: | International Monetary shocks, Japanese economy, Oil/commodity prices, SVEC models |
| JEL: | E52 F41 F42 Q43 |
| Date: | 2013–08–05 |
| URL: | http://d.repec.org/n?u=RePEc:tas:wpaper:16920&r=opm |
| By: | Christoph A. Schaltegger; Martin Weder |
| Abstract: | Based on probit estimates, this paper analyzes the effects of fiscal consolidation on the prob- ability of sovereign defaults in the short run. Using a panel of 104 developing countries from 1980 to 2009 and controlling for various economic, fiscal and political fa ctors, we find that fiscal adjustments in general do not significantly reduce the probability of default even if they are large. Instead, the composition of budget consolidation is decisive in reducing default risk. In contrast to industrialized countries, expenditure based adjustments are not successful while revenue based adjustments lower the probability of default in the following year by 33 to 56 percent. This finding also holds when economic growth is low or government debt is high as well as when IMF lending is taken into account. |
| Keywords: | sovereign default; fiscal policy; fiscal adjustment; bailout |
| JEL: | E62 H62 H63 |
| Date: | 2013–04 |
| URL: | http://d.repec.org/n?u=RePEc:cra:wpaper:2013-06&r=opm |
| By: | Ehsan U. Choudhri (Carleton University, Canada); Lawrence L. Schembri (Bank of Canada, Canada) |
| Abstract: | The paper examines the experience of Canada and the United States in the run-up to the two biggest financial crises in global history, in the 1920s and 2000s, and the roles of their monetary and financial stability policies. Comparing the Canadian and the U.S. experiences over the two periods is instructive because Canadian monetary policy was somewhat more conservative than U.S. monetary policy and there were important institutional differences in the two periods: Canada did not have a central bank in the 1920’s and followed different financial stability policies in the 2000’s. We present evidence that suggests two conclusions. Firstly, a more moderate Canadian monetary policy in the two booms affected Canada’s relative macroeconomic performance during the booms; in particular, the extent of the economic expansion was less. Secondly, this difference, however, by itself, does not explain why Canada fared better in the recent crisis, but not in the Great Depression. Indeed, the comparative evidence suggests that it was the difference in the effectiveness of financial stability policies, primarily financial regulation supervision with respect to banks and housing finance, that explains the better Canadian performance during the recent crisis. In contrast, in the 1920s, both countries lacked the financial policies to control excess credit growth and both suffered as a consequence. In addition, both countries made policy mistakes in aftermath of the stock market crash and credit collapses; in particular, Canada pursued inflexible interest and exchange rate policies that aggravated the economic downturn. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:44_13&r=opm |