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on Open Economy Macroeconomics |
| By: | Michael B. Devereux; Eric R. Young; Changhua Yu |
| Abstract: | The dangers of high capital flow volatility and sudden stops have led economists to promote the use of capital controls as an addition to monetary policy in emerging market economies. This paper studies the benefits of capital controls and monetary policy in an open economy with financial frictions, nominal rigidities, and sudden stops. We focus on a time-consistent policy equilibrium. We find that during a crisis, an optimal monetary policy should sharply diverge from price stability. Without commitment, policymakers will also tax capital inflows in a crisis. But this is not optimal from an ex-ante social welfare perspective. An outcome without capital inflow taxes, using optimal monetary policy alone to respond to crises, is superior in welfare terms, but not time-consistent. If policy commitment were in place, capital inflows would be subsidized during crises. We also show that an optimal policy will never involve macro-prudential capital inflow taxes as a precaution against the risk of future crises (whether or not commitment is available). |
| JEL: | E44 E58 F41 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21791&r=opm |
| By: | Jonathan Eaton; Samuel S. Kortum; Brent Neiman |
| Abstract: | Obstfeld and Rogoff (2001) propose that trade frictions lie behind key puzzles in international macroeconomics. We take a dynamic multicountry model of international trade, production, and investment to data from 19 countries to assess this proposition quantitatively. Using the framework developed in Eaton, Kortum, Neiman, and Romalis (2015), we revisit the puzzles in a counterfactual with drastically lower trade frictions. Our results largely support Obstfeld and Rogoff's explanation. Most notably, with lower trade frictions, domestic investment becomes much less correlated with domestic saving, mitigating the Feldstein-Horioka (1980) puzzle. Nominal GDP becomes less variable while real GDP becomes much more closely tied to nominal GDP, mitigating the purchasing power parity and exchange rate disconnect puzzles. Lower trade frictions don't help resolve all of the puzzles, however. The correlation of consumption growth across countries, if anything, diminishes. |
| JEL: | E3 F17 F4 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21774&r=opm |
| By: | Nicolas Coeurdacier; Hélène Rey; Pablo Winant |
| Abstract: | We revisit the debate on the benefits of financial integration in a two-country neoclassical growth model with aggregate uncertainty. Our framework accounts simultaneously for gains from a more efficient capital allocation and gains from risk sharing—together with their interaction. In our general equilibrium model, risk sharing brought by financial integration has an effect on the steady-state itself, altering convergence gains from capital accumulation. Because we use global numerical methods, we are able to do meaningful welfare comparisons along the transition paths. Allowing for country asymmetries in terms of risk, capital scarcity and size, we find important differences in the effect of financial integration on output, direction of capital flows, consumption and welfare over time and across countries. This opens the door to a richer set of empirical implications than previously considered in the literature. |
| JEL: | F21 F3 F43 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21817&r=opm |
| By: | Michael Bleaney; Lin Yin |
| Abstract: | In a rational expectations model, wages and prices should respond more to shocks in currency unions than in soft pegs because of the absence of exchange rate adjustment. Empirical evidence from three currency unions tends to support this hypothesis, but the rate of adjustment is slow. |
| Keywords: | currency union, exchange rate, price JEL codes: F31 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:not:notecp:15/06&r=opm |
| By: | David Backus; Chase Coleman; Axelle Ferriere; Spencer Lyon |
| Abstract: | In models with recursive preferences, endogenous variation in Pareto weights would be interpreted as wedges from the perspective of a frictionless model with additive preferences. We describe the behavior of the (relative) Pareto weight in a two-country world and explore its interaction with consumption and the real exchange rate. |
| JEL: | F31 F41 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21773&r=opm |
| By: | Carmen M. Reinhart; Christoph Trebesch |
| Abstract: | A sketch of the International Monetary Fund’s 70-year history reveals an institution that has reinvented itself over time along multiple dimensions. This history is primarily consistent with a “demand driven” theory of institutional change, as the needs of its clients and the type of crisis changed substantially over time. Some deceptively “new” IMF activities are not entirely new. Before emerging market economies dominated IMF programs, advanced economies were its earliest (and largest) clients through the 1970s. While currency problems were the dominant trigger of IMF involvement in the earlier decades, banking crises and sovereign defaults became they key focus since the 1980s. Around this time, the IMF shifted from providing relatively brief (and comparatively modest) balance-of-payments support in the era of fixed exchange rates to coping with more chronic debt sustainability problems that emerged with force in the developing nations and now migrated to advanced ones. As a consequence, the IMF has engaged in “serial lending”, with programs often spanning decades. Moreover, the institution faces a growing risk of lending into insolvency, most widespread among low income countries in chronic arrears to the official sector, but most evident in the case of Greece since 2010. We conclude that these practices impair the IMF’s role as an international lender of last resort. |
| JEL: | E50 F33 F40 F55 G01 G15 G2 N0 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21805&r=opm |
| By: | Barry Eichengreen; Domenico Lombardi |
| Abstract: | Previous studies have focused on when the renminbi will play a significant role as an international currency, but less attention has been paid to where. We fill this gap by contrasting two answers to the question. One is that the renminbi will assume the role of a global currency similar to the U.S. dollar. Supporters point to China’s widely diversified trade and financial flows and to its institutional initiatives, not just in Asia but around the world. The other is that the renminbi will play a regional role in Asia equivalent to that of the euro in greater Europe. Proponents of this view argue that China has a natural advantage in leveraging regional supply chains and deepening its links with other Asian countries as well as in developing regional institutions. Asia, they argue on these grounds, will become the natural habitat for the renminbi. |
| JEL: | F0 F02 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21716&r=opm |
| By: | Michele Fratianni (Indiana University, Kelly School of Business, Bloomington US, Univ. Plitecnica Marche and MoFiR); Federico Giri (Universit… Politecnica delle Marche, Dipartimento di Scienze economiche e sociali) |
| Abstract: | The great depression of 1929 and the great financial crisis of 2008 have been the two big events of the last 75 years. Not only have they produced serious economic consequences but they also changed our view of economics and policymaking. The aim of this work is to compare these two great crises and highlight similarities as well as differences. Monetary policy, the exchange rate system and the role of the banks are our fields of investigation. Our findings are that two big events have more similarities than dissimilarities. |
| Keywords: | Eurozone, Great Depression, Great Financial Crisis, gold standard, money multiplier, shadow banking |
| JEL: | E31 E42 E5 G21 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:117&r=opm |
| By: | Adrian, Tobias (Federal Reserve Bank of New York); Etula, Erkko (Harvard University); Shin, Hyun Song (Bank for International Settlements) |
| Abstract: | We present evidence that the growth of U.S.-dollar-denominated banking sector liabilities forecasts appreciations of the U.S. dollar, both in-sample and out-of-sample, against a large set of foreign currencies. We provide a theoretical foundation for a funding liquidity channel in a global banking model where exchange rates fluctuate as a function of banks’ balance sheet capacity. We estimate prices of risk using a cross-sectional asset pricing approach and show that the U.S. dollar funding liquidity forecasts exchange rates because of its association with time-varying risk premia. Our empirical evidence shows that this channel is separate from the more familiar “carry trade” channel. Although the financial crisis of 2007-09 induced a structural shift in our forecasting variables, when we control for this shift, the forecasting relationship is preserved. |
| Keywords: | asset pricing; financial intermediaries; exchange rates |
| JEL: | F30 F31 G12 G24 |
| Date: | 2015–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:750&r=opm |
| By: | Joshua Aizenman |
| Abstract: | This paper highlights the rare conditions leading to international cooperation, and the reasons why eliciting this cooperation may be beneficial in preventing adverse tail shocks from spiraling into global depressions. In normal times, deeper macro cooperation among countries is associated with welfare gains akin to Harberger’s second-order magnitude triangle, making the odds of cooperation low. When bad tail events induce imminent and correlated threats of destabilizing financial markets, the perceived losses have a first-order magnitude of terminating the total Marshalian surpluses. The apprehension of these losses in times of peril may elicit rare and beneficial macro cooperation. We close the paper by overviewing the obstacles preventing cooperation, and the proliferation of precautionary policies of emerging market economies as a second-best outcome of limited cooperation. |
| JEL: | F36 F41 F42 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21793&r=opm |
| By: | Li, Wu |
| Abstract: | In this paper, a general equilibrium model is developed to analyze the determination of the equilibrium exchange rates. The model can deal with multiple types of moneys and moneys are integrated into the model through demand functions. When the endowments, preferences, production technologies and interest rates are given, the equilibrium exchange rates, equilibrium prices, equilibrium outputs and equilibrium utility levels can be computed by the model. A numerical example of a two-country economy is also presented to illustrate the model. |
| Keywords: | exchange rate; general equilibrium; multi-country economy; CGE model |
| JEL: | C5 D5 F31 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:68528&r=opm |
| By: | Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi |
| Abstract: | This paper explores the effects of labor and product market reforms in a New Keynesian, small open economy model with labor market frictions and endogenous producer entry. We show that it takes time for reforms to pay off, typically at least a couple of years. This is partly because the benefits materialize through firm entry and increased hiring, both of which are gradual processes, while any reform-driven layoffs are immediate. Some reforms—such as reductions in employment protection—increase unemployment temporarily. Implementing a broad package of labor and product market reforms minimizes transition costs. Importantly, reforms do not have noticeable deflationary effects, suggesting that the inability of monetary policy to deliver large interest rate cuts in their aftermath—either because of the zero bound on policy rates or because of membership in a monetary union—may not be a relevant obstacle to reform. Alternative simple monetary policy rules do not have a large effect on transition costs. |
| JEL: | E24 E32 E52 F41 J64 L51 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21784&r=opm |
| By: | Olivier CARDI; Romain RESTOUT |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:leo:wpaper:2299&r=opm |
| By: | Ryan Banerjee; Michael B. Devereux; Giovanni Lombardo |
| Abstract: | This paper explores the nature of macroeconomic spillovers from advanced economies to emerging market economies (EMEs) and the consequences for independent use of monetary policy in EMEs. We first empirically document the effects of US monetary policy shocks on a sample group of EMEs. A contractionary monetary shock leads a retrenchment in EME capital flows, a fall in EME GDP, and an exchange rate depreciation. We construct a the- oretical model which can help to account for these findings. In the model, macroeconomic spillovers are exacerbated by financial frictions. We assess the extent to which domestic monetary policy can mitigate the negative spillovers from foreign shocks. Absent financial frictions, international spillovers are minor, and an inflation targeting rule represents an ef- fective policy for the EME. With frictions in financial intermediation, however, spillovers are substantially magnified, and an inflation targeting rule has little advantage over an exchange rate peg. However, an optimal monetary policy markedly improves on the performance of naive inflation targeting or an exchange rate peg. Furthermore, optimal policies don’t need to be coordinated across countries. Under the specific set of assumptions maintained in our model, a non-cooperative, self-oriented optimal policy gives results very similar to those of a global cooperative optimal policy. |
| JEL: | E3 E5 F3 F5 G1 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21737&r=opm |
| By: | Charles Yuji Horioka; Akiko Terada-Hagiwara; Takaaki Nomoto |
| Abstract: | In this paper, we find that home bias is still present in all economies and regions, especially in the case of short-term debt securities, but that there are substantial variations among economies and regions in the strength of home bias, with the Eurozone economies, the US, and developing Asia showing relatively weak home bias and advanced Asia, especially Japan, showing relatively strong home bias. We then examine trends over time in foreign holdings of debt securities and find that capital has been flowing from the US and the Eurozone economies to both advanced Asia (especially Japan) and developing Asia and that foreign holdings of debt securities have been increasing in advanced as well as developing Asia but for different reasons. The main reason in the case of advanced Asia (especially Japan) appears to be higher risk-adjusted returns, whereas the main reason in the case of developing Asia appears to be the growth of debt securities markets combined with relatively weak home bias and (in the case of short-term securities) lower exchange rate volatility. Finally, we find that since the Global Financial Crisis, foreign holdings of debt securities have declined (i.e., that home bias has strengthened) in all economies and regions except developing Asia, where they have increased (except for a temporary decline in 2008) but where their share is still much lower than the optimal share warranted by the capital asset pricing market model. |
| JEL: | F21 F32 F34 G01 G15 O53 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21734&r=opm |
| By: | Agustín S. Bénétrix (Department of Economics, Trinity College Dublin); Philip R. Lane (Central Bank of Ireland, Trinity College Dublin and CEPR) |
| Abstract: | There is an extensive literature on the behaviour of fiscal variables vis-a-vis the output cycle. We show that fiscal variables also co-vary with the financial cycle, as captured by fluctuations in the current account balance and credit growth. These financial factors affect fiscal outcomes, over and above their influence on the output cycle. We argue that fiscal surveillance and the design of fiscal rules should pay close attention to the interaction between the financial cycle and the fiscal cycle. |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:tcd:tcduee:tep0815&r=opm |
| By: | Lee E. Ohanian; Paulina Restrepo-Echavarria; Mark L. J. Wright |
| Abstract: | Since 1950, the economies of East Asia grew rapidly but received little inter-national capital, while Latin America received considerable international capitaleven as their economies stagnated. The literature typically explains the failureof capital to flow to high growth regions as resulting from international capitalmarket imperfections. This paper proposes a broader thesis that country-specificdistortions, such as domestic labor and capital market distortions, also impactcapital flows. We develop a DSGE model of Asia, Latin America, and the Rest ofthe World that features an open-economy business cycle accounting framework tomeasure these domestic and international distortions, and to quantify their con-tributions to international capital flows. We find that domestic distortions havebeen the predominant drivers of international capital flows, and that the generalequilibrium effects of these distortions are very large. International capital market distortions also matter, but less. |
| JEL: | F21 F32 F41 F44 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21744&r=opm |