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on Open Economy Macroeconomics |
| By: | Stephane Auray (CREST-Ensai and ULCO); Aurelien Eyquem (CREST-Ensai and Universite de Lyon); Paul Gomme (Concordia University and CIREQ) |
| Abstract: | We solve for the Ramsey-optimal path for government debt, labor income taxes and capital income taxes for a small open economy with an endogenously-determined real exchange rate. Due to the endogenous exchange rate, the model must be solved using the `primal problem': maximize the lifetime utility of the representative household subject to equilibrium conditions and the government budget constraint. The open economy constrains the government's setting of the capital income tax rate since physical capital cannot be dominated in rate of return by foreign assets. However, the endogenous real exchange rate loosens this constraint relative to a one good open economy model in which the real exchange rate is necessarily fixed. |
| Keywords: | Optimal fiscal policy, Tax reforms, Welfare |
| JEL: | E32 E52 F41 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:crd:wpaper:17002&r=opm |
| By: | Richard H. Clarida |
| Abstract: | This paper highlights some of the theoretical and practical implications for monetary policy and exchange rates that derive specifically from the presence of a global general equilibrium factor embedded in neutral real policy rates in open economies. Using a standard two country DSGE model, we derive a structural decomposition in which the nominal exchange rate is a function of the expected present value of future neutral real interest rate differentials plus a business cycle factor and a PPP factor. Country specific “r*” shocks in general require optimal monetary policy to pass these through to the policy rate, but such shocks will also have exchange rate implications, with an expected decline in the path of the real neutral policy rate reflected in a depreciation of the nominal exchange rate. We document a novel empirical regularity between the equilibrium error in the VECM representation of the empirical Holston Laubach Williams (2017) four country r* model and the value of the nominal trade weighted dollar. In fact, the correlation between the dollar and the 12 quarter lag of the HLW equilibrium error is estimated to be 0.7. Global shocks to r* under optimal policy require no exchange rate adjustment because passing though r* shocks to policy rates ‘does all the work’ of maintaining global equilibrium. We also study a richer model with international spill overs so that in theory there can be gains to international policy cooperation. In this richer model we obtain a similar decomposition for the nominal exchange rate, but with the added feature that r* in each country is a function global productivity and business cycle factors even if these factors are themselves independent across countries. We argue that in practice, there could well be significant costs to central bank communication and credibility under a regime formal policy cooperation, but that gains to policy coordination could be substantial given that r*’s are unobserved but are correlated across countries. |
| JEL: | E4 F31 F33 |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:23562&r=opm |
| By: | Antonia Lopez-Villavicencio; Valérie Mignon |
| Abstract: | This paper assesses the impact of globalization and regionalization on exchange rate pass-through (ERPT) into import prices in three core eurozone countries. To this end, we consider various indicators of globalization and rely on both aggregated (i.e., country level) and disaggregated (i.e., good level) data. Using quarterly data since 1992, we do not find compelling evidence that global factors cause a structural change in the degree of exchange rate pass-through. Indeed, increased trade openness or lower trade tariffs push up ERPT in some sectors, though results are quite sparse. However, regionalization, defined as a higher proportion of intra-EU imports' share in total imports, reduces the pass-through in a more generalized way. Most importantly, we show that ERPT incompleteness generally observed in the literature is in appearance only and not at play when intra-EU trade is controlled for. Overall, our findings show that ERPT is complete and significant in numerous sectors, meaning that exchange rate changes still exert important pressure on domestic prices. |
| Keywords: | exchange rate pass-through; import prices; globalization; eurozone. |
| JEL: | E31 F31 F4 C22 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2017-32&r=opm |
| By: | Stefan Avdjiev; Leonardo Gambacorta; Linda S. Goldberg; Stefano Schiaffi |
| Abstract: | The post-crisis period has seen a considerable shift in the composition and drivers of international bank lending and international bond issuance, the two main components of global liquidity. The sensitivity of both types of flow to US monetary policy rose substantially in the immediate aftermath of the Global Financial Crisis, peaked around the time of the 2013 Fed “taper tantrum”, and then partially reverted towards pre-crisis levels. Conversely, the responsiveness of international bank lending to global risk conditions declined considerably post-crisis and became similar to that of international debt securities. The increased sensitivity of international bank flows to US monetary policy has been driven mainly by post-crisis changes in the behaviour of national lending banking systems, especially those that ex ante had less well capitalized banks. By contrast, the post-crisis fall in the sensitivity of international bank lending to global risk was mainly due to a compositional effect, driven by increases in the lending market shares of better-capitalized national banking systems. The post-2013 reversal in the sensitivities to US monetary policy partially reflects the expected divergence of the monetary policy of the US and other advanced economies, highlighting the sensitivity of capital flows to the degree of commonality of cycles and the stance of policy. Moreover, global liquidity fluctuations have largely been driven by policy initiatives in creditor countries. Policies and prudential instruments that reinforced lending banks’ capitalization and stable funding levels reduced the volatility of international lending flows. |
| JEL: | F34 G10 G21 |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:23565&r=opm |
| By: | Chaoran Chen (University of Toronto) |
| Abstract: | Cross-country differences in capital intensity are larger in the agricultural sector than in the non-agricultural sector, indicating that rich and poor countries differ in agricultural technology adoption. I build a two-sector general equilibrium model featuring technology adoption in agriculture. As the economy develops, farmers gradually adopt a modern capital-intensive technology to replace the traditional labour-intensive technology, as is observed in the U.S. historical data. Using this model, I find that the technology adoption channel is key to accounting for low agricultural capital intensity and labour productivity in poor countries. In the model, measured aggregate factors – land endowment, economy-wide productivity, and barriers to investment – can explain 1.56-fold more in rich-poor agricultural productivity differences compared to a model without technology adoption. I further show that land market frictions in agriculture impede technology adoption and magnify productivity differences. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:9&r=opm |
| By: | Dagfinn Rime; Andreas Schrimpf; Olav Syrstad |
| Abstract: | This paper studies the violation of the most basic no-arbitrage condition in international finance - Covered Interest Parity (CIP). To understand the CIP conundrum, it is key to (i) account for funding frictions in U.S. dollar money markets, and (ii) to study the challenges of swap intermediaries when funding liquidity evolves differently across major currency areas. We find that CIP holds remarkably well for most potential arbitrageurs when applying their marginal funding rates. With severe funding liquidity differences, however, it becomes impossible for dealers to quote prices such that CIP holds across the full rate spectrum. A narrow set of global top-tier banks enjoys risk-less arbitrage opportunities as dealers set quotes to avert order flow imbalances. We show how a situation with persistent arbitrage profits arises as an equilibrium outcome due to the constellation of market segmentation, the abundance of excess reserves and their remuneration in central banks' deposit facilities. |
| Keywords: | Covered interest parity, money market segmentation, funding liquidity premia, FX swap market, U.S. dollar funding |
| JEL: | E43 F31 G15 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:651&r=opm |