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on Open Economy Macroeconomics |
| By: | Jacopo Cimadomo (European Central Bank, Germany); Oana Furtuna (University of Amsterdam and Tinbergen Institute, the Netherlands); Massimo M. Giuliodori (University of Amsterdam and Tinbergen Institute, The Netherlands) |
| Abstract: | This paper investigates the contribution of private and public channels for consumption risk sharing in the EMU over the period 1999-2015. In particular, we explore the role of financial integration versus international financial assistance for private consumption smoothing in this set of countries. In addition, we present a time-varying test which allows estimating how risk sharing has evolved since the start of the EMU, and in particular during the recent crisis. Our results suggest that, whereas in the early years of the EMU only about 40% of output shocks were smoothed, in the aftermath of the euro zone’s sovereign debt crisis about 65% of output shocks were absorbed, therefore reducing consumption growth differentials across countries. This progressive improvement of the shock absorption capacity is due to a higher financial integration, but also to the activation of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) channelling official loans to distressed euro zone economies. We also show that cross-border holdings of equities and debt seem to be more effective than cross-border bank loans in isolating households from country-specific shocks, therefore contributing to consumption smoothing. |
| Keywords: | risk sharing; time-variation; financial integration; international financial assistance |
| JEL: | C23 E62 G11 G15 |
| Date: | 2017–07–18 |
| URL: | http://d.repec.org/n?u=RePEc:tin:wpaper:20170064&r=opm |
| By: | Laura Povoledo (University of the West of England, Bristol) |
| Abstract: | External demand is considered to be one of the channels of transmission of monetary policy to aggregate demand. If external demand matters in the monetary transmission, then the response of output to monetary shocks must be more pronounced in the sectors that are more open to trade and exposed to foreign competition. However, the empirical evidence is not conclusive. Using a New Keynesian open economy model, I show that the role of trade openness in the transmission of monetary shocks can be reversed completely by the degree of exchange-rate pass-through into import prices. If the pass-through is complete, traded output increases more than nontraded output after a positive monetary shock, if the pass-through is zero, traded output increases less. The lack of conclusive evidence on the role of external demand in the transmission of monetary shocks may also be explained by sectoral heterogeneity in price rigidity: if prices are more rigid in the nontraded sector, then it is not possible to find a positive correlation between the response of output to monetary shocks and the degree of openness, regardless of the degree of exchange rate pass-through. |
| Keywords: | Monetary transmission; External demand channel; Exchange rate pass-through; |
| JEL: | E52 F41 |
| Date: | 2016–01–09 |
| URL: | http://d.repec.org/n?u=RePEc:uwe:wpaper:20161609&r=opm |
| By: | Brauning, Falk (Federal Reserve Bank of Boston); Ivashina, Victoria (Harvard Business School) |
| Abstract: | Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often denominated in different currencies. This leads to a foreign exchange (FX) exposure that banks need to hedge. If cross‐currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest interest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity. |
| Keywords: | global banks; monetary policy transmission; cross‐border lending |
| JEL: | E44 E52 F36 G15 G21 G28 |
| Date: | 2016–12–23 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbwp:17-5&r=opm |
| By: | Matthew Greenwood-Nimmo (Department of Economics, The University of Melbourne); Viet Hoang Nguyen (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); Yongcheol Shin (Department of Economics and Related Studies, University of York) |
| Abstract: | We develop an empirical network model to study bilateral sovereign credit risk spillovers during the European debt crisis. We show that the spillover density is typically asymmetric with heavy tails. This confounds efforts to track time-variation in spillover activity using the mean-based summary statistics that are widespread in the literature. Density-based measures — specifically divergence criteria — yield stronger and timelier signals of changes in spillover activity than mean-based measures. This is particularly apparent for sovereign bailouts, which principally affect the tails of the spillover density. Consequently, densitybased measures provide valuable additional information about changes in the credit risk environment. |
| Keywords: | Sovereign credit risk, credit default swaps (CDS), network models and connectedness, spillover density, divergence criteria |
| JEL: | C58 F45 G15 H63 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:iae:iaewps:wp2017n17&r=opm |
| By: | Jesús Fernández-Villaverde; Tano Santos |
| Abstract: | This paper argues that institutions and political party systems are simultaneously determined. A large change to the institutional framework, such as the creation of the euro by a group of European countries, will realign – after a transition period – the party system as well. The new political landscape may not be compatible with the institutions that triggered it. To illustrate this point, we study the case of the euro and how the party system has evolved in Southern and Northern European countries in response to it. |
| JEL: | D72 F30 F40 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:23599&r=opm |
| By: | Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas) |
| Abstract: | The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, I show that the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that the theoretical predictions of the workhorse open-economy New Keynesian model are largely consistent with the stylized facts of the globalization era started in the 1960s and the Great Moderation period that followed. |
| JEL: | C11 C13 F41 |
| Date: | 2017–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:321&r=opm |
| By: | Enrique Mendoza (University of Pennsylvania) |
| Abstract: | Infrequent but turbulent episodes of outright sovereign default on domestic creditors are considered a “forgotten history†in Macroeconomics. We propose a heterogeneous-agents model in which optimal debt and default on domestic and foreign creditors are driven by distributional incentives and endogenous default costs due to the value of debt for self-insurance, liquidity and risk-sharing. The government's aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical co-movements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt and yet spreads are zero most of the time. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:279&r=opm |
| By: | Kanda Naknoi (University of Connecticut); Hanno Lustig (Stanford University); YiLi Chien (Federal Reserve Bank of St. Louis) |
| Abstract: | Empirical work on asset prices suggests that pricing kernels have to be almost perfectly correlated across countries. If they are not, real exchange rates are too smooth to be consistent with high Sharpe ratios in asset markets. However, the cross-country correlation of macro fundamentals is far from perfect. We reconcile these empirical facts in a two-country stochastic growth model with heterogeneous household portfolios. A large fraction of households either hold low risk portfolios and/or do not adjust their portfolio optimally, and these households drive down the cross-country correlation in aggregate consumption. Only a small fraction of households participate in international risk sharing by frequently trading domestic and foreign equities. These active traders are the marginal investors, who impute the almost perfect correlation in pricing kernels. In our calibrated economy, we show that this mechanism can quantitatively account for the excess smoothness of exchange rates in the presence of highly volatile stochastic discount factors. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:214&r=opm |
| By: | Alok Johri; Terry Yip |
| Abstract: | The collapse in trade relative to GDP during 2008-09 was unusually large historically and puzzling relative to the predictions of canonical two-country models.In a calibrated dynamic general equilibrium two-country model where firms must build supply chain relationship in order to sell their product, we show that a tightening of credit can cause a sizable fall in the trade-GDP ratio (44 percent of the observed value) while productivity shocks cannot. The key mechanism underlying the sharper fall in trade relative to GDP involves an endogenous reallocation of scarce resources from international to domestic supply-chains, that are acquired and maintained at lower cost. |
| JEL: | E32 F41 F44 |
| Date: | 2017–06–07 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:deptwp:2017-11&r=opm |
| By: | Stephen McKnight (El Colegio de México); Laura Povoledo (University of the West of England, Bristol) |
| Abstract: | We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. In contrast to the one-good models of the existing literature, we show that sunspot shocks alone cannot replicate the data. Next, we consider a combination of sunspot shocks and technology shocks, and find that the indeterminacy model can now account for the counter-cyclical behavior observed for the terms of trade and real net exports, while simultaneously increasing their volatilities relative to output. The empirical success of the model is due to an unconventional transmission mechanism, whereby the terms of trade appreciates, rather than depreciates, in response to a positive technology shock. This unconventional feature, when combined with sunspot shocks, helps to reconcile the model with the data. However, the major failure of the model is its inability to resolve the Backus-Smith puzzle without a strongly negative cross-country correlation for productivity shocks. |
| Keywords: | Indeterminacy; Sunspots; International Business Cycles; Net Exports; Terms of |
| JEL: | E32 F41 F44 |
| Date: | 2016–01–10 |
| URL: | http://d.repec.org/n?u=RePEc:uwe:wpaper:20161610&r=opm |
| By: | Patrick Bolton; Haizhou Huang |
| Abstract: | When a nation can finance its investments via foreign-currency denominated debt or domestic-currency claims, what is the optimal capital structure of the nation? Building on the functions of fiat money as both medium of exchange, and store of value like corporate equity, our model connects monetary economics, fiscal theory and international finance under a unified corporate finance perspective. With frictionless capital markets both a Modigliani-Miller theorem for nations and the classical quantity theory of money hold. With capital market frictions, a nation's optimal capital structure trades off inflation dilution costs and expected default costs on foreign-currency debt. Our framing focuses on the process by which new money claims enter the economy and the potential wealth redistribution costs of inflation. |
| JEL: | E5 E62 F3 F4 G3 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:23612&r=opm |