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on Open Economy Macroeconomics |
| By: | Olivier J. Blanchard; Mitali Das |
| Abstract: | Debt sustainability is fundamentally a probabilistic concept: Debt is rarely sustainable with probability one. We propose an index of external debt sustainability that reflects this uncertainty. Namely we construct the index as the probability that, at the current exchange rate, net external debt is equal to or less than the present value of net exports. Constructing this index involves three steps: (1) deriving the distribution of the present value of net exports at the current exchange rate; (2) deriving the distribution of exchange rates associated with the condition that, for each realization, the present discounted value of net exports is at least equal to the value of current net debt; and (3) assessing where the current exchange rate stands in the distribution of exchange rates and thus the probability that debt is sustainable. Having shown how this can be done, we then compute the index for two countries, the United States and Chile. Our main conclusion is the large degree of uncertainty implied by the presence of large gross asset and liability positions, together with uncertainty about rates of return on these assets and liabilities. The size of the distribution of exchange rate adjustments implies that one should be careful in concluding that debt is or is not sustainable at the current exchange rate and that strong measures are potentially needed to reestablish sustainability. Exchange rates that appear overvalued in the baseline may still imply a reasonably high probability that debt is sustainable at the current exchange rate; symmetrically, exchange rates that appear undervalued in the baseline may still come with a reasonably low probability that debt is unsustainable at the current exchange rate. |
| JEL: | F32 F34 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24068&r=opm |
| By: | Laura Alfaro (Harvard Business School, Business, Government and the International Economy Unit); Alejandro Cuñat (University of Vienna); Harald Fadinger (University of Mannheim); Yanping Liu (University of Mannheim) |
| Abstract: | We evaluate manufacturing firms' responses to changes in the real exchange rate (RER) using detailed firm-level data for a large set of countries for the period 2001-2010. We uncover the following stylized facts: In emerging Asia, real depreciations are associated with faster growth of firm-level TFP, sales and cash-ow, higher probabilities to engage in R&D and export. We find no significant effects for firms from industrialized economies and negative effects for firms in other emerging economies, which are less export-intensive and more import-intensive. Motivated by these facts, we build a dynamic model in which real depreciations raise the cost of importing intermediates, but increase demand and the profitability to engage in exports and R&D, thereby relaxing borrowing constraints and enabling more firms to overcome the fixed-cost hurdle for financing R&D. We decompose the effects of RER changes on productivity growth into these channels and explain regional heterogeneity in the effects of RER changes in terms of differences in export intensity, import intensity and financial constraints. We estimate the model and quantitatively evaluate the different mechanisms by providing counterfactual simulations of temporary real exchange rate movements. Effects on physical TFP growth, while different across regions, are non-linear and asymmetric. |
| Keywords: | real exchange rate, firm level data, innovation, productivity, exporting, importing, credit constraints |
| JEL: | F O |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:hbs:wpaper:18-044&r=opm |
| By: | Arellano, Cristina (Federal Reserve Bank of Minneapolis); Bai, Yan (University of Rochester); Lizarazo, Sandra (International Monetary Fund) |
| Abstract: | We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases the lenders' pricing kernel, which makes home borrowing more expensive and can induce a home default. Countries also default together because by doing so they can renegotiate the debt simultaneously and pay lower recoveries. We apply our model to the 2012 debt crises of Italy and Spain and show that it can replicate the time path of spreads during the crises. In a counterfactual exercise, we find that the debt crisis in Spain (Italy) can account for one-half (one-third) of the increase in the bond spreads of Italy (Spain). |
| Keywords: | Sovereign default; Bond spreads; Renegotiation; European debt crisis |
| JEL: | F30 G01 |
| Date: | 2017–11–13 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:559&r=opm |
| By: | Edward Nelson |
| Abstract: | Economic research in recent years has given considerable prominence to the issue of whether a floating exchange rate provides autonomy with regard to monetary policy to a central bank whose economy is highly open. In particular, Rey (2016) has argued that inflation-targeting advanced economies lack monetary policy autonomy by pointing to results suggesting that U.S. monetary policy shocks matter for the behavior of key financial variables in these economies. In contrast, it is argued in this paper that monetary autonomy does prevail in inflation-targeting advanced economies, notwithstanding the reaction of these economies’ asset prices to U.S. monetary policy developments. The reason is that the monetary-autonomy argument, as advanced by Milton Friedman and as embedded in new open-economy models, rests on the fact that the monetary base is insulated from foreign influences under floating rates. This fact allows the home monetary authority to pursue a stabilization policy in which it has a decisive influence on nominal variables in the long run, as well as a short-run influence on real variables. The result that rest-of-world monetary policy is among the other factors affecting the short-run behavior of real variables (including real asset prices) in a small, floating-rate open economy turns out to be consistent with the traditional and appropriate concept of monetary policy autonomy under floating exchange rates. It follows that such effects of rest-of-world monetary policy on the home economy are consistent with the celebrated open-economy trilemma. |
| Keywords: | Monetary policy autonomy ; Trilemma ; Floating exchange rates ; Inflation targeting |
| JEL: | E51 E52 F41 |
| Date: | 2017–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2017-112&r=opm |
| By: | Shahed Khan (McMaster University); Alok Johri (McMaster University); Cesar Sosa-Padilla (University of Notre Dame) |
| Abstract: | As the United States emerged from the Great Recession, there was considerable uncer- tainty around the future direction of US monetary policy exemplified by the chatter and speculation around tapering of quantitative easing by the US Fed in the financial press. The increased uncertainty around the timing and speed of the tapering coincided with a sharp spike in the sovereign bond yields of several emerging economies. We explore the impact of an increase in interest rate uncertainty on the borrowing costs of a small open economy in an otherwise standard model of sovereign default, where spread is endogenous. We find that introducing time-varying volatility in the world interest rate (i.e. uncertainty shocks) the model predicts a mean sovereign spread that is 115% larger and 126% more volatile. The model also predicts that countries default more than twice as frequently. Moreover, the equilibrium debt-to-income ratio is 19% lower. The welfare gains from eliminating uncertainty about the world interest rate amount up to a 1.8% permanent increase in consumption. Overall, we find quantitative support for the widespread con- cerns regarding the uncertainty about when and how the Fed will unwind its quantitative easing. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1192&r=opm |
| By: | Stijn Claessens; M Ayhan Kose |
| Abstract: | This paper surveys the literature on the linkages between asset prices and macroeconomic outcomes. It focuses on three major questions. First, what are the basic theoretical linkages between asset prices and macroeconomic outcomes? Second, what is the empirical evidence supporting these linkages? And third, what are the main challenges to the theoretical and empirical findings? The survey addresses these questions in the context of four major asset price categories: equity prices, house prices, exchange rates and interest rates, with a particular focus on their international dimensions. It also puts into perspective the evolution of the literature on the determinants of asset prices and their linkages with macroeconomic outcomes, and discusses possible future research directions. |
| Keywords: | equity prices, exchange rates, house prices, interest rates, credit, output, consumption, investment, real-financial linkages, macrofinancial linkages, imperfections, frictions |
| JEL: | D53 E21 E32 E44 E51 F36 F44 G01 G10 G12 G14 G15 G21 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:676&r=opm |
| By: | Eda Gülşen (Central Bank of the Republic of Turkey, Research Department, Ankara, Turkey); Erdal Özmen (Middle East Technical University, Department of Economics, Ankara, Turkey) |
| Abstract: | We empirically investigate the validity of the monetary policy trilemma postulation for emerging market (EME) and advanced (AE) economies under different exchange rate and monetary policy regimes before and after the recent global financial crisis (GFC). Consistent with the dilemma proposition, domestic interest rates are determined by global financial conditions and the FED rate even under floating exchange rate regimes (ERR) in the long-run. The impact of the FED rates is higher in EME than AE and EME are much more sensitive to global financial cycle under managed than floating ERR. The spillover from the FED rate substantially increases after the GFC in EME with floating ERR and AE. The results from the monetary policy reaction functions based on equilibrium correction mechanism specifications suggest that domestic interest rates respond to inflation and output gaps especially under inflation targeting (IT) in the short-run. The response to inflation gap tends to be smaller in IT AE after the GFC. |
| Keywords: | Exchange rate regimes, Global financial crisis, Inflation targeting, Monetary policy, Policy trilemma |
| JEL: | E50 E52 F30 F33 F42 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:met:wpaper:1714&r=opm |
| By: | Zouhair Aït Benhamou |
| Abstract: | In an open economy setting, the slope in the New Keynesian Phillips Curve (NKPC) becomes sensitive to openness to trade, particularly so in emerging economies. The literature tends to overlook the underlying issues of this aspect, a shortcoming which we seek to address in this paper. We argue that a new Keynesian model framework with real rigidities can remedy to this limitation. To the literature's use of a constant domestic bias parameter, we substitute the concept of imperfect access to consumption goods. Our model incorporates real rigidities in the New Keynesian framework through domestic firm-level investment schedule, which determines aggregate openness to trade. We argue that capital-intensive goods are more integrated in global trade. The proposed model in this paper formulates a micro-founded Phillips curve augmented with an openness to trade component, which captures its ambiguous effects on inflation: strategic complementarity between domestic and foreign goods increases price stickiness, whereas competitive foreign products drive aggregate prices down. Finally, the paper describes welfare changes following different monetary policy regimes in an open economy setting. The welfare results implied by the usual tradeoff facing monetary authorities between exchange rate and inflation stability becomes sensitive to openness to trade. |
| Keywords: | International Trade, Neo-Keynesian Model, Emerging Economies, Monetary Policy, Welfare Effects, Strategic Interactions |
| JEL: | F12 F41 E52 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2017-49&r=opm |
| By: | Jamel Saadaoui |
| Abstract: | From the onset of the euro crisis to the Brexit vote, we have witnessed impressive reductions of current account imbalances in peripheral countries of the euro area. These reductions can be the result of either a compression of internal demand or an improvement in external competitiveness. In this paper, we compute exchange rate misalignments within the euro area to assess whether peripheral countries have managed to improve their external competitiveness. After controlling for the reduction of business cycle synchronization within the EMU, we find that peripheral countries have managed to reduce their exchange rate misalignments thanks to internal devaluations. To some extent, these favourable evolutions reflect improvements in external competitiveness. Nevertheless, these gains could only be temporary if peripheral countries do not improve their non-price competitiveness, their trade structures and their international specializations in the long run. |
| Keywords: | Internal Devaluation, Equilibrium Exchange Rate, External Competitiveness. |
| JEL: | F31 F32 F44 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2017-34&r=opm |