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on Open Economy Macroeconomics |
| By: | Chen, Natalie; Novy, Dennis |
| Abstract: | How do trade costs affect international trade? This paper offers a new approach. We rely on a flexible gravity equation that predicts variable trade cost elasticities, both across and within country pairs. We apply this framework to the effect of currency unions on international trade. While we estimate that currency unions are associated with a trade increase of around 38 percent on average, we find substantial underlying heterogeneity. Consistent with the predictions of our framework, we find effects around three times as strong for country pairs associated with small import shares, and a zero effect for large import shares. Our results imply that conventional homogeneous currency union estimates do not provide helpful guidance for countries considering to join a currency union. Instead, countries need to take into account the distribution of their trade shares to assess the impact of trade costs. |
| Keywords: | currency unions; Euro; gravity; heterogeneity; trade costs; trade elasticity; translog |
| JEL: | F14 F15 F33 |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:88487&r=opm |
| By: | Pintus, Patrick A. (CNRS-InSHS and Aix-Marseille University); Wen, Yi (Federal Reserve Bank of St. Louis); Xing, Xiaochuan (Yale University) |
| Abstract: | This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments today, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and foreign economies. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of world business-cycle factor documented by recent empirical studies through dynamic factor analysis and such a factor’s intimate link to global financial markets. |
| Keywords: | World Interest Rate; International Co-Movement; Self-Fulfilling Equilibria |
| JEL: | E21 E22 E32 E44 E63 |
| Date: | 2018–05–14 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2018-009&r=opm |
| By: | Nicola Acocella; Parolo Pasimeni |
| Abstract: | The uncovered interest rate parity condition lies at the heart of the "impossible trinity", stating that the three objectives of fixed exchange rates, free capital flows, and independent monetary policy cannot be pursued simultaneously. We argue that although monetary unification does indeed eliminate the tension between exchange rates and nominal interest rates, it does not solve the problem of the intrinsic instability of the system. By eliminating the intra-area exchange rates (with a single currency) and interest rate differentials (with a single common policy rate set by the common central bank), the problem of instability is simply transferred to inflation rate differentials, what we call the (impossibility of the) "uncovered inflation rate parity condition" in a monetary union. The analysis of the actual divergences and imbalances in the EMU, then, suggests that failure to respect the "uncovered inflation rate parity condition" in a monetary union may lead to increasing economic and political tensions. Thus we conclude with the application of the Rodrik's political trilemma to the EMU, which epitomises the existential challenges that the EU faces nowadays. |
| Keywords: | Monetary Union, interest rate, exchange rate, inflation differentials, political trilemma |
| JEL: | E42 F33 F41 F42 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:imk:fmmpap:28-2018&r=opm |
| By: | Christoph Bierbrauer (Hochschule Darmstadt) |
| Abstract: | We present an analytically tractable two-country New Open Economy Macroeconomics model of a currency union featuring an overlapping generations structure of the Blanchard (1985)-Yaari (1965) type. It enables us to study the transmission and spillover effects of a wider range of fiscal shocks in comparison to the standard model. We show that, depending on the financing decision of the government, fiscal policy measures can have very different effects on key macroeconomic variables such as consumption and output. Moreover, the spillovers of national fiscal policy depend on the composition of government spending, the type of the fiscal measure and the cross-country substitutability between goods. |
| Keywords: | Overlapping generations; New open economy macroeconomics; Public Debt; Decentralized fiscal policy; Monetary union |
| JEL: | E62 F33 F41 H31 H50 H63 |
| Date: | 2017–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:iee:wpaper:wp0109&r=opm |
| By: | Dvorkin, Maximiliano (Federal Reserve Bank of St. Louis); Sanchez, Juan M. (Federal Reserve Bank of St. Louis); Sapriza, Horacio (Federal Reserve Board); Yurdagul, Emircan (Universidad Carlos III) |
| Abstract: | Sovereign debt crises generally involve debt restructurings characterized by a mix of face-value haircuts and debt maturity extensions. We develop a quantitative model of endogenous sovereign debt maturity choice and restructuring that captures key stylized facts of debt over the business cycle and during restructuring episodes, including the variation of haircuts, maturity extensions and default duration found in the data. We also find that policy interventions implementing minimum haircuts and redistributing losses away from holders of short term debt improve the outcome of distressed debt restructurings and reduce the frequency of debt distress events. Methodologically, the use of dynamic discrete choice solution methods allows us to smooth decision rules on default and debt portfolio choices, rendering the problem tractable. |
| Keywords: | Crises; Default; Sovereign Debt; Restructuring; Rescheduling; Country Risk; Maturity; International Monetary Fund; Dynamic Discrete Choice |
| JEL: | F34 F41 G15 |
| Date: | 2018–06–25 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2018-013&r=opm |
| By: | Jamel Saadaoui (CEPN - Centre d'Economie de l'Université Paris Nord - UP13 - Université Paris 13 - USPC - Université Sorbonne Paris Cité - CNRS - Centre National de la Recherche Scientifique, BETA - Bureau d'Économie Théorique et Appliquée - INRA - Institut National de la Recherche Agronomique - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique) |
| 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 |
| Date: | 2017–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01633389&r=opm |
| By: | Corbo, Vesna (Monetary Policy Department, Central Bank of Sweden); Di Casola, Paola (Monetary Policy Department, Central Bank of Sweden) |
| Abstract: | The pass-through from exchange rate changes to inflation differs depending on the underlying shock. This paper quantifies the conditional exchange rate pass-through (CERPT) to prices, i.e. the change in prices relative to that in the exchange rate following a certain exogenous shock, with a structural econometric approach using data for Sweden, a small economy that is very open to trade. We find that the pass-through to consumer prices following an exogenous exchange rate shock is rather small. Importantly, this shock is not the most important driver of exchange rate uctuations, unlike what standard structural macroeconomic models would indicate. For Sweden, the CERPT is negative not only for domestic but also for global demand shocks. The estimated combination of shocks with positive and negative CERPT implies that the average pass-through to consumer prices is roughly zero. |
| Keywords: | Exchange rate; pass-through; consumer prices; import prices; monetary policy; SVAR. |
| JEL: | E31 E52 F31 F41 |
| Date: | 2018–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0352&r=opm |
| By: | Richard 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. |
| Keywords: | monetary policy, policy coordination, exchange rates, r* |
| JEL: | E4 E5 F3 F31 |
| Date: | 2018–07 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:732&r=opm |
| By: | Agnes Benassy-Quere; Matthieu Bussière; Pauline Wibaux |
| Abstract: | The debate on trade wars and currency wars has re-emerged since the Great recession of 2009. We study the two forms of non-cooperative policies within a single framework. First, we compare the elasticity of trade flows to import tariffs and to the real exchange rate, based on product level data for 110 countries over the 1989-2013 period. We find that a 1 percent depreciation of the importer’s currency reduces imports by around 0.5 percent in current dollar, whereas an increase in import tariffs by 1 percentage point reduces imports by around 1.4 percent. Hence the two instruments are not equivalent. Second, we build a stylized short-term macroeconomic model where the government aims at internal and external balance. We find that, in this setting, monetary policy is more stabilizing for the economy than trade policy, except when the internal transmission channel of monetary policy is muted (at the zero-lower bound). One implication is that, in normal times, a country will more likely react to a trade “aggression” through monetary easing rather than through a tariff increase. The result is reversed at the ZLB. |
| Keywords: | tariffs, exchange rates, trade elasticities, protectionism |
| JEL: | F13 F14 F31 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7112&r=opm |
| By: | Weshah Razzak |
| Abstract: | We show that the Purchasing Power Parity (PPP) puzzle, whereby the half-life of the shock to the real exchange rate is long and unjustifiable by monetary and financial shocks, is a result of specification and estimation issues. We provide an alternative specification for PPP and show that the half-life of the shock could be as short as 6.8 months and as long as 2 years, which is considerably shorter than what have been reported in the literature. |
| Keywords: | PPP, unit root, half-life of shocks |
| JEL: | C13 C18 F31 |
| Date: | 2018–06–05 |
| URL: | http://d.repec.org/n?u=RePEc:eei:rpaper:eeri_rp_2018_05&r=opm |