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on Open Economy Macroeconomics |
| By: | Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER) |
| Abstract: | Unemployment differentials are bigger in Europe than in the United States. Migration responds to unemployment differentials, though the response is smaller in Europe. Mundell (1961) argued that factor mobility is a precondition for a successful currency union. We use a multi-country DSGE model with cross-border migration and search frictions to quantify the benefits of increased labor mobility in Europe and compare this outcome to a case of fully flexible exchange rates. Labor mobility and flexible exchange rates both work to reduce unemployment and per capita GDP differentials across countries provided that monetary policy is sufficiently responsive to national output. |
| Keywords: | Labor mobility, currency union, unemployment |
| JEL: | E24 E42 E52 E58 F15 F16 F22 F33 |
| Date: | 2018–12 |
| URL: | http://d.repec.org/n?u=RePEc:mie:wpaper:671&r=all |
| By: | Natalie Chen; Wanyu Chung; Dennis Novy |
| Abstract: | Using detailed firm-level transactions data for UK imports, we find that invoicing in a vehicle currency is pervasive, with more than half of transactions in our sample invoiced in neither sterling nor the exporter’s currency. We then study the relationship between invoicing currency choices and the response of import prices to exchange rate changes. We find that for transactions invoiced in a vehicle currency, import prices are much more sensitive to changes in the vehicle currency than in the bilateral exchange rate. Pass-through therefore substantially increases once we account for vehicle currencies. Our results help to explain the higher-than-expected pass-through into import prices during the Great Recession and after the EU referendum. Finally, within a theoretical framework we conceptualize an omitted variable bias arising in estimating pass-through with only bilateral exchange rates under vehicle currency pricing. Overall, our results contribute to understanding the disconnect between exchange rates and prices. |
| Keywords: | CPI, dollar, euro, exchange rate pass-through, inflation, invoicing, sterling, UK, vehicle currency pricing |
| JEL: | F14 F31 F41 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7695&r=all |
| By: | Hou, Jia; Knaze, Jakub |
| Abstract: | In contrast to the widely recognized importance of exchange rate regimes, evidence on their effect on business cycle synchronization focuses almost exclusively on the role of currency unions, thus implicitly ignoring potential effect of other exchange rate regimes. In this paper we use a new dataset on bilateral de-facto exchange rate regimes for the period 1973-2016 to study the effect of seven types of regimes on business cycle synchronization. Using the Extreme Bound Analysis (EBA) methodology, we find that the exchange rate regime is a robust determinant of business cycle synchronization. Compared to country pairs with freely floating arrangements, we find that: (i) the correlation coefficient measuring business cycle synchronization is higher by around 0.12 points in countries with no separate legal tenders; (ii) other hard pegs such as currency board arrangements and de-facto pegs have also significantly more synchronised business cycles, but the size of the correlation coefficient is halved compared to countries with no separate legal tenders; (iii) the effect is not always linearly decreasing with the increasing exchange rate regime flexibility, since crawling pegs and crawling bands turn out to be insignificant, whereas the effect of moving bands as a more flexible type of exchange rate regimes is positive and significant; (iv) the effect is stronger for countries with high degree of financial openness and good institutional quality. |
| Keywords: | Exchange rate regimes; Currency unions; Business cycles synchronization |
| JEL: | E32 E52 F33 F42 |
| Date: | 2019–07–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:95182&r=all |
| By: | Francesco Pappadà; Yanos Zylberberg |
| Abstract: | We show that, in many countries, tax compliance is volatile and markedly responds to fiscal policy. To explore the consequence of this novel stylized fact, we build a model of sovereign debt with limited commitment and imperfect tax enforcement. Fiscal policy persistently affects the size of the informal economy, which impact future fiscal revenues and thus default risk. This mechanism captures one key empirical regularity of economies with imperfect tax enforcement: the low sensitivity of debt price to fiscal consolidations. The interaction of imperfect tax enforcement and limited commitment strongly constrains the dynamics of optimal fiscal policy. During default crises, high tax distortions force the government towards extreme fiscal policies, notably including costly austerity spells. |
| Keywords: | sovereign default, imperfect tax enforcement, informal economy, fiscal policy |
| JEL: | E02 E32 E62 F41 H20 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7694&r=all |
| By: | Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER) |
| Abstract: | Cross-country differences in austerity, defined as government purchases below forecast, account for 75 percent of the observed cross-sectional variation in GDP in advanced economies during 2010-2014. Statistically, austerity is associated with lower GDP, lower inflation and higher net exports. A multi-country DSGE model calibrated to 29 advanced economies generates effects of austerity consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity was so contractionary that debt-to-GDP ratios in some countries increased as a result of endogenous reductions in GDP and tax revenue. |
| Keywords: | Austerity, Fiscal Policy, Multi-Country DSGE Model |
| JEL: | E62 F41 F44 |
| Date: | 2019–02–07 |
| URL: | http://d.repec.org/n?u=RePEc:mie:wpaper:672&r=all |
| By: | D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Mendoza, Enrique G. (University of Pennsylvania) |
| Abstract: | Infrequent but turbulent overt sovereign defaults on domestic creditors are a “for- gotten history” in macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives versus the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency) and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government’s lack of commitment reduces sustainable debt sharply. |
| Keywords: | public debt; sovereign default; debt crisis; European crisis |
| JEL: | E44 E6 F34 H63 |
| Date: | 2019–07–22 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:19-31&r=all |
| By: | Angeles Galvan Daniel; Cortés Espada Josué Fernando; Sámano Daniel |
| Abstract: | This paper analyzes the exchange rate pass through to consumer prices in Mexico using different methodologies. First, we estimate Vector Autoregressive Models (VAR). Subsequently, we estimate Autoregressive Distributed Lags Models (ARDL) in order to make a long run analysis. In particular, we find that the exchange rate pass through to consumer prices is low and has barely changed in relation with the findings in previous studies. We also estimate that when the economy grows above its long-run trend, the point estimation of the exchange rate pass through is larger on average. Finally, we provide some evidence of asymmetry in the exchange rate pass through, that is, the point estimation of the exchange rate pass through is greater when there is a depreciation than when there is a currency appreciation. It should be noted that in the long run analysis these results are preserved. |
| Keywords: | Depreciation;Inflation;Exchange Rate Pass Through;Asymmetries |
| JEL: | C22 C32 E31 F31 F41 |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:bdm:wpaper:2019-10&r=all |
| By: | Galstyan, Vahagn (Central Bank of Ireland) |
| Abstract: | The increase in the current account surplus of the euro area has been accompanied by muted growth in real wages and an increase in corporate profits. I show that these developments are linked. In particular, temporary shifts in labor income covary negatively with the current account, while permanent shifts show little correlation. On the other hand, temporary shifts in capital income covary positively with the euro area current account, while permanent shifts are marginally negatively correlated. With recent income dynamics likely being temporary in nature, the findings suggest that both external and internal imbalances could unwind simultaneously, were the upward pressure in the labor market to translate into a redistribution of corporate profits towards labor income. |
| Date: | 2019–06 |
| URL: | http://d.repec.org/n?u=RePEc:cbi:ecolet:8/el/19&r=all |
| By: | Cristina Arellano; Yan Bai |
| Abstract: | This paper develops a New Keynesian model with sovereign debt and default. We focus on domestic interest rules governing monetary policy and external foreign currency government debt that is defaultable. Monetary policy and default risk interact as they both impact domestic consumption and production. We find that default risk generates monetary frictions, which amplify the monetary response to shocks. Large sovereign default risk depresses domestic consumption and production. These monetary frictions in turn discipline sovereign borrowing, resulting in slower debt accumulation and lower spreads. Our framework replicates the positive co-movements of sovereign spreads with domestic nominal rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and sovereign spreads. A counterfactual experiment shows that, by raising the domestic rate, the Brazilian central bank not only reduced inflation but also alleviated the debt crisis. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:19-02&r=all |
| By: | Valérie Mignon; Antonia Lopez Villavicencio |
| Abstract: | This paper assesses whether the emergence of new trading partners (i.e., China and Eastern Europe) as suppliers reduces the exchange rate pass-through (ERPT) in Eurozone countries which differ regarding their external exposure. Using bilateral data on import prices at the two-digit sector level, we find that (i) pass-through is complete in many cases, (ii) ERPT from China is higher than from the United States, and (iii) there is no compelling evidence of a generalized link between ERPT and the increasing integration of some emerging markets in European imports. We also show that the launch of the single currency has not provoked a sufficient change in the part of trade exposed to exchange rate fluctuations and, therefore, has not affected the pass-through. Overall, the trend of liberalization in new players' markets has not altered the competitive environment such as to induce exporters of other countries to absorb exchange rate depreciations. |
| Keywords: | Exchange rate pass-through; import prices; China; Eastern Europe; Eurozone |
| JEL: | E31 F31 F4 C22 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2019-16&r=all |
| By: | Romain Houssa; Jolan Mohimont; Chris Otrok |
| Abstract: | This paper develops a small open economy (SOE) dynamic stochastic general equilibrium (DSGE) model that helps to explain business cycle synchronization between an emerging market and advanced economies. The model captures the specificities of both economies (e.g. primary commodity, manufacturing, intermediate inputs, and credit) that are most relevant for understanding the importance as well as the transmission mechanisms of a wide range of domestic and foreign (supply, demand, monetary policy, credit, primary commodity) shocks facing an emerging economy. We estimate the model with Bayesian methods using quarterly data from South Africa, the US and G7 countries. In contrast to the predictions of standard SOE models, we are able to replicate two stylized facts. First, our model predicts a high degree of business cycle synchronization between South Africa and advanced economies. Second, the model is able to account for the influence of foreign shocks in South Africa. We are also able to demonstrate the specific roles these shocks played during key historical episodes such as the global financial crisis in 2008 and the commodity price slump in 2015. The ability of our framework to capture endogenous responses of commodity and financial sectors to structural shocks is crucial to identify the importance of these shocks in South Africa. |
| Keywords: | macroeconomic policies, emerging markets, SOE, DSGE, Bayesian, foreign shocks, monetary policy |
| JEL: | E30 E43 E52 C51 C33 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7702&r=all |
| By: | Galstyan, Vahagn (Central Bank of Ireland) |
| Abstract: | The euro area current account was on average in balance over 1999-2010 period, while the average rate of inflation was close to the ECB target. In contrast, the post-2011 increase in the euro area current account surplus has been accompanied by a period of low inflation. This paper suggests that observed low inflation can be partly explained by the surplus in the external balance. I propose a version of an open-economy inflation Phillips curve showing that, in addition to output gap and inflationary expectations, inflation is also shaped by the trade balance. At an empirical level, I find a statistically significant and negative correlation between the two variables. |
| Date: | 2019–05 |
| URL: | http://d.repec.org/n?u=RePEc:cbi:ecolet:4/el/19&r=all |
| By: | Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER) |
| Abstract: | We exploit differences across U.S. states in terms of their exposure to trade to study the effects of changes in the exchange rate on economic activity at the business cycle frequency. We find that a depreciation in the state-specific trade-weighted real exchange rate is associated with an increase in exports, a decline in unemployment and an increase in hours worked. The effect is particularly strong in periods of economic slack. We develop a multi-region model with inter-state trade and labor flows and calibrate it to match the state-level orientation of exports and the extent of labor migration and trade between states. The model replicates the relationship between exchange rates and unemployment. Counterfactuals show that the high degree of interstate trade plays a dominant role in transmitting shocks across states in the first year, whereas interstate migration shapes cross-sectional patterns in following years. The model suggests that a 25% Chinese import tariff on U.S. goods would be felt throughout the United States, even in states with small direct linkages to China, raising unemployment rates by 0.2 to 0.7 percentage points in the short run. |
| Keywords: | Regions, exchange-rate fluctuations |
| JEL: | F22 F41 |
| URL: | http://d.repec.org/n?u=RePEc:mie:wpaper:673&r=all |