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on Open Economy Macroeconomics |
| By: | Oleg Itskhoki; Dmitry Mukhin |
| Abstract: | We develop a general policy analysis framework for an open economy that features nominal rigidities and financial frictions giving rise to endogenous PPP and UIP deviations. The efficient allocation can be implemented with monetary policy closing the output gap and FX interventions eliminating UIP deviations. When the “natural” real exchange rate is stable, both goals can be achieved solely by monetary policy that fixes the exchange rate — an open-economy divine coincidence. More generally, optimal policy features a managed float/crawling peg complemented with FX forward guidance and macroprudential accumulation of FX reserves, in line with the “fear of floating” observed in the data. Capital controls are not necessary to achieve the frictionless allocation, but they facilitate the extraction of rents in the currency market. Constrained unilateral policies are not optimal from the global perspective, and international cooperation features a complementary use of FX interventions across countries. |
| JEL: | F30 F40 G10 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31933&r=opm |
| By: | Philippe Bacchetta; J. Scott Davis; Eric van Wincoop |
| Abstract: | Since 2007, an increase in risk or risk aversion has resulted in a US dollar appreciation and greater deviations from covered interest parity (CIP). In contrast, prior to 2007, risk had no impact on the dollar, and CIP held. To explain these phenomena, we develop a two-country model featuring (i) market segmentation, (ii) limited CIP arbitrage (since 2007), (iii) global dollar dominance. During periods of heightened global financial stress, dollar shortages in the offshore market emerge, leading to increased CIP deviations and a dollar appreciation. The appreciation occurs even in the absence of global dollar demand shocks. Central bank swap lines mitigate these effects. |
| JEL: | E44 F31 G15 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31937&r=opm |
| By: | Maurice Obstfeld |
| Abstract: | This paper surveys the decline in real interest rates in advanced and emerging economies over the past several decades, linking that process to a range of global factors that have operated with different force in different periods. The paper argues that estimates of long-run equilibrium real rates (r̄) may not always furnish an accurate guide to the rate appropriate for short-term monetary policy (r*). It argues further that effective monetary should consider not only equilibrium in the market for domestic goods, but also the current account balance, financial conditions (including capital flows), and imperfect policy credibility. Equilibrium long-term real interest rates have risen recently according to market indicators. However, the main underlying factors that have pushed real interest rates down since the 1980s and 1990s – notably demographic shifts, lower productivity growth, corporate market power, and safe asset demand relative to supply – do not appear poised to reverse strongly enough to drive a big and durable rise in global real interest rates over the coming years. Low equilibrium interest rates may well continue periodically to bedevil monetary policy and financial stability. |
| JEL: | E43 E44 E52 F36 N10 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31949&r=opm |
| By: | Raphael Auer; Ariel Burstein; Sarah Lein; Jonathan Vogel; Raphael A. Auer; Sarah Marit Lein; Jonathan E. Vogel |
| Abstract: | What are the unequal effects of changes in consumer prices on the cost of living? In the context of changes in import prices (driven by, e.g., changes in trade costs or exchange rates), most analyses focus on variation across households in initial expenditure shares on imported goods. However, the unequal welfare effects of non-marginal foreign price changes also depend on differences in how consumers substitute between imported and domestic goods, on which there is scant evidence. Using data from Switzerland surrounding the 2015 appreciation of the Swiss franc, we provide evidence that lower-income households have higher price elasticities. We quantify the contribution of heterogeneous elasticities for the unequal welfare effects of observed price changes between 2014–15 and for counterfactual shocks to the mean and dispersion of import price changes. |
| JEL: | E30 F10 F41 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10810&r=opm |
| By: | Benny Kleinman; Ernest Liu; Stephen J. Redding; Motohiro Yogo |
| Abstract: | We generalize the closed-economy neoclassical growth model (CNGM) to allow for costly goods trade and capital flows with imperfect substitutability between countries. We develop a tractable, multi-country, quantitative model that matches key features of the observed data (e.g., gravity equations for trade and capital holdings) and is well suited for analyzing counterfactual policies that affect both goods and capital market integration (e.g., U.S.-China decoupling). We show that goods and capital market integration interact in non-trivial ways to shape impulse responses to counterfactual changes in productivity and goods and capital market frictions and the speed of convergence to steady-state. |
| JEL: | F10 F21 F60 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31951&r=opm |
| By: | Julian di Giovanni; Şebnem Kalemli-Özcan; Alvaro Silva; Muhammed A. Yildirim; Muhammed Ali Yildirim |
| Abstract: | We estimate a multi-country multi-sector New Keynesian model to quantify the drivers of domestic inflation during 2020–2023 in several countries, including the United States. The model matches observed inflation together with sector-level prices and wages. We further measure the relative importance of different types of shocks on inflation across countries over time. The key mechanism, the international transmission of demand, supply and energy shocks through global linkages helps us to match the behavior of the USD/Euro exchange rate. The quantification exercise yields four key findings. First, negative supply shocks to factors of production, labor and intermediate inputs, initially sparked inflation in 2020–2021. Global supply chains and complementarities in production played an amplification role in this initial phase. Second, positive aggregate demand shocks, due to stimulative policies, widened demand-supply imbalances, amplifying inflation further during 2021–2022. Third, the reallocation of consumption between goods and service sectors, a relative sector-level demand shock, played a role in transmitting these imbalances across countries through the global trade and production network. Fourth, global energy shocks have differential impacts on the US relative to other countries’ inflation rates. Further, complementarities between energy and other inputs to production play a particularly important role in the quantitative impact of these shocks on inflation. |
| Keywords: | inflation, international spillovers, global production network |
| JEL: | E20 E30 E60 F10 F40 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10789&r=opm |
| By: | Sebastian Edwards |
| Abstract: | In this paper I analyze the work on exchange rates and external imbalances by University of Chicago faculty members during the university’s first hundred years, 1892-1992. Many people associate Chicago’s views with Milton Friedman’s advocacy for flexible exchange rates. But, of course, there was much more than that, including the work of J. Laurence Laughlin on bimetallism, Jacob Viner on the balance of payments, Lloyd Metzler on transfers, Harry Johnson on trade and currencies, Lloyd Mints on exchange rate regimes, Robert Mundell on optimal currency areas, and Arnold Harberger on shadow exchange rates, among other. The analysis shows that, although different scholars emphasized different issues, there was a common thread in this research, anchored on the role of relative prices’ changes during the adjustment process. |
| JEL: | B22 E52 E58 F31 F33 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31928&r=opm |
| By: | Warnes Ignacio; Grosz Fernando Andrés |
| Abstract: | In this paper we analyze whether there is a long-run relation between real exchange rates, exchange rate volatility and total as well as sectoral Argentine exports. When we analyze each of the sectoral exports and real exchange rate volatility, we find a cointegrating vector that passes all diagnosis tests in three cases: total exports and volatility, hydrocarbons and volatility, and heavy industry and volatility. In these cointegrating vectors the coefficients of exchange rate volatility are significant and the sign coincides with most empirical findings, namely that more volatility will be associated with a decrease in exports in the corresponding sector. Nevertheless, these results are not robust to the introduction of the variable real exchange rate into the system, suggesting that more research should be performed. We also find that for the food sector there is a cointegrating vector relating sectoral exports, real exchange rate and its volatility measure. |
| JEL: | F10 F31 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aep:anales:4700&r=opm |
| By: | Marcos Chamon (IMF); Francisco Roldán (IMF) |
| Abstract: | We investigate the effect of uncertainty about the nature of output costs of sovereign default on debt tolerance. While the theoretical literature assumes output losses lasting until market access is restored, the empirical evidence points to persistent effects, and output may not return to its pre-default trend. We include such uncertainty in a model of sovereign default and find that it can significantly boost equilibrium debt levels. We also consider a government which is averse to this type of uncertainty and seeks robust decision rules. We calibrate the model to match evidence on the output trajectory around debt restructuring episodes and infer output costs of about the size found in the empirical literature, alongside significant uncertainty about their permanence and a strong desire for robustness. |
| Keywords: | Sovereign debt, default, debt tolerance, permanent costs, robustness |
| JEL: | E43 E44 F34 H63 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:296&r=opm |
| By: | Valérie Mignon; António Afonso; Jamel Saadaoui |
| Abstract: | We assess the impact of China's bilateral political relations with three main trading partners - the US, Germany, and the UK - on current account balances and exchange rates, over the 1960Q1-2022Q4 period. Relying on the lag-augmented VAR approach with time-varying Granger causality tests, we find that political relationships with China strongly matter in explaining the dynamics of current accounts and exchange rates. Such relationships cause the evolution of the exchange rate (except in the UK) and the current account; these causal links being time-varying for the US and the UK and robust over the entire period for Germany. These findings suggest that policymakers should account for bilateral political relationships to understand the global macroeconomic consequences of political tensions. |
| Keywords: | Political relationships with China strongly matter in explaining the dynamics of current accounts and exchange rates |
| JEL: | C22 F51 Q41 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2023-33&r=opm |
| By: | Marina Azzimonti; Nirvana Mitra |
| Abstract: | Emerging countries exhibit volatile fiscal policies and frequent sovereign debt crises, that significantly diminish the well-being of their citizens. International advisors typically suggest developed-world solutions as a remedy. We argue that the root of the problem lies in the institutional environment, which does not incentivize responsible policymaking, particularly tax-smoothing practices. Focusing on democratic representation and control of corruption, our dynamic political-economy bargaining model shows that nations with weaker institutions experience frequent default episodes and greater economic volatility. Our results are in line with stylized facts from a panel of 58 countries between 1990 and 2022. Through counterfactual experiments, we find that while emerging economy policymakers might favor moderate reforms to improve democratic representation, achieving the institutional depth seen in developed countries is politically unfeasible, despite its clear advantages for citizens. |
| JEL: | D72 E43 E62 F34 F40 F41 H20 H4 H6 P33 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31943&r=opm |
| By: | Botta, Alberto; Spinola, Danilo; Yajima, Giuliano; Porcile, Gabriel |
| Abstract: | This paper studies the relationship between financial integration, external debt sustainability, and fiscal policy space in emerging and developing (EDE) countries. We do so by applying Pasinetti’s “geometry of debt sustainability” to EDE countries and analysing how it is shaped by exposure to global financial cycles. Through the lenses of Pasinetti’s theoretical framework, we study whether global finance opens “windows of opportunities” or creates more constraints for EDE countries in offering fiscal support for structural changes, including green structural transformations. This analysis is crucial for tackling the pressing issue of the climate crisis. We suggest EDE countries may face a “gridlock”. Global finance and pressures to keep external debt sustainable make them struggle to maintain vital public investment and enact counter-cyclical fiscal actions. Lack of fiscal space in turn exacerbates technological backwardness, which feeds back in the form of more binding external constraints and tighter “surveillance” by international creditors. We support our theoretical analysis with an econometric study over a sample of 55 countries from 1980-2018. Capital controls and external macroprudential policy emerge as fundamental policies enabling EDE countries to adeptly manoeuvre through debt challenges without falling into the pitfalls of stagnation and enduring technological underdevelopment. |
| Keywords: | Financial globalisation; fiscal space; structural change |
| Date: | 2023–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:akf:cafewp:25&r=opm |
| By: | Georgios Georgiadis; Gernot J. Müller; Ben Schumann |
| Abstract: | The dollar is a safe-haven currency and appreciates when global risk goes up. We investigate the dollar’s role for the transmission of global risk to the world economy within a Bayesian proxy structural vectorautoregressive model. We identify global risk shocks using high-frequency asset-price surprises around narratively selected events. Global risk shocks appreciate the dollar, induce tighter global financial conditions and a synchronized contraction of global economic activity. We benchmark these effects against counterfactuals in which the dollar does not appreciate. In the absence of dollar appreciation, the contractionary impact of a global risk shock is much weaker, both in the rest of the world and the US. For the rest of the world, contractionary financial channels thus dominate expansionary expenditure switching when global risk rises and the dollar appreciates. |
| Keywords: | Dollar exchange rate, global risk shocks, international transmission, Bayesian proxy structural VAR |
| JEL: | F31 F42 F44 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp2057&r=opm |
| By: | Masako Ikefuji; Yoshiyasu Ono |
| Abstract: | Global warming is a serious and acute threat to our planet, but, when negotiating the allocation of permissible carbon emissions, conflicts of interest exist between developed and developing countries. Developing countries insist that global warming is the result of prolonged pollution emissions by developed countries, while developed countries demand that developing countries make efforts comparable to their own to reduce carbon emissions. They both generally believe that stricter emission limits will burden their economies because of the extra abatement costs required. We use a two-country model with wealth preferences and find that the effects of a country’s emission limit on the two countries’ real consumption and pollution emissions differ, depending on the combination of their business situations. If both countries achieve full employment, one country’s stricter emission limit decreases both countries’ real consumption, as expected. However, if one country faces aggregate demand stagnation and the other achieves full employment, a stricter emission limit imposed by the stagnant country increases both countries’ real consumption. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:1222&r=opm |
| By: | Philippe Bacchetta; J. Scott Davis; Eric Van Wincoop |
| Abstract: | Since 2007, an increase in risk or risk aversion has resulted in a U.S. dollar appreciation and greater deviations from covered interest parity (CIP). In contrast, prior to 2007, risk had no impact on the dollar, and CIP held. To explain these phenomena, we develop a two-country model featuring (i) market segmentation, (ii) limited CIP arbitrage (since 2007) and (iii) global dollar dominance. During periods of heightened global financial stress, dollar shortages in the offshore market emerge, leading to increased CIP deviations and a dollar appreciation. The appreciation occurs even in the absence of global dollar demand shocks. Central bank swap lines mitigate these effects. |
| Keywords: | dollar; CIP deviations; Central Bank Swap Lines |
| JEL: | E44 F31 G15 |
| Date: | 2023–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:97492&r=opm |
| By: | Kazuo Nishimura (RIEB, Kobe University, Kobe, Japan); Harutaka Takahashi (Research fellow, Graduate School of Economics, Kobe University, Kobe, Japan and Professor Emeritus, Meiji Gakuin University, Tokyo, Japan); Alain Venditti (Aix-Marseille Univ., CNRS, AMSE, Marseille, France) |
| Abstract: | The Balassa-Samuelson effect ("BS effect") has attracted attention as a theory to explain the stagnation of the Japanese economy over the past 30 years. In particular, it has been used to explain the long-term depreciation of the real effective exchange rate since 1995. Furthermore, macroeconomic data show that the BS effect explains well Japan's long-term economic stagnation. However, the BS effect was originally derived theoretically for small open economies, not for large economies like Japan. In other words, the BS effect cannot be theoretically applied to large economies. This is a serious problem in applying the BS effect empirically. In this paper, we embed Balassa-Samuelson's original argument into the optimal growth theory framework. That is, we set up an optimal growth problem for large countries. It is then shown that there exists a stable optimal steady state and that the BS effect is more directly valid in that optimal steady state. In other words, as a long-run property, the BS effect is applicable to large as well as small countries, although, contrary to the small open economy case, it does not depend on the capital shares of the two sectors. |
| Keywords: | Two-sector optimal growth models, optimal steady state, capital intensity, Balassa-Samuelson effect |
| JEL: | C61 C62 E32 F31 O41 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2329&r=opm |
| By: | Emile A. Marin; Sanjay R. Singh |
| Abstract: | Classical contributions in international macroeconomics rely on goods-market mechanisms to reconcile the cyclicality of real exchange rates when financial markets are incomplete. However, cross-border trade in one domestic and one foreign-currency-denominated risk-free asset prohibits these mechanisms from breaking the pattern consistent with complete markets. In this paper, we characterize how goods markets drive exchange rate cyclicality, taking into account trade in risk-free and/or risky assets. We show that goods-market mechanisms come back into play, even when there is cross-border trade in two risk-free assets, as long as we allow for empirically plausible heterogeneity in the stochastic discount factors of domestic marginal investors. |
| Keywords: | risk sharing; incomplete markets; exchange rates |
| JEL: | E32 F31 F44 G15 |
| Date: | 2023–11–30 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:97453&r=opm |
| By: | Rafael Berriel; Eugenia Gonzalez-Aguado; Patrick J. Kehoe; Elena Pastorino |
| Abstract: | We apply ideas from fiscal federalism to reassess how fiscal authority should be delegated within a monetary union. In a real-economy model with fiscal externalities, in which local fiscal authorities have an informational advantage about the preferences of their citizens for public spending relative to a fiscal union, a decentralized regime is optimal for small federations of countries, whereas a centralized regime is optimal for large ones. We then consider a monetary-economy model, in which governments finance their expenditures with nominal debt, and inflation has a negative impact on aggregate productivity. When the monetary authority lacks commitment, the resulting time inconsistency problem generates an indirect endogenous fiscal externality. When a country-level fiscal authority chooses a higher level of nominal debt, it induces the monetary authority to inflate more to reduce the level of distortionary taxes needed to finance the higher debt. The resulting fiscal externality naturally becomes more severe as the number of countries in the monetary union increases. Here also a decentralized fiscal regime is optimal for small monetary unions, whereas a fiscal union is optimal for sufficiently large ones. Our key result is that as the size of a monetary union increases, it becomes relatively more desirable to centralize fiscal authority. |
| JEL: | E61 E63 F34 F42 F45 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31953&r=opm |
| By: | Montes Rojas Gabriel; Dvoskin Ariel; Feldman Germán |
| Abstract: | This paper studies, both theoretically and empirically, tradable (T) and non-tradable (N) sectorial profit rates dynamics in a small, price-taker peripheral economy with foreign exchange controls and parallel exchange rate (ER) markets. Using a state-space econometric representation of the Argentine economy for the period 2016-2023, we found evidence to support three main hypotheses derived from the theoretical models. First, an official exchange rate depreciation increases tradable goods profit rates, but has no effect on non-tradeable goods profitability. Second, the rise of the financial exchange rate increases sector N’s profit rate but has no effect on T’s. Moreover, this effect depends on the magnitude of the ER gap in a positive, but in a non-linear way. Third and finally, over sufficient time, both profit rates tend to influence each other, through the action of competition. This means that, eventually, and increase (depreciation) in the official exchange rate exerts its influence in sector N’s profit rate; while, if sufficiently persistent and big enough, a rise in the financial ER ends up affecting sector T’s profit rate too. |
| JEL: | E31 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aep:anales:4673&r=opm |
| By: | Matteo Maggiori; Brent Neiman; Jesse Schreger |
| Abstract: | We explore the consequences of global capital market segmentation by currency for the optimal currency composition of borrowing by firms. Global bond portfolios are driven by the currency of denomination of assets as investors prefer to lend in their home currency or the international currency, the US Dollar. Larger and more productive firms select into foreign currency issuance. International segmentation results in a quantity-dimension of the exorbitant privilege whereby US firms that only issue in the domestic currency benefit from being able to more easily borrow from global investors. |
| JEL: | F3 G15 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31891&r=opm |
| By: | Harutaka Takahashi (Graduate School of Economics, Kobe University, Kobe? Japan and Meiji Gakuin University, Tokyo, Japan); Alain Venditti (Aix-Marseille Univ., CNRS, AMSE, Marseille, France) |
| Abstract: | The Balassa-Samuelson effect is still an important phenomenon in the theory of economic development, as Balassa states, "As economic development is accompanied by greater inter-country differences in the productivity of tradable goods, differences in wages and service prices increase, and correspondingly so do differences in purchasing power parity and exchange rates." To the best of our knowledge, the Balassa-Samuelson effect has not been formally examined in the framework of optimal growth theory. By embedding the Balassa-Samuelson’s original model in an optimal growth model setting, we investigate the validity of the Balassa-Samuelson effect in such a case and show that the Balassa-Samuelson effect follows from one of the properties of the optimal steady state. |
| Keywords: | Two sector optimal growth, optimal steady state, saddle-point stability, phase diagram, Hamiltonian, capital intensity |
| JEL: | C61 F31 O41 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2331&r=opm |
| By: | Georgios Georgiadis; Gernot J. Müller; Ben Schumann |
| Abstract: | We develop a two-country business-cycle model of the US and the rest of the world with dollar dominance in trade invoicing, in cross-border credit, and in safe assets. The interplay between these elements—dollar trinity—rationalizes salient features of the Global Financial Cycle in the data: When its tide subsides, the dollar appreciates, financial conditions tighten, the world business cycle slows down, and emerging-market central banks face a trade-off between mitigating the recession and dampening price pressures. We find the dollar is no sideshow in this, but central for the transmission of the Global Financial Cycle to the world economy. |
| Keywords: | Dollar dominance, dominant currency paradigm, Bayesian proxy structural VAR model, convenience yield |
| JEL: | F31 F42 F44 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp2058&r=opm |