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on Open Economy Macroeconomics |
| By: | Rehim Kılıç |
| Abstract: | By using realized and survey-based expected exchange rate data, the paper presents five key findings regarding the Uncovered Interest rate Parity (UIP) and related puzzles in an Emerging Market (EM). First, Fama regressions, when not accounting for shifts in the UIP relationship, yield slopes that are statistically identical to one, irrespective of whether survey-based expected exchange rates or realized exchange rates are used. Second, caution is necessary however, as our analysis identifies three distinct sub-periods within each exchange rate measure, each exhibiting varying levels of puzzling behavior. Third, under realized exchange rates, expectation errors can introduce both downward and upward biases or no bias at all, depending on the sub-period. On the other hand, currency risk premiums consistently lead to a downward bias. Under expected exchange rates, currency risk premiums continue to exert a downward bias at varying degrees across sub-periods. Fourth, responses to interest rate differential shocks by expectation errors are pivotal in inducing both downward and upward biases or removing biases altogether when utilizing realized exchange rate data. Fifth, evidence concerning overshooting and reversal puzzles, as well as their link to the UIP puzzle, varies depending on the specific sub-period and the choice of exchange rate measurement, making it more intricate than the previous literature has documented. |
| Keywords: | UIP Puzzle; FX Rate Overshooting Puzzle; Predictability Reversal Puzzle; Fama Regression; Expectations |
| JEL: | F31 F41 G11 G15 |
| Date: | 2023–11–22 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2023-74&r=opm |
| By: | Julian di Giovanni; Åžebnem Kalemli-Özcan; Alvaro Silva; Muhammed A 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; supply chains; trade economics; structural global network model; supply shocks |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbaacp:acp2023-01&r=opm |
| By: | António Afonso; Valérie Mignon; 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 relations, time-varying causality, lag-augmented vector autoregression, China |
| JEL: | C22 F51 Q41 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10814&r=opm |
| By: | Mr. Jiaqian Chen; Ms. Era Dabla-Norris; Carlos Goncalves; Zoltan Jakab; Jesper Lindé |
| Abstract: | This paper argues case that a tighter fiscal policy stance can meaningfully support central banks in fighting inflation in both advanced and emerging market economies. While the standard textbook result suggest that monetary policy is much more effective than fiscal policy in battling inflation in open economies due to the exchange rate channel, we show that a tighter fiscal stance is notably more effective in the current situation. This is so because when many countries currently need to tighten the policy stance simultaneously, the exchange rate channel does not provide monetary policy with an edge over fiscal policy. We also show that fiscal consolidation can be helpful in small open emerging markets and developing economies by reaffirming their commitment to price stability, and by putting the fiscal house in order which reduces risk premiums and strengthens the currency. Furthermore, we show that spillovers from major economies can be more adverse from tighter monetary policy. By applying a two-agent New Keynesian modeling framework with unconstrained and hand-to-mouth households, we show that any adverse effects of tighter fiscal policy (relative to tighter monetary policy) on consumption inequality can be handled with a combination of general spending cuts and targeted transfers to vulnerable households. |
| Keywords: | Policy Coordination; Monetary Policy; Fiscal Policy; High Inflation |
| Date: | 2023–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2023/260&r=opm |
| By: | Shigeto Kitano (Research Institute for Economics and Business Administration (RIEB), Kobe University, JAPAN); Kenya Takaku (Faculty of International Studies, Hiroshima City University, JAPAN) |
| Abstract: | Fluctuations in commodity prices have significant effects on output and financial stability in emerging countries. We examine the effect of macroprudential policies on commodity-exporting countries, which consist of two sectors---the commodity-producing sector and final goods sector. When a commodity-exporting country suffers from volatile fluctuations in commodity prices, we find that macroprudential policy in each sector is welfare-enhancing and that it is optimal to impose macroprudential policies in both sectors. We also show that macroprudential policies are more effective in improving welfare for commodity-exporting economies suffering from a stronger link between commodity prices and interest rate spreads, higher sensitivity of interest spreads to debt, and larger commodity price shocks. |
| Keywords: | Macroprudential policies; Commodity-exporting countries; DSGE model; Financial frictions; Emerging economies; Mongolia |
| JEL: | E32 E44 F32 O20 Q48 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2023-21&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. |
| Keywords: | persistent unemployment, wealth preferences, pollution, emission restriction, clean technology transfer |
| JEL: | F13 F41 F42 Q52 Q56 Q58 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10825&r=opm |
| By: | António Afonso; José Alves; Sofia Monteiro |
| Abstract: | We assess the impact of geopolitical risk and world uncertainty on the sovereign debt risk of 26 European Economies during the period 1984-2022, through the implementation of OLS-Fixed Effects regressions and the Generalized Method of Moments (GMM). We find that geopolitical tensions and global uncertainty in border countries contribute to the rise of European country’s sovereign risk as measured by 5- and 10-year Credit Default Swaps (CDS) and bond returns. Moreover, this interconnection is more pronounced during turbulent times such as the subprime crisis. Lastly, we found that geopolitical tensions in other country’ groups such as South America and Asia have a significant impact on the government risks of European countries. |
| Keywords: | geopolitical risk, world uncertainty, political tensions, sovereign risk, European economy, GMM, subprime crisis |
| JEL: | C23 E44 G32 H63 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10801&r=opm |
| By: | Abderazak Madouri (Research Center in Applied Economics for Development –CREAD-Algeria); Hacene Tchoketch-Kebir (Research Center in Applied Economics for Development –CREAD-Algeria) |
| Abstract: | This paper analyzes the potential benefits of an alternative exchange rate regime proposed by Jeffrey Franke, called the Commodity-Currency Basket (CCB) regime, over the current exchange rate regime in Algeria. The CCB regime, which combines the advantages of both floating and fixed exchange rate systems, has been suggested as a way to mitigate the negative impacts of oil price volatility on the economies of countries that heavily rely on oil exports. We use wavelet analysis and quantile-on-quantile regression techniques to estimate and evaluate the impact of the CCB regime on internal and external balance indicators in Algeria, including inflation rates and foreign exchange reserves, over the period of 2001-2021. The findings suggest that the CCB regime is superior to the current floating exchange rate system in terms of maintaining monetary stability and achieving internal and external balance, while also providing more flexibility and stimulation to the domestic economy due to its ability to achieve terms of trade stability through an active countercyclical monetary policy. However, the proposed regime remains subject to further discussion, adjustment, experimentation, and development |
| Date: | 2023–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:erg:wpaper:1656&r=opm |
| By: | David de Villiers (Department of Economics, Stellenbosch University); Hylton Hollander (Department of Economics, Stellenbosch University); Dawie van Lill (Department of Economics, Stellenbosch University) |
| Abstract: | Against the backdrop of a proliferation of policy tools, ongoing policy uncertainty surrounds the suitability of capital flow management in mitigating systemic risk and financial disruptions. We study the effectiveness of macroprudential policies in managing extreme capital flow episodes (surges, stops, flight, and retrenchment), comparing them to capital controls and foreign exchange interventions. Using propensity score matching, based on a panel of 54 countries spanning 1990Q1 to 2020Q3, we find that macroprudential policy can reduce the likelihood of extreme capital flow episodes at least as effectively as capital controls or foreign exchange interventions. Their relative effectiveness, however, varies considerably across type of instrument, proliferation of tools, country income-development level, and type of extreme capital flow episode. |
| Keywords: | macroprudential policy, capital controls, foreign exchange interventions, extreme capital flows, financial stability |
| JEL: | E58 F3 F4 G01 G1 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:sza:wpaper:wpapers382&r=opm |
| By: | Dario Caldara; Francesco Ferrante; Matteo Iacoviello; Andrea Prestipino; Albert Queraltó |
| Abstract: | We use historical data and a calibrated model of the world economy to study how a synchronous monetary tightening can amplify cross-border transmission of monetary policy. The empirical analysis shows that historical episodes of synchronous tightening are associated with tighter financial conditions and larger effects on economic activity than asynchronous ones. In the model, a sufficiently large synchronous tightening can disrupt intermediation of credit by global financial intermediaries causing large output losses and an increase in sacrifice ratios, that is, output lost for a given reduction in inflation. We use this framework to show that there are gains from coordination of international monetary policy. |
| Keywords: | Monetary Policy; Inflation; International Spillovers; Financial Frictions; Open Economy Macroeconomics; Panel Data Estimation |
| JEL: | C33 E32 E44 F42 |
| Date: | 2023–11–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1384&r=opm |
| By: | Hakan Yilmazkuday (Department of Economics, Florida International University) |
| Abstract: | This paper theoretically shows that when the trade elasticity is allowed to be country specific and it increases with trade openness across countries, it is possible for the gains from trade to decrease with trade openness across countries under certain conditions, which we call as the diminishing gains from trade. In order to empirically test this possibility, country-specific trade elasticity measures are estimated by using quarterly time-series data for 40 countries, where the model-implied macroeconomic relationship between the home expenditure share and the real income per capita is employed. The average trade elasticity is estimated about 2.7, with a range between 0.3 and 11.9 across countries, which corresponds to the gains from trade of about 30% for the average country. Instead, when a common trade elasticity of 2.7 is used for all countries, the gains from trade are underestimated by about 8% for the average country, showing the importance of using country-specific trade elasticity measures. In a secondary cross-country analysis, the country-specific trade elasticity estimates are shown to increase and the gains from trade are shown to decrease with trade openness measures. It is implied that there are diminishing gains from trade across countries with respect to their trade openness. |
| Keywords: | Trade Elasticity, Gains from Trade, Trade Openness |
| JEL: | F14 F41 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:fiu:wpaper:2306&r=opm |
| By: | Philippe Bacchetta (University of Lausanne Swiss Finance Institute and CEPR); J. Scott Davis (Federal Reserve Bank of Dallas); Eric van Wincoop (University of Virginia and NBER) |
| 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. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp23117&r=opm |
| By: | Ricardo Correa; Julian di Giovanni; Linda S. Goldberg; Camelia Minoiu |
| Abstract: | This paper uses U.S. loan-level credit register data and the 2018–2019 Trade War to test for the effects of international trade uncertainty on domestic credit supply. We exploit cross-sectional heterogeneity in banks’ ex-ante exposure to trade uncertainty and find that an increase in trade uncertainty is associated with a contraction in bank lending to all firms irrespective of the uncertainty that the firms face. This baseline result holds for lending at the intensive and extensive margins. We document two channels underlying the estimated credit supply effect: a wait-and-see channel by which exposed banks assess their borrowers as riskier and reduce the maturity of their loans and a financial frictions channel by which exposed banks facing relatively higher balance sheet constraints contract lending more. The decline in credit supply has real effects: firms that borrow from more exposed banks experience lower debt growth and investment rates. These effects are stronger for firms that are more reliant on bank finance. |
| Keywords: | Trade uncertainty; Bank loans; Trade finance; Global value chains; Trade war |
| JEL: | G21 F34 F42 |
| Date: | 2023–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1383&r=opm |