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on Open Economy Macroeconomics |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | I study how, in the presence of default risk, the Dutch disease amplifies an inefficiency in the sectoral allocation of capital. I develop a sovereign default model with production of tradable and non-tradable goods, and endowments of commodities. Default incentives increase when more capital is allocated to non-traded production. Households do not internalize this effect, giving rise to over-investment in the non-traded sector. Commodity windfalls amplify this inefficiency through the classic Dutch disease mechanism and an increased desire to borrow. Policies that reduce the returns of non-traded capital, such as exchange rate sterilization, ameliorate the degree of over-investment during commodity windfalls. Evidence from spreads, commodity endowments, and exchange rate data supports the main findings of the model. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Dutch Disease, Real exchange rates |
| JEL: | F34 F41 H63 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202403&r=opm |
| By: | Yossi Yakhin (Bank of Israel) |
| Abstract: | The paper introduces foreign exchange interventions (FXIs) to an otherwise standard new-Keynesian small open economy model. The paper studies the transmission mechanism of FXIs, solves for the optimal policy, suggests an implementable policy rule, and evaluates the welfare implications of different policies. Relying on the portfolio balance channel, a purchase of foreign reserves crowds out private holdings of foreign assets, thereby raising the UIP premium and the effective real return domestic agents face. As a result, a purchase of foreign reserves contracts domestic demand. At the same time, it depreciates the value of the domestic currency, which raises the price of foreign goods relative to domestic goods, thereby expanding foreign demand for home exports and contracting domestic imports. The effect on production depends on the wealth effect on labor supply. Optimal FXIs completely insulate the economy from the effect of financial shocks, such as capital flows and risk premium shocks. A policy rule that aims at stabilizing the UIP premium brings the economy close to its optimal allocation, regardless of the source of the shocks. The paper discusses the conditions under which strict targeting of the UIP premium is optimal. Calibrating the model to the Israeli economy, lifetime welfare gains from following optimal FXI policy, relative to maintaining a fixed level of foreign reserves, amount to 2.4% of annual steady state consumption. The results are robust to a variety of microstructures of the financial sector suggested in recent literature. |
| Keywords: | Foreign Exchange Interventions, UIP Premium, Monetary Policy, Open Economy Macroeconomics |
| JEL: | E44 E52 E58 F30 F31 F40 F41 G10 G15 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:boi:wpaper:2024.01&r=opm |
| By: | OGAWA Eiji; LUO Pengfei |
| Abstract: | The international finance trilemma represents the trade-off among exchange rate stability, monetary policy autonomy and free capital flows, resulting in varied reactions to global risk factors among Asian economies. This study explores how various monetary policy objectives shape the diverse responses of Asian interest rates and exchange rates to global risk factors. Using the Structural Vector Autoregressive Model with Exogenous Variables (SVARX), we analyze the impulse responses of short-term interest rates and exchange rates to global risk factors, including the US monetary policy changes, global economic policy and financial risks, and oil prices. The main findings are as follows: first, we found that most of the Asian monetary authorities except Japan mirror the US monetary policy changes, demonstrating that a key policy objective is to stabilize their cross-border capital flows and exchange rates. The magnitude of mirroring depends on countries’ exchange rate regimes. Furthermore, although global economic policy and financial risks trigger the depreciation of most of the Asian exchange rates, their influence on Asian short-term interest rates is relatively smaller, showing the limited influence of global risk appetite on monetary policy objectives. Last, we found the opposite responses of Asian interest rates and exchange rates to oil prices, showing the diverse economic effects of oil prices on oil export and import countries. |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:eti:dpaper:24006&r=opm |
| By: | Issiaka Coulibaly; Blaise Gnimassoun; Hamza Mighri; Jamel Saadaoui |
| Abstract: | The paper adds to the literature on the issue of public debt in African economies, by investigating the role foreign exchange reserves play in improving the level of indebtedness and as buffer of the negative effect of exchange rate depreciation while considering the exchange rate policy. Our results show a direct link between the level of foreign currency reserves and that of external debt in Africa. Particularly, we demonstrate that higher foreign currency reserves tend to decrease the public debt stock to GDP. This effect is even more significant when countries go through high exchange rate depreciation episodes (10% or higher). This impact, however, is not homogenous among country groups, as only countries with a floating exchange regime tend to benefit from this buffer effect compared to anchored regimes. In a time where most African economies face severe exchange rate depreciation episodes following the U.S. monetary tightening policy, central bankers and policy makers need to consider a plethora of policy issues including interventions in the FX market to mitigate depreciations and maintain a sustainable public debt stock. |
| Keywords: | Exchange Rate, International Reserves, Buffer Effect, Public Debt. |
| JEL: | F3 F31 F32 F34 H6 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2023-42&r=opm |
| By: | Carlos Esquivel (Rutgers University; The World Bank Research Department) |
| Abstract: | We study how debt limits can be expansionary in economies facing sovereign risk. We develop a sovereign debt model with capital accumulation, long-term debt, and fiscal rules that features two distortions: debt dilution and a pecuniary externality of private investment on spreads. The optimal debt limit increases capital accumulation due to lower sovereign risk, generating an economic expansion in the long run. Welfare gains are a result of lower sovereign spreads due to expectations about future borrowing and investment. We present evidence of a positive (negative) relation between debt limits and investment (spreads), consistent with the predictions of the model. |
| Keywords: | Fiscal Rules, Sovereign Debt, Expansionary Fiscal Consolidation |
| JEL: | F34 F41 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202401&r=opm |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | Capital and its sectoral allocation affect default incentives. Under general assumptions, default risk is decreasing in the total stock of capital and increasing in the share of capital allocated to non-tradable production. This implies that when competitive households make all investment decisions capital has two externalities: a capital-stock externality and a portfolio externality. These hamper the ability of a benevolent government to make optimal borrowing and default decisions and are exacerbated during periods of distress. Competitive equilibria feature underinvestment, larger non-traded sectors, more default, and lower debt and consumption than a centralized planner's allocation. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Underinvestment, Investment externalities |
| JEL: | F34 F41 H63 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202402&r=opm |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | I study the impact of giant oil field discoveries on default risk. I document that interest rate spreads of emerging economies increase by 1.3 percentage points following a discovery of median size. I develop a sovereign default model with investment, three-sector production, and oil discoveries. Following a discovery, borrowing and investment increase. Capital reallocates from manufacturing toward oil and non-traded sectors, increasing the volatility of tradable income. Borrowing increases default risk and higher volatility increases the risk premium, both of which increase spreads. Discoveries generate welfare gains of 0.44 percent. Insurance against low oil prices increases these gains to 0.60. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Oil Discoveries |
| JEL: | F34 F41 Q33 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202404&r=opm |
| By: | Rohan Kekre (Chicago Booth and NBER); Moritz Lenel (Princeton University and NBER) |
| Abstract: | We study the effects of dollar swap lines using high frequency responses in asset prices around policy announcements. News about expanded dollar swap lines causes a reduction in liquidity premia, compression of deviations from covered interest parity (CIP), and depreciation of the dollar. Equity prices rise and the VIX falls, while the response of long-term government bond prices is mixed. The cross-section of high frequency responses implies that swap lines affect the dollar factor or the price of risk. Our findings are qualitatively consistent with models relating the supply of dollar liquidity to the broader economy. |
| Keywords: | dollar swap lines, liquidity premium, exchange rates |
| JEL: | E44 F31 G15 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:pri:econom:2023-17&r=opm |