Creator: Uy, Timothy, Yi, Kei-Mu, and Zhang, Jing Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 456 Abstract:
We study the importance of international trade in structural change. Our framework has both productivity and trade cost shocks, and allows for non-unitary income and substitution elasticities. We calibrate our model to investigate South Korea’s structural change between 1971 and 2005. We find that the shock processes, propagated through the model’s two main transmission mechanisms, non-homothetic preferences and the open economy, explain virtually all of the evolution of agriculture and services labor shares, and the rising part of the hump-shape in manufacturing. Counterfactual exercises show that the role of the open economy is quantitatively important for explaining South Korea’s structural change.
Keyword: Structural transformation, Sectoral labor reallocation, and International trade Subject (JEL): F20 - International Factor Movements and International Business: General, O13 - Economic Development: Agriculture; Natural Resources; Energy; Environment; Other Primary Products, F40 - Macroeconomic Aspects of International Trade and Finance: General, and O41 - One, Two, and Multisector Growth Models
Creator: Fogli, Alessandra and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 512 Abstract:
Does macroeconomic volatility/uncertainty affect accumulation of net foreign assets? In OECD economies over the period 1970-2012, changes in country specific aggregate volatility are, after controlling for a wide array of factors, significantly positively associated with net foreign asset position. An increase in volatility (measured as the standard deviation of GDP growth) of 0.5% over period of 10 years is associated with an increase in the net foreign assets of around 8% of GDP. A standard open economy model with time varying aggregate uncertainty can quantitatively account for this relationship. The key mechanism is precautionary motive: more uncertainty induces residents to save more, and higher savings are in part channeled into foreign assets. We conclude that both data and theory suggest uncertainty/volatility is an important determinant of the medium/long run evolution of external imbalances in developed countries.
Keyword: Uncertainty, Business cycles, Global imbalances, Current account, and Precautionary saving Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, F34 - International Lending and Debt Problems, and F41 - Open Economy Macroeconomics
Creator: Chodorow-Reich, Gabriel, Karabarbounis, Loukas, and Kekre, Rohan Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 758 Abstract:
The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment away from taxes toward spending or away from capital taxes toward other taxes would generate longer-term production and consumption gains. Eliminating the rise in transfers to households during the boom would significantly reduce the burden of tax adjustment in the bust and the magnitude of the depression.
Keyword: Greek depression, Taxes, Fiscal policy, Nominal rigidity, and Productivity Subject (JEL): E44 - Financial Markets and the Macroeconomy, E62 - Fiscal Policy, F41 - Open Economy Macroeconomics, E32 - Business Fluctuations; Cycles, and E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data)
Creator: Chari, V. V., Nicolini, Juan Pablo, and Teles, Pedro Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 745 Abstract:
We study cooperative optimal Ramsey equilibria in the open economy addressing classic policy questions: Should restrictions be placed to free trade and capital mobility? Should capital income be taxed? Should goods be taxed based on origin or destination? What are desirable border adjustments? How can a Ramsey allocation be implemented with residence-based taxes on assets? We characterize optimal wedges and analyze alternative policy implementations.
Keyword: Value-added taxes, Origin- and destination-based taxation, Border adjustment, Free trade, Production efficiency, and Capital income tax Subject (JEL): E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General, and E62 - Fiscal Policy
Creator: Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 305 Keyword: Ricardian Proposition, World economy, Dynamic theory, Global economics, Monetary economics, and Optimal consumption behavior Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth and F41 - Open Economy Macroeconomics
Creator: Miller, Preston J. and Todd, Richard M. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 154 Abstract:
We present a 2-country model with heterogeneous agents in which changes in a country’s monetary policy affect real interest rates, relative prices of traded and nontraded goods and real exchange rates. Nontransitory real effects of monetary policy stem solely from a friction (country-specific reserve requirements) that generates separate demands for a country’s money and bonds. Without violating the classical assumptions of individual rationality and flexible prices, the model’s implications seem qualitatively in accord with the U.S. experience of the 1980s: a monetary policy tightening leading to a rise in the real interest rate and to an initial rise in the real value of the dollar which is subsequently reversed. In the model a monetary policy change leads to different welfare effects for agents born at different times, living in different countries, or participating on different sides of a market. The welfare of some agents can be affected more by relative price changes than by real interest rate changes.
Keyword: Monetary policy, Open economy, Nontraded goods, Legal restrictions, and General equilibrium Subject (JEL): E50 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General and F41 - Open Economy Macroeconomics
Creator: Neumeyer, Pablo Andrés and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 335 Abstract:
We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.
Keyword: Country risk, Financial crises, Sudden stops, Working capital, and International business cycles Subject (JEL): F32 - Current Account Adjustment; Short-term Capital Movements, E32 - Business Fluctuations; Cycles, and F41 - Open Economy Macroeconomics
Creator: Hevia, Constantino and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 702 Abstract:
We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.
Keyword: Optimal monetary policy, Small open economy, Terms of trade shocks, and Devaluations Subject (JEL): E52 - Monetary Policy and F41 - Open Economy Macroeconomics
Creator: Hevia, Constantino and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 726 Abstract:
We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
Keyword: Inflation targeting, Foreign exchange intervention, and Dutch disease Subject (JEL): F31 - Foreign Exchange and F41 - Open Economy Macroeconomics
Creator: Ayres, João, Hevia, Constantino, and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 743 Abstract:
In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ﬁnal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
Keyword: Real exchange rate disconnect puzzle and Primary commodity prices Subject (JEL): F31 - Foreign Exchange and F41 - Open Economy Macroeconomics