Advances in Open Economy Macroeconomics

Paper Session

Saturday, Jan. 7, 2017 2:30 PM – 4:30 PM

Hyatt Regency Chicago, Burnham
Hosted By: Econometric Society
  • Chair: Matteo Maggiori, Harvard University

A Model of the International Monetary System

Matteo Maggiori
,
Harvard University
Emmanuel Farhi
,
Harvard University

Abstract

We propose a simple model of the international monetary system. We study the world supply and demand for reserve assets denominated in different currencies under a variety of scenarios: a Hegemon vs. a multipolar world; abundant vs. scarce reserve assets; a gold exchange standard vs. a floating rate system; away from vs. at the zero lower bound (ZLB). We rationalize the Triffin dilemma, which posits the fundamental instability of the system, as well as the common prediction regarding the natural and beneficial emergence of a multipolar world, the Nurkse warning that a multipolar world is more unstable than a Hegemon world, and the Keynesian argument that a scarcity of reserve assets under a gold standard or at the ZLB is recessive. We show that competition among few countries in the issuance of reserve assets can have perverse effects on the total supply of reserve assets. We analyze forces that lead to the endogenous emergence of a Hegemon. Our analysis is both positive and normative.

Dominant Currency Paradigm

Gita Gopinath
,
Harvard University
Camila Casas
,
Bank of the Republic of Columbia
Federico Diez
,
Federal Reserve Bank of Boston
Pierre-Olivier Gourinchas
,
University of California-Berkeley

Abstract

Most trade is invoiced in very few currencies. Despite this, the Mundell-Fleming
benchmark and its variants focus on pricing in the producer's currency or in local currency.
We model instead a `dominant currency paradigm' for small open economies
characterized by three features: pricing in a dominant currency; pricing complementarities,
and imported input use in production. Under this paradigm: (a) terms of
trade are stable; (b) dominant currency exchange rate pass-through into export and
import prices is high regardless of destination or origin of goods; (c) exchange rate
pass-through of non-dominant currencies is small; (d) expenditure switching occurs
mostly via imports and export expansions following depreciations are weak. Using
merged firm level and customs data from Columbia we document strong support for
the dominant currency paradigm and reject the alternatives of producer currency and
local currency pricing.

Lending of Last Resort in an Open Economy

Luigi Bocola
,
Northwestern University
Guido Lorenzoni
,
Northwestern University

Abstract

The paper analyzes a small open economy with flexible exchange rates in which the financial sector is possibly subject to confidence crises. A feedback between the health of the financial sector and the exchange rate amplifies the effects of the crisis. The paper shows that even if the domestic banking sector is initially financed mostly with deposits in domestic currency, a two-phase crisis can take place in which first consumers fly from domestic currency deposits, pushing the banks to dollarize their liabilities, and next the country is subject to a bank run cum currency crisis. We use this framework to analyze operations of lending of last resort. The possibility of capital flights in an open economy raises the amount of resources necessary to backstop a confidence crisis. Precautionary reserve accumulation by the fiscal authority facilitates effective lending of last resort, and it can lead to a less dollarized financial sector and
to a more stable exchange rate.

Real Interest Rates, Imbalances and the Curse of Regional Safe Asset Providers at the Zero Lower Bound

Helene Rey
,
London Business School

Abstract

The current environment is characterized by low real rates and by policy rates close to or at their lower bound in all major financial areas. We analyze these unusual economic conditions from a historical perspective and draw some implications for external imbalances, safe asset demand and the process of external adjustment. First, we decompose the fluctuations in the world consumption wealth ratio over long period of times and show that they anticipate movements of the real rate of interest. Second, our estimates suggest that the world real rate of interest is likely to remain low or negative for an extended period of time. In this context, we argue that there is a renewed Triffin dilemma where safe asset providers face a trade-off in terms of external exposure and real appreciation of their currency. This tradeoff is particularly acute for smaller economies. This is the `curse of the regional safe asset provider.' We discuss how this `curse' is playing out for two prominent regional safe asset providers: core EMU and Switzerland.
Discussant(s)
Maurice Obstfeld
,
University of California-Berkeley
Brent Neiman
,
University of Chicago
Mark Aguiar
,
Princeton University
Kenneth Rogoff
,
Harvard University
JEL Classifications
  • E0 - General