Tariffs,Offshoring and Unemployment in A Two‐Country Model

This paper develops a two‐country model that incorporates offshoring opportunities, and analyses the effects of tariffs under economic stagnation in a liquidity trap that causes unemployment. We find that a rise in tariffs on imports of outsourced goods contributes to an increase in employment by inducing a shift in production, but also leads to an appreciation of the real exchange rate that tends to reduce employment. The effect of real exchange rate appreciation dominates the effect of the production shift, and accordingly employment and consumption fall. The effects of tariff adjustments are reversed, however, when there is no liquidity trap and hence no unemployment.     

Limited asset market participation and the consumption‐real exchange rate anomaly

Abstract Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country's aggregate consumption rises relative to foreign consumption, when the country's real exchange rate depreciates. Yet empirically, relative consumption and the real exchange rate are essentially uncorrelated. This paper shows that this ‘consumption‐real exchange rate anomaly’ can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand‐to‐mouth (HTM) lives. HTM behaviour also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.     

Composition of International Assets and the Long‐run Current Account

We document the role of capital gains and losses for the current account that a country can sustain along a balanced growth path. While it is well know that growth allows a country to run a current account deficit and still keep its external debt stable as a share of GDP, the sensitivity of the current account to the composition of external assets and liabilities has received little attention. We show that this composition matters because several assets, such as equity or FDI, earn substantial capital gains that are not reflected in the current account. A country that is a net creditor in such assets can then sustain a larger current account deficit. Using a broad sample, we show that this aspect substantially tilts estimates of the long‐run current account towards a deficit among industrialized economies, with the opposite situation for emerging markets. We also show that industrialized economies are likely to benefit from predictable capital gains in the future.     

Deforestation and the real exchange rate

Deforestation is a phenomenon that has largely been concentrated in the developing world. We construct a theoretical model of deforestation that focuses on the factors affecting the incentives to transform forested land into agricultural land. We show that: (i) lower discount rates and stronger institutions decrease deforestation; (ii) a depreciation in the real exchange rate increases deforestation in developing countries whereas the opposite obtains in developed countries; (iii) paradoxically, better institutions may exacerbate the deleterious impact of a depreciation in developing countries. These hypotheses are tested on an annual sample of 101 countries over the 1961–1988 period, and are not rejected by the data. Our results suggest that short-term macroeconomic policy, institutional factors, and the interaction between the two, are potentially important determinants of environmental outcomes.     

Risk aversion,exchange‐rate uncertainty,and the law of one price: insights from the market for online air‐travel tickets

Abstract We argue that risk aversion driven by exchange‐rate uncertainty causes a wedge between the domestic and foreign prices of a homogeneous good. We test our hypothesis using a unique micro‐data set from a market with minimum imperfections. The empirical findings validate our hypothesis, as accounting for exchange‐rate uncertainty we are able to explain a significant proportion of deviations from the law of one price. Overall, our analysis suggests the possibility of a new solution to the purchasing power parity puzzles.     

International transmission of environmental policy: A New Keynesian perspective

In this paper we examine the international transmission of environmental policy using a New Keynesian model of the global economy. We first consider the case in which the quality of the environment affects utility, but not productivity. This allows us to look at the trade-off between environmental quality and output. We then consider the case in which the quality of the environment increases productivity but does not affect utility. Our main results show that in both cases a unilateral implementation of a more stringent environmental policy by the domestic country raises foreign welfare under a benchmark parameterization. Our modeling strategy allows an analysis of how nominal rigidities interact with the implementation of environmental reforms, by allowing the domestic country to shift, through exchange rate depreciation, parts of the costs of more stringent environmental policies to the foreign one.     

The international risk sharing puzzle is at business cycle and lower frequency

Abstract We decompose the correlation between relative consumption and the real exchange rate in its dynamic components at different frequencies. Using multivariate spectral analysis techniques, we show that, at odds with a high degree of risk sharing, in most OECD countries the dynamic correlation tends to be quite negative, and significantly so, at frequencies lower than two years – the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum.     

Exchange‐Rate Risk and Japanese–Thai Industry Trade

Over the past decade, many papers have studied the effects of exchange‐rate volatility on international trade, particularly at the bilateral level for large numbers of individual industries. This is necessary because the underlying theory is ambiguous and because earlier papers failed to uncover significant results at a higher degree of aggregation. This paper examines the case of Japan and Thailand over the period from 1970 to 2010. We find that slightly more than half of 117 export industries and 54 import industries are affected by volatility in the short run. In the long run, 6 export and 2 import industries are affected positively, and 22 export and 9 import industries are affected negatively. Small Japanese export industries are more likely to be negatively affected, while imports show no differences regarding industry size. In a sectoral analysis, we find some evidence that Japanese exports of manufactures and certain machinery and transport equipment might be relatively more affected by the exchange‐rate risk. Raw material imports are least affected. These findings therefore suggest which industries might benefit most by a policy promoting a stable yen.     

Import sensitive products and perverse tariff‐rate quota liberalization

Abstract This paper shows that a Tariff‐Rate‐Quota's (TRQ) minimum access expansion can perversely trigger domestic price increases. Often, TRQs have prohibitive over‐quota tariffs to mimic import quotas in providing minimum market access. In the WTO's Doha Round, it is likely that countries using TRQs will avoid aggressive tariff reductions if they increase the quota portion of TRQs. We show that when the import price lies between the unit cost of production and the price received by domestic upstream firms, an increase in import quota as a share of domestic production may cause an increase in the domestic retail price.     

Structural reforms,fiscal consolidation and external rebalancing in monetary union: A model-based analysis

The paper analyses the impact of structural reforms on external positions in monetary union in a 3-region version of QUEST III. Wage cost moderation and fiscal consolidation improve the current account balance in the medium term, but positive income effects tend to offset the initial increase in the long term. The general pattern is robust across alternative levels of initial foreign indebtedness. While lasting imbalance correction requires a contraction of debt-financed domestic demand, supply-side reform can mitigate the associated output contraction. A scenario is given as illustration that would reverse the 20% competitiveness loss in the EMU periphery during the 2000s and reduce foreign and government debt by 30% and 50% of GDP within ten years.     

Terms‐of‐Trade Shocks and Exchange Rate Regimes in a Small Open Economy*

We examine the impact of terms‐of‐trade shocks on key macroeconomic variables by numerically solving a dynamic stochastic general equilibrium model of a small open economy. The model considers nominal price rigidity under different exchange rate regimes. The numerical solutions obtained are consistent with the empirical regularities documented by Broda (2004), in which output responses to shocks are smoother in floats than in pegs; in moving from pegs to floats, the rise in nominal exchange rate volatility is coupled by the rise in real exchange rate volatility; and in both exchange rate regimes, net foreign assets is the most volatile variable.     

National Treatment and the optimal regulation of environmental externalities

Abstract. We analyze the role of National Treatment in the regulation of environmental product standards for an open economy. A social planner uses product standards to control emissions from the consumption of a traded good. We show that whether National Treatment of standards interferes with welfare‐maximizing policy depends on the instruments available to the policy maker (consumption or emissions tax) and differences in the cost of complying with the standard. We also highlight the asymmetric incidence of the domestic and import product standard when taxes are suboptimal. This asymmetric incidence can also cause welfare‐maximizing policy to violate National Treatment.     

International trade, exhaustible-resource abundance and economic growth

Countries with oil and other natural resources have grown less rapidly than those countries without. This phenomenon is known as the “natural resource curse”. We develop an infinite-horizon, two-country model of trade in which countries are identical, except that one country is endowed with deposits of an exhaustible resource and the other is not. Within the context of the model, we show that this phenomenon can be explained in part by an inelastic demand for the exhaustible resource that increases growth in trade revenues and induces the resource-abundant country to invest relatively less than the country lacking in exhaustible resources. These results are derived analytically and illustrated by an empirical analysis based on plausible parameters obtained from data.     

Exchange rate policy under sovereign default risk

We examine monetary policy options for a small open economy where sovereign default might occur due to intertemporal insolvency. Under interest rate policy and floating exchange rates the equilibrium is indetermined. Under a fixed exchange rate the equilibrium is uniquely determined and independent of sovereign default.     

Economic integration and agglomeration in a middle product economy

We examine the interactions between economic integration and employment agglomeration in a neoclassical-growth, middle-product economy. There are two vertically integrated economies, with competitive final good firms operating plants in both regions and monopolistically-competitive intermediate good firms operating each in only one region. Immobile workers are employed with traded middle products to produce the nontraded final good; mobile workers are used with immobile capital to design and produce differentiated intermediate good inputs. While agglomeration and growth need not be positively related, trade need not enhance regional growth nor widen the skilled-unskilled wage gap.     

RE‐EXAMINATION OF THE GROWTH‐ENHANCING BUBBLE

We investigate the growth and welfare effects of the bubble that arise on equities on newly created firms by R&D activities. Considering an economy where the input to the R&D sector is the final goods financed by the savings of the household sector, we show that such a bubble has a growth‐enhancing effect under the condition opposite to the previous literature. We also explore the characteristics of the steady state equilibrium with the bubble and demonstrate that there can be dual bubbly equilibria, one of which is unstable and the other stable, and that the growth and welfare effects of an unexpected permanent change in the initial bubble are very different depending on which equilibrium the economy stays in.     

Hub‐and‐spoke free trade areas: theory and evidence from Israel

Abstract We study how the sequential formation of free trade areas affects trade flows between member countries. In a three‐country, three‐good model of comparative advantage if two countries have an FTA, and both sign a similar agreement with the third, trade between the two decreases. However, if only one of them signs an additional FTA, a hub‐ and‐spoke pattern arises, and trade between the initial members increases. Israel’s experience lends strong support to our model: trade between Israel and the EU, subject to an FTA since 1975, increased by an additional 29% after the introduction of the US‐Israel FTA in 1985.     

The unbearable tightness of being in a monetary union: Fiscal restrictions and regional stability

We study how constrained fiscal policy can affect macroeconomic stability and welfare in a two-region model of a monetary union with sticky prices and distortionary taxation. Both government spending and taxes can be used to stabilize regional variables; however, the best welfare outcome is obtained under some tax variability and constant regional inflations. We use a variety of rules to characterize constrained fiscal policy and find that strict fiscal rules coupled with a monetary policy that targets union-wide inflation result in regional inflation stability and the welfare costs of such rules are not as unbearable as one would expect. Fiscal authorities can enhance welfare by targeting the regional output gap, while targeting regional inflation is less successful since inflation stability is guaranteed by the central bank.     

Persistence of Current‐account Disequilibria and Real Exchange‐rate Misalignments

This paper aims at studying whether the persistence of the gap between the observed current‐account position and its equilibrium value nonlinearly depends on real exchange‐rate misalignments. Estimating a panel smooth transition regression model on a sample of 22 industrialized countries, we find evidence for this hypothesis, showing that persistence of current‐account imbalances strongly depends on the deviation of the real exchange rate from its long‐term equilibrium. More specifically, while there is no persistence in cases of currency undervaluation or weak overvaluation, persistence tends to augment for overvaluations higher than 11%. In addition, whereas disequilibria are persistent even for very low overvaluations in the euro area, persistence is observed only for overvaluations higher than 14% for non‐eurozone members.     

On the relevance of exchange rate regimes for stabilization policy

This paper assesses the relevance of the exchange rate regime for stabilization policy. Using both fiscal and monetary policy, we conclude that the exchange rate regime is irrelevant. This is the case independently of the severity of price rigidities, independently of asymmetries across countries in shocks and transmission mechanisms. The only relevant conditions are on the mobility of labor and financial assets. The results can be summarized with the claim that every currency area is an optimal currency area. However, with labor mobility or tradable state-contingent assets, additional policy instruments would be required to establish the irrelevance result.