The effect of a currency union on trade: Lessons from the Irish experience

This paper studies the introduction of an exchange rate between Ireland and the UK in 1979 to shed light on the effects of a common currency on the composition of international trade. No evidence is found from time series or panel regressions that the change of exchange rate regime had a significant effect on Anglo-Irish trade. This finding is consistent with previous studies of currency unions between larger, developed countries but conflicts with findings based on more heterogeneous country groupings. The reasons for this discrepancy are discussed.     

On the endogeneity of exchange rate regimes

The literature has identified three main approaches to account for the way exchange rate regimes are chosen: (i) the optimal currency area theory; (ii) the financial view, which highlights the consequences of international financial integration; and (iii) the political view, which stresses the use of exchange rate anchors as credibility enhancers in politically challenged economies. Using de facto and de jure regime classifications, we test the empirical relevance of these approaches separately and jointly. We find overall empirical support for all of them, although the incidence of financial and political aspects varies substantially between industrial and non-industrial economies. Furthermore, we find that the link between de facto regimes and their underlying fundamentals has been surprisingly stable over the years, suggesting that the global trends often highlighted in the literature can be traced back to the evolution of their natural determinants, and that actual policies have been less influenced by the frequent twist and turns in the exchange rate regime debate.     

Societal benefits of illiquid bonds

In this paper, I provide a possible explanation of why nominally risk-free bonds are essential in monetary economies. I argue that the role of nominal bonds is to enable agents to engage in intertemporal exchanges of money. I show that bonds can only serve this role if they are illiquid (costly to exchange for goods). Finally, I argue that in economies in which nominal bonds are essential, it is optimal for monetary policy to respond to changes in the distribution of liquidity needs.     

The business cycle implications of the euro adoption in Poland

This article analyses the macroeconomic impact of the loss of autonomous monetary policy after the euro adoption in Poland. Using a two-country Dynamic Stochastic General Equilibrium (DSGE) model with sticky prices and wages, we find that the euro adoption will have a noticeable impact on the magnitude of economic fluctuations. In particular, the volatility of output, interest rate, consumption and employment is expected to increase while the volatility of inflation should decrease. Also, in order to quantify the effect of the euro adoption, we compute the welfare effect of this monetary policy change. Our findings suggest that the welfare cost is not large.     

Impact of Central Bank Intervention during Periods of Speculative Pressure: Evidence from the European Monetary System

Abstract. This paper studies the effects of Banco de España and Banque de France interventions during the 1992–93 European Monetary System crises. In particular, a Markov Switching model is estimated where interventions influence the probabilities of transition between a calm and a turbulent regime. Furthermore, we analyze the impact of intervention on the expected rate of realignment. On balance, the results are consistent with the view that publicly known interventions but not secret interventions increased both the probability of switching to the turbulent regime as well as the expected realignment rate.     

Currency substitution,inflation, and welfare

Currency substitution affects the mapping between social welfare and inflation by altering the underlying money demand function and influencing interest rates. In order to explore the essence of this effect, I build a model with working capital under which foreign currency is substituted with the less liquid components of domestic money. The framework closely mimics the actual pattern of currency substitution across varying rates of inflation and enables the study of an additional channel that works through the impact of currency substitution on interest rates. It is found that there is a threshold inflation rate, which turns out to be 44% under baseline calibration, below which currency substitution decreases welfare and vice versa. A practical implication is that, at inflation rates lower (greater) than the threshold, the potential welfare gains from disinflation to a near-zero inflation rate are higher (lower) if there is currency substitution than otherwise.     

On the welfare effects of trade and investment liberalization

Using a three-factor knowledge- and physical capital model of trade and multinational activity, we consider a set of policy experiments to assess the welfare effects of trade and investment liberalization in general equilibrium. Specifically, we address the question of whether and under which circumstances a single versus a combined trade/investment liberalization strategy or a unilateral versus a bilateral policy change is preferable from a single country's and the world's point of view. The focus of this paper is to look at three relevant questions. First, when is investment liberalization beneficial and when is it harmful for a single economy or the whole world? Second, is pure investment liberalization a welfare maximizing strategy? Third, when is either kind of liberalization (trade, investment, or both) welfare improving and when neither of them?     

Dollarization and the inflation threshold

Abstract.  Empirical evidence suggests non-linearity in the impact of inflation on financial intermediation and real activity. Evidence also suggests that high inflation affects financial intermediation through the substitution of dollars 'under the mattress' for savings in domestic banks. We model an economy where inflation and real activity are positively related at low levels of inflation. However, when the inflation rate exceeds a threshold, agents substitute dollars for deposits issued by domestic banks, reducing the scale of financial intermediation and investment. As a consequence, at high levels of inflation, capital stock and output become negatively related to the inflation rate.     

Currency crisis transmission through international trade

The Eurozone recent crisis has shown how balance of payments problems in less developed European Monetary Union (EMU) member countries can affect EMU trading partners, spreading the crisis to a larger group of countries. This paper introduces a three-country dynamic general equilibrium model to analyze whether and how terms of trade effects can generate a spillover effect or a currency crisis transmission between countries. Specifically, using a two period model, it incorporates world market clearing conditions for tradables into a new theoretic model, analyzes net capital flow movements between countries, and establishes cross-border macroeconomic linkages. This paper shows how a currency crisis can transmit through the real (trade) sector channel of the economy.     

Policy Measures to Alleviate Foreign Currency Liquidity Shortages under Aggregate Risk with Moral Hazard

During the recent global financial crisis, certain central banks introduced two innovative cross‐border operations to deal with the problems of foreign currency liquidity shortages: domestic liquidity operations using cross‐border collateral and operations that supply foreign currency among central banks based on standing swap lines. We show theoretically that central banks improve the efficiency of equilibrium under foreign currency liquidity shortages using these two innovative temporary policy measures.     

On the dynamics of international inflation

We investigate the dynamic properties of inflation in 20 OECD countries with a novel approach based on the autocorrelation function. We find evidence in favor of long memory and nonlinearity. Linear autoregressive models are shown to be misspecified.     

Privatization, strategic foreign direct investment and host-country welfare

Recent evidence shows that developing countries and transition economies are increasingly privatizing their public firms and at the same time experiencing rapid growth of inward foreign direct investment (FDI). We show that there is a two-way causality between privatization and greenfield FDI. Privatization increases the incentive for FDI, which, in turn, increases the incentive for privatization compared to the situation of no FDI. The optimal degree of privatization depends on the cost difference of the firms, and on the foreign firm's mode of entry.     

The international effects of government spending composition

This paper incorporates a distinction between spending for government employment and spending for non-wage government consumption in a ‘new open economy macroeconomics’ model. Our results show that a permanent reduction in public employment in one country increases relative private consumption and appreciates the domestic exchange rate. We also compare announced reductions in domestic government employment and consumption, showing that these two policies have the same qualitative effects. When the reduction in public employment is used to finance increased government non-wage spending, the analytical results of the model are ambiguous, but a numerical analysis shows that relative consumption increases for a reasonable parameterization.