Open Economy Setting Research Articles

Limited (energy) supply, monetary policy, and sunspots

In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

Limited (Energy) Supply, Monetary Policy, and Sunspots

In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

A Theory of Heterogeneous City Evolution with Heterogenous Agents

This paper develops a new unified theoretical general equilibrium model in which the interactions between heterogeneous workers and firms influence heterogeneous city evolutions. Given the heterogeneous worker–firm–city framework, I study in depth the possible heterogenous city evolutions and the resulting implications on the labor market, as well as on overall productivity. In particular, it is shown that the same exogenous shocks may lead to completely different results depending on the relative dominance of the two countervailing effects of congestion and agglomeration. In an open economy setting, it is also shown that such relative dominance may affect the trading partner and generate the comovement of city evolution in each country.

Redistribution In A Globalized World

Abstract Due to technological change, the opening of borders, and increased economic integration, the financial costs of relocating businesses and factors of production, moving residences, changing jobs, and transporting goods and services across borders pose new challenges for countries and subnational governments seeking to implement redistributive policies. This increasing mobility across borders implies that redistributive policies may amplify interjurisdictional fiscal externalities. In this article, we selectively review the literature relating to redistributive policy in an open economy setting. We then consider some of the implications of globalization for policy design, both within federal systems and across countries. Although globalization poses new challenges for fiscal systems, it does not necessarily imply that redistributive policy becomes untenable and possibly enhances the need for redistribution.

Tax Neutrality and Tax Amenities

Efforts to identify and implement an appropriate tax neutrality benchmark have been persistent themes in scholarly and policy debates on international taxation for fifty years. This paper questions whether the concept of tax neutrality has been adequately specified for analyzing the efficiency properties of international tax systems. As distinct from the closed-economy setting, in the open-economy setting, neither tax revenues received nor the burdens that tax revenues pay for may be taken as fixed. Because tax revenues finance infrastructure and other productivity-enhancing goods — so-called “tax amenities” — and because capital burdens infrastructure, the reallocation of tax revenues among jurisdictions and the movement of assets and productive capacities across borders cause the amount of tax revenue collected in each jurisdiction to diverge from the revenue target. A consequence is that what are viewed as tax incentive effects, or distortions, improve productivity in some cases. Neutrality as a value, however, rests on the idea that tax incentive effects reduce efficiency by causing resources to be allocated away from some optimum non-tax-affected baseline; this idea is what justifies referring to tax-influenced allocations as distortions. An implication is that the baseline is not well specified in the open-economy setting.This article suggests that, in light of these considerations and of the difficulty in implementing a theoretically satisfactory specification of neutrality, an analysis focusing on the allocative, distributive, and competitive properties of international tax rules would be more helpful than one focused on their neutrality properties. A simple model relating tax revenue and population to productivity is offered.

Pandemic and containment policies in open economy

This paper analyzes the economic and epidemiological externalities of containment policies in an open-economy setting with firm entry and exit, SIR virus transmission, and a production network. Motivated by empirical evidence that non-pharmaceutical intervention policies (such as workplace closure or social distancing) are substitutes for medication-related policies (healthcare facilities and vaccine development), we incorporated four types of containment policies into our model. We find the workplace closure policy is the most effective in pandemic management, and social distance is a beggar-thy-neighbor strategy. Furthermore, we evaluate the efficacy of existing policy combinations and compare them to the optimal policy choice in the cooperative and Nash equilibrium, and a “prepare-for-worst” situation. Inter-country policy collaboration allows each country to specialize in different policies while also improving overall welfare. Real-world policies differ from optimum policies in the cooperative and Nash equilibrium, but they are closer to the second-best policies in the “prepare-for-worst” scenario, in which the U.S. policies cannot be predicted.

Financial development and economic growth in a microfounded small open economy model

The global financial crisis since 2008 revived the debate on whether or not and to what extent financial development contributes to economic growth. This paper reviews different theoretical schools of thought and empirical findings on this nexus, building on which we aim to develop a unified, microfounded model in a small open economy setting to accommodate various theoretical possibilities and empirical observations. The model is then calibrated to match some well-documented stylized facts. Numerical simulations show that, in the long run, the welfare-maximizing level of financial develop is lower than the growth-maximizing level. In the short run, the price channel (through world interest rate) dominates the quantity-channel (through financial productivity), suggesting a vital role of international cooperation in tackling systemic risk of the global financial system.

Government Size, Trade Openness, and Intersectoral Income Fluctuation: An International Panel Analysis

Using the between-sector variation in income as a new measure of economic uncertainty, this article proposes simple models and supportive empirical evidence for the simultaneous relationship between economic uncertainty and government size in the open economy setting. Main empirical findings are that (i) a larger government reduces economic uncertainty, and, at the same time, (ii) an economy facing higher uncertainty has a larger government. However, (iii) the government tends to resort to redistributive policies to reduce the uncertainty, while (iv) government direct spending is also an effective option for the purpose. The study also finds that (v) the new cross-sectional measure of economic uncertainty tends to rise when a country becomes more open to international trade. Our results suggest that there is some trade-off between economic stability and a small government.

Population, Income, and Farmland Pricing in an Open Economy

Farmland valuation models usually incorporate local purchasing power as one of the pricing factors. A plausible rationale is that a larger population and higher income per capita imply increasing demand for agricultural products and farmland. In this paper, we study the relationship between the agricultural land prices, the regional population, and income per capita in an open economy setting in nominal and real variable terms using data from 1929 to 2018 at the state level. We show that in most areas of the United States, agricultural land prices are less affected by the state population or personal income. The valuation of agricultural land should not factor in the local purchasing power factors, with a few exceptions.

SHOCKS AND FRICTIONS IN THAI ECONOMY: THROUGH THE LENS OF BUSINESS CYCLE ACCOUNTING

This paper applies business cycle accounting methodology to analyze the sources of aggregate fluctuations in Thai economy, especially during the recent severe recessions in 1997–1998 and 2008–2009. This exploration helps researchers uncover possible shocks and frictions that drive business cycle in a small and open economy within a minimal model set-up. Under this methodology, a fluctuation in aggregate output can be accounted for by exogenous time-varying wedges, namely efficiency wedge, investment wedge, labor wedge, government wedge, etc. This study found that the efficiency wedge is essential in accounting for aggregate output, consumption and investment fluctuation, while the bond wedge, which only present in an open economy setting, is a prime factor in accounting for movement in current accounts. I conducted counterfactual experiments to see what accounts for the output drop during recent recessions. I find that the efficiency wedge played a key role in recent recessions in Thailand, while the investment wedge was accounted for slow economic recovery after the recessions.

On the existence of positive equilibrium profits in competitive screening markets

Frictionless consumer choices and price competition are often associated with competitive markets and vanishing equilibrium profits. We discuss vanishing profits in competitive screening markets like insurance. We assume symmetric firms which exhibit constant returns to scale. Consumer heterogeneity creates the possibility of adverse selection. Firms can offer multiple contracts in equilibrium and (importantly) in any deviation. Nash equilibrium profits vanish if each consumer has a unique optimizing bundle at equilibrium prices or, more generally, if there exists a linear ordering of contracts that dictates the preferences of firms whenever consumers are indifferent between multiple optimal contracts. Of particular interest, equilibrium profits vanish if, for each agent, indifference curves are steeper than iso-profit curves. The results extend to Miyazaki-Wilson-Spence equilibria. We provide examples of economies where there exists an equilibrium with strictly positive profit and show that these examples are robust (hold for an open set of economies).

On the Existence of Positive Equilibrium Profits in Competitive Screening Markets

We assume a fixed number of symmetric firms, competition in prices, constant returns to scale and frictionless consumer choices. Consumers differ in their preferences and profitability (e.g., due to heterogeneous risk aversion and loss probabilities), which creates adverse selection. Firms can offer multiple contracts to screen individuals, in equilibrium and in any deviation. We show that equilibrium profits vanish if each consumer has a unique optimising bundle at equilibrium prices or, more generally, if there exists a linear ordering over of contracts that dictates the preferences of firms whenever consumers are indifferent between multiple optimal contracts. For instance, equilibrium profits vanish if the marginal rate of substitution of quality for price is sharper for profit than for utility. In particular, profit also vanishes if utility equals the sum of (negative) profit, and a surplus (eg, due to risk aversion). We pro- vide examples of economies where there exists an equilibrium with strictly positive profit and show that these examples are robust (hold for an open set of economies).

Monetary Policy in a Small Open Economy with Imperfect Pass-Through

This paper studies the stabilization and welfare properties of various monetary policy regimes in a tractable framework suitable for the analysis of monetary policy in a small open economy environment with imperfect pass-through and inflation indexation. Using welfare criteria to evaluate the best monetary policy, results show that price-level targeting performs well and provides an alternative method for conducting successful monetary policy in the case of a small-open economy. Benefits of price-level targeting rules noted in the literature for closed economies also translate to the small open economy setting once allowing for the combination of inflation inertia and exchange rate imperfect pass-through. As the exchange rate is an important element of the transmission of monetary policy, movements in these variable and other foreign variables often account for a significant part of the variation in the consumer price index via their direct effect on the price of imported goods. Imperfect exchange rate pass-through favors the choice of price-level targeting over consumer price index inflation targeting.

Full and constrained Pareto efficiency with incomplete financial markets

We study the efficiency properties of equilibria in general equilibrium economies with incomplete financial markets. We focus the analysis on economies with a finitely large number of agents and initial endowments close to a Pareto optimal one. Consider an economy with a Pareto optimal equilibrium allocation and a sufficiently small, but nonzero, amount of trade. If the matrix of the derivatives of the indirect utility functions with respect to prices has maximal rank (equal to the number of non-numeraire commodities), then locally all the economies have a unique, constrained Pareto-efficient equilibrium. To the contrary, pick a Pareto optimal initial endowment. Then, locally, there are open sets of economies with a unique, constrained Pareto-efficient equilibrium and other open sets of economies with a unique constrained Pareto-inefficient equilibrium. The key step of the analysis is based on the observation that, in some small open neighborhood of an economy with a Pareto optimal initial endowment, we can partially characterize constrained Pareto optimal equilibria as the optimal solution of a well-defined, strictly concave optimization problem.

Stabilization policy, infrastructure investment, and welfare in a small open economy

Using a two-sector neoclassical growth model in an open economy setting with heterogeneous agents, this paper studies the distributional effects and welfare implications of a joint monetary and fiscal policy response to public infrastructure expansion in emerging market economies. The results show that fiscal stabilization policy is critical for achieving fiscal sustainability and price stability. With joint support of monetary and fiscal policy, government infrastructure investment provides significant welfare gains to the economy, and the choice of fiscal instruments has major distributional effects across agents: saving households accrue the highest welfare gains with new bond issuance, while hand-to-mouth consumers are better off when non-distorting taxes are adjusted. These potential tradeoffs in welfare due to households’ differing responses to infrastructure expansion have important implications for policy making.

A Revisit to an Open Economy Analysis and the Demand for Money Stability: A Case of India

The stability for Demand for Money (DFM hereafter) functional form has been a hot topic amongst Monetarists and Keynesian economists since the 1970s. Numerous studies have since been in search of the proper estimates of the DFM function and its determinants. This paper is a revisit of Kulkarni-Yuan (2006) paper, “Demand for Money in an Open Economy Setting: A Case of India”. It will compare K-Y Vector Error Correction Model (VECM hereafter) regression model for a closed and open economy using 12 years of additional data up to 2016, to new VECM regressions using data spanning for 48 years. With over half the data now available under an open economy setting, we should see an open economy model being the appropriate model to apply to India’s open economy. After running the regressions, we observe that our findings are consistent with traditional Monetarist theory where real GDP being the most significant determinant of demand for money, and interest rate and other variables have little lower effect than GDP. In case of India, this is quite consistent with expectations because interest rates are not inherently very flexible.

A re-examination of constrained Pareto inefficiency in economies with incomplete markets

We establish that, when the number of agents is sufficiently large, but finite, there are open sets of economies with constrained Pareto inefficient equilibria and provide a simple sufficient condition for constrained inefficiency. We also show that there are open sets of economies with constrained efficient equilibria. Hence, for these economies, neither constrained efficiency, nor its lack, are generic properties. However, constrained inefficiency is a pervasive feature: for each economy with preferences satisfying a mild restriction, there are open sets of endowments such that their equilibrium allocations are constrained inefficient.

Stabilization Policy, Infrastructure Investment, and Welfare in a Small Open Economy

This paper studies a joint monetary and fiscal policy response to an increase in public infrastructure investment in emerging market economies. I extend the neoclassical growth model to a two-sector open economy setting, and introduce heterogeneous agents to examine the distributional effects of public investment on welfare. My results show that the effects of public infrastructure investment hinge crucially on how the increases in government spending are ultimately financed. Monetary policy without fiscal adjustment for financing infrastructure expansion is inflationary, and has sizable crowding-out effects on private consumption and investment over shorter horizons. Fiscal stabilization policy is critical for the sustainability of rising government spending and price stability. With the joint effort of monetary and fiscal policy, infrastructure investment brings in significant welfare gains to the economy. Public investment has major distributional effects across agents, and the choice of fiscal instruments matters both quantitatively and qualitatively. Saving households accrue the highest welfare gains as a result of new bond issuance, while hand-to-mouth consumers are better off when non-distorting taxes are adjusted.

On‐the‐job‐search, wage dispersion and trade liberalization

AbstractThis paper builds a dynamic, general equilibrium, open economy model that allows for ex ante homogeneous workers to experience different wage growth before and after trade liberalization. Key features of our model include a product market composed of heterogeneous firms and a labour market characterized by directed, on‐the‐job‐search and dynamic contracts. We characterize the complementarity of these two sources of wage dispersion in an open economy setting where trade liberalization affects the endogenous equilibrium set of producers and the structure of wages. We find that worker job‐to‐job transitions, through on‐the‐job search, increases the impact of trade liberalization on wage dispersion by 4%.RésuméRecherche d’emploi en cours d’emploi, dispersion des salaires et libéralisation du commerce. Ce mémoire construit un modèle dynamique d’équilibre général d’une économie ouverte qui permet à des travailleurs ex ante homogènes de faire l’expérience de croissance différente des salaires avant et après la libéralisation du commerce. Les caractéristiques importantes du modèle incluent un marché du produit composé de firmes hétérogènes et un marché du travail caractérisé par une recherche dirigée d’emploi en cours d’emploi et des contrats de salaires dynamiques. On caractérise la complémentarité de ces deux sources de dispersion des salaires dans une économie ouverte où la libéralisation du commerce affecte l’équilibre endogène de l’ensemble des producteurs et la structure des salaires. On découvre que les transitions d’emploi à emploi des travailleurs, via la recherche d’emploi en cours d’emploi, accroîssent l’impact de la libéralisation du commerce sur la dispersion des salaires de 4 %.

The interdependence between the saving rate and technology across regimes: evidence from South Africa

This paper hypothesises that the saving rate and technological progress are interdependently determined by a common exogenous source, so that an exogenous shock to the saving rate determines long-run growth transitions. In an open-economy setting, the saving rate measures the quality of investment-led policies. The evidence shows that the down-break across South Africa’s ‘faster-growing’ regime (1952–1976) and ‘slower-growing’ regime (1977–2003) was caused by a negative shock to the saving rate that simultaneously led to a slowdown in the growth rate of technology via a structural decrease in the learning-by-doing parameter. The down-break results suggest that the saving rate is potentially an important policy variable to engineer a sustainable up-break. To assess this prediction with real data, the analysis looks at what happened in the post-2003 period (2004–2012). The results show that the up-break in the fixed investment rate was not matched by the saving rate, which implies that capital investment did not generate a faster rate of technological progress. The stylised facts suggest that a sustained increase in the total investment rate, which not only includes infrastructure investment, but also machinery and equipment investment and complementary foreign direct investment, may be an effective investment-led strategy to raise the economy’s growth rate on a sustainable basis.