Globalization and Monetary Policy Institute
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The Globalization and Monetary Policy Institute Working Papers
2008 | 2007
2007
No. 5
Production Sharing and Real Business Cycles in a Small Open Economy
José Joaquín López
Abstract: Production sharing and vertical specialization account for a significant share of trade between developed and developing countries. The Mexican maquiladora industry provides an ideal example of production sharing in a small open economy. The typical "maquila" imports most of its inputs from and exports all its output to the United States. This article tries to determine to what extent production sharing, as in the Mexican maquiladora, can serve as a transmission mechanism of business cycles in small open economies. We utilize a simple two-sector small open economy model of real business cycles that incorporates production sharing in the traded sector. The transmission channel of business cycles is introduced in the model via demand shocks to the traded sector, originated in the United States' manufacturing sector. The model is successful in replicating real business cycles statistics for the maquiladora sector, as well as some of the characteristics of the nontraded sector.
No. 4
Cross-Border Returns Differentials
Stephanie E. Curcuru, Tomas Dvorak and Francis E. Warnock
Abstract: Were the U.S. to persistently earn substantially more on its foreign investments ("U.S. claims") than foreigners earn on their U.S. investments ("U.S. liabilities"), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, we find that the returns differential of U.S. claims over U.S. liabilities is far smaller than previously reported and, importantly, is near zero for portfolio equity and debt securities. For portfolio securities, we confirm our finding using a separate dataset on the actual foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors; in the context of equity and bond portfolios we find no evidence that the U.S. can count on earning more on its claims than it pays on its liabilities. Finally, we reconcile our finding of a near zero returns differential with observed patterns of cumulated current account deficits, the net international investment position, and the net income balance.
- Published as "Cross Border Returns Differentials" in Quarterly Journal of Economics, Volume 123, Issue 4, November 2008
No. 3
International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities
Charles Engel and Jian Wang
Abstract: Data for OECD countries document: 1. imports and exports are about three times as volatile as GDP; 2. imports and exports are pro-cyclical, and positively correlated with each other; 3. net exports are counter-cyclical. Standard models fail to replicate the behavior of imports and exports, though they can match net exports relatively well. Inspired by the fact that a large fraction of international trade is in durable goods, we propose a two-country two-sector model, in which durable goods are traded across countries. Our model can match the business cycle statistics on the volatility and comovement of the imports and exports relatively well. In addition, the model with trade in durables helps to understand the empirical regularity noted in the trade literature: home and foreign goods are highly substitutable in the long run, but the short-run elasticity of substitution is low. We note that durable consumption also has implications for the appropriate measures of consumption and prices to assess risk-sharing opportunities, as in the empirical work on the Backus-Smith puzzle. The fact that our model can match data better in multiple dimensions suggests that trade in durable goods may be an important element in open-economy macro models.
No. 2
A Monetary Model of the Exchange Rate with Informational Frictions
Technical Appendix (For code and dataset files, contact the author  .)
Enrique Martinez-Garcia
Abstract: Data for the U.S. and the Euro area during the post-Bretton Woods period shows that nominal and real exchange rates are more volatile than consumption, very persistent, and highly correlated with each other. Standard models with nominal rigidities match reasonably well the volatility and persistence of the nominal exchange rate, but require an average contract duration above 4 quarters to approximate the real exchange rate counterparts. I propose a two-country model with financial intermediaries and argue that: First, sticky and asymmetric information introduces a lag in the consumption response to currently unobservable shocks, mostly foreign. Accordingly, the real exchange rate becomes more volatile to induce enough expenditure-switching across countries for all markets to clear. Second, differences in the degree of price stickiness across markets and firms weaken the correlation between the nominal exchange rate and the relative CPI price. This correlation is important to match the moments of the real exchange rate. The model suggests that asymmetric information and differences in price stickiness account better for the stylized facts without relying on an average contract duration for the U.S. larger than the current empirical estimates.
No. 1
Is Openness Inflationary? Imperfect Competition and Monetary Market Power
Dataset  | Code (Fig. 1) | Code (Fig.2) 
Richard W. Evans
Abstract: Much empirical work has documented a negative correlation between different measures of globalization or openness and inflation levels across countries and across time. However, there is much less work exploring this relationship through structural international models based on explicit microeconomic foundations. This paper asks the question of how the degree of openness of an economy affects the equilibrium inflation level in a simple two-country OLG model with imperfect competition in which the monetary authority in each country chooses the money growth rate to maximize the welfare of its citizens. I find that a higher degree of openness in a country is associated with a higher equilibrium inflation rate. This result is driven by the fact that the monetary authority enjoys a degree of monopoly power in international markets as Foreign consumers have some degree of inelasticity in their demand for goods produced in the Home country. The decision of the monetary authority is then to balance the benefits of increased money growth that come from the open economy setting with the well-known consumption tax costs of inflation. In addition, I find that the level of imperfect competition among producers within a country is a perfect substitute for the international market power of the monetary authority in extracting the monopoly rents available in this international structure.
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