How well can the New Open Economy Macroeconomics explain the exchange rate and current account?

Abstract

This paper advances the New Open Economy Macroeconomic literature in an empirical direction, estimating and testing a two-country model. Fit to U.S. and G7 data, the model performs moderately well for the exchange rate and current account. Results offer guidance for future theoretical work. Parameter estimates lend support to the assumption of local currency pricing. Estimates are found for key parameters commonly calibrated in the theoretical literature, such as the elasticity of substitution between home and foreign composite goods, and the response of a country's risk premium to the net foreign asset position. Results also indicate that deviations from interest rate parity are not closely related to monetary policy shocks, as recently hypothesized, but that these deviations are strongly related to shifts in the current account.

International macroeconomic interdependence and imports of oil in a small open economy

“…The elasticity ν m 2 is set to be very low, equal to 2, reflecting the low degree of substitutability between varieties of oil and a high market power of each oil firm. The elasticity of substitution between domestic and imported intermediate goods ϑ is set at 1.1 following Bergin (2004). Finally, the elasticity of export demand is η = 0.6 reflecting a low sensibility of Foreign demand to export prices set by Home firms.…”

Capital mobility and labor market volatility

“…We calibrated the Calvo-pricing parameter such that the average delay between price adjustments is four periods (γ = 0.75), a value roughly the same as the one in Danthine and Kurmann (2004). We resorted to the empirical estimates that have recently been reported by Bergin (2006) to calibrate the adjustment costs households' incur when adjusting their capital stock. Accordingly, we assumed ψ = 21.5.…”

“…Accordingly, we assumed ψ = 21.5. Following again Bergin (2006), we assumed that the proportion of firms that follow a PTM pricesetting strategy is relatively large. We set ξ = 0.95.…”

“…Accumulating approximation errors would deteriorate the accuracy of the loglinear approximation and would invalidate the computation of standard deviations and correlations. Following Schmitt-Grohé and Uribe (2003), Bergin (2006), and others, we extended the condition of uncovered interest rate parity implied by our model by a (linearized) risk premium that is proportional to holdings in bonds, D t , where we set = 0.004, based on the empirical estimates reported by Bergin (2006).…”

The joint response of stock and foreign exchange markets to macroeconomic surprises: Using US and Japanese data

“…2 Previous empirical investigations of the relation between macroeconomic surprises and subsequent market responses have overwhelmingly focused on the effect of the surprises either on the stock market or on the FX market in a separate framework without linking the two markets. For example, one class of these studies focuses on the connection between macroeconomic surprises and subsequent movements in stock prices (see Flannery and Protopapadakis (2002), Boyd et al (2005), Bernanke and Kuttner (2005), Basistha and Kurov (2008), Bhamra et al (2010), Birz and Lott (2011), Gilbert (2011), and Rangel (2011), among others), while the other class of these studies examines the influence of macroeconomic surprises on the exchange rate movement (see Almeida et al (1998), Anderson et al (2003), Simpson et al (2005), Bergin (2006), Evans and Lyons (2008), and Chen and Gau (2010), among others). This isolated analysis of only a particular market response ignores cross-market information effects of macroeconomic surprises and the results may not simultaneously hold true.…”