Globalization and Monetary Policy Institute
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The Globalization and Monetary Policy Institute Working Papers
2008 | 2007
2008
No. 15
Variety, Globalization, and Social Efficiency 
W. Michael Cox and Roy J. Ruffin
Astract: This paper puts recent work on the benefits of variety into the context of a more complete quantitative analysis of the Dixit-Stiglitz-Krugman model of monopolistic competition. We show how the gains from globalization are reflected in the increase in variety and the exploitation of economies of scale, and that the social efficiency question is quantitatively insignificant. These results follow from examining a Bertrand-Nash equilibrium that allows for a finite number of varieties to affect the elasticity of demand facing each firm. We develop a precise expression for per capita real income with any number of sectors where globalization increases productivity through economies of scale.
No. 14
The Effect of Trade with Low-Income Countries on U.S. Industry
Raphael Auer and Andreas M. Fischer
Abstract: When labor-abundant nations grow, their exports increase more in labor-intensive sectors than in
capital-intensive sectors. We utilize this sectoral difference in how exports are affected by growth
to identify the causal effect of trade with low-income countries (LICs) on U.S. industry. Our
framework relates differences in sectoral inflation rates to differences in comparative advantageinduced
import growth rates and abstracts from aggregate fluctuations and sector specific trends.
In a panel covering 325 manufacturing industries from 1997 to 2006, we find that LIC exports are
associated with strong downward pressure on U.S. producer prices and a large effect on
productivity. When LIC exporters capture 1% U.S. market share, producer prices decrease by
3.1%, which is nearly fully accounted by a 2.4% increase in productivity and a 0.4% decrease in
markups. We also document that while LICs on average find it easier to penetrate sectors with
elastic demand, the price and productivity response to import competition is much stronger in
industries with inelastic demand. Overall, between 1997 and 2006, the effect of LIC trade on
manufacturing PPI inflation was around two percentage points per year, far too large to be
neglected in macroeconomic analysis.
No. 13
Globalisation, Domestic Inflation and Global Output Gaps: Evidence from the Euro Area
Alessandro Calza
Abstract: This paper tests whether the proposition that globalisation has led to greater sensitivity of
domestic inflation to the global output gap (the "global output gap hypothesis") holds for the euro
area. The empirical analysis uses quarterly data over the period 1979–2003. Measures of the
global output gap using two different weighting schemes (based on PPPs and trade data) are
considered. We find little evidence that global capacity constraints have either explanatory or
predictive power for domestic consumer price inflation in the euro area. Based on these findings,
the prescription that central banks should specifically react to developments in global output gaps
does not seem to be justified for the euro area.
No. 12
Financial Globalization, Governance, and the Evolution of the Home Bias
Bong-Chan Kho, René M. Stulz, and Francis E. Warnock
Abstract: Standard portfolio theories of the home bias are disconnected from corporate finance theories of
insider ownership. We merge the two into what we call the optimal ownership theory of the home
bias. The theory has the following components. In countries with poor governance, it is optimal
for insiders to own large stakes in corporations and for large shareholders to monitor insiders.
Foreign portfolio investors will exhibit a large home bias against such countries because their
investment is limited by the shares held by insiders (the "direct effect" of poor governance) and
domestic monitoring shareholders ("the indirect effect"). Foreigners can also enter as foreign
direct investors; if they are from countries with good governance, they have a comparative
advantage as insider monitors in countries with poor governance, so that the relative importance
of foreign direct investment in total foreign equity investment is negatively related to the quality
of governance. Using two datasets, we find strong evidence that the theory can help explain the evolution of the home bias. Using country-level U.S. data, we find that on average the home bias
of U.S. investors towards the 46 countries with the largest equity markets did not fall over the
past decade, but it decreased the most towards countries in which the ownership by corporate
insiders decreased, and the importance of foreign direct investment fell in countries in which
ownership by corporate insiders fell. Using firm-level data for Korea, we find evidence of the
additional indirect effect of poor governance on portfolio equity investment by foreign investors.
No. 11
Globalization and Monetary Policy: An Introduction
Enrique Martinez-Garcia
Abstract: Greater openness has become an almost universal feature of modern, developed economies. This paper develops a workhorse international model, and explores the role of standard monetary policy rules applied to an open economy. For this purpose, I build a two-country DSGE model with monopolistic competition, sticky prices, and pricing-to-market. I also derive the steady state and a log-linear approximation of the equilibrium conditions. The paper provides a lengthy explanation of the steps required to derive this benchmark model, and a discussion of: (a) how to account for certain well-known anomalies in the international literature, and (b) how to start "thinking" about monetary policy in this environment.
No. 10
Vehicle Currency
Michael B. Devereux and Shouyong Shi
Abstract: While in principle, international payments could be carried out using any currency or set of
currencies, in practice, the US dollar is predominant in international trade and financial
flows. The dollar acts as a "vehicle currency" in the sense that agents in nondollar economies
will generally engage in currency trade indirectly using the US dollar rather than using direct
bilateral trade among their own currencies. Indirect trade is desirable when there are
transactions costs of exchange. This paper constructs a dynamic general equilibrium model
of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle
currency, and show how this depends on the total number of currencies in existence, the size
of the vehicle currency economy, and the monetary policy followed by the vehicle currency's
government. We find that there can be very large welfare gains to a vehicle currency in a
system of many independent currencies. But these gains are asymmetry weighted towards the
residents of the vehicle currency country. The survival of a vehicle currency places natural
limits on the monetary policy of the vehicle country.
No. 9
Country Portfolios in Open Economy Macro Models
Michael B. Devereux and Alan Sutherland
Abstract: This paper develops a simple approximation method for computing equilibrium portfolios in
dynamic general equilibrium open economy macro models. The method is widely applicable,
simple to implement, and gives analytical solutions for equilibrium portfolio positions in any
combination or types of asset. It can be used in models with any number of assets, whether
markets are complete or incomplete, and can be applied to stochastic dynamic general
equilibrium models of any dimension, so long as the model is amenable to a solution using
standard approximation methods. We first illustrate the approach using a simple two-asset
endowment economy model, and then show how the results extend to the case of any
number of assets and general economic structure.
No. 8
How Should Central Banks Define Price Stability?
Mark A. Wynne
Abstract: It is now generally accepted that the primary objective of central banks should be the maintenance of price stability. This paper considers the question of how central banks should define price stability. I address three specific questions. First, should central banks target broad or narrow measures of inflation? Second, should central banks target headline or core measure of inflation? And third, should central banks define price stability as prevailing at some positive measured rate of inflation?
No. 7
Accounting for Persistence and Volatility of Good-level Real Exchange Rates: The Role of Sticky Information
Mario J. Crucini, Mototsugu Shintani and Takayuki Tsuruga
Abstract: Volatile and persistent real exchange rates are observed not only in aggregate series but also
on the individual good level data. Kehoe and Midrigan (2007) recently showed that, under a
standard assumption on nominal price stickiness, empirical frequencies of micro price
adjustment cannot replicate the time-series properties of the law-of-one-price deviations. We
extend their sticky price model by combining good specific price adjustment with
information stickiness in the sense of Mankiw and Reis (2002). Under a reasonable
assumption on the money growth process, we show that the model fully explains both
persistence and volatility of the good-level real exchange rates. Furthermore, our framework
allows for multiple cities within a country. Using a panel of U.S.-Canadian city pairs, we
estimate a dynamic price adjustment process for each 165 individual goods. The empirical
result suggests that the dispersion of average time of information update across goods is
comparable to that of average time of price adjustment.
No. 6
Driving Forces of the Canadian Economy: An Accounting Exercise
Simona E. Cociuba and Alexander Ueberfeldt
Abstract: This paper analyzes the Canadian economy for the post-1960 period. It uses an accounting
procedure developed in Chari, Kehoe, and McGrattan (2006). The procedure identifies
accounting factors that help align the predictions of the neoclassical growth model with
macroeconomic variables observed in the data. The paper finds that total factor productivity
and the consumption-leisure trade-off—the productivity and labor factors—are key to
understanding the changes in output, labor supply and labor productivity observed in the
Canadian economy. The paper performs a decomposition of the labor factor for Canada and
the United States. It finds that the decline in the gender wage gap is a major driving force of
the decrease in the labor market distortions. Moreover, the milder reduction in the labor
market distortions observed in Canada, compared to the US, is due to a relative increase in
effective labor taxes in Canada.
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