Abstract Persistent deviations of exchange rates from their equilibrium values have long been viewed as a source of macroeconomic instability, yet there remains little consensus on when and under what conditions exchange rate misalignments affect long-term economic growth. This paper examines the growth effects of real exchange rate misalignments using a large cross-country panel spanning the period 1980–2023. Exchange rate misalignments are estimated within a Behavioral Equilibrium Exchange Rate (BEER) framework, and their dynamic effects on economic growth are analyzed using local projection methods. The results show that exchange rate misalignments, particularly episodes of currency overvaluation, are associated with significant, persistent, and cumulative declines of approximately 3.8 percentage points in real GDP per capita over a 5-year horizon. These adverse effects are concentrated in emerging market and developing economies, whereas advanced economies display greater resilience. Moreover, the growth costs of exchange rate misalignments are amplified under fixed and heavily managed exchange rate regimes and depend critically on initial macroeconomic conditions, particularly current account balances and fiscal positions. Overall, the findings demonstrate that the growth effects of exchange rate misalignments are highly heterogeneous, varying systematically across levels of economic development, exchange rate arrangements, and macroeconomic fundamentals.
We develop a two-country DSGE model to investigate how financial frictions faced by foreign banks influence China's macroeconomic stability and social welfare. Foreign banks benefit from liquidity support provided by their parent banks, yet their expansion in China is constrained by credit friction and deposit friction that limit lending and deposit-taking activities. A reduction in frictions is achievable if foreign banks increase their local engagement or China broadens its policy openness to foreign banks. Our counterfactual analysis examines a transition from China's current high friction state, where foreign banks account for only about 1.5 % of total lending, to a low friction state similar to that observed in Eastern Europe, where their lending share reaches 30 %. The high-friction state currently prevailing means that foreign banks contribute almost insignificantly to macroeconomic fluctuations in China. Reducing financial frictions allows foreign banks to mitigate short-run domestic financial recessions with the help of liquidity transfer from parent banks but slowing long-run recovery and amplifying the impact of foreign financial shocks. Our model also reveals that the relationship between credit friction and deposit friction in determining welfare is non-monotonic. When credit friction is high, reducing deposit friction lowers welfare. Conversely, under low credit friction, welfare first rises and then falls as deposit friction decreases.
This paper re-examines the empirical identification of investment-specific technology (IST) shocks by highlighting the role of oil and food price fluctuations in shaping the relative price of equipment (RPE), the key observable used to estimate such shocks. Using U.S. quarterly data, I show that conventional IST measures are strongly correlated with identified oil price shocks and generate counterintuitive impulse responses, including falling real wages and rising oil prices. After adjusting the RPE from oil and food price movements, these anomalies disappear and the importance of IST shocks for GDP, consumption, and investment declines. To interpret these findings, I estimate a medium-scale DSGE model with an explicit commodity-producing sector, where its price moves both consumption and investment prices and the RPE is an observable. The model confirms that commodity price shocks explain a sizable share of RPE variation, while IST shocks play a more limited role in business cycle dynamics.
This paper investigates the welfare cost of business cycles in the U.S. economy over the period 1959-2019. In contrast to the existing literature, we allow for both structural breaks in the unconditional variance of consumption shocks and conditional heteroskedasticity. Our results provide strong evidence of structural breaks associated with distinct regimes in the consumption process, but no evidence of heteroskedasticity. Taking these regimes into account, we find that the welfare cost of business cycles declines substantially between the initial and the final regime. In our preferred specification under unitary relative risk aversion, the estimated welfare cost falls from 0.60 % to 0.12 % of consumption, suggesting that the marginal welfare gain from eliminating the remaining uncertainty faced by consumers has become very small.
Should an economy implement reforms during a deep crisis? A vast body of literature has evolved around this question. Early studies, based on standard New Keynesian models, suggested that reforms can be harmful when an economy is constrained by the zero lower bound. More recent research uses complex models to show which model assumptions influence this conclusion. In contrast, we take a simple model and show that two seemingly trivial assumptions significantly affect the result: the returns to labor in the production function and the presence of trend inflation. While trend inflation alone dampens the negative effect of the reforms, decreasing returns to labor can entirely reverse their short-run impact.
