Balance Sheet Effects of a Currency Devaluation: A Stock-Flow Consistent Framework for Mexico

Balance Sheet Effects of a Currency Devaluation: A Stock-Flow Consistent Framework for Mexico

by Lorenzo Nalin and Giuliano Toshiro Yajima
Levy Institute Working paper n.980, December 2020

Abstract
This working paper empirically and theoretically analyzes the exchange rate’s role in Mexico’s
development for the period 2004–19. We test the hypothesis of the re(emergence) of the balance
sheet effect due to an increase in external debt in the nonfinancial corporate sector; higher foreign
debt would affect private investment after episodes of real currency depreciation, in the spirit of the
literature put forward by Gertler, Gilchrist, and Natalucci (2007) and Céspedes, Chang, and Velasco
(2004). We build a stock-flow consistent (SFC) model, following the OPENFLEX model proposed
in Godley and Lavoie (2006), to explore the balance sheet implications from a theoretical
perspective. We simulate the 2014 fall in the Mexican peso generated by the drop in oil prices to
replicate stylized facts for Mexico for the period under investigation. The scenario analysis points to
a hysteresis effect of the real exchange rate (RER) depreciation on investment flows. That is, firms’
investment ratio does not completely recover from negative shocks in the currency.

Global imbalances and financial capitalism

Book cover

Jacques Mazier (with Vincent Duwicquet, Luis Reyes, Jamel Saadaoui and Sebastian Valdecantos) has published a new book: Global imbalances and financial capitalism: Stock-Flow-Consistent Modelling.

The Table of Contents follows:

PART I
Finance- led regime and global imbalances:A first glance
1 A simple finance- led SFC model
2 Exchange rate misalignments and global imbalances
3 Global imbalances and macroeconomic adjustments: a three- country SFC model

PART II
European challenges
4 From the European Monetary System to the single currency trap
5 Alternative economic policies in the euro zone
6 Alternative exchange rate regimes for the euro zone

PART III
Enhancing regional and international monetary stability
7 Exploring monetary cooperation in East Asia
8 Enhancing the role of the SDR

Conclusion

Assessing the Marshall–Lerner condition within a stock-flow consistent model

Assessing the Marshall–Lerner condition within a stock-flow consistent model

by Emilio Carnevali, Giuseppe Fontana and Marco Veronese Passarella

Abstract
We derive the general equilibrium condition for the terms of trade in a two-country economy model. We show that the Marshall–Lerner condition is only a special case of this condition, in which a full exchange rate pass-through to import prices is assumed. In fact, the Marshall–Lerner condition is not even a ‘useful approximation’ of the general condition. For the full pass-through assumption has destabilising, rather than stabilizing, effects, when it is introduced in a stock-flow consistent dynamic model. More generally, the higher (lower) the pass-through, the slower (quicker) is the adjustment of the economy towards the equilibrium. This is tantamount to saying that the speed of adjustment is a positive function of the strategic behaviour of the exporters, who attempt to retain their market share by keeping their foreign currency-denominated prices unchanged.

published in the Cambridge Journal of Economics, 2020

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New paper on Latin America

Lorenzo Nalin and Giuliano Toshiro Yajima (2019) Commodity Speculation and Exchange Rate Swings in Latin America: a Stock Flow Consistent (SFC) Analysis, Working Papers 13/19, Sapienza University of Rome, DISS.

Abstract
We are investigating the role of speculative agents during a commodity-boom period in a small-open, peripheral economy. Latin American countries (LAs) have a long history of speculative attacks, balance of payments crises, and currency devaluations. At the beginning of the 2000s, LAs experienced rising commodity prices and foreign investors shifted part of their portfolio composition towards their securities in search of short-term capital gains. Unlike past episodes, financialization has allowed international investors to have a wider range of financial instruments in which to invest. Apart from the traditional government bonds, new asset categories have appeared such as derivatives, exchange traded funds and structured notes. In order to replicate this macro-financial episode, this work will adopt a Stock Flow Consistent (SFC) framework. International real-financial connections are one of the main issues tackled by this methodology, as put forward in Godley (1999). The element of novelty of our contribution consists in depicting a speculative financial sector, which issues commodity-based assets (CBAs) to be sold to rentier households in the developed country. Comparative static exercises with different scenarios will be performed.

Download the paper

A SFC course at UNAM

I have delivered a series of lectures on stock-flow-consistent modeling at Universidad Nacional Autonoma de Mexico (UNAM).

In this page you can find all slides and related materials.

New working paper

Modeling economic forces, power relations, and stock-flow consistency:
a general constrained dynamics approach
by Oliver Richters and Erhard Gloetzl

Abstract: In monetary Stock-Flow Consistent (SFC) models, accounting
identities reduce the number of behavioral functions to avoid an
overdetermined system of equations. We relax this restriction using a
differentialalgebraic equation framework of constrained dynamics.
Agents exert forces on the variables according to their desire, for
instance to gradually improve their utility. The parameter ‘economic
power’ corresponds to their ability to assert their interest. In
analogy to Lagrangian mechanics, system constraints generate additional
constraint forces that lead to unintended dynamics. We exemplify the
procedure using a simple SFC model and reveal its implicit assumptions
about power relations and agents’ preferences.

Link: https://ideas.repec.org/p/old/dpaper/409.html