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Meeting Globalization's Challenges
"In the US, in Europe, and throughout the world, globalization, in tandem with technological progress, has left a massive number of people behind, feeling dispossessed, disenfranchised, and angry. Leading the charge of "hyperglobalization" during the second half of the last century, and enforcing the Western framework of austerity in the developing world has been the International Monetary Fund. Along with the World Bank and WTO, many consider the IMF one of the most consequential institutions to have pushed the world economy blindly towards excessive globalization, while not adequately considering its powerful negative consequences. In October 2017, however, the IMF convened with some of th...
Country and Industry Dynamics in Stock Returns
A perennial question in international finance is to what extent stock returns are influenced by country-location, as opposed to industry-affiliation, factors. This paper develops a novel methodology to measure these effects, in which portfolios mimicking "pure" country and industry factors are first constructed and their joint dynamics then modeled as regime-switching processes. Estimation using global firm-level data allows us to identify well-defined volatility states over the past thirty years and shows that the contribution of the industry factor becomes systematically more prominent during high global volatility states, while the country factor contribution declines. Using the model's estimates, we find that portfolio diversification possibilities vary considerably across economic states.
World Food Prices, the Terms of Trade-Real Exchange Rate Nexus, and Monetary Policy
How should monetary policy respond to large fluctuations in world food prices? We study this question in an open economy model in which imported food has a larger weight in domestic consumption than abroad and international risk sharing can be imperfect. A key novelty is that the real exchange rate and the terms of trade can move in opposite directions in response to world food price shocks. This exacerbates the policy trade-off between stabilizing output prices vis a vis the real exchange rate, to an extent that depends on risk sharing and the price elasticity of exports. Under perfect risk sharing, targeting the headline CPI welfare-dominates targeting the PPI if the variance of food price shocks is not too small and the export price elasticity is realistically high. In such a case, however, targeting forecast CPI is a superior choice. With incomplete risk sharing, PPI targeting is clearly a winner.
World Food Prices and Monetary Policy
The large swings in world food prices in recent years renew interest in the question of how monetary policy in small open economies should react to such imported price shocks. We examine this issue in a canonical open economy setting with sticky prices and where food plays a distinctive role in utility. We show how world food price shocks affect natural output and other aggregates, and derive a second order approximation to welfare. Numerical calibrations show broad CPI targeting to be welfare-superior to alternative policy rules once the variance of food price shocks is sufficiently large as in real world data.
Exchange Rates in the Periphery and International Adjustment Under the Gold Standard
The role of exchange rate flexibility in the periphery of the gold standard has been grossly overlooked. This paper builds a new dataset on trade-weighed exchange rates for the period 1870-1913 and finds that large currency movements in periphery countries operating inconvertible paper-money and silver-standard regimes induced major fluctuations in effective exchange rates worldwide. We relate the phenomenon to the international trade structure at the time and show that such currency fluctuations had powerful effects on trade flows. We conclude that nominal exchange rate flexibility in the periphery was an important ingredient of international payments adjustment under the gold standard.
Fiscal Deficits and Inflation
Macroeconomic theory postulates that fiscal deficits cause inflation. Yet empirical research has had limited success in uncovering this relationship. This paper reexamines the issue in light of broader data and a new modeling approach that incorporates two key features of the theory. Unlike previous studies, we model inflation as nonlinearly related to fiscal deficits through the inflation tax base and estimate this relationship as intrinsically dynamic, using panel techniques that explicitly distinguish between short- and long-run effects of fiscal deficits. Results spanning 107 countries over 1960-2001 show a strong positive association between deficits and inflation among high-inflation and developing country groups, but not among low-inflation advanced economies.
External Liabilities and Crises
We examine the determinants of external crises, focusing on the role of foreign liabilities and their composition. Using a variety of statistical tools and comprehensive data spanning 1970-2011, we find that the ratio of net foreign liabilities (NFL) to GDP is a significant crisis predictor, and the more so when it exceeds 50 percent in absolute terms and 20 percent of the country-specific historical mean. This is primarily due to net external debt--the effect of net equity liabilities is weaker and net FDI liabilities seem if anything an offset factor. We also find that: i) breaking down net external debt into its gross asset and liability counterparts does not add significant explanatory power to crisis prediction; ii) the current account is a powerful predictor, either measured unconditionally or as deviations from conventionally estimated “norms” iii) foreign exchange reserves reduce the likelihood of crisis more than other foreign asset holdings; iv) a parsimonious probit containing those and a handful of other variables has good predictive performance in- and out-of-sample. The latter result stems largely from our focus on external crises stricto sensu.
International Financial Integration and Funding Risks: Bank-Level Evidence from Latin America
Using a sample of over 700 banks in Latin America, we show that international financial liberalization lowers bank capital ratios and increases the shares of short-term funding. Following liberalization, large banks substitute interbank borrowing for equity and long-term funding, whereas small banks increase the proportions of retail funding in their liabilities, which have been particularly vulnerable to flight-to-quality during periods of financial distress in much of Latin America. We also find evidence that riskier bank funding in the aftermath of financial liberalizations is exacerbated by asymmetric information, which rises on geographical distance and the opacity of balance sheets.
Default Premium
We re-assess the view that sovereigns with a history of default are charged only a small and/or short-lived premium on the interest rate warranted by observed fundamentals. Our reassessment uses a metric of such a “default premium” (DP) that is consistent with asymmetric information models and nests previous metrics, and applies it to a much broader dataset relative to earlier studies. We find a sizeable and persistent DP: in 1870-1938, it averaged 250 bps upon market re-entry, tapering to around 150 bps five years out; in 1970- 2011 the respective estimates are about 400 and 200 bps. We also find that: (i) these estimates are robust to many controls including on actual haircuts; (ii) the DP accounts for as much as 60% of the sovereign spread within five years of market re-entry; (iii) the DP rises with market exclusion spells. These findings help reconnect theory and evidence on why sovereign defaults are infrequent and earlier debt settlements are desirable.
Financial De-Dollarization
We re-appraise the cross-country evidence on the dollarization of financial systems in emerging market economies. Amidst striking heterogeneity of patterns across regions, we identify a broad global trend towards financial sector de-dollarization from the early 2000s to the eve of the global financial crisis of 2008–09. Since then, de-dollarization has broadly stalled or even reversed in many economies. Yet a few of them have continued to de-dollarize. This suggests that domestic factors are also important and interact with global factors. To gain insight into such an interaction, we examine the experience of Peru since the early 1990s and find that low global interest rates, low global risk-aversion, and high commodity prices have fostered de-dollarization. Domestic macro-prudential measures that raise the relative cost of domestic dollar loans and the introduction and adherence to inflation targeting have also been key.
