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Euro Area Sovereign Risk During the Crisis
While the use of public resources is critical to cushion the impact of the financial crisis on the euro-area economy, it is key that the entailed fiscal costs not be seen by markets as undermining fiscal sustainability. From this perspective, to what extent do movements in euro area sovereign spreads reflect country-specific solvency concerns? In line with previous studies, the paper suggests that euro area sovereign risk premium differentials tend to comove over time and are mainly driven by a common time-varying factor, mimicking global risk repricing. Since October 2008, however, there is evidence that markets have become progressively more concerned about the potential fiscal implications of national financial sectors' frailty and future debt dynamics. The liquidity of sovereign bond markets still seems to play a significant (albeit fairly limited) role in explaining changes in euro area spreads.
One Shock, Many Policy Responses
Policymakers have relied on a wide range of policy tools to cope with capital flow shocks. And yet, the effects and interaction of these policies remain under debate, as does the motivation for using them. In this paper, quantile local projections are used to estimate the entire distribution of future policy responses to portfolio flow shocks for 20 emerging markets and understand the variety of policy choices across the sample. To assuage endogeneity concerns, estimates rely on the fact that global capital flows are exogenous from the viewpoint of any one of these countries. The paper finds that: (i) policy responses to capital flow shocks are heterogeneous across countries, fat-tailed—â€...
Capital Flows at Risk: Taming the Ebbs and Flows
The volatility of capital flows to emerging markets continues to pose challenges to policymakers. In this paper, we propose a new framework to answer critical policy questions: What policies and policy frameworks are most effective in dampening sharp capital flow movements in response to global shocks? What are the near- versus medium-term trade-offs of different policies? We tackle these questions using a quantile regression framework to predict the entire future probability distribution of capital flows to emerging markets, based on current domestic structural characteristics, policies, and global financial conditions. This new approach allows policymakers to quantify capital flows risks and evaluate policy tools to mitigate them, thus building the foundation of a risk management framework for capital flows.
On Impatience and Policy Effectiveness
An increasing body of evidence suggests that the behavior of the economy has changed in many fundamental ways over the last decades. In particular, greater financial deregulation, larger wealth accumulation, and better policies might have helped lower uncertainty about future income and lengthen private sectors' planning horizon. In an overlapping-generations model, in which individuals discount the future more rapidly than implied by the market rate of interest, we find indeed evidence of a falling degree of impatience, providing empirical support for this hypothesis. The degree of persistence of "windfall" shocks to disposable income also appears to have varied over time. Shifts of this kind are shown to have a key impact on the average marginal propensity to consume and on the size of policy multipliers.
After the Crisis
Italy’s deep-rooted structural problems resulted in an unsatisfactory productivity performance and a dismal growth over the last 15 years. The global financial crisis has exacerbated these long-standing weaknesses, taking a heavy toll on Italy’s economy. With output back to its end-2001 level, Italy’s output losses associated with the crisis have been, thus far, about 132 billion of 2000 euro (around 10 percent of precrisis 1998 - 2004 real GDP). About three quarters of these losses are estimated to be due to a shortfall in potential output. Potential output is not expected to rebound to its precrisis trend over the medium term, even though growth is projected to do so within the next two years. In the short-run, the decline in output is mainly accounted for by a collapse in productivity; in the medium term, employment and capital are also likely to be affected, with implications for the longer-term growth and fiscal outlook.
Deconstructing the Art of Central Banking
This paper proposes a markedly different transmission mechanism from monetary policy to the macroeconomy, focusing on how policy changes nominal inertia in the Phillips curve. Using recent theoretical developments, we examine the properties of a small, estimated U.S. monetary model distinguishing four monetary regimes employed since the late 1950s. We find that changes in monetary policy are linked to shifts in nominal inertia, and that these improvements in supply-side flexibility are indeed the main channel through which monetary policy lowers the volatility of inflation and, even more importantly, output.
Regional Financial Spillovers Across Europe
The recent financial crisis raises important issues about the transmission of financial shocks across borders. In this paper, a global vector autoregressive (GVAR) model is constructed to assess the relevance of international spillovers following a historical slowdown in U.S. equity prices. The GVAR model contains 27 country-specific models, including the United States, 17 European advanced economies, and 9 European emerging economies. Each country model is linked to the others by a set of country-specific foreign variables, computed using bilateral bank lending exposures. Results reveal considerable comovements of equity prices across mature financial markets. However, the effects on credit growth are found to be country-specific. Evidence indicates that asset prices are the main channel through which-in the short run-financial shocks are transmitted internationally, while the contribution of other variables-like the cost and quantity of credit-becomes more important over longer horizons.
The Volatility Costs of Procyclical Lending Standards
The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks’ capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the “overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher.
Monetary Magic? How the Fed Improved the Flexibility of the U.S. Economy
Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary uncertainty accounts for sluggish expectations adjustment to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in U.S. monetary policy and the Phillips curve, we find strong evidence that this link exists. These results bring into question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the United States and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply side of the economy.
Long-Run Productivity Shifts and Cyclical Fluctuations: Evidence for Italy
Using unobserved stochastic components and Kalman filter techniques, the paper assesses the relative importance of transitory and permanent shifts in Italian real GDP within a production function framework. Evidence suggests that the increase in hours worked that has accompanied pension and labor market reforms accounts for the bulk of low-frequency variation in growth, but points to factor utilization as the main driver of business cycle fluctuations. In contrast with the predictions of standard Real Business Cycle models, a positive shock to the underlying rate of total factor productivity growth generates a slight decline in hours, whereas the response of output to the same shock is found to be positive.
