Working Papers
2017
December 22, 2017
Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?
Description: Most countries hold large gross asset positions, lending in domestic currency and borrowing in foreign. Thus, their balance sheets are exposed to nominal exchange rates. We argue that when asset markets are incomplete, nominal exchange rate exposure allows countries to partially insure against shocks that move real exchange rates. We demonstrate that asset market incompleteness can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates correlate negatively. We also show that local perturbation methods that use stabilizing endogenous discount factors are inaccurate when average and steady state interest rates differ. To address this, we develop a novel global solution method to accurately solve the model.
December 22, 2017
Monetary Policy and the Relative Price of Durable Goods
Description: In a SVAR model of the US, the response of the relative price of durables to a monetary contraction is either flat or mildly positive. It significantly falls only if narrowly defined as the ratio between new-house and nondurables prices. These findings are rationalized via the estimation of a two-sector New-Keynesian (NK) models. Durables prices are estimated to be as sticky as nondurables, leading to a flat relative price response to a monetary shock. Conversely, house prices are estimated to be almost flexible. Such results survive several robustness checks and a three-sector extension of the NK model. These findings have implications for building two-sector NK models with durable and nondurable goods, and for the conduct of monetary policy.
December 22, 2017
Structural Transformation and the Agricultural Wage Gap
Description: A key feature of developing economies is that wages in agriculture are significantly below those of other sectors. Using Brazilian household surveys and administrative panel data, I use information on workers who switch sectors to decompose the drivers of this gap. I find that most of the gap is explained by differences in worker composition. The evidence speaks against the existence of large short-term gains from reallocating workers out of agriculture and favors recently proposed Roy models of inter-sector sorting. A calibrated sorting model of structural transformation can account for the wage gap level observed and its decline as the economy transitioned out of agriculture.
December 22, 2017
China’s Impacts on SSA through the Lens of Growth and Exports
Description: The analysis of China’s impacts on the 44 SSA countries reveals that: (i) after joining the WTO in 2001, China has started to impact significantly on SSA growth: one-percent increase in China’s GDP per capita leads to 0.02 percent increase on the SSA’s GDP per capita; (ii) oil and investment-goods exporters benefit more from China’s growth; (iii) compared to China’s consumption, its investment growth acts as a more important channel in influencing SSA; (iv) exports to China, highly linked to China’s growth, is an important indicator for SSA’s exports. Our results call for SSA countries to be well prepared for China’s rebalancing given its growing economic influence and to proactively search a sustainable way to continuously enhance productivity.
December 22, 2017
Oil Price Shocks and Economic Growth in Oil-Exporting Countries: Does the Size of Government Matter?
Description: This paper examines the impact of government size on how output and government expenditure respond to oil price shocks in 28 oil-exporting countries between 1990 and 2016. Results suggest that if the size of government (measured by government expenditure-to-(non-oil) GDP ratio) is larger, non-oil output growth, in response to a positive oil price shock, tends to be greater and output volatility higher. Furthermore, I find that an unexpected increase in oil price leads to expansion in government expenditure and the expansion is larger, the larger is the government. This paper provides empirical evidence for direct correlation between government size and macroecnomic stability in oil-exporting countries. The findings imply that fiscal consolidation and economic diversification help to narrow down economic exposure to exogenous oil price shocks and reduce volatility in non-oil output.
December 22, 2017
Australia’s Fiscal Framework: Revisiting Options for a Fiscal Anchor
Description: This paper revisits options for fiscal anchors in Australia against the backdrop of a medium-term budget balance anchor that has led to larger than expected upward drift in the net debt to GDP ratio since the end of the mining investment boom. The IMF’s G20MOD model is used to compare the budget balance anchor with a long-term debt anchor. Using model simulations evaluated against objective macro stabilization-debt control criteria under three likely scenarios for the Australian economy, the latter is found to perform at least as well as the former. The paper also considers the operationalization of a long-term debt anchor utilizing a combination of fiscal rules which includes expenditure restrictions and a flexible time horizon for convergence, aiming at encouraging countercyclical fiscal policy and minimizing the cost in terms of real GDP foregone in the medium term under fiscal consolidation.
December 22, 2017
Shadow Banking and Market Discipline on Traditional Banks
Description: We present a model in which shadow banking arises endogenously and undermines market discipline on traditional banks. Depositors' ability to re-optimize in response to crises imposes market discipline on traditional banks: these banks optimally commit to a safe portfolio strategy to prevent early withdrawals. With costly commitment, shadow banking emerges as an alternative banking strategy that combines high risk-taking with early liquidation in times of crisis. We bring the model to bear on the 2008 financial crisis in the United States, during which shadow banks experienced a sudden dry-up of funding and liquidated their assets. We derive an equilibrium in which the shadow banking sector expands to a size where its liquidation causes a fire-sale and exposes traditional banks to liquidity risk. Higher deposit rates in compensation for liquidity risk also weaken threats of early withdrawal and traditional banks pursue risky portfolios that may leave them in default. Policy interventions aimed at making traditional banks safer such as liquidity support, bank regulation and deposit insurance fuel further expansion of shadow banking but have a net positive impact on financial stability. Financial stability can also be achieved with a tax on shadow bank profits.
December 21, 2017
FDI, Global Value Chains, and Local Sourcing in Developing Countries
Description: The local sourcing of intermediate products is one the main channels for foreign direct investment (FDI) spillovers. This paper investigates whether and how participation and positioning in the global value chains (GVCs) of host countries is associated to local sourcing by foreign investors. Matching two firm-level data sets of 19 Sub-Saharan African countries and Vietnam to country-sector level measures of GVC involvement, we find that more intense GVC participation and upstream specialization are associated to a higher share of inputs sourced locally by foreign investors. These effects are larger in countries with stronger rule of law and better education.
December 21, 2017
Exchange Rate Misalignment and Growth: A Myth?
Description: The impact of real exchange rate movements on GDP growth is a hotly debated issue both in policy and academic circles. In this paper, we provide evidence suggesting that the association between exchange rate misalignment and growth for a broad panel of countries is very weak. Controlling for country fixed effects, time effects and initial GDP, a more depreciated currency is associated with higher growth if one does not exclude outliers. However, this positive association always vanishes after controling for the savings rate. Importantly, this applies for both a large panel of countries and for the emerging economies subsample.
December 14, 2017
Crisis and Reform: The 1893 Demise of Banca Romana
Description: More than a century later, the Banca Romana crisis still provides useful insights on the challenges of preserving financial stability. This paper reviews the case and discusses implications that can be relevant today. The crisis was spurred by an unsustainable credit expansion encouraged by capital inflows, which provoked an asset price bubble and other imbalances. A system of corruption and collusion with politicians and journalists enabled the bank managers to run risky and illegal operations – effectively, asset-stripping – undetected and unhindered. As a result, it would not have been easy for an observer not endowed with investigative powers to detect the mounting risks, while the government, which had these powers, failed to take action when needed and concealed critical information from the public. When the crisis erupted, its resolution was facilitated by a previous, decade-long debate on the reform of the banking system which had led to the exploration and development of possible solutions that could then be rapidly implemented.