Working Papers
2014
August 8, 2014
Friedman Redux: External Adjustment and Exchange Rate Flexibility
Description: Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments” of exogenous changes in bilateral exchange rate regimes.
August 8, 2014
Capital Flow Deflection
Description: This paper focuses on the coordination problem among borrowing countries imposing controls on capital infl ows. In a simple model of capital flows and controls, we show that inflow restrictions distort international capital flows to other countries and that, in turn, such capital flow deflection may lead to a policy response. We then test the theory using data on inflow restrictions and gross capital inflows for a large sample of developing countries between 1995 and 2009. Our estimation yields strong evidence that capital controls deflect capital flows to other borrowing countries with similar economic characteristics. Notwithstanding these strong cross-border spillover effects, we do not find evidence of a policy response.
August 8, 2014
Credit Quality in Developing Economies: Remittances to the Rescue?
Description: This paper analyzes the link between remittances inflows and nonperforming loans (NPLs) in a large sample of developing countries. Theoretical transmission channels include risk coping, exchange rate and growth impacts. Panel data estimates uncover the significant role of remittance inflows in reducing the size of NPLs in recipient economies. Econometric results also indicate a stronger marginal impact of remittances in a context of high macroeconomic instability, suggesting a significant effect of remittances on the likelihood of the private sector’s credit default during shocks. These results hold even after factoring in: (i) the endogeneity of remittance inflows and, (ii) the use of an alternative estimator (panel fractional logit) aimed at dealing with bounded dependent variables.
August 5, 2014
Africa Rising: Harnessing the Demographic Dividend
Description: Africa will account for 80 percent of the projected 4 billion increase in the global population by 2100. The accompanying increase in its working age population creates a window of opportunity, which if properly harnessed, can translate into higher growth and yield a demographic dividend. We quantify the potential demographic dividend based on the experience of other regions. The dividend will vary across countries, depending on such factors as the initial working age population as well as the speed and magnitude of demographic transition. It will be critical to ensure that the right supportive policies, including those fostering human capital accumulation and job creation, are in place to translate this opportunity into concrete economic growth.
August 4, 2014
Health Spending in Japan: Macro-Fiscal Implications and Reform Options
Description: Health spending has risen rapidly in Japan. We find two-thirds of the spending increase over 1990–2011 resulted from ageing, and the rest from excess cost growth. The spending level will rise further: ageing alone will raise it by 3½ percentage points of GDP over 2010–30, and excess cost growth at the rate observed over 1990–2011 will lead to an additional increase of 2–3 percentage points of GDP. This will require a sizable increase in government transfers. Japan can introduce micro- and macro-reforms to contain health spending, and financing options should be designed to enhance equity.
August 4, 2014
Balance Sheet Repair and Corporate Investment in Japan
Description: We trace Japanese firms’ behavior over the last decades using aggregate corporate balance sheet data. Financial health of Japanese corporate sector has improved and firms paid back significant amount of debt and rebuilt their liquidity buffers. They also expanded abroad while the pace of corporate investment moderated. Regarding the latter, model estimates on aggregate corporate investment over the post bubble period show that expectation about future profitability, in particular medium-term demand outlook, has been the major driver, implying that a successful implementation of structural reforms could have positive impact even in the near term by improving the medium-term demand outlook.
August 4, 2014
Unstash the Cash! Corporate Governance Reform in Japan
Description: Japan’s high corporate savings might be holding back growth. We focus on the causes and consequences of the current corporate behavior and suggest options for reform. In particular, Japan’s weak corporate governance—as measured by available indexes—might be contributing to high cash holdings. Our empirical analysis on a panel of Japanese firms confirms that improving corporate governance would help unlock corporate savings. The main policy implication of our analysis is that comprehensive corporate governance reform should be a key component of Japan’s growth strategy.
August 4, 2014
Is Japan’s Population Aging Deflationary?
Description: Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need. Many of these factors will beset other advanced countries as well, but we find that deflation risk from aging is not inevitable as ambitious structural reforms and an aggressive monetary policy reaction can provide the offset.
August 4, 2014
Japan’s Corporate Income Tax: Facts, Issues and Reform Options
Description: This paper explores how corporate income tax reform can help Japan increase investment and boost potential growth. Using international and Japan-specific empirical estimates of corporate tax elasticities, investment is predicted to expand by around 0.4 percent for each point of rate reduction. International consensus estimates suggest further that between 10 and 30 percent of the static revenue loss could be recovered in the long run through dynamic scoring, although Japan’s offset may be closer to the lower bound. Compensating fiscal measures are necessary in light of Japan’s tight fiscal constraints. The scope for base broadening in the corporate income tax is found to be limited and some forms of base broadening will undo positive investment effects of a rate cut. Alternative revenue sources include higher consumption and property taxes. A gradual approach toward lowering tax rates mitigates windfall gains and reduces short-run revenue costs. An incremental allowance-for-corporate-equity system could boost investment with limited fiscal costs in the short run.
July 25, 2014
Strategies for Reforming Korea’s Labor Market to Foster Growth
Description: While the Korean unemployment rates are currently among the lowest in OECD countries, the labor market duality and the underemployment in some segments of the population are important labor market challenges, and factors contributing to lower potential growth. The paper shows the benefits of comprehensive policy reforms aimed at increasing labor force participation and youth employment and reducing duality are likely to be considerable in the medium term.