Working Papers
2013
January 30, 2013
Financial Crises Explanations, Types, and Implications
Description: This paper reviews the literature on financial crises focusing on three specific aspects. First, what are the main factors explaining financial crises? Since many theories on the sources of financial crises highlight the importance of sharp fluctuations in asset and credit markets, the paper briefly reviews theoretical and empirical studies on developments in these markets around financial crises. Second, what are the major types of financial crises? The paper focuses on the main theoretical and empirical explanations of four types of financial crises—currency crises, sudden stops, debt crises, and banking crises—and presents a survey of the literature that attempts to identify these episodes. Third, what are the real and financial sector implications of crises? The paper briefly reviews the short- and medium-run implications of crises for the real economy and financial sector. It concludes with a summary of the main lessons from the literature and future research directions.
January 30, 2013
External Conditions and Debt Sustainability in Latin America
Description: Highly favorable external conditions have helped Latin America strengthen its economic fundamentals over the last decade. But, has the region built enough buffers to guard itself from a weakening of the external environment? This paper addresses this question by developing a simple framework that integrates econometric estimates of the effect of global factors on key domestic variables that determine public and external debt dynamics, with the IMF‘s standard debt sustainability framework. Results suggest that, while some countries in the region are well placed to withstand moderate or even large shocks, many would benefit from having stronger buffers to be in a position to deploy countercyclical policies, especially under tail events. External sustainability, on the other hand, does not appear to be a source of concern for most countries.
January 29, 2013
Chronicle of a Decline Foretold: Has China Reached the Lewis Turning Point?
Description: China is on the eve of a demographic shift that will have profound consequences on its economic and social landscape. Within a few years the working age population will reach a historical peak, and then begin a precipitous decline. This fact, along with anecdotes of rapidly rising migrant wages and episodic labor shortages, has raised questions about whether China is poised to cross the Lewis Turning Point, a point at which it would move from a vast supply of low-cost workers to a labor shortage economy. Crossing this threshold will have far-reaching implications for both China and the rest of the world. This paper empirically assesses when the transition to a labor shortage economy is likely to occur. Our central result is that on current trends, the Lewis Turning Point will emerge between 2020 and 2025. Alternative scenarios—with higher fertility, greater labor participation rates, financial reform or higher productivity—may peripherally delay or accelerate the onset of the turning point, but demographics will be the dominant force driving the depletion of surplus labor.
January 28, 2013
The Changing Collateral Space
Description: This paper highlights the changing collateral landscape and how it may shape the global demand/supply for collateral. We first identify the key collateral pools (relative to the “old” collateral space) and associated collateral velocities. Post-Lehman and continuing into the European crisis, some aspects of unconventional monetary policies pursued by central banks are significantly altering the collateral space. Moreover, regulatory demands stemming from Basel III, Dodd Frank, EMIR etc., new net debt issuance, and collateral connectivity via custodians (e.g., Euroclear/ Clearstream/ BoNY etc) will affect collateral movements.
January 28, 2013
Income Mobility and Welfare
Description: This paper develops a framework for the quantitative analysis of individual income dynamics, mobility and welfare. Individual income is assumed to follow a stochastic process with two (unobserved) components, an i.i.d. component representing measurement error or transitory income shocks and an AR(1) component representing persistent changes in income. We use a tractable consumption-saving model with labor income risk and incomplete markets to relate income dynamics to consumption and welfare, and derive analytical expressions for income mobility and welfare as a function of the various parameters of the underlying income process. The empirical application of our framework using data on individual incomes from Mexico provides striking results. Much of measured income mobility is driven by measurement error or transitory income shocks and therefore (almost) welfare-neutral. A smaller part of measured income mobility is due to either welfare-reducing income risk or welfare-enhancing catching-up of low-income individuals with high-income individuals, both of which have economically significant effects on social welfare. Decomposing mobility into its fundamental components is thus seen to be crucial from the standpoint of welfare evaluation.
January 25, 2013
Assessing the Determinants of Interest Rate Transmission Through Conditional Impulse Response Functions
Description: We employ a structural panel VAR model with interaction terms to identify determinants of effective transmission from central bank policy rates to retail lending rates in a large country sample. The framework allows deriving country specific pass-through estimates broken down into the contributions of structural country characteristics and policies. The findings suggest that industrial economies tend to enjoy a higher pass-through largely on account of their more flexible exchange rate regimes and their more developed financial systems. The average pass-through in our sample increased from 30 to 60 percent between 2003 and 2008, mainly due to positive risk sentiment, rising inflation and increasingly diversified banking sectors. The crisis reversed this trend partly as banks increased precautionary liquidity holdings, non-performing loans proliferated and inflation moderated.
January 24, 2013
Assessing the Macroeconomic Impact of Structural Reforms The Case of Italy
Description: Wide-ranging structural reforms are underway in Italy, aimed at addressing key bottlenecks in the product and labor markets. Our analysis, based on the IMF‘s Global Integrated Monetary and Fiscal model (GIMF), attempts to quantify the potential gains to the economy from a comprehensive package of structural reforms. We find that these gains can be sizeable. While in most cases, the reforms go in the right direction, their impact would depend on effective and timely implementation. In some areas, especially in the labor market, reforms would benefit from further strengthening. The priorities should be to strengthen competition in the non-tradable sector and make the labor market more efficient and inclusive, supported by growth-friendly fiscal reforms.
January 23, 2013
Inflation Targeting and Country Risk: An Empirical Investigation
Description: The sovereign debt crisis in Europe has highlighted the role of country risk premia as a link between countries’ fiscal and external balances, financial conditions and monetary policy. The purpose of this paper is to estimate how adoption of inflation targeting (IT) affects spreads. It is hypothesized that country risk premia for IT countries (especially among emerging market economies) may be lower than for other countries owing to greater policy predictability and more stable long-term inflation. The findings suggest that IT reduces the risk premium, both through adoption of the IT regime, and through the observed track record in stabilizing inflation.
January 22, 2013
You Never Give Me Your Money? Sovereign Debt Crises, Collective Action Problems, and IMF Lending
Description: We review the impact of the global financial crisis, and its spillovers into the sovereign sector of the euro area, on the international “rules of the game” for dealing with sovereign debt crises. These rules rest on two main pillars. The most important is the IMF’s lending framework (policies, financing facilities, and financial resources), which is designed to support macroeconomic adjustment packages based on the key notion of public debt sustainability. The complementary pillar is represented by such contractual provisions as Collective Action Clauses (CACs) in sovereign bonds, which aim to facilitate coordination among private creditors in order to contain the costs of a debt default or restructuring. We analyze the most significant changes (and their consequences) prompted by the recent crises to the Fund’s lending framework, not only in terms of additional financial resources, new financing facilities (including precautionary ones), and cooperation with euro-area institutions, but also as regards the criteria governing exceptional access to the Fund’s financial resources. We highlight a crucial innovation to these criteria, namely that, for the first time, they now explicitly take account of the risk of international systemic spillovers. Finally, we discuss how the recent crises have provided new political support for a broader dissemination of CACs in euro-area sovereign bonds. Importantly, in the first case involving an advanced economy, CACs were activated in the debt exchange undertaken by Greece in Spring 2012.
January 22, 2013
Macroprudential Policies for a Resource Rich Economy The Case of Mongolia
Description: This paper explores the extent to which macroprudential tools can be used to manage banking sector risks in Mongolia, a commodity producing country exposed to both procyclical and cross-sectional financial sector risks. Loose fiscal policy, rising credit activity, and heightened risk appetite—attributable to the commodity boom—are fuelling price volatility in asset markets, posing significant risks to financial stability if left unchecked. Rising interconnectedness, potential increase in dollarization and concentrated exposures are compounding those risks. Macroprudential tools can complement fiscal and monetary policy adjustments to avoid the buildup of vulnerabilities in the banking sector.