Working Papers
2012
October 4, 2012
Sovereign Risk and Asset and Liability Management: Conceptual Issues
Description: Country practices towards managing financial risks on a sovereign balance sheet continue to evolve. Each crisis period, and its legacy on sovereign balance sheets, reaffirms the need for strengthening financial risk management. This paper discusses some salient features embedded in in the current generation of sovereign asset and liability management (SALM) approaches, including objectives, definitions of relevant assets and liabilities, and methodologies used in obtaining optimal SALM outcomes. These elements are used in developing an analytical SALM framework which could become an operational instrument in formulating asset management and debtor liability management strategies at the sovereign level. From a portfolio perspective, the SALM approach could help detect direct and derived sovereign risk exposures. It allows analyzing the financial characteristics of the balance sheet, identifying sources of costs and risks, and quantifying the correlations among these sources of risk. The paper also outlines institutional requirements in implementing an SALM framework and seeks to lay the ground for further policy and analytical work on this topic.
October 2, 2012
Deciding to Enter a Monetary Union: TheRole of Trade and Financial Linkages
Description: This paper evaluates the role of trade and financial linkages in the decision to enter a monetary union. We estimate a two-country DSGE model for the U.K. economy and the euro area, and use the model to compute the welfare trade-offs from joining the euro. We evaluate two alternative scenarios. In the first one, we consider a reduction of trade costs that occurs after the adoption of a common currency. In the second, we introduce interest rate spread shocks of the same magnitude as the ones observed during the recent debt crisis in Europe. The reduction of trade costs generates a net welfare gain of 0.9 percent of life-time consumption, while the increased interest rate spread volatility generates a net welfare cost of 2.9 percentage points. The welfare calculation suggests two ways to preserve the welfare gains in a monetary union: ensuring fiscal and financial stability that reduces macroeconomic country risk, and increasing wage flexibility such that the economy adjusts to external shocks faster.
October 2, 2012
Tests of German Resilience
Description: From its early post-war catch-up phase, Germany’s formidable export engine has been its consistent driver of growth. But Germany has almost equally consistently run current account surpluses. Exports have powered the dynamic phases and helped emerge from stagnation. Volatile external demand, in turn, has elevated German GDP growth volatility by advanced countries’ standards, keeping domestic consumption growth at surprisingly low levels. As a consequence, despite the size of its economy and important labor market reforms, Germany’s ability to act as global locomotive has been limited. With increasing competition in its traditional areas of manufacturing, a more domestically-driven growth dynamic, especially in the production and delivery of services, will be good for Germany and for the global economy. Absent such an effort, German growth will remain constrained, and Germany will play only a modest role in spurring growth elsewhere.
October 2, 2012
Banking and Trading
Description: We study the effects of a bank's engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, shortterm, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitablity expand the scale of trading. However, there are two inefficiencies. A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting. Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepending of the financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.
October 2, 2012
Emerging Market Business Cycles: The Role of Labor Market Frictions
Description: Emerging economies are characterized by higher consumption and real wage variability relative to output and a strongly countercyclical current account. A real business cycle model of a small open economy that embeds a Mortensen-Pissarides type of search-matching frictions and countercyclical interest rate shocks can jointly account for these regularities. In the face of countercyclical interest rate shocks, search-matching frictions increase future employment uncertainty, improving workers’ incentive to save and generating a greater response of consumption and the current account. Higher consumption response in turn feeds into larger fluctuations in the workers’ bargaining power while the interest rates shocks lead to variations in the firms’ willingness to hire; both of which contribute to a highly variable real wage.
September 28, 2012
External Imbalances in the Euro Area
Description: The paper examines the extent to which current account imbalances of euro area countries are related to intra-euro area factors and to external trade shocks. We argue that the traditional explanations for the rising imbalances are correct, but are incomplete. We uncover a large impact of declines in export competitiveness and asymmetric trade developments vis-à-vis the rest of the world –in particular vis-à-vis China, Central and Eastern Europe, and oil exporters- on the external balance of euro area debtor countries. While current account imbalances of euro area deficit countries vis-à-vis the rest of the world increased, they were financed mostly by intra-euro area capital inflows (in particular by the purchase of government and financial institutions’ securities, and cross-border interbank lending) which permitted external imbalances to grow over time.
September 27, 2012
Caribbean Growth in an International Perspective: The Role of Tourism and Size
Description: After earlier success, growth performance in most Caribbean countries has been disappointing since the early 1990s. With slower growth, output has fallen behind that of relevant comparator countries. This paper analyzes the growth experience of the Caribbean countries from a cross country perspective. Three findings stand out. First, the slowdown in growth is explained more by a decline in productivity rather than a lack of investment. Second, tourism has been a significant contributor to higher growth (through both capital accumulation and productivity) and lower output volatility, and in many countries there is scope for further expansion of this sector. Third, the small size and the fact that most of these countries are islands have limited growth. Policies aimed at improving productivity, further development of the tourism sector, and regional integration could pay dividends in terms of higher growth in the region.
September 27, 2012
Central America, Panama, and the Dominican Republic: Trade Integration and Economic Performance
Description: This paper studies the potential for the export sector to play a more important role in promoting growth in Central America, Panama, and the Dominican Republic (CAPDR) through deeper intra-regional and global trade integration. CAPDR countries have enacted many free trade agreements and other regional integration initiatives in recent years, but this paper finds that their exports remain below the norm for countries of their size. Several indexes of outward orientation are constructed and suggest that the breadth of geographic trading relationships, depth of integration into global production chains, and degree of technological sophistication of exports in CAPDR are less conducive to higher exports and growth than in fast-growing, export-oriented economies. To boost exports and growth, CAPDR should implement policies to facilitate economic integration, particularly building a customs union, harmonizing trade rules, improving logistics and infrastructure, and enhancing regional cordination.
September 26, 2012
Assessing the Cost of Financial Regulation
Description: This study assesses the overall impact on credit of the financial regulatory reforms in Europe, Japan, and the United States. Long-term cost estimates are provided for Basel III capital and liquidity requirements, derivatives reforms, and higher taxes and fees. Overall, average lending rates in the base case would rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States. These results are similar to the official BIS assessments of Basel III and an OECD analysis, but lower as a result of including expense cuts and reductions in the returns required by investors. As a result, they are markedly lower than those of the IIF.
September 21, 2012
Structural Reforms, IMF Programs and Capacity Building: An Empirical Investigation
Description: This paper investigates the role that International Monetary Fund (IMF) programs and capacity building play in fostering structural reforms. To do so, we exploit two novel datasets on IMF capacity building and structural reforms available for over one hundred IMF member countries over the period 1980 - 2010. The main results are threefold. First, there is a general association between IMF programs and structural reforms but this relationship is not very robust. Second, IMF training leads to an increase in structural reforms but only through IMF programs and only when a significant share of public servants is trained. Third, IMF technical assistance does not significantly lead to more structural reforms but raises the likelihood of completion of ongoing IMF programs. Our results are robust to a large number of checks, estimators and correcting for endogeneity.