Working Papers
2012
June 1, 2012
Commodity Prices and Exchange Rate Volatility: Lessons from South Africa’s Capital Account Liberalization
Description: We examine the relationship between South African Rand and gold price volatility using monthly data for the period 1980-2010. Our main findings is that prior to capital account liberalization the causality runs from South African Rand to gold price volatility but the causality runs the other way around for the post-liberalization period. These findings suggest that gold price volatility plays a key role in explaining both the excessive exchange rate volatility and current disproportionate share of speculative (short-run) inflows that South Africa has been coping with since the opening up of its capital account.
June 1, 2012
Peru: Monetary and Exchange Rate Policies, 1930-1980
Description: This paper reviews monetary and exchange rate policies in Peru in 1930-80. The review covers major transformations to the world economy, including the post-1929 crash and WWII, and changing economic paradigms, such as the collapse of the gold standard and the rise and fall of the Bretton Woods system of fixed exchange rates. The analysis emphasizes the lasting partnership between Peruvian policymakers and the Bretton Woods institutions, while stressing the local authorities’ ownership of final policy decisions. The review shows that, in general, during the fifty year period under analysis, the Peruvian authorities sought to deliver nominal exchange rate stability, even at the cost of introducing market distortions and/or incurring heavy losses in international reserves.
June 1, 2012
Government Bonds and their Investors: What Are the Facts and Do they Matter?
Description: This paper introduces a new dataset on the composition of the investor base for government securities in the G20 advanced economies and the euro area. During the last decades, investors from abroad have increased their presence in government bond markets. The financial crisis broke this trend. Domestic financial institutions allocated a larger share of government securities in their portfolios, as Japan has done since its crisis in the 1990s. Increases in the share held by institutional investors or non-residents by 10 percentage points are associated with a reduction in yields by about 25 or 40 basis points, respectively. The data show a varied lead-lag relationship between bond yields and investor holdings. Portfolio balance estimates suggest that a change in statutory or regulatory holdings of government securities to the tune of 10 percent of the outstanding stock causes expected returns to decline by 7 to 25 basis points.
June 1, 2012
Banks' Liability Structure and Mortgage Lending During the Financial Crisis
Description: We examine the impact of banks’ exposure to market liquidity shocks through wholesale funding on their supply of credit during the financial crisis in the United States. We focus on mortgage lending to minimize the impact of confounding demand factors that could potentially be large when comparing banks’ overall lending across heterogeneous categories of credit. The disaggregated data on mortgage applications that we use allows us to study the time variations in banks’ decisions to grant mortgage loans, while controlling for bank, borrower, and regional characteristics. The wealth of data also allows us to carry out matching exercises that eliminate imbalances in observable applicant characteristics between wholesale and retail banks, as well as various other robustness tests. We find that banks that were more reliant on wholesale funding curtailed their credit significantly more than retail-funded banks during the crisis. The demand for mortgage credit, on the other hand, declined evenly across wholesale and retail banks. To understand the aggregate implications of our findings, we exploit the heterogeneity in mortgage funding across U.S. Metropolitan Statistical Areas (MSAs) and find that wholesale funding was a strong and significant predictor of a sharper decline in overall mortgage credit at the MSA level.
June 1, 2012
Systemic Risk and Asymmetric Responses in the Financial Industry
Description: To date, an operational measure of systemic risk capturing non-linear tail comovement between system-wide and individual bank returns has not yet been developed. This paper proposes an extension of the so-called CoVaR measure that captures the asymmetric response of the banking system to positive and negative shocks to the market-valued balance sheets of individual banks. For the median of our sample of U.S. banks, the relative impact on the system of a fall in individual market value is sevenfold that of an increase. Moreover, the downward bias in systemic risk from ignoring this asymmetric pattern increases with bank size. The conditional tail comovement between the banking system and a top decile bank which is losing market value is 5.4 larger than the unconditional tail comovement versus only 2.2 for banks in the bottom decile. The asymmetric model also produces much better estimates and fitting, and thus improves the capacity to monitor systemic risk. Our results suggest that ignoring asymmetries in tail interdependence may lead to a severe underestimation of systemic risk in a downward market.
June 1, 2012
What’s in it for Me? A Primeron Differences between Islamic and Conventional Finance in Malaysia
Description: What attracts conventional investors to Islamic financial instruments? We answer this question by comparing Malaysian Islamic and conventional security prices and their response to macrofinancial factors. Our analysis suggests that Islamic and conventional bond and equity prices are driven by common factors. Likewise, especially in recent years, Islamic banks have responded to economic and financial shocks in the same way as conventional banks, suggesting that the gap between Islamic and conventional financial practices is shrinking.
June 1, 2012
Inflation and Income Inequality: Is Food Inflation Different?
Description: There is an extensive literature noting that high inflation can add to income inequality, and a parallel literature assessing the effect of rising food prices on the poor. This paper attempts to combine these strands by dividing inflation into food and nonfood inflation and assessing whether food inflation affects income inequality differently from nonfood inflation. In an international sample and a sample of Chinese provinces, nonfood inflation exacerbates income inequality while the role of food inflation is more mixed. In a sample of Indian states broken down into urban and rural areas, we find that nonfood inflation adds to income inequality in both areas, while food inflation has a neutral to positive effect on income inequality in rural areas, providing support for the theory that rural wages may respond elastically to food prices.
June 1, 2012
Public Investment, Growth, and Debt Sustainability: Putting together the Pieces
Description: We develop a model to study the macroeconomic effects of public investment surges in low-income countries, making explicit: (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) the macroeconomic adjustment required to ensure internal and external balance. Well-executed high-yielding public investment programs can substantially raise output and consumption and be self-financing in the long run. However, even if the long run looks good, transition problems can be formidable when concessional financing does not cover the full cost of the investment program. Covering the resulting gap with tax increases or spending cuts requires sharp macroeconomic adjustments, crowding out private investment and consumption and delaying the growth benefits of public investment. Covering the gap with domestic borrowing market is not helpful either: higher domestic rates increase the financing challenge and private investment and consumption are still crowded out. Supplementing with external commercial borrowing, on the other hand, can smooth these difficult adjustments, reconciling the scaling up with feasibility constraints on increases in tax rates. But the strategy may be also risky. With poor execution, sluggish fiscal policy reactions, or persistent negative exogenous shocks, this strategy can easily lead to unsustainable public debt dynamics. Front-loaded investment programs and weak structural conditions (such as low returns to public capital and poor execution of investments) make the fiscal adjustment more challenging and the risks greater.
June 1, 2012
How Effective is Monetary Transmission in Low-Income Countries? A Survey of the Empirical Evidence
Description: This paper surveys the evidence on the effectiveness of monetary transmission in low-income countries. It is hard to come away from this review with much confidence in the strength of monetary transmission in such countries. We distinguish between the "facts on the ground" and "methodological deficiencies" interpretations of the absence of evidence for strong monetary transmission. We suspect that "facts on the ground" are an important part of the story. If this conjecture is correct, the stabilization challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge.
June 1, 2012
Credit Growth and the Effectiveness of Reserve Requirements and Other Macroprudential Instruments in Latin America
Description: Over the past decade policy makers in Latin America have adopted a number of macroprudential instruments to manage the procyclicality of bank credit dynamics to the private sector and contain systemic risk. Reserve requirements, in particular, have been actively employed. Despite their widespread use, little is known about their effectiveness and how they interact with monetary policy. In this paper, we examine the role of reserve requirements and other macroprudential instruments and report new cross-country evidence on how they influence real private bank credit growth. Our results show that these instruments have a moderate and transitory effect and play a complementary role to monetary policy.