Working Papers
2010
April 1, 2010
Implementing Official Dollarization
Description: This paper identifies key aspects that countries willing to officially dollarize must necessarily address. Based on country experiences, it discusses the critical institutional bases that are necessary to unilaterally introduce a new legal tender, describes the relevant operational issues to smooth the transition toward the use of the new currency, and identifies key structural reforms that are necessary to favor the sustainability over time of this monetary regime. The paper is aimed at providing preliminary guidance to policy makers and practitioners adopting official dollarization. The paper does not take a position on how appropriate this monetary arrangement is. Experiences from adopting dollarization in Ecuador, El Salvador, Kosovo, Montenegro, and Timor-Leste are illustrated briefly.
April 1, 2010
Development Accounting and the Rise of TFP
Description: The paper presents evidence that the contribution of differences in total factor productivity (TFP) to income differences across countries steadily increased between 1970 and 2000. We verify that our finding is neither imputable to measurement errors in input factors nor dependent on the assumption of factor neutral differences in technology. We conclude that theories explaining cross-country income differences based on institutions or on forces that are constant over time, such as geography or legal origin, should be reconsidered in the light of their consistency with the rise of the explanatory power of TFP.
April 1, 2010
Quantitative properties of sovereign default models: solution methods matter
Description: We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis questions the robustness of results in the sovereign default literature and is also relevant for the study of other credit markets.
April 1, 2010
Collateral, Netting and Systemic Risk in the OTC Derivatives Market
Description: To mitigate systemic risk, some regulators have advocated the greater use of centralized counterparties (CCPs) to clear Over-The-Counter (OTC) derivatives trades. Regulators should be cognizant that large banks active in the OTC derivatives market do not hold collateral against all the positions in their trading book and the paper proves an estimate of this under-collateralization. Whatever collateral is held by banks is allowed to be rehypothecated (or re-used) to others. Since CCPs would require all positions to have collateral against them, off-loading a significant portion of OTC derivatives transactions to central counterparties (CCPs) would require large increases in posted collateral, possibly requiring large banks to raise more capital. These costs suggest that most large banks will be reluctant to offload their positions to CCPs, and the paper proposes an appropriate capital levy on remaining positions to encourage the transition.
April 1, 2010
Beyond the Crisis: Revisiting Emerging Europe’s Growth Model
Description: Focusing on the nexus between economic growth and buildup of external vulnerabilities, this paper provides a systematic account of different growth strategies followed in Central and Eastern Europe in 2000-08 and then uses this growth diagnostics to derive implications for the post-crisis recovery. The main findings point to three policy lessons for improving growth sustainability. First, greater reliance on tradable sectors should be the cornerstone of the future growth model. Second, enhancing domestic sources of bank credit funding would contribute to mitigation of external vulnerabilities and make domestic financial system more resilient to global financial shocks. Third, prudential and macroeconomic policies will have to be more proactive in managing capital inflows, including funneling these inflows into investment in the export-oriented industries.
April 1, 2010
Russia's Output Collapse and Recovery: Evidence from the Post-Soviet Transition
Description: The health of the Russian economy still depends heavily on natural resource revenues. The history of the economic collapse and recovery in 1970–2004 provides new evidence on the sources of Russian economic growth, while a survey of the economic literature suggests that the Russian economy could be viewed as a weighted combination of virtual and normal forces. If the Russian economy is considered to be dominated by normal market economy forces, higher energy export receipts provide an opportunity for structural reforms while compensating for social costs, making the economy less vulnerable to decline in world energy prices. However, the domination of virtual forces—value transfers from the energy sector to strategic enterprises—suggests that high world energy prices are masking an inefficient manufacturing sector, and that the Russian economy is highly vulnerable to energy price declines.
April 1, 2010
Inflation Expectations and Monetary Policy in India: An Empirical Exploration
Description: This paper pursues a computationally intensive approach to generate future inflation, followed by an exploration of the determinants of inflation expectations by estimating a new Keynesian type Phillips curve that takes into account country-specific characteristics, the stance of monetary and fiscal policies, marginal costs and exogenous supply shocks. The empirical results indicate that high and climbing inflation could easily seep into people’s anticipation of future inflation and linger. There is a reputational bonus for monetary policy to act against inflation now rather than going for cold turkey when societal compulsions reach a critical mass.
March 1, 2010
The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy
Description: We develop a tractable open-economy new-Keynesian model with two sectors to analyze the short-term effects of aid-financed fiscal expansions. We distinguish between spending the aid, which is under the control of the fiscal authorities, and absorbing the aid-using the aid to finance a higher current account deficit-which is influenced by the central bank's reserves policy when access to international capital markets is limited. The standard treatment of the transfer problem implicitly assumes spending equals absorption. Here, in contrast, a policy mix that results in spending but not absorbing the aid generates demand pressures and results in an increase in real interest rates. It can also lead to a temporary real depreciation if demand pressures are strong enough to threaten external balance. Certain features of low income countries, such as limited participation in domestic financial markets, make a real depreciation more likely by amplifying demand pressures when aid is spent but not absorbed. The results from our model can help understand the recent experience of Uganda, which saw an increase in government spending following a surge in aid yet experienced a real depreciation and an increase in real interest rates.
March 1, 2010
The Real Exchange Rate and Growth Revisited: The Washington Consensus Strikes Back?
Description: There is good reason and much evidence to suggest that the real exchange rate matters for economic growth, but why? The "Washington Consensus" (WC) view holds that real exchange rate misalignment implies macroeconomic imbalances that are themselves bad for growth. In contrast, Rodrik (2008) argues that undervaluation relative to purchasing power parity is good for growth because it promotes the otherwise inefficiently small tradable sector. Our main result is that WC and the Rodrik views of the role of misalignment in growth are observationally equivalent for the main growth regressions he reports. There is an identification problem: Determinants of misalignment are also likely to be independent drivers of growth, and these types of growth regressions are hard-pressed to disentangle the different channels. However, we confirm that not only are overvaluations bad but undervaluations are also good for growth, a result squarely consistent with the Rodrik story but one that requires some gymnastics from the WC viewpoint.
March 1, 2010
Structural Models in Real Time
Description: This paper outlines a simple approach for incorporating extraneous predictions into structural models. The method allows the forecaster to combine predictions derived from any source in a way that is consistent with the underlying structure of the model. The method is flexible enough that predictions can be up-weighted or down-weighted on a case-by-case basis. We illustrate the approach using a small quarterly structural and real-time data for the United States.