Working Papers
2010
February 1, 2010
Do Currency Fundamentals Matter for Currency Speculators?
Description: The answer seems affirmative. We compare currency carry trades with an investment strategy based on currency fundamentals: taking a long (short) position in undervalued (overvalued) currencies. Carry trades have high risk-adjusted returns, but are subject to "crash risk." In contrast, the fundamental strategy has lower risk-adjusted returns, but is less prone to crash risk, because the realization of crash risk coincides with corrections towards fundamentals. In particular, the fundamental strategy outperformed carry trades during the recent global financial crisis. Building on these results, we present early warning indicators for potential turbulence in the currency market.
January 1, 2010
Financial Shocks and TFP L4318Growth
Description: The paper investigates how changes in industries' funding costs affect total factor productivity (TFP) growth. Based on panel regressions using 31 U.S. and Canadian industries between 1991 and 2007, and using industries' dependence on external funding as an identification mechanism, we show that increases in the cost of funds have a statistically significant and economically meaningful negative impact on TFP growth. This finding cannot be explained by either increasing returns to scale or factor hoarding, as results are not sensitive to controlling for industry size and our calculations account for changes in factor utilization. Based on a stylized theoretical model, the estimates suggest that financial shocks distort the allocation of factors across firms even within an industry, reducing its TFP. The decline in productivity growth accounts for a large fraction of the negative impact of funding costs on output.
January 1, 2010
Responding to Banking Crises: Lessons From Cross-Country Evidence
Description: A common legacy of banking crises is a large increase in government debt, as fiscal resources are used to shore up the banking system. Do crisis response strategies that commit more fiscal resources lower the economic costs of crises? Based on evidence from a sample of 40 banking crises we find that the answer is negative. In fact, policies that are riskier for the government budget are associated with worse, not better, post-crisis performance. We also show that parliamentary political systems are more prone to adopt bank rescue measures that are costly for the government budget. We take advantage of this relationship to instrument the policy response, thereby addressing concerns of joint endogeneity. We find no evidence that endogeneity is a source of bias.
January 1, 2010
Canada's Potential Growth: Another Victim of the Crisis?
Description: This study investigates the impact of the current financial crisis on Canada's potential GDP growth. Using a simple accounting framework to decompose trend GDP growth into changes in capital, labor services and total factor productivity, we find a sizeable drop in Canadian potential growth in the short term. The estimated decline of about 1 percentage point originates from a sharply decelerating capital stock accumulation (as investment has dropped steeply) and a rising long-term unemployment rate (which would raise equilibrium unemployment rates). However, over the medium term, we expect Canada's potential GDP growth to gradually rise to around 2 percent, below the pre-crisis growth rate, mostly reflecting the effects of population aging and a secular decline in average working hours.
January 1, 2010
Macrofinancial Linkages of the Strategic Asset Allocation of Commodity-Based Sovereign Wealth Funds
Description: This paper analyses the links between the investment strategies of a commodity-based SWF and the macroeconomic framework of the owner country. We examine some basic macrofinancial linkages of an SWF's strategic asset allocation (SAA) strategies with regard to the government budget, monetary policy, and exchange rate movements. Based on a simple Markowitz-model framework, which integrates the specific objectives and constraints facing an SWF and the country's specific characteristics and macroeconomic vulnerabilities (especially in relation to commodity prices and prospective defined liabilities), we derive an SAA. The asset-liability methodology that is applied in the selection of an SWF SAA also allows assessing whether (i) the SAA adequately takes into account the country-specific risks and vulnerabilities, and (ii) its objectives and macrofinancial constraints are consistent. Some analytical and practical issues in determining an SAA model are also discussed, along with key effects of a financial crisis.
January 1, 2010
The Spillover Effects of the Global Crisison Economic Activity in Mena Emerging Market Countries: An Analysis Using the Financial Stress Index
Description: The estimated spillover of the global crisis to emerging market (EM) economies in the Middle East and North Africa (MENA) indicates that nearly two-thirds of the increased financial stress in MENA EM countries after the Lehman shock is attributable to direct or indirect spillovers of financial stress in advanced economies. Moreover, the estimated models suggest that the increased financial stress and slowdown in economic activity in advanced economies can explain about half of the drop in real GDP growth in MENA EM countries after the Lehman shock.
January 1, 2010
What Level of Public Debt Could India Target?
Description: This paper discusses possible medium-term public debt targets for India, based on evidence from the economic literature on prudent levels of public debt and the feasibility for the country to meet a particular target over the next 5-6 years. While recognizing the challenges in determining an appropriate debt target, cross-country analysis and simulations suggest that a debt ratio in the range of 60-65 percent of GDP by 2015/16 might be suitable for India. Such a debt ceiling, while still above the average debt level for emerging markets, is within the range of debt ratios that would provide room for countercyclical fiscal policy and contingent liabilities. It would also send a strong signal of the government's commitment to fiscal consolidation by making a clear break with the past.
January 1, 2010
Correlations in Emerging Market Bonds: The Role of Local and Global Factors
Description: This paper examines the comovement in emerging market bond returns and disentangles the influence of external and domestic factors. The conceptual framework, set in the context of asset allocation, allows us to describe the channels through which shocks originating in a particular emerging or mature market are transmitted across countries and markets. We show that using a simple measure of cross-country correlations together with the commonly used average correlation coefficient can be more informative during episodes of heightened market instability. Data for the period 1997-2008 are analyzed for evidence of true contagion and common external shocks.
January 1, 2010
Investment by Large Firms in Argentina
Description: Strong growth in investment made a key contribution to the economic recovery in Argentina earlier this decade. The paper uses firm-level data to assess changes in financing constraints and the linkages between real investment at the firm level and macroeconomic developments in the real exchange rate and real interest rates. It concludes that several factors explain the performance of investment, including the real exchange rate, the cost of borrowing as well as an easing of financing constraints.
January 1, 2010
Public Debt Sustainability and Management in a Compound Option Framework
Description: This paper introduces the Asset and Liability Management (ALM) compound option model. The model builds on the observation that the public sector net worth in a multi-period setting corresponds to the value of an option on an option on total government assets. Hence, the ALM compound option model is better suited for analyzing and evaluating the risk profile of public debt than existing one-period models, and is especially useful for analyzing the soundness of exit strategies from the large fiscal expansions undertaken by G-20 countries in the wake of the recent financial crisis. As an illustration, the model is used to analyze the risk profile and sustainability of Australia's public debt under different policies.