Working Papers
2004
September 1, 2004
An Institutional Framework for Comparing Emerging Market Currency Boards
Description: This paper offers an in-depth review of the institutional arrangements underlying existing currency boards (CBAs) in Argentina (until 2001), Eastern Europe, and Asia. An index of precommitment is derived from an analysis of legislative frameworks and monetary policy operations. The index covers features associated with monetary and exchange rate credibility such as: (i) clarity of legal basis, (ii) quality of reserve coverage, (iii) coverage of monetary aggregates, (iv) claims on reserves, (v) operational autonomy, (vi) transparency and accountability, and (vii) escape clauses. The paper concludes with a discussion of flexibility and credibility trade-offs and exit issues.
September 1, 2004
What is An Emerging Market?
Description: As developing economies become richer, they seek to contract with the global economy in increasingly complex ways. Dealing with that complexity often implies the need to renegotiate contracts. However, such recontracting is viewed with concern, particularly by market participants. At the same time, iron-clad commitments to abstain from recontracting are untenable. Sovereign debt experts have long dealt with this dilemma. This paper argues that the acute trade-off between commitment and flexibility is not unique to sovereign debt. Instead, it is the defining characteristic of an emerging market. Examples of World Bank guarantees on behalf of sovereign governments to private lenders, exchange rate regimes, and international bond contracts, highlight the evolution from commitment to flexibility. Early interaction with international markets typically benefits from strong transaction-specific commitment. However, the goal is to grow out of transactional commitments to achieve commitment through credible institutions. Institutional commitment allows the benefits of flexibility, with the country's "word" acting as the necessary assurance to behave responsibly.
September 1, 2004
Insurance Value of International Reserves: An Option Pricing Approach
Description: A quantitative framework is developed to bring forward the insurance motive of holding international reserves. The insurance value of reserves is quantified as the market price of an equivalent option that provides the same insurance coverage as the reserves. This quantitative framework is applied to calculating the cost of a regional insurance arrangement (e.g., an Asian Monetary Fund) and to analyzing one leg of an optimal reserve-holding decision.
September 1, 2004
Domestic Competition Spurs Exports: The Indian Example
Description: India's exports nearly tripled in the 1990s. Decomposing export growth shows that it has been driven by incumbent firms rather than the entry of new firms. By using a new panel on Indian firms and estimating a dynamic discrete-choice model of the firm's decision to export, we find evidence that economic liberalization has led to greater domestic competition, spurring firm efficiency and increasing Indian firms' competitiveness and ability to export. We show that export growth has been an outcome of local firm innovation which has come about due to increased competitive pressure from FDI entry.
September 1, 2004
The Role of Kamco in Resolving Nonperforming Loans in the Republic of Korea
Description: This paper aims to provide a balanced assessment of Korea Asset Management Corporation's role in resolving nonperforming loans in the aftermath of the 1997-98 financial crisis. It argues that KAMCO's incentive to dispose of NPLs can be explained by a strong social desire for a recovery of public funds injected for financial sector restructuring. KAMCO's market-making role also helped overcome informational and coordination problems in the development of a market for distressed assets.
September 1, 2004
Financing Uganda'S Poverty Reduction Strategy: Is Aid Causing More Pain Than Gain?
Description: Uganda's market-friendly development strategy and poverty reduction agenda have attracted large financial inflows, including aid. During 2000-02, concerns about a possible aid-induced Dutch disease were heightened by widening macroeconomic imbalances and an upward trend in the real effective exchange rate (REER). This paper shows that the REER remained broadly stable during a 10-year period and nontraditional exports increased remarkably, contrary to the predictions of the Dutch disease model. Also, economic growth was strong. This good performance is attributed to sound macroeconomic policies and important structural reforms, which have allowed an increased use of available production factors.
September 1, 2004
Will You Buy My Peg? the Credibility of a Fixed Exchange Rate Regime As a Determinant of Bilateral Trade
Description: This paper examines the relationship between fixed exchange rate arrangements and trade using a gravity model of international trade together with bilateral trade data from 24 countries from the Caribbean and Latin America for the period 1960-2001. The analysis indicates that a credible fixed peg has a positive impact on the value of bilateral trade. Moreover, the positive impact on trade is more pronounced with a stricter definition of the fixed peg or a longer duration of the peg. This supports the argument that the credibility of an exchange rate peg is an important element to determine bilateral trade. There is, however, no evidence to suggest that a currency union provides additional benefits.
September 1, 2004
Monetary Policy Rules and the U.S. Business Cycle: Evidence and Implications
Description: This paper estimates Taylor-type interest rates for the United States allowing for both time and state dependence. It provides evidence that the coefficients of the Taylor rule change significantly over time, and that the behavior of the Federal Reserve over the cycle can be explained using a two-state switching regime model. During expansions, the Federal Reserve follows a rule that can be characterized as inflation targeting with a high degree of interest rate smoothing. During recessions, the Federal Reserve targets output growth and conducts policy in a more active manner. The implications of conducting this type of policy are analyzed in a small scale new Keynesian model.
September 1, 2004
Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank
Description: An independent central bank can manage its balance sheet and its capital so as to commit itself to a depreciation of its currency and an exchange rate peg. This way, the central bank can implement the optimal escape from a liquidity trap, which involves a commitment to higher future inflation. This commitment mechanism works even though, realistically, the central bank cannot commit itself to a particular future money supply. It supports the feasibility of Svensson's Foolproof Way to escape from a liquidity trap.
September 1, 2004
Grants Versus Loans
Description: Under what conditions should grants be preferred to loans? To answer this question, we present a simple model à la Krugman (1988) and show that, for any given level of developmental assistance, the optimal degree of loan concessionality is positively associated with economic growth if countries are poor, have bad policies, and high debt obligations. We then test our model by estimating a modified growth model for a panel of developing countries, and find evidence supporting our predictions. Finally, we assess the determinants of current aid allocations and find that the degree of concessionality is negatively correlated with countries' levels of development.