Working Papers
2020
December 18, 2020
The Aggregate-Demand Doom Loop: Precautionary Motives and the Welfare Costs of Sovereign Risk
Description: Sovereign debt crises coincide with deep recessions. I propose a model of sovereign debt that rationalizes large contractions in economic activity via an aggregate-demand amplification mechanism. The mechanism also sheds new light on the response of consumption to sovereign risk, which I document in the context of the Eurozone crisis. By explicitly separating the decisions of households and the government, I examine the interaction between sovereign risk and precautionary savings. When a default is likely, households anticipate its negative consequences and cut consumption for self-insurance reasons. Such shortages in aggregate spending worsen economic conditions through nominal wage rigidities and boost default incentives, restarting the vicious cycle. I calibrate the model to Spain in the 2000s and find that about half of the output contraction is caused by default risk. More generally, sovereign risk exacerbates volatility in consumption over time and across agents, creating large and unequal welfare costs even if default does not materialize.
December 18, 2020
Effects of Emerging Market Asset Purchase Program Announcements on Financial Markets During the COVID-19 Pandemic
Description: The COVID-19 pandemic led many emerging market central banks to adopt, for the first time, unconventional policies in the form of asset purchase programs. In this study, we analyze the effects of these announcements on domestic financial markets using both event studies and local projections methodology. We find that these asset purchase announcements lowered bond yields, did not lead to a depreciation of domestic currencies, and did not have much effect on equities. While the immediate effect of asset purchases appears positive, further consideration of the risks and longer-term effects of unconventional monetary policies is needed. We highlight the trade-offs involved with the implementation of these measures, and discuss their risks. This working paper adds to the debate on how asset purchase programs should be a regular part of the emerging market policy toolkit.
December 18, 2020
House Prices and Macroprudential Policies: Evidence from City-level Data in India
Description: This paper examines the efficacy of macroprudential policies in addressing housing prices in a developing country while underscoring the importance of fundamental factors. The estimated models using city-level data for India suggest a strong influence of fundamental factors in driving housing prices. There is compelling evidence of the effectiveness of macroprudential tools viz., Loan-to-value (LTV) ratio, risk weights, and provisioning requirements, in influencing housing price movements. A granular analysis suggests an even stronger impact on housing prices of a change in the regulatory LTV ratio for large-sized vis-à-vis small-sized mortgages, which buttresses their potency in fighting house price speculations. A tightening of the risk weights on the housing assets of banks causes significant downward pressure on house prices. Similarly, regulatory changes in standard asset provisioning on housing loans also influence house prices.
December 18, 2020
Managing External Volatility: Policy Frameworks in Non-Reserve Issuing Economies
Description: Since the global financial crisis, non-reserve-issuing economies (NREs) have been highly sensitive to episodes of external pressures. With monetary policy independence constrained by this sensitivity, many NREs have utilized other policy instruments. This paper confirms the vulnerability of NREs to external shocks and finds that in some circumstances managing such shocks with multiple instruments can both lessen the policy response required from any one policy tool to financial and external shocks and increase the effectiveness of policies in stabilizing macro-financial conditions. Effectiveness however does not always imply appropriateness, which rests on an evaluation of potential trade-offs and unintended consequences.
December 11, 2020
Exchange Rate Fluctuations and Firm Leverage
Description: We quantify the effect of exchange rate fluctuations on firm leverage. When home currency appreciates, firms who hold foreign currency debt and local currency assets observe higher net worth as appreciation lowers the value of their foreign currency debt. These firms can borrow more as a result and increase their leverage. When home currency depreciates, the reverse happens as firms have to de-lever with a negative shock to their balance sheets. Using firm-level data for leverage from 10 emerging market economies during the period from 2002 to 2015, we show that firms operating in countries whose non-financial sectors hold more of the debt in foreign currency, increase (decrease) their leverage relatively more after home currency appreciations (depreciations). Combining the leverage data with firm-level FX debt data for 4 emerging market countries, we further show that our results hold at the most granular level. Our quantitative results are asymmetric: the effects of depre-ciations, that are generally associated with sudden stops, are quantitatively larger than those of appreciations, which take place at a slower pace over time during capital inflow episodes. As our exercise compares depreciations and appreciations of similar size, these results are suggestive of financial frictions being more binding during depreciations than a possible relaxation of such frictions during appreciations.
December 11, 2020
Mobility under the COVID-19 Pandemic: Asymmetric Effects across Gender and Age
Description: Lockdowns and voluntary social distancing led to significant reduction in people’s mobility. Yet, there is scant evidence on the heterogeneous effects across segments of the population. Using unique mobility indicators based on anonymized and aggregate data provided by Vodafone for Italy, Portugal, and Spain, we find that lockdowns had a larger impact on the mobility of women and younger cohorts. Younger people also experienced a sharper drop in mobility in response to rising COVID-19 infections. Our findings, which are consistent across estimation methods and robust to a variety of tests, warn about a possible widening of gender and inter-generational inequality and provide important inputs for the formulation of targeted policies.
December 11, 2020
Identifying Reform Priorities: The Role of Non-linearities
Description: Can countries improve their business climate through reforms in specific policy areas? Kraay and Tawara (2013) find that the answer depends on how we measure the business climate. When regressing seven different business climate indices on 38 policy indicators, they find little agreement among the seven models as to which of those policy indicators matter most. I revisit this puzzle using the same data but replacing their linear models with a Random Forest algorithm. I find a strong consensus across models on the importance ranking of policy indicators: No matter which business climate index is considered, the top ten contributors to a better business climate always include high recovery rates in insolvency proceedings (i.e., cents on the dollar for creditors), shorter border formalities for both importers and exporters, and low costs for starting a business. I show that the marginal effect of reforms is heterogeneous across countries and document how reform priorities depend on country specific circumstances.
December 11, 2020
Assessing Targeted Containment Policies to Fight COVID-19
Description: The large economic costs of full-blown lockdowns in response to COVID-19 outbreaks, coupled with heterogeneous mortality rates across age groups, led to question non-discriminatory containment measures. In this paper we provide an assessment of the targeted approach to containment. We propose a SIR-macro model that allows for heterogeneous agents in terms of mortality rates and contact rates, and in which the government optimally bans people from working. We find that under a targeted policy, the optimal containment reaches a larger portion of the population than under a blanket policy and is held in place for longer. Compared to a blanket policy, a targeted approach results in a smaller death count. Yet, it is not a panacea: the recession is larger under such approach as the containment policy applies to a larger fraction of people, remains in place for longer, and herd immunity is achieved later. Moreover, we find that increased interactions between low- and high-risk individuals effectively reduce the benefits of a targeted approach to containment.
December 11, 2020
Pandemics and Firms: Drawing Lessons from History
Description: The global economy is in the midst of an unprecedented slump caused by the COVID-19 pandemic. To assess the likely evolution of nonfinancial corporate performance going forward, this paper investigates empirically the impact of past pandemics using firm-level data on more than 537,000 companies from 14 developing countries during the period 1998–2018. The analysis indicates that the prevalence of infectious diseases has an economically and statistically significant negative effect on nonfinancial corporate performance. This adverse impact is particularly pronounced on smaller and younger firms, compared to larger and more established corporations. We also find that a higher number of infectious-disease cases in population increases the probability of failure among nonfinancial firms, particularly for small and young firms. In the case of COVID-19, the magnitude of these effects will be much greater, given the unprecedented scale of the outbreak and strict policy responses to contain its spread.
December 11, 2020
Addressing the Pandemic's Medium-Term Fallout in Australia and New Zealand
Description: While the world is focused on addressing the near-term ramifications of the COVID-19 shock, we turn attention to another important aspect of the pandemic: its fallout on medium-term potential output through scarring. Taking Australia and New Zealand as examples, we show that the pandemic will likely have a large and persistent impact on potential output, broadly in line with the experience of advanced economies from past recessions. The impact is driven by employment, capital stock, and productivity losses in the wake of an unprecedented sectoral reallocation, hightened uncertainty, and reduced migration. Maintaining fiscal and monetary policy support until the recovery is firmly entrenched and putting in place a strong structural policy agenda to counter the pandemic’s adverse effects on medium-term potential output will be important to support standards of living and strengthen economic resilience in case of renewed shocks.