R E S E A R C H B Y S U B J E C T
Real and Financial Cycles
What Happens During Global Recessions?
with A. Kose and N. Sugawara. Published in A. Kose and F. Onshorge (eds.), A Decade After the Global Recession: Lessons and Challanges for Emerging and Developing Economies. The World Bank. 2019.
The world economy has experienced four global recessions over the past seven decades: in 1975, 1982, 1991 and 2009. Each of these global recessions was associated with a contraction in annual real per capita global GDP and broad-based weakness in other main indicators of global economic activity. The global recessions were highly synchronized internationally, with severe economic and financial disruptions in many countries around the world. The 2009 global recession, set off by the global financial crisis, was by far the deepest and most synchronized of the four. As the epicenter of the crisis, advanced economies felt the brunt of the recession. The subsequent expansion has been the weakest in the post-war period in advanced economies as many of them have struggled to overcome the legacies of the crisis. In contrast, most emerging market and developing economies weathered the latest global recession relatively well and delivered a stronger recovery than after previous global recessions.
Do Fixers Perform Worse than Non-Fixers during Global
Recessions and Recoveries?
There is an important debate about how economies with different exchange rate regimes performed during the Great Recession and its ensuing recovery. While economic theory suggests that economies with fixed exchange rates are more affected and recover more slowly from global shocks than economies with non-fixed exchange rates, the empirical evidence on the most recent global recession has been mixed. This paper examines the exchange rate and economic growth nexus and assesses how this relationship is affected by the four global recessions and recoveries the world economy has experienced post-Bretton Woods. While there is no robust long-term relationship between exchange rate regimes and growth, there is evidence that fixers recover from global recessions at a weaker pace than non-fixers.
From the Global to the National Cycle: An Intricate Liaison.
with M. A. Kose and P. Loungani, 2013.
Pacific Economic Review, Vol. 18:3, pp. 370-402
This paper examines the linkages between the global business cycle and national cycles. We first analyze the evolution of the global business cycle and present its main properties during global recessions and recoveries. We then consider how the sensitivity of national cycles to the global cycle varies over different phases of the global cycle and depends on country-specific features. Our findings collectively portray an intricate liaison between the global business cycle and national cycles. National business cycles are tightly linked to the global cycle, but the sensitivity of national cycles to the global cycle is much higher during global recessions than expansions. There are significant differences across countries in how they respond to the global cycle as advanced economies appear to be more sensitive to global recessions than are developing economies. Moreover, countries tend to be more sensitive to the global cycle, the more integrated they are to the global economy.
How Do Business and Financial Cycles Interact?
with S. Claessens and M.A. Kose. 2012.
Journal of International Economics, Vol.87, pp. 178-190
This paper analyzes the interaction between business and financial cycles using an extensive database covering 44 countries for the period 1960:1-2010:4. Our analysis shows that there are strong linkages between the different phases of business and financial cycles. In particular, recessions associated with financial disruptions, notably house and equity price busts, tend to be longer and deeper than other recessions. Conversely, while recoveries following asset price busts tend to be weaker, recoveries associated with rapid growth in credit and house prices are often stronger. These findings emphasize the importance of financial market developments for the real economy.
Financial Cycles: What? How? When?
with S. Claessens and M.A. Kose
Published in Clarida R. and Giavazza F. (eds). International Seminar on Macroeconomics 2010. Pp. 345-350
This paper provides a comprehensive analysis of financial cycles using a large database covering 21 advanced countries over the period 1960:1-2007:4. Specifically, we analyze cycles in credit, house prices, and equity prices. We report three main results. First, financial cycles tend to be long and severe, especially those in housing and equity markets. Second, they are highly synchronized within countries, particularly credit and house price cycles. The extent of synchronization of financial cycles across countries is high as well, mainly for credit and equity cycles, and has been increasing over time. Third financial cycles accentuate each other and become magnified, especially during coincident downturns in credit and housing markets. Moreover, globally synchronized downturns tend to be associated with more prolonged and costly episodes, especially for credit and equity cycles. We discuss how these findings can guide future research on various aspects of financial market developments.
Globalization, the Business Cycle, and Macroeconomic Monitoring
with A. S. Boragan, F.X. Diebold, and M.A. Kose
Published in Clarida R. and Giavazza F. (eds). International Seminar on Macroeconomics 2010. Pp. 245-286
We propose and implement a framework for characterizing and monitoring the global business cycle. Our framework utilizes high-frequency data, allows us to account for a potentially large amount of missing observations, and is designed to facilitate the updating of global activity estimates as data are released and revisions become available. We apply the framework to the G-7 countries and study various aspects of national and global business cycles, obtaining three main results. First, our measure of the global business cycle, the common G-7 real activity factor, explains a significant amount of cross-country variation and tracks the major global cyclical events of the past forty years. Second, the common G-7 factor and the idiosyncratic country factors play different roles at different times in shaping national economic activity. Finally, the degree of G-7 business cycle synchronization among country factors has changed over time.
Recessions and Financial Disruptions in Emerging Markets: A Bird’s Eye View
with S. Claessens and M.A. Kose.
Published in Cespedes, L., Chang, R., and Saravia, D. (eds.), Monetary Policy Under Financial Turbulence. 2010.
This paper provides an overview of the implications of recession and financial disruption episodes in emerging markets. We report three major findings. First, compared to advanced countries, recessions and financial disruptions in emerging markets are often more costly. Second, recessions associated with financial disruption episodes, such as credit crunches, equity price busts and financial crises, tend to be deeper than other recessions in emerging markets. Third, the temporal dynamics of macroeconomic and financial variables around these episodes in emerging markets are different from those in advanced countries. In light of these broad observations, the paper provides a review of recessions and financial market disruptions in Chile.
The Global Financial Crisis: How Similar? How Different? How Costly?
with S. Claessens and M.A. Kose. 2010
Journal of Asian Economics, Vol. 21, pp.247-264
This paper provides a brief analysis of three major questions raised in the context of the recent global financial crisis. First, how similar is the crisis to previous episodes? We argue that the crisis featured some close similarities to earlier ones, including the presence of credit and asset price booms fueled by rapid debt accumulation. Second, how different is it from earlier episodes? We show that, as much as it displayed some similarities with previous cases, it also featured some significant differences, such as the explosion of opaque and complex financial instruments in a context of highly integrated global financial markets. Third, how costly are recessions that followed these types of crises? Although the latest episode took a very heavy toll on the real economy, we argue that this was not a surprising outcome. In particular, historical comparisons indicate that recessions associated with periods of deep financial disruptions result in much larger declines in real economic activity. We discuss the implications of these findings for economic and financial sector policies and future research.
From Recession to Recovery: How Soon and How Strong?
with P. Kannan and A. Scott, World Economic Outlook, April 2009, pp 103-138
This paper examines recessions and recoveries in advanced economies and the role of countercyclical macroeconomic policies. Are recessions and recoveries associated with financial crises different from others? What are the main features of globally synchronized recessions? Can countercyclical policies help to shorten recessions and strengthen recoveries? The results suggest that recessions associated with financial crises tend to be unusually severe and that recoveries from such recessions are typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and in boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest that the current recession is likely to be unusually long and severe and the recovery sluggish.
What Happens During Recessions, Crunches, and Busts?
with S. Claessens and M.A. Kose, Economic Policy, 60, 653-700, 2009.
We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the period 1960–2007. In particular, we analyze the implications of 122 recessions, 112 (28) credit contraction (crunch) episodes, 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts) and their various overlaps in these countries over the sample period. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of recessions. Specifically, we find evidence that recessions associated with credit crunches and house price busts tend to be deeper and longer than other recessions.
Financial Stress and Economic Activity
with S. Claessens and M.A. Kose
BRSA Journal of Banking and Financial Markets, vol:2, no: 2, 11-24, 2008. (Lead Article)
This paper briefly summarizes the results presented in Claessens, Kose and Terrones (2008a, 2008b) to provide a set of basic stylized facts about the linkages between macroeconomic and financial variables during recessions and episodes of financial stress, including the periods of credit crunches and asset (house and equity) price busts. The analysis employs a comprehensive database of key macroeconomic and financial variables for 21 OECD countries over the 1960-2007 period. The results indicate that recessions following periods of financial stress are often longer and deeper than other recessions are. The paper concludes with a short discussion of the implications of its findings for the current crisis.
How do Fluctuations in the G-7 Countries Affect Developing Countries?
World Economic Outlook, September 2001, pp. 79-104
This essay looks at the key mechanisms through which business cycle fluctuations in the industrial countries affect developing ones and discusses how these effects have varied both by country regions (focusing on Africa, Asia, the Middle East, and Western Hemisphere) and by analytic groups (particularly fuel and primary commodity producers).
El Ciclo Economico en el Peru
(with C. Calderon)
1993, Grade, Documento de Trabajo 20.
Se hace aquí una caracterización del ciclo económico en el Perú, usando información de los últimos 50 años. Se ha estudiado el comportamiento cíclico de los principales precios y agregados macroeconómicos (reales y monetarios) de la economía peruana, encontrándose que su ciclo tiene similitud con el de economías más desarrolladas: por ejemplo, el consumo privado, la inversión, las importaciones, las remuneraciones reales y la oferta monetaria son procíclicas, mientras el tipo de cambio nominal es contracíclico. Sin embargo, se observan también rasgos muy peculiares: los gastos corrientes del gobierno, las exportaciones y algunos agregados monetarios tienen un patrón procíclico bastante débil y el nivel de precios un patrón contracíclico débil. También se encuentra que, a partir de 1978 y como resultado de la crisis derivada del problema de la deuda externa, la estructura del ciclo económico en el Perú experimenta un cambio, observándose una mayor volatilidad absoluta de la mayoría de precios y agregados macroeconómicos.
Booms and Busts
Credit Booms and their Demise
with E.G. Mendoza.
NBER Working Paper No. 18379, Issued in September 2012
What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrial countries over the 1960-2010 period. We identify 70 credit boom events, half of them in each group of countries. Event analysis shows a systematic relationship between credit booms and a boom-bust cycle in production and absorption, asset prices, real exchange rates, capital inflows, and external deficits. Credit booms are synchronized internationally and show three striking similarities in industrial and emerging economies: (1) credit booms are similar in duration and magnitude, normalized by the cyclical variability of credit; (2) banking crises, currency crises or Sudden Stops often follow credit booms, and they do so at similar frequencies in industrial and emerging economies; and (3) credit booms often follow surges in capital inflows, TFP gains, and financial reforms, and are far more common with managed than flexible exchange rates.
An Anatomy of Credit Booms: Evidence From Macro Aggregates and Micro Data
with E.G. Mendoza
Working Paper No. 08/226, September 01, 2008
We study the characteristics of credit booms in emerging and industrial economies. Macro data show a systematic relationship between credit booms and economic expansions, rising asset prices, real appreciations and widening external deficits. Micro data show a strong association between credit booms and leverage ratios, firm values, and banking fragility. We also find that credit booms are larger in emerging economies, particularly in the nontradables sector; most emerging markets crises are associated with credit booms; and credit booms in emerging economies are often preceded by large capital inflows but not by financial reforms or productivity gains.
Are Credit Booms in Emerging Markets a Concern?
World Economic Outlook, April 2004, pp 147-166
This chapter studies episodes of excessive credit expansion in the emerging market economies between 1970 and 2002. It focuses on the following key questions: (1) What are the main reasons for rapid credit growth? What are the roles of balance sheet effects and shifts in the price and production of nontradable goods relative to tradable goods? (2) What do credit booms look like? Are they more strongly associated with consumption or investment booms? How is the composition of banks’ assets and liabilities affected? What happens to the nontradable corporate sector? (3) How risky are credit booms in emerging market countries? Are they associated with typical cyclical fluctuations, or do they usually entail sharp economic downturns and financial crises? How should policymakers respond?
Asset Price Fluctuations
Do Asset Price Drops Foreshadow Recessions?
with J. Bluedorn and J. Decressin 2016.
International Journal of Forecasting, Vol. 32, Issue 2, pp. 518-526.
This paper examines the usefulness of asset prices in predicting the beginning of recessions in the G-7 countries. It finds that equity/house price drops have a substantial marginal effect on the likelihood of a new recession. Increased market uncertainty, a second-moment variable associated with equity price changes, is also a useful predictor of new recessions in these countries. These findings are robust to the inclusion of the term-spread and oil prices. The new recession forecasting performance of our baseline model is superior to that of a similar model estimated over all recession and expansion periods, highlighting a difference between the probabilities of a new recession versus a continuing recession.
Global House Price Fluctuations: Synchronization and Determinants
with H. Hirata, M.A. Kose, and C. Otrok 2013
Published in Giavazzi, F. and K. West (eds) NBER International Seminar in Macroeconomics 2012.
We examine the properties of house price fluctuations across 18 advanced economies over the past 40 years. We ask two specific questions: First, how synchronized are housing cycles across these countries? Second, what are the main shocks driving movements in global house prices? To address these questions, we first estimate the global components in house prices and various macroeconomic and financial variables. We then evaluate the roles played by a variety of global shocks, including shocks to interest rates, monetary policy, productivity, credit, and uncertainty, in explaining house price fluctuations using a wide range of FAVAR models. We find that house prices are synchronized across countries, and the degree of synchronization has increased over time. Global interest rate shocks tend to have a significant negative effect on global house prices whereas global monetary policy shocks per se do not appear to have a sizeable impact. Interestingly, uncertainty shocks seem to be important in explaining fluctuations in global house prices.
The Global House Price Boom
World Economic Outlook, September 2004, pp 71-89 and 118-121
This essay studies house price fluctuations in industrial countries, paying particular attention to the current house price boom. In particular, it addresses the following questions: (1) What are the main features of house price fluctuations in industrial countries? Is the current boom in house prices “atypical”? (2) Is there a global house price cycle? Are the fluctuations in house prices mainly related to global factors or to country-specific factors? (3) What are the implications of global house price cycles for the future? What are the risks associated with an increase in world interest rates?
When Bubbles Burst—The Real and Financial Effects
with T. Helbling, World Economic Outlook, April 2003, pp. 61-76 and 88-94.
This essay documents the main regularities of asset price busts in the industrial countries and the behavior of key macroeconomic and financial variables during such episodes. In particular, the following questions are addressed: (1) How frequent and how big are equity and asset price busts? Do all asset price booms end in a bust? Are busts synchronized across countries? What is the link between equity and housing price boom-bust chronologies and business cycles? (2) What macroeconomic and financial developments are associated with asset price busts? Are they always severe? If not, what are the conditions for busts to have serious implications? (3) How do the most recent busts compare with earlier episodes and what are the implications for the outlook?
Reaping the Benefits of Financial Globalization
with G. Dell'Ariccia, J. di Giovanni, A. Faria, M. A. Kose, P. Mauro, M. Schindler, and J. D. Ostry. 2010.
Published in C. Crowe, S. Johnson, J. Ostry and J. Zettelmeyer (eds). Macro Financial Linkages. IMF.
Financial globalization has increased dramatically over the past three decades, particularly for advanced economies, while emerging market and developing countries experienced more moderate increases. Divergences across countries stem from different capital control regimes, and factors such as institutional quality and domestic financial development. Although, in principle, financial globalization should enhance international risk sharing, reduce macroeconomic volatility, and foster economic growth, in practice its effects are less clear-cut. This paper envisages a gradual and orderly sequencing of external financial liberalization and complementary reforms in macroeconomic policy framework as essential components of a successful liberalization strategy.
Does Openness to International Financial Flows Raise Productivity Growth?
with M. A. Kose and E. Prasad. 2009.
Journal of International Money and Finance. Vol. 28. Pp. 549-738.
This paper provides a comprehensive analysis of the relationship between financial openness and total factor productivity (TFP) growth using an extensive dataset that includes various measures of productivity and financial openness for a large sample of countries. We find that de jure capital account openness has a robust positive effect on TFP growth. The effect of de facto financial integration on TFP growth is less clear, but this masks an important and novel result. We find strong evidence that FDI and portfolio equity liabilities boost TFP growth while external debt is actually negatively correlated with TFP growth. The negative relationship between external debt liabilities and TFP growth is attenuated in economies with higher levels of financial development and better institutions.
How Does Financial Globalization Affect Risk Sharing? Patterns and Channels
with M. A. Kose and E. Prasad
Working Paper No. 07/238, October 01, 2007
In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. This paper provides a comprehensive empirical evaluation of the patterns of risk sharing among different groups of countries and examines how international financial integration has affected the evolution of these patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. The most interesting result is that even emerging market economies, which have experienced large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which has dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing.
How Do Trade and Financial Integration Affect the Relationship Between Growth and Volatility?
with M. A. Kose and E. Prasad
Working Paper No. 05/19, January 01, 2005
The influential work of Ramey and Ramey (1995) highlighted an empirical relationship that has now come to be regarded as conventional wisdom-that output volatility and growth are negatively correlated. We reexamine this relationship in the context of globalization-a term typically used to describe the phenomenon of growing international trade and financial integration that has intensified since the mid-1980s. Using a comprehensive new data set, we document that, while the basic negative association between growth and volatility has been preserved during the 1990s, both trade and financial integration significantly weaken this negative relationship. Specifically, we find that, in a regression of growth on volatility and other controls, the estimated coefficient on the interaction between volatility and trade integration is significantly positive. We find a similar, although less significant, result for the interaction of financial integration with volatility.
Volatility and Comovement in a Globalized World Economy: An Empirical Exploration
with M.A. Kose and E. Prasad, in Horst Siebert ed., Macroeconomic Policies in the World Economy, Springer, 89-122, 2004.
This paper analyzes the evolution of volatility and cross-country comovement in output, consumption, and investment fluctuations using two distinct datasets. The results suggest that there has been a significant decline in the volatility of business cycle fluctuations and a slight increase in the degree of cyclical comovement among industrialized countries over time. However, for emerging market economies, financial globalization appears to have been associated, on average, with an increase in macroeconomic volatility as well as declines in the degree of comovement of output and consumption growth with their corresponding world aggregates.
Financial Integration and Macroeconomic Volatility
with M. A. Kose and E. Prasad
Working Paper No. 03/50, March 01, 2003
This paper examines the impact of international financial integration on macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three preceding decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption-smoothing possibilities appear to accrue only beyond this threshold.
How Does Globalization Affect the Synchronization of Business Cycles?
with M. A. Kose and E. Prasad
Working Paper No. 03/27, January 01, 2003
This paper examines the impact of rising trade and financial integration on international business cycle comovement among a large group of industrial and developing countries. The results provide at best limited support for the conventional wisdom that globalization has increased the degree of synchronization of business cycles. The evidence that trade and financial integration enhance global spillovers of macroeconomic fluctuations is stronger for industrial countries. One striking result is that, on average, cross-country consumption correlations have not increased in the 1990s, precisely when financial integration would have been expected to result in better risk-sharing opportunities, especially for developing countries.
International Reserve Accumulation
Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism
with C.B. Durdu and E. G. Mendoza, Journal of Development Economics, 89, 194-209, 2009
Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops in the 1990s. The surge in foreign reserves since then is viewed as a New Merchantilism in which reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a framework in which precautionary savings affect foreign assets via business cycle volatility, financial globalization, and endogenous Sudden Stops. Our results show that financial globalization and Sudden Stop risk are plausible explanations of the surge in reserves but cyclical volatility, which has declined in the globalization period, is not.
Sustainability of the Current Account
On the Solvency of Nations: Cross-Country Evidence on the Dynamics of External Adjustment
with C.B. Durdu and E. G. Mendoza. 2012.
Journal of International Money and Finance. Vol 32, pp. 762-80.
We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970-2006 period. Our analysis adapts Bohn’s (2007) error-correction reaction function approach—which tests for a negative long-run relationship between net exports (NX) and net foreign assets (NFA) as a sufficiency condition for the intertemporal budget constraint to hold—to a dynamic panel framework. Pooled Mean Group and Mean Group error-correction estimation yield evidence of a statistically significant, negative response of NX to NFA. Moreover, we cannot reject the hypothesis that the response is largely homogeneous across countries. Our sensitivity analysis shows that the countries with relatively weaker fundamentals need to respond more strongly to the changes in NFA to keep their NFAs on a sustainable path.
On the Solvency of Nations: Are Global Imbalances Consistent with Intertemporal Budget Constraints?
with C.B. Durdu and E.G. Mendoza. 2012.
Working Paper No. 10/50, February 01, 2010.
Theory predicts that a nation's stochastic intertemporal budget constraint is satisfied if net exports (NX) and net foreign assets (NFA) satisfy an error-correction specification with a residual integrated of any finite order. We test this hypothesis using data for 21 industrial and 29 emerging economies for the 1970-2004 period to search for existence of negative relationship between NX and NFA. The results show that, despite the large global imbalances of recent years, NX and NFA positions are consistent with external solvency. Pooled Mean Group error-correction estimation yields evidence of a statistically significant, negative response of the NX-GDP ratio to the NFA-GDP ratio that is largely homogeneous across countries.
Exchange Rate Regimes and External Adjustment
with A.R. Ghosh and J. Zettelmeyer
Published in Charles Wyplosz ed. “The New International Monetary System: Essays in Honor of Alexander Swoboda” 2010. Routledge International Studies in Money and Banking.
Recent research has found that current account balances under flexible regimes seem to be no less persistent than under fixed regimes. This result appears to undermine Milton Friedman’s well known — and commonly accepted — claim that flexible exchange rates facilitate the adjustment of external imbalances. Should we then dismiss Friedman’s case for flexible exchange rates as superficially plausible, but ultimately wrong? In this paper we argue that this would be premature, as the answer to the question of whether flexible regimes facilitate external adjustment appears to be sensitive to how exactly the question is asked. Are flexible exchange rate regimes associated with smaller external imbalances and more infrequent current account reversal than fixed exchange rate regimes? We find considerable evidence that large current account reversals very rarely occur under flexible regimes. Moreover, when these reversals take place they involve smaller imbalances than those reversals that take place under fixed regimes. This suggests that estimated current account persistence that does not control for these important threshold effects could be misleading.
Global Imbalances: A Saving and Investment Perspective
with R. Cardarelli, World Economic Outlook,
September 2005, pp 91-124
This chapter examines the main factors that have driven the recent evolution of saving and investment across the globe, to shed light on both existing global imbalances and low real interest rates. Specifically, it addresses the following questions: (1) What factors account for recent movements in saving and investment in industrial, emerging market, and oil-producing countries? Are these changes due to country-specific developments, or do they reflect broader global and regional trends? (2) Looking forward, what policies can help change existing saving-investment gaps, and lead to a reduction in global imbalances?
How Worrisome are External Imbalances?
with T. Bayoumi, World Economic Outlook
September 2002, pp. 65-81
This essay analyzes the growing external imbalances from a multilateral perspective, rather than focusing on the situation in the United States. In particular, we focus on the following key analytic issues. (1) How concerned should policymakers be about external current account deficits, especially if they result from private sector decisions? (2) What are the causes of the imbalances that have developed over the past decade? (3) Are the present imbalances viable in the medium term and, if not, what can we say about how they will adjust? (4) Can macroeconomic policies, both in the deficit and surplus countries, reduce the risk of a disruptive exchange rate and current account adjustment and, if so, how?
Current Account Persistence
Are Global Imbalances at a Turning Point?
with A. Aslam, S. Beidas-Strom, and J. Yepez
World Economic Outlook, October 2014, pp. 115-154.
Global current account (“flow”) imbalances have narrowed significantly since their peak in 2006, and their configuration has changed markedly in the process. The imbalances that used to be the main concern—the large deficit in the United States and surpluses in China and Japan—have more than halved. But some surpluses, especially those in some European economies and oil exporters, remain large, and those in some advanced commodity exporters and major emerging market economies have since moved to deficit. This chapter argues that the reduction of large flow imbalances has diminished systemic risks to the global economy. Nevertheless, two concerns remain. First, the nature of the flow adjustment—mostly driven by demand compression in deficit economies or growth differentials related to the faster recovery of emerging market economies and commodity exporters after the Great Recession—has meant that in many economies, narrower external imbalances have come at the cost of increased internal imbalances (high unemployment and large output gaps). The contraction in these external imbalances is expected to last as the decrease in output due to lowered demand has likely been matched by a decrease in potential output. However, there is some uncertainty about the latter, and there is the risk that flow imbalances will widen again. Second, since flow imbalances have shrunk but not reversed, net creditor and debtor positions (“stock imbalances”) have widened further. In addition, weak growth has contributed to increases in the ratio of net external liabilities to GDP in some debtor economies. These two factors make some of these economies more vulnerable to changes in market sentiment. To mitigate these risks, debtor economies will ultimately need to improve their current account balances and strengthen growth performance. Stronger external demand and more expenditure switching (from foreign to domestic goods and services) would help on both accounts. Policy measures to achieve both stronger and more balanced growth in the major economies, including in surplus economies with available policy space, would also be beneficia
Getting the Balance Right: Transitioning out of Sustained Current Account Surpluses
with A. Abiad and D. Leigh
World Economic Outlook, April 2010, pp. 109-137
This chapter examines the experiences of economies that ended large, sustained current account surpluses through policy actions such as exchange rate appreciation or macroeconomic stimulus. In particular, it focuses on the following questions: (1) What were the main pretransition features of economies that undertook reversal from large and sustained current account surpluses? What policy frameworks were in place? (2) What policies were implemented during surplus reversals? What role did macroeconomic, exchange rate, and structural policies play? (3) What were the implications of reversals for economic performance—particularly output growth?
Uncovered Interest Rate Parity
Uncertainty and the Uncovered Interest Parity Condition: How Are They Related?
with N.R. Ramirez-Rondan. 2019.
There is a well-established literature that documents the failure of the uncovered interest parity (UIP) condition. While a host of factors have been examined as possible reasons behind this result, the role of uncertainty is not fully understood. In this paper, we examine the extent to which economic uncertainty affects the UIP condition in a sample of fourteen economies over the period 2003:1-2018:12. Using threshold panel regression models and exchange rate survey data, we find evidence that the UIP condition holds during low-uncertainty periods but does not during high-uncertainty periods. This finding is robust to the inclusion of other controls, different proxies of uncertainty, changes in the deposit maturity, and estimation method.
Deficit and Inflation
Fiscal Deficits and Inflation
with L. Catão. 2005
Journal of Monetary Economics. Vol 52. Pp. 529-54.
Macroeconomic theory postulates that fiscal deficits cause inflation. Yet empirical research has had limited success in uncovering this relationship. This paper reexamines the issue in light of broader data and a new modeling approach that incorporates two key features of the theory. Unlike previous studies, we model inflation as nonlinearly related to fiscal deficits through the inflation tax base and estimate this relationship as intrinsically dynamic, using panel techniques that explicitly distinguish between short- and long-run effects of fiscal deficits. Results spanning 107 countries over 1960-2001 show a strong positive association between deficits and inflation among high-inflation and developing country groups, but not among low-inflation advanced economies.
Fiscal Deficits and Inflation: A New Look at the Emerging Market Evidence
with L. Catão
Working Paper No. 01/74, May 01, 2001
Empirical studies have had little success in finding a statistically significant relationship between fiscal deficits and inflation in broad cross-country panels. This paper provides new econometric estimates for a panel of 23 emerging market countries during 1970-2000. Unlike previous studies, we allow for a rich dynamic specification and focus on the long-run relationship between the two variables controlling for differences in the inflation tax base. We find that a 1 percentage point reduction in the ratio of fiscal deficit to GDP typically lowers long-run inflation by 1½ to 6 percentage points, depending on the size of the inflation tax base.
Public Debt in Emerging Markets: Is it Too High?
with T. Callen, X. Debrun, J. Daniel., and C. Allard
World Economic Outlook, September 2003, pp 113-152.
This chapter examines the relatively high public debt levels in emerging market economies. In particular, it addresses the following two questions: At what point does public debt become too high? What policy actions does a government need to take to ensure that its debt is sustainable?
Political Business Cycles
Macroeconomic policy and elections: Theories and challenges
1991, Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 6(2), pages 173-195.
This paper reviews recent developments in the literature of economic policy-making. It focuses in particular on the relation between elections and macroeconomic policy. It should be noted that in spite of tremendous advances in the area, there are still many important unresolved issues. In particular, both the normative and empirical areas are the ones in most urgent need of study.
Macroeconomic Policy Cycles under Alternative Electoral Structures
1989, UWO Research Report 8905.
University of Western Ontario, Department of Economics.
This paper generalizes earlier work on political budget cycles to allow for the endogenous timing of elections by incumbents. In particular, it is shown that macroeconomic policy cycles are more pronounced in an electoral system with fixed-term elections than in one with endogenous elections. These findings are consistent with empirical evidence for some Parliamentary Democracies in the period after the Second World War. Moreover, these results show the sensitivity of economic performance to different political arrangements.
Monetary Policy in a Low Inflation Era
with S. Sgherri, World Economic Outlook,
April 2002, pp.85-102.
This essay focuses on the role of monetary policy in achieving low and stable inflation in the advanced economies, how this has affected the behavior of the private sector and the nature of the inflation process, and the new challenges that confront policymakers. Two key conclusions are that, because of the existence of the zero interest rate bound, the danger of getting into a deflationary spiral increases markedly as inflation targets are lowered below 2 percent and that there is a case for becoming more proactive with regard to sharp falls in activity.
The Decline of Inflation in Emerging Markets: Can it be Maintained?
with L. Cãtao and M. Hacker
World Economic Outlook, April 2001, pp. 116-144.
This chapter studies the recent decline of inflation in the emerging market economies, whether this decline is likely to be permanent, and what steps need to be taken to keep inflation under control. In particular it addresses four broad questions: Why has inflation been historically high in emerging markets and why has it declined sharply in recent years? Has there been a systemic relationship between fiscal performance and inflation? Which monetary regime has been better in controlling money growth and inflation? What additional steps need to be taken to curb inflation in some countries and to keep inflation at current low levels in others?
Financial De-Dollarization: A Global Perspective and the Peruvian Experience
with L. Catão
Published in G. Yamada and D. Winkelried (eds.), 2016, Politica y Estabilidad Monetaria en el Peru. Fondo Editorial de la Universidad del Pacifico.
We re-appraise the cross-country evidence on the dollarization of financial systems in emerging market economies. Amidst striking heterogeneity of patterns across regions, we identify a broad global trend towards financial sector de-dollarization from the early 2000s to the eve of the global financial crisis of 2008–09. Since then, de-dollarization has broadly stalled or even reversed in many economies. Yet a few of them have continued to de-dollarize. This suggests that domestic factors are also important and interact with global factors. To gain insight into such an interaction, we examine the experience of Peru since the early 1990s and find that low global interest rates, low global risk-aversion, and high commodity prices have fostered de-dollarization. Domestic macro-prudential measures that raise the relative cost of domestic dollar loans and the introduction and adherence to inflation targeting have also been key
Determinants of Dollarization - The Banking Side
with L. Catão
Working Paper No. 00/146, August 01, 2000
Dollarization in financial intermediation has exhibited a widely diverse pattern across countries. Empirical work relating it to macroeconomic variables has had only limited success in explaining this phenomenon. This paper presents a two-currency banking model to show that deposit and loan dollarization are determined by a broader set of factors. These include interest rate and exchange rate risk, as well as structural factors related to costly banking, credit market imperfections, and availability of tradable collateral. The direction in which dollarization tends to move with macroeconomic shocks is shown to depend on those factors as well as on initial dollarization levels.
Does financial sector development affect the growth gains from trade openness?
with NR. Ramirez-Rondan and A. Vilchez. 2019. Review of World Economics.
A sizeable literature suggests that financial sector development could be an important enabler of the growth benefits of trade openness. We provide a comprehensive analysis of how financial development can affect the relationship between trade openness and growth using a dynamic panel threshold model and an extensive dataset for a large sample of countries for the 1970-2015 period. We find that there is a financial development threshold in which trade openness has a positive and significant effect on economic growth. We also find that when splitting the sample into industrialized and non-industrialized countries, the financial development threshold that enables the growth benefits of trade is higher in the former group of countries than in the latter. This finding is consistent with the fact that the export composition of industrialized countries is tilted towards more capital-intensive finance-constrained goods
Educacion, capital humano y crecimiento economico: El caso de America Latina.
with C. Calderón
Se evalúa en este artículo la influencia del nivel de educación formal de la población sobre el crecimiento económico, para el caso de los países de América Latina. El interés de tal evaluación radica en que estos países -que tienen cierta homogeneidad cultural y que durante el período de análisis implementaron similares estrategias de desarrollo han experimentado tasas de crecimiento económico declinantes, a pesar de sus esfuerzos en el campo educativo. Se verifica en el estudio, mediante el control de otras influencias, que hay una importante relación entre educación, formación de capital humano y crecimiento económico: los distintos índices usados como aproximaciones del capital humano (índices de composición del alumnado) muestran un elevado grado de correlación parcial con el crecimiento. Sin embargo, solamente el nivel de matrícula en educación primaria y el porcentaje de personas estudiando ciencias e ingeniería muestran una relación directa con el crecimiento económico. Estos resultados permiten hacer algunas recomendaciones de política educativa que implican, de hecho, una redefinición de la comúnmente aceptada relación entre educación y crecimiento económico.
Influence activities and Economic Growth
1990. UWO, Research Report 9006,
University of Western Ontario, Department of Economics.
This paper studies the relation between influence (or redistribute) activities and economic performance in the context of a dynamic model with endogenous growth. That societies engage in influence activities has long been recognized and by now there is an extensive body of literature that studies the effects of influence activities on the economy in the context of static models. The effects of influence activities in dynamic macroeconomic models are less understood. Here, I show that that influence activities may be detrimental for the economic performance of an economy since both the levels and, more importantly, the rates of growth of the different macroeconomic variables are inversely related to the amount of influence activities in which economic agents engage. This implies that the social costs of influence activities are much higher than those suggested by static models. Moreover, as some societies are more successful than other in reducing or eliminating the sources of influence activities (i.e. by improvements on their legal, political, and social institutions), this model predicts a wide variety of levels and rates of growth for the different macroeconomic variables across countries.
Environmental Legislation and Enforcement: A Voting Model Under Asymmetric Information.
with T. M. Selden, May 1993
Journal of Environmental Economics and Management, Elsevier, Vol. 24(3), pp. 212-228.
This paper examines the effects of asymmetric voter information on the environmental policies of democratic governments. The model builds on the electoral signaling model of Rogoff to illustrate the possibility that democratic governments may systematically overlegislate—and yet underenforce—environmental standards in a rational expectations equilibrium. The model also offers insights into the welfare implications of “right to know” legislation, proposals to depoliticize environmental policy, and private voluntary institutions.
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