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Monetary union, asymmetric productivity shocks and fiscal insurance: An analytic discussion of welfare issues
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Macroeconomic stabilization with a common currency: Does European Monetary Unification create a need for fiscal insurance of federalism?
Full text linkThe implications of monetary unification for fiscal policies are discussed. The roles of nominal exchange rate flexibility in the presence of asymmetric national shocks and nominal price rigidities as an automatic stabilizer and source of disturbances to real economic performance are reviewed. Two main themes are considered. The first is whether a system of fiscal insurance across member states qualitatively replicates the effects of autonomous monetary policy instruments when exchange rates are permanently fixed. It is argued that while fiscal insurance schemes increase the instruments available to fiscal authorities to influence resource allocation, they do not augment existing fiscal instruments in a manner that replicates monetary policy under long-run monetary neutrality in an overlapping generations economy. Restrictions imposed on national fiscal instruments as a condition of monetary unification may give rise to a need for fiscal insurance to replace their role as stabilizers. The second theme addresses whether political unification is a necessary logical conclusion of the usefulness of fiscal insurance scheme. The argument that sustainable insurance arrangements can be devised without foregoing national sovereignty over fiscal policymaking is discussed. --monetary union,exchange rate regimes,fiscal insurance,fiscal policy coordination
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U.S. Monetary Policy Shocks And Their Impacts On International Capital Flows
Full text linkDuring the 2008 global financial crisis, several emerging market economy (EME) authorities argued that advanced economy policies including large-scale asset purchases by the U.S. Federal Reserve were primary sources of excessive capital flows and created adverse spillover effects to the EMEs. More recently, EME policy makers have been concerned about the adverse effects of advanced economy monetary policy normalization. Tracking the link between the monetary policy shocks in advanced countries and capital flows to emerging markets can be crucial for informing the debate about appropriate policy responses to capital inflows by the EMEs.Many studies investigate the role of advanced economy policy measures as driversof capital flows between countries. However, the estimation of the relationship betweenU.S. monetary policies and EME capital flows needs to account for anticipatory movements within the policy measures as well as endogeneity. That is why some of the recent literature, for example Miranda-Agrippino (2015), applies the Romer and Romer shocks (Romer and Romer (2004)) as a proxy for U.S. monetary shocks, to estimate the responses of global asset prices and international credit flows to US monetary policy. However, Coibion, et al (2016) recently found that the Romer and Romer proxy for U.S. monetary shock, does not influence important U.S. macroeconomic variables for sample periods starting from 1980. To investigate this issue and get valid estimates for U.S. monetary shocks, this paper revisits the Federal Reserve’s information set which is created from observing the federal funds target rates set by the Federal Reserve around FOMC meetings. As a result, this paper derives a new measure for U.S. monetary shocks that adequately takes account of the Fed’s true information set at the time of FOMC meetings. In detail, this paper uses projected values for the CPI for periods when the PCE was not used by fed, then uses forecasts for the PCE for the rest of the sample period, instead of GDP deflator. Forecasts for foreign GDP and CPI indices are also used to take international endogenous and anticipatory movements into account in setting the Fed’s target rate.The results show that using the new U.S. monetary shock measures reveals significantlydifferent effects in responses of U.S. domestic macroeconomic variables to monetaryshocks as well as in responses of some international financial variables, compared to results using the Romer and Romer shock. Specifically, a one percentage point increase in the new policy measure increases U.S. unemployment rate by 6 percent after one year, reduces GDP by 0.12 percent from its trend at the trough, and decreases the PPI by 35 percent at the lowest point. For international capital variables, a one percentage point rise in the U.S. policy shock increases cumulative net outflows of debt assets from Korea by over 10 billion dollars
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Essays in Exchange Rate Dynamics
Full text linkThis dissertation studies the dynamics of exchange rates and their effect on nominal and real macro variables and furthermore on policy choices. The dissertation provides a theoretical framework where a policymaker can choose a path of international policy portfolio of capital controls and exchange rate regimes under financial frictions. The paper presents a novel theoretical approach to explain the coexistence of active use of capital controls and volatile exchange rates, which has become a robust feature in emerging market economies. Building upon the small open economy framework, I create an environment where the policymaker can decide the level of exchange rate regimes -- instead of a binary choice of exchange rate regime, fixed or floating -- in response to external shocks, where capital controls are introduced as a tax on international capital flows. I further assume that regime choice is subject to a financial friction; breaking the peg signals the country's economic instability, which raises the country's risk premium. Under this set-up, the floating exchange rate regime does not welfare-dominate the capital controls any longer because loosening/losing the controls over exchange rates may expose households to additional risk premium. The simulation results show that the coexistence of managed float and capital controls becomes optimal. Furthermore, this additional friction has a multiplying effect, which makes exchange rate stabilization become important to prevent a bigger welfare loss. It also captures that optimal capital controls indirectly manage exchange rate depreciation, which allow policymakers to put less resource to stabilize the exchange rates. Considering the fact that the countries actively intervene in the foreign exchange market, the dissertation re-investigates one of classical puzzles in international economics using a new estimation technique and a modern data categorization methodology. The Purchasing Power Parity puzzle states that even though real exchange rates may converge to parity in the long run, the consensus emerging from an extensive literature appears to be that the rate of mean-reversion is slow, where a half-life mean-reversion is between 3 - 5 years; however, this is much too long to be compatible with arbitrage. This paper first proposes that investigating the periods of de facto floating regime will explain seemingly unrealistic persistence in real exchange rates by presenting lower persistence in real exchange rates than the estimates of previous studies, which include the periods de facto fixed regime in their data set by using de jure regimes. Secondly, previous studies have included the periods when real exchange rates that are within ``the regions of inaction''; because the trend of mean-reversion rates is non-linear, including the periods when real exchange rates are already converged to their means will bias the estimates toward zero, which are translated to the slow mean-reversion in real exchange rate estimates. Therefore, unbiased mean-reversion estimates can be estimated if I investigate the periods when the sample countries are under de facto float regimes and the periods when real exchange rates are statistically far from their means. Studying the data of nineteen goods CPI for eleven countries confirms these propositions. The mean group estimation decreases the half-life by 28.26% (half-life of 23.14 months) compared to fixed-effects estimation. The exchange rates regime dummy decreases the half-life estimate to 19.81 months and the region of inaction dummy decreases the estimates to 15.22 - 20.54 months. Using both dummy variables elicits the results that make the puzzle less puzzling; the half-life estimates are 9.30 - 13.89 months.The dissertation also explores the exchange rate regime-elastic risk premium quantitatively. This paper takes foreign investor's perspective and studies how the trend of risk premium changes when the regime switches in ten emerging market economies through the event study framework. Using a daily data set, the events of de facto regime switching are identified following the comparable methodology used in Calvo and Reinhart (2002), and EMBI+ is used as a proxy for country risk. The results confirm that switching exchange rate regimes from fixed to floating incurs an abrupt increase in average risk premium. EMBI+ rises by 141.11 - 165.48 basis points (0.257 - 0.525 standard deviations) around the events and shows 205.72 - 340.30 basis points of 40-day average difference before and after the events. The abnormal return estimates during the events range from 0.0036 to 0.0075, which imply 8.31 - 225.85% increase in the returns of EMBI+ during the periods of breaking pegs
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Three Essays on Computationally Intensive Economic Problems
Full text linkChapter 1: Inspired by the political events that followed after the sovereign debt crisis in Greece post 2009, I develop an overlapping generations model with aggregate and idiosyncratic shocks to analyze agent's decisions if each had a vote in whether the country should default or not. The hypothetical economy where agents vote to default almost became a reality in 2015 when Prime Minister of Greece asked the voting population whether the country should remain in the bailout program through a referendum. Model results exhibit similar patterns as the Greek referendum with the young and less wealthy more inclined to vote for default. Chapter 2: We develop a theoretical model to highlight a previously unexplored mechanism of price discovery: relative minimum price increments for equivalent assets trading on distinct financial exchanges. Although conventional wisdom dictates that futures market assets lead equities equivalents in terms of price formation, our model predicts that the opposite should be true when particular relative price conditions hold for the bids and offers of each asset. We develop a new empirical measure of price discovery which is suited to asynchronous, high-frequency transaction and quotation data, and apply it to the highly liquid E-mini/SPY pair in order to test the predictions of the model. Empirical evidence strongly supports the model and further demonstrates that relative minimum contract size plays an additional role in the formation of prices.Chapter 3: United States population has increasingly become older. The aging is expected to continue as life expectancy increases, more baby boomers reach retirement age and birth rate declines. These demographic changes have had significant impact on the solvency of the Social Security Trust Fund. Social Security Administration projects the fund's insolvency around 2035. Given the imminent insolvency, policies such as increasing eligibility age and expanding the tax base have been proposed. These policies are usually analyzed using many period OLG model with a hump-shaped age-dependent productivity profile. We believe this profile is dynamic as the population itself. We incorporate the dynamic age-dependent profile in an OLG framework in a closer look at insolvency of the Social Security Trust Fund
Financial Intermediation and Monetary Policy Transmission in EMEs: What has Changed Since the 2008 Crisis?
No full textIn contrast to the benign neglect of the financial system in traditional monetary models, there has been growing evidence in recent years that the size and the structure of financial intermediation play a critical role in the transmission of monetary policy. This paper reviews the implications of three key post-2008 crisis developments in financial intermediation—the role of banks, the globalization of debt markets and the sustained decline in global long-term interest rates—for various transmission channels of monetary policy in EMEs. The paper argues that the globalization of debt markets means that monetary policy can no longer be conducted through the short-term interest rate alone. This raises questions about the appropriate instruments to be used for economic stabilization in this new environment
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Transmission Channels of Global Liquidity in Emerging Market Economies
Full text linkI study the role of banks, exchange rates, and firms in the transmission of global liquidity in emerging market economies. This close examination comprises three chapters.The first chapter investigates the importance of the bank leverage cycle in the propagation of exchange rate fluctuations. Emerging market economies can be sensitive to large currency depreciation because it may increase the default risk of firms that have their liabilities in foreign currency and assets in local currency. Since banks adjust their leverage based on the riskiness of borrowers, bank credit flows should inform us whether corporate balance sheets are affected by exchange rate fluctuations. Using country level differences in the foreign currency decomposition of bank claims, I construct an instrument to disentangle the effect of exchange rate fluctuations on bank loans. I find that a 1\% real depreciation of the local currency causes a 1.36\% reduction in foreign currency loans channeled by domestic banks. This significant response is however absent for direct loans by global banks. I explain this with a model that takes into account balance sheet differences of ultimate borrowers. Firms that borrow from domestic banks are more likely to be local firms subject to currency mismatch while firms that can borrow directly from global banks are multinational corporations with resources to hedge them against foreign currency fluctuations. The results have two major implications. First, the risk sensitive lending behavior of banks plays an important role in the propagation of exchange rate fluctuations. Second, policy makers should enforce domestic banks to monitor the foreign currency exposure of their clients more closely.DSGE models have a shortfall in simulating the sensitive nature of emerging market economies to global financial conditions. The second chapter contributes on that aspect by providing a new theoretical mechanism that amplifies the effect of world interest rates. Moral hazard arises when corporate borrowers prefer investing in riskier projects when interest rates rise, which in turn influences the financial intermediary's willingness to lend. To the extent that world interest rates are transmitted to domestic interest rates, the lending behavior of the financial intermediary amplifies the effect of world interest rates. I empirically investigate this theoretical finding using a structural VAR. Results indicate that a global financial tightening is immediately followed by a drop in domestic bank credit while investment and output also decrease significantly, consistent with the amplification of global financial shocks induced by moral hazard.After the Global Financial Crisis (GFC), three trends highlight international financial markets for emerging market economies, historically low term premium in the yield curve, the emerging corporate bond boom in foreign markets, and the stagnation of emerging market banks cross-border liabilities. The final and third chapter links these post GFC trends to US unconventional monetary policy in a theoretical framework. In addition, I investigate whether firm size matters in terms of sensitivity to this financial spillover. The model shows that, when the term premium of corporate bond yields rise, large firms divert their funding from foreign lenders to domestic banks, crowding small firms out of domestic bank credit markets. The evolution of small firms' share in the total bank credit for a sample of emerging market economies validate the findings of the model. Emerging market policymakers should therefore ease financing for small firms as the Fed and central banks of other advanced economies normalize the size of their balance sheet
Inefficient private renegotiation of sovereign debt
Full text linkThe negotiation of sovereign debt repayments and of new loans after default may yield inefficient outcomes that justify intervention by creditor country governments and international financial institutions. The author analyzes possible distortions arising in renegotiations between private creditors and sovereign borrowers. He argues that legal privileges accorded to existing creditors in their home jurisdictions can distort the flow of resources for capital formation abroad. Seniority privileges for old lenders convey to them some of the social returns from new lending, reducing the potential rewards for those who might provide the new funds. Hence the author urges investigation of official alienation of these privileges, regulatory reform, and introduction of alternative financial instruments that embody opportunities for creditor commitment.Strategic Debt Management,Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation
Indian Economy During the Era of Quantitative Easing: A Dynamic Stochastic General Equilibrium Perspective
No full textThe effect of external Quantitative Easing (QE) on a small open economy like India is analyzed using a dynamic stochastic general equilibrium (DSGE) model. The modeling is motivated by some broad empirical regularities of the Indian economy during the pre and post-QE periods . QE is modeled as a negative shock to the short term foreign policy rate with a mean reverting pattern. The mean reversion reflects the phasing out of the QE operation. In addition, we analyze the “news” effect of the tapering out phase of QE. Our model has standard real and nominal frictions as in any New Keynesian model. Monetary policy is modeled by the forward looking inflation targeting Taylor rule . We show that the impact and news effects of QE work through this terms of trade via the uncovered interest parity condition. Using our DSGE model, we also compare the effect of a QE shock with a domestic fiscal spending shock. The model impulse response functions qualitatively support some key empirical regularities of the Indian economy during the QE era
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