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11. On the Solvency of Nations: Are Global Imbalances Consistent with Intertemporal Budget Constraints?

Author:
Ceyhun Bora Durdu
Publication Date:
06-2009
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Theory predicts that a nation's stochastic intertemporal budget constraint is satisfied if net foreign assets (NFA) are integrated of any finite order, or if net exports (NX) and NFA satisfy an error- correction specification with a residual integrated of any finite order. We test these conditions using data for 21 industrial and 29 emerging economies for the 1970-2004 period. The results show that, despite the large global imbalances of recent years, NFA and NX positions are consistent with external solvency. Country-specific unit root tests on NFA-GDP ratios suggest that nearly all of them are integrated of order 1. 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.
Topic:
Debt, Budget, Global Financial Crisis, and Economic Inequality
Political Geography:
Global Focus

12. Did Easy Money in the Dollar Bloc Fuel the Global Commodity Boom?

Author:
Christopher Erceg, Luca Guerrieri, and Steven B. Kamin
Publication Date:
08-2009
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Among the various explanations for the runup in oil and commodity prices of recent years, one story focuses on the role of monetary policy in the United States and in developing economies. In this view, developing countries that peg their currencies to the dollar were forced to ease their monetary policies after reductions in U.S. interest rates, leading to economic overheating, excess demand for oil and other commodities, and rising commodity prices. We assess that hypothesis using the Federal Reserve staff’s forward-looking, multi- country, dynamic general equilibrium model, SIGMA. We find that even if many developing country currencies were pegged to the dollar, an easing of U.S. monetary policy would lead to only a transitory runup in oil prices. Instead, strong economic growth in many developing economies, as well as shortfalls in oil production, better explain the sustained runup in oil prices observed until earlier this year. Moreover, a closer look at exchange rates and interest rates around the world suggests that the monetary policies of many developing economies, including in East Asia, are less closely influenced by U.S. policies than is frequently assumed.
Topic:
Energy Policy, Oil, Commodities, and Interest Rates
Political Geography:
United States and North America

13. Are Chinese Exports Sensitive to Changes in the Exchange Rate?

Author:
Shaghil Ahmed
Publication Date:
12-2009
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper builds a model of two types of Chinese exports, those processed and assembled laregely from imported inputs ("processed" exports) and "non- processed" exports. Based on this model, the sensitivity of Chinese exports to exchange rate changes is empirically examined. Unlike previous work, the estimation period includes the net real appreciation of the renminbi that has occurredoverthepastthreeyears. Theresultsshowthatgreaterexchangerate appreciation dampens export growth, both for non-processed and processed ex- ports, with the estimated cumulative price elasticity being substantially greater thanunity. WhenthesourceoftheincreaseintheChineserealexchangerateis appreciations against the currencies of other emerging Asian trading partners, the e§ect on processing exports is positive but insignÖcant, while the e§ect on non-processing exports is signiÖcantly negative. By contrast, when the source of the increase in the Chinese real exchange rate is appreciation against Chinaís advanced-economy trading partners, the e§ects on both types of exports are negative. These results are consistent with the predictions of the theoretical model. Counterfactualsimulationsbasedontheestimatedmodelstronglysug- gest that if the trade-weighted real renminbi had appreciated at an annual rate of 10 percent per quarter since mid-2005, Chinese real exports would have been roughly 30 percent lower today. Thus greater exchange rate áexibility could contribute to lowering Chinaís huge trade surplus through restraining growth of exports.
Topic:
Economics, International Trade and Finance, Exchange Rate Policy, and Exports
Political Geography:
China and Asia

14. Labor Market Search in Emerging Economies

Author:
Emine Boz, Ceyhun Bora Durdu, and Nan Li
Publication Date:
12-2009
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper shows that labor markets of emerging economies are characterized by large fluctuations in wages while employment fluctuations are subdued. We find that a real business cycle model of a small open economy that embeds a Mortensen-Pissarides type of search-matching frictions can account for these aforementioned regularities. Moreover, the joint interaction of countercyclical interest rates and search-matching frictions can go a long way in accounting for higher consumption variability relative to output and countercyclical current account observed in emerging markets. Extending this baseline model to incorporate procyclical variations in the technical efficiency at which matches are generated, the model can match the unemployment variability observed in the data.
Topic:
Economics, Emerging Markets, and Labor Issues
Political Geography:
Global Focus

15. Political Disagreement, Lack of Commitment and the Level of Debt

Author:
Davide Debortoli and Ricardo Nunes
Publication Date:
07-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We analyze how public debt evolves when successive policymakers have different policy goals and cannot make credible commitments about their future policies. We consider several cases to be able to disentangle and quantify the respective effects of imperfect commitment and political disagreement. Absent political turnover, imperfect commitment drives the long-run level of debt to zero. With political disagreement, debt is a sizeable fraction of GDP and increasing in the degree of polarization among parties, no matter the degree of commitment. The frequency of political turnover does not produce quantitatively relevant effects. These results are consistent with much of the existing empirical evidence. Finally, we find that in the presence of political disagreement the welfare gains of building commitment are lower.
Topic:
Economics, Markets, and Political Economy
Political Geography:
United States

16. Optimal Fiscal and Monetary Policy in Customer Markets

Author:
David M. Arseneau and Sanjay K. Chugh
Publication Date:
01-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and monetary policy, which are based on Walrasian markets. Echoing the basic intuition of models based on sticky prices, unanticipated inflation in our environment causes a type of relative price distortion across markets. Such distortions stem from fundamental trading frictions that give rise to long-lived customer relationships and makes pursuing inflation stability optimal.
Topic:
Economics and Markets
Political Geography:
United States

17. On the Application of Automatic Differentiation to the Likelihood Function for Dynamic General Equilibrium Models

Author:
Houtan Bastani and Luca Guerrieri
Publication Date:
02-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A key application of automatic differentiation (AD) is to facilitate numerical optimization problems. Such problems are at the core of many estimation techniques, including maximum likelihood. As one of the first applications of AD in the field of economics, we used Tapenade to construct derivatives for the likelihood function of any linear or linearized general equilibrium model solved under the assumption of rational expectations. We view our main contribution as providing an important check on finite-difference (FD) numerical derivatives. We also construct Monte Carlo experiments to compare maximum-likelihood estimates obtained with and without the aid of automatic derivatives. We find that the convergence rate of our optimization algorithm can increase substantially when we use AD derivatives.
Topic:
Economics and Markets
Political Geography:
United States

18. Cross-Border Returns Differentials

Author:
Stephanie E. Curcuru, Tomas Dvorak, and Francis E. Warnock
Publication Date:
02-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Were the U.S. to persistently earn substantially more on its foreign investments ("U.S. claims") than foreigners earn on their U.S. investments ("U.S. liabilities"), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, using a monthly dataset on the foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors, we find that the returns differential for portfolio securities is near zero, far smaller than previously reported. Examining all U.S. claims and liabilities (portfolio securities as well as direct investment and banking), we find that previous estimates of large differentials are biased upward. The bias owes to computing implied returns from an internally inconsistent dataset of revised data; original data produce a much smaller differential. We also attempt to reconcile our finding of a near zero returns differential with observed patterns of cumulated current account deficits, the net international investment position, and the net income balance. Overall, we find no evidence that the U.S. can count on earning substantially more on its claims than it pays on its liabilities.
Topic:
Economics and International Trade and Finance
Political Geography:
United States

19. Cross-border Bank Acquisitions: Is there a Performance Effect?

Author:
Ricardo Correa
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper uses a unique database that includes deal and bank balance sheet information for 220 cross-border acquisitions between 1994 and 2003 to analyze the characteristics and performance effects of international takeovers on target banks. A discrete choice estimation shows that banks are more likely to get acquired in a cross-border deal if they are large, bad performers, in a small country, and when the banking sector is concentrated. Post-acquisition performance for target banks does not improve in the first two years relative to domestically-owned financial institutions. This result is explained by a decrease in the banks' net interest margin in developed countries and an increase in overhead costs in emerging economies.
Topic:
Economics, International Trade and Finance, and Markets

20. Do Differences in Financial Development Explain the Global Pattern of Current Account Imbalances?

Author:
Joseph W. Gruber and Steven B. Kamin
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper addresses the popular view that differences in financial development explain the pattern of global current account imbalances. One strain of thinking explains the net flow of capital from developing to industrial economies on the basis of the industrial economies' more advanced financial systems and correspondingly more attractive assets. A related view addresses why the United States has attracted the lion's share of capital flows from developing to industrial economies; it stresses the exceptional depth, breadth, and safety of U.S. financial markets.
Topic:
Economics, International Trade and Finance, and Markets
Political Geography:
United States