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741. European Debt Crisis: What Is The Way Out

Author:
Charles Wyplosz
Publication Date:
03-2011
Content Type:
Working Paper
Institution:
Center for Social and Economic Research - CASE
Abstract:
"The current European debt crisis is just bringing to the fore well-defined cracks in the Eurozone’s construction. Fiscal discipline was left in the careless hands of national governments, banking regulation and supervision was delegated to national authorities more interested in promoting national champions than in completing the Single Market. Moreover, crisis management was masterminded not by the Commission but by national governments. This leaves panicked policymakers with the firm view that economics is largely useless and that any policy can be pursued if it makes good political sense."
Topic:
Debt, Globalization, Markets, Macroeconomics, and Economic Integration
Political Geography:
Europe

742. Limited Market Participation and Asset Prices in the Presence of Earnings Management

Author:
Bo Sun
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We examine the role of earnings management in explaining the properties of asset prices and stock market participation. We demonstrate that investors' uncertainty about the extent of manipulation can cause excess movements in stock price relative to fluctuations in output. When faced with information asymmetry about fundamentals in the presence of earnings management, investors demand a higher equity premium for bearing the additional risk associated with their payoffs. In addition, when investors have heterogeneous beliefs about managerial manipulation, the dispersion in belief endogenously gives rise to limited stock market participation. Our model suggests that the increasing stringency of corporate governance and varying composition of investors may have played a role in the contemporaneous run-up of market participation rates in the recent years.
Topic:
Markets, Finance, Investment, and Stock Markets
Political Geography:
Global Focus

743. Evaluating the Forecasting Performance of Commodity Futures Prices

Author:
Trevor A. Reeve and Robert J. Vigfusson
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Commodity futures prices are frequently criticized as being uninformative for forecasting purposes because (1) they seem to do no better than a random walk or an extrapolation of recent trends and (2) futures prices for commodities often trace out a relatively flat trajectory even though global demand is steadily increasing. In this paper, we attempt to shed light on these concerns by discussing the theoretical relationship between spot and futures prices for commodities and by evaluating the empirical forecasting performance of futures prices relative to some alternative benchmarks. The key results of our analysis are that futures prices have generally outperformed a random walk forecast, but not by a large margin, while both futures and a random walk noticeably outperform a simple extrapolation of recent trends (a random walk with drift). Importantly, however, futures prices, on average, outperform a random walk by a considerable margin when there is a sizeable difference between spot and futures prices.
Topic:
International Trade and Finance, Markets, Investment, and Commodities
Political Geography:
Global Focus

744. Housing Wealth and Consumption

Author:
Matteo Iacoviello
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Housing wealth is about one half of household net worth, and consumption is a considerable fraction (about two thirds) of Gross Domestic Product in the United States. Empirically, movements in housing wealth are associated with movements in consumption in the same direction. This observation has led many economists, commentators and policy makers to study how housing wealth and consumption are linked together. A sizeable portion of the comovement between housing wealth and consumption reflects common factors driving both variables, rather than the "wealth effect" of the former on the latter; however, a growing body of evidence suggests that the comovement is larger in developed financial markets and in the presence of liquidity constraints.
Topic:
Economics, Markets, Infrastructure, and Housing
Political Geography:
North America and United States of America

745. A Theory of Capital Rationing

Author:
Jan Toporowski
Publication Date:
09-2010
Content Type:
Working Paper
Institution:
School of Oriental and African Studies - University of London
Abstract:
This paper revisits some of the issues originally put forward by the author as the theory of capital market inflation, in the book The End of Finance (Toporowski 2000). The paper makes much clearer the key assumptions and relationships between the operations of the capital market dominated by institutional investors, and the balance sheets of companies. In this way, it presents a theory of how macroeconomic dynamics may be affected by disequilibrium in the capital market. The first part of the paper examines the demand for new equity issues by institutional investors, namely insurance companies and pension funds. In the second part of the paper it is argued that the tendency of pension funds to mature may be a factor in forcing companies into debt and thus discouraging their investment and restricting their cash flow. The tendency towards forced indebtedness may be reinforced by an inelastic demand for capital by banks. The third part of the paper argues that the inelastic supply of capital in the capital market gives rise to processes of capital market inflation or deflation. The first of these may make banks more fragile. The second may contribute to deflationary processes in the macroeconomy. A fourth section argues that further instability is added by international capital market integration.
Topic:
Debt, Markets, Banks, and Investment
Political Geography:
Global Focus

746. Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks

Author:
David Bowman, Etienne Gagnon, and Mike Leahy
Publication Date:
03-2010
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.
Topic:
Markets, Interest Rates, Central Bank, and Fiscal Policy
Political Geography:
Global Focus

747. International investment law and media disputes: a complement to WTO law

Author:
Luke Eric Peterson
Publication Date:
01-2010
Content Type:
Policy Brief
Institution:
Columbia Center on Sustainable Investment
Abstract:
The recent high-stakes dispute between Google and China over censorship and cyber-security has spawned renewed discussion of the international trade law protections that internet and media companies may enjoy. Less recognized, however, is a perhaps more powerful legal tool in the arsenal of internet and media companies engaging in cross-border investment s, namely international investment law.
Topic:
Economics, International Trade and Finance, Markets, Mass Media, and Law
Political Geography:
China

748. Financial Integration and Foreign Banks in Latin America: Do They Amplify External Financial Shocks?

Author:
Liliana Rojas-Suarez, Arturo J. Galindo, and Alejandro Izquierdo
Publication Date:
02-2010
Content Type:
Working Paper
Institution:
Center for Global Development (CGD)
Abstract:
This paper explores the impact of international financial integration on credit markets in Latin America. Using a cross-country dataset covering 17 Latin American countries between 1996 and 2008, the authors find that financial integration amplifies the impact of international financial shocks on aggregate credit and interestrate fluctuations. Despite this pernicious effect, the net impact of integration on deepening credit markets is positive and dominates for the large majority of states of nature. The paper also uses a detailed bank-level dataset covering more than 500 banks in Latin America for a similar time period to explore the role of financial integration—captured through the participation of foreign banks—in propagating external shocks. The authors find that interest rates charged and loans supplied by foreign-owned banks respond more to external financial shocks than those supplied by domestically owned banks. However, this result does not hold for all foreign banks: Spanish banks in the sample behave more like domestic banks and do not amplify the impact of foreign shocks on credit and interest rates. Important policy recommendations to avoid foreign banks' amplification of external financial shocks include the establishment of ring-fencing mechanisms, the development of early-warning systems, and the incorporation for agreements between domestic and foreign supervisors.
Topic:
Economics and Markets
Political Geography:
Latin America and Spain

749. Is the recovery sustainable in the US and Europe?

Publication Date:
02-2010
Content Type:
Working Paper
Institution:
Oxford Economics
Abstract:
Following the worst recession since the 1930s, the US, UK and Eurozone economies have all now returned to positive growth. With the boost from policy stimulus and the inventory cycle peaking, however, this raises questions about the sustainability of the current rebound. The analysis presented here suggests that the recoveries in both the US and Europe will be relatively muted compared to recent historical experience. The US is likely to be the growth leader, reflecting the more dynamic nature of its economy and financial sector. A key uncertainty relates to how labour markets will perform during the recovery phase. To date, the rise in US unemployment been particularly severe when compared to the experience of Europe. In light of the sharp falls in European productivity, we expect employment gains in Europe to be more muted in the recovery phase than in the US. The performance of residential real estate markets also remains important. Home prices in the US are now close to fair value by most metrics, suggesting that the correction in prices is likely to be bottoming out. In Europe, only Spain and Ireland appear to be in the midst of substantial housing market corrections. Commercial real estate markets are also facing ongoing corrections in many countries. While conditions in the US and Eurozone may deteriorate further, commercial property values appear to be stabilising in the UK following earlier sharp declines. The ability of the banking sector to finance the economic recoveries in the US and Europe remains a key risk to the growth outlook. As the process of absorbing credit losses and rebuilding capital is likely to be protracted, the normalisation of lending standards is likely to take longer than following recent recessions. This is a particular concern for the Eurozone, where bank funding is more important for companies. Whether domestic demand in the US and Europe recovers will also depend on whether private sector deleveraging has further to run. The destruction of household net wealth in the US suggests that the personal savings rate has further to rise, whereas there no longer appears to be a pressing need for households in the UK and Eurozone to consolidate their balance sheets. In contrast, non-financial corporations in the US are in a stronger financial position than their European peers, having not increased debt levels as rapidly during the credit boom. Risks around public finances have received the most attention in recent weeks. In particular, the adjustments underway in Greece pose a risk of potential contagion from sovereign credit risk that could threaten growth on both sides of the Atlantic.
Topic:
Economics, Markets, and Financial Crisis
Political Geography:
United States, United Kingdom, and Europe

750. Is Greece heading for default?

Publication Date:
02-2010
Content Type:
Working Paper
Institution:
Oxford Economics
Abstract:
Greece has slid into a serious fiscal crisis over the last few months. A ballooning budget deficit and high levels of government debt have raised questions in the minds of investors about the sustainability of the country's public finances. The level of concern among investors can be seen from developments in Greek borrowing costs relative to those in Germany. At the beginning of 2008, the yield on Greek 10-year bonds was only around 0.3% higher than on equivalent German securities, but this gap has now risen to over 3%. This yield spread is at its widest for more than a decade and is by far the largest within the Eurozone. The root cause of Greece's problems is a long period of fiscal indiscipline. In 2009, after years of heavy spending, the budget deficit rose to almost 13% of GDP and the public debt to GDP ratio is set to reach 125% this year. The deteriorating fiscal position has led to a slew of ratings downgrades, and outside the Eurozone Greece's credit rating would probably be in 'junk' territory. On top of the fiscal problems, Greece also suffers from weak external competitiveness. The real exchange rate has appreciated substantially since Greece joined the Eurozone, contributing to a sharp widening in the current account deficit to around 12% of GDP last year. On some estimates, the real effective exchange rate is now around 20% overvalued. As a result Greece now faces a series of policy choices all of which look unpalatable. Within the Eurozone, the only realistic orthodox option is a combination of massive fiscal retrenchment and 'internal devaluation' – forcing down costs relative to those of Greece's competitors. But fiscal cutbacks and cost deflation on the scale required could plunge the country into a deep and prolonged recession and might prove politically and socially unsustainable. The Greek economy is already showing signs of serious stress, with GDP down 2.6% on the year in 2009Q4. The extreme alternatives are default and/or leaving the Eurozone and enacting devaluation. But the political barriers to such moves are immense, and while default and devaluation could ease budgetary and external imbalance problems, they would also cause massive economic and financial disruption and probably a deeper recession in the near-term. Default and devaluation would also risk huge negative contagion effects on the Eurozone and the wider global economy. With Greece's debt approaching €300 billion a default would be the largest sovereign collapse since WWII, dwarfing those in Russia and Argentina. Eurozone banks could face losses of up to €100 billion on top of the heavy writedowns already suffered, risking a renewed Europe-wide credit squeeze. There could also be collapses in demand for the debt of other weaker Eurozone members such as Spain, Portugal and Ireland. World markets for equities, corporate bonds and emerging market debt would also likely be badly affected. There could also be pressure for the major economies to accelerate their fiscal adjustment efforts, given the impact on investor confidence and the scale of their budget deficits. Our estimation results suggest that a Greek default could be a real threat to the progress of the global recovery, cutting growth in the major economies by around 1% per annum compared to our baseline forecast and world growth by 0.6%. Given the potential massive consequences of a Greek default, the pressure for a bailout has been growing. Although there are questions about the legality of such a move, we believe it is possible if the political will exists. Estimation results using the Oxford Model suggest a bailout would be likely to be less economically damaging than a default, even assuming some negative impact from higher bond yields in the core Eurozone countries. The costs of a bailout could rise rapidly, however, if it extended beyond Greece to other troubled countries. A bailout would create a big risk of moral hazard, perhaps inducing fiscal misbehaviour among other Eurozone members or being used by Greece to sidestep the necessary adjustment. To avoid this, any bailout would have to incorporate strict conditionality, perhaps raising serious questions about fiscal sovereignty within the Eurozone. Over the last two weeks, the other EU countries have taken a relatively hard line with Greece, stopping short of announcing explicit financial support and pushing for strong fiscal adjustment measures. Although a bailout remains the most likely outcome if Greece struggles to refinance its debts, there are some signs that political resistance to such a move is growing. The key risk period could be April-May, when a large volume of Greek debt matures.
Topic:
Economics, Markets, and Financial Crisis
Political Geography:
Europe, Greece, and Argentina