Financial intermediation and fragility: the role of the periphery

A peculiar feature of the present international economy is that the leading ‘hegemonic’ country, USA, has a large and mounting external deficit which it finances by issuing debt in its own currency. The US can be seen to be at the apex of a pattern of triangular payments recycling the surpluses of creditor countries to debtor countries in the periphery. The paper shows, within a stock‐flow‐consistent framework, how capital flight from debtor periphery countries, by precipitating a shift from assets denominated in domestic currency to those denominated in dollars, acts like a safety valve for the international monetary system.     

Beyond the Sovereign Debt Crisis: Alternative Forms of Market-Based Debt Restructuring Schemes

The resolution of the international debt crises has stimulated extensive research onhow to design solutions for countries facing external debt overhang problems. Thispaper analyses the benefits for creditors and debtors of the following `market-based'debt restructuring schemes: (i) issue of collateralised new assets inexchange for the old debt; (ii) automatic roll-over of the debt repayment with astate-contingent penalty rate. The first proposal combines the basic debt conversionscheme proposed by Krugman (1989) with Cline's proposal (1995) of self-enhancementson the new claims as a form of risk-compensation for creditors (seealso Williamson, 1988). Under this scheme the debtor country modifies the streamof the debt service payments by voluntarily exchanging the outstanding debt fornew assets with different debt service characteristics where the principal and/or theinterest rate payment can be fully or partially collateralised. The roll-over schemeentitles illiquid countries to extend the outstanding debt for a specified period at apenalty rate which is contingent on a measure of the country's creditworthiness.This solution has the desirable effect of reducing the future contractual obligationsby lowering the penalty rate on the excess of debt rolled over, thus helping thedebtor country to use additional resources to invest in the economy.     

Portfolio Composition and Valuation Effects in Emerging Market Economies*

ABSTRACT

The increase in cross-border assets and liabilities of nations with globalization, implies small asset price and currency movements create large wealth changes. The national net external position is increasingly driven by valuation effects, which the current account does not capture. We analyze valuation effects for a group of seven emerging economies, namely Brazil, Colombia, India, Republic of Korea, Mexico, Peru and Turkey for the time period 2005:Q1-2015:Q4 by scrutinizing their external asset portfolio while controlling for country fundamentals. Both asset and liability categories of Direct Investment equity are found to positively impact valuation. Equity liabilities and debt assets of Portfolio Investment positively influence valuation. Debt liabilities of all kinds of investment negatively impact valuation. Countries with stronger currency tend to gain through valuation effects. An appreciated real effective exchange rate is associated with higher valuation gains. We also found non-linear effects of the composition of external debt portfolio by interacting external portfolio and country characteristics. The external portfolio selection of emerging economies (with more in Direct Investment equity liabilities and Portfolio Investment debt assets) in the period has shielded them from global volatility, and enabled valuation gains.     

Is external debt sustainable? A probabilistic approach

We develop a probabilistic approach to measure a country's external debt sustainability. Using data on international investment position and balance of payments from the International Monetary Fund, we estimate a vector autoregressive model for 38 countries (11 developed and 27 developing). Using the estimated parameters, we perform a Monte Carlo simulation to compute the distribution of the capacity to repay for each country. A large portion of the projected distribution to the right of current debt is a warning indicator, signalling the need for devaluation. We provide simulations for each country. One scenario is where the discount factor is lower than 1. According to the literature, this situation should prevail in the medium and long run. A quite different situation is where external sustainability is achieved because of a simulated discount factor of more than 1. Here, interest on debt is lower than GDP growth. This situation is associated with dynamic inefficiency. The results suggest that flight to safety is penalising some developing countries, whilst benefiting some developed countries.     

VEHICLE CURRENCY*

Historically, the world economy has been dominated by a single currency accepted in the exchange of goods and assets among countries. In recent decades, the U.S. dollar has played this role. The dollar acts as a “vehicle currency” in the sense that agents in nondollar economies will generally engage in currency trade indirectly using the U.S. dollar instead of using direct bilateral trade among their own currencies. A vehicle currency is desirable when there are transactions costs of exchange. This article constructs a dynamic general equilibrium model of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle currency and show how it depends on the total number of currencies in existence, the size of the vehicle currency economy, and the monetary policy followed by the vehicle currency’s government. We find that there can be significant welfare gains to a vehicle currency in a system of many independent currencies. But these gains are asymmetrically weighted toward the residents of the vehicle currency country. The survival of a vehicle currency places natural limits on the monetary policy of the vehicle currency country.     

对外负债与经济增长

本文分别在理论和实证上分析了对外负债与经济增长的关系。在拉姆齐-卡斯-库普曼斯框架下构建的理论模型预测结果显示:对于大国,对外负债率与经济增长之间可能呈现负向或正向的单调关系,也可能呈现倒"U"型的关系;对于小国,对外负债率与经济增长之间只存在负向或正向的单调关系。分别以发达国家和发展中国家为样本实证分析的结果表明:对于发达国家,当对外负债率处于较低水平时,负债率增加会促进经济增长,当对外负债率超过60%时,负债率增加不利于经济增长;对于发展中国家,不管对外负债率处于何种水平,负债率增加都会使经济增长的速度下降。实证分析的结果与理论模型的预测基本吻合。     

The price of the euro: evidence from sovereign debt markets

The objective of this article is to ascertain how the Economic and Monetary Union (EMU) in Europe has affected its members’ long-term government bond yields. In order to estimate the effect, this article utilizes a synthetic control approach. The main finding is that the majority of the member countries did not receive economic gains from the EMU in sovereign debt markets. Synthetic counterfactual analysis finds strong evidence that Austria, Belgium, Finland, France and the Netherlands have paid a positive and substantial euro-premium in their 10-year government bonds since the adoption of the single currency. After the most recent financial crisis, government bond yields have been higher in all member countries compared to the situation that would have occurred without the monetary unification. This article concludes that from the viewpoint of sovereign borrowing, it would be beneficial for a country to maintain its own currency and monetary policy.     

ECONOMIC ADJUSTMENT IN HEAVILY INDEBTED DEVELOPING COUNTRIES

The threat to the international financial system resulting from the developing-country debt problem has diminished since the initial 1982 crisis, despite halting adjustment and impaired creditworthiness in heavily indebted developing countries. The threat to the financial system has eased as commercial banks have reduced sharply the share of their assets and capital exposed to the troubled debtor countries. The countries themselves, however, are no better off. A sizable balance-of-payments adjustment has occurred in the heavily indebted developing countries, but that adjustment was concentrated–at least in quantitative terms–during the years immediately following the onset of the crisis and might have been more efficient had it been executed more gradually. Despite the adjustment that has occurred, the creditworthiness of the heavily indebted countries–as evaluated by conventional indices–has not improved. And, for reasons that this article explores, economic growth per capita has not resumed either.     

The application of risk analysis to the appraisal of optional investment in the electricity supply industry

Although currency substitution is a widely observed phenomenon in both developed and developing counries, most of the studies on currency substitutioin in small open economies have focused on high inflatin South American countries. This paper extends the previous analysis to a newly industrializing, high-inflation economy, namely Turkey. A vector autoregression model has beeb estimated employing the certain policy variables to investigate the dynamics of currency substitution in the economy. Dynamic impulse responses show that the residents have a preference for substitutiong foregn currencies for domestic currency because of reawl-exchange-rate depreciations. The results suggest that to stop or to reverse the on-going currency substition process a plicy aiming to increase the expected real return on domestic assets should be adopted.     

Withstanding financial crises: would trade partners help or hurt?

This article provides new empirical evidence on the losses of real activity caused by various financial shocks. Spillover effects due to foreign trade linkages deserve special attention. To this end, we estimate a modify auto-regressive process and a Seemingly Unrelated Regression Equations estimator is used to account for the dependency of one’s country growth on its trade-weighted partners growth. We run estimations on a set of currency collapses, banking crises and sovereign defaults in 49 advanced and developing countries from 1978 to 2011. The trade-weighted foreign demand effect mitigated the economic downturn following a banking or a sovereign debt crisis in all countries, while only the advanced ones benefited from it after a currency collapse. Trade-based spillover effects make banking crises more costly in the developing countries, in those that liberalize their financial account. It contrasts with what is observed during currency or sovereign debt crises.     

Sustainable government debt in a two-good,two-country overlapping generations model

The recent dramatic rise of government deficits in most advanced countries to counter the effects of the global financial crisis arouses renewed interest for one of the perennial topics of fiscal policy: the sustainability of government debt. This paper explores maximum sustainabile debt in a two-good, two-country overlapping generations (OLG) model and analyzes existence and dynamic stability of steady states as well as the transitional dynamics of private capital when government debt remains below the maximum sustainable level. We find that maximum government debt levels for both countries exist and are negatively related. Moreover, if sustainable government debt is unilaterally expanded, private capital is crowded out in both countries while the terms of trade of the debt-expanding country are unaffected if capital income shares are internationally equal.     

Composition of International Assets and the Long‐run Current Account

We document the role of capital gains and losses for the current account that a country can sustain along a balanced growth path. While it is well know that growth allows a country to run a current account deficit and still keep its external debt stable as a share of GDP, the sensitivity of the current account to the composition of external assets and liabilities has received little attention. We show that this composition matters because several assets, such as equity or FDI, earn substantial capital gains that are not reflected in the current account. A country that is a net creditor in such assets can then sustain a larger current account deficit. Using a broad sample, we show that this aspect substantially tilts estimates of the long‐run current account towards a deficit among industrialized economies, with the opposite situation for emerging markets. We also show that industrialized economies are likely to benefit from predictable capital gains in the future.     

Public Debt,Terms of Trade and Welfare: The Role of Capital Production Shares,External Balances,and Dynamic (In)efficiency

In view of still large external imbalances across the world economy and dramatically risen public debts in major advanced economies, this paper reconsiders the relationship between public debt, the terms of trade and welfare in a two-good, two-country overlapping generations model with technological differences across countries. We find that the terms of trade effect of a public debt shock depends only on international differences in capital production shares and the dynamic (in)efficiency of the world economy. As in a model with similar capital production shares, domestic welfare rises and foreign welfare decreases when Home has a positive external balance and the Golden Rule holds. Under dynamic efficiency, welfare decreases in the debt-expanding, net foreign creditor country if she has a relatively smaller capital production share, and if the welfare effect through the accumulation channel is negative. In contrast, under dynamic inefficiency she can increase her welfare by debt expansion.     

Killing two birds with one currency: Income and fiscal policies in a growth model of a currency union

Building on a two-country Kaleckian model of a currency union, we examine the consequences of balance-of-payments adjustment policies, focusing on the interdependence between the long-run growth paths of member countries. The model separates the short-run from the long-run dynamic, comparing price and wage dynamics in each country in the light of Thirlwall’s balance-of-payments-constrained growth model. We show that by shifting the burden of adjustment to the less competitive country, austerity and wage moderation policies lead to long-term recessionary effects. Only expansionary policies in the more competitive country can achieve the two goals of reducing external imbalances and increasing the long-run growth rate in both member countries.     

Creditworthiness and thresholds in a credit market model with multiple equilibria

Summary. The paper studies creditworthiness in a model with endogenous credit cost and debt constraints. Such a model can give rise to multiple candidates for steady state equilibria. We use new analytical techniques such as dynamic programming (DP) with flexible grid size to find solutions and to locate thresholds that separate different domains of attraction. More specifically, we (1) compute present value borrowing constraints and thus creditworthiness, (2) locate thresholds where the dynamics separate to different domains of attraction, (3) show jumps in the decision variable, (4) distinguish between optimal and non-optimal steady states, (5) demonstrate how creditworthiness and thresholds change with change of the credit cost function of the debtor and (6) explore the impact of debt ceilings and consumption paths on creditworthiness.JEL Classification Numbers: C61, C63, D91, D92, E51, G12, G32.An earlier version of this paper has been prepared for the 1998 North American Winter Meeting of the Econometric Society, January 1998, Chicago. We want to thank Jess Benhabib, Buz Brock, Gustav Feichtinger, Franz Wirl, Michael Woodford, Wolf-Jürgen Beyn and Thorsten Pampel for helpful discussions and comments on various versions of the paper. We also want to thank participants in a workshop at the University of Technology, Vienna, the Macroeconomic Workshop at Columbia University, and the SCE conference, at Yale University, June 2001. We are also grateful for comments from a referee of the journal.     

Monetary and macroprudential policy with foreign currency loans

In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions, where housing loans can be denominated in domestic or foreign currency. The model is calibrated for Poland - a typical small open economy with a large share of foreign currency loans (FCL). We show that the presence of FCLs negatively affects the transmission of monetary policy and deteriorates the output-inflation volatility trade-off it faces. The trade-off can be improved with macroprudential policy but the outcomes are still worse than under this same policy mix applied to an economy with domestic currency debt. We also demonstrate that a high share of FCLs is harmful for social welfare, even if financial stability considerations are not taken into account. Finally, we show that regulatory policies that discriminate against FCLs may have a negative impact on economic activity and discuss the redistributive consequences of forced currency conversion of household debt.     

欧债危机对中国的影响及国际货币体系的改革思考

近期,欧债危机愈演愈烈,已显现出向欧元区核心国家蔓延的态势。本文重点分析了欧债危机对中国的影响,在此基础上从短期和长期两个角度提出了中国面对欧债危机的应对之策。同时,作者分析了欧债危机对今后区域与国际货币体系改革的启示,并探讨了中国如何参与当前国际货币体系的改革。     

The sovereign spread in Asian emerging economies: The significance of external versus internal factors

This paper investigates the dynamic relations between external factors, domestic macroeconomic factors with sovereign spreads, debt to GDP ratio, etc. in Asian emerging countries. First, we develop a theoretical model that determines the equilibrium debt level, probability of default and sovereign spread and draw empirical implications. We then employ a Structural Vector Autoregression (SVAR) model to investigate empirically how the spread of sovereign debt is influenced over time by both external and domestic factors. The empirical results show that variations in sovereign spreads are mainly driven by external shocks, with the term structure of US interest rate and the global risk aversion having the most important role. The findings also indicate that shocks from the US have a direct effect on sovereign spread and an indirect effect via domestic macroeconomic fundamentals. Finally, the evidence produced validates the presence of some response patterns of sovereign spread to the external shocks.     

The long-term consequences of external debt: Revisiting the evidence and inspecting the mechanism using panel VARs

We estimate a panel vector autoregression model to examine the relationship between external debt and economic growth. We use a large dataset based on 123 countries, classified according to income levels over the period 1990–2015. While total external debt appears to have a negative effect on growth rate overall, it is positively associated with income growth in the lower- and upper-middle income countries. Further disaggregating external debt into its components reveals that public external debt negatively affects economic growth across all income categories of countries, whereas the impact of private external debt is not statistically significant. We do not detect a common threshold level in the relationship between public debt and economic growth across countries. Savings and investment are the primary channels through which external debt impacts economic growth. These results are robust to various model specifications, additional controls, and identifying restrictions.     

Economic Power and the Firm in New Institutional Economics: Two Conflicting Problems

The objective of this study has been to undertake an analysis of the economic and institutional determining factors of fiscal pressure in a group of European countries with different levels of economic development, recent history, or level of cooperation and integration among them. We have used a panel of data from 40 countries and a time period of eleven years. Apart from the variables generally used, we have introduced additional ones such as governing party ideology, rate of economic freedom of Euro-area countries, together with another set of institutional variables. Results obtained show that the purely economic model improves when institutional and geopolitical variables are included and, in this way, it is possible to see which countries governed by the left, belonging to the Euro-area or having been members of the Soviet block, and with economic freedom, are more liable to increase fiscal pressure.