Exchange rate and inflation dynamics in dollarized economies

We use a panel of a hundred-plus countries with differing degrees of dollarization to perform an empirical analysis of the effects on inflation of exchange rate depreciations. The results qualify the common view that countries with higher dollarization exhibit higher inflation pass-through. We show that large depreciations tend to generate a negative impact on the pass-through coefficient, this impact being more intense the higher the level of dollarization of the economy. We interpret this as evidence that, in highly dollarized economies, the classic inflationary effects of a real depreciation—higher internal demand and imported inflation—can be offset or diminished by both the larger financial costs and the balance-sheet effect, especially if the depreciation is “large”. Additionally, the exchange rate regime is shown to matter: countries with fixed exchange rates suffer more noticeably the balance-sheet effects of large depreciations.     

Do domestic bond markets participation help reduce financial dollarization in developing countries?

In this paper, I analyze the effect of domestic sovereign bond market (BM) participation on financial dollarization using a large panel of 114 developing countries over the period 1984–2009. Building on entropy balancing, my results reveal strong evidence that domestic BM participation significantly reduces financial dollarization in domestic BM countries compared to their non-domestic BM peers. Moreover, I find that the favorable impact of domestic BM on financial dollarization (i) is larger for inflation targeting countries compared to non-inflation targeting countries, (ii) is apparent exclusively in a non-pegged exchange rate regime, (iii) and is larger when there are fiscal rules that constrain the discretion of fiscal policy makers. Finally, I show that the induced drop in inflation rate and its variability, nominal exchange rate variability, and seigniorage revenue are potential transmission mechanisms through which the presence of domestic BM reduces financial dollarization in domestic BM countries.     

Structural Changes and the Scope of Inflation Targeting in Korea *

A small, open macroeconomic model that accounts for new financial accelerator effects (the effects of fluctuations in asset prices on bank credit and economic activity) is developed to evaluate various policy rules for inflation targeting. Given the conditions of asset markets and the fragility of the financial sector, monetary policy responses can potentially amplify the financial accelerator effect. Simulations are used to compare various forms of inflation targeting using a model that emphasizes long-term inflation expectations, output changes, and the asset price channels. The simulations suggest that a successful outcome can be obtained by adhering to simple forward-looking rules, rather than backward-looking policy rules. Furthermore, inflation targeting can contribute to price as well as output stability by helping to keep the financial accelerator from being activated. Inflation targeting in emerging economies can provide an environment conducive to long-term capital market development. [E51,F3,F4]     

Stock Market Capitalism: Welfare Capitalism: Japan and Germany versus the Anglo-Saxons

The financial sector has acquired great prominence in most developed economies. Some authors argue that the growth of finance is at the root of the financial and economic difficulties of the past decade. This article aims to analyze this claim by looking at financialization in the European periphery, focusing on the Portuguese case. The emergence of this phenomenon is contextualized from a historical, economic and international perspective. Based on the analysis of several indicators, the article concludes that the Portuguese economy exhibits symptoms of financialization that are typically found in Southern European countries and that these differ significantly from the patterns characterizing financialization processes in more advanced economies. The article discusses how the increasing importance of financial actors and motives in the Portuguese economy played a decisive role in the emergence of the crisis.     

The Financial Sector and Economic Growth*

The Mankiw–Romer–Weil (1992) augmented Solow–Swan ( Solow 1956 ; Swan 1956 ) model is extended to incorporate the financial sector in this study. Distinguishing between financial capital, physical capital and human capital, the research attempts to identify, in particular, the effects of financial capital on economic growth. The effects of financial sector efficiency on economic growth are also examined. The financial sector augmented model is tested on a cross‐section of 35 economies. Strong support is found for the model.     

Monetary policy rules for financially vulnerable economies

One distinguishable characteristic of emerging market economies is that they are not financially robust. These economies are incapable of smoothing out large external shocks, as sudden capital outflows imply abrupt swings in the real exchange rate. Using a small open-economy model, this paper examines alternative monetary policy rules for economies with different degrees of liability dollarization. The paper answers the question of how efficient it is to use inflation targeting (IT) under high liability dollarization. Our findings suggest that it might be optimal to follow a nonlinear policy rule that defends the real exchange rate in a financially vulnerable economy.     

Finance and industry: the case of Greece

This article argues that the Greek banking system contributed to the emergence of a weak, uncompetitive, and ultimately highly inefficient industrial sector. This inefficiency is quantified with the help of translog cost-curve estimates for 68 firms in eight industries. The estimation shows that Greek firms operate at too small a scale, relative to their capacity, and do not exploit scale economies. It was the structure of the financial sector, as it operated within the specific political context, that led to processes that dampened competition and ultimately distorted the country's development. The financial sector's behaviour is conditioned by three structural facets: it is an oligopoly; it possesses an internal hierarchy which is fully vertical; and it is state-owned. That the financial process led to inefficiency is confirmed by examining the counterexample of efficient industrial configurations. In this case, efficient industries were able to deny the potentially harmful policies of the financial sector. In conclusion, the structure of the financial sector, and by extension the structure of the state itself, played an important role in the Greek economy.     

Private Pension Funds in Oligopolistic Financial Markets: Some qualifications to conventional theory of financial development

The paper inquires into the efficiency of financial development policies in economies where the financial sector is based on oligopolistic commercial banking. In this case, interest rates on deposits may be set below the level required to achieve balance of payments equilibrium, so that banks are able to exact a risk free financial margin in their holdings of government bonds. Under such circumstances, banks lack incentives to place indirect debt in domestic security markets, as a means of providing long-term finance; and private capital market deepening is hindered. Pension fund privatisation, in this institutional environment, does not relieve public finances, because the government must act as issuer of last resort in order to stabilise the currency. This point is illustrated with Mexican data, and some policy measures to deal with this situation in developing economies are proposed.     

International Financial Contagion: Why are Eastern Europe's banks not failing when everybody else's are?

While the Asian financial crisis spread to Russia and Brazil, the transition economies in Central and Eastern Europe (CEECs) are largely unaffected by international financial contagion. This is the more surprising considering that most economies have experienced severe banking sector problems in the past, that large bad loan ratios are still prevalent, that banking regulation and supervision are only slowly improving, and that stabilizing policies have slowly been eliminated. What insulated the CEECs from the recent wave of financial instability? To consider the counterfactual, we first provide a framework that links banking crises to financial deregulation. We then focus on a number of macro- and microeconomic factors, using data compiled from the IMF's International Financial Statistics, from the World Bank's World Debt Tables, and from the BIS's Consolidated International Banking Statistics. We first compare past experiences in CEECs with those in other emerging economies as a cross-sectional reference point. We then consider whether the situation in CEECs has changed since the last banking sector problems, in order to establish a reference point across time. Our results indicate that the factors leading up to past banking crises are generally different in CEECs from those in other emerging economies. However, in recent years, the characteristics of CEECs have become more similar to those of other emerging economies.     

The role of the government in financial sector development

This study examines the impact of two dimensions of the government, namely, size and quality, on two dimensions of the financial sector, size and efficiency, in a cross section of 71 economies. The study finds that increased quality of the government as measured by governance and legal origin positively influences both financial sector size and efficiency. The size of the government proxied by government expenditure and the government ownership of banks has a negative effect on financial sector efficiency, and a positive impact on financial sector size, particularly in the low income economies.     

Banking sector development and interest rate volatility in emerging economies

Over the last decades, macroeconomic stability is said to be one of the major concerns of emerging economies. Financial sector as a core of macroeconomic stability has been under close consideration of policy makers. The relationship between interest rate uncertainty and banking sector development as one of the most important indicators of financial sector development, especially for emerging economies, has not received enough attention in the literature. Perhaps this article is the most comprehensive study that investigates the relationship between interest rate uncertainty and banking sector development for a large group of emerging economies. To do this, the short-run and long-run models using a bounds testing approach to cointegration for 12 emerging economies over the period 1980–2011 have been developed. Estimated results from all models indicate that interest rate uncertainty has significant effect on banking sector development in both short-run and long-run phenomena in the majority of countries. The findings indicate that the link between interest rate uncertainty and banking sector development in each country depends on each country’s specific structure.     

Financial crisis in Southeast Asia: dispelling illusion the Minskyan way

This paper extends Minsky's financial instability hypothesisto the case of the open, ‘liberalised’, economy,making it possible to put forward a specifically Minskyan accountof the road to the financial crisis in Southeast Asia (1997/1998).The analysis suggests that the threats to growth and employmentemanating from the financial sector which Minsky identifiedin the closed economy setting are much intensified in open,liberalised, developing economies. Financial liberalisationis an important key factor in this process. Rival explanationsof the crisis are examined and rejected in favour of the extendedMinskyan explanation. The policy implications are derived anddiscussed.     

Interaction of formal and informal financial markets in quasi-emerging market economies

The primary objective of this paper is to investigate the interaction of formal and informal financial markets and their impact on economic activity in quasi-emerging market economies. Using a four-sector dynamic stochastic general equilibrium model with asymmetric information in the formal financial sector, we come up with three fundamental findings. First, we demonstrate that formal and informal financial sector loans are complementary in the aggregate, suggesting that an increase in the use of formal financial sector credit creates additional productive capacity that requires more informal financial sector credit to maintain equilibrium. Second, it is shown that interest rates in the formal and informal financial sectors do not always change together in the same direction. We demonstrate that in some instances, interest rates in the two sectors change in diametrically opposed directions with the implication that the informal financial sector may frustrate monetary policy, the extent of which depends on the size of the informal financial sector. Thus, the larger the size of the informal financial sector the lower the likely impact of monetary policy on economic activity. Third, the model shows that the risk factor (probability of success) for both high and low risk borrowers plays an important role in determining the magnitude by which macroeconomic indicators respond to shocks.     

Capital controls,macroprudential regulation,and the bank balance sheet channel

We incorporate a banking sector with balance sheet frictions into a model of a small open economy and compare the effectiveness of capital controls and macroprudential regulation. We show that the welfare-improving effect of capital controls is larger than that of macroprudential regulation if the degree of financial friction between domestic banks and foreign investors is high, while the welfare-improving effect of macroprudential regulation is larger than that of capital controls if the degree of financial friction is low. We also show that the welfare ranking of the two policies depends on whether an economy suffers from liability dollarization.     

Exchange Rate Policy and Liability Dollarization: What do the Data Reveal about Causality?

The paper identifies the contemporaneous relationship between exchange rate policy and liability dollarization using three different definitions of dollarization. The presence of endogeneity makes the empirical identification elusive. We use identification through heteroskedasticity to solve the endogeneity problem in the present context ( Rigobon, 2003 ). While we find that countries with high liability dollarization (external, public, or financial) tend to be more actively involved in exchange rate stabilization operations, we do not find evidence that floating, by itself, promotes de‐dollarization.     

Solving the Currency Conundrum

This paper reviews the prospects for the exchange rate system in different parts of the world. It discounts radical changes like a single world currency and a trio of regional monetary unions: in Europe, where intergration is political as well as economic and financial, the euro should provide the basis for an expanding zone of monetary stability; in the Americas, in contrast, dollarization is likely to be the solution for countries with strong financial links to the USA that find it difficult to run an autonomous monetary policy; and in Asia, continued floating is the only plausible outcome, given the obstacles to the alternatives.
(J.E.L.: F3)     

Money and the rule of law in ecuador

The rule of law is defined and its implications in the monetary sphere are elaborated. When national monetary arrangements fail to comport with the rule of law, “dollarization” is desirable. That policy provides for more stable money and expectations about its future value. The salutary effects of Ecuador's “dollarization” program of 2000 are reviewed. In addition, a manifesto for economic reform in Ecuador is presented. Its elements are: financial integration, fiscal transparency and control, tax simplification and reform, supermajority voting, deregulation, and privatization.     

Institutions and financial dollarization: Indirect effects based on a policy experiment

We provide evidence that institutional improvements lead to lower levels of financial dollarization through previously unidentified channels. These indirect channels operate in addition to the direct impact identified in the literature and further illustrate the importance of institutions for the extent of banking dollarization.     

Financial development and openness: Evidence from panel data

This paper addresses the empirical question of whether trade and financial openness can help explain the recent pace in financial development, as well as its variation across countries in recent years. Utilising annual data from developing and industrialised countries and dynamic panel estimation techniques, we provide evidence which suggests that both types of openness are statistically significant determinants of banking sector development. Our findings reveal that the marginal effects of trade (financial) openness are negatively related to the degree of financial (trade) openness, indicating that relatively closed economies stand to benefit most from opening up their trade and/or capital accounts. Although these economies may be able to accomplish more by taking steps to open both their trade and capital accounts, opening up one without the other could still generate gains in terms of banking sector development. Thus, our findings provide only partial support to the well known Rajan and Zingales hypothesis, which stipulates that both types of openness are necessary for financial development to take place.     

Financial development,industrialization, the role of institutions and government: a comparative analysis between India and China

This research is the first comparative attempt incorporating the role of economic, demographic, sectoral contribution, government and trade in explaining financial development for India and China. Using time-series estimations, we establish that institutional quality and government size impede financial development, whereas urbanization, industrialization and service sector growth help in financial development for both countries. Trade openness also enhances Indian financial development but hinders Chinese financial development. We suggest that the policy advisers should not underestimate the role of urbanization, industrialization and service sector growth in implementing financial development. Finally, we find that the institutions and governments will play a key role for both economies in enhancing finance and growth.