Capital controls and welfare with cross-border bank capital flows

This performance of time-varying capital controls on cross-border bank borrowing is studied in an open-economy, dynamic stochastic general equilibrium model with financial frictions and imperfect capital mobility. The model is parameterized for a middle-income country and replicates the stylized facts associated with a drop in world interest rates—capital inflows, real appreciation, credit boom, asset price pressures, and output expansion. A capital controls rule, which is fundamentally macroprudential in nature, is defined in terms of changes in bank foreign borrowing. The welfare-maximizing rule is established numerically and compared to the Ramsey policy. The analysis is then extended to solve jointly for optimal countercyclical reserve requirements and capital controls rules. The results show that the implementation of a countercyclical credit-based reserve requirement rule induces less reliance on capital controls. Thus, these two instruments are partial substitutes in maximizing welfare.     

How does issuing contingent convertible bonds improve bank's solvency? A Value-at-Risk and Expected Shortfall approach

This paper examines how issuing an innovative financial instrument called contingent convertible bond (CoCo) may enhance bank's solvency in comparison to issuing a conventional bond. CoCos convert automatically into common equity or have a principal write-down when bank's regulatory capital fails to meet a predetermined level. They have been invented and put into legislation with an objective to absorb losses thus preventing institutions from bankruptcy. From the standpoint of an issuer CoCos bring about two counter effects regarding his solvency: on one hand they recapitalize a bank approaching insolvency on the other hand CoCos pay much higher coupon comparing to conventional bonds. In our model a bank has two funding alternatives: either to issue CoCos or conventional bonds. We measure issuer's default risk using the concept of Value-at-Risk (VaR) and Expected Shortfall (ES). We conclude that CoCos have the potential to strengthen the resilience of the issuer on the condition that the probability of conversion triggering is higher than the VaR's significance level. Our findings can be helpful to the policymakers and banks to better understand the impact of CoCos on issuer's solvency.     

Macro effects of capital requirements and macroprudential policy

I investigate macro effects of higher bank capital requirements on the Norwegian economy and their use as a macroprudential policy instrument under Basel III. To this end, I develop a macroeconometric model where the capital adequacy ratio, lending rates, asset prices and credit interact with each other and with the real economy. The empirical results suggest that changes in capital requirements are primarily transmitted via lending rates to the other variables in the model. The proposed increases in capital requirements under Basel III are found to have significant effects especially on house prices and credit. I also derive optimal paths for the countercyclical capital buffer in response to various shocks. The buffer is found to equal its imposed ceiling of 2.5% in response to most of the shocks considered while its duration varies in the range of 1–12 quarters depending on the shock and its persistence.     

Endogenous cycles and human capital

Existing evidence shows that human capital investment is countercyclical. In a dynamic model, I show that countercyclical investment in human capital arises as a result of a parametric combination relating to preferences and technologies. This countercyclical reaction is responsible for complex dynamics in the evolution of human capital, thus initiating a self-sustained sequence of events that generate endogenous cycles.     

Capital utilization and retirement

This empirical analysis assesses the determinants of firms’ capital retirement. Particular attention is paid to the impact of the business cycle and the capital usage intensity. Compared to previous studies, we directly control for the capital utilization and disentangle the short-run mechanisms from the long-run ones. The analysis is carried out with an original and large firm-level dataset. The main results of the analysis may be summarized as follows: (i) the retirement rate increases during slowdowns and decreases during booms. This corresponds to a countercyclical capital retirement; (ii) the capital retirement rate increases with the capital usage intensity in the long run. This corresponds to a wear and tear effect, which is small compared to the countercyclical one; (iii) the capital retirement rate increases with the average age of capital; (iv) the profit rate and the wage cost per capita do not have a significant impact on the retirement rate.     

Cyclical wage movements in emerging markets compared to developed economies: The role of interest rates

This paper documents that, at the aggregate level, (i) real wages are positively correlated with output and, on average, lag output by about one quarter in emerging markets, while there are no systematic patterns in developed economies, and (ii) real wage volatility (relative to output volatility) is about twice as high in emerging markets compared with developed economies. We then present a small open economy model with productivity shocks and countercyclical interest rates. The model incorporates a working capital requirement and the Jaimovich and Rebelo (2009) preference that allows for flexible parameterization of the strength of income effects on labor supply. The model can account for the high volatility of wage and consumption relative to output and countercyclical trade balances that characterize emerging-market economies. During economic downturns, rising interest rates in emerging markets induce relatively large income effects on labor supply, so households would not reduce their labor input as much even though wages drop significantly.     

Countercyclical taxes in a monopolistically competitive environment

In the context of a neoclassical growth model with monopolistic competition, this paper studies the stabilizing effects of countercyclical tax policy when the income tax rate has an additional role of financing government budget deficits. Consistent with the conventional wisdom, countercyclical taxes generally reduce aggregate volatility, unless the fiscal response to debt accumulation is weak. The presence of monopoly power enhances these effects. Even when automatic stabilizers successfully stabilize business cycle fluctuations, countercyclical taxes are welfare inferior, due to reduced precautionary saving motives. While, if the fiscal response to debt is weak and countercyclical tax policy destabilizing, the increased precautionary saving motive is not welfare enhancing as the asset accumulated is government debt rather than capital. These results are generally robust. Nominal inertia may, however, dominate the precautionary saving mechanism.     

Housing market dynamics and macroprudential policies

In this paper, we analyze the implications of macroprudential and monetary policies for credit cycles, housing market stability and spillovers to consumption. We consider a countercyclical loan‐to‐value (LTV) policy that responds to a credit‐to‐income ratio, and we compare its effectiveness with a permanent tightening of the LTV ratio and a monetary policy rule that responds to credit. To this end, we construct a dynamic stochastic general equilibrium model with housing market, household debt and collateral constraints, and we estimate it with Canadian data using Bayesian methods. Our study suggests that a countercyclical LTV ratio is a useful policy to reduce spillovers from the housing market into consumption and to lean against housing market boom–bust cycles. It performs better than the permanent tightening of the LTV ratio—a policy that has been used in a number of countries—and the monetary policy rule, both in terms of the stabilization of household indebtedness and spillovers into consumption. Monetary policy that leans against the wind is the least desirable due to its large adverse consequences on the real economy.     

Contingent convertible bonds: Who invests in European CoCos?

Using a comprehensive data set on issuances and holdings of contingent convertible debt instruments (CoCos) issued by European banks, we investigate who invests in European CoCos. The results indicate that most European CoCos are not directly held by euro area investors. Foreign investors outside the euro area and investment funds located in Ireland and Luxembourg hold the large majority. Euro area banks, insurers and pension funds only have very limited direct exposures. Households in the euro area hold almost no direct positions in European CoCos, although there could be indirect holdings through non-euro area entities and euro area investment funds. Concerns for contagion through cross-holdings of CoCos by banks seem to be unwarranted.     

Demographics and real interest rates: Inspecting the mechanism

The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity—or expectations thereof—puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.     

Accelerated depreciation and the efficacy of temporary fiscal policy: Implications for an inflationary economy

The effect on investment of temporary tax rate changes depends on the age profile of depreciation deductions. If the depreciation allowance schedule is accelerated, then temporary cuts in the corporate tax rate could reduce investment. Inflation causes the age profile of real depreciation deductions to become accelerated and thus could make temporary tax cuts have a contractionary effect on investment. Two currently proposed reforms are shown to exacerbate this effect. Under each of these proposals, temporary tax cuts are likely to have opposite effects on investment in short-lived and long-lived capital, thereby complicating the conduct of countercyclical fiscal policy.     

Business cycles and schooling

It has been suggested that recessions are the appropriate time for undertaking activities that promote long-term performance (such as re-organization, human capital investments, R&D). In this paper, we study the cyclical patterns of one such activity, namely schooling. In particular, we examine the cyclicality in the school enrollment rates of various age groups in the US. The overall pattern is countercyclical. In addition, schooling seems to respond negatively to the expected real interest rate. Overall, the results seem to support the view that variation in opportunity costs associated with business cycles plays a major role in schooling decisions.     

略论中国外汇储备面临的潜在资本损失

本文分析了中国巨额外汇储备面临的由本币升值汇率风险而导致的资本损失。文章从两个角度来研究该项损失:一是从央行资产负债表由于货币错配而招致的现实以及潜在资本损失的角度;二是从以一篮子货币或者一篮子商品来衡量的中国外汇储备国际购买力损失的角度。本文的结论是:中国央行资产负债表面临的资本损失是显著的;中国外汇储备国际购买力的波动显著高于市场价值的波动,尤其是用油价来衡量的外汇储备购买力波动相当剧烈。     

A dynamic small open economy model with involuntary unemployment

Abstract It is well known that real business cycle small open economy (SOE) models rely on Greenwood, Hercowitz, and Huffman (1988) preferences to match the countercyclical trade balance observed in open economies, as well as other second moments, while standard preferences à la King, Plosser, and Rebelo (1988) are commonly labelled ‘ineffective,’ owing to their inability to yield the countercyclical trade balance. In this paper, I show that an SOE model with standard preferences and ‘involuntary’ unemployment with efficient risk sharing can obtain a countercyclical trade balance and match main empirical regularities in small open economies.     

The Interplay of Wage and Exchange Rate Policies in Singapore: A Case of Collective Bargaining in Macroeconomic Management

This article analyzes an optimization model of the policy game between Singapore's National Wage Council and the Monetary Authority of Singapore and further simulates the model over policy rules (Nash game versus non-Nash game), economic scenarios, and the game players' preference and bargaining power. The results indicate that the exchange rate appreciation and wage growth act as substitutes under the Nash rule of policy responses, whereas they act as complements under the non-Nash rule. Under the Nash rule, the exchange rate appreciation tends to be procyclical and wage growth countercyclical; union workers' bargaining power relative to employers' strengthens the procyclical appreciation uniformly but reinforces the countercyclical wage growth only when the economy undergoes a downturn. Both the Nash and non-Nash rules call for more moderate appreciation and more flexible wage adjustments than their actual movements. (JEL E64 , E61 , F41 )     

Countercyclical capital rules for small open economies

The growing literature on macroprudential regulation focuses on how a combination of monetary and macroprudential policies can boost macroeconomic and financial stability. We contribute to this literature by developing a DSGE model that assesses the effectiveness of countercyclical capital regulation in small open economies, in monetary unions or with exchange rate pegs, where policymakers do not have full control over traditional stabilisation instruments such as nominal interest and exchange rates. In such economies, macroprudential policy could potentially play an even more relevant role in mitigating the adverse effects of macro-financial feedback loops. To validate the model’s ability to replicate the stylised facts of financial crises, we calibrate using data for the Irish economy, the scene of a recent housing crash. Our results demonstrate that the pro-active use of countercyclical capital regulation – in the form of Basel III-type rules – can help attenuate boom-bust cycles driven by over-optimistic expectations. We also find that more aggressive action by regulators during the release phase can bolster the economy’s ability to absorb a negative shock.     

The Consumption/Wealth and Book/Market Ratios in a Dynamic Asset Pricing Contex

This paper addresses new insights into the predictability of financial returns. In particular, we analyze two aspects of the controversial forecasting literature. On the one hand, we demonstrate a positive and contemporaneous link between aggregate book/market and consumption/wealth ratios. On the other hand, we show that real estate and human capital, as the present value of all future salaries, are key components of the consumption/wealth ratio in Spain. Specifically, we find that the cointegrating residuals of consumption, asset holdings, real estate holdings, and our measure of human capital provide a better forecast of future returns than does the standard proxy of the consumption/wealth ratio. This result is important because it clarifies the importance of country-specific components of wealth for cases in which the consumption/wealth ratio is employed as an instrument in conditional asset pricing models.Belén Nieto: Financial support from the Ministerio de Ciencia y Tecnología grant SEJ2005-09372 is gratefully acknowledged.Rosa Rodríguez: Financial support from the Ministerio de Ciencia y Tecnología grant SEC2003-06457 is gratefully acknowledged.     

INTERNATIONAL CAPITAL FLOWS: PRIVATE VERSUS PUBLIC FLOWS IN DEVELOPING AND DEVELOPED COUNTRIES

Empirically, net capital inflows are procyclical in developed countries and countercyclical in developing countries. Private inflows are procyclical and public inflows are countercyclical in both groups of countries. The dominance of private (public) inflows in developed (developing) countries drives the difference in net inflows. We rationalize these patterns using a two-sector model of a small open economy facing borrowing constraints. Private agents overborrow because of the pecuniary externality arising from these constraints. The government saves to reduce aggregate debt, making the economy resilient to adverse shocks. Differences in borrowing constraints and shock processes across countries explain the empirical patterns of capital inflows.     

Demand shocks,supply shocks and the cyclicality of real wages

The behaviour of real wages over the business cycle has received increasiing attention in recent years. The cyclicality of real wages constitues an important aspect of recent models of the business cycle. However,empirical studies undertaken to determine whether real wages are procyclical or countercyclical have reported conflicting findings. In thiis paper we use vector-autoregressions to analyse the cyclicality of real wages. We find that the source of the disturbance plays a decisive role in the cyclical behaviour of real wages. In particular, we demonstrate that a supply shock generates procyclical real wages,whereas a demand shock yields countercyclicality.     

我国货币政策与股票市场的实证分析

资本市场是现代金融市场最主要构成部分之一,对实际经济生活的影响日益增大。通过我国股票市场与经济增长的实证检验可知,货币政策与资本市场是一种互动关系。一方面,中央银行的货币政策会直接或间接地影响资本市场;另一方面,资本市场的发展对货币政策及其传导机制有深刻的影响。