Regime-switching effects of debt on real GDP per capita the case of Latin American and Caribbean countries

In this paper, we try to investigate how the debt and real GDP per capita relationship varies with indebtedness levels and other country characteristics in a balanced panel of 21 developing Latin American and Caribbean countries over the period 1992–2006. The empirical results indicate that there exist two threshold values of 32.88% and 55.89%. The latter is lower than the Maastricht criterion and Stability and Growth Pact of a total external Debt per GDP ratio at 60% in the OECD countries. Both thresholds divide our panel into three regimes. In the middle (stimulus) regime, the Debt per GDP ratio has a positive impact on real GDP per capita, which is consistent with the stimulus view (Eisner, 1984). However, the impact becomes negative and consistent with the crowding-out view (Friedman, 1977, 1985) in the left and right (crowding-out) regimes. Based on our findings, we find no supportive evidence for Ricardian view (Barro, 1989). Therefore, our empirical results have important implications for fiscal policymakers in these Latin American and Caribbean countries.     

On the feasibility of monetary union: Does it make sense to look for shocks symmetry across countries when none of the countries constitutes an optimum currency area?

Usually, a monetary union is not considered feasible between countries if the correlations of shocks are positive but weak. This may not be so if the country with the larger output gap converges to full-employment equilibrium faster than the country with the smaller gap. We argue that common monetary policy can be destabilizing when countries' responses to non-monetary shocks are perfectly symmetric with a correlation of 1 but exhibit differing investment sensitivities to the real interest rate. We use Canada, Mexico and the United States to test the feasibility of a monetary union by documenting whether: 1) gross investments in Canada and Mexico are equally responsive to the real fund rate, and 2) Canada and Mexico's output growth and inflation respond differently to US monetary policy shocks and oil price shocks. This approach implicitly dictates whether the shocks themselves are symmetric or asymmetric. Using quarterly data and SVAR methodology, we conducted two layers of analysis. We estimated SVARs for the periods 1970–2008, 1970–1990 and 1991–2008 to find that a monetary union is feasible between Canada and the US for the first two sample periods. For Canada and Mexico, we find similar responses of output growth to US monetary policy shocks. We conducted further robustness tests by estimating two identified VARs with common US variables and oil prices for Canada and Mexico to assess commonality in responses to shocks with the US. These results affirm that a monetary union is also feasible between Canada and the US.     

A segmented trend model to assess fiscal sustainability: The US experience 1929–2009

The academic literature has focused largely on testing for long-run fiscal sustainability. In this exercise we formulate a flexible regression model that can be used to assess the sustainability of a more recent build-up of fiscal deficits and debt that would be of major concern to policy makers. The analysis of US data shows that, after adjusting for some fundamentals, the gross Federal debt–income ratio has been growing at an unsustainable rate of 4 % per year since 2007. The net debt–income ratio does not show such a significant trend. Since not all government assets are readily available to reduce debt, significant positive trends in the gross debt–income ratio calls for policy actions.     

Geography, skills or both: What explains Fed watchers’ forecast accuracy of US monetary policy?

The paper shows that there is a substantial degree of heterogeneity in the ability of Fed watchers to forecast US monetary policy decisions. Based on a novel database for 268 individual professional forecasters since 1999, the average absolute forecast error of FOMC decisions varies 5–10 basis points between the best and worst-performers across the sample. This heterogeneity is found to be related to both the skills of analysts – such as their educational and employment backgrounds – and to geography. In particular, forecasters located in regions which experience more idiosyncratic economic conditions perform worse in anticipating monetary policy. This evidence is indicative that limited attention and heterogeneous priors are present even for anticipating important events such as monetary policy decisions.     

Public debt and financial development

We examine the role of public debt in financial development. The literature has highlighted its supportive role through providing collateral and benchmark. We contrast this “safe asset” view to a “lazy banks” view: developing banking sectors that lend mainly to the public sector may develop more slowly, because it could make banks profitable but inefficient. Results from country-level and bank-level regressions are more supportive of the “lazy banks” view, but the “safe asset” view seems to play a role at moderate levels of public debt held by banks. There is also evidence of a harmful interaction between public debt and financial repression.     

Sovereign debt, structural adjustment, and conditionality

The lack of a proper enforcement mechanism for sovereign debt generates a commitment failure. As a result, a sovereign may seek to improve its position in debt renegotiations and thus evade its debt obligations by reducing exports. Conditionality seeks to provide a solution to the incentive problem by addressing the commitment failure. Formalizing this argument, we show that conditionality helps the repayment of sovereign debt. In certain circumstances, it can eliminate debt overhang, especially when it is coupled with concessionary lending of sufficient magnitude. It is, however, unable to restore first best. When it is anticipated by lenders, conditionality may get international financial institutions and sovereign debtors into a trap where the debt overhang persist, debt rescheduling takes place periodically, and conditionality continues indefinitely.     

Outside versus inside bonds: A Modigliani–Miller type result for liquidity constrained economies

When agents are liquidity constrained, two options exist – sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government (outside) bonds and in the other they can borrow by issuing (inside) bonds. All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.     

Long-term recurrence patterns in the late 2000 economic crisis: Evidences from entropy analysis of the Dow Jones index

The depth (4.5% US GDP decline and 9.5% stable unemployment) and duration (more than two years) of the present global economic recession have suggested to many researchers and practitioners to think that it is singular relative to previous recession that occurred in the aftermath of the World War II. It has been argued that the singularity of the late 2000 crises arises from non-precedent components, such as globalization and a dominant financial system equipped with exotic instruments (e.g., derivatives) designed from highly specialized mathematical theories. This paper uses the historic (1928–2010) Dow Jones index analyzed with informational entropy methods to show the presence of recurrent cycles with dominant periods of 4.5 and 22 years. For time series, entropy is a measure of the diversity of patterns for given time scales. In this form, the higher the entropy, the more complex the underlying system dynamics. It is shown that the present economic downturn coincides with the occurrence of a 22-year cycle in the entropy dynamics of the Dow Jones index. It suggests that the crisis is not singular, but its origin can be also explained from recurrent long-term patterns. Implications of the empirical results for the evolution of the late 2000 crisis and the potential aftermath courses of the global economy are discussed.     

Post COVID-19 exit strategies and emerging markets economic challenges

We study emerging markets' 1980s lost growth decade, triggered by the massive reversal of the snowball effect in the US during 1974–1984, finding that higher flow costs of servicing debt overhang explain the dramatic decline in growth rates of exposed emerging markets. We also show how lowering the US cost of servicing its public debt has been associated with higher US, Japan, and Western Europe real output growth rates during the post WWII recovery decades, 1946–1956, and validate that fiscal adjustments of large countries have strong growth and volatility spillovers effects on exposed emerging markets and developing countries.     

Capital flight from sub‐Saharan Africa: linkages with external borrowing and policy options

Even as African countries became increasingly indebted, they experienced large‐scale capital flight. Some of this was legitimately acquired capital fleeing economic and political uncertainties; some was illegitimately acquired wealth spirited to safer havens abroad. This paper presents new estimates of the magnitude and timing of capital flight from 33 sub‐Saharan African countries from 1970 to 2004. We then analyze its determinants, including linkages to external borrowing. Our results confirm that sub‐Saharan Africa is a net creditor to the rest of the world, in that the subcontinent’s private external assets exceed its public external liabilities: total capital flight amounted to $443 billion (in 2004 dollars), compared to the external debt of $195 billion. Econometric analysis indicates that for every dollar in external loans to Africa in this period, roughly 60 cents flowed back out as capital flight in the same year, a finding that suggests the existence of widespread debt‐fueled capital flight. The results also show a debt‐overhang effect, as increases in the debt stock spur additional capital flight in later years. In addition to policies for recovery of looted wealth and repatriation of externally held assets, we discuss the need for policies to differentiate between legitimate and odious debts, both to ease current burdens on African countries and to improve international financial governance in the future.     

Military expenditure and economic growth across different groups: A dynamic panel Granger-causality approach

Applying GMM (Arellano and Bond, 1991) to panel data of 90 countries spanning over 1992–2006, this paper explores possible relationships between military expenditure and economic growth. Based on the definitions of income levels by the World Bank – high, middle and low – our results indicate military spending leads negatively economic growth for the panels of low income countries with a marginally significance level of 10%. Of four different regional panels (Africa, Europe, the Middle East–South Asia and Pacific Rim), a negative but stronger (5% significance level) causal relationship from military expenditure to economic growth is found for the Europe and Middle East–South Asia regions.     

Global banking and international business cycles

This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007–09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.     

“Burden sharing” in sovereign debt reduction

We examine a concerted debt reduction deal between a sovereign debtor, a private creditor, and an official creditor, who insures the deposits of the commercial bank. Our results show that a weakening of the financial position of the commercial bank reduces the contribution of the commercial bank and increases that of the official creditor, without affecting the net terms faced by the debtor. This result is robust to changes in seniority. Moreover, leaving both creditor values unchanged requires that commercial banks retire debt at “unfairly” high prices, while official creditors make a net contribution.     

Fiscal policy in the US: Sustainable after all?

The sustainability of US public debt has been widely discussed since the Great Recession. Using annual data since 1940, we estimate and compare different specifications of fiscal rules. Estimates of constant-parameter fiscal rules show no evidence of sustainability. This may be due to the instability of government's behaviour over time. Thus, we estimate a Markov-switching fiscal rule in order to identify periods of unsustainable and sustainable fiscal policies. First, we show that the government stabilizes public debt only periodically. Second, during these periods, the government's reaction is sufficiently tight to stabilize public debt over the entire horizon. We conclude that a relatively short-lived but tight fiscal contraction can be sufficient to ensure long-run US debt sustainability.     

Reallocation and restructuring: A generalization of the Balassa–Samuelson effect

Despite its strong theoretical position when it comes to explaining inflation in transition economies, the empirical findings of the Balassa–Samuelson (B–S) effect assign only a minor role to structural inflation – to the disappointment of analysts and policymakers. This article points to 3 theory-based contributing factors to these ‘weak’ findings and offers an alternative methodological approach. First, a short-term focus makes B–S prone to underestimating the magnitude of the productivity growth differential. Second, the conventional demand side CPI based definition of sectoral value added reduces the extent to which the productivity growth differential is passed through to inflation. Third, by ignoring the dependence between the 2 main B–S components, a further downward bias to the productivity growth pass through comes about. The key to our proposed alternative methodology centres on an endogenous relation between the productivity growth differential and sector sizes. Together with the long-run supply-side approach this allows us to capture inflation drivers that conventional B–S fails to incorporate. In our extension to the conventional B–S model a reduced productivity growth differential can be compensated by an increased productivity growth pass-through, or vice versa – with the effect of augmenting inflation pressure. Hence, the link between productivity growth differentials and the dynamics of structural inflation is shown to be more complex than previously assumed.     

Formal targets, central bank independence and inflation dynamics in the UK: A Markov-Switching approach

We examine inflation and uncertainty in the UK with a version of the Markov Switching model, which allows for changes in the variance as well as in the mean and persistence of a series. We find that the UK’s attempts at exchange rate pegs in the form of shadowing the deutschmark and entering the ERM were ineffective, and in the latter case counterproductive in lowering inflation uncertainty. The 1981 budget, however, greatly lowered uncertainty, and the adoption of a formal inflation target also had a palpable, negative impact on inflation uncertainty. As a suggestive exercise, we examine inflation uncertainty in the US, and find that, over 2005–2008, in the absence of an inflation target, uncertainty rose in the US, while uncertainty remained low in the UK over this period of rising commodity prices and financial turmoil.     

Public pension and household saving: Evidence from urban China

We relate household savings to pension reform, to explain the high household savings rates in urban China from a new perspective. We use the exogenous – policy-induced – variation in pension wealth to estimate explicitly the impact of pension wealth on household savings, and obtain evidence of a significant offset effect of pension wealth on household savings. Although the size of the effect depends on the parameter values assumed, the finding that household savings are affected by pension reform is robust. Our estimates show that, under plausible scenarios, pension reform boosted household savings rates in 1999 by about 6–9 percentage points for cohorts aged 25–29 and by about 2–3 percentage points for cohorts aged 50–59. Our results also indicate that declining pension wealth reduces expenditure on education and health more than on other consumption items.     

Sovereign default: Which shocks matter?

This paper analyses a small open economy that wants to borrow from abroad, cannot commit to repay debt but faces costs if it decides to default. The model generates analytical expressions for the impact of shocks on the incentive compatible level of debt. Debt reduction generated by severe output shocks is no more than a couple of percentage points. In contrast, shocks to world interest rates can substantially affect the incentive compatible level of debt.     

Income distributions and decomposable divergence measures

Inequality indices evaluate the divergence between the income distribution and the hypothetical situation where all individuals receive the mean income, and are unambiguously reduced by a Pigou–Dalton progressive transfer. This paper proposes a new approach to evaluate the divergence between any two income distributions, where the latter can be a reference distribution for the former. In the case where the reference distribution is perfectly egalitarian – and uniquely in this case – we assume that any progressive transfer reduces the divergence, and that the divergence can be additively separated into inequality and efficiency loss. We characterize the unique class of decomposable divergence measures consistent with these views. We derive the associated relative and absolute subclasses, and we illustrate the applicability of our results. This approach extends the generalized entropy studied in inequality measurement.     

Financial crises,debt overhang,and firm growth in transition economies

ABSTRACT

We examine the effects of the global financial crisis of 2008 and the European debt crisis of 2011 on the relationship between capital structure, investments, and performance for Eastern European companies. While the existing literature documents how firms’ investments are sensitive to the availability of internal funds and to debt holdings, we further investigate whether this investment sensitivity also translates in different levels of performance, and document that capital structure indeed has both a direct and an indirect effect, mediated by the capital expenditure channel. We show that firms with higher financial flexibility experience higher investments and returns on capital. Over-levered firms instead suffer from a debt overhang condition, forcing them to curb investments, and consequently experiencing lower performance. Overall, we provide evidence on the importance of capital structure and financial flexibility on investments and performance, showing the real consequences of the debt overhang condition on firm value creation. Firms should therefore aim at maintaining adequate financial flexibility in order to be able to pursue future profitable investment opportunities, and avoid the under-investment problem arising from a debt overhang situation.