Creator: Bianchi, Javier Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 730 Abstract:
We develop a quantitative equilibrium model of financial crises to assess the interaction between ex-post interventions in credit markets and the buildup of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. We find that moral hazard effects are limited if bailouts are systemic and broad-based. If bailouts are idiosyncratic and targeted, however, this makes the economy significantly more exposed to financial crises.
Keyword: Credit crunch, Macroprudential policy, Moral hazard, and Financial shocks Subject (JEL): E44 - Financial Markets and the Macroeconomy, G18 - General Financial Markets: Government Policy and Regulation, E32 - Business Fluctuations; Cycles, and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Kehoe, Patrick J. and Midrigan, Virgiliu Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 656 Abstract:
The classic explanation for the persistence and volatility of real exchange rates is that they are the result of nominal shocks in an economy with sticky goods prices. A key implication of this explanation is that if goods have differing degrees of price stickiness then relatively more sticky goods tend to have relatively more persistent and volatile good-level real exchange rates. Using panel data, we find only modest support for these key implications. The predictions of the theory for persistence have some modest support: in the data, the stickier is the price of a good the more persistent is its real exchange rate, but the theory predicts much more variation in persistence than is in the data. The predictions of the theory for volatility fare less well: in the data, the stickier is the price of a good the smaller is its conditional variance while in the theory the opposite holds. We show that allowing for pricing complementarities leads to a modest improvement in the theory’s predictions for persistence but little improvement in the theory’s predictions for conditional variances.
Subject (JEL): F00 - International Economics: General and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Schlegl, Matthias, Trebesch, Christoph, and Wright, Mark L. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 759 Abstract:
Sovereign governments owe debt to many foreign creditors and can choose which creditors to favor when making payments. This paper documents the de facto seniority structure of sovereign debt using new data on defaults (missed payments or arrears) and creditor losses in debt restructuring (haircuts). We overturn conventional wisdom by showing that official bilateral (government-to-government) debt is junior, or at least not senior, to private sovereign debt such as bank loans and bonds. Private creditors are typically paid first and lose less than bilateral official creditors. We confirm that multilateral institutions like the IMF and World Bank are senior creditors.
Keyword: Sovereign default, IMF, International financial architecture, Pecking order, Insolvency, Official debt, Sovereign bonds, Arrears, and Priority Subject (JEL): G10 - General Financial Markets: General (includes Measurement and Data), F30 - International Finance: General, F50 - International Relations, National Security, and International Political Economy: General, and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Uy, Timothy, Yi, Kei-Mu, and Zhang, Jing Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 456 Abstract:
We study the importance of international trade in structural change. Our framework has both productivity and trade cost shocks, and allows for non-unitary income and substitution elasticities. We calibrate our model to investigate South Korea’s structural change between 1971 and 2005. We find that the shock processes, propagated through the model’s two main transmission mechanisms, non-homothetic preferences and the open economy, explain virtually all of the evolution of agriculture and services labor shares, and the rising part of the hump-shape in manufacturing. Counterfactual exercises show that the role of the open economy is quantitatively important for explaining South Korea’s structural change.
Keyword: Structural transformation, Sectoral labor reallocation, and International trade Subject (JEL): F20 - International Factor Movements and International Business: General, O41 - One, Two, and Multisector Growth Models, F40 - Macroeconomic Aspects of International Trade and Finance: General, and O13 - Economic Development: Agriculture; Natural Resources; Energy; Environment; Other Primary Products
Creator: Arellano, Cristina and Ramanarayanan, Ananth Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 410 Abstract:
This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds rises more than the spread on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Long-term debt provides a hedge against future fluctuations in interest rate spreads, while short-term debt is more effective at providing incentives to repay. The trade-off between these hedging and incentive benefits is quantitatively important for understanding the maturity structure in emerging markets. When calibrated to data from Brazil, the model accounts for the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities.
Keyword: Default, Debt maturity, and Emerging markets Subject (JEL): F30 - International Finance: General, G10 - General Financial Markets: General (includes Measurement and Data), and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Asturias, Jose, Hur, Sewon, Kehoe, Timothy Jerome, 1953-, and Ruhl, Kim J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 521 Abstract:
In what order should a developing country adopt policy reforms? Do some policies complement each other? Do others substitute for each other? To address these questions, we develop a two-country dynamic general equilibrium model with entry and exit of firms that are monopolistic competitors. Distortions in the model include barriers to entry of firms, barriers to international trade, and barriers to contract enforcement. We find that a reform that reduces one of these distortions has different effects depending on the other distortions present. In particular, reforms to trade barriers and barriers to the entry of new firms are substitutable, as are reforms to contract enforcement and trade barriers. In contrast, reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequencing of reforms requires reforming trade barriers before contract enforcement.
Keyword: Sequencing reforms, Entry barriers, Contract enforcement, and Trade barriers Subject (JEL): F13 - Trade Policy; International Trade Organizations, O24 - Development Planning and Policy: Trade Policy; Factor Movement; Foreign Exchange Policy, O19 - International Linkages to Development; Role of International Organizations, F40 - Macroeconomic Aspects of International Trade and Finance: General, and O11 - Macroeconomic Analyses of Economic Development
Creator: Cole, Harold Linh, 1957-, Leung, Ron, and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 356 Abstract:
This paper presents a dynamic, stochastic general equilibrium study of the causes of the international Great Depression. We use a fully articulated model to assess the relative contributions of deflation/monetary shocks, which are the most commonly cited shocks for the Depression, and productivity shocks. We find that productivity is the dominant shock, accounting for about 2/3 of the Depression, with the monetary shock accounting for about 1/3. The main reason deflation doesn’t account for more of the Depression is because there is no systematic relationship between deflation and output during this period. Our finding that a persistent productivity shock is the key factor stands in contrast to the conventional view that a continuing sequence of unexpected deflation shocks was the major cause of the Depression. We also explore what factors might be causing the productivity shocks. We find some evidence that they are largely related to industrial activity, rather than agricultural activity, and that they are correlated with real exchange rates and non-deflationary shocks to the financial sector.
Keyword: Productivity Shocks, Great Depression, Deflation, and Monetary Shocks Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Parente, Stephen L. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 333 Abstract:
This essay develops a theory of the evolution of international income levels. In particular, it augments the Hansen-Prescott theory of economic development with the Parente-Prescott theory of relative efficiencies and shows that the unified theory accounts for the evolution of international income levels over the last millennium. The essence of this unified theory is that a country starts to experience sustained increases in its living standard when production efficiency reaches a critical point. Countries reach this critical level of efficiency at different dates not because they have access to different stocks of knowledge, but rather because they differ in the amount of society-imposed constraints on the technology choices of their citizenry.
Keyword: Catch-up, Trading clubs, Capital share, Aggregate economic efficiency, and Transition to modern economic growth Subject (JEL): E00 - Macroeconomics and Monetary Economics: General, O19 - International Linkages to Development; Role of International Organizations, O11 - Macroeconomic Analyses of Economic Development, and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Chari, V. V. and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 316 Abstract:
Financial crises are widely argued to be due to herd behavior. Yet recently developed models of herd behavior have been subjected to two critiques which seem to make them inapplicable to financial crises. Herds disappear from these models if two of their unappealing assumptions are modified: if their zero-one investment decisions are made continuous and if their investors are allowed to trade assets with market-determined prices. However, both critiques are overturned—herds reappear in these models—once another of their unappealing assumptions is modified: if, instead of moving in a prespecified order, investors can move whenever they choose.
Keyword: Information cascades, Capital flows, and Financial collapse Subject (JEL): F20 - International Factor Movements and International Business: General, G15 - International Financial Markets, F32 - Current Account Adjustment; Short-term Capital Movements, E32 - Business Fluctuations; Cycles, and F40 - Macroeconomic Aspects of International Trade and Finance: General