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Creator: Kehoe, Timothy Jerome, 1953- and Ruhl, Kim J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 414 Abstract:
A sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994–95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.
Mot-clé: Developing country crisis, Real exchange rate, Sudden stop, Mexico, Nontradable, Tradable, and Total factor productivity Assujettir: E21 - Macroeconomics: Consumption; Saving; Wealth, F21 - International Investment; Long-term Capital Movements, F32 - Current Account Adjustment; Short-term Capital Movements, F34 - International Lending and Debt Problems, O54 - Economywide Country Studies: Latin America; Caribbean, O41 - One, Two, and Multisector Growth Models, F43 - Economic Growth of Open Economies, and O47 - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence
Creator: Huo, Zhen and Ríos-Rull, José-Víctor Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 490 Abstract:
We build a variation of the neoclassical growth model in which both wealth shocks (in the sense of wealth destruction) and financial shocks to households generate recessions. The model features three mild departures from the standard model: (1) adjustment costs make it difficult to expand the tradable goods sector by reallocating factors of production from nontradables to tradables; (2) there is a mild form of labor market frictions (Nash bargaining wage setting with Mortensen-Pissarides labor markets); (3) goods markets for nontradables require active search from households wherein increases in consumption expenditures increase measured productivity. These departures provide a novel quantitative theory to explain recessions like those in southern Europe without relying on technology shocks.
Mot-clé: Paradox of thrift, Endogenous productivity, and Great Recession Assujettir: E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), E32 - Business Fluctuations; Cycles, and F44 - International Business Cycles
Creator: Arellano, Cristina, Bai, Yan, and Mihalache, Gabriel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 555 Abstract:
Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital inﬂows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a reﬂection of the scarcity of traded goods. We ﬁnd that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.
Mot-clé: Real exchange rate, Capital accumulation, European debt crisis, Sovereign default with production economy, and Traded and nontraded production Assujettir: F30 - International Finance: General and E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data)
Creator: Kehoe, Patrick J., Midrigan, Virgiliu, and Pastorino, Elena Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 536 Abstract:
During the Great Recession, regions of the United States that experienced the largest declines in household debt also experienced the largest drops in consumption, employment, and wages. Employment declines were larger in the nontradable sector and for firms that were facing the worst credit conditions. Motivated by these findings, we develop a search and matching model with credit frictions that affect both consumers and firms. In the model, tighter debt constraints raise the cost of investing in new job vacancies and thus reduce worker job finding rates and employment. Two key features of our model, on-the-job human capital accumulation and consumer-side credit frictions, are critical to generating sizable drops in employment. On-the-job human capital accumulation makes the flows of benefits from posting vacancies long-lived and so greatly amplifies the sensitivity of such investments to credit frictions. Consumer-side credit frictions further magnify these effects by leading wages to fall only modestly. We show that the model reproduces well the salient cross-regional features of the U.S. data during the Great Recession.
Mot-clé: Debt constraints, Human capital, Search and matching, and Employment Assujettir: J21 - Labor Force and Employment, Size, and Structure, E21 - Macroeconomics: Consumption; Saving; Wealth, J64 - Unemployment: Models, Duration, Incidence, and Job Search, E32 - Business Fluctuations; Cycles, and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Creator: Mendoza, Enrique G., 1963- and Smith, Katherine A. Series: Advances in dynamic economics Abstract:
"Sudden Stops " experienced during emerging markets crises are characterized by large reversals of capital inflows and the current account, deep recessions, and collapses in asset prices. This paper proposes an open-economy equilibrium asset pricing model in which financial frictions cause Sudden Stops. Margin requirements impose a collateral constraint on foreign borrowing by domestic agents and trading costs distort asset trading by foreign securities firms. At equilibrium, margin constraints may or may not bind depending on portfolio decisions and equilibrium asset prices. If margin constraints do not bind, productivity shocks cause a moderate fall in consumption and a widening current account deficit. If debt is high relative to asset holdings, the same productivity shocks trigger margin calls forcing domestic agents to fire-sell equity to foreign traders. This sets off a Fisherian asset-price deflation and subsequent rounds of margin calls. A current account reversal and a collapse in consumption occur when equity sales cannot prevent a sharp rise in net foreign assets.
Mot-clé: Collateral constraints, Fisherian deflation, Emerging markets, Margin calls, Open economy asset pricing, Asset pricing, Sudden stops, Nonlinear dynamics, and Trading costs Assujettir: F32 - International finance - Current account adjustment ; Short-term capital movements, D52 - General equilibrium and disequilibrium - Incomplete markets, E44 - Money and interest rates - Financial markets and the macroeconomy, and F41 - Macroeconomic aspects of international trade and finance - Open economy macroeconomics
Creator: Bengui, Julien and Bianchi, Javier Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 754 Abstract:
The outreach of macroprudential policies is likely limited in practice by imperfect regulation enforcement, whether due to shadow banking, regulatory arbitrage, or other regulation circumvention schemes. We study how such concerns affect the design of optimal regulatory policy in a workhorse model in which pecuniary externalities call for macroprudential taxes on debt, but with the addition of a novel constraint that financial regulators lack the ability to enforce taxes on a subset of agents. While regulated agents reduce risk taking in response to debt taxes, unregulated agents react to the safer environment by taking on more risk. These leakages undermine the effectiveness of macroprudential taxes but do not necessarily call for weaker interventions. A quantitative analysis of the model suggests that aggregate welfare gains and reductions in the severity and frequency of financial crises remain, on average, largely unaffected by even significant leakages.
Mot-clé: Financial crises, Regulatory arbitrage, Macroprudential policy, and Limited regulation enforcement Assujettir: F32 - Current Account Adjustment; Short-term Capital Movements, E32 - Business Fluctuations; Cycles, D62 - Externalities, E44 - Financial Markets and the Macroeconomy, and F41 - Open Economy Macroeconomics
Creator: Hevia, Constantino and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 726 Abstract:
We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.
Mot-clé: Inflation targeting, Foreign exchange intervention, and Dutch disease Assujettir: F31 - Foreign Exchange and F41 - Open Economy Macroeconomics
Creator: Kehoe, Timothy Jerome, 1953- and Meza, Felipe Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 693 Abstract:
In 1950 Mexico entered an economic takeoff and grew rapidly for more than 30 years. Growth stopped during the crises of 1982–1995, despite major reforms, including liberalization of foreign trade and investment. Since then growth has been modest. We analyze the economic history of Mexico 1877–2010. We conclude that the growth 1950–1981 was driven by urbanization, industrialization, and education and that Mexico would have grown even more rapidly if trade and investment had been liberalized sooner. If Mexico is to resume rapid growth — so that it can approach U.S. levels of income — it needs further reforms.
Mot-clé: Economic growth, Mexico, and Total factor productivity Assujettir: O11 - Macroeconomic Analyses of Economic Development, O54 - Economywide Country Studies: Latin America; Caribbean, and N16 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: Latin America; Caribbean
Creator: Bianchi, Javier, Ottonello, Pablo, and Presno, Ignacio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 762 Abstract:
The excess procyclicality of fiscal policy is commonly viewed as a central malaise in emerging economies. We document that procyclicality is more pervasive in countries with higher sovereign risk and provide a model of optimal fiscal policy with nominal rigidities and endogenous sovereign default that can account for this empirical pattern. Financing a fiscal stimulus is costly for risky countries and can render countercyclical policies undesirable, even in the presence of large Keynesian stabilization gains. We also show that imposing austerity can backfire by exacerbating the exposure to default, but a well-designed "fiscal forward guidance" can help reduce the excess procyclicality.
Mot-clé: Procyclicality, Fiscal stabilization policy, and Sovereign default Assujettir: F44 - International Business Cycles, H50 - National Government Expenditures and Related Policies: General, E62 - Fiscal Policy, F41 - Open Economy Macroeconomics, and F34 - International Lending and Debt Problems
Creator: Ayres, João, Hevia, Constantino, and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 743 Abstract:
In this paper, we show that a substantial fraction of the volatility of real exchange rates between developed economies such as Germany, Japan, and the United Kingdom against the US dollar can be accounted for by shocks that affect the prices of primary commodities such as oil, aluminum, maize, or copper. Our analysis implies that existing models used to analyze real exchange rates between large economies that mostly focus on trade between differentiated ﬁnal goods could benefit, in terms of matching the behavior of real exchange rates, by also considering trade in primary commodities.
Mot-clé: Real exchange rate disconnect puzzle and Primary commodity prices Assujettir: F31 - Foreign Exchange and F41 - Open Economy Macroeconomics