Twenty-first Annual EASE Conference

The global experience of the last two years has shaken conventional beliefs in the benefits of unfettered financial markets. In response to the Asian crisis of a decade ago, most Asian economies had switched to an apparently more durable system of financing economic growth. But this did not prevent Asian countries from suffering considerably from the global financial crisis. Moreover, the spread of the crisis across countries seems to have been channeled more by financial linkages than conventional trade linkages. This raises questions about the future of financial integration among Asian economies and between Asia and the rest of the world. Devereux and Yetman first document some features of the propagation of the global financial crisis. They then goes on to explore a two-country theoretical model in which there is a trade-off between the risk sharing benefits of international financial markets and the contagion effects of international financial interdependence. The key result of their paper is to show that financial market integration in the presence of financial constraints can generate very high macroeconomic co-movement among economies, quite independent of international trade linkages.

Jonathan Eaton, Pennsylvania State University and NBER, and Samuel S. Kortum, Brent Neiman, and John Romalis, University of Chicago and NBER
Trade and the Global Recession

The ratio of global trade to GDP declined by nearly one third during the global recession of 2008-9. This large drop in international trade has generated significant attention and concern. Given the severity of the recession, did international trade behave as we would have expected? Or , did international trade shrink because of factors unique to cross border transactions per se? Eaton, Kortum, Romalis, and Neiman merge an input-output framework with a gravity trade model and solve several counterfactual scenarios that give a quantitative sense for the relative importance of changes in demand, trade frictions, and other shocks in the current recession. Their results suggest that the decline in demand for manufactures was the most important driver of the decline in manufacturing trade. Changes in demand for durable manufactures alone accounted for more than 60 percent of the cross-country variation in changes in manufacturing trade/GDP. The decline in total manufacturing demand (durables and nondurables) accounted for about 70 percent of the global decline in trade/GDP. Increasing trade frictions played an important role in some countries and were insignifi¦cant in others. Globally, changing trade frictions explained about 15 percent of the decline in manufacturing trade/GDP.

The global financial crisis saw the largest and sharpest drop in global economic activity of the modern era. Both the causes of the crisis and the policy responses are reshaping the level and pattern of world trade. McKibbin and Stoeckel seek to disentangle the various direct and indirect effects of the crisis on international trade and how events might unravel. To do this, they use a dynamic, intertemporal general equilibrium model that fully integrates the financial and real sectors of the economy i to unravel and understand the mechanisms at work. Their model incorporates wealth effects, expectations, and financial markets for bonds, equities, and foreign exchange, as well as trade and financial flows.

Liu provides some evidence of the "export overshooting" phenomenon, that is, the unusually large deviation of exports from their long-run level. She shows that export overshooting occurred across a sample of countries during the 2001 and 2008 economic crises, but that the overshooting was more severe in Taiwan than in other nations, especially in those industries with high income elasticity. This bullwhip effect is indeed the driving force behind the phenomenon of export overshooting. Broadly speaking, she finds that Taiwan’s increased susceptibility to economic crisis can be attributed to an increase in cross-border vertical specialization, outsourcing of downstream production of Taiwan’s export manufacturing, and a concentration of Taiwan’s exports in high-tech products that are sensitive to demand shocks and business cycles.

A wave of trade liberalizations have taken place in both developing and developed countries in the last two decades. Global capital inflows and the so-called global imbalances also have risen to an unprecedented level. Are the two developments related? Ju and Wei study how trade reforms affects capital inflows in a modified Heckscher-Ohlin framework that incorporates convex costs of capital inflows, factor adjustment costs, and financial institutions. They show that goods trade and capital inflows are substitutes in most cases. Since the nature of trade liberalizations is inherently asymmetric between developed and developing countries, they show that trade reforms could induce cross-country capital inflows in a way that could contribute to global imbalances.

Ippei Fujiwara, Nao Sudou, and Yuki Teranishi, Bank of Japan; and Tomoyuki Nakajima, Kyoto University
Global Liquidity Trap

Fujiwara, Nakajima, Sudo, and Teranishi consider a two-country New Open Economy Macroeconomics model and analyze the optimal monetary policy when countries cooperate in the face of a global liquidity trap -- that is, a situation in which the two countries are simultaneously caught in liquidity traps. Compared to the closed economy case, one notable feature of the optimal policy in this case is its international dependence. Whether a country's nominal interest rate is hitting the zero bound will affect the target inflation rate of the other country. The direction of the effect depends on whether goods produced in the two countries are Edgeworth complements or substitutes. The authors also compare several classes of simple interest-rate rules. They find that targeting the price level yields higher welfare than targeting the inflation rate, and that it is desirable to let the policy rate of each country respond not only to its own price level and output gap, but also to those in the other country.

Huang, Lin, Kunyu, Bijun, and Xun compare the roles of monetary systems for the resulting economic performance of China during the two global crises. They first examine the differences in economic indicators including growth, inflation, money supply, and trade. They learn that the Chinese economy performed reasonably well in the initial years of the Great Depression because of the insulation provided by the silver standard. But eventually it could not escape collapsing growth and deflation. The impacts of the Great Crash were deep but also brief. With the help of aggressive monetary and fiscal policies, the Chinese economy turned around quickly, thanks to the capital account controls. Finally, the authors attempt to synthesize their comparative analyses, applying the Mundell-Fleming model framework.

Joshua Aizenman, University of California, Santa Cruz and NBER; Yothin Jinjarak, Nanyang Technological University; and Donghyun Park, Asian Development Bank
International Reserves and Swap Lines: Substitutes or Complements

Developing Asia experienced a sharp surge in foreign currency reserves prior to the 2008-9 crisis. The global crisis has been associated with an unprecedented rise of swap agreements between central banks of larger economies and their counterparts in smaller economies. Aizenman, Jinjarak, and Park explore whether such swap lines can reduce the need for reserve accumulation. The evidence suggests that there is only a limited scope for swaps to substitute for reserves. The selectivity of the swap lines indicates that only countries with significant trade and financial linkages can expect access to such ad hoc arrangements, on a case by case basis. Moral hazard concerns suggest that the applicability of these arrangements will remain limited. However, deepening swap agreements and regional reserve pooling arrangements may weaken the precautionary motive for reserve accumulation.

The long-running debate about the role of monetary policy in responding to rising asset prices has received renewed attention in the wake of the global financial crisis. Bloxham, Kent, and Robson contribute to this debate by describing the Australian experience of a cycle in house prices and credit from 2002 to 2004, and by discussing the role played by various policies during this episode. In particular, they focus on the efforts by the Reserve Bank of Australia to draw attention to the risks associated with large, ongoing increases in housing prices and household borrowing.

Hyun Song Shin, Princeton University, and Kwanho Shin, Korea University
Macroprudential Policy and Monetary Aggregates

Shin and Shin examine the empirical properties of non-core liabilities of the Korean banking sector and in particular the link between the relative size of non-core liabilities and the stage of the financial cycle. They find that non-core liabilities (defined as the sum of foreign exchange liabilities of the banking sector and wholesale bank funding) have undergone substantial changes over the financial cycle, and they trace out dramatic patterns over the two financial crises in recent years – the 1997 Asian financial crisis and the 2008 crisis following the bankruptcy of Lehman Brothers. Moreover, they demonstrate that their measure of non-core liabilities is closely related to four market measures of the capacity to take on risk, including key credit spreads and other market indicators.

Shin-ichi Fukuda, University of Tokyo
Money Market Integration during the Global Financial Crisis: Evidence from the Interbank Markets in Tokyo and London

Fukuda explores how international money markets were integrated during the global financial crisis in 2007-9. After matching the currency denomination, he investigates how the Tokyo Interbank Offered Rate (TIBOR) was synchronized with the London Interbank Offered Rate (LIBOR) denominated in U.S. dollars and the Japanese yen. Regardless of the currency denomination, TIBOR was highly synchronized with LIBOR in tranquil periods. However, the interbank rates showed substantial deviations in turbulent periods. Fukuda finds remarkably asymmetric responses in reflecting market-specific and currency-specific risk premiums. His regression results suggest that counter-party credit risk was responsible for the different responses across the markets, while liquidity risk caused the difference across the currency denominations. The results also support the view that a shortage of U.S. dollasr as liquidity distorted the integration during the global financial crisis.

Yongheng Deng, Jing Wu, and Bernard Yeung, National University of Singapore; and Randall Morck, University of Alberta and NBER
Monetary and Fiscal Stimuli, Ownership Structure and China's Housing Market

The recent financial crisis and resulting global recession have brought about renewed discussion of the effectiveness of government stimulus policy. While developed countries like the United States and European Union provide only mixed evidence on the effectiveness of stimulus packages, the Chinese government's stimulus policy appears to have achieved a quick and significant response. One year after the adoption of the 4 trillion yuan (US $586 billion) economic stimulus package, China's GDP grew by an annualized 11.9 percent rate in the first quarter of 2010, accelerating from 6.2, 7.9, 9.1, and 10.7 percent in the previous four quarters, respectively. Amid this phenomenal response are record-breaking land auction prices and a surge in house prices in major cities, to new highs since March 2009. Allegedly, the stimulus package in China has led to overheated activity in real estate markets. Deng, Morck, Wu, and Yeung focus on why monetary and fiscal stimulation in China seems to achieve such quick results and how the success of the Chinese stimulation can be a curse in disguise. They argue that state ownership of banks and large enterprises leads these firms to respond quickly to government stimulus. Yet, the resultant impact on China's real estate markets is uncertain, and the authors question whether the resultant credit and liquidity surge creates real business opportunity. To provide empirical evidence, they conduct a micro-level analysis of recent land auctions in Beijing and Shanghai. They are able to identify the location and physical attributes of each land sale, and then create a constant quality land price index at city level. The indexes show a very sharp rise in constant quality land prices of almost 300 percent over the past 18-24 months in both cities. There is also evidence that the surge in Beijing's land auction prices are associated with state-owned enterprises' purchases and bids.