International Seminar on Macroeconomics

June 27-28, 2014
Richard Clarida of Columbia University, Jeffrey Frankel of Harvard University, Francesco Giavazzi of Bocconi University, and Hélène Rey of London Business School, Organizers

Kristin Forbes, MIT and NBER; Marcel Fratzscher,DIW Berlin and CEPR; and Roland Straub, European Central Bank

Capital Controls and Macroprudential Measures: What Are They Good For?

Are capital controls and macroprudential measures successful in achieving their objectives? Assessing their effectiveness is complicated by selection bias and endogeneity; countries that change their capital-flow management measures (CFMs) often share specific characteristics and are responding to changes in variables that the CFMs are intended to influence. Forbes, Fratzscher, and Straub address these challenges by using a propensity-score matching methodology. They also create a new database with detailed information on weekly changes in controls on capital inflows, capital outflows, and macroprudential measures from 2009 to 2011 for 60 countries. Results show that macroprudential measures can significantly reduce some measures of financial fragility. However, most CFMs do not significantly affect other key targets, such as exchange rates, capital flows, interest-rate differentials, inflation, equity indices, and different volatilities. One exception is that removing controls on capital outflows may reduce real exchange rate appreciation. Therefore, certain CFMs can be effective in accomplishing specific goals, but most popular measures are not "good for" accomplishing their stated aims.

Agustín Bénétrix and Philip Lane, Trinity College Dublin, and Jay Shambaugh, George Washington University and NBER

International Currency Exposures, Valuation Effects and the Global Financial Crisis

Bénétrix, Lane, and Shambaugh examine the evolution of international currency exposures, with a particular focus on the 2002–12 period. They show that there was a widespread shift toward positive net foreign currency positions such that relatively few countries exhibited the archetypal emerging-market "short foreign currency" position on the eve of the global financial crisis. Finally, the authors explore the distribution of currency-generated valuation effects during the global financial crisis.

Cecilia Hornok, Hungarian Academy of Sciences, and Miklos Koren, Central European University

Lumpy Trade and the Welfare Effects of Administrative Barriers

Using detailed U.S. and Spanish export data, Hornok and Koren document that administrative trade costs of a per-shipment nature (documentation, customs clearance, and inspection) lead to less frequent and larger-sized shipments, that is, more lumpiness in international trade. They build a model to analyze these effects and their welfare consequences. Exporters decide not only how much to sell at a given price, but also how to break up total trade into individual shipments. Consumers value frequent shipments because they enable them to consume close to their preferred dates. Hence, having fewer shipments entails a welfare cost. Calibrating the model to observed shipping frequencies and per-shipment costs, the authors show that countries would gain 2 to 3 percent of their GDP by eliminating such barriers.

Òscar Jordà, Federal Reserve Bank of San Francisco; Moritz Schularick, University of Bonn; and Alan Taylor, University of California, Davis and NBER

Betting the House

Is there a link between loose monetary conditions, credit growth, house price booms, and financial instability? Jordà, Schularick, and Taylor analyze the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. They exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. The authors use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house price bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.

Evi Pappa, Rana Sajedi, and Eugenia Vella, European University Institute

Fiscal Consolidation with Tax Evasion and Rent Seeking

Using cross-country data, Pappa, Sajedi, and Vella show that tax evasion and corruption are highly important for determining the size of the fiscal multiplier. They introduce these two features in a New Keynesian model with search and matching frictions in order to revisit the effects of tax- and expenditure-based consolidations. VAR evidence for Italy suggests that expenditure-based consolidations reduce tax evasion significantly, while tax-based consolidations increase it. In the model, expenditure cuts reduce demand for both formal and informal goods, and thus for tax evasion. Tax hikes induce agents to work and produce more in the informal sector, which is less productive, and so imply higher output and welfare losses. The authors use the model to assess the losses from the recent fiscal consolidation plans in Italy, Spain, Portugal, and Greece. Policy conclusions are sensitive to the model's assumptions. Counterfactual exercises highlight the benefits of fighting tax evasion and corruption in economies undertaking fiscal consolidation.

Alberto Alesina, Harvard University and NBER; Carlo Favero, Bocconi University; and Francesco Giavazzi

The Output Effect of Fiscal Consolidation Plans

Alesina, Favero, and Giavazzi show that the correct experiment to evaluate the effects of a fiscal adjustment is the simulation of a multi-year fiscal plan rather than of individual fiscal shocks. Simulation of fiscal plans adopted by 16 OECD countries over a 30-year period supports the hypothesis that the effects of consolidations depend on their design. Fiscal adjustments based upon spending cuts are much less costly, in terms of output losses, than tax-based ones and have especially low output costs when they consist of permanent rather than stop-and-go changes in taxes and spending. The difference between tax-based and spending-based adjustments appears not to be explained by accompanying policies, including monetary policy. It is mainly attributable to the different responses of business confidence and private investment.

Carmen Reinhart and Kenneth Rogoff, Harvard University and NBER, and Vincent Reinhart, Morgan Stanley

Effective Defaults on Sovereign Debt in Advanced Countries

Matthias Efing, Swiss Finance Institute; Harald Hau, University of Geneva; Patrick Kampkötter, University of Cologne; and Johannes Steinbrecher, Ifo Dresden

Incentive Pay and Bank Risk Taking: Evidence from Austrian, German, and Swiss Banks

Efing, Hau, Kampkötter, and Steinbrecher use payroll data on 1.2 million bank employee years in the Austrian, German, and Swiss banking sector to identify incentive pay in the critical banking segments of treasury/capital market management and investment banking for 66 banks. The authors document an economically significant correlation of incentive pay with both the level and volatility of bank trading income, particularly for the pre-crisis period 2003–7 for which incentive pay was strongest. In a second step, they use the strength of incentive pay in unrelated bank divisions like retail banking to instrument the bonus share in the capital market divisions: a stronger "pay incentive culture" increases both the level and volatility of bank trading income, generating an overall risk-return trade-off unfavorable to shareholders during the pre-crisis period.