NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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International Finance and Macroeconomics Program Meeting

March 9, 2012
Kristin Forbes of MIT and Helene Rey of London Business School, Organizers

Jack Favilukis, London School of Economics, and Sydney C. Ludvigson and Stijn Van Nieuwerburgh, New York University and NBER

Foreign Ownership of U.S. Safe Assets: Good or Bad?

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. Favilukis, Ludvigson, and Van Nieuwerburgh argue that these trends in international capital flows are likely to be a boon for some (by a lot) but a bane for others (by less). Conversely, a sell-off of foreign government holdings of U.S. safe assets could be tremendously costly for some individuals, while the possible benefits to others are several times smaller. In a general equilibrium life cycle model with aggregate and idiosyncratic risks, the young and oldest households are likely to benefit substantially from a capital inflow, but middle-aged savers may suffer because they are crowded out of the safe bond market and exposed to greater systematic risk in equity and housing markets. In some states, the youngest working-age households and the oldest retired households would be willing to give up 2.0-2.8 percent of lifetime consumption in order to avoid just one year of a typical annual decline in foreign holdings of the safe asset. Middle-aged savers could benefit from an outflow, but they do so by an amount that is typically one-tenth of the magnitude of the losses to the youngest and oldest households. Under the veil of ignorance, a newborn would be willing to give up 18 percent of lifetime consumption to avoid a large capital outflow.


Matteo Maggiori, University of California at Berkeley

Financial Intermediation, International Risk Sharing, and Reserve Currencies

Maggiori provides a framework for understanding the global financial architecture as an equilibrium outcome of the risk sharing between countries with different levels of financial development. The country that has the most developed financial sector takes on a larger proportion of global fundamental and financial risk because its financial intermediaries are better able to deal with funding problems following negative shocks. This asymmetric risk sharing has real consequences. In good times, and in the long run, the more financially developed country consumes more, relative to other countries, and runs a trade deficit financed by the higher financial income that it earns as compensation for taking greater risk. During global crises, it suffers heavier capital losses than other countries, exacerbating its fall in consumption. This country's currency emerges as the world's reserve currency because it appreciates during crises and so provides a good hedge. The model is able to rationalize these facts, which characterize the role of the US as the key country in the global financial architecture.


Gabriel Zucman, Paris School of Economics

The Missing Wealth of Nations: Are Europe and the U.S. Net Debtors or Net Creditors?

Zucman shows that official statistics substantially underestimate the net foreign asset positions of rich countries because they fail to capture most of the assets held by households in offshore tax havens. Drawing on systematic anomalies in portfolio investment positions and a unique Swiss dataset, he finds that 8 percent of the global financial wealth of households is held in tax havens, 6 percent of which goes unrecorded. Accounting for unrecorded assets turns the eurozone, officially the world's second largest net debtor, into a net creditor. It also reduces the U.S. net debt significantly. The results shed new light on global imbalances and challenge the widespread view that, after a decade of poor-to-rich capital flows, external assets are now in poor countries and debts in rich countries. I provide concrete proposals to improve international investment statistics and curb tax evasion.


Marcel Fratzscher, Marco Lo Duca, and Roland Straub, European Central Bank

Quantitative Easing, Portfolio Choice and International Capital Flows

Fratzscher, Lo Duca, and Straub analyze the impact of announcements and actual operations of the Federal Reserve's unconventional monetary policy measures on portfolio allocations across asset classes, as well as on asset prices in 42 countries. They show that the impact of Fed operations, including Treasury and MBS purchases, on portfolio allocations and asset prices dwarfed the impact of Fed announcements. Fed policies functioned mainly through a portfolio balance channel across countries rather than across asset classes within the United States. The policies magnified the pro-cyclicality of capital flows to EMEs, but acted in a counter-cyclical manner for the United States. Yet in terms of economic significance, Fed policies exerted larger overall effects on global asset prices than on capital flows and portfolio allocations. The results thus illustrate how U.S. monetary policy since 2007 has contributed to portfolio reallocation as well as to a re-pricing of risk in financial markets at the global level.

Meghana Ayyagari, George Washington University; Asli Demirguc-Kunt, The World Bank; and Vojislav Maksimovic, University of Maryland,

Do Phoenix Miracles Exist? Role of Financial Markets in Firm-Level Recovery from Financial Crises

Ayyagari, Demirguc-Kunt, and Maksimovic provide empirical evidence on the firm recoveries from financial system collapses (Systemic Sudden Stops (3S) episodes) in developing countries, and compare these with the U.S. experience in the 2008 financial crisis. While macro studies have found that economies recover from 3S episodes before the financial sector, and termed these recoveries Phoenix miracles, micro-data across countries show that less than 28 percent of firms follow a pattern of recovery in operating cash flows without a recovery in external credit, and even these firms have access to other sources of cash. However, the researchers do find that financial strategies consistent with Phoenix miracle recoveries are adopted by firms early in the 3S episodes, before the GDP bottoms out. They also find that firms with high short-term debt exposure increase operating cash flows while experiencing a sharp reduction in short-term credit, whereas firms with high prior cash holdings experience negative cash flows and deplete their cash holdings. The experience of U.S. firms during the 2008 financial crisis also suggests no evidence of credit-less recoveries. In the U.S. crisis where the financial system did not collapse as much, firms with high prior cash are still able to access external borrowing. The results on prior short-term debt and cash holding are consistent with trade-off theories of firms' financial structure and cash holdings.


Viral V. Acharya, New York University and NBER, and Raghuram Rajan, University of Chicago and NBER

Sovereign Debt, Government Myopia and the Financial Sector

What determines the sustainability of sovereign debt? Acharya and Rajan develop a model where myopic governments seek electoral popularity but nevertheless can commit credibly to service external debt. They do not default when they are poor because they would lose access to debt markets and be forced to reduce spending; they do not default when they become rich because of the adverse consequences to the domestic financial sector. Interestingly, the more myopic a government, the greater the advantage it sees in borrowing, and therefore the less likely it will be to default (in contrast to models where sovereigns repay because they are concerned about their long term reputation). More myopic governments are also likely to tax in a more distortionary way, and to create more dependencies between the domestic financial sector and government debt that raise the costs of default.


Robin Greenwood, Harvard University and NBER; Augustin Landier, Toulouse School of Economics; and David Thesmar, HEC Paris

Vulnerable Banks

When a bank experiences a negative shock to its equity, one way to return to target leverage is to sell assets. If asset sales occur at depressed prices, then one bank's sales may impact other banks with common exposures, resulting in contagion. Greenwood, Landier, and Thesmar propose a simple framework that accounts for this effect and adds it up across all related banks. The framework explains how the distribution of leverage and risk exposures across banks contributes to systemic risk. The researchers compute bank exposures to system-wide deleveraging, as well as the spillover of a single bank's deleveraging onto other banks. They use the model to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. In this model, "microprudential" interventions, which target the solvency of individual banks, tend to be less effective than "macroprudential" policies which aim to minimize spillovers across firms. The authors apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011, and to U.S. banks between 2001 and and 2010.


 
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