Twenty-Fourth Annual EASE Conference
June 21 and 22, 2013
Kristin Forbes, MIT and NBER; Marcel Fratzscher, DIW Berlin and Humboldt University Berlin; and Roland Straub, European Central Bank
Assessing the effectiveness of capital controls and prudential measures is complicated by selection bias and endogeneity; countries that change their capital flow management (CFM) policies often share certain characteristics and are responding to changes in variables (such as capital flows and exchange rates) that are intended to be influenced by these policies. This paper attempts to adjust for these challenges by estimating propensity scores and using different algorithms to match "control" groups with "treatment" countries that adjust their CFMs. Forbes, Fratzscher, and Straub also create a new database with detailed information on weekly changes in controls on capital inflows and capital outflows and prudential measures for 60 countries from 2009-2011. The results indicate that certain types of CFMs can significantly reduce financial fragilities (such as bank leverage, credit growth, and exposure to short-term debt). Most CFMs do not significantly affect other key targets, however, such as exchange rates, capital flows, interest rate differentials, inflation, equity indices, and different measures of volatility. The main exception is that removing controls on capital outflows can reduce real exchange rate appreciation. Therefore, certain CFMs can be effective in accomplishing specific goals - especially for reducing financial vulnerabilities - but many popular measures appear to be less effective in accomplishing their stated aims.
Yuming Fu, Wenlan Qian, and Bernard Yeung, National University of Singapore
Fu, Qian, and Yeung examine the impact of rising transaction taxes on trade volume, price volatility and informativeness. They take advantage of a policy change in Singapore that effectively raised the transaction cost for real estate speculators in only one sub-market. Based on a difference-in-differences analysis, they find that the policy change significantly reduced speculative trading activities in the treatment sample, raised its price volatility, and reduced the price informativeness compared to the unaffected control sample. They further show that these findings are consistent with a relatively greater withdrawal by informed speculators than by destabilizing speculators after the transaction cost increase.
Yothin Jinjarak, University of London; Ilan Noy, Victoria University of Wellington; and Huanhuan Zheng, Chinese University of Hong Kong
Controls on capital inflows have been experiencing a renaissance since 2008, with several prominent emerging markets implementing them. Jinjarak, Noy, and Zheng focus on Brazil, which instituted five changes in its capital account regime in 2008-2011. Using the synthetic control method, they construct counterfactuals (that is, Brazil with no policy change) for each of these changes. They find no evidence that any tightening of controls was effective in reducing the magnitudes of capital inflows, but they observe some modest and short-lived success in preventing further declines in inflows when the capital controls were relaxed. The authors hypothesize that price-based capital controls' only perceptible effect is to be found in the content of the signal they broadcast regarding the government's larger intentions and sensibilities. Brazil's left-of-center government's willingness to remove controls was perceived as a noteworthy indication that the government was not as hostile to the international financial markets as many expected it to be.
Dongchul Cho, Korea Development Institute, and Changyong Rhee, Asian Development Bank
Cho and Rhee study the effects of U.S. quantitative easing on Asia by examining capital flows and financial markets. After the global financial crisis, Asian economies with more open and developed capital markets experienced greater swings in capital inflows. In particular, large capital flows were manifest more in portfolio investment and other investment such as bank loans than in foreign direct investment. Empirical analysis shows quantitative easing, QE, and QE1 in particular, significantly contributed to the rebounding of capital inflows to the region after the onset of the crisis by lowering domestic yield rates as well as CDS premiums. Although the currency value responses differed across countries, it appears that economies with stable exchange rates roughly coincide with those in which house prices have been rising, suggesting that monetary easing of advanced countries has affected Asian countries through either appreciation of currency values or increases in the prices of housing.
Pengfei Wang and Zhiwei Xu, Hong Kong University of Science & Technology, and Jianjun Miao, Boston University
Miao, Wang, and Xu present an estimated DSGE model of stock market bubbles and business cycles using Bayesian methods. Bubbles emerge through a positive feedback loop mechanism supported by self-fulfilling beliefs. The authors identify a sentiment shock that drives the movements of bubbles and is transmitted to the real economy through endogenous credit constraints. This shock explains more than 96 percent of the stock market volatility and about 25-to-45 percent of the variations in investment and output. It generates the co-movements between stock prices and macroeconomic quantities and is the dominant force in driving the internet bubbles and the Great Recession.
Ju-Yin Tang, National Taiwan University, and Chung-Shu Wu, CIER
Tang and Wu study the trade credit of Taiwan's manufacturing firms during times of financial crisis. They investigate whether trade credit plays a role in mitigating the impact of the crisis by providing such credit to financially constrained customers, or whether it amplifies the impact of the crisis by propagating liquidity shocks through the supply chains in Taiwan's economy. The authors examine the extent to which a financial crisis affects the relationship between trade credit and bank credit. Using firm-level panel data, they find that Taiwan manufacturing firms use trade credit as a substitute for bank credit, and that the provision and use of trade credit lessened the impact of the 2008-09 sub-prime mortgage crisis, whereas liquidity shocks were propagated along the supply chains during the time of the 2000-01 dot-com bubble.
Kathryn Dominguez, University of Michigan and NBER
The relationships between exchange rates, capital controls, and foreign reserves during the financial crisis suggest that reserve management plays a much more central role than has typically been emphasized in international finance models. Dominguez finds that reserves seem to be important not only for stabilizing fixed regimes, but also to deter currency market pressure in intermediate and even floating regimes, and in so doing help to mitigate trilemma trade-offs.
Kosuke Aoki, University of Tokyo, and Kalin Nikolov, European Central Bank
Aoki and Nikolov investigate how the growth of non-bank sources of credit affects the susceptibility of the financial system to crisis. They study two main ways in which loans come to be held by non-banks: direct market funding (for example, through corporate bonds) and shadow banking (off-balance sheet operations of the banks in the model). The authors find that the growth of corporate bond markets can increase banking fragility although it also diminishes the impact of banking crises. This is because corporate bond markets provide an alternative financing source for the real economy, reducing its dependence on bank credit. Shadow banking allows higher financial system leverage and thus increases bank fragility even further. Because it relies on bank capital for its operations, the shadow banking sector provides no funding diversification and cannot offset the real economy impact of a banking crisis.
Joshua Chan, Renee Fry-McKibbin, and Cody Yu Ling Hsiao, Australian National University
Chan, Fry-McKibbin, and Hsiao propose a regime switching skew-normal model for financial crisis and contagion in which they develop a new class of multiple-channel crisis and contagion tests. Crisis channels are measured through changes in "own" moments of the mean, variance, and skewness, while contagion is measured through changes in the covariance and co-skewness of the joint distribution of asset returns. In this framework: 1) linear and non-linear dependence is allowed; 2) transmission channels are simultaneously examined; 3) crisis and contagion are distinguished and individually modeled; 4) the market that a crisis originates is endogenous; and 5) the timing of a crisis is endogenous. In an empirical application, Chan, Fry-McKibbin, and Hsiao apply the proposed model to equity markets during the Great Recession using Bayesian model comparison techniques to assess the multiple channels of crisis and contagion. The results generally show that crisis and contagion are pervasive across Europe and the US. The second moment channels of crisis and contagion are systematically more evident than the first and third moment channels.
Bo Zhao, Peking University
Zhao studies an endowment economy inhabited by overlapping generations of homeowners and investors, with the only difference being that homeowners derive utility from housing services while investors do not. Tight collateral constraints limit the borrowing capacity of homeowners and drive down the equilibrium interest rate level to the housing price growth rate, which makes housing attractive as a store of value for investors. As long as the rental market friction is large enough, the investors will hold a positive amount of vacant houses in the equilibrium. The housing bubble arises in an equilibrium in which investors hold houses for resale purposes only, and not with the expectation of receiving a dividend either in terms of utility or rent. Zhao applies the model to China, in which the threat of a housing bubble can be attributed to the rapid decline in the replacement rate of the pension system.
Maurice Obstfeld, University of California at Berkeley and NBER
Because of recent economic crises, financial fragility has regained prominence in both the theory and practice of macroeconomic policy. Consistent with macroeconomic paradigms prevalent at the time, the original architecture of the euro zone assumed that safeguards against inflation and excessive government deficits would suffice to guarantee macroeconomic stability. Recent events, in both Europe and the industrial world at large, challenge this assumption. After reviewing the roots of the euro crisis in financial-market developments, Obstfeld draws some conclusions for the reform of euro area institutions. The euro area is moving quickly to correct one aspect of the Maastricht treaty, the vesting of all financial supervisory functions with national authorities. However, the sheer size of bank balance sheets suggests that the euro area will also confront a financial/fiscal trilemma: countries in the euro zone can no longer enjoy all three of financial integration with other member states, financial stability, and fiscal independence, because the costs of banking rescues may now go beyond national fiscal capacities. Thus, plans to reform the euro zone architecture may require centralized supervision with some centralized fiscal backstop to finance deposit insurance and bank resolution. This perspective also suggests a new argument for fiscal constraints in a monetary union.
Tokuo Iwaisako, Hitotsubashi University
Iwaisako provides an overview of the sustainability of Japan's government debt, emphasizing the viewpoint of market participants in the Japanese government bonds (JGB) market. The Japanese government will be able to finance its debt as long as current surpluses continue, meaning there is sufficient domestic demand for JGB. Looking at domestic investors' portfolio choices, both life insurance companies and pension funds are increasing their holdings of long-term government bonds to match the maturities of their assets and their payments to households. Japanese banks, on the other hand, are increasing their holdings of short-term government debt, almost proportionally to the increase in their deposits. However, there is substantial heterogeneity in portfolio choice. Three megabank groups (Mitsubishi-Tokyo-UFJ, Mizuho, Sumitomo-Mitsui) and large regional banks have decreased their portfolio weights of JGB recently. Smaller banks specializing in small-firm lending and agricultural lending as well as Japan Post Bank (Yu-cho) have increased the proportion of government debt in their portfolios. Hence, potential losses in their portfolios, once the JGB yield starts to increase, are much higher with the latter group of financial institutions.