International Finance and Macroeconomics
October 30, 2015
Javier Cravino and Andrei Levchenko, University of Michigan and NBER
The Distributional Consequences of Large Devaluations
Cravino and Levchenko study the differential impact of large exchange rate devaluations on the cost of living at different points on the income distribution. Across product categories, the poor have relatively high expenditure shares in tradeable products. Within tradeable product categories, the poor consume lower-priced varieties. Changes in the relative price of tradeables and the relative prices of lower-priced varieties following a devaluation will affect the cost of the consumption basket of the low-income households relative to that of the high-income households. The researchers quantify these effects following the 1994 Mexican peso devaluation and show that their distributional consequences can be large. In the two years that follow the devaluation, the cost of the consumption basket of those in the bottom decile of the income distribution rose between 1.46 and 1.6 times more than the cost of the consumption basket for the top income decile.
Gita Gopinath, Harvard University and NBER; Sebnem Kalemli-Özcan, University of Maryland and NBER; Loukas Karabarbounis, University of Chicago and NBER; and Carolina Villegas-Sanchez, ESADE-Universitat Ramon Llull
Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. Gopinath, Kalemli-Özcan, Karabarbounis, and Villegas-Sanchez use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. The researchers develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. They illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. The authors conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.
Doireann Fitzgerald, Federal Reserve Bank of Minneapolis and NBER; Stefanie Haller, University College Dublin; and Yaniv Yedid-Levi, University of British Columbia
Using firm and customs data for Ireland, Fitzgerald, Haller, and Yedid-Levi show that conditional on costs, the first five years of successful export spells are characterized by growth in quantities, while prices remain flat. At the same time, higher initial quantities predict longer export spells, but there is no relationship between initial prices and export spell length. The researchers argue that these facts point strongly to a role for customer base in explaining post-entry export growth. They estimate a model with learning about idiosyncratic demand and costly investment in customer base through marketing and advertising to match these facts. The authors find that both learning and costs of adjusting customer base are necessary to explain exporter growth.
Philippe Bacchetta and Elena Perazzi, University of Lausanne, and Eric van Wincoop, University of Virginia and NBER
This paper examines the potential for monetary policy to avoid self-fulfilling sovereign debt crises. Bacchetta, Perazzi, and van Wincoop combine a version of the slow-moving debt crisis model proposed by Lorenzoni and Werning (2014) with a standard New Keynesian model. The researchers consider both conventional and unconventional monetary policy. Under conventional policy the central bank can preclude a debt crisis through inflation, lowering the real interest rate and raising output. These reduce the real value of the outstanding debt and the cost of new borrowing, and increase tax revenues and seigniorage. Unconventional policies take the form of liquidity support or debt buyback policies that raise the monetary base beyond the satiation level. The authors find that generally the central bank cannot credibly avoid a self-fulfilling debt crisis. Conventional policies needed to avert a crisis require excessive inflation for a sustained period of time. Unconventional monetary policy can only be effective when the economy is at a structural ZLB for a sustained length of time.
George A. Alessandria, University of Rochester and NBER, and Horag Choi, Monash University
Alessandria and Choi study empirically and theoretically the dynamics of the U.S. trade balance. The researchers propose a theoretical decomposition of fluctuations in the trade balance into terms related to trade integration (global and unilateral) and terms related to asymmetries in the business cycle. They find three main results. First, the relatively large trade deficits as a share of GDP of the U.S. in the 2000s compared to the 1980s mostly reflect a rise in trade share of GDP. Second, between 40 and 80 percent of the fluctuations in ratio of the trade balance to trade reflects an uneven pace of trade liberalization. Third, while asymmetries in the business cycle account for 20 to 60 percent of fluctuations in the trade balance over trade, over two-thirds of the business cycle induced movements in net trade flows are a lagged response to changes in the terms of trade and real exchange rate. That is, the short-run Armington elasticity is about 0.15 while the long-run is closer to 1.7 with only 7 percent of the gap closed per quarter. Constant elasticity models of trade explain less than 10 percent of the movements in the trade balance.
Hanno Lustig, Stanford University and NBER, and Adrien Verdelhan, MIT and NBER
Exchange rates are puzzlingly smooth and only weakly correlated with macro-economic fundamentals compared to the predictions of exchange rate models with complete spanning. This paper derives an upper bound on the effects of incomplete spanning in international financial markets. Lustig and Verdelhan introduce stochastic wedges between log exchange rate changes and the difference in the countries' log pricing kernels without violating the foreign investors' Euler equations for the domestic risk-free assets. The wedges reconcile the volatility of no-arbitrage exchange rates with the data, provided that the volatility of the wedges is approximately as large as the maximum Sharpe ratio, but these same wedges cannot deliver exchange rates that simultaneously match currency risk premia and the exchange rates' correlation with fundamentals in the data.