International Finance and Macroeconomics

March 27, 2015
Gita Gopinath and Laura Alfaro of Harvard University, Organizers

Emmanuel Farhi, Harvard University and NBER, and Jean Tirole, Toulouse School of Economics

Deadly Embrace: Sovereign and Financial Balance Sheet Doom Loops

Alberto Martin, CREI, and Raquel Fernández, New York University and NBER

The Long and the Short of It: Sovereign Debt Crises and Debt Maturity (NBER Working Paper 20786)

Fernández and Martin present a simple model of sovereign debt crises in which a country chooses its optimal mix of short- and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent. The researchers show that in order to satisfy incentive compatibility, the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. The authors examine two policies - restructuring and reprofiling - and show that both improve ex ante welfare if structured correctly. Key to the welfare results is the country's ability to choose its debt structure so as to neutralize any negative effects resulting from redistribution of payments across creditors in times of crises.

Liliana Varela, University of Houston

Reallocation, Competition and Productivity: Evidence from a Financial Liberalization Episode

This paper studies the impact of capital market distortions on misallocation, competition and aggregate productivity. Focusing on distortions in the access to international borrowing across firms, Varela shows that a reduction in these distortions leads to an increase in aggregate productivity through two different channels. First, previously credit-constrained firms respond to better financing terms by increasing their investments in technology, a reallocation effect. Second, non-constrained firms also expand their investments in technology due to increased competition, a pro-competitive effect. Varela provides evidence for these two channels using firm-level census data around the deregulation of international financial flows in Hungary.

David Atkin, University of California, Los Angeles and NBER; Benjamin Faber, University of California, Berkeley and NBER, and Marco Gonzalez-Navarro, University of Toronto

Retail Globalization and Household Welfare: Evidence from Mexico

The arrival of global retail chains in developing countries is causing a radical transformation in the way that households source their consumption. This paper draws on a new and unique collection of Mexican microdata to estimate the effect of foreign supermarket entry on household welfare and its underlying channels. The richness of the data allows Faber, Atkin, and Gonzalez-Navarro to estimate a general expression for the welfare gains from retail FDI, and to decompose the total effect into several distinct components. To base estimates on plausibly exogenous variation in foreign retail entry the researchers propose an event study design that exploits data on the universe of foreign store locations and opening dates in combination with high frequency data on barcode-level store prices, consumption quantities, and household incomes in those same locations over the period 2002-14. The authors find that foreign retail entry causes large and significant welfare gains for the average household that are mainly driven by a reduction in the cost of living. A substantial share of this price index effect is due to pro-competitive effects on consumer prices charged by domestic stores. The researchers find little evidence of significant changes in average municipality level incomes, wages or employment. They do, however, find evidence of store exit and adverse effects on domestic store profits and the incomes of traditional retail sector workers. Finally, the authors present evidence that the gains from retail FDI are on average positive for all income groups but strongly regressive, and quantify the opposing forces that underlie this finding.

Jesse Schreger and Benjamin Hebert, Harvard University

The Costs of Sovereign Default: Evidence from Argentina

Hebert and Schreger estimate the causal effect of sovereign default on the equity returns of Argentine firms. The researchers identify this effect by exploiting changes in the probability of Argentine sovereign default induced by legal rulings in the case of Republic of Argentina v. NML Capital. Because the legal rulings affected the probability of Argentina defaulting on its debt, independent of underlying economic conditions, these rulings allow the authors to study the effect of default on firm performance. Using both standard event study methods and a Rigobon (2003) heteroskedasticity-based identification strategy, they find that an increase in the probability of sovereign default causes a decline in the Argentine equity market. A 1 percent increase in the risk-neutral probability of default causes a 0.55% fall in an index of Argentine American Depository Receipts (ADRs). Extrapolating from these estimates, they conclude that the recent Argentine sovereign default episode caused a cumulative 33% drop in the ADR index from 2011 to 2014.

Rosen Valchev, Duke University

Exchange Rates and UIP Violations at Short and Long Horizons

The much-studied Uncovered Interest Rate Parity (UIP) puzzle, the observation that exchange rates do not adjust sufficiently to offset interest rate differentials, is more complicated than commonly understood. It changes nature with the horizon. In this paper, Valchev confirms existing short-run evidence that high interest rate currencies depreciate less than predicted by the interest rate differential. But, building on Engel (2015), at longer horizons (4 to 7 years) Valchev finds a reverse puzzle: high interest rate currencies depreciate too much. Interestingly, the long-horizon excess depreciation leads exchange rates to converge to the UIP benchmark over the long-run. The author proposes a novel model, based on the mechanism of bond convenience yields, that can explain both the short and the long horizon UIP violations. The model presents interesting new links between exchange rates and monetary-fiscal interaction. Valchev also provides direct empirical evidence that supports the mechanism.

Shaghil Ahmed, Stephanie E. Curcuru, and Andrei Zlate, Board of Governors of the Federal Reserve System, and Francis E. Warnock, University of Virginia and NBER

The Two Components of International Capital Flows

In empirical studies and policy discussions, capital flows are almost always described in terms that connote active portfolio reallocations. But measures of international portfolio flows, whether based on flows or changes in stocks, conflate two components. Flow-based measures conflate flows due to the placement of new savings (an income effect) with flows that actively reallocate between asset classes or countries (a switching effect). Portfolio-based measures combine a passive component (passive reallocations due solely to relative price changes) along with active portfolio reallocations. Ahmed, Curcuru, Warnock, and Zlate form an easily constructed measure - relative weight - that isolates active portfolio reallocations and then, using a dataset on equity flows to EMEs and a set of simple graphs and regressions, show the importance of distinguishing between the active and passive components. The graphs suggest that the post-GFC surge of flows into EME equities was due more to the income effect and/or passive changes in portfolios rather than the active reallocations toward EMEs. The regressions suggest that analysis of the effects of QE, VIX and capital controls on EME capital flows depend importantly on the type of flow measure used. Different questions demand different measures of flows, but we must recognize that existing data typically conflate the focus of the researcher or policymaker (active decisions) with something more passive.

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