International Finance and Macroeconomics

October 26-27, 2017
Guido Lorenzoni of Northwestern University and Vivian Yue of Emory University, Organizers

Doireann Fitzgerald, Federal Reserve Bank of Minneapolis and NBER; Yaniv Yedid-Levi, the University of British Columbia; and Stefanie Haller, the University College Dublin

Can Sticky Quantities Explain Exchange Rate Disconnect

Why are trade flows insensitive to movements in real exchange rates? Fitzgerald, Yedid-Levi, and Haller use micro data on exports for Ireland to show that this insensitivity persists at the firm level, and sticky prices and markup adjustment cannot explain it: some quantity stickiness is also necessary. They propose customer base as a potential source of quantity stickiness. Researchers show using a quantitative model of customer base that if costs of accumulating in customer base are incurred in the foreign market, firms will choose to cut back on foreign customer base just when the home currency depreciates.

Javier Bianchi, Federal Reserve Bank of Minneapolis and NBER; Pablo Ottonello, the University of Michigan; and Ignacio Presno, Board of Governors of Federal Reserve System

Fiscal Policy, Sovereign Risk, and Unemployment

How should fiscal policy be conducted in the presence of default risk? Bianchi, Ottonello, and Presno address this question using a sovereign default model with downward wage rigidity. An increase in government spending during a recession stimulates economic activity and reduces unemployment. Because the government lacks commitment to future debt repayments, expansionary fiscal policy increases sovereign spreads making the fiscal stimulus less desirable. Researchers analyze the optimal fiscal policy and study quantitatively whether austerity or stimulus is optimal during an economic slump.

John D. Burger, Loyola University Maryland; Francis E. Warnock, the University of Virginia and NBER; and Veronica Cacdac Warnock, the University of Virginia

Currency Matters: Analyzing International Bond Portfolios (NBER Working Paper No. 23175)

Currency denomination is a prominent feature in the analysis of the structure of international bond markets, but is largely absent from analyses of cross-border investment in debt securities. This omission owes in part to the limitations of widely used datasets such as the IMF's CPIS data (on positions) and its BOP data (on flows): Neither identifies the currency denomination of the underlying bonds and both combine in a single data point bonds of various currencies. In this paper Burger, Warnock, and Cacdac Warnock show that bonds denominated in the investor's currency are special. They show this indirectly in a global dataset of bilateral bond holdings--indirectly because the global dataset does not differentiate by currency denomination--and then more directly in datasets of US holdings of foreign bonds that do differentiate by currency. Researchers find strong evidence that factors associated with greater (or less) cross-border investment in bonds differ by currency denomination. And one phenomenon of international portfolios--the ever-present home bias--in some cases actually disappears when bonds are denominated in the investor's currency, suggesting that the home bias is to some extent a home currency bias.

Christopher Erceg, Andrea Prestipino, and Andrea Raffo, Federal Reserve Board

The Macroeconomic Effects of Trade Policy

Erceg, Prestipino, and Raffo study the short-run macroeconomic effects of trade policies that are equivalent in a frictionless economy, namely a uniform increase in import tariffs and export subsidies (IX), a value-added tax increase accompanied by a payroll tax reduction (VP), and a border adjustment of corporate profit taxes (BAT). Using a dynamic New Keynesian open-economy framework, they show that IX and BAT policies are equivalent and tend to boost output and inflation even under flexible exchange rates. Although these policies may have no allocative effects under specific assumptions as the exchange rate appreciates enough to fully offset the effects on trade prices researchers argue that the conditions required for such neutrality are very unlikely to hold in practice (even approximately). Finally, Erceg, Prestipino, and Raffo show that VP policies have substantially different effects than IX or BAT policies under a wide range of assumptions including about monetary policy and price-setting and are likely to be contractionary rather than expansionary for output.

Yusuf Soner Baskaya, University of Glasgow; Julian di Giovanni, ICREA-Universitat Pompeu Fabra; Sebnem Kalemli-Ozcan, the University of Maryland and NBER; and Mehmet Fatih Ulu, California Business Roundtable

International Spillovers and Local Credit Cycles (NBER Working Paper No. 23149)

Most capital inflows are intermediated by domestic banks. Soner Baskaya, di Giovanni, Kalemli-Ozcan, and Ulu use transaction-level data on bank credit to estimate the causal impact of capital inflows on lending. The key mechanism is a failure of UIP, where capital inflows due to increases in global risk-appetite lead domestic banks to lower borrowing rates. Researchers' estimates explain 43% of observed credit growth, where bank heterogeneity is critical for the aggregate impact. Foreign banks, exchange-rate driven balance-sheet shocks, and the relaxation of firm-level collateral constraints cannot account for our large estimates. Textbookmodels, where UIP holds and capital flows are endogenous to demand cannot explain their findings.

Andrew K Rose, the University of California at Berkeley and NBER; Stijn Claessens, Bank for International Settlements; and Eugenio M Cerutti, International Monetary Fund

How Important is the Global Financial Cycle? Evidence from Capital Flows (NBER Working Paper No. 23699)

This study quantifies the importance of a Global Financial Cycle (GFCy) for capital flows. Claessens, Cerutti, and Rose use capital flow data dis-aggregated by direction and type between 1990Q1 and 2015Q4 for 85 countries, and conventional techniques, models and metrics. Since the GFCy is an unobservable concept, they use two methods to represent it: directly observable variables in center economies often linked to it, such as the VIX; and indirect manifestations, proxied by common dynamic factors extracted from actual capital flows. Their evidence seems mostly inconsistent with a significant and conspicuous GFCy; both methods combined rarely explain more than a quarter of the variation in capital flows. Succinctly, most variation in capital flows does not seem to be the result of common shocks nor stem from observables in a central country like the United States.

Tomas Williams, Universitat Pompeu Fabra

Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market

This paper uses a quasi-natural experiment to show that government access to foreign funding increases private access to credit. Williams identifies a sudden, unanticipated and exogenous increase in capital inflows to the sovereign debt market in Colombia. This was due to J.P. Morgan's inclusion of Colombian bonds into its emerging markets local currency government debt index, which led to an increase in the share of sovereign debt held by foreigners from 8.5 to 19 percent. This event had significant and heterogeneous effects on Colombia's commercial banks: banks that acted as market makers in the treasury market reduced their sovereign debt holdings by 4.2 percentage points of assets and increased their commercial credit supply by 3.9 percentage points of assets compared to the rest of the banks. The differential increase in credit is around 2 percent of GDP. Firm and industry level evidence suggests that this had positive effects on the real economy. A higher exposure to market makers led to a higher growth in financial debt, investments, employment, production and sales.

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