International Finance and Macroeconomics

Members of the NBER's International Finance and Economics Program met March 8 in Cambridge. Faculty Research Fellow Cristina Arellano of Federal Reserve Bank of Minneapolis, Research Associate Brent Neiman of University of Chicago and Program Director Pierre-Olivier Gourinchas of University of California, Berkeley organized the meeting. These researchers' papers were presented and discussed:

Egemen Eren, Bank of International Settlements, and Semyon Malamud, Swiss Finance Institute

Dominant Currency Debt

Why is the dollar the dominant currency of choice for debt contracts and what are its macroeconomic implications? Eren and Malamud develop an international general equilibrium model where firms optimally choose the currency composition of their debt. They show that there always exists a dominant currency debt equilibrium, in which all firms borrow in a single common currency. It is the currency of the country that effectively pursues aggressive expansionary monetary policy in global downturns, lowering real debt burdens of firms. The researchers show that the dollar empirically fits this description, despite its short term safe haven properties. They provide further modern and historical empirical support for their mechanism across time and currencies. The researchers also test hypotheses using granular bond-level issuance data. They use their model to study how the optimal monetary policy differs if the Federal Reserve reacts to global versus domestic conditions.

Javier Bianchi, Federal Reserve Bank of Minneapolis and NBER, and Jorge Mondragon, University of Minnesota

Monetary Independence and Rollover Crises (NBER Working Paper No. 25340)

Bianchi and Mondragon show that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. They study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary autonomy, lenders anticipate that the government will face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. By contrast, a government with monetary autonomy can stabilize the economy and can easily remain immune to a rollover crisis. In a quantitative application, the researchers find that the lack of monetary autonomy played a central role in making the Eurozone vulnerable to a rollover crisis. A lender of last resort can help ease the costs from giving up monetary independence.

Kalina Manova, University College London; Antoine Berthou, Banque de France; Jong Hyun Chung, Stanford University; and Charlotte Sandoz, International Monetary Fund

Productivity, (Mis)allocation and Trade

Manova, Berthou, Hyun Chung, and Sandoz examine the impact of international trade on aggregate productivity. They show theoretically and numerically that bilateral and unilateral export liberalizations increase aggregate welfare and productivity, while unilateral import liberalization can either raise or reduce them. However, all three trade reforms have ambiguous effects in the presence of resource misallocation across heterogeneous firms. Using unique new data on 14 European countries and 20 manufacturing industries during 1998-2011, the researchers empirically establish that exogenous shocks to both export demand and import competition generate large aggregate productivity gains. They develop a precise mapping between theory and empirics, and provide evidence for the adjustment mechanisms. First, both trade aspects increase average firm productivity, but export expansion also reallocates activity towards more productive firms, while import penetration acts in reverse. Second, both export and import exposure raise the minimum productivity among active firms. Finally, efficient institutions, factor and product markets amplify the productivity gains from import competition, but dampen those from export expansion. The researchers conclude that the effects of globalization operate through firm selection and reallocation in the presence of resource misallocation.

Illenin Kondo, University of Notre Dame; Fabrizio Perri, Federal Reserve Bank of Minneapolis; and Sewon Hur, Federal Reserve Bank of Cleveland

Real Interest Rates, Inflation, and Default

Kondo, Perri, and Hur argue that the co-movement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, they show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, the researchers present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical inflation yields lower real rates. However, procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could increase default risk and trigger an increase in real rates. The patterns of real rates predicted by the model are quantitatively consistent with those documented in the data.

Juan Morelli and Diego Perez, New York University, and Pablo Ottonello, University of Michigan

Global Banks and Systemic Debt Crises

Morelli, Ottonello, and Perez study the role of financial intermediaries in the global market for risky external debt. They first provide empirical evidence measuring the effect of global banks' net worth on bond prices of emerging-market economies. The researchers show that, around Lehman Brothers' collapse, within emerging-market bonds with similar risk, those held by more distressed global banks experienced larger price contractions. They then construct a model of global banks' lending to emerging economies and quantify their role using their empirical estimates and other key data. In the model, banks' net worths affect bond prices by the combination of a form of market segmentation and banks' financial frictions. The researchers show that these banks' exposure to emerging economies significantly determines their role in propagating shocks. With the current observed exposure, global banks play an important role in transmitting shocks originating in developed economies, accounting for the bulk of the variation of spreads in emerging economies during the recent global financial crisis. Global banks help explain key patterns of debt prices observed in the data, and the evolution of their exposure over recent decades can explain the changing nature of systemic debt crises in emerging economies.

Mishita Mehra, Grinnell College

Skilled Immigration, Firms, and Policy

Mehra studies the macroeconomic general equilibrium effects of skilled immigration policy changes by explicitly taking into account the role of firm demand for foreign skilled labor. To this end, Mehra develops a two-sector dynamic stochastic general equilibrium model with monopolistically competitive firms and heterogeneous workers. Unlike most previous studies that view immigration as a labor supply shock, the researchers models skilled labor immigration as an endogenous response to an increase in firm labor demand in the receiving economy. The model is calibrated to mimic the U.S. economy with its current immigration policy: Firms face hiring costs and there is an occasionally binding cap on the foreign skilled workers that can be hired each period. The results indicate that a less restrictive skilled immigration policy via an immigration cap increase leads to heterogeneous effects on skilled and unskilled workers -- unskilled domestic workers gain but skilled domestic workers lose. However, the magnitude of the welfare impacts depend on the structure of the labor market (presence of search frictions). This paper also evaluates the welfare gain from moving toward an alternate skilled immigration policy with a market-driven allocation of permits for hiring skilled foreign workers. Such a policy increases welfare and brings the economy's allocation closer to the social planner's first-best allocation.

Rodrigo Barbone Gonzalez, Central Bank of Brazil, and Dmitry Khametshin, Jose-Luis Peydro, and Andrea Polo, Pompeu Fabra University

Hedger of Last Resort: Evidence from Brazilian FX Interventions, Local Credit, and Global Financial Cycles

Barbone Gonzalez, Khametshin, Peydro, and Polo analyze whether the global financial cycle (GFC) affects credit in domestic currency in Brazil and the related real effects, and whether local unconventional policies can attenuate such spillovers. For identification, they exploit GFC shocks, differential reliance of domestic banks on foreign debt, and central bank interventions in FX derivatives using three matched administrative registers: the register of foreign credit flows to banks, the credit register, and a matched employer-employee database. Using loan-level data, the researchers find that after the announcement of US Quantitative Easing tapering by Ben Bernanke, chairman of the FED, in May 2013, domestic banks with larger reliance on foreign debt reduce the supply of credit to firms, which in turn reduces employment. The tapering speech is associated with massive appreciation of the USD and increased FX volatility in EMEs. However, the Central Bank of Brazil (BCB) attenuates these negative effects announcing a large intervention program in the FX derivatives market, which consists in supplying insurance against FX risks -- hedger of last resort. In addition to these two subsequent shocks, Barbone Gonzalez, Khametshin, Peydro, and Polo analyze a panel over 2008-2015 and find a broader channel: banks with larger foreign debt respond to USD appreciation, increased FX volatility, and tighter US monetary policy decreasing credit supply. FX interventions mitigate these effects of the GFC, confirming that these policies have been effective in decreasing local economy exposure to global conditions.

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