nep-ifn New Economics Papers
on International Finance
Issue of 2010‒02‒20
eighteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Asia Confronts the Impossible Trinity By Ila Patnaik; Ajay Shah
  2. Methodological advances in the assessment of equilibrium exchange rates By Matthieu Bussière; Michele Ca’ Zorzi; Alexander Chudík; Alistair Dieppe
  4. Marshall-Lerner Condition and Economic Globalization By Paul J.J. Welfens
  5. Portfolio and Short-term Capital Inflows to the New and Potential EU Countries: Patterns, Determinants and Policy Responses By Pirovano M.; Vanneste J.; Van Poeck A.
  6. Does it matter how aggregates are measured? The case of monetary transmission mechanisms in the euro area By Andreas Beyer; Katarina Juselius
  7. The Baltic Challenge and Euro-Area Entry By Zsolt Darvas
  8. Dutch Disease in Former Soviet Union: Witch-Hunting By Balázs Égert
  9. The Role of Intermediaries in Facilitating Trade By JaeBin Ahn; Amit K. Khandelwal; Shang-Jin Wei
  10. Liquidity, Institutional Quality and the Composition of International Equity Flows By Itay Goldstein; Assaf Razin; Hui Tong
  11. International Supply Chains and Trade Elasticity in Times of Global Crisis By Escaith, Hubert; Lindenberg, Nannette; Miroudot, Sébastien
  12. A composite measure to determine a host country's attractiveness for foreign direct investment By Groh, Alexander P.; Wich, Matthias
  13. Firm Heterogeneity in the Choice of Offshoring: Evidence from Korean Manufacturing Firms By Hea-Jung Hyun
  14. The interbank market after August 2007: what has changed, and why? By Paolo Angelini; Andrea Nobili; Maria Cristina Picillo
  15. Detecting Crowded Trades in Currency Funds By Momtchil Pojarliev; Richard M. Levich
  16. Greasing the Wheels of International Commerce: How Services Facilitate Firms' International Sourcing By Debaere, Peter; Görg, Holger; Raff, Horst
  17. China's Financial Sector Reforms By Richard Herd; Samuel Hill; Charles Pigott
  18. The international crisis and the Italian productive system: a firm-level study By Matteo Bugamelli; Riccardo Cristadoro; Giordano Zevi

  1. By: Ila Patnaik; Ajay Shah
    Abstract: Capital account openness and exchange rate flexibility in 11 Asian countries are examined. Asia has made slow progress on de jure capital account openness, but has made much more progress on de facto capital account openness. While there is a slow pace of increase in exchange rate flexibility, most Asian countries continue to have largely inflexible exchange rates. This combination { of moving forward with de facto capital account integration without bringing in exchange rate flexibility { has lead to procyclicality of monetary policy when capital flows are procyclical. The paper emphasizes the case for a consistent monetary policy framework. [NIPFP WP No. 2010-64].
    Keywords: Korea, capital, account, monetary policy, Asian countries, Asia, China, defacto, exchange rate flexibility, de jure, India, industrial countries, Chinn-Ito measure,
    Date: 2010
  2. By: Matthieu Bussière (Banque de France, 31 rue Croix-des-Petits-Champs, 75001 Paris, France.); Michele Ca’ Zorzi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexander Chudík (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alistair Dieppe (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper reviews three different concepts of equilibrium exchange rates that are widely used in policy analysis and constitute the backbone of the IMF CGER assessment: the Macroeconomic Balance, the External Sustainability and the reduced form approaches. We raise a number of econometric issues that were previously neglected, proposing some methodological advances to address them. The first issue relates to the presence of model uncertainty in deriving benchmarks for the current account, introducing Bayesian averaging techniques as a solution. The second issue reveals that, if one considers all the sets of plausible identification schemes, the uncertainty surrounding export and import exchange rate elasticities is large even at longer horizons. The third issue discusses the uncertainty associated to the estimation of a reduced form relationship for the real exchange rate, concluding that inference can be improved by panel estimation. The fourth and final issue addresses the presence of strong and weak cross section dependence in panel estimation, suggesting which panel estimators one could use in this case. Overall, the analysis puts forward a number of innovative solutions in dealing with the large uncertainties surrounding equilibrium exchange rate estimates. JEL Classification: F31, F32, F41.
    Keywords: Equilibrium exchange rates, IMF CGER methodologies, current account, trade elasticities, global imbalances.
    Date: 2010–01
  3. By: Yu-Fu Chen; Michael Funke; Nicole Glanemann
    Abstract: Hong Kong’s currency is pegged to the US dollar in a currency board arrangement. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities revamped the one-sided currency board mechanism into a symmetric two-sided system with a narrow exchange rate band. This paper reviews the characteristics of the new currency board arrangement and embeds a theoretical soft edge target zone model typifying many intermediate regimes, to explain the notable achievement of speculative peace and credibility since May 2005.
    Keywords: Currency Board Arrangement, Target Zone Model, Credibility, Hong Kong
    JEL: C61 E42 F31 F32
    Date: 2009–11
  4. By: Paul J.J. Welfens (Department of Economics University of Wuppertal - Europäisches Institut für internationale Wirtschaftsbeziehungen (EIIW))
    Abstract: The analysis considers the impact of FDI inflows and FDI outflows and shows that the presence of (cumulated) FDI requires higher import elasticities in absolute terms than stated in the standard Marshall Lerner condition. One may derive a range for the elasticity of the ratio of exports to imports with respect to the real exchange rate, namely that the sum of the absolute import elasticities at home and abroad must exceed unity plus an addi-tional parameter – for standard special cases the sum of both elasticities must exceed 2 if a real depreciation is to improve the real current account. Not only can one determine a modified Marshall Lerner condition for a world economy with economic globalization, rather one also can get new insights from considering a broader macroeconomic perspective. The insights obtained are highly relevant for the discussion about high deficits of the US and high surplus positions of countries such as Japan, China and Germany. The relevance of real income effects for current account adjustment – much emphasized by McKinnon – is emphasized here in a specific way: there is a direct real income effect of changes of the real exchange rate
    Keywords: Marshall-Lerner Condition, FDI, Current Account, Globalization
    JEL: F02 F21 F32
    Date: 2009–04
  5. By: Pirovano M.; Vanneste J.; Van Poeck A.
    Abstract: In this paper we estimate a dynamic panel model (Arellano-Bond GMM) explaining the volume of portfolio and short-term capital inflows (predominantly bank loans) in the new and potential EU member States as a function of a set of variables representing macroeconomic fundamentals (both domestic and foreign), macroeconomic policies and development of the financial sector. We find that while inflows of short-term bank loans are significantly explained by macroeconomic factors, exchange rate regime and liquidity of the banking sector, portfolio inflows seem to be meaningfully influenced only by the level of foreign GDP. We suggest two explanations for the latter result. First, the inability of aggregate data to capture the risk and expected profitability dimensions that typically underlie portfolio decisions. Second, portfolio capital in the form of bonds might react to interest rates other than the domestic and the European ones. During the last decade, the volume of short-term capital in the form of bank loans to the New and potential member States increased (with some heterogeneity across countries). In light of the econometric results, their vulnerability to reversals could be mitigated by adequate macroeconomic policies and further improvement of their financial sector.
    Date: 2009–12
  6. By: Andreas Beyer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Katarina Juselius (Department of Economics, University of Copenhagen, Studiestræde 6, 1455 Copenhagen K, Denmark.)
    Abstract: Beyer, Doornik and Hendry (2000, 2001) show analytically that three out of four aggregation methods yield problematic results when exchange rate shifts induce relative-price changes between individual countries and found the least problematic method to be the variable weight method of growth rates. This papers shows, however, that the latter is sensitive to the choice of base year when based on real GDP weights whereas not on nominal GDP weights. A comparison of aggregates calculated with different methods shows that the differences are tiny in absolute value but highly persistent. To investigate the impact on the cointegration properties in empirical modelling, the monetary model in Coenen &Vega (2001) based on fixed weights was re-estimated using flexible real and nominal GDP weights. In general, the results remained reasonably robust to the choice of aggregation method. JEL Classification: C32, C42, E41.
    Keywords: Aggregation, Flexible weights, Eurowide money demand, Cointegration.
    Date: 2010–01
  7. By: Zsolt Darvas
    Abstract: Resident Fellow Zsolt Darvas takes a look at the issue of the Baltic states - Estonia, Latvia and Lithuania - and the challenges facing those three countries in the aftermath of the financial crisis. He argues that because it is in the broader European interest to prevent a collapse in the Baltics, the best option is immediate euro entry at a suitable exchange rate supported by appropriate resolution in order to manage the resulting debt overhang. However, there seems to be no legal basis for this under the current euro accession criteria. Furthermore, the economic foundations of the criteria are fundamentally flawed, as euro-area members continue to violate the criteria while the EU's expansion to 27 members has made the criteria tougher for new member states to meet themselves. Ultimately, the European Council has the ability to reform the criteria without a formal treaty change. The Council should do so, the author argues, and allow for more meaningful benchmarks for all future euro-area applicants.
    Date: 2009–11
  8. By: Balázs Égert
    Abstract: This study seeks to determine the extent to which countries of the former Soviet Union are "infected" by the Dutch Disease. We take a detailed look at the functioning of the transmission mechanism of the Dutch Disease, i.e. the chains that run from commodity prices to real output in manufacturing. We complement this with two econometric exercises. First, we estimate nominal and real exchange rate models to see whether commodity prices are correlated with the exchange rate. Second, we run growth equations to analyse the possible effects of commodity prices and the dependency of economic growth on natural resources.
    Keywords: Dutch disease, exchange rate, growth, oil, commodity prices, CIS, transition
    JEL: E31 F31 O11 P17
    Date: 2009
  9. By: JaeBin Ahn; Amit K. Khandelwal; Shang-Jin Wei
    Abstract: We provide systematic evidence that intermediaries play an important role in facilitating trade using a firm-level the census of China's exports. Intermediaries account for around 20% of China's exports in 2005. This implies that many firms engage in trade without directly exporting products. We modify a heterogeneous firm model so that firms endogenously select their mode of export - either directly or indirectly through an intermediary. The model predicts that intermediaries will be relatively more important in markets that are more difficult to penetrate. We provide empirical confirmation for this prediction, and generate new facts regarding the activity of intermediaries.
    JEL: F1
    Date: 2010–01
  10. By: Itay Goldstein; Assaf Razin; Hui Tong
    Abstract: FDI investors control the management of the firms, whereas FPI investors delegate decisions to managers. Therefore, direct investors are more informed than portfolio investors about the prospects of projects. This information enables them to manage their projects more efficiently. However, if investors need to sell their investments before maturity because of liquidity shocks, the liquidation price they can get will be lower when buyers know that they have more information on investment projects. In this paper we examine the choice between Foreign Direct Investment and Foreign Portfolio Investment at the level of the source country. Based on the Goldstein and Razin model, we predict that (1) source countries with higher expectation of future liquidity problems export relatively more FPI than FDI, and (2) this effect strengthens as the source country’s capital market transparency worsens. To test these hypotheses, we examine the variation of FPI relative to FDI for source countries from 1985 to 2004. Our key variable is the predicted severity of liquidity shock, as proxied by episodes of economy-wide sales of external assets. Consistent with our theory, we find that the predicted liquidity shock has a strong effect on the composition of foreign equity investment. Furthermore, greater capital market opacity in the source country strengthens the effect of the liquidity shock.
    JEL: F23 F3
    Date: 2010–02
  11. By: Escaith, Hubert; Lindenberg, Nannette; Miroudot, Sébastien
    Abstract: The paper investigates the role of global supply chains in explaining the trade collapse of 2008-2009 and the long-term variations observed in trade elasticity. Building on the empirical results obtained from a subset of input-output matrices and the exploratory analysis of a large and diversified sample of countries, a formal model is specified to measure the respective short-term and long-term dynamics of trade elasticity. The model is then used to formally probe the role of vertical integration in explaining changes in trade elasticity. Aggregated results on long-term trade elasticity tend to support the hypothesis that world economy has undertaken in the late 1980s a "traverse" between two underlying economic models. During this transition, the expansion of international supply chains determined an apparent increase in trade elasticity. Two supply chains related effects (the composition and the bullwhip effects) explain also the overshooting of trade elasticity that occurred during the 2008-2009 trade collapse. But vertical specialization is unable to explain the heterogeneity observed on a country and sectoral level, indicating that other contributive factors may also have been at work to explain the diversity of the observed results.
    Keywords: international supply chain; trade elasticity; global crisis; trade collapse; input-output analysis; error-correction-model
    JEL: R3 D57 F14 R15 F1
    Date: 2010–02–01
  12. By: Groh, Alexander P. (IESE Business School); Wich, Matthias (Darmstadt University of Technology)
    Abstract: We contribute to the question of why some countries are more attractive for foreign direct investment (FDI) than others by constructing a composite measure that describes a host country's attractiveness for receiving FDI. This index considers all identified major, measurable and, for our scope, comparable aspects that affect FDI decisions. As a result, we can rank 127 countries with respect to their FDI attraction. The index provides the possibility of conducting detailed strength and weakness analyses for all of our sample countries and regions. These analyses provide support to policy-makers to improve their country's attractiveness for receiving inward FDI. They also enhance the discussion of why FDI flows still remain concentrated in advanced economies and, additionally, in which areas emerging and developing economies have to improve in order to narrow the existing gap. We provide correlation and sensitivity analyses to test the quality of our composite measure. Additionally, we benchmark our index with several alternative indices. Thereby, we show that no other index tracks actual FDI activity more closely.
    Keywords: Country Comparison; Composite Measure; Index; FDI;
    JEL: F15 F21 F43 O16 O57 P52 R11
    Date: 2009–11–05
  13. By: Hea-Jung Hyun (Korea Institute for International Economic Policy)
    Abstract: Using firm-level data on offshoring of Korean manufacturers, the paper examines the relationship between firm heterogeneity and the probability of adopting offshoring. The results of the paper suggest that firm productivity may not be an important determinant for Korean firms’ offshoring decision. Firm’s global sourcing decision may rather depend on other characteristics such as factor intensity, R&D intensity, ICT level, and affiliation with foreign markets, when industry specificity is controlled for.
    Keywords: Offshoring, Outsourcing, Insourcing, Firm Heterogeneity.
    JEL: F23 L23 D21
    Date: 2009
  14. By: Paolo Angelini (Bank of Italy); Andrea Nobili (Bank of Italy); Maria Cristina Picillo (Bank of Italy)
    Abstract: The outbreak of the financial crisis coincided with a sharp increase of worldwide interbank interest rates. We analyze the micro and macroeconomic determinants of this phenomenon, finding that before August 2007 interbank rates were insensitive to borrower characteristics, whereas afterwards they became reactive to borrowers’ creditworthiness. At the same time, conditions for large borrowers became relatively more favorable, both before and after the failure of Lehman Brothers. This suggests that banks have become more discerning in their lending, a welcome change, but that moral hazard considerations related to the â€too big to fail†argument should remain a main concern for central banks.
    Keywords: Interbank markets, Spreads, Financial crisis
    JEL: E43 E52
    Date: 2009–10
  15. By: Momtchil Pojarliev; Richard M. Levich
    Abstract: The financial crisis of 2008 highlights the importance of detecting crowded trades due to the risks they pose to the stability of the financial system and to the global economy. However, there is a perception that crowded trades are difficult to identify. To date, no single measure to capture the crowdedness of a trade or a trading style has developed. We propose a methodology to measure crowded trades and apply it to professional currency managers. Our results suggest that carry became a crowded trading strategy towards the end of Q1 2008, shortly before a massive liquidation of carry trades. The timing suggests a possible adverse relationship between our measure of style crowdedness and the future performance of the trading style. Crowdedness in the trend following and value strategies confirm this hypothesis. We apply our approach to currencies but the methodology is general and could be used to measure the popularity or crowdedness of any trade with an identifiable time series return. Our methodology may offer useful insights regarding the popularity of certain trades – in currencies, gold, or other assets – among hedge funds. Further research in this area might be very relevant for investors, managers and regulators.
    JEL: F31 G15
    Date: 2010–01
  16. By: Debaere, Peter (University of Virginia); Görg, Holger (Kiel Institute for the World Economy); Raff, Horst (Kiel Institute for the World Economy)
    Abstract: We use unique plant-level data to study the link between the local availability of services and the decision of manufacturing firms to source materials from abroad. To guide our empirical analysis we develop a monopolistic-competition model of the materials sourcing decisions of heterogeneous firms. The model generates predictions about how the intensity of international sourcing of materials depends on a firm’s productivity and the availability of local services. These predictions are supported by the data. We find evidence that more productive manufacturing firms tend to have a higher ratio of imported materials to sales. In addition, we find evidence that services grease the wheels of international commerce: A greater availability of services across regions, industries and time increases a firm’s foreign sourcing of materials relative to sales. Interestingly, this positive impact of local service availability on imports especially applies to stand-alone firms that, unlike multinationals, are less likely to rely on imported or internally provided services.
    Keywords: international trade, services, off-shoring, supply chain management, firm heterogeneity
    JEL: F12 L23
    Date: 2010–01
  17. By: Richard Herd; Samuel Hill; Charles Pigott
    Abstract: Reforms to modernise and strengthen the financial sector have continued in recent years. The cleaning-up of the stock of non-performing loans is largely completed and considerable progress has been made in improving commercial banks’ corporate governance structures and risk management systems. These reforms have given rise to stronger Chinese banks which have so far weathered the global slowdown well. Reform of capital markets has focused on phasing out trading prohibitions on non-traded shares and modernising securities market institutions. Efforts have also been made to improve credit access to underserved segments, notably small and medium-sized enterprises and rural China. Despite progress in opening up the financial sector to international investors and in allowing domestic investors to invest abroad, liberalisation has been slow and in most market segments the foreign share remains very small. Ownership of financial institutions remains dominated by the State, raising issues concerning the financial system’s ability to serve the private sector as well as the extent to which banks lending decisions are based purely on commercial considerations. Although the bond market has continued to grow, corporate bond issuance remains relatively small and this segment will need to be further developed in order to address the over-reliance on the banking system<P>Les réformes financières en Chine<BR>Les réformes visant à moderniser et à renforcer le secteur financier ont continué dans les années récentes. L’assainissement des bilans a beaucoup avancé et on a assisté à une nette amélioration des systèmes de gouvernance et de gestion des risques dans les banques commerciales. Ces changements ont abouti à une consolidation des banques chinoises, qui jusqu’ici ont bien résisté au ralentissement mondial. La réforme des marchés de capitaux a privilégié la suppression progressive des restrictions concernant les actions non négociables et la modernisation des institutions opérant sur les marchés de titres. On a aussi pris des mesures pour faciliter l’accès au crédit des secteurs mal desservis, notamment les PME et le milieu rural. Malgré l’ouverture progressive du secteur financier aux investisseurs internationaux et l’autorisation postérieure donnée aux investisseurs nationaux d’opérer à l’étranger, la libéralisation a été lente et la part étrangère reste très réduite dans la plupart des compartiments du marché. L’État demeure le principal propriétaire des institutions financières, ce qui amène à s’interroger sur leur capacité à servir le secteur privé et sur le degré auquel les décisions de prêt des banques sont guidées par des considérations commerciales. Bien que le marché obligataire continue à se développer, l’émission de titres de sociétés est encore relativement limitée et devra s’accroître pour réduire le recours excessif au système bancaire.
    Keywords: risk, financial sector, capital markets, liberalisation, China, management, SMEs, libéralisation, secteur financier, marchés de capitaux, gestion des risques, Chine, PME, banques commerciales, mouvements de capitaux internationaux, prêts non productifs, actions non-négociables
    JEL: G00 H80
    Date: 2010–02–01
  18. By: Matteo Bugamelli (Banca d'Italia); Riccardo Cristadoro (Banca d'Italia); Giordano Zevi (Banca d'Italia)
    Abstract: We study the effects of the world economic crisis which began in 2007 on the Italian productive system. National accounts data are supplemented with information gathered in spring 2009 from the Bank of Italy’s survey on industrial and service firms, and from interviews with about 70 of their managers. Our sources confirm that this recession is the most severe recorded since the Second World War and that more than in the past, the recovery of the Italian economy will have to rely on internal demand dynamics and on firms’ ability to respond to increased competitive pressure. Our rich dataset allows us to formulate some initial responses to important issues by distinguishing between firms according to size, sector and propensity to export. When the crisis struck, the Italian productive system was in the middle of a profound, albeit partial, restructuring process, the first fruits of which were beginning to be seen. It is therefore important to understand whether some of the firms that have been most involved in the restructuring process and which are therefore in debt today, are encountering external funding difficulties in this context of widespread falling demand—difficulties serious enough to threaten their very survival.
    Keywords: cyclical fluctuations, recession, investment, firms’ strategies, microdata, restructuring
    JEL: C21 E22 E23 L20
    Date: 2009–12

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