nep-ifn New Economics Papers
on International Finance
Issue of 2011‒09‒22
fifteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. External Adjustment and the Global Crisis By Gian Maria Milesi-Ferretti; Philip R. Lane
  2. Global crisis and equity market contagion By Geert Bekaert; Michael Ehrmann; Marcel Fratzscher; Arnaud Mehl
  3. De Jure versus De Facto Exchange Rate Regimes in Sub-Saharan Africa By Slavi T Slavov
  4. The Financial Crisis and the Geography of Wealth Transfers By Gourinchas, Pierre-Olivier; Rey, Hélène; Truempler, Kai Alexander
  5. Economic Policies and FDI Inflows to Emerging Market Economies By Elif Arbatli
  6. Mark my Words: Information and the Fear of Declaring one’s Exchange Rate Regime By Pierre-Guillaume Méon; Geoffrey Minne
  7. Liquidity management of U.S. global banks: internal capital markets in the Great Recession By Nicola Cetorelli; Linda Goldberg
  8. Information Asymmetry and Foreign Currency Borrowing by Small Firms By Brown, M.; Ongena, S.; Yesin, P.
  9. Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition By Arvind Subramanian
  10. The Federal Reserve as an Informed Foreign Exchange Trader: 1973 – 1995 By Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
  11. Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses By D. Filiz Unsal
  12. Gravity Models of Trade-based Money Laundering By Joras Ferwerda; Mark Kattenberg; Han-Hsin Chang; Brigitte Unger; Loek Groot; Jacob A. Bikker
  13. Tax havens or safe havens By Pieretti, Patrice; Thisse, Jacques-François; Zanaj, Skerdilajda
  14. When the Music Stopped: Transatlantic Contagion During the Financial Crisis of 1931 By Gary Richardson; Patrick Van Horn
  15. FDI and institutional reform in Portugal By Paulo Júlio; Ricardo Pinheiro-Alves; José Tavares

  1. By: Gian Maria Milesi-Ferretti; Philip R. Lane
    Abstract: After widening substantially in the period preceding the global financial crisis, current account imbalances across the world have contracted to a significant extent. This paper analyzes the factors underlying this process of external adjustment. It finds that countries whose pre-crisis current account balances were in excess of what could be explained by economic fundamentals have experienced the largest contractions in their external balance. External adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Changes in other investment flows were the main channel of financial account adjustment, with official external assistance and ECB liquidity cushioning the exit of private capital flows for some countries.
    Keywords: Cross country analysis , Currency pegs , Current account balances , Current account deficits , Demand , Exchange rate regimes , Financial crisis , Global Financial Crisis 2008-2009 , Production , Real effective exchange rates ,
    Date: 2011–08–15
  2. By: Geert Bekaert (Columbia University, 3022 Broadway, New York, NY 10027, USA.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Arnaud Mehl (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: Using the 2007-2009 financial crisis as a laboratory, we analyze the transmission of crises to country-industry equity portfolios in 55 countries. We use an asset pricing framework with global and local factors to predict crisis returns, defining unexplained increases in factor loadings as indicative of contagion. We find evidence of systematic contagion from US markets and from the global financial sector, but the effects are very small. By contrast, there has been systematic and substantial contagion from domestic equity markets to individual domestic equity portfolios, with its severity inversely related to the quality of countries’ economic fundamentals and policies. Consequently, we reject the globalization hypothesis that links the transmission of the crisis to the extent of global exposure. Instead, we confirm the old “wake-up call” hypothesis, with markets and investors focusing substantially more on idiosyncratic, country-specific characteristics during the crisis. JEL Classification: F3, G14, G15.
    Keywords: Contagion, financial crisis, equity markets, global transmission, market integration, country risk, factor model, financial policies, FX reserves, current account.
    Date: 2011–09
  3. By: Slavi T Slavov
    Abstract: There are 22 countries in Sub-Saharan Africa (SSA) with floating exchange rate regimes, de jure. Some target the money supply or the inflation rate; others practice "managed floating." Statistical analysis on monthly data for the past decade reveals that in most cases these exchange rate regimes can be approximated surprisingly well by a soft peg to a basket dominated by the US dollar. The weight on the dollar appears to have fallen somewhat across the continent in the aftermath of the global financial crisis. Replicating the model with weekly data for The Gambia suggests that the focus on the dollar might be even more pronounced at higher data frequencies. While there might be strong arguments in favor of limiting exchange rate volatility in SSA countries, soft-pegging to the dollar does not appear to be the best fit for them, given the currency structure of their external trade and finance. The paper concludes by discussing some policy options for SSA countries with flexible exchange rates, in the context of an illustrative recent country case.
    Keywords: Cross country analysis , Currency pegs , Economic models , Exchange rate regimes , Floating exchange rates , Reserves , Sub-Saharan Africa ,
    Date: 2011–08–16
  4. By: Gourinchas, Pierre-Olivier; Rey, Hélène; Truempler, Kai Alexander
    Abstract: This paper studies the geography of wealth transfers during the 2008 global financial crisis. We construct valuation changes on bilateral external positions in equity, direct investment and portfolio debt at the height of the crisis to map who benefited and who lost on their external exposure. We find a very diverse set of fortunes governed by the structure of countries' external portfolios. In particular, we are able to relate the gains and losses on debt portfolios to the country's exposure to ABCP conduits and the extent of dollar shortage.
    Keywords: global financial crisis; international monetary system; reserve currency; valuation effects
    JEL: F32 F33
    Date: 2011–09
  5. By: Elif Arbatli
    Abstract: This paper investigates the determinants of FDI inflows to emerging market economies, concentrating on the effects of economic policies. The empirical analysis also addresses the role of external push factors and of political stability using a domestic conflict events database. The results suggest that lowering corporate tax rates and trade tariffs, adopting fixed or managed exchange rate policies and eliminating FDI related capital controls have played an important role. Domestic conflict events and political instability are found to have significant negative effects on FDI, which highlights the role of incluside policies to promote growth and avoid sudden stops of FDI inflows.
    Keywords: Capital inflows , Economic models , Economic policy , Emerging markets , Foreign direct investment , Group of seven ,
    Date: 2011–08–10
  6. By: Pierre-Guillaume Méon; Geoffrey Minne
    Abstract: This paper investigates the role of a free press and of the circulation of information on the capacity of a country to declare an exchange regime that is different from the regime it de facto implements. We put forward consistent evidence that increased press freedom and easier access to information results in a lower probability of untruthfully reporting the regime that is implemented. The finding is resistant to a large set of robustness checks, including controlling for democracy.
    Keywords: Official exchange rate regime; de facto exchange rate regime; press freedom; information; fear of floating.
    JEL: F33 F41 F53 F59 L82
    Date: 2011–09
  7. By: Nicola Cetorelli; Linda Goldberg
    Abstract: The recent crisis highlighted the importance of globally active banks in linking markets. One channel for this linkage is the liquidity management of these banks, specifically the regular flow of funds between parent banks and their affiliates in diverse foreign markets. We use the Great Recession as an opportunity to identify the balance-sheet shocks to parent banks in the United States and then explore which features of foreign affiliates are associated with protecting, for example, their status as important locations in sourcing funding or as destinations for foreign investment activity. We show that distance from the parent organization plays a significant role in this allocation, where distance is bank-affiliate specific and depends on the location’s ex ante relative importance in local funding pools and overall foreign investment strategies. These flows are a form of global interdependence previously unexplored in the literature on international shock transmission.
    Date: 2011
  8. By: Brown, M.; Ongena, S.; Yesin, P. (Tilburg University, Center for Economic Research)
    Abstract: We model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs. Under perfect information foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and/or low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk.
    Keywords: foreign currency borrowing;competition;banking sector;market structure.
    JEL: G21 G30 F34 F37
    Date: 2011
  9. By: Arvind Subramanian (Peterson Institute for International Economics)
    Abstract: Against the backdrop of the recent financial crisis and the ongoing rapid changes in the world economy, the fate of the dollar as the premier international reserve currency is under scrutiny. This paper attempts to answer whether the Chinese renminbi will eclipse the dollar, what will be the timing of, and the prerequisites for this transition, and which of the two countries controls the outcome. The key finding, based on analyzing the last 110 years, is that the size of an economy—measured not just in terms of GDP but also trade and the strength of the external financial position—is the key fundamental correlate of reserve currency status. Further, the conventional view that sterling persisted well beyond the strength of the UK economy is overstated. Although the United States overtook the United Kingdom in terms of GDP in the 1870s, it became dominant in a broader sense encompassing trade and finance only at the end of World War I. And since the dollar overtook sterling in the mid-1920s, the lag between currency dominance and economic dominance was about 10 years rather than the 60-plus years traditionally believed. Applying these findings to the current context suggests that the renminbi could become the premier reserve currency by the end of this decade, or early next decade. But China needs to fulfill a number of conditions—making the reniminbi convertible and opening up its financial system to create deep and liquid markets—to realize renminbi preeminence. China seems to be moving steadily in that direction, and renminbi convertibility will proceed apace not least because it offers China's policymakers a political exit out of its mercantilist growth strategy. The United States cannot in any serious way prevent China from moving in that direction.
    Keywords: Reserve Currency, Dollar, Sterling, Renminbi, China
    JEL: F02 F31 F33
    Date: 2011–09
  10. By: Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
    Abstract: If official interventions convey private information useful for price discovery in foreign-exchange markets, then they should have value as a forecast of near-term exchange-rate movements. Using a set of standard criteria, we show that approximately 60 percent of all U.S. foreign-exchange interventions between 1973 and 1995 were successful in this sense. This percentage, however, is no better than random. U.S. intervention sales and purchases of foreign exchange were incapable of forecasting dollar appreciations or depreciations. U.S. interventions, however, were associated with more moderate dollar movements in a manner consistent with leaning against the wind, but only about 22 percent of all U.S. interventions conformed to this pattern. We also found that the larger the size of an intervention, the greater was its probability of success, although some interventions were inefficiently large. Other potential characteristics of intervention, notably coordination and secrecy, did not seem to influence our success rates.
    JEL: E52 E58 F31 N22
    Date: 2011–09
  11. By: D. Filiz Unsal
    Abstract: The resumption of capital flows to emerging market economies since mid 2009 has posed two sets of interrelated challenges for policymakers: (i) to prevent capital flows from exacerbating overheating pressures and consequent inflation, and (ii) to minimize the risk that prolonged periods of easy financing conditions will undermine financial stability. While conventional monetary policy maintains its role in counteracting the former, there are doubts that it is sufficient to guard against the risks of financial instability. In this context, there have been increased calls for the development of macroprudential measures, with an explicit focus on systemwide financial risks. Against this background, this paper analyses the interplay between monetary policy and macroprudential regulations in an open economy DSGE model with nominal and real frictions. The key result is that macroprudential measures can usefully complement monetary policy. Even under the "optimal policy," which calls for a rather aggressive monetary policy reaction to inflation, introducing macroprudential measures is found to be welfare improving. Broad macroprudential measures are shown to be more effective than those that discriminate against foreign liabilities (prudential capital controls). However, these measures are not a substitute for an appropriate moneraty policy reaction. Moreover, macroprudential measures are less useful in helping economic stability under a technology shock.
    Keywords: Capital controls , Capital flows , Capital goods , Capital inflows , Corporate sector , Economic models , Emerging markets , Financial stability , Monetary policy ,
    Date: 2011–08–08
  12. By: Joras Ferwerda; Mark Kattenberg; Han-Hsin Chang; Brigitte Unger; Loek Groot; Jacob A. Bikker
    Abstract: Several attempts have been made in the economics literature to measure money laundering. However, the adequacy of these models is difficult to assess, as money laundering takes place secretly and, hence, goes unobserved. An exception is trade- based money laundering (TBML), a special form of trade abuse that has been discovered only recently. TBML refers to criminal proceeds that are transferred around the world using fake invoices that under- or overvalue imports and exports. This article is a first attempt to test well-known prototype models proposed by Walker and Unger to predict illicit money laundering flows and to apply traditional gravity models borrowed from international trade theory. To do so, we use a dataset of Zdanowicz of TBML flows from the US to 199 countries. Our test rejects the specifications of the Walker and Unger prototype models, at least for TBML. The traditional gravity model that we present here can indeed explain TBML flows worldwide in a plausible manner. An important determinant is licit trade, the mass in which TBML is hidden. Furthermore, our results suggest that criminals use TBML in order to escape the stricter anti money laundering regulations of financial markets.
    Keywords: Money laundering, international trade, gravity model, Walker model.
    JEL: C21 F10
    Date: 2011–09
  13. By: Pieretti, Patrice; Thisse, Jacques-François; Zanaj, Skerdilajda
    Abstract: Our aim is to explain how a small country can be viable as an international banking center (IBC). We build a model in which mobile investors choose between two banking centers located respectively in a small country and in a large country. These countries compete in two instruments, taxation and institutional infrastructure. It follows that an IBC can be a tax haven, a safe haven, or both. A small country that hosts an IBC is a safe haven when it is able to provide a high level of institutional infrastructure, whereas it chooses to be a tax haven when it cannot be competitive in institutional infrastructure. Even in this last case, an IBC need not be as bad as claimed in the general press because its presence fosters institutional competition across countries, which is ultimately beneficial to all investors.
    Keywords: institutional infrastructure competition; international banking centers; portfolio investments; tax competition
    JEL: G20 H40 H54
    Date: 2011–09
  14. By: Gary Richardson; Patrick Van Horn
    Abstract: In 1931, a financial crisis began in Austria, struck numerous European nations, forced Britain to abandon the gold standard, and spread across the Atlantic. This article describes how banks in New York City, the central money market of the United States, reacted to events in Europe. An array of data sources – including memos detailing private conversations between leading bankers the governors of the New York Federal Reserve, articles written by prominent commentators, and financial data drawn from the balance sheets of commercial banks – tell a consistent tale. Banks in New York anticipated events in Europe, prepared for them by accumulating substantial reserves, and during the crisis, continued business as usual. Leading international bankers deliberately and collectively decided on the business-as-usual policy in order to minimize the impact of the panic in the United States and Europe.
    JEL: E42 E44 G21 N1 N12 N14 N2 N22 N24
    Date: 2011–09
  15. By: Paulo Júlio (Gabinete de Estratégia e Estudos, Portuguese Ministry of Economy and Employment, and NOVA School of Business and Economics); Ricardo Pinheiro-Alves (Gabinete de Estratégia e Estudos, Portuguese Ministry of Economy and Employment and Instituto de Artes Visuais, Design e Marketing); José Tavares (NOVA School of Business and Economics and Center for Economic Policy Research)
    Abstract: This article analyses the effects of several geographic, economic and institutional factors on bilateral inward FDI in Europe. Moreover, it assesses the required reform effort, and the expected benefits, for Portugal to converge with the EU in the institutional variables that are relevant to attract investment. We conclude that good institutions favouring economic freedom and the ease of doing business, and geography, market size and labor costs, affect bilateral inward FDI. Political risk does not lead to significant differences in FDI across the EU. The results are robust to different methods – principal component analysis, factor-based scores and by considering several institutional indicators successively. We also find that most promising reforms arise in the financial system, corruption, property rights, and in some business regulations associated with starting a business. Increasing labor market flexibility to the EU level has also a large impact on inward FDI, but this reform comes at a comparatively higher effort.
    Keywords: FDI, Institutional reform, Institutions, Portugal, EU
    JEL: F30 H00
    Date: 2011–09

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