nep-ifn New Economics Papers
on International Finance
Issue of 2012‒04‒17
nine papers chosen by
Vimal Balasubramaniam
National Institute of Public Finance and Policy

  1. Capital Controls with International Reserve Accumulation: Can this Be Optimal ? By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  2. The Macroeconomic Effects of Reserve Requirements By Glocker, Ch.; Towbin P.
  3. FX Intervention in the Yen-US Dollar Market: A Coordination Channel Perspective By Stefan Reitz , Mark P. Taylor
  4. Properties of Foreign Exchange Risk Premiums By Lucio Sarno; Paul Schneider; Christian Wagner
  5. Measuring sovereign contagion in Europe By Massimiliano Caporin; Loriana Pelizzon; Francesco Ravazzolo; Roberto Rigobon
  6. Can the exchange rate, inflation and domestic risk factors be overlooked in international asset pricing? By Begoña Font Belaire
  7. International Capital Flows with Limited Commitment and Incomplete Markets By Jurgen von Hagen; Haiping Zhang
  8. Does Financial Development Cause Higher Firm Volatility and Lower Aggregate Volatility? By Shalini Mitra
  9. "Shadow Banking and the Limits of Central Bank Liquidity Support: How to Achieve a Better Balance between Global and Official Liquidity" By Thorvald Grung Moe

  1. By: Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
    Abstract: Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve savings opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. We argue that the domestic interest rate should be temporarily above the international rate. We also find that capital controls can still help reach the first best when the planner has more fiscal instruments.
    Keywords: reserve accumulation; capital controls; Ramsey planner; credit constraints
    JEL: E58 F36 F41
    Date: 2011–12
  2. By: Glocker, Ch.; Towbin P.
    Abstract: Monetary authorities in emerging markets are often reluctant to raise interest rates when dealing with credit booms driven by capital inflows, as they fear that an increase attracts even more capital and appreciates the currency. A number of countries therefore use reserve requirements as an additional policy instrument. The present study provides evidence on their macroeconomic effects. We estimate a vector autoregressive (VAR) model for the Brazilian economy and identify interest rate and reserve requirement shocks. For both instruments a discretionary tightening leads to a decline in domestic credit. We find, however, very different effects for other macroeconomic aggregates. In contrast to interest rate policy, a positive reserve requirement shock leads to an exchange rate depreciation and an improvement in the current account, but also to an increase in prices. The results suggest that reserve requirement policy can complement interest rate policy in pursuing a financial stability objective, but cannot be its substitute with regards to a price stability objective.
    Keywords: Reserve Requirements, Capital flows, Monetary Policy, Business Cycle.
    JEL: E58 E52 F32 F41
    Date: 2012
  3. By: Stefan Reitz , Mark P. Taylor
    Abstract: The coordination channel has recently been established as an additional means by which foreign exchange market intervention may be effective. It is conjectured that strong and persistent misalignments of the exchange rate are caused by a coordination failure among fundamentals-based traders. In such situations official intervention may act as a coordinating signal, encouraging traders to engage in stabilizing speculation. We apply the framework developed in Reitz and Taylor (2008) to daily data on the yen-US dollar exchange rate and on Federal Reserve and Japanese Ministry of Finance intervention operations. The results provide further support for the coordination channel of intervention effectiveness
    Keywords: foreign exchange intervention, coordination channel, STR-GARCH model
    JEL: C10 F31 F41
    Date: 2012–04
  4. By: Lucio Sarno (Faculty of Finance, Cass Business School, City University London, UK; Centre for Economic Policy Research (CEPR), UK; The Rimini Centre for Economic Analysis (RCEA), Italy); Paul Schneider (Finance Group, Warwick Business School, University of Warwick, UK); Christian Wagner (Institute for Finance, Banking and Insurance, Vienna University of Economics and Business, Austria)
    Abstract: We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.
    Keywords: term structure; exchange rates; forward bias; predictability
    JEL: F31 E43 G10
    Date: 2012–03
  5. By: Massimiliano Caporin (Univerista' di Padova); Loriana Pelizzon (Univerista' Ca' Foscari Venezia and MIT Sloan); Francesco Ravazzolo (Norges Bank (Central Bank of Norway) and BI Norwegian Business School); Roberto Rigobon (MIT Sloan and NBER)
    Abstract: This paper analyzes the sovereign risk contagion using CDS spreads for the major euro area countries. Using several econometric approaches (non linear regression, quantile regression and Bayesian quantile with heteroskedasticity) we show that propagation of shocks in Europe's CDS's has been remarkably constant even though in a signi cant part of the sample periphery countries have been extremely a ected by their sovereign debt and scal situations. Thus, the integration among the di erent countries is stable, and the risk spillover among countries is not a ected by the size of the shock.
    Keywords: Sovereign Risk, Contagion
    JEL: E58 F34 F36 G12 G15
    Date: 2012–04–10
  6. By: Begoña Font Belaire (Universitat de València)
    Date: 2012–03
  7. By: Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University)
    Abstract: Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their effects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production efficiency, and aggregate output.
    Keywords: E44, F41
    Date: 2012–01
  8. By: Shalini Mitra (University of Connecticut)
    Abstract: The period before the financial crisis was characterized by unprecedented calm in the U.S. and other developed countries. Volatility of aggregate output growth declined in the U.S. beginning in the early 1980's until the fall of 2007 (the phenomenon has been widely called the Great Moderation). Meanwhile micro level evidence suggests increasing volatility at the firm level over the last 60 years including the period of the Great Moderation. I conduct a quantitative analysis of the role played by financial development in the divergence of firm and aggregate volatilities. In a DSGE setting based on Kiyotaki and Moore (1997) type borrowing constraints I show that financial development is associated with increasing firm growth volatility and declining aggregate volatility. The reason for the divergence is a decline in correlation of the firm with the aggregate as financial development occurs. Classification-JEL: D21, D58, E27, E32
    Keywords: Great Moderation, Firm-Level Volatility, Borrowing Constraints, Heterogenous Firms, Business Cycle
    Date: 2012–03
  9. By: Thorvald Grung Moe
    Abstract: Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot's advice to "lend freely at high rates against good collateral" has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be? Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises. In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks' lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of "liquidity illusion" to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a "fair-weather" view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis. Recently, the concept of "endogenous finance" has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky's theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III "package" will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis.
    Keywords: Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy
    JEL: E44 E52 E58 G28
    Date: 2012–04

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