nep-ifn New Economics Papers
on International Finance
Issue of 2013‒03‒23
three papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Early warning for currency crises: what is the role of financial openness? By Jon Frost; Ayako Saiki
  2. The Elephant Hiding in the Room: Currency Intervention and Trade Imbalances By Joseph E. Gagnon
  3. Financial shocks and the macroeconomy: heterogeneity and non-linearities By Kirstin Hubrich; Antonello D’Agostino; Marianna Cervená; Matteo Ciccarelli; Paolo Guarda; Markus Haavio; Philippe Jeanfils; Caterina Mendicino; Eva Ortega; Maria Teresa Valderrama; Marianna Valentinyiné Endrész

  1. By: Jon Frost; Ayako Saiki
    Abstract: We explore the role of financial openness – capital account openness and gross capital inflows – and a newly constructed gravity-based contagion index to assess the importance of these factors in the run-up to currency crises. Using a quarterly data set of 46 advanced and emerging market economies (EMEs) during the period 1975Q1-2011Q4, we estimate a multi-variable probit model including in the post-Lehman period. Our key findings are as follows. First, capital account openness is a robust indicator, reducing the probability of currency crisis for advanced economies, but less so for EMEs. Second, surges in gross (but not net) capital inflows in general increase the risk of a currency crisis, but looking at a disaggregated level, gross portfolio flows increase the risk of a currency crisis for advanced economies, whereas gross FDI inflows decrease the risk of a crisis for EMEs. Third, contagion has a very strong impact, consistent with the past literature, especially during the post-Lehman shock episode. Last, our model performs well out-of-sample, confirming that early warning models were helpful in judging relative vulnerability of countries during and since the Lehman crisis.
    Keywords: Currency crisis; early warning; financial stability; capital account openness; capital flows; contagion; exchange rate regime
    JEL: F31 F32 F33 F41 G10 G15
    Date: 2013–03
  2. By: Joseph E. Gagnon (Peterson Institute for International Economics)
    Abstract: Official purchases of foreign assets--a broad definition of currency intervention--are strongly correlated with current account (trade) imbalances. Causality runs in both directions, but statistical analysis using instrumental variables reveals that the effect of official asset purchases on current accounts is very large. A country’s current account balance increases between 60 and 100 cents for each dollar spent on intervention. This is a much larger effect than is widely assumed. These results raise serious questions about the efficiency of international financial markets.
    Keywords: current account, financial flows, foreign exchange reserves
    JEL: F30 F31 F32
    Date: 2013–03
  3. By: Kirstin Hubrich (European Central Bank); Antonello D’Agostino (European Stability Mechanism); Marianna Cervená (Magyar Nemzeti Bank); Matteo Ciccarelli (European Central Bank); Paolo Guarda (Banque centrale du Luxembourg); Markus Haavio (Suomen Pankki); Philippe Jeanfils (National Bank of Belgium); Caterina Mendicino (Banco de Portugal); Eva Ortega (Banco de España); Maria Teresa Valderrama (Oesterreichische Nationalbank); Marianna Valentinyiné Endrész (Magyar Nemzeti Bank)
    Abstract: This paper analyses the transmission of financial shocks to the macroeconomy. The role of macro-financial linkages is investigated from an empirical perspective for the euro area as a whole, for individual euro area member countries and for other EU and OECD countries. The following key economic questions are addressed: 1) Which financial shocks have the largest impact on output over the full sample on average? 2) Are financial developments leading real activity? 3) Is there heterogeneity or a common pattern in macro-financial linkages across the euro area and do these linkages vary over time? 4) Do cross-country spillovers matter? 5) Is the transmission of financial shocks different during episodes of high stress than it is in normal times, i.e. is there evidence of non-linearities? In summary, it is found that real asset prices are significant leading indicators of real activity whereas the latter leads loan developments. Furthermore, evidence is presented that macro-financial linkages are heterogeneous across countries – despite persistent commonalities – and time-varying. Moreover, they differ between euro area and other countries. Results also indicate that cross-country spillovers matter. Finally, important non-linearities in the transmission of financial shocks are documented, as the evidence suggests that the transmission differs in episodes of high stress compared with normal times. JEL Classification: E 440, E320, C320
    Keywords: macro-financial linkages, financial shocks, lead-lag relationships, heterogeneity, cross-country spillovers, non-linearities
    Date: 2013–02

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