nep-ifn New Economics Papers
on International Finance
Issue of 2022‒10‒31
five papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Trapped in the Trilemma: When Security Trumps Economics By Michael D. Bordo; Harold James
  2. Foreign currency exposure and the financial channel of exchange rates By Longaric, Pablo Anaya
  3. Foreign direct investment, prices and efficiency: Evidence from India By Nesma Ali; Joel Stiebale
  4. A Quantitative Theory of Relationship Lending By Kyle Dempsey; Miguel Faria-e-Castro
  5. Horses for Courses: Measuring Foreign Supply Chain Exposure By Richard Baldwin; Rebecca Freeman; Angelos Theodorakopoulos

  1. By: Michael D. Bordo; Harold James
    Abstract: This paper describes the challenges of globalization in terms of the logic underpinning four distinct policy constraints or “trilemmas” and their interrelationship; in particular the disturbances that arise from capital flows and the difficulties of adjusting monetary policies to a global monetary environment. These trilemmas intersect and interlock. The trilemmas are: 1. The traditional Macroeconomic trilemma between capital mobility, fixed exchange rates and monetary autonomy; 2. The International relations trilemma between capital mobility, sovereignty and international order; 3. The Political economy trilemma between capital mobility, democracy and sovereignty; 4. The Financial stability trilemma between capital mobility, financial stability and independent national policies. The four trilemmas offer a way to analyze how domestic monetary, financial, economic and political systems are interconnected within the international system that opens up vulnerabilities. They can be described as the impossible policy choices at the heart of globalization.
    JEL: E52 E60 F30 F40 G28 N1
    Date: 2022–09
  2. By: Longaric, Pablo Anaya
    Abstract: Exchange rate movements affect the economy through changes in net exports, i.e. the trade channel, and through valuation changes in assets and liabilities denominated in foreign currencies, i.e. the financial channel. In this paper, I investigate the macroeconomic and financial effects of U.S. dollar (USD) exchange rate fluctuations in small open economies. Specifically, I examine how the financial channel affects the overall impact of exchange rate fluctuations and assess to what extent foreign currency exposure determines the financial channel’s strength. My empirical analysis indicates that, if foreign currency exposure is high, an appreciation of the domestic currency against the USD is expansionary and loosens financial conditions, which is consistent with the financial channel of exchange rates. Moreover, I estimate a small open economy New Keynesian model, in which a fraction of the domestic banks’ liabilities is denominated in USD. In line with the empirical results, the model shows that an appreciation against the USD can be expansionary depending on the strength of the financial channel, which is linked to the level of foreign currency exposure. Finally, the model indicates that the financial channel amplifies the effects of foreign monetary policy shocks. JEL Classification: E44, F31, F41
    Keywords: exchange rates, financial and trade channels, local projections - instrumental variable, open economy DSGE model
    Date: 2022–10
  3. By: Nesma Ali; Joel Stiebale
    Abstract: This paper uses a rich panel data set of Indian manufacturers to analyze the effects of foreign direct investment (FDI) on domestic firms. Detailed product-level information on prices and quantities allows us to estimate physical productivity and marginal costs. In line with the previous literature, we find little evidence for horizontal spillovers based on commonly used measures of revenue productivity. In contrast, we measure sizable efficiency gains using measures that are not affected by pricing heterogeneity. Our results indicate that domestic firms can benefit from the ability of multinational subsidiaries to produce high-quality products at relatively low costs.
    Keywords: Foreign Direct Investment, Spillovers, Productivity, Marginal Costs, Prices, Markups, Multi-Product Firms
    Date: 2022
  4. By: Kyle Dempsey; Miguel Faria-e-Castro
    Abstract: Banks' loan pricing decisions reflect the fact that borrowers tend to have long-lasting relationships with lenders. Therefore, pricing decisions have an inherently dynamic component: high interest rates may yield higher static profits per loan, but in the long run they erode a banks' customer base and reduce future profitability. We study this tradeoff using a dynamic banking model which embeds lending relationships using deep habits (“customer capital”) and costs of adjusting loan portfolio composition. High customer capital raises the level and decreases the interest rate elasticity of loan demand. When faced with an adverse shock to net worth, banks with high customer capital recapitalize quickly by charging high interest rates and eroding customer capital in the short term, while banks with low customer capital face persistent financial distress. Using Call Report data to measure the franchise value of banks' loan portfolios, we find that this effect has strong implications for how individual banks and the financial sector as a whole recover from shocks.
    Keywords: banks; Customer Capital; relationship lending; interest rates; financial crises
    JEL: E4 G2
    Date: 2022–09–23
  5. By: Richard Baldwin; Rebecca Freeman; Angelos Theodorakopoulos
    Abstract: Perceptions of global supply chains (GSCs) have shifted in recent years from a positive to a more cautious view. Standard GSC measures have mostly not adapted to this change as they focus on participation in, rather than exposure to, foreign supply chains. This paper presents the tools necessary to track foreign GSC exposure, and introduces a systematic shocks approach to GSC indicator design. We use this to develop indicators that gauge the impact of a variety of foreign shocks. We argue that different indicators are appropriate to different questions and show that they can provide qualitatively different answers to the same foreign exposure question.
    JEL: D57 F13 F14 F15 F60 R15
    Date: 2022–09

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