Review of “This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff”

This Time is Different: Eight Centuries of Financial Folly is one of the best, if not the best, books ever written on the history of financial crises. It presents a comprehensive survey of financial crises utilizing an extraordinary database of macroeconomic and financial series. The massive data analysis constituting the core of the manuscript leads the authors to arrive at a simple but powerful conclusion: while times change, locations change, actors change, financial crises often exhibit more similarities than differences throughout history. This conclusion nicely relates to the title of the book as it proves wrong the claim “this time is different” that is often heard during boom times preceding crises. The book is a must read for anyone interested in economics and finance. This review presents a brief summary of the book and a discussion about its implications for future research.

Small Countries and Preferential Trade Agreements "How Severe is the Innocent Bystander Problem?"

This paper examines the welfare implications of preferential trade agreements (PTAs) from the perspective of small countries in the context of a multi-country, general equilibrium model. We calibrate our model to represent one relatively small country and two symmetric big countries. We consider two cases. In one case, the small country is an 'innocent bystander', that is, it is left out of a PTA between the two large countries. In the second case, the small country signs a PTA with one of the large countries. We simulate the model and calculate consumption allocations, prices, t rade volume, and tariffs in these two cases considering three different equilibria: Free Trade (FT), Free Trade Area (FTA), and Customs Union (CU). We find that free trade is the best outcome for the small country. If the large country PTA takes the for m of a CU then the cost of being an 'innocent bystander' is very large. If it is a FTA then the cost of being an 'innocent bystander' is relatively modest. In fact, the small country prefers to be an 'innocent bystander' to being a member of a FTA with one of the large countries.Preferential trade agreements, general equilibrium, tariffs, welfare, small countries

Can the standard international business cycle model explain the relation between trade and comovement?

Recent empirical research finds that pairs of countries with stronger trade linkages tend to have more highly correlated business cycles. We assess whether the standard international business cycle framework can replicate this intuitive result. We employ a three-country model with transportation costs. We simulate the effects of increased goods market integration under two asset market structures: complete markets and international financial autarky. Our main finding is that under both asset market structures the model can generate stronger correlations for pairs of countries that trade more, but the increased correlation falls far short of the empirical findings. Even when we control for the fact that most country pairs are small with respect to the rest of the world, the model continues to fall short. We also conduct additional simulations that allow for increased trade with the third country or increased TFP shock comovement to affect the country pair’s business cycle comovement. These simulations are helpful in highlighting channels that could narrow the gap between the empirical findings and the predictions of the model.Business cycles ; International trade

Thresholds in the Process of International Financial Integration

The financial crisis has re-ignited the fierce debate about the merits of financial globalization and its implications for growth, especially for developing countries. The empirical literature has not been able to conclusively establish the presumed growth benefits of financial integration. Indeed, a new literature proposes that the indirect benefits of financial integration may be more important than the traditional financing channel emphasized in previous analyses. A major complication, however, is that there seem to be certain "threshold" levels of financial and institutional development that an economy needs to attain before it can derive the indirect benefits and reduce the risks of financial openness. In this paper, we develop a unified empirical framework for characterizing such threshold conditions. We find that there are clearly identifiable thresholds in variables such as financial depth and institutional quality − the cost-benefit trade-off from financial openness improves significantly once these threshold conditions are satisfied. We also find that the thresholds are lower for foreign direct investment and portfolio equity liabilities compared to those for debt liabilities.financial openness, capital account liberalization, growth, threshold conditions, financial development, institutions, macroeconomic policies

Recessions and Financial Disruptions in Emerging Markets: A Bird´s Eye View.

This paper provides an overview of the implications of recession and financial disruption episodes in emerging markets. We report three major findings. First, compared to advanced countries, recessions and financial disruptions in emerging markets are often more costly. Second, recessions associated with financial disruption episodes, such as credit crunches, equity price busts and financial crises, tend to be deeper than other recessions in emerging markets. Third, the temporal dynamics of macroeconomic and financial variables around these episodes in emerging markets are different than those in advanced countries. In light of these broad observations, the paper provides a review of recessions and financial market disruptions in Chile

Does Openness to International Financial Flows Contribute to Productivity Growth?

Economic theory has identified a number of channels through which openness to international financial flows could raise productivity growth. However, while there is a vast empirical literature analyzing the impact of financial openness on output growth, far less attention has been paid to its effects on productivity growth. This paper provides a comprehensive analysis of the relationship between financial openness and total factor productivity (TFP) growth using an extensive dataset that includes various measures of productivity and financial openness for a large sample of countries. We find that de jure capital account openness has a robust positive effect on TFP growth. The effect of de facto financial integration on TFP growth is less clear, but this masks an important and novel result. We find strong evidence that FDI and portfolio equity liabilities boost TFP growth while external debt is actually negatively correlated with TFP growth. The negative relationship between external debt liabilities and TFP growth is attenuated in economies with higher levels of financial development and better institutions.foreign direct investment, external assets and liabilities, capital flows, capital account liberalization, financial openness, portfolio equity, debt, total factor productivity

Growth and Volatility in an Era of Globalization

We extend the analysis in Kose, Prasad, and Terrones (2005) to provide a comprehensive examination of the cross-sectional relationship between growth and macroeconomic volatility over the past four decades. We also document that while there has generally been a negative relationship between volatility and growth during this period, the nature of this relationship has been changing over time and across different country groups. In particular, we detect major shifts in this relationship after trade and financial liberalizations. In addition, our results show that volatility stemming from the main components of domestic demand is negatively associated with economic growth. Copyright 2005, International Monetary Fund

Thresholds in the process of international financial integration

The financial crisis has re-ignited the fierce debate about the merits of financial globalization and its implications for growth, especially for developing countries. The empirical literature has not been able to conclusively establish the presumed growth benefits of financial integration. Indeed, a new literature proposes that the indirect benefits of financial integration may be more important than the traditional financing channel emphasized in previous analyses. A major complication, however, is that there seem to be certain"threshold"levels of financial and institutional development that an economy needs to attain before it can derive the indirect benefits and reduce the risks of financial openness. This paper develops a unified empirical framework for characterizing such threshold conditions. The analysis finds that there are clearly identifiable thresholds in variables such as financial depth and institutional quality -- the cost-benefit trade-off from financial openness improves significantly once these threshold conditions are satisfied. The findings also show that the thresholds are lower for foreign direct investment and portfolio equity liabilities compared with those for debt liabilities.Debt Markets,Economic Theory&Research,Currencies and Exchange Rates,Emerging Markets,Achieving Shared Growth

Financial Globalization and Economic Policies

We review the large literature on various economic policies that could help developing economies effectively manage the process of financial globalization. Our central findings indicate that policies promoting financial sector development, institutional quality and trade openness appear to help developing countries derive the benefits of globalization. Similarly, sound macroeconomic policies are an important prerequisite for ensuring that financial integration is beneficial. However, our analysis also suggests that the relationship between financial integration and economic policies is a complex one and that there are unavoidable tensions inherent in evaluating the risks and benefits associated with financial globalization. In light of these tensions, structural and macroeconomic policies often need to be tailored to take into account country specific circumstances to improve the risk-benefit tradeoffs of financial integration. Ultimately, it is essential to see financial integration not just as an isolated policy goal but as part of a broader package of reforms and supportive macroeconomic policies.emerging markets, capital flows, capital account liberalization, financial globalization