Retail Bank Interest Rate Pass-Through: Is Chile Atypical?

This paper investigates empirically the pass-through of money market interest rates to retail banking interest rates in Chile, the United States, Canada, Australia, New Zealand, and five European countries. Overall, Chile’s pass-through does not appear atypical. Based on a standard errorcorrection model, we find that, as in most countries considered, Chile’s measured pass-through is incomplete. But Chile’s pass-through is also faster than in many other countries considered and is comparable to that in the United States. While we find no significant evidence of asymmetry in Chile’s pass-through across states of the interest rate or monetary policy cycle, we do find some evidence of parameter instability, around the time of the Asian and Russian crises. However, we do not find evidence that the switch to a more flexible exchange rate regime in 1999 and the “nominalization” of Chile’s interest rate targets in 2001 have affected significantly the pass-through process.

Socially excessive bankruptcy costs and the benefits of interest rate ceilings on loans

The authors study the capital accumulation and welfare implications of ceilings on loan interest rates in a dynamic general equilibrium model. Binding ceilings on loan rates reduce the probability of bankruptcy. Lower bankruptcy rates result in lower bankruptcy and liquidation costs. The authors state conditions under which the resources freed by this cost-saving result increase the steady state capital stock, reduce steady state credit rationing, and raise the steady state welfare of all agents. The authors also argue that the conditions stated are likely to be satisfied in practice. Finally, their results hold even if initially there is capital over-accumulation.Loans ; Interest rates ; Bankruptcy

Government financing in an endogenous growth model with financial market restrictions

In this paper we develop an endogenous growth model with market regulations on explicitly modeled financial intermediaries to examine the effects of alternative government financing schemes on growth, inflation, and welfare. ; We find that in the presence of binding legal reserve requirements, a marginal increase in government spending need not result in a reduction in the rate of economic growth if it is financed with an increase in the seigniorage tax rate. Raising the seigniorage tax base by means of an increase in the reserve requirement retards growth and has an ambiguous effect on inflation. An increase in income tax—financed government spending also suppresses growth and raises inflation although not to the extent that the required seigniorage tax rate alternative would. Switching from seigniorage to income taxation as a source of government finance is growth-reducing but deflationary. From a welfare perspective, the least distortionary way of financing an increase in the government spending requirements is by means of a marginal increase in the seigniorage tax rate. Finally, under the specification of logarithmic preferences, the optimal tax structure is indeterminate.Finance, Public ; Fiscal policy ; Financial markets

On business cycles and countercyclical policies

Since the third quarter of 2000, the U.S. economy began to experience a slowdown in its rate of growth. This slowdown serves as a reminder that the business cycle is still alive and raises the following questions: What do we know about the driving forces behind the business cycle? What should policymakers do in the face of economic fluctuations? ; The authors examine two explanations for business cycles that are well-known in academic circles: the animal spirits theory and the real business cycle theory. The former is closely connected with the Keynesian economic tradition and identifies market participants' mood swings as the key source of economic fluctuations. The second explanation is rooted in the classical economic tradition and views productivity shocks as the driving force behind economic fluctuations. The article then looks at what these theories suggest about countercyclical policies, which try to eliminate business cycle fluctuations or insulate market participants from their effects. The authors conclude that neither theory makes an unambiguous case supporting countercyclical policies. ; This conclusion may come as a surprise to government and business economists who have an ingrained belief in the benefits of such policies. It is important to remember, however, that attempts to understand business cycles and the effects and desirability of policies that may (or may not) moderate them are still at a very early stage.Business cycles ; Monetary policy ; Keynesian economics

Barriers to international capital flows: when, why, how big, and for whom?

Until recently, the trend in world capital markets has been toward increasing “globalization.” Recent events in Latin America and Asia have forced a rethinking of the desirability of unrestricted world capital flows. In this paper we ask whether simple restrictions on capital mobility can succeed in reducing the volatility of funds flows, whether such restrictions are consistent with the long-term development of the countries that might impose them, whether such restrictions are beneficial for poorer countries while harming wealthier countries, and whether barriers to capital movements should be reduced in magnitude as the development process proceeds. ; We find first that appropriately selected barriers to capital movements can be used by a poorer country to eliminate the short-term volatility of capital flows and other economic volatility as well. Second, we find that these barriers are consistent with increased rather than reduced levels of economic development in both the short and long run. Third, we show that it is empirically plausible that such barriers will be reduced over time as economies develop. Fourth, we show that, in the long run, all countries can benefit from the presence of barriers to capital mobility. And, fifth, we show that barriers to capital mobility can increase the magnitude of net capital flows in a steady state.International economic relations ; International finance ; Capital movements ; Monetary policy

Government financing in an endogenous growth model with financial market restrictions

In this paper we develop an endogenous growth model with market regulations on explicitly modeled financial intermediaries to examine the effects of alternative government financing schemes on growth, inflation, and welfare. ; We find that in the presence of binding legal reserve requirements, a marginal increase in government spending need not result in a reduction in the rate of economic growth if it is financed with an increase in the seigniorage tax rate. Raising the seigniorage tax base by means of an increase in the reserve requirement retards growth and has an ambiguous effect on inflation. An increase in income tax—financed government spending also suppresses growth and raises inflation although not to the extent that the required seigniorage tax rate alternative would. Switching from seigniorage to income taxation as a source of government finance is growth-reducing but deflationary. From a welfare perspective, the least distortionary way of financing an increase in the government spending requirements is by means of a marginal increase in the seigniorage tax rate. Finally, under the specification of logarithmic preferences, the optimal tax structure is indeterminate

Debt maturity, risk, and asymmetric information

We test the implications of Flannery’s (1986) and Diamond’s (1991) models concerning the effects of risk and asymmetric information in determining debt maturity, and we examine the overall importance of informational asymmetries in debt maturity choices. We employ data from more than 6,000 commercial loans from 53 large U.S. banks. Our results for low-risk firms are consistent with the predictions of both theoretical models, but our findings for high-risk firms conflict with the predictions of Diamond’s model and with much of the empirical literature. Our findings also suggest a strong quantitative role for asymmetric information in explaining debt maturity.

Why do borrowers pledge collateral? new empirical evidence on the role of asymmetric information

An important theoretical literature motivates collateral as a mechanism that mitigates adverse selection, credit rationing, and other inefficiencies that arise when borrowers hold ex ante private information. There is no clear empirical evidence regarding the central implication of this literature—that a reduction in asymmetric information reduces the incidence of collateral. We exploit exogenous variation in lender information related to the adoption of an information technology that reduces ex ante private information, and compare collateral outcomes before and after adoption. Our results are consistent with this central implication of the private-information models and support the empirical importance of this theory.

Barriers to international capital flows: when, why, how big, and for whom?

Until recently, the trend in world capital markets has been toward increasing "globalization." Recent events in Latin America and Asia have forced a rethinking of the desirability of unrestricted world capital flows. In this paper we ask whether simple restrictions on capital mobility can succeed in reducing the volatility of funds flows, whether such restrictions are consistent with the long-term development of the countries that might impose them, whether such restrictions are beneficial for poorer countries while harming wealthier countries, and whether barriers to capital movements should be reduced in magnitude as the development process proceeds. ; We find first that appropriately selected barriers to capital movements can be used by a poorer country to eliminate the short-term volatility of capital flows and other economic volatility as well. Second, we find that these barriers are consistent with increased rather than reduced levels of economic development in both the short and long run. Third, we show that it is empirically plausible that such barriers will be reduced over time as economies develop. Fourth, we show that, in the long run, all countries can benefit from the presence of barriers to capital mobility. And, fifth, we show that barriers to capital mobility can increase the magnitude of net capital flows in a steady state

Barriers to international capital flows: who should erect them and how big should they be?

Until recently, the trend in world capital markets has been toward increasing globalization. Recent events in Latin America and Asia have caused many in policy-making circles to question whether this trend should be wholly, or at least partially, reversed. It is commonly argued that—at a minimum—countries should be given the discretion to erect such barriers, at least in certain circumstances. Recent events, then, have forced a rethinking of the desirability of unrestricted world capital flows. The general presumption appears to be that the "victims" of highly volatile capital flows should be allowed to limit or restrict inflows and outflows of funds. But outflows of funds from smaller and less developed economies often represent inflows of funds to larger and more developed economies. This raises the issue of whether there would be benefits associated with larger and wealthier economies taking actions to limit capital mobility. This paper presents a formal analysis of erecting barriers to international capital flows. We find that, in contrast to conventional thinking, when there are substantial differences in per capita GDP across countries, long-run output in all countries can be increased by having wealthier economies erect some partial barriers to capital mobility. Interestingly, wealthier economies need not persuade poorer economies to cooperate: by implementing an appropriately selected tax on capital flows it will often be the case that the wealthy economy can unilaterally obtain a higher steady state welfare level for all agents in all economies. We also show that these same barriers need not eliminate endogenously arising volatility in income, capital flows, and asset returns. Under some circumstances, then, if it is desirable to reduce such volatility, this must be accomplished by other means. However, and this bears emphasis, the case for imposing barriers on capital flows does not depend critically on the ability of these barriers to eliminate excess volatility