Feeling the Heat: Climate Risks and the Cost of Sovereign Borrowing

This paper empirically examines the link between the cost of sovereign borrowing and climate risk for 40 advanced and emerging economies. Controlling for a large set of domestic and global factors, the paper shows that both vulnerability and resilience to climate risk are important factors driving the cost of sovereign borrowing at the global level. Overall, we find that vulnerability to the direct effects of climate change matter substantially more than climate risk resilience in terms of the implications for sovereign borrowing costs. Moreover, the magnitude of the effect on bond yields is progressively higher for countries deemed highly vulnerable to climate change. Impulse response analysis from a set of panel structural VAR models indicates that the reaction of bond yields to shocks imposed on climate vulnerability and resilience become permanent after around 12 quarters, with high risk economies experiencing larger permanent effects on yields than other country groups

Persistent Current Account Imbalances: Are they Good or Bad for Regional and Global Growth?

This paper examines the regional and global growth effects of current account imbalances in Japan, Germany, and the People’s Republic of China (PRC)—the three largest persistent surplus countries—and the United States and United Kingdom, the two largest persistent deficit countries. Controlling for a set of macroeconomic determinants, we use a structural vector autoregression (SVAR) framework to show that positive shocks to current account balances in the PRC, Germany, and Japan transmit positive regional and global growth effects, particularly in the case of spillovers to regional growth from Japan. As expected, the global growth response is lower in magnitude than the regional growth response. In addition, the extent of the effect is amplified by global value chains, pointing to the significant role played by trade in intermediate goods. For current account deficit countries, the magnitudes of the responses of growth to shocks are much lower on average than in the case of current account surplus countries. We find some marginal positive effects on regional and global growth emanating from a positive shock on the UK current account—i.e., a reduction in the deficit. For the US, a positive shock to its persistent current account deficit marginally drags on global growth, possibly reflecting declining import demand and wealth effects linked to the US dollar’s status as the global reserve currency. Our findings have important policy implications at the global level, particularly in light of the re-emergence of discussions on global imbalances in recent years

Financial Market and Capital Flow Dynamics During the COVID-19 Pandemic

This paper empirically examines the reaction of global financial markets across 38 economies to the COVID-19 outbreak, with a special focus on the dynamics of capital flow across 14 emerging market economies. Using daily data over the period 4 January 2010 to 30 April 2020 and controlling for a host of domestic and global macroeconomic and financial factors, we use a fixed effects panel approach and a structural VAR framework to show that emerging markets have been more heavily affected than advanced economies. In particular, emerging economies in Asia and Europe have experienced the sharpest impact on stocks, bonds, and exchange rates due to COVID-19, as well as abrupt and substantial capital outflows. Our results indicate that fiscal stimulus packages introduced in response to COVID-19, as well as quantitative easing by central banks, have helped to restore overall investor confidence through reducing bond yields and boosting stock prices. Our findings also highlight the role that global factors and developments in the world’s leading financial centers have on financial conditions in EMEs. Importantly, the impact of COVID-19 related quantitative easing measures by central banks in advanced countries, which helped to lower sovereign bond yields and prop up stock markets at home, extended to EMEs, notably in relation to stabilizing capital flow dynamics. Going forward, while the ultimate resolution of COVID-19 may be expected to lead to a market correction as uncertainty declines, our impulse response analysis suggests that there may be some permanent effects on financial markets and capital flows as a result of COVID-19, particularly in EMEs

Local Currency Bond Markets, Foreign Investor Participation and Capital Flow Volatility in Asia

This paper examines the role of local currency bond markets (LCBMs) and foreign investor participation in these markets in capital flow volatility in emerging Asian economies over the period 1999 to 2020. Using a panel analysis and impulse response functions generated from a panel structural vector autoregression, we show that greater development of LCBMs across 10 Asian emerging economies in terms of capitalization helps to mitigate against the capital flow volatility, while foreign investor participation has the opposite effect, particularly for less developed LCBMs. Our findings have policy implications from a financial stability perspective, whereby continued efforts to enhance LCBMs while reducing reliance on foreign investors should be encouraged. Strengthening the local investor base and mobilizing domestic resources through LCBMs ought to be a priority for raising long-term capital that will enable the financing of sustainable investment and development. Our findings also suggest that greater efforts are needed to enhance foreign exchange hedging arrangements for foreign investors in LCBMs, particularly in times of heightened financial stress

Local Currency Bond Markets, Foreign Investor Participation, and Capital Flow Volatility in Emerging Asia

This paper examines the role of local currency bond markets (LCBMs) and foreign investor participation in these markets in capital flow volatility in emerging Asian economies over the period 1999 to 2020. Using a panel analysis and impulse response functions generated from a panel structural vector autoregression, we show that greater development of LCBMs across ten Asian emerging economies in terms of capitalization helps to mitigate against capital flow volatility, while foreign investor participation has the opposite effect, particularly for less developed LCBMs. Our findings have policy implications from a financial stability perspective, whereby continued efforts to enhance LCBMs while reducing reliance on foreign investors should be encouraged. Strengthening the local investor base and mobilizing domestic resources through LCBMs ought to be a priority for raising long-term capital that will enable the financing of sustainable investment and development. Our findings also suggest that greater efforts are needed to enhance foreign exchange hedging arrangements for foreign investors in LCBMs, particularly in times of heightened financial stress

Non-Bank Finance and Monetary Policy Transmission in Asia

Focusing on Asian economies over the period 2006 to 2019, we find that while non-bank finance appears to complement rather than substitute credit provision by the traditional banking sector, weaker regulatory quality is an important driving factor. Moreover, while we find that central bank policy rates countercyclically affect credit provision by non-banks, impulse responses to monetary policy shocks with and without non-bank finance indicate that the effectiveness of monetary policy as a transmission channel to GDP growth, inflation, house prices, and traditional bank credit is weakened in the presence of non-bank finance. Our paper has implications for monetary policy implementation, potentially incorporating non-banks into central bank operations and liquidity provision, as well as for financial supervisors on mitigating regulatory arbitrage

When the United States and the People’s Republic of China Sneeze: Monetary Policy Spillovers to Asian Economies

This paper examines monetary policy spillovers from the US and the People’s Republic of China (PRC) to real and financial sectors in advanced and emerging Asian economies over the period 2000 to 2020. Using a structural vector autoregression (SVAR) approach, we find that Asian economies overall are more susceptible to spillovers to GDP, inflation, and the current account emanating from monetary policy shocks in the PRC than to those from the US. This is related to high inter- regional trade integration in Asia and is in line with previous research findings. However, while the prevailing literature has highlighted the dominant role of US monetary policy as a transmitter of shocks to global and Asian financial markets, we find more persistence in the response of advanced Asian interest rates to PRC mon- etary policy shocks. In addition, emerging Asian economies are found to be more susceptible to shocks emanating from the PRC in respect of equity markets and exchange rates. The rising synchronization of Asian financial markets in relation to the PRC as the financial account in the PRC has gradually opened as well as indirect effects via trade and regional value chains help to rationalize our findings

The Effects of Natural Disasters on Price Stability in the Euro Area

This paper investigates the impact of natural disasters on price stability in the euro area. We estimate panel and country-specific structural vector autoregression (VAR) models by combining estimated damages of disaster events with monthly data for the Harmonised Index of Consumer Prices (HICP) for all euro area countries over the period 1996-2021. Besides estimating the effect on overall headline inflation, we examine effects on its 12 main sub-indices and further sub-categories of food price inflation. This allows us to disentangle differences in the direction and strength of price effects across consumption categories. Our results suggest significant positive effects of natural disasters on overall headline inflation, with diverging results at the sub-index level. Positive inflation effects are particularly pronounced for prices of food and beverages, while negative effects prevail for other sub-indices. Our country-specific results suggest heterogeneous inflation effects of natural disasters across different countries. A key implication of our findings is that climate change is likely to make it increasingly difficult for the European Central bank to achieve its inflation target