Fiscal stimulus for debt intolerant countries?

Fashions are hard to resist, and it is now fashionable in much of the North to rely on a fiscal engine of growth. As for emerging markets, however, boosting spending at a time in which revenues are contracting or, in many cases, collapsing for an uncertain period of time is an more complicated matter. Policymakers would do well to keep four risks in mind. Fiscal multipliers: North and South; Emerging markets and global crowding out; Domestic debt is no panacea; and Above all--remember debt intolerance!fiscal stimulus, debt, financial crises, procyclical policies

Forecasting turning points in Canada

Economists have long been involved in the search for a few key indicators that predict the behavior of market economies. For Canada, it has been shown that the yield curve reliably tilts down and that real M1 growth declines before economic contraction, but this has been demonstrated almost exclusively in the context of single estimation equations or atheoretical VARs. This paper offers an alternative approach to the study of economic turning points. To qualify as a business-cycle indicator, a variable must behave differently when an economy is approaching or in recession than it does during economic expansions. That simple logic admits a variety of parametric and nonparametric tests of a variable’s usefulness, in forecasting. We examine the behavior around recessions of sixteen Canadian and U.S. time series. In the end we find that only the slopes of the Canadian and the U.S. term structure meet the prespecified criteria; the change in the nominal MCI and in real M1 follow behind.business cycles monetary policy yield curve interest rates

Output Fluctuations and Monetary Shocks: Evidence from Colombia

Using annual data for Colombia over the last 30 years, we test competing theories that explain macroeconomic fluctuations: the neoclassical synthesis, which posits that in the presence of temporary price rigidity, an unanticipated monetary expansion produces output gains that erode over time with increases in the price level; and an alternative explanation, which focuses on "real" technological or preference shocks as sources of output changes. Coefficients from this system are used to examine the long-run neutrality of nominal quantities with respect to permanent movements in the money stock and the short-run sensitivity of output to inflation.Colombia, inflation, growth, exchange rates,VAR

What hurts most?: G-3 exchange rate or interest rate volatility

With many emerging market currencies tied to the U.S. dollar either implicitly or explicitly, movements in the exchange values of the currencies of major countries have the potential to influence the competitive position of many developing countries. According to some analysts, establishing target bands to reduce the variability of the G-3 currencies would limit those destabilizing shocks emanating from abroad. This paper examines the argument for such a target zone strictly from an emerging market perspective. Given that sterilized intervention by industrial economies tends to be ineffective and that policy makers show no appetite to return to the controls on international capital flows that helped keep exchange rates stable over the Bretton Woods era, a commitment to damping G-3 exchange rate fluctuations requires a willingness on the part of G-3 authorities to use domestic monetary policy to that end. Under a system of target zones, then, relative prices for emerging market economies may become more stable, but debt-servicing costs may become less predictable. We use a simple trade model to show that the resulting consequences for welfare are ambiguous. Our empirical work supplements the traditional literature on North-South links by examining the importance of the volatilities of G-3 exchange-rates, and U.S. interest rate and consumption on capital flows and economic growth in developing countries over the past thirty years.capital flows trade exchange rate volatility interest rates debt emerging markets advanced economies

Twin fallacies about exchange rate policy in emerging markets

Two assertions about exchange rate regimes circulate with some frequency in policy circles. The first, the hypothesis of the excluded middle, holds that authorities must either choose perfectly floating exchange rates (preferably anchored by an inflation target for the central bank) or a hard (preferably irrevocable) peg. The second, seemingly unrelated, argues that the inability of emerging market economies to exercise monetary independence owes to the severe mistrust that they are perceived with by global investors because of the economic failures of prior governments. This paper argues that the theories of the excluded middle and original sin are twin and related fallacies that are contrary to theory and evidence. This paper will provide a model in which the government can choose policies consistent with either a pure float anchored by a constant money stock or a pure peg but, under certain circumstances, fail to find exchange rate stability at either corner. The problem is that the potential for regime change implies that the current government’s successors may behave less admirably, which will weigh on investors’ current behavior. The difficulties imparted by this expectation channel in an otherwise standard model of optimizing agents endowed with rational expectations shows both why looking back to explain credibility problems is looking the wrong way and why the excluded middle is, in fact, so crowdedexchange rate policy fixed bipolar view foreign currency debt credibility

Twin fallacies about exchange rate policy: A note

Two assertions about exchange rate regimes circulate with some frequency in policy circles. The first, which could be called the hypothesis of the excluded middle, holds that authorities must either choose perfectly floating exchange rates or a hard peg. The second, seemingly unrelated, notion attempts to explain why policy makers in some countries have little credibility. That mistrust, exemplified by the inability of emerging market economies to borrow at long maturities in their own currencies (original sin), transcends current fundamentals and traces back to the failure of prior policy makers. We argue that the theories of the excluded middle and original sin are twin and related fallacies that are contrary to theory and evidence. The sense that credibility problems stem from a simple and irrational source–failures of prior generations of policy makers–lends credence to alternative regimes that seem to allow the easy purchase of investor confidence–an exchange rate regime at one of the corners. Two decades of theory and empirical evidence cumulate to argue that this is too simple an answer. As to the theory, the literature on time inconsistency has amply demonstrated that the inability to precommit future policy decisions gives reason to doubt that the current regime will be maintained. That doubt stems, not from the record of prior failures, but from the inconsistency of incentives in the future.exchange rate debt domestic currency original sin

Is a G-3 Target Zone on Target for Emerging Markets?

With many emerging market currencies tied to the U.S. dollar either implicitly or explicitly, movements in the exchange values of the currencies of major countries–in particular the prolonged appreciation of the U.S. dollar vis-a-vis the yen and the deutsche mark in advance of Asia’s troubles–is argued to have worsened the competitive position of many emerging market economies. One solution to reducing destabilizing shocks emanating from abroad, the argument runs, would be to reduce the variability of the G-3 currencies by establishing target bands.1 This paper examines the argument for such a target zone from an emerging market perspective but will be silent on the costs and benefits for industrial countries.

Output Fluctuations and Monetary Shocks

Using annual data for Colombia over the last thirty years and a new battery of econometric techniques, we test opposing theories that explain macroeconomic fluctuations: The neoclassical synthesis, which posits that, in the presence of temporary price rigidity, an unanticipated monetary expansion produces output gains that erode over time with increases in the price level; and an alternative explanation, which focuses on "real" technological or preference shocks as the sources of output changes. The coefficients from these systems are used to examine two basic propositions: the long-run neutrality of nominal quantities with respect to permanent movements in the money stock; and the short-run sensitivity of output to inflation.monetary policy exchange rates output capital controls multipliers

Is the US too big to fail?

Why are investors rushing to purchase US government securities when the US is the epicentre of the financial crisis? This column attributes the paradox to key emerging market economies’ exchange practices, which require reserves most often invested in US government securities. America’s exorbitant privilege comes with a cost and a responsibility that US policy makers should bear in mind as they handle the crisis.financial crisis, exchange rates, reserves,government