Boom-Bust Cycles in Middle Income Countries: Facts and Explanation

In this paper we characterize empirically the comovements of macro variables typically observed in middle income countries, as well as the boom-bust cycle that has been observed during the last two decades. We find that many countries that have liberalized their financial markets, have witnessed the development of lending booms. Most of the time the boom gradually decelerates, but sometimes the boom ends in twin currency and banking crises and is followed by a protracted credit crunch that outlives a short-lived recession. We also find that during lending booms there is a real exchange rate appreciation, and the nontradables (N) sector grows faster than the tradables (T) sector. Meanwhile, the opposite is true in the aftermath of crisis. We argue that these comovements are generated by the interaction of two characteristics of financing typical of middle income countries: risky currency mismatch and asymmetric financing opportunities across the N and T sectors Copyright 2002, International Monetary Fund

Equity Price Dynamics Before and After the Introduction of the Euro

Daily data from the German and U.S. equity markets before and after the introduction of the Euro are used to study the effect of exchange rate regime choices on equity markets. It is found that, since the introduction of the Euro, the volatility and the persistence of the German stock index have fallen significantly relative to those of the U.S. index. However, the switch in exchange rate arrangement appears to have no significant implication for the causal relationships - both the mean and varianc causalities - between the two equity markets

How Strong is the Case for Dollarization in Costa Rica? A Note on the Business Cycle Comovements with the United States

We evaluate the proposal for official dollarization in Costa Rica by applying a new approach to measure the business cycle comovements with the United States. While the literature often focuses on the correlation of shocks, we point out that the response of each country to the shocks is also an important aspect of stabilization policy. We analyze whether Costa Rica and the United States share a common synchronized response to shocks, i.e. a common business cycle, using the Engle and Kozicki (1993) and Cubadda (1999, 2007) serial correlation common features tests, in a quarterly GDP data set from 1991 to 2008. Although we find some tendency towards common AR(p) structures and common long run trends, we reject the hypothesis that the two countries share a common business cycle. Based on this evidence, we conclude that official dollarization in Costa Rica would impede the efforts of its stabilization policy, despite the relatively high contemporaneous correlation of shocks.Dollarization, Business Cycle Comovement, Serial Correlation Common Feature, Central America, Costa Rica

Credit market imperfections, financial market regulation and business cycles in Eastern Europe

Credit market imperfections give rise to boom-bust cycle episodes in emerging markets. In the present paper, we aim to provide a comprehensive analysis for Eastern Europe. We focus on documenting credit market imperfections, asymmetric financing opportunities across sectors, and business cycle fluctuations at the aggregate and sectoral level. The results will be discussed in the policy context of the re-regulation of the financial system. We will propose in an unconventional way to think about the early introduction of the Euro currency. --asymmetric financing opportunities,currency mismatch,sectoral business cycles

A Note on the Time Series Measure of Conservatism

Asymmetric persistence of accounting income is often tested in a regression of changes in earnings on lagged changes in earnings, including an interaction term for negative changes (see Basu [1997] or Ball et al. [2009] for a recent overview). In this note we propose an alternative, but closely related measure of conservatism - regressing the changes in earnings on the lagged levels, similar to the threshold-unit root test specification of Enders and Granger [1998]. We argue that this approach has three distinct advantages compared to the conventional setup: (i) a smooth, non-oscillating impulse response pattern to an unexpected shock in earnings (ii) a return to the old equilibrium of earnings in the long run and (iii) it can be extended to higher order autoregressive processes. We illustrate the differences between the two approaches, when applied to a common data set of firms, as well as a data set from a Monte Carlo simulation.Timely loss recognition, Asymmetric persistence, Conservatism

How Strong is the Case for Dollarization in Costa Rica? A Note on the Business Cycle Comovements with the United States

We evaluate the proposal for official dollarization in Costa Rica by applying a new approach to measure the business cycle comovements with the United States. While the literature often focuses on the correlation of shocks, we point out that the response of each country to the shocks is also an important aspect of stabilization policy. We analyze whether Costa Rica and the United States share a common synchronized response to shocks, i.e. a common business cycle, using the Engle and Kozicki (1993) and Cubadda (1999, 2007) serial correlation common features tests, in a quarterly GDP data set from 1991 to 2008. Although we find some tendency towards common AR(p) structures and common long run trends, we reject the hypothesis that the two countries share a common business cycle. Based on this evidence, we conclude that official dollarization in Costa Rica would impede the efforts of its stabilization policy, despite the relatively high contemporaneous correlation of shocks.dollarization, business cycle comovement, serial correlation common feature, Central America, Costa Rica

The Credit Channel in Middle Income Countries

With inflation under control in many in middle income countries (MICs), it is now swings in credit, investment and asset prices that affect these countries the most. In this paper we present a framework to analyze both theoretically and empirically how credit market shocks are propagated and amplified in MICs.The strength of the credit channel in our model derives from two key characteristics of MICs: (i)a sharp asymmetry across the tradables (T) sector and the more bank-dependent nontradables (N) sector; and (ii)a significant degree of currency mismatch in the N-sector. This makes movements in the real exchange rate the driving element in the amplification of shocks. The equilibrium imposes unambiguous contemporaneous linkages among key macroeconomic variables and allows us to derive structural VARs. Estimating these VARs using quarterly data for a group of MICs, we find evidence for a strong credit channel, for a balance sheet effect and for asymmetric sectorial responses. Our findings indicate that inflation targeting is not sufficient to guarantee economic stability, as such policy might overlook the development of lending booms and associated sectorial asymmetries.

Financial Development and Sectoral Output Growth in 19th Century Germany

In this paper we re-evaluate the hypothesis that the development of the financial sector was an essential factor behind economic growth in 19th century Germany. We apply a structural VAR framework to a new annual data set from 1870 to 1912 that was initially recorded by Walther Hoffmann (1965). With respect to the literature, the distinguishing characteristic of our analysis is the focus on different sectors in the economy and the interpretation of the findings in the context of a two-sector growth model. We find that all sectors were affected significantly by shocks from the banking system. Interestingly, this link is the strongest in sectors with small, non-tradable goods producing firms, such as services, transportation and agriculture. In this regard, the growth patterns in 19th century Germany are reminiscent to those in today\'s emerging markets.Economic Growth, Financial Development, Sectoral asymmetries

Financial Development and Sectoral Output Growth in 19th Century Germany

In this paper we re-evaluate the hypothesis that the development of the financial sector was an essential factor behind economic growth in 19th century Germany. We apply a structural VAR framework to a new annual data set from 1870 to 1912 that was initially recorded by Walther Hoffmann (1965). With respect to the literature, the distinguishing characteristic of our analysis is the focus on different sectors in the economy and the interpretation of the findings in the context of a two-sector growth model. We find that all sectors were affected significantly by shocks from the banking system. Interestingly, this link is the strongest in sectors with small, non-tradable goods producing firms, such as services, transportation and agriculture. In this regard, the growth patterns in 19th century Germany are reminiscent to those in today's emerging markets.economic growth, financial development, sectoral asymmetries

Credit Market Imperfections in Middle Income Countries

In this paper we document three credit market imperfections prevalent in middle income countries that can help to explain boom-bust cycles, as well as other macroeconomic patterns observed at higher frequencies across these countries. These imperfections are: the existence of financing constraints that affect mainly the nontradables sector, currency mismatch and guarantees that cover lenders against systemic crises. In MICs T-sector firms have access to international capital markets, while most N-firms are bank-dependent and are financially constrained. Systemic guarantees generate incentives for borrowers to take on insolvency risk by denominating debt in foreign currency. This currency mismatch makes movements in the real exchange rate – the relative price between N and T goods – the driving element in the amplification of shocks.