Appendices (1) IMF country programs (2) An implication of contractionary devaluation (3) The car...
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Appendices (1) IMF country programs (2) An implication of contractionary devaluation (3) The car crash analogy (4) Currency wars (5) More on predicting
Appendices (1) IMF country programs (2) An implication of
contractionary devaluation (3) The car crash analogy (4) Currency
wars (5) More on predicting crises (6) EM conditions in 2014
Lecture 22: Crises in Emerging Markets
Slide 2
Appendix 1: Major IMF Country-Programs Usual 3 components
Country reforms (conditionality): macro policy (often devaluation
& expenditure-reduction) & perhaps structural (in 1990s;
controversial). Financing from IMF. Stamp of approval is as
important as its money, or more so. Private Sector Involvement:
bailing in lenders rather than bailing out Rolling over loans,
standstills, re-profiling (stretching out maturities), default,
haircuts, restructuring, debt-equity swaps, write-downs
Slide 3
High interest rates raise default probability. The IMF may have
over-done it according to J.Furman & J.Stiglitz; and S.Radelet
& J.Sachs; both in Brookings Panel on Ec. Activity (1998).
Devaluation may be contractionary. Possible channels include: real
balance effect & balance-sheet effect. Why were the real
effects of the East Asia currency crises so severe?
Slide 4
Would some other combination of devaluation vs. monetary
contraction in the 1990s crises have better maintained internal and
external balance? Textbook version: When external balance shifts
out, there exists an optimal combination of devaluation and
interest rate rise that will satisfy external finance constraint
without causing recession. 1998 version: Apparently there existed
no such combination, if reserves have been allowed to run low and $
debt to run high.
Slide 5
API-120 - Macroeconomic Policy Analysis I. Jeffrey Frankel,
Harvard University Textbook version: there exists a combination of
devaluation and interest rate rise that will satisfy external
finance constraint without causing recession.
Slide 6
API-120 - Macroeconomic Policy Analysis I, Professor Jeffrey
Frankel Harvard University Lesson-of-1998 version: There may exist
no combination that avoids recession, if reserves have already been
allowed to run low and dollar debt to run high. ? ?
Slide 7
Appendix 3: The Car Crash Analogy [Might cover at end of
semester, L25, instead] Sudden stops: Its not the speed that kills,
its the sudden stops R.Dornbusch Superhighways: Modern financial
markets get you where you want to go fast, but accidents are
bigger, and so more care is required. R.Merton
Slide 8
Is it the road or the driver? Even when many countries have
accidents in the same stretch of road (Stiglitz), their own
policies are also important determinants; its not determined just
by the system. L.Summers Contagion also contributes to multi-car
pile-ups. THE CAR CRASH ANALOGY, continued
Slide 9
Moral hazard -- G7/IMF bailouts that reduce the impact of a
given crisis, in the LR undermine the incentive for investors and
borrowers to be careful. Like air bags and ambulances. But to claim
that moral hazard means we should abolish the IMF would be like
claiming that drivers would be safer with a spike in the center of
the steering wheel column. M.Mussa Correlation does not imply
causation: That the IMF (doctors) are often found at the scene of
fatal accidents (crises) does not mean that they cause them.
Slide 10
Optimal sequence: A highway off-ramp should not dump high-speed
traffic into the center of a village before streets are paved,
intersections regulated, and pedestrians learn not to walk in the
streets. So a country with a primitive domestic financial system
should not necessarily be opened to the full force of international
capital flows before domestic reforms & prudential regulation.
=> There may be a role for controls on capital inflow (speed
bumps and posted limits). -- Masood Ahmed Reaction time: How the
driver reacts in the short interval between appearance of the
hazard and the moment of impact (speculative attack) influences the
outcome. Adjust, rather than procrastinating (by using up reserves
and switching to short-term $ debt) J.Frankel
Slide 11
Appendix 4: Currency wars Brazils Finance Minister Guido
Mantega complained in 2010 about Fed easing. Indias Central Bank
Governor Raghuram Rajan complained in 2014 about Fed
tightening.
Slide 12
12 Warning from Mantega: Were in the midst of an international
currency war, a general weakening of currency. This threatens us
because it takes away our competitiveness (9/27/2010). I.e.,
countries everywhere are trying to push down the value of their
currencies, to gain exports & employment, a goal that is not
globally consistent. Origin of phrase Currency Wars
Slide 13
Currency wars must be another way of saying competitive
devaluation a kind of beggar-thy-neighbor policy to use language of
the 1930s, one motive at Bretton Woods for fixed exchange rates; or
manipulating exchange ratesto gain an unfair competitive advantage
over other members to quote from IMF Article IV(1)iii. 13
Slide 14
If US unemployment is high & inflation low, the Fed will
naturally choose an easy monetary policy (low i). If the
macroeconomic situation is the reverse in Brazil, its central bank
will naturally choose a tight monetary policy (high i ). Also
naturally, capital will flow from the US to Brazil and will in turn
appreciate the Real. But that is the beauty of floating rates.
14
Slide 15
Rajan complains about Fed tightening. International monetary
cooperation has broken down The U.S. should worry about the effects
of its policies on the rest of the world, 1/30/14. Central banks
should assess spillover effects from their own actions For example,
this would mean that while exiting from unconventional policies,
central banks would pay attention to conditions in emerging markets
[T]he Fed policy statement in January 2014, with no mention of
concern about the emerging market situation, and with no indication
Fed policy would be sensitive to conditions in those markets sent
the probably unintended message that those markets were on their
own. 4/10/2014 (Brookings)
Slide 16
US Congressional failure to approve IMF reform In one respect,
at least, China, India & Brazil are right to complain: the lack
of proportionate representation in international agencies. Congress
refuses to pass the bill updating the allocations of IMF quotas
among member countries. Quotas allocations in the IMF determine
both monetary contributions of the member states and their voting
power. The agreement among the IMF members had been to allocate
greater shares to big EM countries, coming primarily at the expense
of European countries.
Slide 17
Appendix 5: More on predicting crises (i) Definitions (CA
reversal, sudden stop, speculative attack) (ii) Predicting the 1994
Mexican peso crisis (iii) Studies of Early Warning Indicators
Slide 18
(i) Definitions of external financing crises Current Account
Reversal disappearance of a previously substantial CA deficit
Sudden Stop sharp disappearance of private capital inflows,
reflected (esp. at 1 st ) as fall in reserves & (soon) in
disappearance of a previous CA deficit. Often associated with
recession. Speculative attack sudden fall in demand for domestic
assets, in anticipation of abandonment of peg. Reflected in
combination of s - res & i >> 0. (Interest rate defense
against speculative attack might be successful.) Currency crisis
Exchange Market Pressure s - res >> 0. Currency crash s
>> 0, e.g., >25%. But falls in securities prices & GDP
are increasingly relevant.
Slide 19
References Current account reversals Edwards (2004a, b) and
Milesi-Ferretti & Razin (1998, 2000). Sudden stops References:
Dornbusch & Werner (1994), Dornbusch, Goldfajn & Valdes
(1995); Calvo (1998), Calvo, Izquierdo & Mejia (2003), Calvo
(2003), Calvo, Izquierdo & Talvi (2003, 2006), Calvo &
Reinhart (2001), Calvo, Izquierdo & Loo- Kung (2006), Calvo,
Izquierdo & Loo-Kung (2006); Caballero & Krishnamurthy
(2004); Edwards (2004); Guidotti, Sturzenegger & Villar (2004);
Levchenko & Mauro (2006); Arellano & Mendoza (2002), and
Mendoza (2002, 2006, 2010).
Slide 20
(ii) More on predicting crises The early 1990s Calvo, Leiderman
& Reinhart predict the peso crisis
Slide 21
In the 1990s, capital inflows financed current account
deficits. Calvo, Leiderman & Reinhart: Source of capital flows
was low i* at least as much as local reforms (push vs. pull) =>
Could reverse as easily as in 1982. Dornbusch (1994) said the
Mexican peso was overvalued.
Slide 22
(iii) Early Warning Indicators of Currency Crashes Sachs,
Tornell & Velasco (1996): Combination of weak fundamentals (
RER or credit/GDP) and low reserves made countries vulnerable to
tequila contagion. Frankel & Rose (1996): Composition of
capital inflow matters (more than the total): short-term bank debt
raises the probability of crash; FDI & reserves lower the
probability. Kaminsky, Lizondo & Reinhart (1998): Best
predictors: M2/Res, Real Exchange Rate. Berg, Borensztein,
Milesi-Ferretti, & Pattillo (1999), They dont hold up as well
out-of-sample. Edwards (2002): CA ratios of some use in predicting
crises (excl. Africa), contrary to earlier research. Rose &
Spiegel (2009): No robust predictors for who got hit by GFC in
2008-09. Dominguez & Ito (2012) Reserves do work to predict who
got hit, and Frankel & Saravelos (2012): as in earlier
studies.
Slide 23
Predictive performance of Early Warning indicators in the1990s
crises. Berg, et al, (1999) did find that if warning indicator
equation sounded an alarm, probability of crisis was 70-89%; but
were generally pessimistic on the ability at each round to predict
the next crisis.
Slide 24
Are big current account deficits dangerous? Neoclassical
theory: if a country has a low capital/labor ratio or transitory
negative shock, a large CAD can be optimal. In practice: Developing
countries with big CADs often get into trouble. Traditional rule of
thumb: CAD > approx. 4% GDP is a danger signal Lawson Fallacy --
CAD not dangerous if government budget is balanced, so borrowing
goes to finance private sector, rather than BD. Amendment after
Mexico crisis of 1994 CAD not dangerous if BD=0 and S is high, so
the borrowing goes to finance private I, rather than BD or C.
Amendment after East Asia crisis of 1997 CAD not dangerous if BD=0,
S is high, and I is well-allocated, so the borrowing goes to
finance high-return I, rather than BD or C or empty beach-front
condos (Thailand) & unneeded steel companies (Korea). Amendment
after Global Financial Crisis of 2008-13 CAD dangerous.
Slide 25
IMF Survey Magazine Oct.8, 2009 Did Foreign Reserves Help
Weather the Crisis? by O. Blanchard, H.Faruqee, & V.Klyuev
http://www.imf.org/external/pubs/ft /survey/so/2009/num100809a.htm
The IMF and Rose & Spiegel (2009) found that countries with
more reserves were not less affected by the 2008-09 crisis: But
Frankel & Saravelos (2012) and Dominguez & Ito (2012) find
they were.
Slide 26
Appendix 6: EM conditions in 2014
Slide 27
EM stocks fell on fears of higher US interest rates in May-June
2013 & again in January 2014 Source: FT
Slide 28
EMs have had to pay higher interest rates since the taper
tantrum of 2013, but conditions eased a bit after April 2014. From
IMF WEO: Legacies, Clouds, Uncertainties, Oct. 2014.
Slide 29
Asia is still doing pretty well. From IMF WEO: Legacies,
Clouds, Uncertainties, Oct. 2014.
Slide 30
Capital flows recovered after the taper tantrum. From IMF WEO:
Legacies, Clouds, Uncertainties, Oct. 2014.