We analyze a union of financially-integrated yet politically-sovereign countries, where
households in the Northern core of the union lend to those in the Southern periphery in a unified
debt market subject to a borrowing constraint. This constraint generates sudden stops throughout
the South, depresses the intra-union interest rate, and reduces Northern welfare below its
unconstrained level, while having ambiguous effects on Southern welfare. During sudden stops,
Pareto improvements can be achieved using North-to-South governmental loans if Southern
governments have the capacity to commit to repay, or using a combination of Southern debt
relief and budget-neutral taxes and subsidies if they do not. From the pre-crisis perspective, it is
Pareto-improving to allow loans and debt relief to be negotiated in later sudden-stop periods as
long as the regions in the union are sufficiently heterogeneous to begin with. We show that our
results are robust to production and to limited financial openness of the union.
A speech delivered by the IMF's Managing Director Christine Lagarde at the German Institute for Economic Research (DIW) as part of the Institute's Europe Lecture Series in Berlin, Germany, on March 26, 2018.
This paper empirically investigates international and domestic monetary policy
transmission mechanisms in the Eastern Caribbean Currency Union (ECCU). We assess
interest rate pass-through of both the U.S. policy rate and the ECCU minimum saving
deposit rate (MSR) into domestic interest rates through the interest rate channel. While
economic theory suggests that the international pass-through should be high in small open
economies with fixed exchange rates and open capital accounts, our findings, based on
regression analysis, point to a low long-run pass-through coefficient of the U.S. interest
rate. The domestic transmission channel, however, is found to operate through changes in
the MSR. The results hold for different interest rates (deposit and lending) and are
supported by survey-based findings.
This paper analyses the nature of the increasing regionalization process in global banking.
Despite the large decline in aggregate cross-border banking lending volumes, some parts
of the global banking network are currently more interlinked regionally than before the
Global Financial Crisis. After developing a simple theoretical model capturing banks'
internationalization decisions, our estimation shows that this regionalization trend is
present even after controlling for traditional gravitational variables (e.g. distance,
language, legal system, etc.), especially among lenders in EMs and non-core banking
systems, such as Australia, Canada, Hong Kong, and Singapore. Moreover, this
regionalization trend was present before the GFC, but it has increased since then, and it
seems to be associated with regulatory variables and the opportunities created by the
retrenchment of several European lenders.
Mr. Helge Berger, Mr. Giovanni Dell'Ariccia, and Mr. Maurice Obstfeld
The paper makes an analytical contribution to the revived discussion about the euro area’s institutional setup. After significant progress during the euro crisis, the drive to complete Europe’s Economic and Monetary Union (EMU) had stalled, and the way forward will benefit from an in-depth look at the conceptual issues raised by the evolution and architecture of Europe, and the tradeoffs involved. A thorough look at the underlying economic issues suggests that in the long run, EMU will benefit from progressing along three mutually supporting tracks: introduce more fiscal risk sharing, helping to make the sovereign “no bailout” rule credible; complementary financial sector reforms to delink sovereigns and banks; and more effective rules to discourage moral hazard. This evolution would ensure that financial markets provide incentives for fiscal discipline. Introducing more fiscal union comes with myriad legal, technical, operational, and political problems, raising questions well beyond the remit of economics. But without decisive progress to foster fiscal risk sharing, EMU will continue to face existential risks.
Mr. Seung M Choi, Ms. Laura E. Kodres, and Jing Lu
This paper examines whether the coordinated use of macroprudential policies can help
lessen the incidence of banking crises. It is well-known that rapid domestic credit growth
and house price growth positively influence the chances of a banking crisis. As well, a
crisis in other countries with high trade and financial linkages raises the crisis probability.
However, whether such “contagion effects” can operate to reduce crisis probabilities when
highly linked countries execute macroprudential policies together has not been fully
explored. A dataset documenting countries’ use of macroprudential tools suggests that a
“coordinated” implementation of macroprudential policies across highly-linked countries
can help to stem the risks of widespread banking crises, although this positive effect may
take some time to materialize.
Mr. Luis Catão, Valeriya Dinger, and Daniel Marcel te Kaat
Using a sample of over 700 banks in Latin America, we show that international financial liberalization lowers bank capital ratios and increases the shares of short-term funding. Following liberalization, large banks substitute interbank borrowing for equity and long-term funding, whereas small banks increase the proportions of retail funding in their liabilities, which have been particularly vulnerable to flight-to-quality during periods of financial distress in much of Latin America. We also find evidence that riskier bank funding in the aftermath of financial liberalizations is exacerbated by asymmetric information, which rises on geographical distance and the opacity of balance sheets.
There have been numerous books examining the 2008 financial crisis from either a U.S. or European perspective. Tamim Bayoumi is the first to explain how the Euro crisis and U.S. housing crash were, in fact, parasitically intertwined.
Starting in the 1980s, Bayoumi outlines the cumulative policy errors that undermined the stability of both the European and U.S. financial sectors, highlighting the catalytic role played by European mega banks that exploited lax regulation to expand into the U.S. market and financed unsustainable bubbles on both continents. U.S. banks increasingly sold sub-par loans to under-regulated European and U.S. shadow banks and, when the bubbles burst, the losses whipsawed back to the core of the European banking system. A much-needed, fresh look at the origins of the crisis, Bayoumi’s analysis concludes that policy makers are ignorant of what still needs to be done both to complete the cleanup and to prevent future crises.