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Juan Yepez
Dutch disease is often referred as a situation in which large and sustained foreign currency inflows lead to a contraction of the tradable sector by giving rise to a real appreciation of the home currency. This paper documents that this syndrome has been witnessed by many emerging markets and developing economies (EMDEs) as a result of surges in capital inflows driven by accommodative U. S. monetary policy. In a sample of 25 EMDEs from 2000-17, U. S. monetary policy shocks coincided with episodes of currency appreciation and a contraction in tradable output in these economies. The paper also shows empirically that the use of capital flow measures (CFMs) has been a common policy response in several EMDEs to U.S. monetary policy shocks. Against this background, the paper presents a two sector small open economy augmented with a learning-by-doing (LBD) mechanism in the tradable sector to rationalize these empirical findings. A welfare analysis provides a rationale for the use of CFMs as a second-best policy when agents do not internalize the LBD externality of costly resource misallocation as a result of greater capital inflows. However, the adequate calibration of CFMs and the quantification of the LBD externality represent important implementation challenges.
Mr. Francisco Roch and Francisco Roldán
We analyze how concerns for model misspecification on the part of international lenders affect the desirability of issuing state-contingent debt instruments in a standard sovereign default model à la Eaton and Gersovitz (1981). We show that for the commonly used threshold state-contingent bond structure (e.g., the GDP-linked bond issued by Argentina in 2005), the model with robustness generates ambiguity premia in bond spreads that can explain most of what the literature has labeled as novelty premium. While the government would be better off with this bond when facing rational expectations lenders, this additional source of premia leads to welfare losses when facing robust lenders. Finally, we characterize the optimal design of the state-contingent bond and show how it varies with the level of robustness. Our findings rationalize the little use of these instruments in practice and shed light on their optimal design.
Natalie Chen and Luciana Juvenal
We investigate theoretically and empirically how exporters adjust their markups across destinations depending on bilateral distance, tariffs, and the quality of their exports. Under the assumption that trade costs are both ad valorem and per unit, our model predicts that markups rise with distance and fall with tariffs, but these effects are heterogeneous and are smaller in magnitude for higher quality exports. We find strong support for the predictions of the model using a unique data set of Argentinean firm-level wine exports combined with experts wine ratings as a measure of quality.
Mr. Sonali Das and Mr. Volodymyr Tulin
This paper studies private investment in India against the backdrop of a significant investment decline over the past decade. We analyze the potential causes of weaker investment at the firm level, using both firm-level financial statements and a novel dataset on firms’ investment project decisions, and find that financial frictions have played a role in the slowdown. Firms with higher financial leverage invest less, as do firms with lower earnings relative to their interest expenses. Consistent with the notion of credit constraints leading to pro-cyclical investment, we also find that firms with higher leverage are (i) less likely to undertake new investment projects, (ii) less likely to complete investment projects once begun, and (iii) undertake shorter-term investment projects.
Mr. Sébastien Walker
This paper develops a Dynamic Stochastic General Equilibrium (DSGE) model with a financial accelerator which captures key features of low-income countries (LICs). The predominance of supply shocks in LICs poses distinct challenges for policymakers, given the negative correlation between inflation and the output gap in the case of supply shocks. Our results suggest that: (1) in the face of a supply-side shock, the most desirable interest rate rule involves simply targeting current inflation and smoothing the policy interest rate; and (2) ignoring financial frictions when evaluating policy rules can be particularly problematic in LICs, where financial frictions loom especially large.