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)| false Fostel, Ana, and Graciela L. Kaminsky, 2007, “ Latin America’s Access to International Capital Markets: Good Behavior or Global Liquidity?” In Current Account and External Financing, ed. Kevin Cowan, Sebastian Edwards, and Rodrigo Valdes. Central Bank of Chile.
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The author thanks Menzie Chinn, Stijn Claessens, Julian di Giovanni, Christian Echeverria, Anna Ivanova, Bin Li, Martin Muhleisen, Pau Rabanal, Alessandro Rebucci, David Romer, Ken Singleton, Camilo Tovar, and seminar participants at IADB, IMF and Banco Central de Chile for comments and discussions.
Another thread of literature is now focusing on the effect of time varying risk or uncertainty. Bloom, Floetotto, and Jaimovich (2009) study the implication of changing uncertainty to business cycle. Their measure of uncertainty is correlated with VIX. Pan and Singleton shows their risk premium is indeed correlated with VIX. In this sense, my paper evaluates an impact of changing uncertainty or risk premium on emerging markets.2
This paper does not address another interesting issue: how does liquidity in one market affect the other? One reason that I do not answer this question is that VIX and the growth rate of the worldwide international reserves are not highly correlated.
The two aspects of liquidity are interrelated and in some case, it may be necessary to take such interrelations into account. For example, Brunnermeier and Pedersen (2009) study the interaction between market liquidity and funding liquidity. I abstract from such interrelations in this paper for simplicity.
For example, Kim (2001) and Craine and Vance (2008). Miniane and Rogers (2007) consider the effect of capital controls on the international transmission of U.S. money shocks. di Giovanni and Shambaugh (2008) find that the effects of external interest rate shocks depend crucially on the exchange rate regime.
Other papers investigating the effect of external shocks to Latin American economies include Österholm and Zettelmeyer (2007) and Izquierdo, Romero and Talvi (2008). Their focus is on the effect of economic growth rather than transmission mechanism.
With slightly different perspective, Fostel and Kaminsky (2007) study the effect of global liquidity as a determinant of international capital market access among emerging economies.
See also Jeanne (2009) for theoretical model of global liquidity trap.
For example, leverage (see Fostel and Geanakoplos(2008) for the review of literature on leverages) may be one way to link.
To see this, denote
See Alvarez, Atkeson, and Kehoe (2007), for interpretation of risk premium defined in this manner.
In a developed country, the private sector or riskier sectors benefit from lower risk premium. This would also enhance the output growth of small open economy through equation (1).
The result based on U.S. t-bill rate as an alternative measure is available from the author. In sum, it is hard to identify the liquidity shock in a simple structure adopted in this paper with the U.S. t-bill rate. As a result, U.S. t-bill rate works poorly as a global liquidity variable.
I also use G7 weighted average of TED spread (between T-bill and Euro Deposit) as a potential measures. Some results are presented in the paper but detailed results are available from the author.
Typically, exogeneity can be rejected around 5%-10% for most cases.
By construction, reordering should not affect impulse response of domestic variables to global liquidity shocks at all.
I use ‘positive’ for increase of international reserves and lower VIX as these indicate ‘positive’ or favorable economic conditions. Figure 2 shows the movement of these shocks. Table 4 shows correlations among them.
Confidence intervals drawn in the figures are 60% and 80% bootstrapped intervals.
Figures that contain different variables as well as matlab programs are available from the author. Figures in this paper are best viewed in color. Note that the change in orders of domestic variables should not affect the impulse response from global liquidity shocks at all thanks to the exogenous assumption.
Note that Chile also has fiscal rules that stabilize its economy.