Formulating a Policy Response Comment on Calvo, Leiderman, and Reinhart

This paper uses microeconomic panel data to examine differences in the cyclical variability of employment, hours, and real wages for skilled and unskilled workers. Contrary to conventional wisdom, it finds that, at the aggregate level, skilled and unskilled workers are subject to the same degree of cyclical variation in wages. However, the quality of labor input is found to rise in recessions, inducing a countercyclical bias in aggregate measures of the real wage. The paper also finds substantial differences across industries in the cyclical variation of employment, hours, and wage differentials, indicating important interindustry differences in labor contracting.

Abstract

This paper uses microeconomic panel data to examine differences in the cyclical variability of employment, hours, and real wages for skilled and unskilled workers. Contrary to conventional wisdom, it finds that, at the aggregate level, skilled and unskilled workers are subject to the same degree of cyclical variation in wages. However, the quality of labor input is found to rise in recessions, inducing a countercyclical bias in aggregate measures of the real wage. The paper also finds substantial differences across industries in the cyclical variation of employment, hours, and wage differentials, indicating important interindustry differences in labor contracting.

Following their examination of the role of external factors in the revival of international capital inflows to Latin America, Calvo, Leiderman, and Reinhart (CLR) review the policy responses available to governments,1 While acknowledging the contribution of improved economic performance, their focus on exogenous influences leads them to concentrate on the dangers of “excessive” influxes of short-term funds. With market failures quite able to generate the excess, the dangers of real exchange rate appreciation, poor intermediation of large-scale flows, and the threat of rapid reversal are clear. From this perspective, CLR examine different policy options for their effectiveness either in limiting the inflows or in neutralizing their effects.

This note argues that the policies discussed are misleadingly treated as alternatives when, owing to substantial differences in principle, their appropriate application would be to very different policy objectives. It is suggested here that if recipient economies are to benefit from the inflows, while managing the risks that preoccupy CLR, a sequence or combination of policies may need to be applied.

Beginning with the problem of “excessive” inflows induced by market failure, those failures associated with variable government credibility in the context of counterinflationary policy may be usefully singled out. Lack of confidence in the durability of contractionary monetary policies may prevent rapid downward adjustment in domestic wages and prices. The resulting high short-term interest rates, however, may attract speculative inflows based on the judgment that, at least temporarily, the exchange rate will be maintained. Whatever their detailed merits, two of the policies discussed by CLR would be relevant in helping to sustain domestic monetary targets under these circumstances: a tax on short-term capital inflows and sterilized intervention. While also helping to defend monetary targets, a rise in marginal bank reserve requirements against short-term foreign deposits would probably better address prudential concerns in view of the likely disintermediation noted by CLR.

With counterinflationary credibility at issue, the employment of “trade” policies and nonsterilized intervention would clearly be inappropriate. Time-limited simultaneous export subsidies and import duties amount to a “temporary” devaluation relying on confidence that prices will fall (when the policy is reversed) to attenuate the more usual inflationary impulse. Nonsterilized intervention would, as CLR also note, directly undermine domestic monetary policy targets. The possible relevance of these options must therefore arise when domestic counterinflationary policy (high short-term interest rates) is not thought to be the primary stimulus to the inflows.

In contrast with the taxation of short-term inflows and sterilization, a characteristic of trade measures and nonsterilized intervention is that they do not seek to limit the flows or to prevent them from influencing the domestic money supply. They reflect instead a prior concern with exchange rates—real in the context of trade taxes and nominal in the case of nonsterilization. While these approaches would not be the natural choice to support domestic counterinflationary policy, when might an exchange rate objective be appropriate in the context of resurgent capital inflows?

If a significant part of the inflows reflect a rational response to improving regional prospects, the interpretation of, and response to, real exchange rate developments becomes a central issue. With large-scale investment opportunities in the production of tradables being unleashed by policy reform, it is still likely that nontradables will be involved in the investment expenditures. The rising relative price of the latter will reflect limited absorptive capacity (acting to slow the appropriate pace of tradables investment, despite the underlying opportunities) and provide the incentive for some further investment in nontradable capacity. By this interpretation, an attempt to prevent real appreciation would be damaging to long-term development. In the context of fixed exchange rates, nonsterilized intervention would be consistent with this pattern whereas trade measures would not.

The real appreciation that may be justified on these grounds will be difficult in practice to distinguish from that induced by excessive inflows. Nevertheless, the discussion provides some pointers. Although “justified” real appreciation would give rise to an increased share of investment in nontradables, the level of investment spending in tradables (such as manufacturing) would be expected to remain strong on the basis of long-term prospects. Collapsing profitability in the sector together with declining investment intentions would not be anticipated.

These observations suggest that a degree of explicit exchange rate policy conditionality may be usefully developed by capital-importing countries. The development and publication of indicators related to manufacturing profitability and investment trends could be applied to this end. An announcement that the indicators would be used to guide exchange rate policy, while encouraging fundamentals-based inflows, would tend to discourage speculation arising from a fixed nominal rate. In the context of a floating regime, the proposal would amount to making monetary policy sensitive to overappreciation of the real exchange rate. Since some real appreciation would still be anticipated in connection with the capital inflow, a key advantage of floating rates over (fixed-rate) nonsterilized intervention, as noted by CLR, would be the reduced risk of rekindling domestic inflation. It would also permit a more flexible response to unwelcome appreciation than the occasional application of trade taxes in a fixed-rate context.

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P. Nicholas Snowden is a Senior Lecturer in economics at the Management School, Lancaster University.

1

Staff Papers, International Monetary Fund, Vol. 40 (March 1993), pp. 108–51.