Abstract
The IMF Research Bulletin, a quarterly publication, selectively summarizes research and analytical work done by various departments at the IMF, and also provides a listing of research documents and other research-related activities, including conferences and seminars. The Bulletin is intended to serve as a summary guide to research done at the IMF on various topics, and to provide a better perspective on the analytical underpinnings of the IMF’s operational work.
The financial crises of the 1990s have intensified interest in understanding the role of financial frictions in the propagation of shocks and their impact on investment and output. Recently developed models emphasize that by affecting their net worth or collateral, shocks to balance sheets have significant effects on firms’ ability to borrow and banks’ ability to lend. IMF researchers have focused on the implications of such balance sheet channels for emerging markets. Two important sources of shocks to balance sheets in emerging markets are large exchange rate swings and fluctuations in real estate values.
Models of the interaction between macroeconomics and finance—such as Bernanke and Gertler’s (1989) financial accelerator model—have strongly influenced the way economists think about the propagation of shocks, and IMF researchers have sought to incorporate their insights into models of emerging market crises.1 Building on various existing models, Jeanne and Zettelmeyer (2002) derive a stylized framework to analyze currency crises.2 The common theme is that currency and maturity mismatches in private sector balance sheets constrain the capacity of macroeconomic policies to deal with self-fulfilling capital account crises, generating a role for international lending. Christiano, Gust, and Roldós (forthcoming) discuss economic policies during crises in open economy models with collateral constraints: they find that the desirability of interest rate cuts during crises depends on the degree of short-term flexibility in the economy.3 Disyatat (2001) develops a model in which countries with healthy banks are less likely to suffer a contraction following an unexpected depreciation.4 Céspedes, Chang, and Velasco (2000, 2002) formalize the trade-offs faced by the monetary and exchange rate policy authorities in the presence of foreign-currency liabilities.5 In a dynamic general equilibrium model, Choi and Cook (2002) show that a fixed exchange rate rule stabilizing bank balance sheets is preferable to an interest rate rule targeting inflation.6 Catão and Rodriguez (2000) explore credit channel mechanisms in an economy where the nontradables sector is dependent on bank credit.7 Allen and others (2002) extensively review sources of balance sheet vulnerabilities and their implications for surveillance and policies.8
IMF researchers have pursued theoretical and empirical approaches to understanding the role of currency mismatches. Why do companies in emerging markets borrow in foreign currency? Jeanne (2000) discusses two different but related possibilities. In one explanation, dollar debt is more risky, but good entrepreneurs use it to signal their type. In the other, dollar debt is a commitment device: entrepreneurs can commit to high effort levels by using dollar debt, which reduces the likelihood that they will be bailed out by the government through exchange rate policy.9 More recently, Jeanne (2002) argues that monetary policy credibility lies at the heart of the problem: in an environment with high monetary policy variance, borrowing in dollars may minimize the probability of default from a company’s perspective.10 Using data on Mexican companies, Gelos (2003) finds that a firm’s share of foreign-currency-denominated debt in total debt is positively correlated with its own size and firm-level imports and exports; in contrast to the predictions of the signaling hypothesis, companies with more dollar debt are less profitable on average.11
What incentives do banks have to borrow and lend in foreign currency? Ize and Levy-Yeyati (forthcoming) develop a model of financial intermediation in which currency choice is determined by hedging decisions on both sides of a bank’s balance sheet. Dollarization depends on the relative volatilities of inflation and real depreciation.12 Similarly, Catão and Terrones (2000) present a banking model where the extent to which banks choose to lend in dollars depends on devaluation risk, foreign interest rates, the availability of tradable collateral, and credit market structure.13 Barajas and Morales (2003) investigate empirically the determinants of dollarization in 14 Latin American banking systems.14 They report that net dollarization (foreign currency deposits minus foreign currency liabilities) is associated with central bank intervention in the foreign exchange market and the market power of borrowers.
The impact of devaluations on companies’ balance sheets and investment has recently begun to be examined systematically. Investigation of balance sheet effects typically requires microeconomic data, and empirical work using such databases has become increasingly widespread among IMF economists.15 Rodriguez (2002) investigates the effects of the 1997 Thai devaluation on firm-level investment, finding significant balance sheet effects.16 By contrast, in a paper on devaluation expectations, Becker, Gelos, and Richards (2002) document that while the stock market clearly distinguished between exporting and importing firms, exposure to foreign currency debt had no effect on abnormal returns around the Mexican devaluation.17 Similarly, using enterprise-level data, Borensztein and Lee (2002) fail to find evidence for a generalized credit crunch after the Korean financial crisis; rather, the crisis seems to have provoked a lending reallocation toward more efficient firms.18
Research has also focused on the role of fluctuations in the nontraded sector (in particular, real estate) and ensuing balance sheet effects. Drawing on a panel of Mexican firms, Gelos and Werner (2002) find that investment is strongly associated with the share of real estate (often used as collateral) in total fixed capital, and that having real estate became perhaps even more important after financial liberalization.19 Collyns and Senhadji (2002) investigate the link between lending booms, asset price cycles, and financial crises across East Asian countries, providing evidence of a strong relationship between bank lending and asset price inflation. While asset price bubbles seem to have been present in most of the Asian crisis countries, the effect of their subsequent bust was related to the strength of bank regulation.20 Hilbers, Lei, and Zacho (2001) discuss links between the real estate and the financial sectors. They examine 11 banking crises, documenting that they were all preceded by a sharp increase and followed by a subsequent decline in real estate prices.21
This brief review highlights a significant evolution in the way IMF economists think and conduct research on emerging market vulnerabilities. As the key lessons from theory are distilled, additional microeconomic balance sheet data become available, and the profession continues to learn from the experience of recent crises, further progress can be expected on this front.
Books from the IMF
China: Competing in the Global Economy
Edited by Wanda Tseng and Markus Rodlauer
Since the start of reforms in 1978, China has enjoyed visible success in growth and economic transformation. Real income per capita has increased fivefold, more than 200 million people have been lifted out of poverty, and the country was able to weather the Asian financial crisis relatively unscathed. The key task facing policymakers in China today is how to sustain the rate of the economy’s growth and development while spreading the benefits more widely across society.
China: Competing in the Global Economy highlights the major factors responsible for China’s strong performance, and lays out the key items on the remaining reform agenda. The book focuses on four broad areas: China’s growth dynamics, macroeconomic stability, state-owned enterprise (SOE) and banking sector reform, and global integration. It emphasizes the interlink-ages among the banks, the SOEs, and the public finances, and argues that structural reforms in these sectors should continue. China’s WTO accession is viewed as a potential watershed for this reform process.
The book reflects the analysis prepared by the IMF staff working on China under the direction of Wanda Tseng. The team of authors was led by Markus Rodlauer and David Robinson and included Thomas Dorsey, Jahangir Aziz, Paul Heytens, Christoph Duenwald, Paul Gruenwald, Thomas Richardson, Raju Singh, George Tsibouris, Harm Zebregs, James Daniel, Cem Karacadag, Nicholas Blancher, and Yongzheng Yang.
Full-text versions (or, in some cases, detailed summaries) of books published by the IMF are available online at http://www.imf.org/publications.
Ben Bernanke and Mark Gertler, “Agency Costs, Net Worth, and Business Fluctuations,” American Economic Review, Vol. 79 (March 1989), pp. 15–31.
Olivier Jeanne and Jeromin Zettelmeyer, “‘Original Sin,’ Balance Sheet Crises, and the Roles of International Lending,” IMF Working Paper 02/234, 2002.
Lawrence J. Christiano, Christopher Gust, and Jorge Roldós, “Monetary Policy in a Financial Crisis,” Journal of Economic Theory, forthcoming (also issued as NBER Working Paper No. 9005, 2002).
Piti Disyatat, “Currency Crises and the Real Economy: The Role of Banks,” IMF Working Paper 01/49, 2001.
Luis Felipe Céspedes, Roberto Chang, and Andrés Velasco, “IS-LM-BP in the Pampas,” paper presented at the Third Annual Research Conference, IMF, 2002. See also idem, “Balance Sheets and Exchange Rate Policy,” NBER Working Paper No. 7840, 2000.
Woon Gyu Choi and David Cook, “Liability Dollarization and the Bank Balance Sheet Channel,” IMF Working Paper 02/141, 2002.
Luis Catão and Sergio Rodriguez, “Bank and Monetary Shocks in Emerging Markets: How Far Can We Go with the ‘Credit View’?” IMF Working Paper 00/68, 2000.
Mark Allen, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini, “A Balance Sheet Approach to Financial Crises,” IMF Working Paper 02/210, 2002. On the empirical side, there is some evidence that corporate sector balance sheet weaknesses help predict the probability of crises. See Mark R. Stone and Melvyn Weeks, “Systemic Financial Crises, Balance Sheets, and Model Uncertainty,” IMF Working Paper 01/162, 2001; Christian Mulder, Roberto Perrelli, and Manuel Rocha, “The Role of Corporate, Legal and Macroeconomic Balance Sheet Indicators in Crisis Detection and Prevention,” IMF Working Paper 02/59, 2002.
Olivier Jeanne, “Foreign Currency Debt and the Global Financial Architecture,” European Economic Review Papers and Proceedings, Vol. 44 (May 2000), pp. 719–27.
Olivier Jeanne, “Why Do Emerging Economies Borrow in Foreign Currency?” (unpublished; Washington: IMF, 2002).
R. Gaston Gelos, “Foreign Currency Debt in Emerging Markets: Firm-Level Evidence from Mexico,” Economics Letters, Vol. 78 (March 2003), pp. 323–27.
Alain Ize and Eduardo Levy-Yeyati, “Dollarization of Financial Intermediation: Causes and Policy Implications,” IMF Working Paper 98/28, 1998 (forthcoming in the Journal of International Economics).
Luis Catão and Marco Terrones, “Determinants of Dollarization—The Banking Side,” IMF Working Paper 00/146, 2000.
Adolfo Barajas and R. Armando Morales, “Dollarization of Liabilities: Beyond the Usual Suspects,” IMF Working Paper 03/11, 2003.
The use of financial derivatives may substantially complicate the measurement of vulnerabilities. See Peter Breuer, “Measuring Off-Balance-Sheet Leverage,” IMF Working Paper 00/202, 2000.
Pedro Rodríguez, “On the Impact of Devaluations on Investment: The Role of Currency Mismatches” (unpublished; Washington: IMF, 2002).
Torbjörn Becker, R. Gaston Gelos, and Anthony Richards, “Devaluation Expectations and the Stock Market—The Case of Mexico in 1994/95,” IMF Working Paper 00/28, 2000 (also published in International Journal of Finance and Economics, Vol. 7 (July 2002), pp. 195–214).
Eduardo Borensztein and Jong-Wha Lee, “Financial Crisis and Credit Crunch in Korea: Evidence from Firm-Level Data,” IMF Working Paper 00/25, 2000 (also published in Journal of Monetary Economics, Vol. 49 (May 2002), pp. 853–75).
R. Gaston Gelos and Alejandro Werner, “Financial Liberalization, Credit Constraints, and Collateral: Investment in the Mexican Manufacturing Sector,” IMF Working Paper 99/25, 1999 (also published in the Journal of Development Economics, Vol. 67 (February 2002), pp. 1–27). Sancak (2002) examines the impact of the Turkish financial liberalization on firm-level financial constraints, finding mixed effects. See Cemile Sancak, “Financial Liberalization and Real Investment: Evidence from Turkish Firms,” IMF Working Paper 02/100, 2002.
Charles Collyns and Abdelhak Senhadji, “Lending Booms, Real Estate Bubbles, and the Asian Crisis,” IMF Working Paper 02/29, 2002.
Paul Hilbers, Quin Lei, and Lisbeth Zacho, “Real Estate Market Developments and Financial Sector Soundness,” IMF Working Paper 01/129, 2001.