International Transmission of Japanese Monetary Shocks Under Low and Negative Interest Rates: A FAVAR Approach
Forthcoming in Pacific Economic Review | With Tai
We examine the implications of Japanese monetary shocks under recent very low and sometimes negative interest rates to the Japanese economy and three of its major trading partners: Korea, China and the United States. In particular, we examine the impli-
cations of shocks to the 2-year JGB rate in a series of factor-augmented vector autoregressive — or FAVAR — models, in which both local and global conditions are proxied by latent factors generated from domestic economic indicators and weighted indicators of major trading partners, respectively. Our results suggest that shocks to 2-year JGB rates have substantive impacts on Japanese economic activity and inflation in conditions of low or even negative short-term rates. However, we find only modest global spillovers from Japanese monetary policy shocks compared to innovations in 2-year U.S. Treasury yields over the same period.
Forthcoming in International Journal of Central Banking | With Rose
We explore the relationship between inflation and the existence of a local domestic‐currency bond market. Domestic bond markets allow governments to inflate away their debt obligations, but also create a potential anti-inflationary force of bond holders. We develop a simple model where bond issuance may lead to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically, finding that inflation‐targeting countries with bond markets experience inflation approximately three to four percentage points lower than those without. This effect is insensitive to a variety of estimation strategies and methods to account for potential endogeneity.
Journal of International Money and Finance 74, June 2017, 353-370 | With Liu and Tai
Exchange rate shocks have mixed effects on economic activity in both theory and empirical
VAR models. In this paper, we extend the empirical literature by considering the implications
of a positive shock to the U.S. dollar in a factor-augmented vector autoregression
(FAVAR) model for the U.S. and three large Asian economies: Korea, Japan and China. The
FAVAR framework allows us to represent a country’s aggregate economic activity by a latent
factor, generated from a broad set of underlying observable economic indicators. To control
for global conditions, we also include in the FAVAR a ‘‘global conditions index,” which is
another latent factor generated from the economic indicators of major trading partners.
We find that a dollar appreciation shock reduces economic activity and inflation not only
for the U.S. economy, but also for all three Asian economies. This result, which is robust
to a number of alternative specifications, suggests that in spite of their disparate economic
structures and policy regimes, the dollar appreciation shock affects the Asian economies primarily through its impact on U.S. aggregate demand; and this demand channel dominates
the expenditure-switching channel that affects a country’s export competitiveness.
Journal of Monetary Economics 74, September 2015, 1-15 | With Chang and Liu
China’s external policies, including capital controls, managed exchange rates, and sterilized interventions, constrain its monetary policy options for maintaining macro-
economic stability following external shocks. We study optimal monetary policy in a dynamic stochastic general equilibrium (DSGE) model that incorporates these “Chinese characteristics”. The model highlights a monetary policy tradeoff between domestic price stability and costly sterilization. The same DSGE framework allows us to evaluate the welfare implications of alternative liberalization policies. Capital account and exchange rate liberalization would have allowed the Chinese central bank to better stabilize the
external shocks experienced during the global financial crisis.
IMF Economic Review 63, September 2015, 298-324 | With Liu
Declines in interest rates in advanced economies during the global financial crisis resulted in surges in capital flows to emerging market economies and triggered advocacy of capital control policies. The paper evaluates the effectiveness for macroeconomic stabilization and the welfare implications of the use of capital account policies in a monetary DSGE model of a small open economy. The model features incomplete markets, imperfect asset substitutability, and nominal rigidities. In this environment, policymakers can respond to fluctuations in capital flows through capital account policies such as sterilized interventions and taxing capital inflows, in addition to conventional monetary policy. The welfare analysis suggests that optimal sterilization and capital controls are complementary policies.
Journal of International Money and Finance, July 2014 | With Fernald and Swanson
We use a broad set of Chinese economic indicators and a dynamic factor model framework to estimate Chinese economic activity and inflation as latent variables. We incorporate these latent variables into a factor-augmented vector autoregression (FAVAR) to estimate the effects of Chinese monetary policy on the Chinese economy. A FAVAR approach is particularly well-suited to this analysis due to concerns about Chinese data quality, a lack of a long history for many series, and the rapid institutional and structural changes that China has undergone. We find that increases in bank reserve requirements reduce economic activity and inflation, consistent with previous studies. In contrast to much of the literature, however, we find that changes in Chinese interest rates also have substantial impacts on economic activity and inflation, while other measures of changes in credit conditions, such as shocks to M2 or lending levels, do not once other policy variables are taken into account. Overall, our results indicate that the monetary policy transmission channels in China have moved closer to those of Western market economies.
Journal of Money, Credit and Banking 46, 2014, 445-468 | With Lopez
We examine the impact of foreign underwriting activity on bond markets using issuelevel data in the Japanese “Samurai” and euro-yen bond markets. Firms choosing Japanese underwriters tend to be Japanese, riskier, and smaller. We find that Japanese underwriting fees, while higher overall on average, are actually lower after conditioning for issuer characteristics. Moreover, firms tend to sort properly in their choice of underwriter, in the sense that a switch in underwriter nationality would be predicted to result in an increase in underwriting fees. Finally, we conduct a matching exercise to examine the 1995 liberalization of foreign access to the “Samurai” bond market, using yen-denominated issues in the euro-yen market as a control. Foreign entry led to a statistically and economically significant decrease in underwriting fees in the Samurai bond market, as spreads fell by an average of 23 basis points. Overall, our results suggest that the market for underwriting services is partially segmented by nationality, as issuers appear to have preferred habitats, but entry increases market competition.
Is Asia Decoupling from the United States (Again)?
Pacific Economic Review 18(3), August 2013, 345-369 | With Leduc
The recovery from the recent global financial crisis exhibited a decline in the synchronization of Asian output with the rest of the world. However, a simple model based on output gaps demonstrates that the decline in business cycle synchronization during the recovery from the global financial crisis was exceptionally steep by historical standards. We posit two potential reasons for this exceptionally steep decline. First, financial markets during this recovery improved from particularly distressed conditions relative to previous downturns. Second, monetary policy during the recovery from the crisis was constrained in developed economies by the zero bound, but less so in Asia. To test these potential explanations, we examine the implications of an increase in corporate bond spreads similar to that which took place during the recent European financial crisis in a three-region open-economy dynamic stochastic general equilibrium model. Our results confirm that global business cycle synchronization is reduced when zero-bound constraints across the world differ. However, we find that the impact of reduced financial contagion actually goes modestly against our predictions.
Income and Democracy: Evidence from Nonlinear Estimations.
188(3), March 2013, 489-492 | With Benhabib and Corvalan
We test the relation between income and democracy during the postwar period. We employ panel estimation methods that explicitly allow for the fact that the primary measures of democracy are censored with substantial mass at the boundaries. We find that the statistically significant positive
income–democracy relationship is robust to the inclusion of country fixed effects.
Journal of International Economics 88(2), November 2012, 326-340 | With Rose
While the global financial crisis was centered in the United States, it led to a surprising appreciation in the dollar, suggesting global dollar illiquidity. In response, the Federal Reserve partnered with other central banks to inject dollars into the international financial system. Empirical studies of the success of these efforts have yielded mixed results, in part because their timing is likely to be endogenous. In this paper, we examine the cross-sectional impact of these interventions. Theory consistent with dollar appreciation in the crisis suggests that their impact should be greater for countries that have greater exposure to the United States through trade and financial channels, less transparent holdings of dollar assets, and greater illiquidity difficulties. We examine these predictions for observed cross-sectional changes in CDS spreads, using a new proxy for innovations in perceived changes in sovereign risk based upon Google-search data. We find robust evidence that auctions of dollar assets by foreign central banks disproportionately benefited countries that were more exposed to the United States through either trade linkages or asset exposure. We obtain weaker results for differences in asset transparency or illiquidity. However, several of the important announcements concerning the international swap programs disproportionately benefited countries exhibiting greater asset opaqueness.
Currency Composition of International Bonds: The EMU Effect
Journal of International Economics 88(1), September 2012, 134-149 | With Hale
We analyze the impact that the launch of the EMU had on the currency denomination of private international bond issues in 1990-2006 using micro-level data. Our stylized model predicts that the introduction of the euro would lead to an increase in the share of euro-denominated debt and a decline in the share of dollar-denominated debt issued by firms located in countries outside both the United States and the euro area. Moreover, our model predicts that the euro effect would be particularly pronounced for nonfinancial firms. Our empirical
results are consistent with these predictions. In addition, we
find that among nonfinancial firms, the impact on new issuers is larger than on seasoned issuers. Extending the model to allow for differences in issuance volumes across future monetary union countries prior to integration, we also predict larger increases in euro-denominated issuance among firms from smaller monetary union countries. We confirm this prediction for international bond issues by euro-area firms.
Central Bank Swaps and International Dollar Illiquidity
Global Journal of Economics 1(1), June 2012, 1-20 | With Rose
We derive an international centralized and decentralized market model, in the spirit of Lagos and Wright (2005), where agents can experience asset-specific illiquidity. We apply the analysis to the question of dollar illiquidity during the global financial crisis and the response through international swap arrangements conducted by the Federal Reserve during that crisis. Our results show that it is possible for a deterioration in US asset values, analogous to the meltdown experienced during the global financial crisis in US real estate and asset-backed securities, to actually result in an appreciation in the dollar exchange rate, as was observed at the crisis apex. The intuition behind this counterintuitive result is that the deterioration in other dollar asset values reduces the availability of dollars for transactions purposes. Given that dollars are required for some transactions, this raises the demand for other dollar assets, such as cash, that can substitute in providing these liquidity services. Our model predicts that the benefits of swap arrangements, such as those pursued by the Federal Reserve swap arrangements are likely to be dependent on a number of agent characteristics. The benefits are shown to be increasing in the probability of needing to transact in dollars, the opaqueness of an agent’s asset portfolio, and its illiquidity.
Read More: http://www.worldscientific.com/doi/abs/10.1142/S2251361212500024
Cross-Country Causes and Consequences of the 2008 Crisis: Early Warning
Japan and the World Economy 24(1), January 2012, 1-16 | With Rose
This paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 107 countries; we focus on national causes and consequences of the crisis, ignoring cross-country “contagion” effects. Our model of the incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and institutional and geographic features. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of “early warning” systems of potential crises, which must also predict their timing.
Developing Asian Local Currency Bond Markets: Why and How?
In Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia, eds. Kawai, Masahiro, David G. Mayes, Peter J. Morgan, Chapter 11 | Asia Development Bank Institute, 2012. 221-227
This paper examines the motivation for, and the success of, regional efforts in Asia to promote local currency bond markets. The analysis demonstrates that Asian local currency bond markets made substantial gains as a region going into the current global financial crisis. However, we argue that the current financial crisis requires a reassessment of the merits of promoting local currency bond markets and the gains that have been made to date. While most of the initial motivations for encouraging the development of domestic local currency bond markets appear to remain valid, there are some exceptions. However, the degree to which success in the development of these markets will be sustained remains unknown until global financial markets regain tranquility and official interventions into these markets are removed.
Bond Currency Denomination and the Yen Carry Trade
In Asia and China in the Global Economy, ed. by Y W Cheung and G Ma, 2012. 245-282 | With Candelaria and Lopez
We examine the determinants of issuance of yen-denominated international bonds over the period from 1990 through 2010. This period was marked by low Japanese interest rates that led some investors to pursue “carry trades,” which consisted of funding investments in higher interest rate currencies with low interest rate, yen-denominated obligations. In principle, bond issuers that have exibility in their funding currency could also conduct a carry-trade strategy by funding in yen during this low interest rate period. We examine the characteristics of firms who appeared to have adopted this strategy using a data set containing almost 80,000 international bond issues. Our results suggest that there was a movement towards issuing in yen in the international bond markets starting in 2003, but this appears to have ended with the outbreak of the global financial crisis in 2007. Furthermore, the breakdown of carry-trade conditions in 2007 corresponds to a resurgence in the ability of economic fundamentals, such as the volume of trade with Japan, to explain the decision to issue international bonds denominated in yen.
Economic Journal 121(553), June 2011, 652-677 | With Rose
Why should countries offer to host costly “mega-events” such as the Olympic Games? We show that hosting a mega-event increases exports. This effect is statistically robust, permanent and large; trade is over 20% higher for host countries. Interestingly, unsuccessful bids to host the Olympics have a similar impact on exports. We conclude that the Olympic effect on trade is attributable to the signal a country sends when bidding to host the games, rather than the act of actually holding a mega-event. We develop an appropriate formal model and derive conditions under which liberalising countries will signal through a mega-event bid.
European Economic Review 55(3), April 2011, 309-324 | With Rose
We update Rose and Spiegel (2010a, b) and search for simple quantitative models of macroeconomic and financial indicators of the “Great Recession” of 2008-09. We use a cross-country approach and examine a number of potential causes that have been found to be successful indicators of crisis intensity by other scholars. We check a number of different indicators of crisis intensity, and a variety of different country samples. While countries with higher income and looser credit market regulation seemed to suffer worse crises, we find few clear reliable indicators in the pre-crisis data of the incidence of the Great Recession. Countries with current account surpluses seemed better insulated from slowdowns.
Real Estate Economics 38(2), December 2010, 171-196 | With Krainer and Yamori
We develop an overlapping generations model of the real estate market in which search frictions and a debt overhang combine to generate price persistence and illiquidity. Illiquidity stems from heterogeneity in agent real estate valuations. The variance of agent valuations determines how quickly prices adjust following a shock to fundamentals. We examine the predictions of the model by studying depreciation in Japanese land values subsequent to the 1990 stock market crash. Commercial land values fell much more quickly than residential land values. As we would posit that the variance of buyer valuations would be greater for residential real estate than for commercial real estate, this model matches the Japanese experience.
Cross-Country Causes and Consequences of the 2008 Crisis: International Linkages and American Exposure
Pacific Economic Review 15(3), August 2010, 340-363 | With Rose
This paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 85 countries; we focus on international linkages that may have allowed the crisis to spread across countries. Our model of the cross-country incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from 2006 and earlier. The causes we consider are both national (such as equity market run-ups that preceded the crisis) and, critically, international financial and real linkages between countries and the epicenter of the crisis. We consider the United States to be the most natural origin of the 2008 crisis, though we also consider six alternative sources of the crisis. A country holding American securities that deteriorate in value is exposed to an American crisis through a financial channel. Similarly, a country which exports to the United States is exposed to an American downturn through a real channel. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to find strong evidence that international linkages can be clearly associated with the incidence of the crisis. In particular, countries heavily exposed to either American assets or trade seem to behave little differently than other countries; if anything, countries seem to have benefited slightly from American exposure.
Review of Development Economics 14(2), May 2010, 177-196 | With Aizenman
This paper identifies factors associated with takeoff–a sustained period of high growth following a period of stagnation. We examine a panel of 241 “stagnation episodes” from 146 countries, 54% of these episodes are followed by takeoffs. Countries that experience takeoffs average 2.3% annual growth following their stagnation episodes, while those that do not average 0% growth; 46% of the takeoffs are “sustained,” i.e. lasting 8 years or longer. Using probit estimation, we find that de jure trade openness is positively and significantly associated with takeoffs. A one standard deviation increase in de jure trade openness is associated with a 55% increase in the probability of a takeoff in our default specification. We also find evidence that capital account openness encourages takeoff responses, although this channel is less robust. Measures of de facto trade openness, as well as a variety of other potential conditioning variables, are found to be poor predictors of takeoffs. We also examine the determinants of nations achieving sustained takeoffs. While we fail to find a significant role for openness in determining whether or not takeoffs are sustained, we do find a role for output composition: Takeoffs in countries with more commodity-intensive output bundles are less likely to be sustained, while takeoffs in countries that are more service-intensive are more likely to be sustained. This suggests that adverse terms of trade shocks prevalent among commodity exports may play a role in ending long-term high growth episodes.
Global Journal of Economics, 2010 | With Rose
This paper models the causes of the 2008 financial crisis together with its manifestations, using a Multiple Indicator Multiple Cause (MIMIC) model. Our analysis is conducted on a cross-section of 107 countries; we focus on national causes and consequences of the crisis, ignoring crosscountry
“contagion” effects. Our model of the incidence of the crisis combines 2008 changes in real GDP, the stock market, country credit ratings, and the exchange rate. We explore the linkages between these manifestations of the crisis and a number of its possible causes from
2006 and earlier. We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and
institutional and geographic features. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of “early warning” systems of potential crises, which must also predict their timing.
International Environmental Arrangements and International Commerce
In The Gravity Model in International Trade, ed. by Van Bergeijk and Brakman | Cambridge: Cambridge University Press, 2010. 255-277 | With Rose
Review of International Economics 17(4), September 2009, 751-776
A number of studies have recently noted that monetary integration in the European Monetary Union (EMU) has been accompanied by increased financial integration. This paper examines the channels through which monetary union increased financial integration, using international panel data on bilateral international commercial bank claims from 1998-2006. I decompose the relative increase in bilateral commercial bank claims among union members following
monetary integration into three possible channels: A “borrower effect,” as a country’s EMU membership may leave its borrowers more creditworthy in the eyes of foreign lenders; a “creditor effect,” as membership in a monetary union may increase the attractiveness of a nation’s commercial banks as intermediaries, perhaps through increased scale economies enjoyed by commercial banks themselves or through an improved regulatory environment after the advent
of monetary union; and a “pairwise effect,” as joint membership in a monetary union increases the quality of intermediation between borrowers and creditors when both are in the same union. This pairwise effect could be attributed to mitigated currency risk stemming from monetary integration, but may also indicate that monetary union integration increases borrowing capacity. I decompose the data into a series of difference-in-differences specifications to isolate these three channels and find that the pairwise effect is the primary source of increased financial integration. This result is robust to a number of sensitivity exercises used to address concerns frequently associated with difference-in-differences specifications, such as serial correlation and issues associated with the timing of the intervention.
Journal of Development Economics 89(2), July 2009, 250-257 | With Rose
This paper shows that proximity to major international financial centers seems to reduce business cycle volatility. In particular, we show that countries that are further from major locations of international financial activity systematically experience more volatile growth rates in both output and consumption, even after accounting for domestic financial depth, political institutions, and other controls. Our results are relatively robust in the sense that more financially remote countries are more volatile, though the results are not always statistically significant. The comparative strength of this finding is in contrast to the more ambiguous evidence found in the literature.
Journal of the Japanese and International Economies 23(2), June 2009, 114-130
This paper examines the impact of European Monetary Union (EMU) accession on bilateral Portuguese international borrowing patterns. Using a difference-indifferences methodology, I demonstrate that Portugal’s accession to the EMU was accompanied by a change in its borrowing pattern in favor of borrowing from its EMU partner nations. This extends the evidence in the literature that overall international borrowing is facilitated by the creation of a monetary union, and raises the issue of financial diversion. The results are shown to survive a wide variety of robustness checks and are corroborated by preliminary evidence concerning Greece’s accession to EMU in 2001.
Journal of Money, Credit, and Banking 41(4), June 2009, 787-798 | With Benhabib
In a recent paper, Atkeson and Kehoe (2004) demonstrated the lack of a robust empirical relationship between inflation and growth for a cross-section of countries with 19th and 20th century data, concluding that the historical evidence only provides weak support for the contention that deflation episodes are harmful to economic growth. In this paper, we revisit this relationship by allowing for inflation and growth to have a nonlinear specification dependent on inflation levels. In particular, we allow for the possibility that high inflation is negatively correlated with growth, while a positive relationship exists over the range of negative-to-moderate inflation. Our results confirm a positive relationship between inflation and growth at moderate inflation levels, and support the contention that the relationship between inflation and growth is non-linear over the entire sample range.
– Workbook with five additional files, including description of methodology and raw data
Journal of Money, Credit, and Banking 41(2-3), March 2009, 337-363 | With Rose
We examine the role of non-economic partnerships in promoting international economic exchange. Since far-sighted countries are more willing to join costly international partnerships such as environmental treaties, environmental engagement tends to encourage international lending. Countries with such non-economic partnerships also find it easier to engage in economic exchanges since they face the possibility that debt default might also spill over to hinder their non-economic relationships. We present a theoretical model of these ideas, and then verify their empirical importance using a bilateral cross-section of data on international crossholdings of assets and environmental treaties. Our results support the notion that international environmental cooperation facilitates economic exchange.
IMF Staff Papers 56, February 2009, 198-221
The literature appears to have reached a consensus that financial globalization has had a “disciplining effect” on monetary policy, as it has reduced the returns from–and hence the temptation for–using monetary policy to stabilize output. As a result, monetary policy over
recent years has placed more emphasis on stabilizing inflation, resulting in reduced inflation and greater output stability. However, this consensus has not been accompanied by convincing empirical evidence that such a relationship exists. One reason is likely to be that de facto measures of financial globalization are endogenous, and that instruments for financial globalization are elusive. In this paper, I introduce a new instrument, financial remoteness, as a plausibly exogenous instrument for financial openness. I examine the relationship between financial globalization and median inflation levels over an 11 year cross-section from 1994 through 2004, as
well as a panel of 5-year median inflation levels between 1980 and 2004. The results confirm a negative relationship between median inflation and financial globalization in the base specification, but this relationship is sensitive to the inclusion of conditioning variables or country fixed effects, precluding any strong inferences.
In China and Asia: Economic and Financial Interactions, Proceedings of the 2006 Asian Pacific Economic Association Conference, ed. by Yin-Wong Cheung and Kar-Yiu Wong | London: Routledge, 2008. 197-214 | With Lopez
We examine foreign intermediation activity in Japan during the so-called “lost decade” of the 1990s, contrasting the behavior of lending by foreign commercial banks and underwriting activity by foreign investment banks over that period. Foreign bank lending is shown to be sensitive to domestic Japanese conditions, particularly Japanese interest rates, more so than their domestic Japanese bank counterparts. During the 1990s, foreign bank lending in Japan fell, both in overall numbers and as a share of total lending. However, there was marked growth in foreign underwriting activity in the international yen-denominated bond sector. A key factor in the disparity between these activities is their different clientele: While foreign banks in Japan lent primarily to domestic borrowers, international yen-denominated bond issuers were primarily foreign entities with yen funding needs or opportunities for profitable swaps. Indeed, low interest rates that discouraged lending activity in Japan by foreign banks directly encouraged foreign underwriting activity tied to the so-called “carry trades.” Regulatory reforms, particularly the “Big Bang” reforms of the 1990s, also play a large role in the growth of foreign underwriting activity over our sample period.
Economic Journal 117(523), October 2007, 1310-1335 | With Rose
This article analyses the causes and consequences of offshore financial centres (OFCs). While OFCs are likely to encourage bad behaviour in source countries, they may also have unintended positive consequences, such as providing competition for the domestic banking sector. We derive and simulate a model of a home country monopoly bank facing a representative competitive OFC which offers tax advantages attained by moving assets offshore at a cost that is increasing in distance to the OFC. Our model predicts that proximity to an OFC is likely to be pro-competitive. We test and confirm the predictions empirically. OFC proximity is associated with a more competitive domestic banking system and greater overall financial depth.
Journal of Banking and Finance 31(3), March 2007, 769-786 | With Yamori
We examine the determinants of Japanese regional bank pricing-to-market decisions and their impact on the intensity of depositor discipline, in the form of the sensitivity of deposit growth to bank financial conditions. To obtain consistent estimates, we first model and estimate the bank pricing-to-market decision and then estimate the intensity of depositor discipline after conditioning for that decision. We find that banks were less likely to adopt market price accounting the larger were their unrealized securities losses. We also find statistically significant evidence of depositor discipline among banks that elected to price to market. Our results indicate that depositor discipline was more intense for the subset of banks that adopted market price accounting.
Journal of the Japanese and International Economies 20(4), December 2006, 699-721 | With Kobayashi and Yamori
One of the primary motivations offered by the Bank of Japan (BOJ) for its quantitative easing program–whereby it maintained a current account balance target in excess of required reserves, effectively pegging short-term interest rates at zero–was to maintain credit extension by the troubled Japanese financial sector. We conduct an event study concerning the anticipated impact of quantitative easing on the Japanese banking sector by examining the impact of the introduction and expansion of the policy on Japanese bank equity values. We find that excess returns of Japanese banks were greater when increases in the BOJ current account balance target were accompanied by “nonstandard” expansionary policies, such as raising the ceiling on BOJ purchases of long-term Japanese government bonds. We also provide cross-sectional evidence that suggests that the market perceived that the quantitative easing program would disproportionately benefit financially weaker Japanese banks.
Review of International Economics 14(4), September 2006, 683-697 | With Aizenman
This paper models and tests the implications of institutional efficiency on the pattern of FDI. We posit that domestic agents have a comparative advantage over foreign agents in overcoming some of the obstacles associated with corruption and weak institutions. Under these circumstances, FDI is more sensitive to increases in enforcement costs. We then test this prediction, comparing institutional efficiency levels for a large cross-section of countries in 1989 to subsequent FDI flows through the period of 1990-99, finding that institutional efficiency is positively associated with the ratio of subsequent foreign direct investment flows to both gross fixed capital formation and to private investment.
In Japan’s Great Stagnation, ed. by M. Hutchison and F. Westermann | Cambridge, MA: MIT Press, 2006. 103-128 | With Yamori
Disclosure is widely regarded as a necessary condition for market discipline in a modern financial sector. However, the determinants of disclosure decisions are still unknown, particularly among banks. This paper investigates the determinants of disclosure by Japanese Shinkin banks in 1996 and 1997. This period is unique because disclosure of nonperforming loans was voluntary for Shinkin banks at this time. We find that banks with more serious bad loan problems, more leverage, and less competitive pressure, and smaller banks were less likely to choose to disclose voluntarily. These results suggest that there may be a role for compulsory disclosure, as weak banks appear to avoid voluntary disclosure disproportionately.
In Handbook of Economic Growth, 1A, Chap. 13, ed. by Aghion and Durlauf | Amsterdam: North Holland, 2006. 936-966 | With Benhabib
This paper generalizes the Nelson-Phelps catch-up model of technology
diffusion. We allow for the possibility that the pattern of technology diffusion can be exponential, which would predict that nations would exhibit positive catch-up with the leader nation, or logistic, in which a country with a sufficiently small capital stock may exhibit slower total factor productivity growth than the leader nation. We derive a nonlinear specification for total factor productivity growth that nests these two specifications. We estimate this specification for a cross-section of nations from 1960 through 1995. Our results support the logistic specification and are robust to a number of sensitivity checks. Our model also appears to predict slow total factor productivity growth well. Of the 27 nations that we identify as lacking the critical human capital levels needed to achieve faster total factor productivity growth than the leader nation in 1960, 22 did achieve lower growth over the next 35 years.
Solvency Runs, Sunspot Runs, and International Bailouts
Journal of International Economics 65(1), January 2005, 203-219
This paper introduces a model of intervention by an international financial institution (IFI) under asymmetric information. The IFI is unable to distinguish between runs due to fundamentals and those which are the result of pure sunspots. However, it maximizes global welfare by offering a relending package consistent with generating a separating equilibrium, where voluntary creditor participation implies that underlying fundamentals are good. The need for direct IFI lending in the package is shown to depend on the commitment capacity of creditors. This adverse selection problem provides an alternative rationale for Bagehot’s principle of last-resort lending at high rates of interest to the moral hazard motivation commonly found in the literature.
Financial Structure and Macroeconomic Performance over the Short and Long Run
In Macroeconomic Implications of Post-Crisis Structural Changes, ed. by L.J. Cho, D. Cho, and Y.H. Kim | Seoul: Korea Development Institute, 2005. 75-103 | With Lopez
We examine the relationship between indicators of financial development and economic performance for a cross-country panel over long and short periods. Our long-term results are consistent with much of the literature in that we find a positive relationship between financial development and economic growth. However, we fail to find a significant positive relationship after accounting for disparities in factor accumulation. These results therefore indicate that the primary channel for financial development to facilitate growth over the long run is through physical and human capital accumulation. We also identify a significant negative relationship between financial development and income volatility, suggesting that financial development does mitigate economic fluctuations in the long run. We then turn to short-run analysis, concentrating on the period immediately surrounding the 1997 Asian financial crisis. Unlike our long-term results, our short-term panel analysis fails to find a significant relationship between financial development and economic performance during this period, both for a broad sample of countries and for a small sample of developing Asian nations. Taken as a whole, our analysis appears to support a relatively new idea in the literature that while financial development is beneficial over the long run, it may exacerbate short-term volatility in isolated episodes. One reason for this discrepancy may be that financial liberalizations are typically only partial, resulting in increased financial market distortions. We analyze the Korean experience in the period surrounding the Asian financial crisis and argue that this experience supports the idea of distortionary partial liberalization.
Sterilization Costs and Exchange Rate Targeting
Journal of International Money and Finance 23(6), October 2004, 897-915 | With Kletzer
We examine the movements of exchange rates and capital inflows in an
environment where an optimizing central bank pursuing the joint goals of
inflation and output targeting engages in costly sterilization activities. Our results predict that, when faced with increased sterilization costs, the central bank will choose to limit its sterilization activities, allowing target variables, such as the nominal exchange rate, to adjust. We then test the predictions of a linearized version of the saddle-path solution to the model for a cross-country panel of developing countries. We use OLS, IV, and GMM specifications to allow for the endogeneity of capital inflows. Our results confirm that monetary policy does respond to sterilization costs.
The Evolution of Bank Resolution Policies in Japan: Evidence from Market Equity Values
Journal of Financial Research 27(1), Spring 2004, 115-132 | With Yamori
We examine the evidence in equity markets concerning bank regulatory
policies in Japan from 1995 to 1999. Our results support the presence of
information-based contagion in Japanese equity markets. When the failure
of a bank of certain regulatory status was announced, it adversely affected excess returns on banks with equal or lower levels of regulatory protection. Market participants therefore initially behaved as if only second regional and smaller banks would be allowed to fail. As the situation deteriorated, however, banks that traditionally enjoyed greater regulatory protection were also perceived to lose their too-big-to-fail status.
A Gravity Model of Sovereign Lending: Trade, Default, and Credit
International Monetary Fund Staff Papers 51, Special Issue, 2004, 50-63 | With Rose
One reason why countries service their external debts is the fear that default might lead to shrinkage of international trade. If so, then creditors should systematically lend more to countries with which they share closer trade links. We develop a simple theoretical model to capture this intuition, then test and corroborate this idea.
Currency Boards, Dollarized Liabilities, and Monetary Policy Credibility
Journal of International Money and Finance 22(7), December 2003, 1065-1087 | With Valderrama
The recent collapse of the Argentine currency board raises new questions
about the desirability of formal fixed exchange rate regimes. This paper examines the relative performance of a currency board with costly abandonment in the presence of dollarized liabilities to a fully discretionary regime. Our results demonstrate that neither regime necessarily dominates with only idiosyncratic firm shocks, but discretion unambiguously dominates with the addition of shocks to the dollar-euro rate. The relatively strong performance of the discretionary regime in this model stems from the benign impact of dollarized liabilities on the monetary authority’s time inconsistency
Review of Malaysian Eclipse: Economic Crisis and Recovery
Journal of Comparative Economics 31(3), September 2003, 593-594
The Impact of Japan’s Financial Stabilization Laws on Bank Equity Values
Journal of the Japanese and International Economies 17(3), September 2003, 263-282 | With Yamori
In the fall of 1998, two important financial regulatory reform acts were
passed in Japan. The Financial Reconstruction Act created a bridge bank
scheme and provided funds for the resolution of failed banks. The Rapid
Recapitalization Act provided funds for the assistance of troubled banks. These acts provided government assistance to the banking sector and called for reforms aimed at strengthening the regulatory environment. Using an event study framework, we examine the anticipated impact of these regulatory reforms. Our evidence suggests that the Financial Reconstruction Act was expected to hurt large banks, while the anticipated impact of the act by financial strength was mixed. In contrast, the anticipated impact of the Rapid Recapitalization Act was expected to be antireform, as news favorable to its passage disproportionately favored large and weak Japanese banks.
Financial Turbulence and the Japanese Main Bank Relationship
Journal of Financial Services Research 23(3), June 2003, 205-223 | With Yamori
Under the Japanese “main bank” relationship, a bank holds equity in a
firm and plays a leading role in its decisionmaking and financing. This
may leave a firm dependent on its main bank for financing due to its
information advantage over other potential lenders. This dependency may
be particularly severe during episodes of financial turbulence. We examine the sensitivity of returns on portfolios of Japanese firm equity to the returns of their main banks using a three-factor arbitrage-pricing model. We find no significant dependence when coefficient values are held constant over the entire sample. However, the data strongly suggest a structural break in the relationship subsequent to the last quarter of 1997, a turbulent period for Japanese financial markets. When a structural break is introduced, main bank sensitivity increases after the break, usually to significantly positive levels.
Financial Development and Growth: Are the APEC Nations Unique?
In 2001 APEC World Economic Outlook Symposium Proceedings | APEC, 2002. 79-106
This paper examines panel evidence concerning the role of financial development in economic growth. I decompose the well-documented relationship between financial development and growth to examine whether financial development affects growth solely through its contribution to growth in factor accumulation rates, or whether it also has a positive impact on total factor productivity, in the manner of Benhabib and Spiegel (2000). I also examine whether the growth performances of a subsample of APEC countries are uniquely sensitive to levels of financial development. The results suggest that indicators of financial development are correlated with both total factor productivity growth and investment. However, many of the results are sensitive to the inclusion of country fixed effects, which may indicate that the financial development indicators are proxying for broader country characteristics. Finally, the APEC subsample countries appear to
be more sensitive to financial development, both in the determinations of subsequent total factor productivity growth and in rates of factor accumulation, particularly accumulation of physical capital.
Financial Crises in Emerging Markets: An Introductory Overview
In Financial Crises in Emerging Markets, ed. by Glick, Moreno, and Spiegel | New York: Cambridge University Press, 2001. 1-34 | With Glick and Moreno
Monetary Union Expansion: The Role of Market Power in Trade
In International Finance Review, Special Issue on European Monetary Union and Capital Markets, Vol 2, ed. by Choi and Wrase | Oxford: Elsevier, 2001
This paper examines the feasibility of a monetary union expansion which
is desirable for both the entering country and the existing union members. The paper concentrates on the fact that the outside country is likely to be small relative to the existing monetary union, and lack the resistance to inflation which comes with market power in trade. Consideration of this market power effect allows for mutually desirable entry if the outside nation central bank is moderately more averse to inflation than the central bank of the existing monetary union.
The Role of Financial Development in Growth and Investment
Journal of Economic Growth 5(4), December 2000, 341-360 | With Benhabib
This paper decomposes the well-documented relationship between financial
development and growth. We examine whether financial development affects growth solely through its contribution to growth in “primitives,” or factor accumulation rates, or whether it also has a positive impact on
total factor productivity growth. Our results suggest that indicators of
financial development are correlated with both total factor productivity
growth and investment. However, the indicators that are correlated with
total factor productivity growth differ from those that encourage investment. In addition, many of the results are sensitive to the inclusion of country fixed effects, which may indicate that the financial development indicators are proxying for broader country characteristics.
Bank Charter Value and the Viability of the Japanese Convoy System
Journal of the Japanese and International Economies 14(3), September 2000, 149-168
This paper compares the performance of a convoy banking system, similar to that which prevailed in Japan, to a fixed-premium deposit insurance regime. While neither regime is generally preferable over the other, the performance of the convoy system is shown to be more sensitive to changes in bank charter values and the overall health of the banking system under fairly general conditions. The recent breakdown of the convoy system may therefore be partly attributable to adverse movements in these characteristics in Japan.
Speculative Capital Inflows and Exchange Rate Targeting in the Pacific Basin: Theory and Evidence
In Managing Capital Flows and Exchange Rates: Evidence from the Pacific Basin, ed. by Glick | New York: Cambridge University Press, 1998. 409-436 | With Kletzer
North-South Customs Unions and International Capital Mobility
Journal of International Economics 46, 1998, 229-251 | With Fernandez-Arias
Inequality and Stability
Annales d’Economie et de Statistique 48, 1997, 15-40 | With Barbosa and Jovanovic
Are Asian Economies Exempt from the ‘Impossible Trinity’? Evidence from Singapore
In Proceedings of the 12th Pacific Basin Central Bank Conference on The Impact of Financial Market Development on the Real Economy | Singapore: Monetary Authority of Singapore, 1997. 9-27 | With Moreno
Does State Economic Development Spending Increase Manufacturing Employment?
Journal of Urban Economics 41, 1997, 153-175 | With de Bartolome
Heterogeneity in Bank Valuation of LDC Debt: Evidence from the 1988 Brazilian Debt Reduction Program
Journal of Monetary Economics 39, 1997, 535-550 | With Demirguc-Kunt and Diwan
Burden Sharing in Sovereign Debt Reduction
Journal of Development Economics 50, August 1996, 337-352
Regional Competition for Domestic and Foreign Investment: Evidence from State Development Expenditures
Journal of Urban Economics 37, 1995, 239-259 | With de Bartolome
Threshold Effects in International Lending
Journal of Development Economics 46, April 1995, 341-356
Are Buybacks Back? Menu-Driven Debt-Reduction Schemes with Heterogeneous Creditors
Journal of Monetary Economics 34, October 1994, 279-293 | With Diwan
The Role of Human Capital in Economic Development: Evidence from Aggregate Cross-Country Data
Journal of Monetary Economics 34, October 1994, 143-174 | With Benhabib
Sovereign Risk Exposure with Potential Liquidation: The Performance of Alternative Forms of External Finance
Journal of International Money and Finance 13, August 1994, 400-414
The Role of Human Capital and Political Instability in Economic Development
In International Differences in Growth Rates, ed. by Baldassari, Paganetto, and Phelps | New York: St. Martin’s Press, 1994. 55-94 | With Benhabib
Debt Write-Downs and Debt Equity Swaps in a Two-Sector Model
Journal of International Economics 33, November 1992, 267-283 | With Goldberg
Concerted Lending: Did Large Banks Bear the Burden?
Journal of Money, Credit, and Banking 24, November 1992, 465-482
Capital Controls and Deviations from Proposed Interest Rate Parity: Mexico, 1982
Economic Inquiry 28, April 1990, 239-248