International Finance and Macroeconomics

Marina Halac, Columbia University, and Pierre Yared, Columbia University and NBER

Fiscal Rules and Discretion in a World Economy (NBER Working Paper No. 21492)

Governments are present-biased toward spending. Fiscal rules are deficit limits that trade off commitment to not overspend and flexibility to react to shocks. Halac and Yared compare centralized rules — chosen jointly by all countries — to decentralized rules. If governments' present bias is small, centralized rules are tighter than decentralized rules: individual countries do not internalize the redistributive effect of interest rates. However, if the bias is large, centralized rules are slacker: countries do not internalize the disciplining effect of interest rates. Surplus limits and money burning enhance welfare, and inefficiencies arise if some countries adopt stricter rules than imposed centrally.

Kinda Cheryl Hachem, University of Chicago and NBER, and Zheng Michael Song, Chinese University of Hong Kong

Liquidity Regulation and Unintended Financial Transformation in China (NBER Working Paper No. 21880)

China increased bank liquidity standards in the late 2000s, yet interbank markets became tighter and more volatile and credit soared. To explain this, Hachem and Song argue that shadow banking developed among small- and medium-sized banks to evade the higher liquidity standards. The shadow banks then poached deposits from big commercial banks by also broaching traditional deposit-rate ceilings. In response, big banks used their interbank market power to restrict loans to shadow banks and lent more to non-financials. The researchers' model delivers a quantitatively important credit boom and higher and more volatile interbank interest rates as unintended consequences of higher liquidity standards.

Dmitriy Sergeyev, Bocconi University

Optimal Macroprudential and Monetary Policy in a Currency Union

In this paper, Sergeyev solves for optimal macroprudential and monetary policies for members of a currency union in an open economy model with nominal price rigidities, demand for safe assets, and collateral constraints. Monetary policy is conducted by a single central bank, which sets a common interest rate. Macroprudential policy is set at a country level through the choice of reserve requirements. The researcher emphasizes two main results. First, with asymmetric countries and sticky prices, the optimal macroprudential policy has a country-specific stabilization role beyond optimal regulation of financial sectors. This result holds even if optimal fiscal transfers are allowed among the union members. Second, there is a role for global coordination of country-specific macroprudential policies. This is true even when countries have no monopoly power over prices of internationally traded goods or assets. These results build the case for coordinated macroprudential policies that go beyond achieving financial stability objectives.

Jean-Noel Barrot and Erik Loualiche, MIT, and Julien Sauvagnat, Bocconi University

The Globalization Risk Premium

Barrot, Loualiche, and Sauvagnat investigate how globalization is reflected in asset prices. They use shipping costs to measure U.S. firms' exposure to globalization. Firms in low shipping cost industries carry a 7.8 percent risk premium, suggesting that their cash-flows covary negatively with U.S. investors' marginal utility. To understand the origins of this globalization risk premium, the researchers develop a dynamic general equilibrium model of trade and asset prices. They find that the premium emanates from the risk of displacement of least efficient firms triggered by import competition. This suggest that foreign productivity shocks are associated with times when consumption is dear for U.S. investors.

Michael B. Devereux, University of British Columbia and NBER; Eric Young, University of Virginia; and Changhua Yu, Peking University

A New Dilemma: Capital Controls and Monetary Policy in Sudden Stop Economies

The dangers of high capital flow volatility and sudden stops have led economists to promote the use of capital controls as an addition to monetary policy in emerging market economies. This paper studies the benefits of capital controls and monetary policy in an open economy with financial frictions, nominal rigidities, and sudden stops. Devereux, Young, and Yu focus on a time-consistent policy equilibrium. They find that during a crisis, an optimal monetary policy should sharply diverge from price stability. Without commitment, policymakers will also tax capital inflows in a crisis. But this is not optimal from an ex-ante social welfare perspective. An outcome without capital inflow taxes, using optimal monetary policy alone to respond to crises, is superior in welfare terms, but not time-consistent. If policy commitment were in place, capital inflows would be subsidized during crises. The researchers also show that an optimal policy will never involve macro-prudential capital inflow taxes as a precaution against the risk of future crises (whether or not commitment is available).

Gauti B. Eggertsson, Brown University and NBER; Neil Mehrotra and Sanjay Singh, Brown University; and Lawrence H. Summers, Harvard University and NBER

A Contagious Malady? Open Economy Dimensions of Secular Stagnation

Eggertsson, Mehrotra, Singh, and Summers propose an open economy model of secular stagnation and show how it can be transmitted from one country to another via current account imbalances. While current account surpluses normally lower interest rates in the recipient country, in a secular stagnation, surpluses transmit recessions due to the zero lower bound on nominal interest rates. In general monetary policies and those directed at competitiveness have negative externalities on trading partners in these circumstances, while fiscal policies and those directed at stimulating domestic demand have positive externalities. This, in a positive sense, explains why the world has relied so much on monetary policies relative to fiscal policies in the wake of the financial crisis and in a normative sense points towards the desirability of fiscal policies. Fiscal policies in response to a secular stagnation are self-financing, as in De Long and Summers (2012) in the authors' numerical experiments, and a one shot increase in debt will raise demand and is fiscally sustainable. While expansionary monetary policy only provides for a possibility of a better outcome without excluding the possibility of continuing secular stagnation, appropriate fiscal policy eliminates secular stagnation by directly raising the natural rate of interest as in Eggertsson and Mehrotra (2014).

Stephanie Schmitt-Grohé and Martín Uribe, Columbia University and NBER

Multiple Equilibria in Open Economy Models with Collateral Constraints: Overborrowing Revisited

In this paper, Schmitt-Grohé and Uribe characterize equilibria in open economy models with pecuniary externalities due to collateral constraints. It shows analytically that there may exist multiple equilibria. This result holds for models with stock collateral constraints and models with flow collateral constraints. The main result of the paper is to establish the existence of equilibria displaying underborrowing, in the sense that the equilibrium level of external debt in the unregulated economy is smaller than it would be in an economy in which agents internalize the externality. In these equilibria, agents understand that the economy is prone to self-fulfilling financial crises and as a result engage in excessive precautionary savings. The existing related literature has to a large extent emphasized equilibria that display overborrowing. The paper argues that there exist equally plausible calibrations for which the pecuniary externality induces a substantial degree of underborrowing.