In emerging markets, a significant share of corporate loans are denominated in dollars. Using novel data that enables us to see currency and the cost of credit, in addition to several other transaction level characteristics, Gutierrez, Ivashina, and Salomao re-examine the reasons behind dollar credit popularity. They find that a dollar-denominated loan has an interest rate that is 2% lower per year than a loan in Peruvian Soles. Expectations of exchange rate movements do not explain this difference. The researchers show that this interest rate differential for lending rates is closely matched by the differential in the deposit market. Their results suggest that the preference for dollar loans is rooted in the local household preference for dollar savings and a banking sector that is closely matching its foreign assets and liabilities. Gutierrez, Ivashina, and Salomao find that borrower competitive pressure increases the pass-through of this differential.
The real costs of deviations or "wedges" from efficient international financial markets depend upon exchange rates, consumption, and returns identified in the data. Lewis and Liu show how to infer the costs of inefficient financial markets using the identifying assumptions that are implicit in asset pricing and macroeconomic models. They measure and decompose these costs in their individual components, including exchange rates. This decomposition demonstrates that the ability of goods markets to respond to financial markets through exchange rate adjustment has significant implications for welfare. For this reason, the researchers explore how different views of exchange rate determination impact these costs. Their analysis illustrates that standard assumptions about the exchange rate behavior implicit in price aggregators used in the macro and finance literature lead to very different implications about the costs of inefficient international markets.
For most of the post WWII period, trade protectionism followed a declining trend, contained within international agreements. Even after the 2008-9 Great Recession, most countries forwent the temptation to restrict trade flows, and the key policy conflicts revolved around monetary policy spillovers, or 'currency wars'. Recently however, there has been a sharp shift towards unilateral, discretionary trade policy focused on short term macroeconomic objectives, and as a consequence, the phenomenon of 'trade wars' has become entangled with 'currency wars'. This paper explores the interaction of non-cooperative trade policy and monetary policy within a standard DSGE open economy macroeconomic model. Auray, Devereux, and Eyquem find that a non-cooperative trade policy can significantly worsen macroeconomic conditions. Moreover, the stance of monetary policy has major implications for the degree of protection in a non-cooperative equilibrium. In particular, cooperative determination of monetary policy (by eliminating 'currency wars') may significantly reduce welfare by increasing the size of trade restrictions. By contrast, when the exchange rate is pegged by one country, equilibrium rates of protection are generally lower, but in this case, there are multiple asymmetric equilibria in tariff rates which benefit one country relative to another.
Saffie, Varela, and Yi empirically and theoretically study the effects of capital flows on resource allocation within sectors and cross-sectors. Novel data on service firms - in addition to manufacturing firms - allows us to assess two channels of resource reallocation. Capital inflows lower the relative price of capital, which promotes capital-intensive industries - an input-cost channel. Second, capital inflows increase aggregate consumption, which tilts the demand towards goods with high expenditure elasticities - a consumption channel. They provide evidence for these two channels using firm-level census data from the financial liberalization in Hungary, a policy reform that led to capital inflows. The researchers show that firms in capital-intensive industries expand, as do firms in industries producing goods with high expenditure elasticities. In the short-term, the consumption channel dominates and resources reallocate towards high expenditure elasticity activities, such as services. They build a dynamic, multi-sector, heterogeneous firm model of an economy transitioning to its steady-state. Saffie, Varela, and Yi simulate a capital account liberalization and show that the model can rationalize their empirical findings. They then use the model to assess the permanent effects of capital flows and show that the structure of the economy depends on the extend of capital inflows upon the liberalization. When an economy with scarce capital opens to financial flows it receives larger capital inflows triggering more long-run debt pushing the country to a larger permanent trade surplus, than a similar liberalization performed by an economy with relatively more physical capital. The additional current account deficit further reduces consumption, depreciates the real exchange rate and tilts long-run production towards manufacturing exporters.
This paper was distributed as Working Paper 27371, where an updated version may be available.
Guntin, Ottonello, and Perez study crises characterized by large adjustments of aggregate consumption, such as the Euro crisis and emerging-market sudden stops, through their micro-level patterns. They show that leading theories designed to explain aggregate consumption dynamics differ markedly in their cross-sectional predictions. While theories based on financial frictions predict that rich households with liquid assets should be able to smooth consumption during bad times, neoclassical theories predict that these agents would optimally adjust their consumption if crises severely affect their permanent income. Using micro-level data on several episodes of large aggregate-consumption adjustment, the researchers document that rich households significantly adjust consumption relative to their income, consistent with the permanent-income hypothesis of consumption during crises. Guntin, Ottonello, and Perez discuss the implications of their findings for the effectiveness of stabilization policies targeting consumption during crises.
This paper was distributed as Working Paper 27917, where an updated version may be available.