Advances in International Finance and Macroeconomics

Paper Session

Friday, Jan. 6, 2017 10:15 AM – 12:15 PM

Sheraton Grand Chicago, Mississippi
Hosted By: Latin American and Caribbean Economic Association
  • Chair: Jesse Schreger, Harvard Business School

Fiscal Rules and Sovereign Default

Laura Alfaro
Harvard Business School and NBER
Fabio Kanczuk
University of Sao Paulo


We provide a quantitative analysis of fiscal rules in a standard model of sovereign debt accumulation and default, modified to incorporate quasi-hyperbolic preferences. For reasons of political economy or aggregation of citizens’ preferences, government preferences are present biased, resulting in over accumulation of debt. A quantitative exercise calibrated to Brazil finds welfare gains of the optimal fiscal policy to be economically substantial, and the optimal rule to not entail a countercyclical fiscal policy. A simple debt rule that limits the maximum amount of debt is analysed and compared to a simple deficit rule that limits the maximum amount of deficit per period. Whereas the deficit rule does not perform well, the debt rule yields welfare gains virtually equal to the optimal rule.

Fiscal Rules, Bailouts and Reputation in Federal Governments

Alessandro Dovis
University of Pennsylvania and NBER
Rishabh Kirpalani
Pennsylvania State University and New York University


Expectations of bailouts by central governments incentivize over-borrowing by local governments. In this paper, we ask if fiscal rules can correct these incentives to over-borrow when central governments cannot commit and if they will arise in equilibrium. We address these questions in a reputation model in which the central government can either be a commitment or a no-commitment type and local govern- ments learn about this type over time. Our first main result is that if the reputation of the central government is low enough, then fiscal rules can be welfare reducing as they can lead to even more debt accumulation relative the case with no rules. This is because the costs of enforcing the punishment associated with the fiscal rule worsens the payoffs of preserving reputation and incentivizes the no-commitment type to re- veal its type earlier relative to an environment without rules. This early resolution of uncertainty makes over-borrowing more attractive for the local governments. Despite being welfare reducing, binding fiscal rules will arise in the equilibrium of a signaling game due to the incentives of the the commitment type to reveal its type. The model can be used to shed light on the numerous examples throughout history where tight fiscal rules were instituted but were not enforced ex-post, such as the Stability and Growth Pact.

Monetary Union Begets Fiscal Union

Adrien Auclert
Stanford University
Matthew Rognlie
Massachusetts Institute of Technology


We propose a mechanism through which monetary union between countries leads to a stronger fiscal union. Although fiscal risk-sharing is valuable under any monetary regime, given nominal rigidities it is more important within a monetary union, when exchange rates can no longer adjust to offset shocks. As a result, countries in a monetary union are capable of achieving better risk-sharing, partly overcoming their lack of commitment. Still, equilibria without fiscal cooperation remain possible and imply inefficient cross-country dispersion in output. A proactive central bank can encourage transfers by providing extra accommodation when fiscal union is under stress.

Taper Tantrums: QE, Its Aftermath and Emerging Market Capital Flows

Anusha Chari
University of North Carolina-Chapel Hill
Karlye Dilts-Stedman
University of North Carolina-Chapel Hill
Christian Lundblad
University of North Carolina-Chapel Hill


This paper examines the implications of unconventional monetary policy (UMP) and its
continued unwinding for emerging market capital flows and asset prices with an
emphasis on quantifying the magnitude of these effects. We combine U.S. Treasury data
on emerging market flows and prices with Fed Funds Futures data to estimate the surprise
component of Fed announcements. Results from a commonly employed affine term
structure model indicate that monetary policy shocks represent, in small part, revisions in
market participants’ expectations about the path of short term interest rates and, even
more significantly, changes in their required risk compensation. The importance of
revisions in risk compensation is true despite the fact that these shocks are extracted from
relatively short-maturity futures contracts. While this interpretation characterizes the
conventional (pre-crisis) period, the risk compensation effects are even more pronounced
in the later unconventional monetary policy period. Controlling for a range of pull and
push factors, panel regression results then suggest that the global impact of alternative
monetary surprise measures varies significantly across the pre-crisis, Quantitative Easing
(QE) and policy “tapering” periods. In particular, the effect of monetary policy shocks on
global asset values is larger than that for physical capital flows. Relative to debt,
emerging market equity positions and valuations are more sensitive to monetary policy
shocks during the QE and normalization periods. There is an order-of-magnitude
difference between the QE and the tapering periods for the effects of monetary policy on
all types of emerging-market portfolio flows. Finally, the primary advantage of extracting
the monetary surprise magnitude is that we can directly estimate a dollar amount in terms
of U.S. investor position and flow changes to emerging markets. The quantification
exercise suggests that the impact of U.S. monetary policy on emerging market capital
flows depends critically on the size, sign and dispersion of the policy surprises.
Juliana Salomao
University of Minnesota
Diego Perez
New York University
Rohan Kekre
University of Chicago
Linda Goldberg
Federal Reserve Bank of New York
JEL Classifications
  • E0 - General
  • F3 - International Finance