Capital Flows and Exchange Rates
Paper Session
Tuesday, Jan. 5, 2021 3:45 PM - 5:45 PM (EST)
- Chair: Harald Uhlig, University of Chicago
Trade Finance and the Durability of the Dollar
Abstract
We propose a model in which the emergence of a single dominant currency is driven by the need to finance international trade. The model generates multiple stable steady states, each characterized by a different dominant asset, consistent with the historical durability of real-world currency regimes. The key force driving persistence of regimes is a positive interaction between the returns to saving in an asset and the use of that asset for financing trade. A calibrated version of the model implies that the welfare gains of dominance are substantial, but accrue primarily during the transition to dominance. We consider several counterfactual experiments that highlight the importance of path dependence and economic policy.A Behavioral Explanation for the Puzzling Persistence of the Aggregate Real Exchange Rate
Abstract
At the aggregate level, the evidence that deviations from the purchasing power parity (PPP) are too persistent to be explained solely by nominal rigidities has long been considered as a puzzle (Rogoff, 1996). The other puzzle suggested by the micro price evidence is that the deviations from the Law of One Price (LOP), the basic building block of PPP, are less persistent than the PPP counterparts. To reconcile the empirical evidence, we adapt the model of behavioral inattention of Gabaix (2014, 2019) to a simple two-country sticky-price model. We propose a simple test of behavioral inattention and find strong evidence in its favor, using the micro price data in the U.S. and Canadian cities. Calibrating behavioral inattention to our estimates, the model can reconcile two puzzles of the PPP and LOP. First, the PPP deviations are more than twice as persistent as the PPP deviations explained only by sticky prices. Second, the LOP deviations decrease to less than two-thirds of the PPP deviations in the degree of persistence.Financial Dollarization in Emerging Markets: Efficient Risk Sharing or Prescription for Disaster?
Abstract
There is a common view that financial dollarization is a source of financial fragility for emerging market countries. We argue that there is little evidence support for this hypothesis. Instead we argue, based on analysis of a large cross-country dataset, that the evidence supports an insurance view in which dollarization enables residents within emerging countries with different hedging needs to supply each other with income insurance. We develop a simple model which formalizes the insurance view, which is consistent with the key cross-country facts on interest rate differentials, deposit dollarization and exchange rate depreciations in recessions.Exploring the Role of Limited Commitment Constraints in Argentina’s "Missing Capital"
Abstract
We study why capital accumulation in Argentina was slow in the 1990s and 2000s, despite high productivity growth and low international interest rates. We show that the disappointing performance of investment over those two periods was the result of two mechanisms introduced by limited commitment constraints. First, the response of investment to a total factor productivity increase is muted and short-lived, while the response to a decrease is large and persistent. Second, unlike in a first-best economy, low international interest rates may reduce capital accumulation, because they increase the relevance of future commitment constraints. A quantitative implementation of the model economy shows that the two mechanisms are quantitatively important for the dynamics of Argentina’s capital accumulation. The model accounts for between 50% and 85% of the capital missing from Argentina in the two decades mentioned above, relative to what it would be in the absence of the limited commitment frictions.Capital Controls and Income Inequality
Abstract
We examine the distributional implications of capital account policy in a small open economy model with heterogeneous agents and financial frictions. Households save through deposits in both domestic and foreign banks. Entrepreneurs finance investment with borrowed funds from domestic banks and foreign investors. Domestic banks engage in costly intermediation of deposits from households and loans to entrepreneurs. Government capital account policy consists of taxes on outflows and inflows. Given policy, a temporary decline in the world interest rate leads to a surge in inflows, benefiting entrepreneurs and hurting households. Raising inflow taxes or reducing outflow taxes mitigate this redistribution. However, in the long run liberalization of either inflows or outflows reduces inequality. The model’s short-run implications are supported by empirical evidence. Based on instrumental variable estimation with a panel of emerging market economies, we demonstrate that increases in private capital inflows raise income inequality, while increases in outflows reduce it. These effects are significant and robust to a wide variety of empirical specifications.JEL Classifications
- F3 - International Finance