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Journal Article
The Impact of Foreign Slowdown on the U.S. Economy: An Open Economy DSGE Perspective
Over the course of 2018, economic activity in major advanced foreign economies and emerging markets—including the Euro area and China—decelerated noticeably. In parallel, foreign growth projections for 2019 and 2020 were revised down, signaling potentially large headwinds for the U.S economy over the medium term. In this article, we use a multi-country simulation model to quantify economic spillovers to the United States from a slowdown originating in the Euro area. Next, we compare these results with spillovers from a slowdown originating in China. We find that spillovers to the U.S. ...
Report
Exchange rate dynamics and monetary spillovers with imperfect financial markets
We use a two-country New Keynesian model with financial frictions and dollar debt in balance sheets to investigate the foreign effects of U.S. monetary policy. Financial amplification works through an endogenous deviation from uncovered interest parity (UIP) arising from limits to arbitrage in private intermediation. Combined with dollar trade invoicing, this mechanism leads to large spillovers from U.S. policy, consistent with the evidence. Foreign monetary policies that attempt to stabilize the exchange rate reduce welfare and may exacerbate exchange rate volatility. We document empirically ...
Working Paper
Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets
We use a two-country New Keynesian model with financial frictions and dollar debt in balance sheets to investigate the foreign effects of U.S. monetary policy. Financial amplification works through an endogenous deviation from uncovered interest parity (UIP) arising from limits to arbitrage in private intermediation. Combined with dollar trade invoicing, this mechanism leads to large spillovers from U.S. policy, consistent with the evidence. Foreign monetary policies that attempt to stabilize the exchange rate reduce welfare, and may exacerbate exchange rate volatility. We document ...
Working Paper
Global financial conditions, country spreads and macroeconomic fluctuations in emerging countries
This paper uses a panel structural vector autoregressive (VAR) model to investigate the extent to which global financial conditions, i.e., a global risk-free interest rate and global financial risk, and country spreads contribute to macroeconomic fluctuations in emerging countries. The main findings are: (1) Global financial risk shocks explain about 20 percent of movements both in the country spread and in the aggregate activity in emerging economies. (2) The contribution of global risk-free interest rate shocks to macroeconomic fluctuations in emerging economies is negligible. Its role, ...
Report
U.S. Monetary Policy Spillovers to Emerging Markets: Both Shocks and Vulnerabilities Matter
We explore how the sources of shocks driving interest rates, country vulnerabilities, and central bank communications affect the spillovers of U.S. monetary policy changes to emerging market economies (EMEs). We utilize a two-country New Keynesian model with financial frictions and partly dollarized balance sheets, as well as poorly anchored inflation expectations reflecting imperfect monetary policy credibility in vulnerable EMEs. Contrary to other recent studies that also emphasize the sources of shocks, our approach allows the quantification of effects on real macroeconomic variables as ...
Working Paper
Financial Frictions and Macroeconomic Fluctuations in Emerging Economies
Estimated dynamic models of business cycles in emerging markets deliver counterfactual predictions for the country risk premium. In particular, the country interest rate predicted by these models is acyclical or procyclical, whereas it is countercyclical in the data. This paper proposes and estimates a small open economy model of the emerging-market business cycle in which a time-varying country risk premium emerges endogenously. In the proposed model, a firm's borrowing rate adjusts countercyclically as the default threshold of the firm depends on the state of the macroeconomy. I ...
Discussion Paper
Modeling the Global Effects of the COVID-19 Sudden Stop in Capital Flows
The COVID-19 outbreak has triggered unusually fast outflows of dollar funding from emerging market economies (EMEs). These outflows are known as “sudden stop” episodes, and they are typically followed by economic contractions. In this post, we assess the macroeconomic effects of the COVID-induced sudden stop of capital flows to EMEs, using our open-economy DSGE model. Unlike existing frameworks, such as the Federal Reserve Board’s SIGMA model, our model features both domestic and international financial constraints, making it well-suited to capture the effects of an outflow of ...
Discussion Paper
Financial Crises and the Desirability of Macroprudential Policy
The global financial crisis has put financial stability risks?and the potential role of macroprudential policies in addressing them?at the forefront of policy debates. The challenge for macroeconomists is to develop new models that are consistent with the data while being able to capture the highly nonlinear nature of crisis episodes. In this post, we evaluate the impact of a macroprudential policy that has the government tilt incentives for banks to encourage them to build up their equity positions. The government has a role since individual banks do not internalize the systemic benefit of ...
Working Paper
The Financial (In)Stability Real Interest Rate, R**
We introduce the concept of financial stability real interest rate using a macroeconomic banking model with an occasionally binding financing constraint as in Gertler and Kiyotaki (2010). The financial stability interest rate, r**, is the threshold interest rate that triggers the constraint being binding. Increasing imbalances in the financial sector measured by an increase in leverage are accompanied by a lower threshold that could trigger financial instability events. We also construct a theoretical implied financial condition index and show how it is related to the gap between the natural ...
Working Paper
How Effective are Macroprudential Policies? An Empirical Investigation
In recent years, policymakers have generally relied on macroprudential policies to address financial stability concerns. However, our understanding of these policies and their efficacy is limited. In this paper, we construct a novel index of domestic macroprudential policies in 57 advanced and emerging economies covering the period from 2000:Q1 to 2013:Q4, with tightenings and easings recorded separately. The effectiveness of these policies in curbing bank credit growth and house price inflation is then assessed using a dynamic panel data model. The main findings of the paper are: (1) ...