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On the record: facing financial troubles in an era of globalization: a conversation with Nathan Sheets
Economist Nathan Sheets, director of the Federal Reserve Board's Division of International Finance, puts a global perspective on the current economic crisis and the Fed's response to it.
AUTHORS: Sheets, Nathan
Regional influences on U.S. monetary policy: some implications for Europe
This paper looks at the monetary policy decisions of the U.S. Federal Reserve and asks whether those decisions have been influenced solely by national concerns, or whether regional factors have played a role. All of the Federal Reserve's policymakers have some regional identity, i.e., either their positions explicitly carry some regional affiliation or their region of origin is a factor that must be considered in the selection process. This research is relevant for the Fed, and it may also be relevant for Europe's fledgling central bank in Frankfurt. Critics have asserted that ECB policymakers have an incentive to base policy on national developments and respond to national political pressures. We find that Fed policymakers do take into account developments in regional unemployment when deciding monetary policy, and that these regional developments are more important for central bankers at the hub than in the spokes. These findings are robust to a variety of different specifications of the voting equation.
AUTHORS: Meade, Ellen E.; Sheets, Nathan
Central bank independence, inflation and growth in transition economies
In this paper, we document two empirical relationships that have emerged as the former communist countries have taken steps to transform their economies from command systems to market-based systems. First, increased central bank independence has tended to improve inflation performance. Second, high inflation has adversely affected real activity. More specifically, in the first section of this paper, we develop indices of central bank independence (CBI) for twelve transition economies and examine the relationship between CBI and inflation performance across these countries. Statistical evidence suggests that the transition economies with more independent central banks have achieved lower inflation than their counterparts. The second section of this paper studies the relationship between inflation and growth in twenty-six transition economies. We present econometric evidence indicating that reducing inflation helps stabilize economic activity, following the sharp output declines that occur during the initial stages of transition. The paper conc1udes that establishing an independent central bank is a concrete institutional reform that may reduce inflation and thus facilitate economic growth.
AUTHORS: Sheets, Nathan; Loungani, Prakash
Exchange rate pass-through to export prices: assessing some cross-country evidence
A growing body of empirical work has found evidence of a decline in exchange rate pass-through to import prices in a number of industrial countries. Our paper complements this work by examining pass-through from the other side of the transaction; that is, we assess the exchange rate sensitivity of export prices (denominated in the exporter's currency). We first sketch out a streamlined analytical model that highlights some key factors that determine pass-through. Using this model as reference, we find that the prices charged on exports to the United States are more responsive to the exchange rate than is the case for export prices to other destinations, which is consistent with results in the literature suggesting that import price pass-through in the U.S. market is relatively low. We also find that moves in the exchange rate sensitivity of export prices over time have been significantly affected by country and region-specific factors, including the Asian financial crisis (for emerging Asia), deepening integration with the United States (for Canada), and the effects of the 1992 ERM crisis (for the United Kingdom).
AUTHORS: Gagnon, Joseph E.; Vigfusson, Robert J.; Sheets, Nathan
U.S. external adjustment: is it disorderly? Is it unique? Will it disrupt the rest of the world?
In recent years, a number of studies have analyzed the experiences of a broad range of industrial economies during periods when their current account deficits have narrowed. Such studies identified systematic aspects of external adjustment, but it is unclear how good a guide the experience of other countries may be to the effects of a future narrowing of the U.S. external imbalance. In contrast, this paper focuses in depth on the historical experience of external adjustment in the United States. Using data from the past thirty-five years, we compare economic performance in episodes during which the U.S. trade balance deteriorated and episodes during which it adjusted. We find trade balance adjustment to have been generally benign: U.S. real GDP growth tended to fall, but not to a statistically significant extent; housing construction slumped; inflation generally rose modestly; and although nominal interest rates tended to rise, real interest rates fell. The paper then compares these outcomes to those in foreign industrial economies. We find that the economic performance of the United States during periods of external adjustment is remarkably similar to the foreign experience. Finally, we also examine the performance of the foreign industrial economies during the periods of U.S. deterioration and adjustment. Contrary to concerns that U.S. adjustment will prove injurious to foreign economies, our analysis suggests that the foreign economies fared reasonably well during past periods when the U.S. trade deficit narrowed: the growth of domestic demand and real GDP abroad generally strengthened during such episodes, although inflation and interest rates tended to rise as well.
AUTHORS: Sheets, Nathan; Reeve, Trevor A.; Kamin, Steven B.
Capital flight from the countries in transition: some theory and empirical evidence.
The first portion of this paper develops a simple framework that decomposes home demand for a domestic risky asset into a portfolio diversification incentive, a relative risk incentive, and a relative return incentive. It shows that capital flight may be caused by factors that increase the relative riskiness of the home asset or by structural distortions (such as financial sector inefficiency), which reduce the relative return of the domestic asset. The second portion of the paper provides empirical estimates of capital flight from Poland, Hungary, Czechoslovakia, and Russia for the 1988-93 period. The analysis concludes that the implementation of "shock therapy" reform programs has been accompanied by substantial capital flight. This has apparently occurred because such reform programs have initially generated increased economic and political uncertainty: prices have jumped toward world levels, property rights have been redistributed, and new institutions have been established. As these reform programs have progressed, however, the quantity of capital flight has declined. Hungary's experience is significantly different from that of the other three countries. Hungary pursued gradual reform and never experienced significant capital flight.
AUTHORS: Sheets, Nathan
The Adjustment of Global External Imbalances: Does Partial Exchange Rate Pass-Through to Trade Prices Matter?
This paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop an open-economy DGE model in which firms set their prices with an eye toward maintaining their competitiveness against other producers; this feature of the model generates a variable desired markup and, hence, pass-through that is less than complete. With trade price elasticities of unity or greater, we find that for a given move in the exchange rate the nominal trade balance adjusts more when pass-through is high. However, an offsetting consideration is that the exchange rate tends to be more sensitive to shocks in a low pass-through environment. We show that the relative importance of these considerations depends on the structural features of the economy, including the magnitude of the trade price elasticities and the sensitivity of private spending to shocks.
AUTHORS: Gust, Christopher J.; Sheets, Nathan
Eastern European export performance during transition
During the past decade, Eastern European exports have undergone a deep transformation, as communist bloc trading relationships have collapsed and trade with the West has increased. The extent of this geographical re-orientation has generally exceeded the predictions of equilibrium models developed by Hamilton and Winters (1992) and Collins and Rodrik (1991), suggesting the prospect for increased export activity among the transition economies as aggregate demand in these countries strengthens and payment systems mature. Significant changes in the product composition of Eastern European exports have accompanied the geographical reorientation. Exports of manufacturing goods to former communist countries have declined sharply, but exports to the EC across an array of goods -- including heavy machinery -- have grown robustly. Evidence suggests that the observed changes in export composition reflect the redirection of physical goods through price competition and the emergence of market-determined comparative advantage.
AUTHORS: Sheets, Nathan; Boata, Simona
Exchange rate pass-through to U.S. import prices: some new evidence
This paper documents a sustained decline in exchange rate pass-through to U.S. import prices, from above 0.5 during the 1980s to somewhere in the neighborhood of 0.2 during the last decade. This decline in the pass-through coefficient is robust to the measure of foreign prices that is included in the regression (i.e., CPI versus PPI), whether the estimation is done in levels or differences, and whether U.S. prices are included as an explanatory variable. Notably, the largest estimates of pass-through are obtained when commodity prices are excluded from the regression. In this case, the pass-through coefficient captures both the direct effect of the exchange rate on import prices and an indirect effect operating through changes in commodity prices. Our work indicates that an increasing share of exchange rate pass-through has occurred through this commodity-price channel in recent years. While the source of the decline in pass-through is difficult to pin down with certainty, our work points to several factors, including the reduced share of (commodity-intensive) industrial supplies in U.S. imports and the increased presence of Chinese exporters in U.S. markets. We detect a particular step down in the pass-through coefficient around the time of the Asian financial crisis and document a shift in the export pricing behavior of emerging Asian firms around that time.
AUTHORS: Faust, Jon; Marazzi, Mario; Sheets, Nathan; Gagnon, Joseph E.; Rogers, John H.; Marquez, Jaime R.; Vigfusson, Robert J.; Martin, Robert F.; Reeve, Trevor A.
The adjustment of global external balances: does partial exchange rate pass-through to trade prices matter?
This paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through world with more adjustment in a low pass-world occurring through a larger response of the exchange rate and terms of trade rather than real trade flows.
AUTHORS: Sheets, Nathan; Gust, Christopher J.; Leduc, Sylvain