Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel during the European Sovereign Crisis
This paper documents a new type of cross-border bank lending channel using a novel dataset on the balance sheets of U.S. branches of foreign banks and their syndicated loans. We show that: (1) The U.S. branches of euro-area banks suffered a liquidity shock in the form of reduced access to large time deposits during the European sovereign debt crisis in 2011. The shock was related to their euro-area affiliation rather than to country- or bank-specific characteristics. (2) The affected branches received additional funding from their parent banks, but not enough to offset the lost deposits. (3) The liquidity shock prompted branches to cut lending to U.S. firms, which occurred mostly along the extensive margin. In turn, the affected U.S. firms suffered reduced access to syndicated loans, which prompted them to cut investment and built up their cash reserves.
AUTHORS: Correa, Ricardo; Zlate, Andrei; Sapriza, Horacio
Offshore Production and Business Cycle Dynamics with Heterogeneous Firms
To examine the effect of offshoring through vertical FDI on the international transmission of business cycles, I propose a two-country model in which firms endogenously choose the location of their production plants over the business cycle. Firms face a sunk cost to enter the domestic market and an additional fixed cost to produce offshore. As such, the offshoring decision depends on the firm-specific productivity and on fluctuations in the relative cost of effective labor. The model generates a procyclical pattern of offshoring and dynamics along its extensive margin that are consistent with data from Mexico's maquiladora sector. The extensive margin enhances the procyclical response of the value added offshore to expansions in the home economy, as the number of offshoring firms mirrors the dynamics of firm entry at home. As a result, offshoring increases the comovement of output across economies, in line with the empirical evidence.
AUTHORS: Zlate, Andrei
Offshoring, Low-skilled Immigration, and Labor Market Polarization
During the last three decades, the U.S. labor market has been characterized by its employment polarization. As jobs in the middle of the skill distribution have shrunk, employment has expanded in high- and low-skill occupations. Real wages have not followed the same pattern. While earnings for high-skill occupations have risen robustly, wages for both low- and middle-skill workers have remained subdued. We attribute this outcome to the rise in offshoring and low-skilled immigration, and develop a three-country stochastic growth model to rationalize their asymmetric effect on employment and wages, as well as their implications for U.S. welfare. In the model, the increase in offshoring negatively affects middle-skill occupations but benefits the high-skill ones, which in turn boosts aggregate productivity. As the income of high-skill occupations rises, so does the demand for complementary services provided by low-skill workers. However, low-skill wages remain depressed due to the rise in low-skilled immigration. Native workers react to immigration by investing in training. Offshoring and low-skilled immigration improve aggregate welfare in the U.S. economy, notwithstanding their asymmetric impact on native workers of different skill levels. The model is estimated using data on real GDP, U.S. employment by skill group, and enforcement at the U.S.-Mexico border.
AUTHORS: Zlate, Andrei; Mandelman, Federico S.
International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals?
We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs), covering the so-called taper-tantrum episode of 2013 and seven other episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in relatively early and persisted through this episode. (3) During the taper tantrum, while controlling for the EMEs' economic fundamentals, financial conditions also deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) During the EME crises of the 1990s and early 2000s, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities. (5) However, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode; it also occurred during the global financial crisis of 2008 and, subsequently, during financial stress episodes related to the European sovereign crisis in 2011 and China's financial market stresses in 2015.
AUTHORS: Ahmed, Shaghil; Coulibaly, Brahima; Zlate, Andrei
Macroprudential Policy: Case Study from a Tabletop Exercise
Since the global financial crisis of 2007-09, policy makers and academics around the world have advocated the use of prudential tools for macroprudential purposes. This paper presents a macroprudential tabletop exercise that aimed at confronting Federal Reserve Bank presidents with a plausible, albeit hypothetical, macro-financial scenario that would lend itself to macroprudential considerations. In the tabletop exercise, the primary macroprudential objective was to reduce the likelihood and severity of possible future financial disruptions associated with the hypothetical overheating scenario. The scenario provided a path for key macroeconomic and financial variables, which were assumed to be observed through 2016:Q4, as well as the corresponding hypothetical projections for the interval from 2017:Q1 to 2018:Q4. Prudential tools under consideration included capital-based tools such as leverage ratios, countercyclical capital buffers, and sectoral capital requirements; liquidity-based tools such as liquidity coverage and net stable funding ratios; credit-based tools such as caps on loan-to-value ratios and margins; capital and liquidity stress testing; as well as supervisory guidance and moral suasion. In addition, participants were asked to consider using monetary policy tools for financial stability purposes. Under the hypothetical scenario, participants found many prudential tools less attractive due to implementation lags and limited scope of application and favored those deemed to pose fewer implementation challenges, such as stress testing, margins on repo funding, and guidance. Also, monetary policy came more quickly to the fore as a financial stability tool than might have been thought before the exercise. The tabletop exercise abstracted from governance issues within the Federal Reserve System, focusing instead on economic mechanisms of alternative tools.
AUTHORS: Zlate, Andrei; Adrian, Tobias; Yang, Emily; de Fontnouvelle, Patrick
Reach for Yield by U.S. Public Pension Funds
This paper studies whether U.S. public pension funds reach for yield by taking more investment risk in a low interest rate environment. To study funds? risk-taking behavior, we first present a simple theoretical model relating risk-taking to the level of risk-free rates, to their underfunding, and to the fiscal condition of their state sponsors. The theory identifies two distinct channels through which interest rates and other factors may affect risk-taking: by altering plans? funding ratios, and by changing risk premia. The theory also shows the effect of state finances on funds? risk-taking depends on incentives to shift risk to state debt holders. To study the determinants of risk-taking empirically, we create a new methodology for inferring funds? risk from limited public information on their annual returns and portfolio weights for the interval 2002-2016. In order to better measure the extent of underfunding, we revalue funds? liabilities using discount rates that better reflect their risk. We find that funds on average took more risk when risk-free rates and funding ratios were lower, which is consistent with both the funding ratio and the risk premia channels. Consistent with risk-shifting, we also find more risk-taking for funds affiliated with state or municipal sponsors with weaker public finances. We estimate that up to one-third of the funds? total risk was related to underfunding and low interest rates at the end of our sample period.
AUTHORS: Zlate, Andrei; Pritsker, Matthew; Anadu, Kenechukwu E.; Bohn, James; Lu, Lina
Monetary Policy Divergence and Net Capital Flows: Accounting for Endogenous Policy Responses
This paper measures the effect of monetary tightening in key advanced economies on net capital flows around the world. Measuring this effect is complicated by the fact that the domestic monetary policies of affected economies respond endogenously to the foreign tightening shock. Using a structural VAR framework with quarterly panel data we estimate the impulse responses of domestic policy variables and net capital flows to a foreign monetary tightening shock. We find that the endogenous response of domestic monetary policy depends on each economy's capital account openness and exchange rate regime. We use a method to compute counterfactual impulse responses for net capital outflows under the assumption that the domestic policy rate does not respond to foreign monetary tightening. Our results suggests that failing to account for the endogenous response of domestic monetary policy biases down the estimated elasticity of net capital flows to foreign interest rates by as much as one-third for countries with open capital accounts.
AUTHORS: Zlate, Andrei; Davis, Scott
Offshoring, low-skilled immigration, and labor market polarization
During the last three decades, jobs in the middle of the skill distribution disappeared, and employment expanded for high- and low-skill occupations. Real wages did not follow the same pattern. Although earnings for the high-skill occupations increased robustly, wages for both low- and middle-skill workers remained subdued. We attribute this outcome to the rise in offshoring and low-skilled immigration, and we develop a three-country stochastic growth model to rationalize this outcome. In the model, the increase in offshoring negatively affects the middle-skill occupations but benefits the high-skill ones, which in turn boosts aggregate productivity. As the income of high-skill occupations rises, so does the demand for services provided by low-skill workers. However, low-skill wages remain depressed as a result of the surge in unskilled immigration. Native workers react to immigration by upgrading the skill content of their labor tasks as they invest in training.
AUTHORS: Mandelman, Federico S.; Zlate, Andrei
Immigration, remittances, and business cycles
We use data on border enforcement and macroeconomic indicators from the United States and Mexico to estimate a two-country business cycle model of labor migration and remittances. The model matches the cyclical dynamics of labor migration to the United States and documents how remittances to Mexico serve an insurance role to smooth consumption across the border. During expansions in the destination economy, immigration increases with the expected stream of future wage gains, but it is dampened by a sunk migration cost that reflects the intensity of border enforcement. During recessions, established migrants are deterred from returning to their country of origin, which places an additional downward pressure on the wage of native unskilled workers. Thus, migration barriers reduce the ability of the stock of immigrant labor to adjust during the cycle, enhancing the volatility of unskilled wages and remittances. We quantify the welfare implications of various immigration policies for the destination economy. ; Formerly titled: Immigration and the macroeconomy
AUTHORS: Mandelman, Federico S.; Zlate, Andrei
Macroprudential Policy: Results from a Tabletop Exercise
This paper presents a tabletop exercise designed to analyze macroprudential policy. Several senior Federal Reserve officials were presented with a hypothetical economy as of 2020:Q2 in which commercial real estate and nonfinancial debt valuations were very high. After analyzing the economy and discussing the use of monetary and macroprudential policy tools, participants were then presented with a hypothetical negative shock to commercial real estate valuations that occurred in the second half of 2020. Participants then discussed the use of the tools during an incipient downturn. Some of the findings of the exercise were that during an asset boom, there were limits to the effectiveness of US macroprudential tools in controlling narrow risks and that changes to the fed funds rate may not always simultaneously meet macroeconomic and financial stability goals. Some other findings were that during a downturn, it would be desirable to use high-frequency indicators for deciding when to release the countercyclical capital buffer (CCyB) and that tensions exist between microprudential and macroprudential goals when using the CCyB and the stress test.
AUTHORS: Rosen, Richard J.; Zlate, Andrei; Musatov, Alex; Vardoulakis, Alexandros; Prescott, Edward Simpson; Duffy, Denise; Tallarini, Thomas D.; Kovner, Anna; Yang, Emily; Haubrich, Joseph G.