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Series:Pacific Basin Working Paper Series  Bank:Federal Reserve Bank of San Francisco 

Working Paper
A cure worse than the disease? currency crises and the output costs of IMF-supported stabilization programs
This paper investigates the output effects of IMF-supported stabilization programs, especially those introduced at the time of a severe balance of payments/currency crisis. Using a panel data set over the 19751997 period and covering 67 developing and emerging market economies (with 461 IMF stabilization programs and 160 currency crises), we find that currency criseseven after controlling for macroeconomic developments and political and regional factorssignificantly reduce output growth for one to two years. Output growth is also lower (0.7 percentage point annually) during IMF stabilization programs, but it appears that growth generally slows prior to implementation of the program. Moreover, programs coinciding with recent balance of payments or currency crises do not appear to further damage short-run growth prospects. Countries participating in IMF programs significantly reduce domestic credit growth, but no effect is found on budget policy. Applying this model to the collapse of output in East Asia following the 1997 crisis, we find that the unexpected (forecast error) collapse of output in Malaysiawhere an IMF program was not followedwas similar in magnitude to those countries adopting IMF programs (Indonesia, Korea, the Philippines, and Thailand).
AUTHORS: Hutchison, Michael M.
DATE: 2001

Working Paper
Financial liberalization and banking crises in emerging economies
In this paper, we provide a theoretical explanation of why financial liberalization is likely to generate financial crises in emerging market economies. We first show that under financial repression the aggregate capital stock and bank net worth are both likely to be low. This leads a newly liberalized bank to be highly levered, because the marginal product of capitaland thus loan interest ratesare high. The high returns on capital, however, also make default unlikely, and they encourage the bank to retain all of its earnings. As the banks net worth grows, aggregate capital rises, the marginal product of capital falls, and a banking crisis becomes more likely. Although the bank faces conflicting incentives toward risk-taking, as net worth continues to grow the bank will become increasingly cautious. Numerical results suggest that the bank will reduce its risk, by reducing its leverage, before issuing dividends. We also find that government bailouts, which allow defaulting banks to continue running, induce significantly more risk-taking than the liability limits associated with standard bankruptcy.
AUTHORS: Jones, John Bailey; Daniel, Betty C.
DATE: 2001

Working Paper
Foreign exchange: macro puzzles, micro tools
This paper reviews recent progress in applying information-theoretic tools to long-standing exchange rate puzzles. I begin by distinguishing the traditional public information approach (e.g., monetary models, including new open-economy models) from the newer dispersed information approach. (The latter focuses on how information is aggregated in the trading process.) I then review empirical results from the dispersed information approach and relate them to two key puzzles, the determination puzzle and the excess volatility puzzle. The dispersed information approach has made progress on both.
AUTHORS: Lyons, Richard K.
DATE: 2001

Working Paper
Asian finance and the role of bankruptcy
The degree to which bankruptcy is permitted to play a role in the allocation of capital is a key distinction between the Asian state-directed financial regime and the Western market-directed version. The paper discusses the two approaches to finance and argues that a major problem with the bank finance model used in many Asian countries is its minimization of bankruptcy risks. A three-sector development model (agriculture, manufacturing, and financial sector) is developed and simulated to compare the outcomes of the two approaches separately and then to evaluate the transition costs of switching from a state- to a market-directed financial regime. The simulation results suggest that the market approach results in a higher long-run growth path because it eliminates inefficient firms through bankruptcy. The results also suggest that switching from a state- to a market-directed model can be very costly to the economy, though the transition costs can be lowered somewhat by a delayed and phased-in liberalization. At the same time, a delayed and phased-in approach may induce other difficulties not considered in the model. Several policy implications are drawn from the model and simulation results; for example, development of an infrastructure to provide for orderly bankruptcy and the development of money and capital markets should be given high priority in the liberalization process.
AUTHORS: Cargill, Thomas F.; Parker, Elliott
DATE: 2001

Working Paper
Financial development and growth: are the APEC nations unique?
This paper examines panel evidence concerning the role of financial development in economic growth. I decompose the well-documented relationship between financial development and growth to examine whether financial development affects growth solely through its contribution to growth in factor accumulation rates, or whether it also has a positive impact on total factor productivity, in the manner of Benhabib and Spiegel (2000). I also examine whether the growth performances of a subsample of APEC countries are uniquely sensitive to levels of financial development. The results suggest that indicators of financial development are correlated with both total factor productivity growth and investment. However, many of the results are sensitive to the inclusion of country fixed effects, which may indicate that the financial development indicators are proxying for broader country characteristics. Finally, the APEC subsample countries appear to be more sensitive to financial development, both in the determinations of subsequent total factor productivity growth and in rates of factor accumulation, particularly accumulation of physical capital.
AUTHORS: Spiegel, Mark M.
DATE: 2001

Working Paper
Australian growth: a California perspective
Examination of special cases assists understanding of the mechanics of long-run economic growth more generally. Australia and California are two economies having the rare distinction of achieving 150 years of sustained high and rising living standards for rapidly expanding populations. They are suitable comparators since in some respects they are quite similar, especially in their initial conditions in the mid-19th century, their legal and cultural inheritances, and with respect to some long-term performance indicators. However, their growth trajectories have differed markedly in some subperiods and over the longer term with respect to the growth in the size of their economies. Most important, the comparison of an economy that remained a region in a much larger national economy with one that evolved into an independent political unit helps identify the role of several key policies. California had no independent monetary policy, or exchange rate, or controls over immigration or capital movements, or trade policy. Australia did, and after 1900 pursued an increasingly interventionist and inward-oriented development strategy until the 1970s. What difference did this make to long-run growth? And what other factors, exogenous and endogenous, account for the differences that have emerged between two economies that shared such similar initial conditions?
AUTHORS: Taylor, Alan M.; McLean, Ian W.
DATE: 2001

Working Paper
Factor analysis of a model of stock market returns using simulation-based estimation techniques
A dynamic latent factor model of stock market returns is estimated using simulation-based techniques. Stock market volatility is decomposed into common and idiosyncratic components, and volatility decompositions are compared between stable and turmoil periods to test for possible shift-contagion in equity markets during Asian financial crisis. Five core Asian emerging stock markets are analyzedThailand, Indonesia, Korea, Malaysia and the Philippines. Results identify the existence of shift-contagion during the crisis and indicate that the Thai market was a trigger for contagious shock transmission. ; Monte Carlo experiments are conducted to compare simulation method of moments and indirect inference estimation techniques. Consistent with the literature such experiments find that, in the presence of autocorrelation and time-varying volatility, indirect inference is a better method of conducting variance decomposition analysis for stock market returns than the conventional method of moments.
AUTHORS: Dungey, Mardi; Zhumabekova, Diana
DATE: 2001

Working Paper
Testing for contagion using correlations: some words of caution
Tests for contagion in financial returns using correlation analysis are seriously affected by the size of the noncrisis and crisis periods. Typically the crisis period contains relatively few observations, which seriously affects the power of the test.
AUTHORS: Zhumabekova, Diana; Dungey, Mardi
DATE: 2001

Working Paper
Is money still useful for policy in East Asia?
Since the East Asian crises of 1997, a number of East Asian economies have allowed greater exchange rate flexibility and abandoned monetary targets in favor of inflation targeting, apparently because the perceived usefulness of money as a predictor of inflation, i.e. the information content of money, has fallen. In this paper, we discuss factors that are likely to have influenced the stability of the relationship between money and inflation, particularly in the 1990s, and then assess this relationship in a set of East Asian economies. We focus on (1) the stability of the behavior of the velocity of money; (2) the ability of money growth to predict inflation as measured by tests of Granger causality, and (3) the contribution of money to the variance of the forecast error of inflation. We find evidence that, with a few exceptions in which capital flows were particularly large, velocity remained generally stable, as did the relationship between money growth and inflation. However, the contribution of money to inflation forecast errors fell considerably in the 1990s, reducing its value as an information variable to monetary authorities.
AUTHORS: Moreno, Ramon; Glick, Reuven
DATE: 2001

Working Paper
The impact of Japan's financial stabilization laws on bank equity values
In the fall of 1998, two important financial regulatory reform acts were passed in Japan. The first of these acts, the Financial Recovery Act, created a bridge bank scheme and provided funds for the resolution of failed banks. The second act, the Rapid Revitalization Act, provided funds for the assistance of troubled banks. While both of these acts provided some government assistance to the banking sector, they also called for reforms aimed at strengthening the regulatory environment. ; Using an event study framework, this paper examines the evidence in equity markets concerning the anticipated impact of the regulatory reforms. Our evidence suggests that the anticipated regulatory impact of the Financial Recovery Act was mixed, while the Rapid Revitalization Act was expected to disporportionately favor weaker Japanese banks. As such, it appears that the market was skeptical about the degree to which the new acts would lead to true banking reform.
AUTHORS: Spiegel, Mark M.; Yamori, Nobuyoshi
DATE: 2001

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