Economic Booms, Trade Deficits, and Economic Policy (original) (raw)
Related papers
Economic Booms, Trade De…cits, and Economic Policy ¤
2000
Many economic booms have been accompanied by real exchange rate appreciations, large trade deficits-which have sometimes persisted after the return to the initial exchange rate parity-and a deteriorating traded sector. Those circumstances have typically raised the question of the desirability of some stabilization policy. We show that the dynamics induced by an expected productivity shock in an economy where the capital stock is non-mobile across sectors, match those circumstances. Furthermore, we obtain that credit market imperfections tend to exacerbate trade deficits, and to cause an inefficient capacity reduction in the traded sector. Some stabilization policies are explored.
Productivity shocks, stabilization policies and the dynamics of net foreign assets
Journal of Economic Dynamics and Control, 2013
In this paper we investigate the role of macroeconomic stabilization policies for the international transmission of productivity shocks and their effects on the external sector. We develop a two-country stochastic Dynamic New-Keynesian "perpetual youth" model of the business cycle with incomplete international financial markets. Our OLG structure implies stationary net foreign asset dynamics and allows for a thorough analysis of the interaction of monetary policy with non-balanced budget fiscal policy. We derive the dynamic and cyclical properties of fiscal deficit feedback rules and their implications for net foreign assets dynamics. Our results imply that the degree of "fiscal discipline", i.e. the extent to which the fiscal rule responds to debt dynamics, is crucial for the dynamics of net foreign assets. We show that under a counter-cyclical fiscal rule with low fiscal discipline temporary positive productivity shocks may result in substantial deteriorations of the Net Foreign Asset position in the medium run. This result crucially hinges on the interplay among nominal rigidities, non-balanced budget fiscal policy, and the wealth effects on consumption that are implied by our OLG structure.
Dynamic effects of terms of trade shocks: The impact on debt and growth
Journal of International Money and Finance, 2008
The recent empirical literature on the economic effects of terms of trade shocks highlights not only the direct effects on growth, but also the resulting changes in volatility and debt. We link the procyclicality of sovereign debt to terms of trade shocks and provide theoretical underpinnings for standby facilities such as the "Exogenous Shocks Facility" recently created by the IMF. By modeling international capital market imperfections and changes in creditworthiness during adverse terms of trade shocks, we show that transitions can involve excessive adjustment as debt decumulation overshoots its long run equilibrium to prolong the adjustment recession. Our model adds a novel dynamic dimension to the Harberger-Laursen-Metzler effect. In contrast to the previous terms of trade literature, we highlight that the precise nature of the capital imperfection is key to the results. When credit depends not on the level of debt but on the debt to equity ratio the model naturally features dynamic effects that are not found in previous models. It also highlights that how a country responds to terms of trade shocks depends importantly on whether the country is a creditor or debtor. Finally we assess the welfare costs associated with terms of trade shocks. For plausible parameterizations we find that a 20 percent deterioration in the terms of trade may lead to a welfare loss on the order of 10 to 15 percent.
Output stabilization in fixed and floating regimes: Does trade of new products matter
Economic Modelling, 2017
This paper studies the dynamics of output and export margins in the aftermath of global shocks in fixed and floating exchange rate regimes. Using a panel vector autoregressive model with exogenous factors, it traces the mean responses of output, terms of trade, extensive and intensive margins to real and nominal shocks in 22 developed economies over the period 1988–2011. We find remarkable differences in the transmission of shocks across exchange rate regimes. Adjustment takes place mainly at the extensive margin in fixed regimes, and implies a crowding out of intensive margins that is not present among floaters. Large movements at the extensive margin are associated with a weaker performance in terms of output stabilization. Our findings are robust to alternative sample selections and identification of the shocks. The evidence in the paper stresses a novel advantage of flexible exchange rates based on their ability to smooth the fluctuations in trade of new products.
Financial liberalization, structural change, and real exchange rate appreciations
Journal of International Economics, 2011
This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. We account for the appreciation of the real exchange rate in Mexico between 1988 and 2002 using a two sector dynamic general equilibrium model of a small open economy with two driving forces: (i) differential productivity growth across sectors and (ii) a decline in the cost of borrowing in foreign markets. These two mechanisms account for 60 percent of the decline in the relative price of tradable goods and explain a large fraction of the reallocation of labor across sectors. We do not find a significant role for migration remittances, foreign reserves accumulation, government spending, terms of trade, or import tariffs.
Journal of International Money and Finance, 1992
A common argument against monetary stabilization policies in developing countries is that they lead to short-run output contractions. This paper argues that, in economies facing severely limited capital markets, such contractionary effects may hold only under a fixed exchange rate system, especially if the policy lacks credibility. However, if currency substitution is an additional feature of the economy, monetary deceleration may be expansionary even under fixed exchange rates. (JEL E52, E63) A well recognized feature of developing countries is the existence of a severely limited capital market. In general, commercial banking constitutes the most important form of financial intermediation. The market for primary securities is at a very incipient stage in some of these countries and is even nonexistent in others. In addition, residents of these countries have limited access to international financial markets.' The literature on developing countries has long recognized that the existence of severely limited capital markets has an important influence on how financial policies affect the real sectors of these economies. Specifically, this literature has two main streams: on the one hand there are the McKinnonShaw Financial Development models initiated by the works of McKinnon (1973) and Shaw (1973) and the later formalizations and extensions of, among others, Kapur (1976) and Mathieson (1979). On the other hand, there are the 'Neo-structuralist' financial models represented by Cavallo (198 1), Bruno (1979), Taylor (198 1), van Wijnbergen (1982, 1986), and Buffie (1984), among others. A common argument among supporters of the second group is that restrictive monetary policies not only reduce output but also increase inflation in the short run. This result does not follow, however, from limited access to financial markets but from wage and interest rate rigidities assumed in fixed exchange rate models. The main objective of this paper is to reexamine the relationship between *I wish to thank Peter Isard, Donald J. Mathieson, and two anonymous referees for their valuable comments. Of course, any errors remain my own.
Springer eBooks, 2006
We produce an example of a small open economy for which small increases in the world interest rate may induce a sharp decline in output and a precipitous depreciation of the nominal and the real exchange rate (RER). Due to a costly state veri¯cation (CSV) problem in domestic credit markets, combined with unrestricted international capital°ows, our economy generates two longrun equilibria, one with low GDP and a relatively depreciated RER, and one with high GDP and a relatively appreciated RER. The¯rst is always a saddle, while the second may be a sink or a source, depending on the level of the world interest rate. More precisely, there exists a critical level of the world interest rate above which the high-GDP steady state turns from a sink to a source. Hence unexpected increases in the world interest rate to \supercritical" levels may induce a \crisis" in the economy. This is identi¯ed in the model with the economy switching from an equilibriumpath approaching the high output steady state, to the saddlepath approaching the low output steady state. We simulate such a \crisis" trajectory for our model economy. In Mexico's recent history, periods of growth associated with an appreciation of the real exchange rate (RER) have alternated with periods of sharp contraction characterized by a depreciation of the RER. Our economy may display such behavior as an equilibrium response to changes in the world interest rate.