Papers
I. Growth,
Volatility, Finance and Risk Sharing
Risk Sharing, Finance and
Institutions in International Portfolios, forthcoming, Journal
of Financial Economics, (with Marcel
Fratzscher)
We develop a
standard model to show how transaction costs in international investment affect
conventional tests of consumption risk sharing, both in a multilateral and a
bilateral setting. We implement the tests in a novel international dataset on
bilateral holdings of equity, bonds, foreign direct
investment and bank loans. In our data, high foreign capital holdings are
associated with international consumption risk sharing as implied by our
theory; this is especially true of investment in equity or bonds, but not of
foreign direct investment or bank loans. In our model, this implies transaction
costs are higher for FDI and international loans. The discrepancy may reflect
technological differences, but also the prospect of expropriation, perhaps most
stringent for FDI or loans. We argue that expropriation risk is endogenous to
both the borrower.s institutions and its openness to
international markets. The detrimental impact of poor institutions is muted in
open economies, where the possibility of subsequent exclusion from world
markets deters expropriation of foreign capital. We show the implied effects of
institutions prevail in both the cross-section of consumption risk sharing, and
in observed international investment patterns.
Keywords:
Risk sharing, Diversification, Portfolio Choice, Financial Integration,
Cross-Border Investment. JEL Classification: F21, F30, G15
Pooling Risk Among Countries, September 2008 (with Paolo Mauro)
Based on a systematic
analysis of all possible combinations of countries in a large sample, we
identify the groups of countries where the potential for international
risk-sharing is most attractive. We show that the bulk of this potential can be
achieved in groups consisting of as few as seven members, and that further
potential marginal benefits quickly become negligible. For many such small
groups, the welfare gains associated with risk sharing are larger than Lucas’s
classic calibration suggested for the United States, under similar assumptions
on utility. Why do we not observe more arrangements of this type? Our results
suggest that large welfare gains can only be achieved within groups where
contracts are relatively difficult to enforce. International diversification
can thus yield substantial gains in some instances, but they remain untapped
owing to potential partners’ weak institutional quality and a history of
default on international
obligations. Noting that existing risk-sharing arrangements often
have a regional dimension, we speculate that shared economic interests such as
common trade may help sustain such arrangements, though risk-sharing gains are
smaller when membership is constrained on a regional basis.
JEL Classification
Numbers: E21, E32, E34, F41
Keywords: Risk Sharing, Diversification, Enforceability
Finance and Efficiency:
Do Bank Branching Regulations Matter?, forthcoming, Review of Finance (with Viral Acharya and Jason
Sturgess)
We
document that the deregulation of bank branching restrictions in the United
States triggered a reallocation across sectors, with end effects on state-level
volatility. This change in state-level volatility cannot be explained simply by
shifts in sector-level returns and volatility. A reallocation effect is at
play. To study this effect, we invoke a benchmark allocation based on
mean-variance portfolio theory applied to sectoral
returns. We find that the realized sectoral
allocation of output at the state-level converges towards this benchmark
allocation, at a rate that is hastened following the deregulation. This partly
occurs because sectors with zero weight in the benchmark allocation see their
share of total output shrink. We show convergence is particularly strong in
sectors characterized by young, small and external finance dependent firms, and
for states that have a larger share of such sectors. The findings are robust to
the endogeneity of deregulation dates. They suggest
that improving bank access to branching affects the sectoral
specialization (or diversification) of output,
in a manner
that depends on the variance-covariance properties of sectoral
returns, rather than on their average only.
Keywords:
Financial development, Growth, Volatility, Diversification, Deregulation,
Liberalization, Mean-variance effciency.
JEL classification:
E44, F02, F36, O16, G11, G21, G28
A companion paper with
extensive robustness can be found here.
Growth and Volatility, Journal
of Monetary Economics, October 2007, 54(7).
Revision of CEPR Discussion Paper 3561. View media
coverage in MoneyWise at http://www.moneywise.co.uk/outsidetheboxdec.htm
Growth and volatility correlate negatively across countries, but positively
across sectors. Analytically, whether or not sectoral
growth and volatility are correlated positively is irrelevant in the aggregate.
Cross-country estimates identify the detrimental effects of macroeconomic
volatility on growth, but they cannot be used to dismiss theories implying a
positive growth-volatility coefficient, which appear to hold in sectoral data. In particular, volatile sectors command high
investment rates, as they would in a mean-variance framework.
Keywords: Sectors, Growth, Volatility.
JEL Classification: E32, O40
II. International
Capital Flows
The Overhang Hangover,
revised December 2008, World Bank Economic Research Working Paper 3673, CEPR DP
5210 (with Romain
Ranciere)
We revisit the debt overhang question. We first use non-parametric techniques
to isolate a panel of countries on the downward sloping section of a debt Laffer curve. In particular, overhang countries are ones
where a threshold level of debt is reached in sample, beyond which (initial)
debt ends up lowering (subsequent) growth. Second, we depart from reduced form
growth regressions and perform direct tests of the theory on the thus selected
sample of overhang countries. In the spirit of event studies, we ask whether,
as the overhang level of debt is reached: (i)
investment falls precipitously as it should when it becomes optimal to default, (ii)
economic policy deteriorates observably, as it should when debt contracts
become unable to elicit effort on the part of the debtor, and (iii) the terms
of borrowing worsen noticeably, as they should when it becomes optimal for
creditors to pre-empt default and exact punitive interest rates. We find a
systematic response of investment, some worsening of the policy environment,
and a fall in interest rates. This
happens because lending by the private sector virtually disappears in overhang
situations, and multilateral agencies step in with concessional rates. These
results are obtained in countries with poor property rights and underdeveloped
financial markets, but not elsewhere. Exit from an overhang zone - but not
effective debt relief - is accompanied by the exact opposite dynamics.
Keywords:
Debt Overhang, Kernel Estimation, Debt Contracts, Investment, Debt Relief.
JEL
Classification Numbers: E62, F34, F43, H63
The Real
Effects of Financial Integration, Journal of International
Economics, March 2006, Vol 68(2).
Fluctuations in GDP are more synchronized internationally than fluctuations in
Consumption, and they remain so even between financially integrated economies,
where the ranking should in theory be the reverse. This paper shows this
happens because correlations in GDP fluctuations rise with financial
integration. Finance
serves to increase international correlations in both consumption and GDP
fluctuations, which explains the persistent gap between the two in the data.
The positive association between financial integration and GDP correlation
constitutes a puzzle, as theory suggests a negative relation if anything.
Nevertheless, it prevails in the data even after the effects of finance on
trade and specialization are accounted for.
Keywords: Financial Integration, International Business Cycles, Risk Sharing,
Quantity Puzzle.
JEL Classfication: F30, F41, E44
Is There a
Quantity Puzzle Within Countries? An
Application Using U.S. and Canadian Data, Bank
of Canada's Thirteenth Annual Monetary Policy Conference Volume, February
2005.
Fluctuations in Disposable Income (net of transfers) are more correlated across
U.S. States or Canadian Provinces than fl‡uctuations
in local Production. Across countries, Consumption plans are less correlated
than business cycles, a theoretical anomaly famously labeled a “Quantity
Puzzle” by Backus, Kehoe and Kydland (1992). In the
aggregate, financially integrated regions tend to have have
highly synchronized GDP fl‡uctuations, as documented
in Imbs (2004b). In contrast, within countries, financial integration is
associated with less correlated business cycles, in a way consistent with the
standard international real business cycle model. In other words, the Quantity
Puzzle pertains to international data, and it stems from the specific impact of
capital flows on international output correlations.
Keywords: Financial Integration, International Business Cycles, Risk Sharing,
Quantity Puzzle.
JEL Classification: F30, F41, E44
Trade, Finance,
Specialization and Synchronization, Review of Economics and Statistics,
August 2004. An extensive sensitivity analysis is available here.
I investigate the determinants of business cycles synchronization across
regions. The linkages between trade in goods, financial openness,
specialization and business cycles synchronization are evaluated in the context
of a system of simultaneous equations. The main results are as follows. (i) Specialization patterns have a sizeable impact on
business cycles. Most of this effect is independent from trade or financial
policy, but directly reflects differences in GDP per capita. (ii) A variety of
measures of financial integration suggest that economic regions with strong
financial links are significantly more synchronized, even though they also tend
to be more specialized. (iii) The estimated role of trade is closer to that
implied by existing models once intra-industry trade is held constant. The
results obtain in a variety of datasets, measurement strategies and
specifications. They relate to a recent strand of International Business Cycles
models with incomplete markets and transport costs, and on the empirical side,
point to an important omission in the list of criteria defining an Optimal
Currency Area, namely specialization patterns.
Keywords: Trade, Specialization, Financial Openness, International Business
Cycle, Optimal Currency Area.
JEL Classification Numbers: F41, E32.
III. Aggregation
One TV, One Price, forthcoming,
Scandinavian Journal of Economics. (with
Haroon
Mumtaz, Morten Ravn and Helene Rey).
We use a
unique dataset on television prices across European countries and regions to
investigate differences in price levels. With detailed price level data, we are
able to account for most of the usual arguments invoked to explain price differences.
Thanks to the dimensionality of our data, we have (partial) information on the
costs involved in production, cross-country differences in firm perception, and
ultimately the international prices of the actual same good. We use these data
to answer classic questions in the literature. We first focus on price
differences, and show that: (i) Quality accounts for
the lion’s share of international price dispersion.
Rich
economies tend to consume higher quality goods. (ii) Even for the exact same television
set, sizeable international price differentials subsist, of 8% on average. This
may reflect the fact that the perception of a given firm does vary sizeably across countries, something we estimate directly.
(iii) EMU countries display lower price dispersion than non-EMU countries. (iv) A border effect subsists. Absolute price differentials
and relative price volatility are positively correlated with exchange rate
volatility, but not with conventional measures of transport costs. (v) In terms
of price dynamics, exchange rate passthrough is low
in the short run, but high in
the long run.
Keywords:
International and Regional price differences, Border Effect, Brand perception.
JEL Classification: F15, F23, F41
Elasticity Optimism, January
2009, (with Isabelle Mejean)
Estimates of
the elasticity of substitution between domestic and foreign varieties are small
in macroeconomic data, and substantially larger in disaggregated studies. This
may be an artifact of heterogeneity. We use disaggregated multilateral trade
data to structurally identify elasticities of
substitution in US goods. We spell out a partial equilibrium model to aggregate
them adequately at the country level. We compare aggregate elasticities
that impose equality across sectors, to estimates allowing for heterogeneity.
The former are similar in value to conventional macroeconomic estimates; but
they are more than twice larger -up to 7- with heterogeneity. The parameter is
central to calibrated models in most of international economics. We discuss the
difference our corrected estimate makes in various areas of international
economics, including the dynamics of external balances, the international
transmission of shocks, international portfolio choice and optimal monetary
policy.
Keywords:
Trade Elasticities, Aggregation, Calibration, Global
Imbalances, International Transmission, International Portfolio, Monetary
Policy.
JEL Classification: F41, F32, F21.
Aggregating Phillips Curves, September 2008. (with
Florian
Pelgrin and Eric Jondeau).
The New Keynesian Phillips Curve is at the center of two raging empirical
debates. First, how can purely forward looking pricing account for the observed
persistence in aggregate inflation. Second, price-setting responds to movements
in marginal costs, which should therefore be the driving force to observed
inflation dynamics. This is not always the case in typical estimations. In this
paper, we show how heterogeneity in pricing behavior is relevant to both
questions. We detail the conditions under which imposing homogeneity results in
overestimating a backward-looking component in (aggregate) inflation, and
underestimating the importance of (aggregate) marginal costs for (aggregate)
inflation. We provide intuition for the direction of these biases, and verify
them in French data with information on prices and marginal costs at the
industry level. We show that the apparent discrepancy in the estimated duration
of nominal rigidities, as implied from aggregate or microeconomic data, can be
fully attributable to a heterogeneity bias.
JEL Classifications: C10, C22, E31, E52.
Keywords: New Keynesian Phillips Curve, Heterogeneity, Inflation Persistence,
Marginal Costs, Nominal Rigidities
"Aggregation
Bias" DOES Explain the PPP Puzzle, revised September 2005. (with Haroon Mumtaz, Morten Ravn and Helene
Rey). CEPR DP 5237, NBER WP 11607
This article summarizes our views on the role of an
"aggregation bias" in explaining the PPP Puzzle, in response to the
several papers recently written in reaction to our initial contribution. We
discuss in particular the criticisms of Imbs, Mumtaz, Ravn and Rey (2002)
presented in Chen and Engel (2005). We show that their contentions are based
on: (i) analytical counter-examples which are not
empirically relevant; (ii) simulation results minimizing the extent of
"aggregation bias"; (iii) unfounded claims on the impact of
measurement errors on our results; and (iv) problematic
implementation of small-sample bias corrections. We conclude, as in our original
paper, that "aggregation bias" goes a long way towards explaining the
PPP puzzle.
For the data used in our paper - as well as a comparison with Chen-Engel's - click here
PPP Strikes Back:
Aggregation and the Real Exchange Rate, Quarterly
Journal of Economics, February 2005, lead article. (with Haroon Mumtaz, Morten Ravn and Helene Rey).
The December 2002 Version can be found here. Also NBER Working
Paper 9372 and CEPR
Discussion Paper 3715.
We show the importance of a dynamic aggregation bias in accounting for the PPP
puzzle. We prove that established time series and panel methods substantially
exaggerate the persistence of real exchange rates because of heterogeneity in
the dynamics of disaggregated relative prices. When heterogeneity is properly
taken into account, estimates of the real exchange rate half-life fall
dramatically, to little more than one year, or significantly below Rogoff’s ‘consensus view’ of three to five years. We show
that corrected estimates are consistent with plausible nominal rigidities,
thus, arguably, solving the PPP puzzle.
Keywords: Real Exchange Rate Persistence, Purchasing Power Parity, Aggregation,
Parameter Heterogeneity.
JEL Classification: F36, F41, C43
The PPP Controversy - A Summary of the Debate surrounding "PPP
Strikes Back" between December 2002 and June 2003
(FIRST POSTED IN SEPTEMBER 2003)
A number of issues on our PPP paper were raised during
discussions and seminar presentations, most prominently by Charles Engel. We
are posting here the documents summarizing the exercises we conducted in
response to these comments. The punchline is that our
result on an aggregation bias in the persistence of real exchange rates (a) is
robust, (b) can be generalized, and (c) is important empirically.
(a) Data and sensitivity.
We use Eurostat data. This dataset is often argued to
contain a number of errors, and one might be tempted to think this is a reason
for our much lower estimates of real exchange rate persistence.
However, measurement error does not affect our results: The aggregation bias is
pervasive. The two notes here and here go through the details
of the analysis. Here
is also a direct answer to a note posted by Julian di
Giovanni on this issue.
Technically: One needs to be careful with the econometric specification. The
Random Coefficient estimator is a generalization of Random Effects,
the Mean Group estimator generalizes Fixed Effects. They are equivalent to each
other asymptotically. Just as in standard panels, appropriate tests should be
implemented when deciding which estimator to implement. Longer time series call
for a Mean Group estimator, which implies a large and positive aggregation
bias. We also implement a variety of corrections to the Eurostat
data (inclusive of some suggested by Charles Engel himself). Our results stand
in all cases.
(b) A generalization of the proof for the existence of an aggregation bias.
The analytical proof in the paper assumed cross-sectional independence of the
errors of relative prices. As shown in this note however,
the same result obtains even when allowing for correlation in the errors. It is
only
under extreme and unrealistic assumptions on the cross-sectional dependence
that the sign of the bias can reverse. Thanks are due to Charles Engel for
forcing us to develop this more general and elegant proof.
(c) Is the aggregation bias empiricaly important?
Estimating the persistence of autoregressive processes in panel data is always
related to two types of biases: The aggregation bias that we discuss and the Nickell "small-sample" attenuating bias. The
question is which dominates. This first note uses Monte-Carlo
simulations to show the aggregation bias dominates in most relevant cases. In
this more recent note,
we dedicate some time to the treatment of explosive roots at the sectoral level, and whether their inclusion influences the
magnitude of the aggregation bias. We show they are innocuous: estimates of the
aggregation bias when explosive roots are excluded are almost identical to our
original results. We also point to existing research showing that, in
Monte-Carlo simulations, a (fixed effects) intercept should be included in both
the Data Generating Process (DGP) and the simulated estimates. Including it
only in the latter severely magnifies the small-sample bias, as shown in this gauss
program.
Technically: Explosive processes are innocuous because we estimate directly the
autoregressive parameters, rather than the half lives which would indeed be
infinite. It is important to deal correctly with the intercept when deriving
the properties of the Fixed Effects estimator. The correct exercise is to allow
for fixed effects in both the DGP and the empirical model. In that case the
aggregation bias dominates. Without fixed effects in the DGP, the Nickell attenuating bias is aggravated and can potentially
dominate. It is also important to note that the aggregation bias survives even
with a large time-series dimension (as in our paper), while the small sample
attenuating bias disappears as the time-series grows.
Non-Linearities and Real Exchange Rates Dynamics, Journal of the European Economic Association,
April-May 2003.
(with Haroon Mumtaz, Morten Ravn and Helene
Rey).
We confirm the presence of substantial non-linearities
in real exchange rate dynamics at the sectoral level.
There exists zones where arbitrage is not profitable because of transaction
costs, and thus mean reversion is inexistent. We compute the speed of mean
reversion of sector specific real exchange rates, conditional on the existence
of arbitrage as implied by our non-linear estimations, and relate them to
plausible economic determinants such as tradability and exchange rate
volatility.
Keywords: Real Exchange Rate Persistence, Purchasing Power Parity, Non-Linearities, Trading Costs.
JEL Classification: F36, F41, C43.
IV. Sectors,
Specialization and Openness
The Dynamics of Trade and Competition,
forthcoming, Journal of International Economics, (with Natalie
Chen and Andrew
Scott)
We
estimate a version of the Melitz and Ottaviano (2008) model of international trade with firm
heterogeneity. The model is constructed to yield testable implications for the
dynamics of prices,
productivity and markups
as functions of openness to trade at a sectoral
level. The theory lends itself naturally to a difference in differences
estimation, with international differences in trade
openness at the
sector level reflecting international differences in the competitive structure
of markets. Predictions are derived for the effects of both domestic and
foreign openness on each
economy. Using
disaggregated data for EU manufacturing over the period 1989-1999 we find short
run evidence that trade openness exerts a competitive effect, with prices and
markups falling and productivity rising. The response of profit margins to
openness has implications on the conduct of monetary policy. Consistent with
the predictions of some recent theoretical models we find
some, albeit
weaker, support that the long run effects are more ambiguous and may even be
anti-competitive. Domestic trade liberalization also appears to induce
pro-competitive effects on
overseas markets.
JEL Classifications:
E31, F12, F14, F15, L16.
Keywords: Competition, Inflation, Openness, Globalization,
Markups, Prices, Productivity.
Stages of
Diversification, American Economic
Review, vol. 93, no.1, March 2003.
(with Romain Wacziarg)
This paper studies the evolution of sectoral
concentration in relation to the level of per capita income. We show that
various measures of sectoral concentration follow a
U-shaped pattern across a wide variety of data sources: countries first
diversify, in the sense that economic activity is spread more equally across
sectors, but there exists, relatively late in the development process, a point
at which they start specializing again. We discuss this finding in light of
existing theories of trade and growth, which generally predict a monotonic
relationship between income and diversification.
JEL: F43, F15, O40. An earlier version exists as CEPR Discussion Paper 2642,
with some theory.
V. Business Cycles
The First Global Recession in Decades,
forthcoming, IMF Economic Review
I use
monthly data on industrial production to estimate the distribution of international
business cycle correlations since the 1980's, with focus on the current
turmoil. The degree of international correlation in national business cycles
since the end of 2008 is unprecedented in three decades. From 2008M12, an
upward shift in the cross-sectional distribution of cycles
synchronization is sizeable and significant, especially between advanced
economies. The magnitude of the shift is unprecedented in recent history, even
relative to what happened since 1973 after alternative shocks with worldwide
consequences. The shift does not arise because volatilities changed with the
crisis. Both goods and assets trade have contributed to this synchronization.
The (large and significant) synchronization amongst OECD economies is
associated with financial openness. The (weaker) diffusion amongst developing economies
tends to happen between trade partners.
Keywords:
International Business Cycle, Sub-Prime Crisis, Trade Linkages, Financial
Linkages.
JEL Classification: E32, F15, F36, F41.
Co-Fluctuations, revised June 2003. (An
earlier version was CEPR
Discussion Paper No. 2267)
This paper calls attention to an often neglected yet quite intuitive
determinant of the synchronization in business cycles. I find countries with
similar sectoral production patterns to be more
synchronized, even when holding constant other possible transmission channels,
in particular trade intensity. The results hold for a large sample of countries
with different income levels, as well as within the OECD. They are robust to
different filtering devices, across yearly and quarterly frequency, and for a
variety of data sources and subsamples. The findings are interpreted in a model
where countries diversify as they grow, develop an increasingly similar
economic structure, and thus react in an
increasingly similar fashion to (aggregate or sector-specific) shocks.
Keywords: International Business Cycles, Trade, Economic Structure.
JEL Classifications: F41, E32, F12.
Sectors
and the OECD Business Cycle, January 2001. (An earlier version was CEPR Discussion Paper No. 2473)
This paper investigates empirically the interactions between trade intensity,
economic structure and business cycles synchronization. I implement an original
methodology in which trade and economic structure are allowed to affect
synchronization both directly and indirectly, and their putative endogeneity is controlled for through appropriate
instrumentation. I find sectoral structure to have a
robust and economically significant impact on cycle synchronization; the
variable is found to be particularly important within EMU member countries,
thus going some way in explaining why outsider countries like the UK or
Scandinavian economies tend to display persistently idiosyncratic business
cycles relative to first-stage members.
Keywords: Trade, Economic Structure, International Business Cycle.
JEL Classification Numbers: F41, E32.
Technology,
Growth and the Business Cycle, Journal of
Monetary Economics, August 1999, 44(1).
Using a partial equilibrium model that allows for factor hoarding, I construct
series on input utilization rates for ten OECD countries. These series are used
in grwoth accounting computations of total factor
productivity which filter out cyclical variations in input utilization rates.
The main findings are as follows: (i) adjusted Solow
residuals grow consistently faster than standard measures; (ii) the variability
of the adjusted Solow residual is in some cases smaller than the standard
residual's; (iii) adjusted Solow residuals are less procyclical
than standard residuals, and fare better at usual exogeneity
tests; (iv) supply shocks are no more synchronized between European countries
than elsewhere, and (v) observed increased output synchronization in Europe is
due to demand factors.
Keywords: Solow Residuals, Factor Hoarding, International
Business Cycle
JEL Classification Numbers: O47, F41, E32.