Real gross domestic product increased 3.0 percent in the second quarter of 2017, according to the “second” estimate released by the Bureau of Economic Analysis. The growth rate was 0.4 percentage point more than the “advance” estimate released in July. In the first quarter, real GDP increased 1.2 percent. Read more
Why do exports not increase immediately after an exchange rate devaluation? This is an important question, because export dynamics have important consequences for growth and capital flows. We trace the dynamic path of exports after 11 large devaluations in emerging economies and find that they they peak in around three years after the devaluation. The extensive margin plays an important role in these dynamics, i.e. the increase in exports is largely fueled by exports of new products and by new firms. We also find that interest rates are important: export growth was more sluggish in episodes where interest rates also increased.
We explain these facts using a simple insight: Entering in an export market often requires a firm to incur very specific costs such as product standardization, certification, etc. which are independent of the scale of production. Such costs play an important role in explaining firm dynamics. In particular, a large devaluation may make it more profitable to export, but it takes time to build export capacity. An increase in interest rates makes it more expensive to amortize these costs and acts as a disincentive to exports.
Using this simple idea, we build a framework to measure the impact of devaluations, and the associated economic crises, on exports, capital flows and output in emerging economies. We find that these export specific costs lead to deeper contractions and stronger recoveries.
A particularly important risk in the financial sector that is often discussed as one of the reasons for the recent collapse of the financial system is that the banks invested in overly risky loan portfolios, particularly those related to the housing market. The riskiness of a bank’s loan portfolio, especially loans related to the housing market, is an important source of instability in the financial system.
I develop a simple model of banks that includes financial regulations and systemic risk and examine various options for the taxation of banks. The model emphasizes systemic risk in a bank’s loan decisions and thus debt in the economy as whole rather than a particular bank’s debt to equity ratio. An externality arises because a bank’s loan decisions affect the economy-wide probability of loan success. The bank takes account of the effect of its loan decisions on itself but ignores the effects on other banks in the system.
The model is utilized to examine the effects of five possible taxes (on bank loans, deposits, liabilities, equity, and profits). Each tax has particular impacts on the market for loans and deposits, and consequent effects on interbank borrowing and the riskiness of a bank’s loan portfolio. All of the taxes except the tax on deposits will decrease the supply of loans and the riskiness of loans in the economy. The tax on deposits does not affect either of these variables due to the assumption of separability of the management costs of deposits and loans. All of the taxes will decrease a bank’s demand for deposits except the tax on loans, again due to the separability assumption. A bank’s borrowing will rise with the tax on deposits, fall with the tax on loans, and will be indeterminate for the other taxes.
I discuss extensions to consider depositor access to international capital markets and tax avoidance by multinational banks. Results for the former case will depend on the degree of substitutability between deposits and funds in international capital markets. An interesting result for the latter case is that tax avoidance by multinational banks tends to increase the riskiness of a bank’s loan portfolio in some cases.
Despite the recent resurgence in the European economies, the 2008 U.S. financial crisis that caused a global recession also pushed many of them, in particular, those in the periphery, into a stubborn recession, which led to the rise of populist political movements. The severity of the crisis is seen as an indictment of the European Monetary Union for failing to generate convergence to its members. Convergence is crucial for the conduct of the single monetary policy where members do not have recourse to fiscal transfer mechanisms nor currency adjustments. In this paper, we examine whether the process towards monetary union and the common experience of the euro, the single European currency, led to the convergence of output growth for member countries and if shocks to the economies affected it.
The skepticism about the promises of the European Monetary Union goes back to its conception, which occurred among intense controversy about whether the Eurozone was ready to become a currency union since it was not satisfying the original criteria of the Optimal Currency Area. Subsequent studies of currency unions showed a significantly deepened trade integration among member countries of a monetary union. The implication is that the Optimal Currency Area criteria can be satisfied after unification resulting in trade integration and income convergence. The endogenous business cycle synchronization argument draws on two linkages: If a currency union increases trade, which, in turn, leads to synchronization of business cycles, then it is argued that business cycles are synchronized “endogenously”. Empirical results are not uniform though several support the argument of increased synchronization through trade. However, these results are challenged by the view that business cycles in Europe are affected by many factors, which are mostly ignored except the trade channel but can decrease output co-movements in the union and their exclusion could lead to potentially biased results.
Convergence is a process that takes place over an extended period, disrupted by crises and recessions, speeding up during recovery and booms. The existing analyses that rely on panel methodologies are neither sufficiently long enough nor suitable to capture such non-linear processes. Our paper investigates output growth converge in the European Monetary Union from an angle different than the existing literature. We exploit the time series characteristics of several economies in the European Union and examine if output growth in the peripheral countries converged towards that of the core countries. The higher the elasticity of peripheral countries growth to that of core countries, the greater the synchronization between the core and the periphery. By using a novel methodology we are able to account for reverse causality and structural changes created by policy and crises, which are mostly ignored in the literature.
Therefore, the evidence we uncover does not support the view that the switch to euro would generate a closer integration of the markets and thus automatically synchronize growth rates between the peripherals and the core countries. However, our results support the view that the preparations towards the creation of the single currency spurred convergence among several countries in the region well before the introduction of the euro, and continued after that. Once the last ripple effects of the Great Recession subside, Europe should see a greater synchronization in the member economies, with possible beneficial impact on the political process.
The odds of a self-inflicted US debt crisis now look pretty good: hard-line Republicans are eager to hold the economy hostage, Democrats are in no mood to make concessions, and Trump is both spiteful and ignorant. So it looks fairly likely that by October or so there will come a day when the U.S. government stops paying some of its bills, including interest on debt.
How bad will that be? The truth is that we don’t know; but it may be helpful to talk about *why* we don’t know.
Until now, US debt has played a special role in the world economy, because it is — or was — the ultimate safe asset, the thing people can use to secure transactions with no questions about it retaining its value. In a way, the dollar is to other moneys as money is to other assets, and US dollar debt is the form in which dollars are held with ultimate safety.
Taking away that role could be very nasty. One prominent interpretation of the 2008 financial crisis is that it was a “safe asset shortage“, pushing safe real interest rates to negative territories:
Source: IMF (2014)
When people realized that those AAA securities engineered from subprime loans weren’t the real thing, they scrambled into an inadequate supply of trill safe stuff. Deprive them of dollar debts as safe assets, and terrible things could happen.
The question then becomes whether an interruption in payments would really knock out the special role of U.S. debt.
Suppose that everyone expected normal payments to resume, with back interest, in a couple of weeks. In that case, even a slight discount on, say, Treasury bills would make them a very good investment — so speculators would basically step in and support the value of U.S. debt despite temporary default. In that case default might not be that big a deal.
The big problem would come if investors see the default as more than a temporary glitch — if they see it as a sign of enduring, critical dysfunction in American governance. In that case they wouldn’t necessarily step in to buy our debt, and their confidence in the whole economic edifice would take a severe hit.
Total nonfarm payroll employment increased by 209,000 in July, and the unemployment rate was little changed at 4.3 percent, the U.S. Bureau of Labor Statistics reported today. Employment increased in food services and drinking places, professional and business services, and health care. Read more
