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Working Paper
Vehicle currency
While in principle, international payments could be carried out using any currency or set of currencies, in practice, the U.S. dollar is predominant in international trade and financial flows. The dollar acts as a "vehicle currency" in the sense that agents in nondollar economies will generally engage in currency trade indirectly using the U.S. dollar rather than using direct bilateral trade among their own currencies. Indirect trade is desirable when there are transactions costs of exchange.> ; This paper constructs a dynamic general equilibrium model of a vehicle currency. We explore the ...
Working Paper
Dollar Bloc or Dollar Block: External Currency Pricing and the East Asian Crisis
This paper provides a quantitative investigation of the East Asian crisis of 1997-1999. The two essential features of the crisis that we focus on are (a) the crisis was a regional phenomenon; the depth and severity of the crisis were exacerbated by a large decline in regional demand, and (b) the practice of setting export goods prices in dollars (which we document empirically) led to a powerful internal propagation effect of the crisis within the region, contributing greatly to the decline in regional trade flows. We construct a model with these two features and show that it can do a ...
Working Paper
Global Current Account Adjustment: A Decomposition
Though China’s share of world trade is comparable to that of Japan, little is known about the response of China’s trade to changes in exchange rates. The few estimates available suffer from two limitations. First, the data for trade prices are based on proxies for prices from other countries. Second, the estimation sample includes the period of China’s transformation from a centrally planned economy to a market-oriented system. To address these limitations, this paper develops an empirical model explaining the shares of China’s exports and imports in world trade in terms of the real ...
Working Paper
International financial integration and crisis contagion
International financial integration helps to diversify risk but also may increase the transmission of crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with endogenous portfolio choice and collateral constraints. Collateral constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. The analysis allows for different degrees of financial integration, moving from financial autarky to bond market integration and equity market integration. Financial integration leads to a significant ...
Working Paper
What determines European real exchange rates?
We study a newly constructed panel data set of relative prices of a large number of consumer goods among 31 European countries. We find that there is a substantial and nondiminishing deviation from PPP at all levels of aggregation, even among euro zone members. However, real exchange rates are very closely tied to relative GDP per capita within Europe, both across countries and over time. This relationship is highly robust at all levels of aggregation. We construct a simple two-sector endowment economy model of real exchange rate determination. Simulating the model using the historical ...
Fed’s 1994 Rate Aggressiveness Led to Emerging-Market Turmoil; Is This Time Different?
As the Federal Reserve embarks on a monetary tightening cycle, only a few spots of vulnerability have appeared among emerging markets.
Working Paper
Fiscal deficits, debt, and monetary policy in a liquidity trap
The macroeconomic response to the economic crisis has revived old debates about the usefulness of monetary and fiscal policy in fighting recessions. Without the ability to further lower interest rates, policy authorities in many countries have turned to expansionary fiscal policies. Recent literature argues that government spending may be very effective in such environments. But a critical element of the stimulus packages in all countries was the use of deficit financing and tax reductions. This paper explores the role of government debt and deficits in an economy constrained by the zero ...
Conference Paper
Global current account adjustment: a decomposition
The rising current account deficit in the USA has attracted considerable attention in recent years. We use the ?business cycle accounting? methodology to identify the principal distortions that have affected the external accounts of the US. In particular, we measure distortions in the optimality conditions of a simple two-country general equilibrium model using data from the US and the other G7 countries. We then feed these measured distortions into the model individually and use the simulated counterfactual paths of the current account to determine the contribution of each of these ?wedges? ...
Working Paper
Exchange rate flexibility under the zero lower bound
An independent currency and a flexible exchange rate generally helps a country in adjusting to macroeconomic shocks. But recently in many countries, interest rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in countries with flexible exchange rates. This paper argues that if the zero bound constraint is binding and policy lacks an effective ?forward guidance? mechanism, a flexible exchange rate system may be inferior to a single currency area. With monetary policy constrained by the zero bound, under flexible exchange ...
Working Paper
Capital Controls as Macro-prudential Policy in a Large Open Economy
The literature on optimal capital controls for macro-prudential policy has focused on capital controls in a small open economy. This ignores the spillover effects to the rest of the world. This paper re-examines the case for capital controls in a large open economy, where domestic financial constraints may bind following a large negative shock. There is a tension between the desire to tax inflows to manipulate the terms of trade and tax outflows for macro-prudential purposes. Non-cooperative capital controls are ineffective as macro-prudential policy. Cooperative policy will ignore ...