Transcript Monetary Policy in Emerging Market Countries Jeffrey Frankel Harpel Professor of Capital Formation & Growth Based on chapter in Handbook of Monetary Economics, edited by.

Monetary Policy
in Emerging Market Countries
Jeffrey Frankel
Harpel Professor of Capital Formation & Growth
Based on chapter in Handbook of Monetary Economics,
edited by Benjamin Friedman and Michael Woodford, 2011.
And on "Nominal GDP Targeting for Middle-Income Countries,“
Central Bank Review, September 2014. HKS RWP 14-033.
Research Seminar Webinar, June 2, 2015
Monetary policy in emerging markets
• has only recently come into its own as a field,
• & had apparently not been surveyed before.
chapter in Handbook of Monetary Economics (North Holland)
edited by Benjamin Friedman and Michael Woodford, 2011.
30 years ago, it would have been inappropriate to apply
to developing countries models that had been designed
for industrialized countries,
– with their assumptions of financial sectors that were
• highly market-oriented
• and open to international flows.
– Rather, developing countries suffered from financial repression.
– Also, capital controls blocked portfolio capital flows.
• But EM countries liberalized financial markets in the 1990s
– and many floated their currencies in the 2000s.
• Meanwhile, some developing-country attributes have turned
out to be relevant for some “advanced” countries since 2008:
• -- default risk.
• Still, there are important differences.
Survey
Outline
1. How EM economies still differ from advanced countries
2. Costs of devaluation
3. Inflation
4. Nominal targets for monetary policy
5. Exchange rate regimes
6. Procyclicality problems
7-8. Financial crises
Question: How can EM economies combine the advantage
of an exchange rate target, that it provides a nominal
anchor for monetary policy, with the advantage of floating,
that it accommodates terms of trade shocks?
1. Characteristics that tend to distinguish EM
countries from large industrialized countries
• lower credibility with respect to
– price stability
– and default risk (“debt intolerance”).
• procyclicality
– domestic fiscal policy
– and international finance.
• greater exposure to supply shocks & trade shocks.
EM & developing economies differ from
industrialized economies
1.
• More exposed to terms of trade shocks
– due to relatively high trade/GDP ratios,
– and volatile terms of trade,
especially for commodity producers,
– but also for commodity importers.
• And more exposed to supply shocks
a) such as natural disasters
(hurricanes, cyclones, earthquakes, tsunamis…)
b) other weather events (droughts…),
c) social unrest (strikes…),
d) productivity shocks (“Are we the next Tiger economy?”).
Developing countries have more
trade shocks & natural disasters
7
“Managing Volatility in Low-Income Countries: The Role and Potential for Contingent Financial Instruments,”
IMF SPRD & World Bank PREM, approved by R.Moghadam & O.Canuto, Oct. 2011. Fig.1.
Minerals, hydrocarbons, & agricultural products
have highly variable prices
Major Commodity
Exports in Latin
American countries
and Standard
Deviation of Prices
on World Markets
Frankel (2011)
* World Bank analysis
(2007 data)
Leading
Commodity Export*
ARG
BOL
BRA
CHL
COL
CRI
ECU
GTM
GUY
HND
JAM
MEX
NIC
PAN
PER
PRY
SLV
TTO
URY
VEN
Soybeans
Natural Gas
Steel
Copper
Oil
Bananas
Oil
Coffee
Sugar
Coffee
Aluminum
Oil
Coffee
Bananas
Copper
Beef
Coffee
Natural Gas
Beef
Oil
Standard Deviation of Log
of Dollar Price 1970-2008
0.28
1.82
0.59
0.41
0.76
0.44
0.76
0.48
0.47
0.48
0.42
0.76
0.48
0.44
0.41
0.23
0.48
1.82
0.23
0.76
2. Costs of Devaluation
• Political costs: Officials tend to lose their jobs.
– Leaders twice as likely, within 6 months of a devaluation.
– Central bank governors & fin.min.s are 63% more likely within 1 year.
• Economic costs:
Devaluation is sometimes contractionary.
– Of many possible contractionary effects,
the balance sheet effect from currency mismatch
receives the most attention.
e.g., Aghion, Banerjee & Bacchetta (2000), Bebczuk, Galindo & Panizza (2006), Caballero & Krishnamurty
(2002), Calvo, Izquierdo & Meija; Calvo, Izquierdo, & Talvi (2003), Cavallo, Kisselev, Perri & Roubini (2004) ,
Cespedes, Chang & Velasco (1999, 2000, 03, 04), Christiano, Gust & Roldos (2002), Dornbusch (2001, 02),
Jeanne & Zettelmeyer (2005), Kiyotaki & Moore (1997), Krugman (1999), Mendoza (2002), Schneider &
Tornell (2001), Guidotti, Sturzenegger & Villar (2003).
The balance
sheet effect
In currency crises
such as late-90s’,
loss in output
depends on foreigndenominated debt
times real
devaluation.
Cavallo, Kisselev, Perri & Roubini (2002)
Why do countries develop weak balance sheets
in the first place?
1. “Original sin:” Investors in high-income countries are not
willing to acquire exposure in EM currencies.
-- Hausmann (1999, 2003)
2. Adjustable currency pegs create a false sense of security:
currency volatility is required if borrowers are to avoid
unhedged dollar liabilities.
-- Eichengreen (1999), Velasco (2001)
3. Moral hazard: by borrowing in $, well-connected locals
put the risk onto the central bank.
-- Dooley (2000a); Krugman (1999); and Wei & Wu (2002).
4. Procrastination of adjustment: when foreigner investors
lose enthusiasm for a country, it shifts to short-term and $denominated debt to postpone adjustment. -- Frankel
(2007).
Procrastination of adjustment:
1992-94
In the months leading up to the Dec.94 Mexican peso
attack,
debt composition shifted...
from peso-denominated (Cetes) to $-linked (tesobonos)...
Shocks
Peso crisis
Currency composition in the post-2003 capital inflows
shifted away from $-denomination, toward Local Currency.
Share of External Debt in LC
(Mean of 14 sample countries)
Wenxin Du & Jesse Schreger, Harvard U., Dec. 2014, “Sovereign Risk, Currency Risk, & Corporate Balance Sheets,” Fig.2, p.19 .
Corporate debt post-2008 swung back to $-denomination,
away from Local Currency, in some EMs.
Wenxin Du & Jesse Schreger, Harvard U., Sept. 2014,
“Sovereign Risk, Currency Risk, & Corporate Balance Sheets” p.18
3. Inflation
Inflation in the median emerging market economy
peaked around 1990, then gradually declined.
24
peak:
≈ 1990
peak:
≈ 1990
15
The highest inflation rates are now in Venezuela & Argentina.
50
45
CPI Inflation, 2014
(Percent, full-year projection)
VEN = 75
40
35
30
25
ARG¹
20
15
10
5
URY
NIC
HND
BRA
0
Source: Cubeddu, Iakova, & Sosa, IMF, Feb.2015. Data from: IMF, World Economic Outlook July 2014 Update; and staff calculations.
¹ For Argentina, projected annual inflation is computed using cumulative inflation through July and assuming monthly inflation for the rest of the year will equal the
average of the last three months.
Taper Tantrum Test:
Countries with higher inflation rates were hit
by greater currency depreciation after May 2013.
Mishra, Moriyama, N’Diaye & Nguyen,
“Impact of Fed Tapering Announcements on Emerging Markets,” IMF WP 14/109, 2014
Countries with high inflation rates
also suffered bigger increases in bond yields in the year starting May 2013.
Klemm, Meiner &
Sosa, IMF, 2014
“Taper Tantrum or Tedium:
How U.S. Interest Rates
Affect Financial Markets
in Emerging Economies”
Institutions have helped deliver credibility
• Since institutional history and credibility are weaker in
developing countries, the need to address dynamic
inconsistency is greater
– Via Central Bank Independence
Most studies in developing countries find CBI does help:
Cukierman, Miller & Neyapti (2002), Crowe & Meade (2008), Jácome (2001), Gutiérez (2003),
Jácome & Vázquez (2008) and Haan, Masciandaro, & Quintyn (2008);
though not all -- Mas (1995) and Landström (2008).
And/Or
– Via Rules.
– Or at least transparency & communication.
19
4. Nominal targets for monetary policy
•
4.1 The move from money targeting
to exchange rate targeting
•
4.2 The move from exchange rate targeting
to inflation targeting.
20
4.1 The successful stabilization programs of the late 1980s
& early 1990s tended to use exchange rate targets
• The inflation crises of the 1980s left a consensus that exchange
rate targets worked better than money targets
• Examples: Chile’s tablita, Argentina’s convertibility plan, Brazil’s real,
plan Bolivia, Mexico…
4.2 The move to IT
• Next the currency crises of 1994-2002 left a view that exchange
rate pegs were untenable.
What, then, could serve as the new nominal anchor?
Inflation Targeting (IT) !
21
Inflation Targeting (IT)
Five advanced
countries
adopt IT:
199093
Many developing
countries
adopt IT:
19992008
Agénor & Pereira da Silva, 2013, Fig.1. "Rethinking Inflation Targeting: A Perspective from the Developing World.”
Countries adopting IT experienced lower inflation
Gonçalves & Salles, 2008, “Inflation Targeting in Emerging Economies…” JDE
API-120 Prof. J.Frankel
In many ways, IT has functioned well.
• It apparently anchored expectations and avoided a return to
inflation in Brazil, for example, despite two severe challenges:
– early 1999, as the country exited the real plan,
– and 2002, when Lula first pulled ahead in the polls.
• E.g., Giavazzi, Goldfajn & Herrera (2005); Mishkin (2004).
• Laxton & Pesenti (2003):
EM central banks tend to have more need to establish credibility.
• But Fraga, Goldfajn & Minella (2003): inflation-targeting central banks in EMEs
miss their declared targets by far more than they do in advanced countries.
• Other studies of EM IT include Savastano (2000), Amato & Gerlach (2002), Batini
& Laxton (2006), Debelle (2001); Eichengreen (2005); Jonas & Mishkin (2005);
Masson, Savastavano & Sharma (1997); Mishkin (2000; 2004); and McGettigan,
Moriyama, Ntsama, Painchaud, Qu, & Steinberg (2013).
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The events of 2008-09 put strains on IT
• analogously to how the events of 1994-2001 put strains
on the regime of exchange rate targeting.
• Three kinds of nominal variables have forced central
bankers to look beyond the CPI:
– asset prices [2]
– commodity prices
– the exchange rate.
[2] Caballero & Krishnamurthy (2006), Ventura (2002), Edison, Luangaram, & Miller
(2000), Aizenman & Jinjarak (2009) and Mendoza & Terrones (2008) explore how
credit booms lead to rising asset prices in emerging markets, often preceded by
capital inflows and followed by financial crises.
25
Most IT analysis is better suited to big industrialized
countries than to developing countries, in several respects.
• The models usually do not feature exogenous shocks in
trade conditions or difficulties in the external accounts.
– They assume countries need not worry about financing deficits,
because international capital markets function well enough
to smooth consumption in the face of external shocks.
-- But international capital markets do not smooth external shocks.
• IT can be vulnerable to supply shocks & trade shocks,
which are larger for developing countries.
– Under strict annual IT, to prevent the price index from rising in the face
of an adverse supply shock monetary policy would have to tighten
so much that all of the fall in nominal GDP is borne by real GDP.
– Most reasonable objective functions would, instead, have the monetary
authorities allow part of the shock to show up as a rise in the price level.
26
5. Exchange rate regimes
•
5.1 The advantages of fixed exchange rates,
– include the credibility of a nominal anchor.
•
5.2 The advantages of floating rates
– include accommodating terms of trade shocks.
27
Advantage of floating the exchange rate
• Fixing the exchange rate
leads to pro-cyclical monetary policy
for a country facing terms of trade shocks:
– Money flows in during commodity booms.
• Excessive credit creation
– can lead to excess demand & inflation.
• Example: oil exporters during the 2003-08 oil boom.
– Money flows out during commodity busts.
• Credit squeeze
– can lead to excess supply, recession & balance of payments crisis.
• Example: oil exporters in mid-1980s, 1997-98, or 2014-15.
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Advantage of floating, continued

Floating accommodates terms of trade shocks:

If terms of trade improve,
currency automatically appreciates,


If terms of trade worsen,
currency automatically depreciates,


preventing excessive money inflows, overheating & inflation.
preventing recession & balance of payments crisis.
Disadvantages of floating:



Volatility can be excessive.
Dutch Disease can be extreme.
One needs a nominal anchor.
29
Demand vs. supply shocks
• An old wisdom regarding the source of shocks:
– Fixed rates work best if shocks are mostly internal
demand shocks (especially monetary);
– floating rates work best if shocks tend to be
real shocks (especially external terms of trade).
• One set of supply shocks:
natural disasters
– R.Ramcharan (2007) finds floating works better.
• A common source
of real shocks: trade.
Terms-of-trade variability
• Prices of crude oil and other agricultural & mineral
commodities hit record highs in 2008 & 2011.
• => Favorable terms of trade shocks for some
• => Unfavorable terms of trade shock for others.
• Textbook theory says a country where trade shocks
dominate should accommodate by floating.
• Confirmed empirically:
– Developing countries facing terms of trade shocks do better with
flexible exchange rates than fixed exchange rates.
– Broda (2004), Edwards & L.Yeyati (2005),
Rafiq (2011), and Céspedes & Velasco (2012)…
Céspedes & Velasco (2012), IMF Economic Review
“Macroeconomic Performance During Commodity Price Booms & Busts”
** Statistically
significant
at 5% level.
Constant term
not reported.
(t-statistics in
parentheses.)
Across 107 major commodity boom-bust cycles,
output loss is bigger the bigger is the commodity price
change & the smaller is exchange rate flexibility.
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6. Procyclicality Problems
•
6.1 Procyclicality of capital flows
•
6.2 Procyclicality of fiscal policy
•
6.3 Procyclicality of monetary policy if the exchange
rate is not allowed to accommodate trade shocks
–
–
as under exchange rate targeting
or annual CPI inflation targeting.
33
6.1 The procyclicality of EM capital flows
• According to intertemporal optimization theory, countries
should borrow during temporary downturns -- to sustain
consumption & investment -- repaying during upturns.
• In practice, capital flows are more procyclical than countercyclical.
– Kaminsky, Reinhart, and Vegh (2005); Reinhart & Reinhart (2009); Perry (2009);
Gavin, Hausmann, Perotti & Talvi (1996); and Mendoza & Terrones (2008).
– Lucas (1990) paradox: Prasad, Rajan, & Subramanaian (2007); Alfaro, KalemliOzcan & Volosovych (2005); Reinhart & Rogoff (2004); Gourinchas & Jeanne
(2007), Kalemli-Ozcan, Sebnem, Reshef, Sorensen & Yosha (2009).
– Most theories to explain the procyclicality involve imperfections in capital
markets: asymmetric information or the need for collateral.
34
6.2 The procyclicality of fiscal policy
• Many authors have documented that fiscal policy also
tends to be procyclical in developing countries,
– compared with industrialized countries:
– Gavin & Perotti(1997), Lane & Tornell (1999), Kaminsky, Reinhart,
& Végh (2004), Talvi & Végh (2005), Alesina, Campante & Tabellini
(2008), Mendoza & Oviedo (2006).
• Explanations?
– Political business cycle
– Dutch Disease, for commodity producers
– Over-optimistic forecasts in booms
35
G traditionally pro-cyclical in developing countries:
(yellow)
rising in booms & falling in recessions; esp. commodity-exporters
procyclical
Correlations between government spending & GDP
Adapted from Kaminsky, Reinhart & Vegh (2004)
1960-1999
countercyclical
G always used to be pro-cyclical
for most developing countries.36
procyclical
Correlations between government spending & GDP
Frankel, Vegh & Vuletin (2013)
2000-09
countercyclical
Last decade,
about 1/3 developing countries
switched to countercyclical fiscal policy:
37
Negative correlation of G & GDP.
6.3 Procyclicality of monetary policy
if the exchange rate is prevented from
accommodating trade shocks
–
as it is under exchange rate targeting.
•
–
A proposed alternative: Peg the Export Price.
or annual CPI inflation targeting.
•
A proposed alternative: Nominal GDP Targeting.
If the exchange rate is not to be
the monetary anchor, what is?
• Popular choice:
Inflation Targeting.
– But CPI targeting can react perversely
• to supply shocks
• & terms of trade shocks.
39
Needed:
Nominal anchors that accommodate
the shocks so common in EM countries
• Terms of trade shocks
– e.g., fall in price of commodity export.
– PEP: include commodity prices in the
currency basket.
PEP
• And supply shocks,
– e.g., weather events.
– Nominal GDP targeting.
40
Peg the Export Price
PEP
accommodates terms of trade shocks
[1]
Proposal for an oil-exporting country that attempts
to peg to a currency basket:
add a barrel of oil into the basket.
• E.g., Azerbaijan, Kazakhstan or Kuwait.
• With oil in the basket,
• money tightens & the currency appreciates
whenever the world price of oil rises,
• and the currency depreciates whenever oil falls.
[1] Frankel (2003, 2008).
41
Why is PEP better than a fixed exchange rate
for countries with volatile export prices?
PEP
• If the $ price of the export commodity rises ,
the currency automatically appreciates,
– moderating the boom.
• If the $ price of export commodity falls,
the currency automatically depreciates,
– moderating the downturn
– & improving the balance of payments.
42
Why is PEP better than CPI-targeting
for countries with volatile terms of trade?
PEP
• If the $ price of imported commodity goes up,
CPI target says to tighten monetary policy
enough to appreciate the currency.
– Wrong response. (E.g., oil-importers in 2007-08.)
– PEP does not have this flaw .
• If the $ price of the export commodity goes up,
PPT says to tighten money enough to appreciate.
– Right response. (E.g., Gulf currencies in 2007-08.)
– CPI targeting does not have this advantage.
43
Figure 2: When a Nominal GDP Target
delivers a better outcome than IT
Supply shock is split between output & inflation objectives
rather than falling exclusively on output as under IT (at B).
Figure 3: Can IT Deliver a better outcome
than a Nominal GDP Target?
NGDPT gives exactly the right answer if
equal weights (simple Taylor Rule) capture
what discretion would do.
Even if not exact, the “true”
objective function would have
to put far more weight on P than GDP, or
AS would have to be very steep, for the P
rule to give a better outcome.
…if the Aggregate Supply curve is steep
(b is low, relative to a, the weight on the price stability objective)
.
Mathematical analysis:
Which regime best achieves objectives
of price stability and output stability?
• Goal: to minimize a quadratic loss function
Λ = ap2 + (y - 𝒚)2
where p ≡ the inflation rate,
y ≡ the log of real output,
𝒚 ≡ the preferred level of output;
a ≡ the weight assigned to the price stability objective.
.
Which regime best achieves objectives of price & output stability? continued
• Any nominal rule, provided it is credible, can set
expected inflation at the desired level (say, 0),
• e.g., eliminating the inflation bias that discretion brings:
• p e = Ep = (𝒚- 𝒚) b/a in Barro-Gordon (1982) model
of dynamic inconsistency,
• where the Aggregate Supply relationship is
y = 𝒚 + b(p – pe) + u ,
• and 𝒚 ≡ potential output.
Which regime best achieves objectives of price & output stability?
continued
• But different rules => different outcomes, when shocks hit
• Rogoff (1985) & Fischer (1990).
• IT & NGDPT both neutralize AD shocks.
• That leaves AS shocks.
• NGDP rule dominates IT, if…
a < (2 + b)b;
•
•
Example 1: holds if b > a (AS flat, vs. loss-function lines).
Example 2: holds if a = 1 (as in Taylor rule)
and AS slope 1/b < (1+ 2 ) = 2.414.
• Under these conditions, the economy looks
more like Figure 2 than like Figure 3:
– If inflation were not allowed to rise in response to an AS shock,
the resulting GDP loss could be severe. => NGDPT dominates IT.
Estimating AS equation
• I have estimated the AS slope for a few EMs.
• E.g., Kazakhstan, over the period 1993-2012.
– Exogenous terms of trade shocks: oil price fluctuations.
– Exogenous demand shocks:
changes in military spending and
income of major trading partners.
– The estimated AS slope is 1.66, statistically < 2.41.
• Supports the condition for NGDPT to dominate IT.
• Conclusion: middle-size middle-income commodityexporting countries should consider using nominal
GDP as their target, in place of the CPI.
Nominal GDP Targeting, continued
• NGDPT is more robust with respect to
supply shocks & terms of trade shocks,
– compared to the alternatives of IT
or exchange rate targets.
• The logic holds whether the immediate aim is
– disinflation (as in 1980s, and again today
among many EM & developing countries);
– monetary stimulus (as among big Advanced Cs recently);
– or just staying the course.
Some Conclusions
• Some models of monetary policy originally designed for
industrialized countries apply strongly to developing countries:
– Dynamic inconsistency in monetary policy and the resulting need for Central
Bank Independence and commitment to nominal targets.
• But other aspects of developing countries merit special care:
– Contractionary effects of devaluation can be important,
• particularly balance sheet effects that arise from currency mismatch.
– Fiscal policy and capital flows are procyclical,
• especially among commodity producers.
– High terms of trade volatility has implications for choice of nominal anchor.
• Allow appreciation/depreciation after positive/negative trade shocks.
• Proposal: In place of a CPI target: target nominal GDP.
• Or, instead of a pure currency basket: include the price of the export commodity.
51
Monetary Policy
in Emerging Market Countries
Jeffrey Frankel
Based on chapter in Handbook of Monetary Economics,
edited by Benjamin Friedman and Michael Woodford, 2011.
And on "Nominal GDP Targeting for Middle-Income Countries,“
Central Bank Review, September 2014. HKS RWP 14-033.
Appendices
1. Models designed for EMs also have lessons for
industrialized countries,
as their post-2007 financial crises have shown.
2. Bruno-Easterly on costs of high inflation
3. The search for a robust nominal anchor.
1. Achilles heels of six conventional choices
2. Does targeting core CPI solve IT’s problem?
Other sections in the handbook survey
7. Capital flows
8. Crises in emerging markets
53
1. Lessons regarding financial crises:
Not just for emerging markets anymore
An analogy
• In the latter part of the 19th century most of the vineyards
of France were destroyed by Phylloxera.
• Eventually a desperate last resort was tried:
grafting susceptible European vines
onto resistant American root stock.
• Purist French vintners initially disdained
what the considered compromising
the refined tastes of their grape varieties.
• But it saved the European vineyards,
and did not impair the quality of the wine.
• The New World had come to the rescue of the Old.
54
Implications of the 2008-09 Global Financial
Crises and 2010-15 euro crisis
• In 2007-08, the global financial system was grievously
infected by “toxic assets” originating in the United States.
• Many ask what fundamental rethinking was necessary to save
orthodox macroeconomic theory.
• Some answers may lie with models that had been designed to
fit the realities of emerging markets, models that are at home
with financial market imperfections which have now turned
up in advanced countries as well (asymmetric information, need for
collateral, balance sheet effects, moral hazard…).
• Purists may be reluctant to seek help from this direction.
• But they should not fear that the hardy root stock of
emerging market models is incompatible with fine taste.
55
2. Costs of high inflation
Inflation above a
threshold ≈ 40%
tends to have
a negative effect
on growth.
Source:
56
4. The search for a robust nominal anchor
Each of the traditional candidates
for nominal anchor has an Achilles heel.
• The CPI anchor does not accommodate
terms of trade changes:
– IT tightens M & appreciates when import prices rise
• not when export prices rise,
• which is backwards.
• Targeting core CPI does not much help.
• Commodity exporters need an alternative anchor
that is robust to trade shocks.
57
6 proposed nominal targets and the Achilles heel of each:
Vulnerability
Targeted
variable
Gold standard
Commodity
standard
Price
of gold
Price of agric.
& mineral
basket
Vulnerability
Example
Vagaries of world
1849 boom;
gold market
1873-96 bust
Shocks in
Oil shocks of
imported
1973-80, 2000-11
commodity
Monetarist rule
M1
Velocity shocks
US 1982
Nominal income
targeting
Fixed
exchange rate
Nominal
GDP
$
Measurement
problems
Appreciation of $
Less developed
countries
(or €)
(or € )
CPI
Terms of trade
shocks
Inflation targeting
EM currency crises
1995-2001
Oil shocks of
1973-80, 2000-11
Professor Jeffrey Frankel
Appendix to Topic 4.3:
“Core” CPI vs. “Headline” CPI
• In practice, Inflation-Targeting central bankers know
they shouldn’t respond to oil import price shocks by
tightening proportionately;
– they want to exclude oil shocks from the measure of the
year’s CPI that is targeted.
– Some explain ex ante that their target is the Core CPI.
– Others to talk of the CPI ex ante, but then in the face of an
adverse supply shock explain ex post that the increase in
farm or energy prices is being excluded due to special
circumstances.
59
• Neither tactic – trying to explain core CPI
to the public either ex ante or ex post –
is ideal for communication & credibility.
• Perhaps this is why IT central banks apparently don’t
make full use of the “core CPI escape clause”:
– When countries adopt inflation targeting, the correlation between
the $ price of oil & the $ price of local currency turns positive.
(Frankel, 2010).
60
Table 1
LAC Countries’ Current Regimes and Monthly Correlations
Exchange
Changes
($/local
currency)
withcurrency)
$ Import
Price
Changes
Table 1: of
LACA
Countries’ CurrentRate
Regimes and
Monthly Correlations
of Exchange
Rate Changes ($/local
with Dollar Import
Price
Changes
Import price changes are changes in the dollar price of oil.
Exchange Rate Regime
Monetary Policy
1970-1999
2000-2008
1970-2008
ARG
Managed floating
Monetary aggregate target
-0.0212
-0.0591
-0.0266
BOL
Other conventional fixed peg
Against a single currency
-0.0139
0.0156
-0.0057
BRA
Independently floating
Inflation targeting framework (1999)
0.0366
0.0961
0.0551
0.0524
-0.0484
CHL
Independently floating
Inflation targeting framework (1990)*
-0.0695
CRI
Crawling pegs
Exchange rate anchor
0.0123
-0.0327
0.0076
GTM
Managed floating
Inflation targeting framework
-0.0029
0.2428
0.0149
GUY
Other conventional fixed peg
Monetary aggregate target
-0.0335
0.0119
-0.0274
HND
Other conventional fixed peg
Against a single currency
-0.0203
-0.0734
-0.0176
JAM
Managed floating
Monetary aggregate target
0.0257
0.2672
0.0417
NIC
Crawling pegs
Exchange rate anchor
-0.0644
0.0324
-0.0412
PER
Managed floating
Inflation targeting framework (2002)
-0.3138
0.1895
-0.2015
PRY
Managed floating
IMF-supported or other monetary program
-0.023
0.3424
0.0543
SLV
Dollar
Exchange rate anchor
0.1040
0.0530
0.0862
URY
Managed floating
Monetary aggregate target
0.0438
0.1168
0.0564
IT
countries
show
correlations
> 0.
Oil Exporters
COL
Managed floating
Inflation targeting framework (1999)
-0.0297
0.0489
0.0046
MEX
Independently floating
Inflation targeting framework (1995)
0.1070
0.1619
0.1086
TTO
Other conventional fixed peg
Against a single currency
0.0698
0.2025
0.0698
VEN
Other conventional fixed peg
Against a single currency
-0.0521
0.0064
-0.0382
* Chile declared an inflation target as early as 1990; but it also had an exchange rate target, under an explicit band-basket-crawl regime, until 1999.
61
Frankel (2010)
Other topics covered in the survey
7. Capital flows
• 7.1 The opening of emerging markets
–
–
–
–
The boom-bust cycle
Measures of financial integration
Sterilization and capital flow offset
Controls, capital account liberalization, sequencing
• 7.2 Does financial openness improve welfare?
– Benefits of financial integration
– Markets don’t quite work that way
– Capital inflow bonanzas
62
8. Crises in emerging markets
•
8.1 Reversals, sudden stops, speculative
attacks, crises
– Definitions
– Contagion
– Management of crises
•
8.2 Default and how to avoid it
•
8.3 Early warning indicators
63
8.3 EM crises: Early Warning Indicators
• Which countries have withstood shocks well?
– 1 Pre-GFC studies
– esp. currency crises of the 1980s & 90s.
– Top EWIs: reserves, RER…
– 2 The GFC
– Lessons learned after 2001
– Who fared worse in the 2008-09 global shock ?
– 3 The 2013 “taper tantrum”.
-1 Which EMs are hit the hardest in crises?
• In past studies of past crises, incl. 1982, 1994, & 1997-98,
• Early Warning Indicators that worked well include:
– Foreign exchange reserves
• especially relative to short-term debt (e.g., the Guidotti Rule);
– Currency overvaluation (i.e., real appreciation);
– Current account deficits.
– Composition of capital inflows.
•
E.g.,
–
–
–
–
Sachs, Tornell, & Velasco (1996) ”Financial crises in emerging markets: lessons from 1995,” BPEA.
Frankel & Rose (1996) "Currency Crashes in Emerging Markets," JIE.
Kaminsky, Lizondo, & Reinhart (1998) “Leading Indicators of Currency Crises," IMF Staff Papers.
Kaminsky & Reinhart (1999) "The twin crises," AER.
The variables that showed up as significant predictors
most often in pre-2008 country crises:
(i) reserves and (ii) currency overvaluation
0%
10%
20%
30%
40%
50%
60%
Reserves
Real Exchange Rate
GDP
Credit
Current Account
Money Supply
Budget Balance
Exports or Imports
Inflation
Equity Returns
Real Interest Rate
Debt Profile
Terms of Trade
Political/Legal
Contagion
Capital Account
External Debt
% of studies where leading indicator was found to be
statistically signficant
(total studies = 83, covering 1950s-2009)
Source: Frankel & Saravelos (2012)
70%
-2 Many EM countries learned lessons
from the crises of the 1990s,
which better prepared them to withstand the 2008-09 GFC
• More flexible exchange rates
• Higher reserve holdings
• Less fx-denominated debt
• More local-currency debt
• More equity & FDI
• Fewer Current Account deficits
• Less pro-cyclical fiscal policy.
• Stronger government budgets in 2003-08 boom.
EM countries used capital inflows to finance CA deficits
in 1976-82 & 1990-97; but not 2003-08.
1st boom
(recycling
petro-dollars)
3rd boom
stop
(international
debt crisis)
(carry trade & BRICs)
2nd boom
stop
(emerging markets)
(Asia
crisis)
start
IMF
start
EMEM
countries
post-2003inflows
inflows
countriesused
used post-2003
to build
foreign
exchange
reserves
to build
international
reserves
Chairman Ben S. Bernanke, 6th ECB Central Banking Conference,
Frankfurt, Nov.19, 2010,” Rebalancing the Global Recovery”
M. Dooley, D. Folkerts-Landau & P. Garber,
“The Revived Bretton Woods System’s First Decade,”
NBER WP 20454, Sept. 2014
Worst & Best Performing Countries in Global Financial Crisis of 2008-09
Frankel & Saravelos (2012)
Appendix 4
GDP Change, Q2 2008 to Q2 2009
Lithuania
Latvia
Ukraine
Estonia
Macao, China
Russian Federation
Bo tto m 10
Georgia
Mexico
Finland
Turkey
Australia
Poland
Argentina
Sri Lanka
Jordan
Indonesia
To p 10
Egypt, Arab Rep.
Morocco
64 countries in sample
India
China
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
Foreign exchange reserves are useful
• One purpose is dampening appreciation in the boom,
– thus limiting current account deficits.
• Another is the precautionary motive:
Reserves were the best predictor of who
got hit in the 2008 Global Financial Crisis.
• Dominguez, Hashimoto & Ito (2012) “International Reserves and the Global Financial Crisis,” JIE.
• Frankel & Saravelos (2012), “Are Leading Indicators Useful for Assessing Country Vulnerability?” JIE.
– This was the same Warning Indicator that also
had worked in the most studies of earlier crises.
Other predictors (besides fx reserves)
of who got into trouble† in 2008-09 GFC
• Current Account
• National Savings
• Bank credit growth, vs. bank reserves
• Short-term debt / exports
† Criteria for “trouble”: loss of GDP, loss of IP, currency market,
equity market & need to go to the IMF.
Source: Frankel & Saravelos (2012), “Are Leading Indicators Useful for Assessing
Country Vulnerability? Evidence from the 2008-09 Global Financial Crisis,” J.Int.Ec.
Actual versus Predicted Incidence of 2008-09 Crisis
Frankel & Saravelos (JIE, 2012)
73
Bottom line for Early Warning Indicators
in the 2008-09 crisis
Frankel & Saravelos (2012)
• Once again, the best predictor of who got hit was
reserve holdings (especially relative to short-term debt),
• Next-best was the Real Exchange Rate.
• This time, current account & national saving too.
• The reforms that most EMs (except E. Europe)
had made after the 1990s apparently paid off.
- 3 The next clean experiment:
Which EM countries were hit the hardest
by the “taper tantrum” of May-June 2013?
• Those with big current account deficits,
• or with inflation/exchange rate overvaluation.
• Less evidence that reserves helped this time.
• Recent studies:
– Eichengreen & Gupta (2014), Tapering Talk: The Impact of Expectations of Reduced
“
Federal Reserve Security Purchases on Emerging Markets,” UCB & World Bank, Jan.
– Hill (2014), “Exploring Early Warning Indicators for Financial Crises in 2013 & 2014,” HKS, April.
– Mishra, Moriyama, N’Diaye & Nguyen (2014), “Impact of Fed Tapering
Announcements on Emerging Markets,” IMF, June.
– Aizenman, Cheung, & Ito (2014), “International Reserves Before and After the Global
Crisis: Is There No End to Hoarding?” NBER WP 20386, Aug.
Taper talk was followed by greater depreciation
among a group of fragile EMs than others.
Aizenman, Binici & Hutchison,
”The Transmission of Federal Reserve
Tapering News to Emerging Financial Markets,”
2014 www.nber.org/papers/w19980.pdf
“We group emerging
markets into those with
‘robust’ fundamentals
(current account surpluses,
high international reserves
and low external debt) and
those with ‘fragile’
fundamentals
and, intriguingly, find that the stronger group was
more adversely exposed to tapering news than
the weaker group. News of tapering coming from
Chairman Bernanke is associated with much
larger exchange rate depreciation, drops in the
stock market, and increases in sovereign CDS
spreads of the robust group compared with the
fragile group.
A possible interpretation is that
tapering news had less impact on
countries that received fewer
inflows of funds in the first
instance.”
Countries with worse current accounts were hit
by greater currency depreciation after May 2013.
Mishra, Moriyama, N’Diaye & Nguyen,
“Impact of Fed Tapering Announcements on Emerging Markets,” IMF WP 14/109 2014
Countries hit in April-July, 2013, had experienced
and
real appreciation
big capital inflows.
B. Eichengreen & P. Gupta (2013) Tapering Talk: The Impact of Expectations of Reduced Federal
“
Reserve Security Purchases on Emerging Markets,” Working Paper.
http://eml.berkeley.edu/~eichengr/tapering_talk_12-16-13.pdf