Ambrogio Cesa-Bianchi

China’s Emergence in the World Economy and Business Cycles in Latin America

This paper investigates how changes in trade linkages between China, Latin America, and the rest of the world have altered the transmission of international business cycles to Latin America. Evidence based on a GVAR model for five large Latin American economies shows that the long-term impact of a China GDP shock on the typical Latin American economy has increased by three times since the mid-1990s, while the long-term impact of a US GDP shock has halved, while the transmission of shocks to Latin America and the rest of emerging Asia GDP (excluding China and India) has not changed. These changes owe more changes in China’s impact on Latin America’s traditional and largest trading partners than to increased direct bilateral trade linkages boosted by the decade-long commodity price boom. These findings have important implications for both Latin America and the international business cycle.

Global Liquidity, House Prices and the Macroeconomy: Evidence from Advanced and Emerging Economies

In this paper we first compare house price cycles in advanced and emerging economies using a new quarterly house price data set covering the period 1990-2012. We find that house prices in emerging economies grow faster, are more volatile, less persistent and less synchronised across countries than in advanced economies. We also find that they correlate with capital flows more closely than in advanced economies. We then condition the analysis on an exogenous change to a particular component of capital flows: global liquidity, broadly understood as a proxy for the international supply of credit. We identify this shock by aggregating bank-to-bank cross-border credit flows and by using the external instrumental variable approach introduced by Stock and Watson and Mertens and Ravn. We find that in emerging markets a global liquidity shock has a much stronger impact on house prices and consumption than in advanced economies. We finally show that holding house prices constant in response to this shock tends to dampen its effects on consumption in both advanced and emerging economies, but possibly through different channels: in advanced economies by boosting the value of housing collateral and hence supporting domestic borrowing; in emerging markets, by appreciating the exchange rate and hence supporting the international borrowing capacity of the economy.

Uncertainty and Economic Activity: A Global Perspective

The 2007-2008 global financial crisis and the subsequent anemic recovery have rekindled academic interest in quantifying the impact of uncertainty on macroeconomic dynamics based on the premise that uncertainty causes economic activity to slow down and contract. In this paper, we study the interrelation between financial markets volatility and economic activity assuming that both variables are driven by the same set of unobserved common factors. We further assume that these common factors affect volatility and economic activity with a time lag of at least a quarter. Under these assumptions, we show analytically that volatility is forward looking and that the output equation of a typical VAR estimated in the literature is mis-specified as least squares estimates of this equation are inconsistent. Empirically, we document a statistically significant and economically sizable impact of future output growth on current volatility, and no effect of volatility shocks on business cycles, over and above those driven by the common factors. We interpret this evidence as suggesting that volatility is a symptom rather than a cause of economic instability.

Monetary Policy Transmission in an Open Economy: New Data and Evidence from the United Kingdom

This paper constructs a new series of monetary policy surprises for the United Kingdom and estimates their effects on macroeconomic and financial variables, employing a high-frequency identification procedure. First, using local projections methods, we find that monetary policy has persistent effects on real interest rates and breakeven inflation. Second, employing our series of surprises as an instrument in a SVAR, we show that monetary policy affects economic activity, prices, the exchange rate, exports and imports. Finally, we implement a test of overidentifying restrictions, which exploits the availability of the narrative series of monetary policy shocks computed by Cloyne and Huertgen (2014), and find no evidence that either set of shocks contains any endogenous response to macroeconomic variables.

Does Easing Monetary Policy Increase Financial Instability

This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of U.S. monetary and regulatory policy in the run up to the Great Recession. There are two main results. First, real interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective second policy instrument aimed at preserving financial stability.

How could a shock to growth in China affect growth in the United Kingdom

This article assesses how a shock to Chinese growth could affect the UK economy using an empirical model of the world economy that exploits the historical comovement between international business cycles. We find that a 1% slowing in China is likely to reduce UK GDP by around 0.1%. This impact arises mainly from the increasingly important role of China in the global economy - that is, via the United Kingdom’s indirect links with China through its main trading partners.

Uncertainty and Economic Activity: A Multi-Country Perspective

Measures of economic uncertainty are countercyclical, but economic theory does not provide definite guidance on the direction of causation between uncertainty and the business cycle. This paper proposes a new multi-country approach to the analysis of the interaction between uncertainty and economic activity, without a priori restricting the direction of causality. We develop a multi-country version of the Lucas tree model with time-varying volatility and show that in addition to common technology shocks that affect output growth, higher-order moments of technology shocks are also required to explain the cross country variations of the realized volatility of equity returns. Using this theoretical insight, two common factors, a ‘real’ and a ‘financial’ one, are identified in the empirical analysis assuming different patterns of cross-country correlations of country-specific innovations to real GDP growth and realized stock market volatility. We then quantify the absolute and the relative importance of the common factor shocks as well as country-specific volatility and GDP growth shocks. The paper highlights three main empirical findings. First, it is shown that most of the unconditional correlation between volatility and growth can be accounted for by the real common factor, which is proportional to world growth in our empirical model and linked to the risk-free rate. Second, the share of volatility forecast error variance explained by the real common factor and by country-specific growth shocks amounts to less than 5 percent. Third, shocks to the common financial factor explain about 10 percent of the growth forecast error variance, but when such shocks occur, their negative impact on growth is large and persistent. In contrast, country-specific volatility shocks account for less than 1-2 percent of the growth forecast error variance.

Financial shocks, credit spreads and the international credit channel

Recent empirical evidence on the cross-country synchronization of credit spreads in response to US monetary policy shocks has led to the notion of an ‘international credit channel’ of US monetary policy. This paper provides novel evidence on the existence of an international credit channel for the transmission of US financial shocks across borders, and compares their impact to US monetary policy shocks. We identify monetary policy and financial shocks by combining the external instruments approach with sign restrictions in a two-country SVAR for the United States and the United Kingdom. Adverse US financial shocks trigger a sharp and persistent contraction in the US economy, and an increase in US credit spreads. Crucially, this tightening in US credit conditions is quickly transmitted internationally, leading to an increase in credit spreads and a slowdown in economic activity in the United Kingdom. Unlike financial shocks, monetary policy shocks do not seem to induce as much international co-movement. Our results are in line with general equilibrium open economy models with credit market imperfections and a high degree of financial integration.

International Credit Supply Shocks

House prices and exchange rates can potentially amplify the expansionary effect of capital inflows by inflating the value of collateral. We first set up a model of collateralized borrowing in domestic and foreign currency with international financial intermediation in which a change in leverage of global intermediaries leads to an international credit supply increase. In this environment, we illustrate how house price increases and exchange rates appreciations contribute to fuelling the boom by inflating the value of collateral. We then document empirically, in a Panel VAR model for 50 advanced and emerging countries estimated with quarterly data from 1985 to 2012, that an increase in the leverage of US Broker-Dealers also leads to an increase in cross-border credit flows, a house price and consumption boom, a real exchange rate appreciation and a current account deterioration consistent with the transmission in the model. Finally, we study the sensitivity of the consumption and asset price response to such a shock and show that country differences are associated with the level of the maximum loan-to-value ratio and the share of foreign currency denominated credit.