Francesca Viani

The international risk-sharing puzzle is at business-cycle and lower frequency

Descomponemos la correlacion entre el consumo relativo y el tipo de cambio real en sus componentes dinamicos a diferentes frecuencias. Utilizando tecnicas de analisis espectral multivariado mostramos que, en contradiccion con un alto grado de diversificacion del riesgo, en la mayoria de los paises de la OCDE la correlacion dinamica tiende a ser bastante negativa, y significativamente negativa a frecuencias inferiores a dos anos -las frecuencias apropiadas para evaluar el desempeno de los modelos internacionales del ciclo economico-. En teoria mostramos que la correlacion dinamica a diferentes frecuencias predicha por modelos estandar de economia abierta, es la suma de dos terminos: un termino constante en cada frecuencia, que puede ser negativo cuando el riesgo no asegurable es grande; y un termino que varia con la frecuencia, que en economias con bonos es necesariamente positivo y que refleja la cobertura de riesgo contra contingencias predecibles proporcionada por el comercio intertemporal. El analisis numerico sugiere que los mecanismos principales propuestos por la literatura para dar cuenta de la anomalia, son consistentes con la evidencia empirica a diferentes frecuencias del espectro.

Countries’ Safety and Competitiveness, and the Estimation of Current Account Misalignments

Current account imbalances and their sustainability are among the most debated international policy issues. Through the recently designed External Balance Assessment methodology (EBA), the IMF estimates the impact of several countries’ fundamentals and policies on their current account balance, calculates misalignments in their current account position and indicates policy recommendations which, if implemented, should contribute to reducing these imbalances. In this paper, we explore some extensions to the EBA, following two courses. First, we distinguish in current account regressions between countries that are considered safe investment destinations and non-safe economies. Since this distinction is likely to acquire special relevance in periods of global turmoil, we also distinguish between periods of global stress and tranquil times. Second, we embed in EBA regressions variables that drive countries’ external competitiveness. Results show that current account dynamics may be affected by competitiveness factors and differ significantly between safe and non-safe economies, with such differences becoming particularly relevant in turbulent times. These fi ndings suggest that EBA regressions may be overlooking the influence of countries’ safety and competitiveness on external balances. Our alternative misalignment estimations show larger imbalances than those calculated with the EBA for some Asian economies and smaller imbalances for some high-surplus EU countries.

The International Risk Sharing Puzzle is at Business Cycle and Lower Frequency - L’Énigme Du Partage International Du Risque

We decompose the correlation between relative consumption and the real exchange rate in its dynamic components at different frequencies. Using multivariate spectral analysis techniques, we show that, at odds with a high degree of risk sharing, in most OECD countries the dynamic correlation tends to be quite negative, and significantly so, at frequencies lower than two years – the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum. On decompose la correlation entre consommation relative et taux de change reel en ses composantes dynamiques a differentes frequences. A l’aide de techniques d’analyse spectrale multivariee, on montre que, en contraste avec un haut degre de partage du risque, dans la plupart des pays de l’OCDE la correlation dynamique tend aetre assez negative, et de maniere significative a des frequences de moins de deux ans – les frequences appropriees pour evaluer la performance des modeles de cycle d’affaires international. Theoriquement, on montre que la correlation dynamique aux diverses frequences que les modeles standards d’economies ouvertes predisent sont la somme de deux termes : un terme constant pour toutes les frequences, qui peut etre negatif quand le risque non‐assurable est grand; et un terme qui varie selon les frequences, qui est necessairement positif dans les economies equipees de marches obligataires – refletant l’assurance que le commerce inter‐temporel fournit contre les contingences previsibles. Une analyse numerique suggere que les mecanismes principaux proposes dans la litterature specialisee pour expliquer l’enigme sont consistants avec les resultats pour toutes les frequences.

Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds

Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyze the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterized by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, i.e., the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

An Anatomy of the Spanish Current Account Adjustment: The Role of Permanent and Transitory Factors

This paper aims to identify how much of the recent current account adjustment in Spain can be explained by cyclical factors. For this purpose, we consider a variant of the External Balance Assessment (EBA) methodology with country-specific slopes and intercepts. The resulting residuals are negligible for most countries so that the positive analysis of current account decompositions provides a more informative assessment. According to our findings, around 60% of the 12 pp. adjustment of the Spanish external imbalance over the 2008-2015 period can be explained by transitory factors such as the output gap, the oil balance, and the financial cycle. The remaining 40% is explained by factors such as the cyclically-adjusted fiscal consolidation, population aging, lower growth expectations, or competitiveness gains, which can all be considered as more permanent phenomena.

Towards Efficient Capital Flow Management

Financial globalisation has advanced notably in recent decades. In principle, greater integration should raise the degree of economic efficiency. However, the empirical evidence suggests that, for this to occur, countries should have well-designed economic institutions and sufficiently developed local financial markets. Moreover, these flows may jeopardise financial stability in certain circumstances, whereby the economic authorities need to draw on criteria and instruments to withstand such situations. These tools should be used as part of a broader programme of measures that includes the macro and microeconomic adjustments required. Furthermore, international cooperation emerges as a necessary complement to globalisation.

Dealing with large and volatile capital flows and the role of the IMF

The last decade has been characterised by the pronounced volatility of capital flows. While cross-border capital flows can have many benefits for both advanced and emerging market economies, they may also carry risks, which require appropriate policy responses. Disentangling the push from the pull factors driving capital flows is key to designing appropriate policies to deal with them. Strong institutions, sound fundamentals and a large domestic investor base tend to shield economies from adverse global conditions and attract less volatile types of capital. However, when the policy space for using traditional macroeconomic policies is limited, countries may also turn to macroprudential and capital flow management policies in a pragmatic manner. The IMF can play an important role in helping countries to deal with capital flows, through its surveillance and lending policy and through international cooperation. JEL Classification: F3, F32, F38, F42, F65, G28