Giancarlo Corsetti

What caused the Asian currency and financial crisis

The paper examines the view that the Asian currency and financial crisis in 1997 and 1998 reflected structural and policy distortions in the countries of the region, even though market overreaction and herding caused the plunge of exchange rates, asset prices and economic activity to be more severe than was warranted by the initial weak economic conditions.

Paper Tigers? a Model of the Asian Crisis

This paper develops an interpretation of the Asian meltdown focused on moral hazard as the common source of overinvestment, excessive external borrowing, and current account deficits. To the extent that foreign creditors are willing to lend to domestic agents against future bail-out revenue from the government, unprofitable projects and cash shortfalls are re-financed through external borrowing. While public deficits need not be high before a crisis, the eventual refusal of foreign creditors to refinance the countrys cumulative losses forces the government to step in and guarantee the outstanding stock of external liabilities. To satisfy solvency, the government must then undertake appropriate domestic fiscal reforms, possibly involving recourse to seigniorage revenues. Expectations of inflationary financing thus cause a collapse of the currency and anticipate the event of a financial crisis. The empirical section of the paper presents evidence in support of the thesis that weak cyclical performances, low foreign exchange reserves, and financial deficiencies resulting into high shares of non-performing loans were at the core of the Asian collapse.

What Determines Government Spending Multipliers

This paper studies how the effects of government spending vary with the economic environment. Using a panel of OECD countries, we identify fiscal shocks as residuals from an estimated spending rule and trace their macroeconomic impact under different conditions regarding the exchange rate regime, public indebtedness, and health of the financial system. The unconditional responses to a positive spending shock broadly confirm earlier findings. However, conditional responses differ systematically across exchange rate regimes, as real appreciation and external deficits occur mainly under currency pegs. We also find output and consumption multipliers to be unusually high during times of financial crisis.

Does One Soros Make a Difference? A Theory of Currency Crises with Large and Small Traders

Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signaling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there is no large investors, small investors attach the currency when fundamentals are stronger. Yet, the difference can be small, or null, depending on the relative precision of private information of the small and large investors. Adding signaling makes the influence of the large trader on small traders behaviour much stronger.

Competitive devaluations: toward a welfare-based approach

Abstract This paper revisits the international transmission of exchange rate shocks in a multicountry economy, providing a choice-theoretic framework for the policy analysis of competitive devaluations. As opposed to the traditional view, a devaluation by one country does not necessarily have an adverse beggar-thy-neighbor effect on its trading partners, because they can benefit from an improvement in their terms of trade. Furthermore, a retaliatory devaluation need not be the optimal strategy for the neighbor countries, as the induced terms of trade deterioration can be large enough to offset the gains from defending their export market share. The concern over competitive devaluations reflected in the Funds charter, and the system-wide implications of changes in exchange rates, still motivate Fund policy recommendations. A major Fund concern in the Asian crisis has been the fear that Asian currencies would become so undervalued and current account surpluses so large as to damage the economies of other countries, developing countries included. This is one reason the Fund has stressed the need first to stabilize and then to strengthen exchange rates in the Asian countries now in crisis — and for this purpose, not to cut interest rates until the currency stabilizes and begins to appreciate.

Pension Reform and Growth

The authors review the qualitative macroeconomic and welfare implications of replacing a pay-as-you-go pension system with a fully funded scheme. They summarize the typically small effects found in the simulations literature, based on exogenous-growth one-sector models. Much larger, and sustained, effects are obtained in the framework of an overlapping-generations model with endogenous growth and formal-informal production sectors - the model presented in this paper. Model simulations using the overlapping-generations model suggest that replacing a pay-as-you-go system with a fully funded system could substantially raise long-term growth rates by eliminating the incentives (under the pay-as-you-go system) to informalize production and employment. A final look at Chiles reform experience suggest that a structural transformation toward formalization is taking place and that both private savings and growth have been rising substantially since 1980. Econometric evidence suggests that Chiles pension reform, in 1981, could be contributing toward Chiles large increase in private savings.

Stability, Asymmetry, and Discontinuity: The Launch of European Monetary Union

ALTHOUGH STILL LESS than one year old as this volume goes to press, European Economic and Monetary Union (EMU) is already under trial, charged with at least three offenses. The first is false advertising: Europeans, it is claimed, did not get the strong, stable currency they were promised, for within seven months of its birth the euro had lost 13.5 percent of its value against the dollar. The second is obfuscation: markets are finding the signals from the new monetary institutions confusing and inconsistent, and a scarcity of relevant information--from delays in releasing reliable euro area--wide statistics to lack of access to the deliberations of the Governing Council--makes it difficult to forecast economic developments and to understand the policy conduct of the new European Central Bank (ECB). The third is lack of impartiality: the ECBs new policies are claimed to be exacerbating asymmetries between fast-growing and slow-growing countries and validating the presumption that the costs and benefits of monetary cohabitation are unfairly distributed among small and large member states. This paper espouses a rather different thesis. In terms of its impact on financial market integration and the ability of its institutions to cope with cyclical contingencies, EMU is performing well above expectations. And it is doing so even though persistent asymmetries across countries represent a threat to the ability of the new policy framework to guarantee economic stability and promote further integration in Europe. It is clearly premature to attempt even a first assessment of the new European monetary architecture--it will take quite a few years before the track record of the ECB becomes sufficiently long and rich for such an evaluation. This paper is instead devoted to the more modest task of casting light on early developments in the euro area and their potential implications for the future of EMU, surveying the main points in the current debate, noting contrasting positions, and evaluating those positions in light of the available evidence. Our synthetic but comprehensive overview of the first few months in the life of the euro is thus aimed at disentangling those facts, empirical evidence, and institutional details that we consider useful toward a balanced interpretation of the current monetary and financial evolution in Europe. The paper is organized as follows. We begin by placing our analysis of the swift launch of the euro in the context of the macroeconomic convergence and integration that took place in Europe following the 1992-93 crisis of the European Monetary System (EMS). We then discuss the monetary strategies of the European System of Central Banks (ESCB), reviewing the official positions taken and the main criticisms leveled in the recent debate. Next we focus on the instruments of monetary policy in the euro area and on liquidity management and money market integration. We then present an update of developments in the bond and equity markets and a preliminary assessment of public debt management strategies by the eleven independent sovereign states coexisting in the euro area. We go on to deal with some open issues in the euro area banking sector, comment on the behavior of the euro in the currency markets, and analyze asymmetries across European regions and their implications for centralized monetary policy. Finally, we review the process of fiscal consolidation and the debate on the code of budgetary discipline in Europe.(1) The Launch of the Euro in Historical Perspective From a technical standpoint, the euro was born on December 31, 1998. That was the date when the fixed conversion rates among euro area currencies were determined, and thus when the national currencies were demoted to nondecimal denominations of the new currency.(2) It was also the start of the changeover weekend, during which clearing and settlement systems were retooled and trading positions and accounts redenominated from the old currencies into euros. …

A portfolio approach to endogenous growth: equilibrium and optimal policy

Abstract This paper develops a portfolio approach to modeling endogenous growth in continuous time that is especially suitable for addressing fiscal and financial issues in policy design. The analysis focuses on the equilibrium relationship between fiscal and financial policy, rates of return and wealth allocation. We analyze two models. The first is based on the Arrow-Romer model with increasing returns and an external effect of capital on labor productivity. The second draws on Barros analysis of government spending and endogenous growth. In both models, we study the equilibrium allocation and discuss the optimal fiscal and financial policy.

DSGE Models of High Exchange-Rate Volatility and Low Pass-Through

This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities--consistent with the evidence in Bils and Klenow [2004--lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Still, exchange rate depreciation worsens the terms of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.

Competitive Devaluations: A Welfare-Based Approach

This paper studies the mechanism of international transmission of exchange rate shocks within a 3-country Center-Periphery model, providing a choice-theoretic framework for the policy analysis and empirical assessment of competitive devaluations. If relative prices and terms of trade exhibit some flexibility conforming to the law of one price, a devaluation by one country is beggar-thy-neighbor relative to another country through its effects on cost-competitiveness in a third market. Yet, due to direct bilateral trade among the two countries, there is a large range of parameter values for which a country is better off by maintaining a peg in response to its partners devaluation. If instead deviations from the law of one price are to be considered the dominant empirical paradigm, then the beggar-thy-neighbor effect based on competition in a third market may disappear. However, a countrys devaluation has a negative welfare impact on the economies of its trading partners based on the deterioration of their export revenues and profits and the increase in disutility from higher labor effort for any level of consumption.