Iikka Korhonen

Some Empirical Tests on the Integration of Economic Activity between the Euro Area and the Accession Countries

This note looks at the correlation of short-term business cycles in the euro area and the EU accession countries. The issue is assessed with the help of vector autoregressive models. There are clear differences in the degree of correlation between accession countries. For Hungary and Slovenia, euro area shocks can explain a large share of variation in industrial production, while for some countries this influence is much smaller. For the latter countries, the results imply that joining the monetary union could entail reasonably large costs, unless their business cycles converge closer to the euro area cycle. Generally, for smaller countries the relative influence of the euro area business cycle is larger. Also, it is found that the most advanced accession countries are at least as integrated with the euro area business cycle as some small present member countries of the monetary union.

A Meta-Analysis of Business Cycle Correlation between the Euro Area and CEECs: What Do We Know - and Who Cares?

We review the literature on business-cycle correlation between the euro area and Central and Eastern European countries (CEECs), a topic that has gained attention in recent years as new EU entrants prepare for participation in the monetary union. Our meta-analysis suggests several CEECs already have comparably high correlation with the euro area business cycle. We also find that estimation methodologies can have a significant effect on correlation coefficients. While central bankers are more conservative in their estimates, we find no evidence of a geographical bias in the studies.

Equilibrium Exchange Rates in Oil-Dependent Countries

We assess the determinants of equilibrium real exchange rates in a sample of oil-dependent countries. Our basic data cover OPEC countries from 1975 to 2005. We also include three oil-producing Commonwealth of Independent States (CIS) countries in our robustness analysis. Utilising several estimation techniques, including pooled mean group and mean group estimators, we find that the price of oil has a clear, statistically significant effect on real exchange rates in our group of oil-producing countries. Higher oil price lead to appreciation of the real exchange rate. Elasticity of the real exchange rate with respect to the oil price is typically between 0.4 and 0.5, but may be larger depending on the specification. Real per capita GDP, on the other hand, does not appear to have a clear effect on real exchange rate. This latter result contrasts starkly with the consensus view of real exchange rates determinants, emphasising the unique position of oil-dependent countries.

Currency boards in the Baltic countries : What have we learned?

Sisallysluettelo: Abstract 5 1 Introduction 6 2 Currency board as an exchange rate arrangement 7 3 A short history of currency board arrangements 10 4 Currency boards in the Baltic countries 12 4.1 Monetary reforms in Estonia and Lithuania 12 4.1.1 Estonia 15 4.1.2 Lithuania 17 4.2 The rnacroeconomic effects of the Baltic currency boards 18 4.2.1 Inflation 20 4.2.2 Output 23 4.3 The Baltic currency boards and financial systems 25 4.4 Assessing the Baltic currency boards 27 5 Concluding remarks 32 References 34 Notes 37 Annex 39

Money demand in post-crisis Russia : De-dollarisation and re-monetisation

Estimating money demand functions for Russia following the 1998 crisis, we find a stable money demand relationship when augmented by a deterministic trend signifying falling velocity. As predicted by theory, higher income boosts demand for real rouble balances and the income elasticity of money is close to unity. Inflation affects the adjustment towards equilibrium, while broad money shocks lead to higher inflation. We also show that exchange rate fluctuations have a considerable influence on Russian money demand. The results indicate that Russian monetary authorities have been correct in using the money stock as an information variable and that the strong influence of exchange rate on money demand is likely to continue despite de-dollarisation of the Russian economy.

The Rise of China and Its Implications for Emerging Markets - Evidence from a GVAR Model

This paper studies empirically the role of China in the world economy. We examine both the way the Chinese economy reacts to selected exogenous macroeconomic shocks and the repercussions for the world economy of a shock emanating from China. With regard to the latter, we focus on the responses of emerging markets, in particular those in Europe. Based on a global VAR (GVAR) model and a new data set that excels in country coverage and covers the most recent time period including the global financial crisis, our results are threefold: First, we show that a +1% shock to Chinese output translates to a permanent increase of 1.2% in Chinese real GDP and a 0.1% to 0.5% rise in output for most large economies. The countries of Central Eastern Europe (CEE) and the former Commonwealth of Independent States (CIS) also experience an output rise of 0.2%, while countries in South-Eastern Europe see a permanent 0.1% reduction in output. Secondly, to benchmark the shock to Chinese output, we examine the response to a +1% shock to US GDP. The results show that the US economy remains dominant in the world economy despite the rapid rise of China in recent years. In this vein, output rises in advanced economies by 1% to 1.4% and in the CIS and CEE regions by 1.5% and 0.7% respectively. By contrast China seems to be little affected by the US shock. Finally, we examine the effect of a +50% hike in oil prices on China and emerging economies. As one of the largest oil exporters, Russias real output increases by about 6%. In contrast, the surge in oil prices puts a drag on Chinese output, amounting to 4.5% in the long-run. JEL Classification: C32, F44, E32, O54 Keywords: China, macroeconomic shocks, foreign shock, GVAR, great recession

The Rise of China and Its Implications for the Global Economy: Evidence from a Global Vector Autoregressive Model

This paper studies empirically the role of China in the world economy. We examine both the way the Chinese economy reacts to exchange rate shocks and the repercussions for the world economy of an output shock emanating from China. Based on a global vector autoregressive model and a new data set that excels in country coverage and covers the most recent time period including the global financial crisis, our results are threefold: First, we show that a +1% shock to Chinese output translates to a permanent increase of 1.1% in Chinese real GDP and a 0.1% to 0.5% rise in output for most large economies. Second, to benchmark the shock to Chinese output, we examine the response to a +1% shock to US GDP. The results show that the US economy remains dominant in the world economy, as output rises in other advanced economies by 0.6 to 1%. By contrast, China seems to be little affected by the US shock. Finally, we are the first to assess the impact of a real appreciation of the renminbi versus the US dollar in a global model. Our results indicate that real appreciation of the renminbi decreases the level of Chinese GDP slightly and the long-run effect is also negative for many countries exporting (e.g. raw materials) to China.

China and Central and Eastern European Countries: Regional Networks, Global Supply Chain, or International Competitors?

China has emerged as one of the top recipients of foreign direct investment in the world. Meanwhile, the successful transition experience of many Central and Eastern European countries has also allowed them to attract an increasing share of global foreign direct investment. In this paper, the authors use a panel data set to investigate whether foreign direct investment flows to these two regions are complements, substitutes, or independent of each other. Taking into account the role of host country characteristics - such as market size, degree of trade liberalization, and human capital - the authors find no evidence that foreign direct investment flows to one region are at the expense of those to the other. Instead, the results suggest that foreign direct investment flows are driven by distinct regional production networks (and thus are largely independent of each other) and the development of global supply chains (indicating that foreign direct investment flows are complementary).

Progress in Economic Transition in the Baltic States

A Finnish economist assesses the economic transition experience of the three Baltic countries—Estonia, Latvia, and Lithuania—the first among the successor states of former Soviet Union (FSU) to liberalize and stabilize their economies. He investigates the extent to which progress in transition reflects favorable initial conditions in the Baltic states vis-a-vis implementation of stable macroeconomic policies and ongoing structural reform. The paper argues that the pronounced break with the past after these countries regained their independence facilitated efforts to steer the reform process in a more radical direction, with the prospect of EU membership providing an added incentive to continue painful structural reforms. Journal of Economic Literature, Classification Numbers: E6, P2, P3. 4 figures, 2 tables, 53 references.

Does diversification increase or decrease bank risk and performance? : Evidence on diversification and the risk-return tradeoff in banking

Conventional wisdom in banking argues that diversification tends to reduce bank risk and improve performance, but the recent financial crisis suggests that aggressive diversification strategies may have resulted in increased risk taking and poor performance. This paper addresses this important question by evaluating the empirical relationship between diversification strategies and the risk-return tradeoff in banking. Our data set covers Russian banks during the 1999-2006 period and finds somewhat mixed results. Specifically, we find that banks’ performance tends to be non-monotonically related to their diversification strategy. The marginal effects of focus indices (inverse measures of diversification) on performance are nonlinearly associated with the level of risk and foreign ownership. A focused strategy is found to be associated with increased profit and decreased risk only up to a certain threshold. Additionally, when foreign ownership is either very high or very low, banks tend to benefit more from being diversified. This analysis provides important strategic and policy implications for bank managers and regulators in Russia as well as in other emerging economies.