Jorge Braga de Macedo

Growth, Reform Indicators and Policy Complementarities

In order to assess the growth implications of policy complementarities, this paper applies second-best results to reform indicators. During the transition from central planning to EU integration, which corresponds to a policy cycle, a complementarity index based on structural indicators compiled by the European Bank for Reconstruc- tion and Development (EBRD) decreases and then increases while the level of reforms tends to rise throughout. Corrected for initial conditions, the extent of macroeconomic stabilization and endogeneity, the level of reforms and changes in their complementarity are found to be positively related to output growth. The study uses panel data for 27 countries between 1989 and 2004.In order to assess the growth implications of policy complementarities, this paper applies second-best results to reform indicators. During the transition from central planning to EU integration, which corresponds to a policy cycle, a complementarity index based on structural indicators compiled by the European Bank for Reconstruction and Development (EBRD) decreases and then increases while the level of reforms tends to rise throughout. Corrected for initial conditions, the extent of macroeconomic stabilization and endogeneity, the level of reforms and changes in their complementarity are found to be positively related to output growth. The study uses panel data for 27 countries between 1989 and 2004.

Exchange rate behavior with currency inconvertibility

Abstract The paper analyzes exchange rate dynamics in a world where the domestic currency is inconvertible into foreign currency and there is a ‘black market’ for foreign exchange. The official exchnage rate is thus set by policy but the black market rate is determined by portfolio balance. The stock of domestic money changes with the reported current account and the stock of foreign assets of the private sector changes with smuggling and other unreported current account transactions. The effects of capital and current account disturbances as well as the effects of changes in the level and the rate of crawl of the official rate on the black market premium and on the currency substitution ratio are analyzed in variants of the basic model.

Currency Inconvertibility, Trade Taxes and Smuggling

Abstract In the classic analysis of smuggling importers choose the optimal mix of legal and illegal trade, given trade taxes and the technology of detection. This paper introduces an inconvertible currency in the framework, so that illegal trade is valued at a rate higher than the (fixed) official exchange rate. Sections 2 and 3 show how the smuggling ratio and the domestic price markup for the import and export good are simultaneously determined. With balanced legal and illegal trade, changes in the (long-run) black market premium are a weighted average of changes in trade taxes, whereas changes in the smuggling ratios depend on the ration of trade taxes. Thus, an import tariff and an export subsidy rising at the same rate would keep smuggling ratios constant but imply a rising black market premium (sections 4 and 5). To determine the quantity of exports and imports, a model of the economy is presented in section 6, featuring the production of exports and non-traded goods and the consumption of imports and non-traded goods, as well as a government confiscating the amounts of traded goods unsuccessfully smuggled. Then export production may fall, and welfare may rise, if trade taxes have a negative effect on the relative price of exports and imports stronger than the positive effect on smuggled exports and imports, which is always welfare-reducing. Section 7 introduces the short-run determination of the black market premium via portfolio balance. In this case, rising trade taxes may be associated with a premium rising even faster if there is unreported capital flight and conversely.

Optimal currency diversification for a class of risk-averse international investors

In the framework of continuous-time finance theory, this paper derives the optimal consumption and portfolio rules for an international investor with constant expenditure shares [alpha, sub j] and constant relative risk aversion [1-gamma] in a dynamic context. The index of value obtained from the consumption rule is used to obtain real returns on N different currencies in terms of their purchasing power over N goods. The portfolio rule is expressed in terms of the determinants of the purchasing powers, namely exchange rates and prices expressed in the numeraire currency. The optimal portfolio is interpreted as a capital position given by the expenditure shares and hedging zero net-worth portfolios depending on unanticipated inflation and risk aversion. It is shown that the minimum variance portfolio is independent of returns, but depends on expenditure patterns. While the speculative portfolio depends on risk aversion and real return differentials. When the effect of references on real return differentials is made explicit, it is shown that the minimum variance portfolio is affected by risk aversion. In that case, the effect of an increase in [alpha, sub i] on the portfolio proportions [x, sub i] will be positive when relative risk aversion is greater than one, as generally presumed. Actual data from eight major countries is used to compute optimal portfolios based on real return differentials for different weighting schemes, degrees of risk aversion and sample periods when exchange rates and prices are assumed to be Brownian.

Currency diversification and export competitiveness: A model of the Dutch disease in Egypt

Abstract The paper presents a dynamic portfolio model under currency inconvertibility which rationalizes the recent Egyptian experience of real exchange rate appreciation and currency diversification following the increase in oil exports and the partial financial liberalization that took place after 1976. The two shocks are linked because the relative price of manufacturing exports in terms of oil is also the premium of the ‘gray’ market rate over the official exchange rate. The effects of various official exchange rate policies on the temporary equilibrium values of the premium and the real wage and on the steady-state values of asset stocks are examined. A review of the Egyptian experience in light of the model results suggests that the unification of 1979 was ineffective against this variant of the ‘Dutch disease’ but that the restoration in 1981 of a parallel rate closer to the ‘gray’ market rate applicable to competitive exports may be more effective.

Portugal's European Integration: The Good Student with a Bad Fiscal Constitution

Portugal’s experience with international economic interdependence, begun under a corporatist regime keen on fostering economic and political integration with African and Asian colonies. This regime constrained private initiative, and the absence of multi-party democracy inhibited political freedom. Due to the lack mutual political responsiveness with major members of the North Atlantic Treaty Organization (NATO), let alone with the Organization for European Economic Co-operation (OECD), the experience was largely ignored. The same is true of membership in the European Free Trade Association (EFTA) in 1960, although it paved the way for a free trade agreement with the European Community (now EU) in 1972. With the 1974 Revolution, mutual political responsiveness emerged, but there was a strong reversal in economic interdependence. In addition to the 1973 oil crisis, civil strife followed the attempt to introduce sovietstyle economic planning in the 1976 constitution. The rigidity inherited from the corporatist regime was compounded by the widespread nationalization of heavy industry and banking, together with agriculture in the southern part of the country, and by successive balance of payments crises. As a consequence the democratic regime accommodated substantial macroeconomic instability, a combination not observed since the aftermath of the 1910 Revolution.

War, Taxes and Gold: The inheritance of the Real

The inheritance of the real (the currency of the Kingdom of Portugal, from 1435 to 1910) on national fiscal and monetary institutions is presented as a response to the challenge of foreign invasions and of their aftermath. The Portuguese crown had to preserve national sovereignty over borders defined in the XIII century in the face of external military threats from neighboring states. The social contract enforced by the crown until the early XX century relied on the ability to obtain increasingly expensive warfare. The pressure to raise revenue became a motive for fiscal change since medieval times, as war provided social legitimacy for tax reform or currency depreciation. Tax reform involved the creation of new taxes (the sisa and the décima) with a comprehensive base, well before they were acknowledged to be part of a modern fiscal system. New methods of taxation, including the incidence of the décima on interest income, profits and even wages in order to improve the efficiency of the fiscal system were also introduced and the immunities enjoyed by the nobility and by the church were reduced. In spite of those modern features, for most of the period state finance was primarily based on domain revenues, coming from monopolies established on trade and other colonial resources. One of them, gold, was also used as money and powerfully affected the link between war and taxes. In particular, the amount and continuity of gold inflows allowed taxation to fall and remain low throughout the 1700s. The high share of customs in tax revenues and the concentration of other taxes (like the excise) in Lisbon were other peculiar attributes of the system. The fiscal collapse of the early 1800s shows how sensitive to fluctuations in foreign trade both domainial revenues and customs duties were. The importance of domainial revenues may also explain why institutional reforms did not develop in XVIII century Portugal as early as might be expected. The crown was unable to extend the modern features of its financial system and to resort to higher levels of consolidated public debt, the only way to deal with extraordinary expenditures. Wealth-holders did not support the modernization of state finance through the creation of a bank responsible for managing public debt and issuing convertible paper money. Perhaps the government’s commitment to upholding property rights was not credible enough. The increase in military expenditures was followed by the fall in colonial commerce due to the loss of Brazil. Either one of the shocks would have been sufficient to bring about a large budget deficit. The resort to inconvertible monetary creation in 1797 was responsible for a period of raging inflation lasting until the 1820s. Moreover, it engendered problems in monetary circulation up to the 1850s. Money creation was only disciplined with the reform of the monetary system and the adhesion to the gold standard in 1854. Compared with the previous period of monetary and financial instability, the almost forty years that elapsed until the declaration of inconvertibility in 1891 allowed living standards to catch up with the European average. The resort to foreign public debt as a way to finance short-term public deficit was based on the assumption that in the long term the increase in tax revenues would balance the deficit. The constitutional agreement that pacified the country in 1852 and the globalisation in the capital markets associated with the heyday of the classical gold standard also enabled this experience of convergence. Outside the gold standard, Portugal endured renewed financial and political difficulties. In 1910, a revolution created a republic and a new inconvertible currency. If, for the monarchy, convertibility had been the rule rather than the exception, the pressure of war remained and so did the difficulties in tax administration. Indeed the resilience of the latter may be the only acknowledged inheritance of the real.

Macroeconomic Policy and Institutions During the Transition to European Union Membership

A framework is developed for macroeconomic policy analysis in four countries of Central Europe (CE) in transition to EU membership (Czech Republic, Hungary, Poland, and Slovakia). A Multi-Annual Fiscal Adjustment Strategy (MAFAS) and a Pre-Pegging Exchange Rate Regime (PPERR) appropriate for maintaining internal and external balance are described and evidence on budgetary procedures is presented, in comparison with those prevailing in EU member states. The comparison suggests that the four CE countries are better fit for fiscal stabilization than Greece, Spain and Portugal were in the 1970s. Nevertheless, there is still much room for institutional improvement. A stronger commitment mechanism to fiscal targets at the preparatory stage would improve fiscal performance in all four countries. The adoption of a kind of convergence program would also be made easier if some group procedures can be adopted among them. The four countries also appear to have moved closer to sustainability in their external and internal balance in the last few years so that a MAFAS and a PPERR become credible. The fact that they established CEFTA (which Slovenia since joined) also helps set them apart from other EU associates in the region.

The Credibility of Cabo Verde's Currency Peg

This paper studies the credibility of the currency peg of Cape Verde (CV) by assessing the impact of economic fundamentals, our explanatory variables, on the stochastic properties of Exchange Market Pressure (EMP), the dependent variable, using EGARCH-M models. Our EMP descriptive analysis finds a substantial reduction in the number of crisis episodes and of (unconditional) volatility after the peg’s adoption. Moreover, our estimation results suggest that mean EMP is driven by fundamentals and that conditional variability is more sensitive to negative shocks. We also find evidence that the expected return from holding CV’s assets is lower under the currency peg for the same increase in monthly volatility. The reason is that the return’s composition is “more virtuous”, as it results from the strengthening of CV’s foreign reserve position and is not due to either a larger risk premium or favourable exchange rate movements. We take this to be a sign of the credibility of the peg, which apparently reflects the intertemporal credibility of CV’s economic policy and so has successfully withstood international markets’ scrutiny.

Drivers of China’s Foreign Direct Investment into Africa

We assess the determinants of Chinese direct investment in Africa compared with those of global FDI. We find that economic size and macroeconomic stability are positively correlated with Chinese and global FDI in Africa. Institutional variables, such as accountability and rule of law, are not significant in either case and the same can be said about FDI-aid complementarities. The presence of oil is a determinant of Chinese FDI but not of global FDI into Africa. Conversely, the openness of the economy is a determinant for global FDI but not of Chinese FDI, which appears to favour closed economies possibly due to industrial organizational concerns. While these differences accord with intuition, we find no evidence for the claim that Chinese FDI in Africa is related to non-economic governance in a specific way that differs from global practice. More refined governance indicators should be used to verify whether Chinese and global FDI into Africa remain indistinguishable on this score: we plan to do this in future research.