Nouriel Roubini

Political Instability and Economic Growth

This paper investigates the relationship between political instability and per capita GDP growth in a sample of 113 countries for the period 1950 through 1982. We define political instability as the propensity of a government collapse, and we estimate a model in which such a measure of political instability and economic growth are jointly determined. The main result of this paper is that in countries and time periods with a high propensity of government collapse, growth is significantly lower than otherwise. We also discuss the effects of different types of government changes on growth.

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.

Predicting Sovereign Debt Crises

We develop an early-warning model of sovereign debt crises. A country is defined to be in a debt crisis if it is classified as being in default by Standard & Poors, or if it has access to nonconcessional IMF financing in excess of 100 percent of quota. By means of logit and binary recursive tree analysis, we identify macroeconomic variables reflecting solvency and liquidity factors that predict a debt-crisis episode one year in advance. The logit model predicts 74 percent of all crises entries while sending few false alarms, and the recursive tree 89 percent while sending more false alarms.

A Balance Sheet Approach to Financial Crisis

The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis. The paper also discusses the potential of macroeconomic policies and official intervention to mitigate the cost of such a crisis.

On the Taxation of Human and Physical Capital in Models of Endogenous Growth

This paper studies the effects of factor income taxation and of subsidies to human capital accumulation in models of endogenous growth. It examines in particular how these effects depend on the specification of the leisure activity and on the technology and tax treatment of the sector producing human capital. It shows that the negative effects of factor income taxes on economic growth are stronger when the human capital sector is a market good. Under these circumstances, a subsidy to human capital accumulation can offset the direct growth effects of labour taxation, making it akin to a consumption tax. The paper then derives the normative implications of the analysis for the optimal taxation of factor incomes, showing that all tax and subsidy ‘wedges’ should be eliminated in the long run.

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.

Economic and political determinants of budget deficits in developing countries

Abstract The evidence from a large sample of developing countries tends to reject the empirical implications of optimizing models of the process of determination of fiscal deficits, tax rates, seigniorage and inflation. The paper also presents some preliminary evidence that an important reason for the failure of the equilibrium approach to fiscal policy is that fiscal deficits are partly determined by political factors and that cross-country differentials in budget deficits may depend on measures of political instability. In particular, as suggested by a number of recent theoretical approaches, an increase in the degree of political instability appears to lead to greater budget deficits.

Growth Effects of Income and Consumption Taxes

The effects of income and consumption taxation are examined in the context of models in which the growth process is driven by the accumulation of human and physical capital. The different channels through which these taxes affect economic growth are discussed. It is shown that the effects of taxation on growth depend crucially on whether the sector producing human capital is a market sector, on the technology for human capital accumulation, and on the specification of the leisure activity. In general, the taxation of factor incomes (human and physical capital) is growth-reducing, while the effects of a consumption tax depend on the specification of leisure. The paper also derives implications for the growth-maximizing choice of tax instruments.

Exchange rate overshooting and the costs of floating

Currency crises are usually associated with large nominal and real depreciations. In some countries depreciations are perceived to be very costly (‘fear of floating’). In this paper we try to understand the reasons behind this fear. We first look at episodes of currency crises in the 1990s and establish that countries entering a crisis with high levels of foreign debt tend to experience large real exchange rate overshooting (devaluation in excess of the long run equilibrium level) and large output contractions. We the develop an model of an open economy with monopolistic competition and short-run price stickiness that helps to explain this evidence. The key element of the model is the presence of a margin constraint on the domestic country. Real devaluations, by reducing the value of domestic assets relative to international liabilities, make countries with high foreign debt more likely to hit the constraint. When countries hit the constraint they are forced to sell domestic assets and this causes a further devaluation of the currency (overshooting) and a reduction of their stock prices (overreaction). This fire sale can have a significant negative wealth effect. The model highlights a key tradeoff when considering fixed versus flexible exchange rate regimes; a fixed exchange regime can, by avoiding exchange rate overshooting, mitigate the negative wealth effect but at the cost of additional distortions and output drops in the short run. There are plausible parameter values under which fixed exchange rates dominate flexible from a welfare perspective.