Paolo A. Pesenti

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.

Benefits and Spillovers of Greater Competition in Europe: A Macroeconomic Assessment

Using a general-equilibrium simulation model featuring nominal rigidities and monopolistic competition in product and labor markets, this paper estimates the macroeconomic benefits and international spillovers of an increase in competition. After calibrating the model to the euro area vs. the rest of the industrial world, the paper draws three conclusions. First, greater competition produces large effects on macroeconomic performance, as measured by standard indicators. In particular, we show that differences in competition can account for over half of the current gap in GDP per capita between the euro area and the US. Second, it may improve macroeconomic management by increasing the responsiveness of wages and prices to market conditions. Third, greater competition can generate positive spillovers to the rest of the world through its impact on the terms of trade.

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.

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. …

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.

Commodity Prices, Commodity Currencies, and Global Economic Developments

In this paper, we seek to produce forecasts of commodity price movements that can systematically improve on naive statistical benchmarks. We revisit how well changes in commodity currencies perform as potential efficient predictors of commodity prices, a view emphasized in the recent literature. In addition, we consider different types of factor-augmented models that use information from a large data set containing a variety of indicators of supply and demand conditions across major developed and developing countries. These factor-augmented models use either standard principal components or the more novel partial least squares (PLS) regression to extract dynamic factors from the data set. Our forecasting analysis considers ten alternative indices and sub-indices of spot prices for three different commodity classes across different periods. We find that, of all the approaches, the exchange-rate-based model and the PLS factor-augmented model are more likely to outperform the naive statistical benchmarks, although PLS factor-augmented models usually have a slight edge over the exchange-rate-based approach. However, across our range of commodity price indices we are not able to generate out-of-sample forecasts that, on average, are systematically more accurate than predictions based on a random walk or autoregressive specifications.

Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-a-vis the rest of the world. Negative demand shocks have more prolonged and startling effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.

Deflationary shocks and monetary rules: An open-economy scenario analysis

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-a-vis the rest of the world. Negative demand shocks have more prolonged and startling effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding. (This abstract was borrowed from another version of this item.)