International Co-movement April 29, 2015
REAL CO-MOVEMENT (GDP)
REAL CO-MOVEMENT (GDP)
FINANCIAL CO-MOVEMENT
Lower correlation productivity-labor
WHAT EXPLAINS CO-MOVEMENT? 1. Shocks could be correlated (global shocks). 2. Country-specific shocks propagate to other countries (spillover). 7
MODEL WITH SEGMENTED MARKETS Two types of agents (sectors): Investors: They are the shareholders of firms and consume dividends. max E β t u(d t ) t=0 Workers: Supply labor and lend funds to firms with bonds. max E δ t U(c t, h t ) t=0 Different discount factors: β < δ. 8
FIRMS Concave production function F ( k, h t ). Fixed capital for the moment. Budget constraint: b t + d t = b t+1 R t + F (h t ) w t h t. Discount factor: m t+1 = βu c(d t+1 ) u c (d t ). Also borrow intra-temporally for working capital l t = F (h t ). Limited enforcement: ξ t k b t+1 R t + l t 9
RECURSIVE PROBLEM FOR THE FIRM V (s; b) = max d,h,b { d + Em V (s ; b ) } subject to: b + d = b R ξ k b R + F (h) + F (h) wh 10
First order conditions F h (h) = w ( 1 ) 1 µ REm = 1 µ µ Multiplier for the enforcement constraint. Positive if binding. 11
OPEN ECONOMY Two symmetric countries. Households borrow and lend internationally. They own domestic bonds, b t, and foreign bonds, n t. Investors are allowed to hold shares of domestic and foreign firms. Full diversification is optimal. 12
OPEN ECONOMY Because of investors diversification, the common discount factor is: m t+1 = βu c(d 1 t+1 + d 2 t+1) u c (d 1 t + d 2 t) Back to first order conditions of firms: F h (h 1 ) = w 1 ( 1 ) 1 µ 1 F h (h 2 ) = w 2 ( 1 ) 1 µ 2 REm = 1 µ 1 REm = 1 µ 2 13
PROPERTY WITH EXOGENOUS ξ t Proposition. An unexpected change in ξ t (domestic credit shock) has the same impact on employment and output of domestic and foreign countries. 14
HETEROGENEOUS DYNAMICS OF LABOR
LABOR WEDGE In the standard neoclassical model we have: Wedge mrs - mpl = φc 1 H (1 θ)y H 17
GLOBAL IMBALANCES March 18, 2015
GLOBAL IMBALANCE FACTS 1. FACT 1: Emerging economies are net lenders to industrialized countries. 2. FACT 2: The gross foreign portfolio of emerging economies is tilted toward liquid assets. Also, US portfolio composition: The US invests in foreign risky assets and finances the investment with foreign borrowing. US excess return: The return on foreign assets for the US is higher than the cost of its liabilities. US distress vulnerability: The portfolio structure of the US is vulnerable to period of global economic stress (global insurer).
% of World GDP Current account (Gourinchas and Rey) 2.50 2.00 1.50 1.00 0.50 0.00-0.50-1.00-1.50 Asian Crisis Financial Crisis -2.00 1980 1984 1988 1992 1996 2000 2004 2008 2012 U.S. Europe Japan Oil Producers Emerging Asia ex-china China Figure 1: Global Imbalances. Source: IMF World Economic Outlook
WHAT EXPLAINS FACT 1 (Emerging economies lending to advanced economies)
DEMAND AND SUPPLY OF SAVINGS Supply of savings Supply of savings r r Demand of savings Demand of savings K K a) Emerging economy b) Advanced economy
AUTARKY INTEREST RATES MUST DIFFER Supply of savings Supply of savings r r Demand of savings Demand of savings K K a) Emerging economy b) Advanced economy
AUTARKY INTEREST RATES MUST DIFFER Supply of savings Lending Supply of savings r r Demand of savings Borrowing Demand of savings K K a) Emerging economy b) Advanced economy
Challending fact: Fast growing countries export capital (Gourinchas and Rey) Capital Inflows (percent of GDP) 10 5 0 5 10 15 RWA TGO MOZ COG TZA MLI SEN MWI NER MDG CIV HND BOL CRI BEN LKA PER JAM NPL CHL CYP CMR GHA ECU GTM TUN DOM JOR KEN MAR HTI ARGFJI ISR PAK MEXPHL PNGPRY UGA THA ETH BRACOL MUS PAN SLV TUR IDN BGD URY MYS EGY IND TTO AGO NGA ZAF GABSYR KOR IRN CHN VEN HKG BWA SGP TWN 4 2 0 2 4 6 Productivity Growth (%) Figure 2: Average productivity growth and average capital inflows between 1980 and 2000 for a select group of developing countries. Source: Gourinchas and Jeanne (forth.)
RECENT CONTRIBUTIONS There is by now an extensive literature on the causes of global imbalances. Shortage of asset supply: Caballero, Farhi & Gourinchas (2008). Excess savings due to uninsurable risk: Willen (2004), Mendoza, Quadrini & Rios-Rull (2009), Carroll and Jeanne (2008), Angeletos and Panousi (2011), Sandri (2011), Buera and Shin (2009), etc. Business self-finance: Storesletten, Song & Zilibotti (2011). Demographics: Henriksen (2005), Curtis, Lugauer & Mark (2010). However, most of these studies Ignore the role of governments for the emergence of imbalances. Explain only the net imbalances (net foreign asset positions), not the gross imbalances (portfolio composition).
US gross assets 140 120 100 80 60 40 20 0 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Gold Non Gold Debt Direct Investment Equity Figure 5: US Gross Asset Position (percent of output). Source: Gourinchas et al. (2010) 59
US gross liabilities 140 120 100 80 60 40 20 0 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Other Government Debt Corporate Debt Direct Investment Equity Figure 6: US Gross Liabilities Position (percent of output). Source: Gourinchas et al. (2010) 60
WHY IS PORTFOLIO COMPOSITION IMPORTANT? There are important valuation effects (Gourinchas and Rey (2008)). The adjustment mechanism depends on the portfolio composition: A dollar devaluation benefits the US since assets are in foreign currency while liabilities are in dollars. If the US slows down, the dollar is likely to depreciate but this is unlikely to trigger a financial crisis. This is a very different situation than in the Asian countries in the late 1990s or Argentina in the early 2000s.
WHAT EXPLAINS FACT 2? (Foreign portfolio composition of US and emerging economies)
MORE CHALLENGING QUESTION There is some work that tries to capture portfolio composition. Mendoza, Quadrini & Rios-Rull (2009), Gourinchas and Rey (2010), Maggiori (2011), etc. However, explaining the portfolio imbalances remains a challenging task for this literature. Why? Explaining gross flows is more difficult than net flows. Modeling the active action of governments is important: A non-negligible portion of foreign assets are issued by governments. They are large players and internalize the impact on markets. They behave strategically (international competition).
SHOULD GOVERNMENTS INTERVENE TO CORRECT THE IMBALANCES?
EQUILIBRIUM WITHOUT TAXES Supply of savings Lending Supply of savings r r Demand of savings Borrowing Demand of savings K K a) Emerging economy b) Advanced economy
EQUILIBRIUM WITH OUTFLOW TAXES r Terms of Trade Gains Lending Supply of savings Demand of savings r Borrowing Supply of savings Demand of savings K K a) Emerging economy b) Advanced economy
EQUILIBRIUM WITH INFLOW TAXES r Lending Supply of savings Demand of savings r Terms of Trade Gains Borrowing Supply of savings Demand of savings K K a) Emerging economy b) Advanced economy
STANDARD OPTIMAL TARIFF RESULT Taxes work only if they are unilateral: The outflow (inflow) tax increases welfare only if the borrowing (lending) country does not respond by taxing capital inflows (outflows).
MORE FUNDAMENTAL QUESTION Is it meaningful to ask about optimal government policies to correct the imbalances when the imbalances are often created by governments? In Argentina and Greece a large portion of foreign borrowing was from governments. Should the government tax itself for not recognizing the cost of default? Foreign borrowing in the 1990s in Asia was mostly private. However, some governments provided guarantees on loans. Should governments tax capital inflows to correct for the implicit government subsidies?
SOME ADDITIONAL FACTS
Size of Finance and Insurance 9% 8% 7% 6% 5% 4% Value added (% Total GDP) Employment (% Nonfarm) 3% 1970 1975 1980 1985 1990 1995 2000 2005 2010
Ratio price index FIRE over price index GDP 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
US Trade in financial services (Percent of total service trade) 9% 8% 7% Exports Imports 6% 5% 4% 3% 2% 1% 0% 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012