Foreign Shocks Research Articles

Push-Pull Effects on South Africa's Capital Inflows

This paper uses a vector error correction model to examine the effects of foreign (push) and domestic (pull) factors on South Africa's capital inflows over the period of 1986–2013. The results show that foreign direct investment is pushed in the short-run but pulled in the long-run; portfolio inflows are pushed in both the short-run and the long-run, while in contrast, the other inflows are pulled in the short-run and the long-run. The results further show that South Africa's capital inflows are particularly vulnerable to foreign business cycle shocks in the short-run but to domestic output and investment shocks in the long-run. Copyright © 2015 John Wiley & Sons, Ltd.

Export dynamics and sales at home

How do firms' sales interact across markets? Are foreign and domestic sales complements or substitutes? Using a French firm-level database combining balance-sheet and product-destination-specific export information over the period 1995–2001, we study how demand conditions in foreign markets affect domestic sales through variations in exports. We identify a number of exogenous shocks affecting the firms' demand on foreign markets, including product-destination specific imports or tariff changes, and large foreign shocks such as financial crises or civil wars. Our results show that exogenous variations in firm-level exports positively impact domestic sales, even after controlling for domestic demand conditions. A 10% exogenous increase in foreign sales generates a 1 to 3% increase in domestic sales in the short-run. This result is robust to various estimation techniques, instruments, controls, and sub-samples. It is also supported by the natural experiment of the Asian crisis in the late 1990's.

Are Sovereign Wealth Funds Contrarian Investors?

This paper investigates the determinants of the investment activity of Sovereign Wealth Funds (SWFs) at a macro level, with special emphasis on the possible reaction to a financial crisis in a potential target economy. The analysis relies upon a specially built proprietary database, which encompasses 1,903 acquisition deals spanning the period 1995-2010 and involving 29 out of the 69 existing SWFs. According to a three-step modelling approach, we find that this class of investors prefers to invest in countries with a higher degree of economic development, larger and more liquid financial markets, institutions that offer better protection of legal rights, and a more stable macroeconomic environment. Most importantly, and in stark contrast with the existing empirical literature on other major institutional investors, SWFs seem to engage in ‘contrarian’ investment behaviour, i.e. increasing their acquisitions in countries where crises hit. The results are shown to be valid if we consider both the likelihood of a country being the target of SWFs’ investments and the amount SWFs choose to invest in each country. Capital flows stemming from SWFs’ acquisition activity worldwide may therefore eventually have a stabilizing effect on local markets during periods of financial turmoil, protecting the targeted countries from foreign shocks instead of propagating them globally.

Macroeconomic Shocks and Dynamics of Labor Markets in Korea

A New Keynesian model with a labor market friction, where involuntary unemployment can be endogenized, is estimated with the Korean macroeconomic data using a Bayesian estimation approach. In order to characterize the Korean labor market more realistically, the model is extended by specifying a small open economy with tradable and nontradable goods sectors. The results of empirical analyses based on the estimated model can be summarized as follows. First, it is confirmed that the sectoral reallocation of labors plays an important role in the adjustments of Korean labor market responding to some macroeconomic shocks, particularly foreign shocks. Second, the historical decomposition analysis demonstrates that the cyclical fluctuations of unemployment in Korea are mostly explained by key domestic shocks such as domestic productivity shocks and preference shocks. A relatively small contribution of foreign shocks onto aggregate labor market variables is in part due to the sectoral shift of employment rather than changes in aggregate employment and labor force at extensive margins.

The role of foreign sentiment in small open economy

The role of foreign sentiment is researched for explaining macroeconomic fluctuations in small open economy. The main goal is to find out whether the domestic variables react significantly to the shocks in the foreign sentiment. For this purpose a structural vector autoregression model is constructed for the Czech Republic and the Slovak Republic including relations between foreign environment and domestic variables. Both small open economies considered are highly dependent on foreign demand from euro area. Therefore the foreign development is represented by real GDP in euro area and alternatively is explored the possibility to replace foreign real GDP by economic sentiment indicator of euro area as sentiment indicators are available in advance. The impact of foreign shocks is examined by impulse response functions on the following domestic variables ? real gross domestic product, consumer prices and effective exchange rate against euro area trading partners. The study confirms that foreign economic sentiment can be used for explaining fluctuations of domestic variables of a small open economy.

The transmission of foreign shocks to South Eastern European economies

This paper investigates the transmission of foreign shocks to economic activity and macroeconomic policies in three South Eastern European (SEE) economies: Croatia, Macedonia and Bulgaria. Specifically, we provide empirical evidence on the influence of several policy and non-policy shocks (euro-zone output gap, money market rate and inflation) on economic activity as well as monetary and fiscal policies in the three countries. The main motivation behind our empirical investigation is the fact that all of these economies are small open economies with rigid exchange rate regimes and different degree of integration within the European Union (EU). As for the methodological issues, we employ recursive vector autoregressions to identify the exogenous shocks in the euro-area. Generally, the estimated results imply that euro-zone economic activity has significant and relatively strong influence on these economies where foreign output shocks are transmitted relatively quickly. The results also suggest that the effects of foreign shocks are of larger magnitude in the countries that are more integrated with the EU. An additional finding is that positive foreign interest rate shocks trigger a contractionary response of domestic monetary policy notwithstanding the fact that domestic money market rates are not linked with euro-zone interest rates. Finally, euro-zone inflation is instantly transmitted to domestic inflation. We can explain these effects by several factors, such as: the fixed exchange rates, the relatively high trade integration of SEE economies within the euro-zone as well as the dependence of SEE banks on foreign financing.

The International Transmission of Shocks: Foreign Bank Branches in Hong Kong During Crises

The international transmission of shocks in the global financial system has always been an important issue for policy makers. Different types of foreign shocks have different effects and policy implications. In this paper, we examine the effects of the recent U.S. financial crisis and the European sovereign debt crisis on foreign bank branches in Hong Kong. Unlike the literature on global banking that studies a global bank’s foreign operations from a home country perspective, our analysis uses foreign bank branches in Hong Kong and has a distinct host country perspective, which is more relevant to the host country policy makers. We find that global banks use their foreign branches in Hong Kong as a funding source during a liquidity crunch in the home country, suggesting that global banks manage their liquidity risk globally. After the central bank in the home country introduced a liquidity facility to relieve funding pressure, this effect disappeared. We also find strong evidence that foreign branches of banks in the crisis countries lend significantly less in Hong Kong relative to a control group, suggesting the presence of a lending channel in the transmission of shocks from the home country to the host country.

Foreign Shocks on Chilean Financial Markets: Spillovers and Comovements Between Bond and Equity Markets

:The domestic impact of external shocks will depend on the degree of coupling of domestic assets to foreign markets, but also on the spillovers among assets. The covariance between different types of assets could be affected by new information. Changes in the covariance, for example, could come from a stronger rebalancing between stocks and bonds. Therefore, we will analyze four different assets-government bonds, corporate bonds, money market instruments, and equities-and study the conditional correlation between them. We find that the corporate bond market tends to increase coupling in turbulent times, while the money market decreases coupling. We propose to test international spillovers taking into account a methodology for estimating the conditional mean, variance, and covariance on domestic bond and equity markets, while considering that shocks may have asymmetric effects depending on whether the news is good or bad.

House prices, capital inflows and macroprudential policy

This paper evaluates the monetary and macroprudential policies that mitigate the procyclicality arising from the interlinkages between current account deficits and financial vulnerabilities. We develop a two-country dynamic stochastic general equilibrium (DSGE) model with heterogeneous households and collateralised debt. The model predicts that external shocks are important in driving current account deficits that are coupled with run-ups in house prices and household debt. In this context, optimal policy features an interest-rate response to credit and a LTV ratio that countercyclically responds to house price dynamics. By allowing an interest-rate response to changes in financial variables, the monetary policy authority improves social welfare, because of the large welfare gains accrued to the Savers. The additional use of a countercyclical LTV ratio that responds to house prices, increases the ability of borrowers to smooth consumption over the cycle and is Pareto improving. Domestic and foreign shocks account for a similar fraction of the welfare gains delivered by such a policy.

Financial integration, push factors and volatility of capital flows: evidence from EU new member states

Due to the recent financial crisis and ensuing sudden stop episodes, the question whether capital inflows are dominated by push or pull factors has become an extremely important policy question in small, open and integrated economies. The aim of this paper is to empirically measure, in a methodologically innovative manner, the extent to which the movement of capital inflows in the non-eurozone European Union new member states (EU NMS) has been determined by domestic and external factors and discuss potential consequences of such trends, thereby filling the existing literature gap, i.e. the lack of empirical papers that systematically model the temporal dynamics of capital flow determinants. The paper uses econometric methods, i.e. historical decomposition from a structural vector autoregression model, to examine the temporal dynamics of capital flow determinants and extract components of capital inflows in non-eurozone EU NMS that are influenced by domestic and foreign shocks separately. Econometric analysis confirmed the hypothesis that macroeconomic factors in the eurozone are becoming increasingly dominant determinants of capital inflows in EU NMS, especially after the EU accession, and proved that these trends can be connected to rising financial integration levels of analysed countries. Furthermore, results suggest that the rising influence of push factors can be connected with the higher volatility of capital inflows, thus making host countries more prone to sudden stop episodes. The paper uncovers several non-negligible macroeconomic risks of large capital inflows determined by push factors for domestic economic authorities in small integrated economies and points out the need to make efforts to strengthen the domestic financial and regulatory system to ensure the capability of these economies in efficiently managing capital inflows.

International Transmissions to Australia: The Roles of the USA and Euro Area

This paper examines the influences of the world's two largest developed economies, namely the USA and the Euro area, on Australia as an exemplar of a small open economy. To do so, we specify and estimate a structural VAR with bilateral linkages between the two large economies, and allow shocks originating in either to affect the Australian economy. More specifically, we show the role of foreign output shocks, the differential effects of USA- or Euro-area-sourced inflation and interest rate shocks on the Australian economy, and the relative unimportance of these foreign shocks to variations in the value of the Australian currency.

Foreign interest rate shocks and exchange rate regimes in East Asia

Using a theoretical dynamic stochastic general equilibrium model and an empirical panel vector autoregression, we assess the transmission of foreign real interest rate shocks on the volatility of various key macroeconomic variables in nine small open economies in East Asia taking into account the role of exchange rate regimes. Both the theoretical and empirical findings confirm the hypothesis that flexible exchange rate may work as a shock absorber when the economy is hit by foreign real interest rate shocks. The findings suggest a clear trade-off between the volatility of real exchange rate and real output to foreign interest rate shocks, both the US and G7 real interest rates, where the responses of real output are mitigated in countries that have more flexible exchange rate regime.

The Ill Wind that Blows from Europe: Implications for Canada's Economy

Speculation about the consequences of a break-up of the eurozone, a worsening sovereign debt crisis or a prolonged recession in the European Union have all in recent years made the headlines. At first glance, the effect that such events might have on the Canadian macroeconomy might appear small. After all, Canada’s trade in goods and services and financial flows to and from the euro area are dwarfed by our economic relationship with the United States. Significant spillover effects, however, likely would arise out of any major economic or financial shock originating from the globe’s largest economic block (as measured by gross domestic product, GDP). The sovereign debt crisis in the eurozone exposed major fault lines in the economic stability of the common currency area. The indirect exposure of Canadian banks – and of the Canadian economy more generally – from a eurozone economic shock ought to represent a pressing source of concern for Canada’s policymakers. The continued uncertain outlook for the global and US economy also suggests that there is a real danger of another “perfect storm” such as the one that affected the world economy in 2008 and 2009. Canada might not escape next time around with only a short-lived recession, nor is it a given that its financial sector would emerge largely unscathed, notwithstanding Canada’s reputation for the quality of its financial regulation and supervision. This Commentary estimates a small macroeconomic model for Canada that explicitly incorporates financial sector influences. Then, foreign shocks with real and financial elements from the eurozone and the United States are added to the model to investigate the potential for spillover effects. The study also considers some counterfactuals, by imagining a large, negative and permanent economic shock from the eurozone, and compares the results with estimates based on observed data. The Commentary concludes that negative shocks from the real and financial sectors of the US and eurozone economies do spillover into the Canadian economy. Clearly, US shocks dominate, but eurozone shocks cannot be ignored. Counterfactual experiments suggest that, under eurozone worst-case scenarios, Canada’s economy would suffer a substantial drop of almost 8 percent in real GDP after two and a half years.

Chinese multi-cultural education: possibilities and paths

Purpose – The purpose of this paper is to reform the multi-cultural education in China so as to construct a homogenous education model. Design/methodology/approach – Based on the appeal for multi-ethnic culture development of the era and the possibilities for constructing multi-cultural education in China, this paper proposed paths to construct multi-cultural education in China. Findings – First, this paper explains the reasons to construct a multi-cultural education in china: the intrinsic appeals for multi-ethnic culture development; the increasing culture exchange during economy transformation; foreign culture shock in the setting of globalization. Second, it indicates the possibilities for establishing multi-cultural education in China: the arrival of the multi-cultural era and the education ideal of “Unity without Uniformity.” Third, it points out the paths to construct Chinese multi-cultural education: to establish an educational policy with core socialist value; to perfect Chinese multi-cultural education policies; to construct a multi-cultural education model. Practical implications – This paper points out the paths to construct Chinese multi-cultural education: to establish an educational policy with core socialist value; to perfect Chinese multi-cultural education policies; to construct a multi-cultural education model. Originality/value – This paper analyzes the possibilities and paths for constructing multi-cultural education in China and would be helpful for reforming multi-cultural education in China.

Lending Rate Spread Shock and Monetary Policy Arrangements: A Small Open Economy Model for ASEAN Countries

We investigate the welfare implications of monetary policy arrangements in a small open economy, considering firms' bank-based finances that are widely observed in emerging ASEAN countries. The impact of an unexpected change in the lending rate spread, or a lending rate spread shock, depends on the presence of banking activity in the economy. This presence is important in Malaysia and Vietnam, where welfare effects of this type of shock are at least comparable to those of foreign monetary policy shocks. We also find that a rigid exchange rate arrangement amplifies the effect of a shock.

DETERMINANTS OF COMMON FACTORS IN KOREAN BANKS’ CREDIT DEFAULT SWAP PREMIUMS

Using the panel analysis of non-stationarity in idiosycratic and common component method, we decompose Credit Default Swap (CDS) premium data of 11Korean banks into common factors and idiosyncratic shocks. We find that the CDS premium of all 11 banks is mostly explained by one common factor. We also find that the common factor of the banks’ CDS premium is mainly affected by the level and the volatility of stock market prices in developed markets and oil prices. It suggests that the Korean banking industry is susceptible to foreign shocks due to the heavy dependency of the Korean economy on export. We also find that a structural break in the common part of CDS premium occurred in mid-2007, implying that the exposure of credit risk in Korean banks jumped up after the 2007 financial crisis.

Interest Rates Targeting of Monetary Policy: An Open Economy SVAR Study of Malaysia

This paper examines the implementation of monetary policy during the interest rates targeting in a small-open economy (i.e. Malaysia) by using an open-economy structural VAR (SVAR) study. It tests the effect of foreign shocks upon domestic macroeconomic fluctuations and monetary policy, and examines how effective monetary policy is in influencing macroeconomic variables. The results show that during interest rates targeting, monetary policy plays a significant role in affecting macroeconomics variables. This finding suggests that monetary policy has an important role as a stabilization policy in a small-open economy.

Foreign shocks and international cost of equity destabilization. Evidence from the MENA region

This paper investigates whether foreign financial shocks can destabilize the cost of equity in emerging markets. After a theoretical discussion, we develop annual metrics for the international cost of equity, financial integration, spillovers and shift-contagion vulnerability in a sample of 535 Middle East and North African firms from Egypt, Tunisia, Morocco and Jordan over the 1998–2011 period. We then analyze the impact of foreign shocks on the international cost of equity, using a set of SGMM and PVAR models. Our results indicate that external shocks can increase the cost of equity in mature emerging markets.

The Choice of Exchange-rate Regime in the Framework of New Open Economy Macroeconomics

This paper extends the model setup of Devereux and Engel (1998) to investigate how consumption home bias, capital mobility, and price-setting behavior affect the consumption volatility, expected level of consumption, and the welfare performance under alternative exchange rate regimes for a country facing foreign monetary shock. The paper then discusses the issue of the choice of exchange rate regime. According to the analysis of theoretical derivation and simulation, the following conclusions are made. First, the variance of domestic consumption is lowest under a floating exchange rate with pricing-to-market (PTM model for short), and the variance of consumption under floating exchange rate with producer-currency pricing (the PCP model for short) depends on the degree of capital mobility, the share of tradable goods, and the degree of home bias. Secondly, the fixed exchange rate (FER) will dominate the floating exchange rate in terms of the expected level of consumption. Thirdly, from the perspective of welfare performance, a floating exchange rate with pricing-to-market (PTM model) is preferable to a fixed exchange rate. A fixed exchange rate dominates a floating exchange rate with producer-currency pricing (PCP model), and the lower degree of capital mobility induces a higher welfare under fixed exchange rate but a lower welfare under PTM and PCP models.

Kiss Me Deadly: From Finnish Great Depression to Great Recession

We investigate the causes of the Finnish Great Depression, 1990-1993. We find that the collapse of the overheated financial and banking sectors starting in 1989 was the trigger of the economic crisis. Foreign shocks, which include the collapse of trade with USSR in 1991, can account for at most about half of the slump, and these shocks occurred only when the economy was already in free fall. Also, the deleveraging and restructuring process of the financial system substantially prolonged the subsequent recovery. Our methodology involves estimating a structural VAR model with sign and exogeneity restrictions. Importantly, we are able to distinguish between financial shocks aecting the demand for intermediated