Net Foreign Assets Research Articles

The Hedging Channel of Exchange Rate Determination

Abstract We propose the currency hedging channel that connects countries’ external imbalances to their exchange rate behavior. We present a model in which investors increase their currency hedging during periods of financial distress in proportion to their net foreign asset exposure. This behavior coupled with constrained financial intermediation explains observed relationships between gradually adjusting external imbalances and volatile spot and forward exchange rates. We find empirical support for the hedging channel in both the conditional and unconditional moments of exchange rates, option prices, and countries’ uses of Federal Reserve swap lines. (JEL E44, F31, F32, F41, G11, G15)

A theory of net capital flows over the global financial cycle

We develop a theory to account for the relationship between global asset price changes and net capital flows. We show empirically that countries that have a net debt of safe assets experience a rise in net outflows of safe assets (i.e. pay off safe asset debt) when global asset prices fall. This is accomplished through a rise in total net outflows (an increase in net savings) and a drop in net outflows of risky assets (the net sale of foreign risky assets). We develop a multi-country portfolio choice model that can account for these facts. The theory relies on cross-country heterogeneity in the share of an investor’s portfolio invested in risky assets. A global drop in risky asset prices changes relative wealth across countries due to this heterogeneity, which leads to changes in net flows of safe and risky assets. The model is applied to 20 advanced countries and calibrated to reflect observed cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for net capital flows are quantitatively consistent with the data.

Trade Wars, Nominal Rigidities, and Monetary Policy

Abstract This paper shows that the outcome of trade wars for tariffs and welfare will be affected by the monetary policy regime. The key message is that trade policy interacts with monetary policy in a way that magnifies the welfare costs of discretionary monetary policy in an international setting. If countries follow monetary policies of flexible inflation targeting, trade wars are relatively mild, with low equilibrium tariffs and small welfare costs. Discretionary monetary policies imply much higher tariffs, high inflation rates, and substantially larger welfare costs. We quantify the effects of a global trade war among major economies using estimates of trade elasticities, economic size, net foreign assets, and trade openness. We find large welfare benefits of an inflation targeting monetary policy for all countries.

The Impact of Financial Development, Net Foreign Assets and Domestic Businesses on Export Performance: A case of Singapore Economy

The effects of financial sector liberalization; foreign assets, domestic businesses in the form of listed companies and domestic manufacturing, and real interest rate on export performance of Singapore economy are tested by using ARDL bounds testing approach by covering period from 1978-2023. The empirical results suggest that liberalizing financial sector and foreign assets significantly accelerate export performance. This study considers two proxies for domestic businesses – listed companies and manufacturing. The results uncover the significantly expansionary effects of both indicators of domestic businesses on export performance. Lastly, real interest rate is adversely affecting export performance in Singapore. This study suggests that by expanding domestic businesses; increasing investments in foreign assets, liberalizing financial sector and reducing real interest rate can give boost to exports in Singapore.

Targeting Debt in Pakistan: A Structural Macro-Econometric Model

Unsustainable debt levels pose serious economic risks, potentially leading to financial instability when repayments become challenging. This paper investigates the intricate dynamics of Pakistan's debt. It aims to assess its sustainability within a broader eclectic and dynamic framework of responsible fiscal management using macro-econometric analysis. A structural macro-econometric model (MEM) based on five blocks has been developed, i.e., Government, Price, Real, Monetary, and External sectors. Moreover, it comprises sixteen behavioral equations along with ten identities. The Generalized Method of Moments (GMM) has been used to estimate the system of behavioral equations and identities to solve the endogeneity problem, while the Guass-Seidel algorithm is used for model simulation purposes, including dynamic & stochastic simulations. Forecasting has been done from 2023 – 2030. Moreover, three main policy variables, i.e., inflation, exchange rate, and government expenditures, have been given shocks to evaluate their impact on future external borrowing, interest payments along with imports, exports, and net foreign and domestic assets. The results revealed that an effective monetary & fiscal policy must be designed to stabilize the economic conditions to manage external debt and repayments effectively. Moreover, to cope with unsustainable debt conditions, it is required to follow strict fiscal discipline via designing & adhering to a budget that prioritizes inflationary controls and responsible spending practices.

A Portfolio Approach to Global Imbalances

ABSTRACTWe use a portfolio‐based framework to understand what drives the decline of the U.S. net foreign asset (NFA) position and the reversal in returns earned on the U.S. NFA (exorbitant privilege). We show that global savings gluts and monetary policies widened the U.S. NFA position, while investor demand shifts partially offset this widening. Moreover, U.S. privilege declined after 2010, in line with increasing foreign demand for U.S. equity. We also highlight a quantity dimension of the U.S. privilege: The U.S. can issue substantially more debt than other countries for a given yield increase.

Income Inequality and External Wealth of Nations

Abstract We study the relationship between income inequality and external wealth using dynamic panel data models with 5-years average observations to consider the slow motion of available data in the case of 88 emerging and developing economies for the period 1970–2020. We find evidence of a significant positive association between inequality indicators and net external wealth. This relationship is statistically significant for all income inequality measures and net external wealth variables. If the Top 1 of the richest individuals in a given country increments their share by 1 % point this will produce an average same-year increment in net foreign assets of 0.45 % in terms of the country’s GDP. The long-run effect is more than double in magnitude (1.05 % of GDP). For the Top 10, the long-run effect increases tenfold (11.6 % of GDP). When disaggregated into foreign assets and liabilities, we find a heterogeneous behavior of the financial elites. These findings reveal that financialized elites have a greater propensity to accumulate external wealth than the rest of the population.

Statistical omissions as the stabilizing factor of net foreign assets in EU countries

In this paper, we investigate the effect of balance of payments statistical leakages (Net errors and omissions) on the external solvency of net foreign asset positions in the EU28 sample over the period 1995–2019. The Bohn (2007) error-correction reaction function approach adapted to a dynamic panel framework (pooled mean group estimator) yields evidence of a substantial improvement in the sustainability of external positions in one out of four analyzed countries (compared to only one to three countries reporting deterioration), once the extent of hypothesized trade and non-interest income misreporting is accounted for. These findings may reflect the presence of a possible association between statistical omissions and current account transactions linked to remittances flows or tax optimization behavior, as the statistical leakages are sensitive to changes in corporate tax rates and international migrant stock.

Unequal wealth of nations: Evidence from the World Bank wealth accounts

<p>Using the World Bank's Changing Wealth of Nations database, this paper provides novel evidence on the cross-country inequality of wealth from 1995 to 2018. Overall, judging by both the top/middle/bottom shares and coefficients of variation, the analysis found that inequality in wealth per capita decreased prior to the 2008 global financial crisis and has remained stable since then. Adopting a before-after approach, this study further showed that different components of national wealth, including human capital, produced capital, natural capital, and net foreign assets, have heterogeneous impacts on between-country wealth inequality. In addition, we introduced a rank-based correlation analysis to explore wealth mobility across nations, revealing extremely low and decreasing mobility over time. Unlike most existing studies that exclude some major components of wealth, this study relied on a more comprehensive accounting of wealth and thus offers new insights into the dynamics of global per capita wealth inequality, the impact of the 2008 financial crisis, and the component-level contributions to wealth disparities. These findings have significant implications for understanding global challenges, including the North-South divide, climate change, and the distributive consequences of globalization.</p>

Nexus between monetary policy, net foreign assets and exchange rate: fresh insight from Lao PDR

Nexus between monetary policy, net foreign assets and exchange rate: fresh insight from Lao PDR

Nexus between Monetary Policy, Net Foreign Assets and Exchange Rate: Fresh insight from Lao PDR

Nexus between Monetary Policy, Net Foreign Assets and Exchange Rate: Fresh insight from Lao PDR

Oil price effects on optimal extraction–exploration and offshore entities: An applied-theoretical and empirical investigation in oil-rich economies

We present a novel open-economy endogenous growth framework that integrates an optimal extraction-to-exploration (“extraction rate”) problem and a principal–agent style offshore investment and appropriation choice problem. Using a combination of applied-theoretical simulation and econometric analyses, we investigate the nexus between oil price and the extraction rate, as well as the relationship between extraction rate and offshore appropriation, focusing on offshore entities in tax havens associated with 31 oil-rich economies from 1979 to 2020. Consistent with recent literature and aggregate evidence, our benchmark simulation results find the first nexus to be negative, but positive if we impose a decreasing return to exploration specification. Regarding the second nexus, except for economies with large initial net foreign asset (NFA) positions, we find a positive association between offshore inactivation and the extraction rate. We also present empirical evidence to corroborate the benchmark results (with constant returns to exploration): a negative association between oil prices and extraction rates, which is further associated with a lower number of offshore entities.

Determinants of central bank digital currency adoption – a study of 85 countries

ABSTRACT This study attempts to explore the macroeconomic development factors that determine countries’ decisions to implement CBDCs. The study uses data regarding CBDC adoption and macroeconomic variables from 85 countries spanning the 2013–2021 period. The results of the probit regression analysis show that higher levels of financial inclusion, net foreign assets, remittances, and income are associated with a higher probability of CBDC adoption. In contrast, higher values for the Human Development Index, manufacturing value added, and population growth rate are inversely correlated with the probability of CBDC adoption. The findings of the study have implications for both investors and policymakers.

Consumption taxation to finance pension payments

To assess how a permanent shift from financing a public pay-as-you-go pension by direct taxation toward financing it by indirect taxation affects the economy and welfare, we use an overlapping-generations-augmented two-region general equilibrium framework with search frictions on the labor market. The analyzed tax reform partially shifts the tax burden from domestic to foreign producers, lowers marginal costs of domestic production and generates positive domestic macroeconomic effects. Furthermore, the partial postponement of a household’s tax burden to retirement leads to higher savings and increases domestic assets; however after the implementation of the tax reform, the policy-induced increase in consumption costs makes retirees and households close to retirement worse off. Moreover, the increase in domestic net foreign assets implies that consumption of foreign households eventually falls, which contradicts results commonly found in models without an endogenous savings motive.

Asset home bias in debtor and creditor countries

Why do debtor countries have on average a less diversified international portfolio than creditor countries? With two symmetric countries, the existing literature has showed why portfolios are home-biased to the same degree across countries. We show that, in a model with debtor and creditor countries, a new hedging motive of net external positions implies a short (long) position of both home and foreign assets in the debtor (creditor) country. Marginally, the debtor (creditor) country loses (gains) the net foreign asset (NFA) as a diversified portfolio on top of the above symmetrically biased portfolio, which intensifies (dilutes) the home bias there. An extended model with both equity and bond assets also yields global two-way capital flows that are in consistent with the data. The theory helps understand the financial capital flows between the debtor developing and creditor developed countries during the financial globalization from 1990s, and receives empirical support.

Oil Shocks, External Adjustment, and Country Portfolio

AbstractThis study examines the intertemporal nature of countries’ external adjustment by using two oil income shocks with different timings: giant oil discovery news shocks and contemporaneous oil revenue shocks from international oil price changes. Empirical estimates using a large panel of countries support the intertemporal theory. Net foreign assets hike immediately upon oil revenue shocks, but decline for the first 5 years after oil discoveries and rebound subsequently. These adjustments are largely through the current account but partially stabilized by valuation effects for oil revenue shocks. Oil discoveries attract FDI inflows, while oil revenue shocks increase foreign debt assets holdings.

Balance of Payments as a Monetary Phenomenon: An ARDL Bounds Test Method for Algeria

Abstract Research background Every country attempts to improve its balance of payments (BOP) position to enhance macroeconomic policy. Algeria, like many developing countries, is experiencing a BOP deficit. This raises concerns about the reasons for this deficit and prioritizes the quest for potential answers. Purpose In the context of the Monetary Approach to the balance of payments (MABP), this paper investigates the long-run relationship between domestic credit, inflation, interest rate, GDP, and net foreign assets to find whether BOP is a monetary phenomenon in Algeria from 1980 to 2019. Research methodology: The Autoregressive Distributed Lag (ARDL) bounds test, combined with the critical approximation p-values of Kripfganz and Schneider (2020), has been applied. Results The findings clearly showed a long-run relationship among the variables. The long-run estimates strongly supported MABP propositions, and domestic credit had a negative and statistically significant influence on net foreign assets. This suggests that Algeria’s BOP is a monetary phenomenon, and excess money supply played a crucial role in Algeria’s balance of payments disequilibrium. Novelty The contribution of this paper is the use of the ARDL bounds test in combination with the novel critical approximation p-values of Kripfganz and Schneider (2020), which provided more robust results. This study could help monetary authorities to elaborate the suitable policies in dealing with BOP problems in Algeria.

The global financial cycle and capital flows during the COVID-19 pandemic

We estimate the heterogeneous effect of the global financial cycle on exchange rates and cross-border capital flows during the COVID-19 pandemic, using weekly exchange rate and portfolio flow data for a panel of 59 advanced and emerging market economies. We estimate a global financial cycle (GFC) index at the weekly frequency with data through the end of 2021. We then estimate the country-specific sensitivities of exchange rates and capital flows to fluctuations in the GFC. The ability of the GFC to explain fluctuations in exchange rates and capital flows increased dramatically during the pandemic. There is significant cross-country heterogeneity in the response of exchange rates or capital flows to fluctuations in the GFC. During the pandemic, high-frequency indicators like weekly changes in Covid cases and vaccination rates were just as important as standard macroeconomic fundamentals like the current account, reserves, and net foreign assets in explaining this heterogeneity.

Assessment of Fiji’s exchange rate

This paper empirically estimates Fiji’s bilateral equilibrium real exchange rate with two of its key trading partners, the US and Australia. Applying the Behavioural Equilibrium Exchange Rate (BEER) approach, we estimate the equilibrium exchange rate by considering the productivity differential, real interest rate differential, net foreign assets, money supply, and terms of trade. Using monthly data from March 2011 to September 2022 and a system approach to cointegration, a strong relationship between the real exchange rate and its fundamentals is found, but importance of factors differed by trading partner. Our findings show that the Fijian Dollar has been undervalued against both US Dollar and Australian Dollar in recent years, but to varying degrees. Our analysis underlines the importance of assessing bilateral exchange rate misalignments in basket pegs when devising exchange rate policy.

Economic Consequences of Greylisting by the Financial Action Task Force

This study considers the impact of the FATF’s greylisting process from a market perspective. The results are intended to inform the development of public policy and improvement of market signalling. The study develops a theoretical market impact model and identifies the indicators which may impact banking operations and institutional decisions. It is explicitly market-oriented in that the model seeks to reflect how stakeholders in financial and non-financial markets typically respond to signals sent out by the FATF. The authors find that the FATF’s greylisting signalling has changed over time and distinguish four broad periods reflecting different messaging. The study uses financial, trade, and other variables derived from the World Bank’s ‘World Development Indicators’ databank to explore evidence of impact in each of the different phases of the FATF’s approach to greylisting. The study uses a pooled cross-section and time series approach with fixed effects, based on a sample of 177 countries and 3540 country-years of data from 2000 to 2020. The study examines impacts on net official development assistance, the banking environment (non-performing loans, risk premiums), net foreign assets, indebtedness, and market capitalisation. It finds significant correlations between many financial variables and FATF listing events, including an apparent reduction in development assistance during greylisting periods which endured after the country was delisted. This is of significant concern, as such reductions may impact disproportionately on developing economies.