Net Foreign Assets Research Articles

Measuring real exchange rate misalignment in Croatia: cointegration approach

The purpose of the paper is to analyze misalignment of the real exchange rate in Croatia. The misalignment analysis is conducted using the permanent equilibrium exchange rate approach. The equilibrium real exchange rate is computed using the cointegration approach whereby the real exchange rate and its fundamentals, namely terms of trade, net foreign assets and the ratio of prices of tradables to non-tradables are included in cointegration analysis. The Hodrick and Prescott filter is used to obtain permanent values of the equilibrium real exchange rate. The real exchange rate misalignment is computed as the deviation of the RER from its permanent equilibrium level. Four overvaluation periods and three undervaluation periods are recorded in Croatia in the observed period. Overvaluation periods are more often and of longer duration than undervaluation periods. However, the real exchange rate does not deviate largely from its estimated equilibrium value in the observed period, and it is neither overvalued nor undervalued constantly, but the periods alternate. Considering the results of the analysis, together with the empirical characteristics of Croatian economy, namely the high foreign currency indebtedness, highly euroized economy and underdeveloped export oriented sector, the depreciation of the real exchange rate is not recommended to economic policy makers and the current Croatian exchange rate policy is appropriate.

Valuation effects and long-run real exchange rate dynamics

This paper uses the Johansen test for cointegration to check the prediction of a portfolio balance model that predictable valuation effects are associated with a saddle-path dynamic relationship between the net foreign asset position and the real exchange rate. The analysis uses newly constructed quarterly series on the net foreign position as a percentage of the nominal gross domestic product, together with data on real effective exchange rate indices for a sample of developed countries which borrow in their own currency. The results indicate that the net foreign asset position and the real exchange rate are not cointegrated for all the countries in the sample. The rejection of saddle-path dynamics suggests that predictable valuation effects are quantitatively small in developed countries. The rejection of cointegration suggests that the net foreign asset position is not a determinant for long-run real exchange rates in developed countries.

Macroeconomic volatility and external imbalances

Does macroeconomic volatility/uncertainty affects accumulation of net foreign assets? In OECD economies over the period 1970–2012, changes in country specific aggregate volatility are, after controlling for a wide array of factors, significantly positively associated with net foreign asset position. A standard open economy model with time varying macroeconomic uncertainty can quantitatively account for this relationship. The key mechanism is precautionary motive: more uncertainty induces residents to save more, and higher savings are in part channeled into foreign assets. Data and theory suggest that volatility is an important determinant of the medium/long run evolution of external imbalances in developed countries.

Capital Flows and Foreign Exchange Intervention

I consider a New Keynesian model of a small open economy where international financial markets are imperfect and the exchange rate is determined by capital flows. I use this framework to study the effects of exchange rate fluctuations driven by capital flows and characterize the optimal foreign exchange intervention. Capital flow shocks cause inefficient exchange rate fluctuations that trigger boom-bust cycles in the domestic economy. The optimal policy response is to use both foreign exchange intervention and monetary policy to stabilize the economy. Foreign exchange intervention “leans against the wind” and stabilizes the path of the exchange rate, while monetary policy corrects the inefficiencies caused by price rigidity. The two tools are complements rather than substitutes. I derive the optimal foreign exchange intervention rule in closed form as a function of three implicit targets: a wedge in the Bakus-Smith condition, domestic net foreign assets, and the level of foreign reserves.

Discussion of “Macroeconomic volatility and external imbalances” by Alessandra Fogli and Fabrizio Perri

This paper by Fogli and Perri investigates both theoretically and empirically the effects of volatility on net foreign asset accumulation. There are two key contributions. On the empirical side, the paper shows that countries that experienced higher volatility relative to other OECD countries accumulated on average more net foreign assets. On the theoretical side, the paper shows that a two country incomplete market model with time-varying volatility can account for this empirical relationship. The authors are addressing an important topic related to earlier discussions on global imbalances, which have become even more relevant in the context of the global financial crisis. In this comment, I review some of the main empirical and theoretical findings and provide some further thoughts about the broader implications of this paper for international macro.

Why does bank credit not drive money in Germany (any more)?

Since the turn of the millennium a gap between credit growth and GDP growth has emerged in Germany. The gap widens with surpluses of the German trade balance to other euro area countries and becomes negative, when surpluses of the trade balance contract. This phenomenon is accompanied by a new pattern of money growth, which is not driven by domestic credit of banks any more but by their net foreign assets. German nonfinancial corporations have rising equity ratios and provide other sectors with funds on a net basis. Moreover, their deposits with German banks have grown at a much stronger pace than their loans. We suspect that German membership in the European monetary union is an important explanation of the changing behavior in the real and financial sector and show the substitution between export cash-flows and domestic credit theoretically in a two-country model of post-Keynesian type, in which the two countries use a common currency.

An OLG model of global imbalances

In this paper, we investigate the relationship between East Asian countries' high propensity to save and global imbalances in a two-country OLG model with production. The saving behavior of emerging economies and capital outflows to the United States can be attributed to their poor pay-as-you-go systems. The model predicts that emerging countries run a trade surplus only as long as the long-run growth rate of the economy is higher than the real interest rate (capital overaccumulation case). The low real interest rate in the US is therefore evidence in favor of the hypothesis that there is a “global saving glut” in the world economy. The model can explain why the US current account deteriorated gradually and only in the late 1990s, although the net foreign asset position had already turned negative in the early 1980s. Finally, the analysis also implies that an improvement of the pay-as-you-go system in China would have the effect of reducing the imbalances. In accordance with the theory, we find that the higher is the percentage of the working population covered by the pay-as-you-go system the lower are savings and the current account balance in a cross-section of countries.

The net foreign asset position and government size

This paper analyzes the relationship between the net foreign asset position of a country, and government size and consumption–wealth ratio in a stochastically growing small open economy. The model suggests that more indebted countries are associated with bigger governments when utility-enhancing government spending is also volatility-reducing. More indebted countries would have a higher volatility originating from domestic sources, thus encouraging government to increase its size. Consumption–wealth ratio would also be higher for more indebted countries. The empirical evidence based on a sample of 49 countries for the period 1970–2009 broadly supports the main results of the model across many different specifications.

An asymmetric model on Seigniorage and the dynamics of net foreign assets

The emergence of international current account imbalances has dominated the economic debate for several years and has been considered one of the main reasons for the turbulences in the world economy since 2007. Economic theory suggests that an economy cannot run persistent current account deficits without depleting its net foreign assets. Nevertheless, for most of the 2000s, the US net foreign liabilities grew at a rate below the one of the cumulative current account deficit. To investigate on the mechanisms that allow the USA to do so, this paper sets up a two-country DGE model with asymmetric liquidity constraints. The model will show that there is a permanent wealth transfer from the world to the USA. The unique position of the USA not only allows them to run persistent current account deficits, but also imposes a permanent decay on the American current account. As the issuer of the world key currency in an asymmetric world monetary system, the USA can make use of Seigniorage and valuation effects to be able to run a continuous current account deficit. These mechanisms work in favour of their net foreign bond holdings, but let their current account further deteriorate. The corresponding one-way capital flows were part of the distortions that laid the ground for the world financial crisis 2007–2009. Future will show if a multi polar world with several (regional) reserve currencies emerges.

On the individual optimality of economic integration

Which countries find it optimal to form an economic union? We emphasize the risk-sharing benefits of economic integration. Consider an endowment world economy model, where international financial markets are incomplete and contracts not enforceable. A union solves both frictions among member countries. We uncover conditions on initial incomes and net foreign assets of potential union members such that forming a union is welfare-improving over standing alone in the world economy. Consistently with evidence on economic integration, unions in our model occur (i) relatively infrequently, and (ii) emerge more likely among homogeneous countries, and (iii) rich countries.

Testing for external sustainability under a monetary integration process. Does the Lawson doctrine apply to Europe?

Abstract Monetary integration, and more specifically, the creation of a monetary union in Europe, raises new economic questions concerning its functioning and governance. In particular, we focus on the implications of high and persistent current account deficits for the economic performance of monetary union members in the medium term. Recent literature has argued that conventional measures of external sustainability are misleading because they omit the effects of capital variations on net foreign asset positions due to, among others, stock or debt market crises. In this paper we revisit external sustainability making use of the database developed by Lane and Milesi-Ferretti (2007) that includes these “valuation effects”. The sample period studied covers from the launching of the monetary integration process in Europe (the creation of the European Snake in 1972) up to 2011. Our econometric methodology accounts for the increasing cross-section dependence among EMU countries as well as for possible structural breaks endogenously determined. The results point to the need of abrupt adjustments, either led by the markets or promoted by pro-active policy measures, in order to offset external disequilibria. These results would give support to the surveillance measures proposed by the European Commission (2009, 2010a) and would reject the Lawson's doctrine of “laissez-faire”.

Net foreign assets and macroeconomic volatility

This study analyses the co-movements of net foreign asset accumulation, consumption, real exchange rate, and real interest rate in a cross section of countries. Our sample covers both industrial and developing economies, spanning 1981–2010 period. We find that the accumulation of net foreign assets is associated with increasing consumption and real exchange rate appreciation. In a cross section of countries, when a country increases its net foreign assets to GDP ratio by a one-standard deviation, consumption to GDP increases by 0.02% per year and real exchange rate appreciates by 2% per year. Consumption to GDP responds more positively to net foreign asset accumulation in G7 countries, +0.1 to +0.2% per year, while the response is smaller and negative in developing countries reporting a −0.02% per year. The real exchange rate appreciation, however, is about +3% per year in developing countries and only about +0.2% per year in OECD countries.

Business Cycles in Emerging Markets: The Role of Liability Dollarization and Valuation Effects

Understanding differences in business cycle phenomena between Emerging Market Economies (EMEs) and industrialized countries has been at the center of recent research on macroeconomic fluctuations. The purpose of this paper is to investigate the importance of certain credit market imperfections in different EMEs. To this end, we develop a small open economy Dynamic Stochastic General Equilibrium (DSGE) framework featuring both permanent and transitory productivity shocks, differentiated home and foreign goods, and endogenous exchange rate movements. Furthermore, our model incorporates liability dollarization as a particular form of financial frictions in EMEs. In this vein, we account for the fact that emerging markets traditionally have had difficulties in borrowing in domestic currency on international capital markets and thus allow for valuation effects in our analysis. We estimate our model using Bayesian techniques for a number of EMEs and thereby control for potential heterogeneity across countries. Contrary to previous studies in this strand of the literature, we include a (vector-)autoregressive measurement error component to capture off-model dynamics. Regarding business cycles in emerging markets, our main findings are that (i) even though we incorporate financial frictions in the framework, trend shocks are the main determinant of macroeconomic fluctuations, (ii) accounting for liability dollarization ameliorates the model fit, and (iii) valuation effects on average stabilize changes in the net foreign asset position.

External balances, trade flows and financial conditions

This paper studies how changing expectations concerning future trade and financial conditions are reflected in international external positions. In the absence of Ponzi schemes and arbitrage opportunities, the net foreign asset position of any country must, as a matter of theory, equal the expected present discounted value of future trade deficits, discounted at the cumulated world stochastic discount factor (SDF) that prices all freely traded financial assets. I study the forecasting implications of this theoretical link in 12 countries (Australia, Canada, China, France, Germany, India, Italy, Japan, South Korea, Thailand, The United States and The United Kingdom) between 1970 and 2011. I find that variations in the external positions of most countries reflect changing expectations about trade conditions far into the future. I also find the changing forecasts for the future path of the world SDF are reflected in the dynamics of the U.S. external position.

Financial Institutions’ Operations & Capital Flight In Nigeria

This study examines the impact of Financial Institution variables and operations on the level of capital flight in Nigeria for a period of forty two years. The financial institutions globally are expected to perform certain fundamental functions that are believed to the prerequisites for economic growth and stability. Required secondary data were sourced from the Central Bank of Nigeria statistical bulletin, the Nigeria Stock Exchange fact books and IMF financial reports while the Ordinary Least Square Method of Regression analysis and Co-integration Technique were employed to estimate and test the impact of selected economic and financial institutions’ variables such as the prevailing Deposit Rate, Private Sector Credit, Change in Net Foreign Asset of Domestic Financial Institutions, Inflation Rate, Gross Capital Formation and Nigeria and U. S interest rate differentials on the level of capital outflow from Nigeria. With the World Bank and Erbe (1985) capital flight estimate, the findings reveal that all the explanatory variables are significance in explaining the behavior of capital. The results also show that each of the explanatory variables has specific impact on the dependent variable. Specifically, high inflation rate induces capital flight, increase Gross Capital Formation (LGCF) reduces capital flight, and appreciable deposit rate on bank deposit encourages domestic savings while the Credit to Private sector has not brought about the desire expectation of improving and sustaining the domestic economy. The study recommends that government should provide an enabling environment that will enhance the ability of the financial institutions to perform their functions effectively and the private individuals to invest in the domestic economy profitably. While financial institutions managers and operators should adhere to the sound ethical practices and desist from shape practices that encourage illegal transferring of money.

فعالية بنك الجزائر في تعقيم تراكم احتياطات الصرف الأجنبي خلال الفترة 2000 - 2011 = The Effectiveness of the Bank of Algeria to Sterilize the Accumulation of Foreign - Exchange Reserves in Algeria during the Period 2000 - 2011

احتياطات الصرف الأجنبي | صافي الأصول الأجنبية | سياسة التعقيم | العرض النقدي | أدوات السياسة النقدية | Foreign - Exchange Reserves | Net Foreign Assets | Sterilization Policy | Monetary Supply | Monetary Policy Tools

The determinants of ASEAN-5 real effective exchange ratevis-á-visthe UK pound

Purpose– The purpose of this paper is to present an empirical analysis of long-run and short-run forcing variables of purchasing power parity (PPP) for ASEAN-5 currenciesvis-à-visthe UK pound, i.e. their real effective exchange rate (REER).Design/methodology/approach– This study uses a recently developed autoregressive distributed lag (ARDL) approach to co-integration (Pesaranet al., 2001) over the period 1991:Q1-2006:Q2. Our empirical results suggest that the foreign interest rate (R*) and domestic money supply (M1) are the significant long-run forcing variables of PPP for ASEAN-5 REERs for the three periods.Findings– In the short-run, the variables have different impacts during the sub-periods and full period for ASEAN-5 countries. The results suggest that the domestic money supply (M1) for Malaysia, domestic interest rate and foreign interest rate (R*) for Indonesia, domestic money supply (M1) and term of trades (TOT) for Philippines, foreign interest rate (R*) for Thailand, and foreign interest rate (R*) and net foreign assets (NFA) for Singapore, respectively, have the highest significant short-run forcing variable of PPP for countries REERs.Originality/value– In this respect, the outcomes can derive policy implication for the monetary authorities in these ASEAN-5 countries.

The Economic Adjustment Program for Portugal: assessing welfare impact in a heterogeneous-agent framework

The sovereign debt crisis, triggered by the 2007-08 global financial crisis, has affected several European Union (EU) countries, leading to unprecedented financial assistance programs. In May 2011, the Portuguese Government set an agreement with the Troika (a supranational institution composed by the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF)), through which, in exchange for external help, the Portuguese authorities committed to an Economic Adjustment Program (EAP). In order to assess the impacts of the EAP on welfare and, in particular, on inequality, this paper simulates the debt consolidation strategy proposed by the Troika using a general equilibrium model with heterogeneous agents. The model enables to explore the impacts of the fiscal adjustment on the endogenous cross-section distribution of income, wealth and welfare. Our results predict a positive net welfare gain, despite the existence of significant transition costs in terms of output losses and inequality, especially during the first years of implementation. Overall, the net positive welfare gains are biased towards the poorer, which means that the consolidation plan will be, in the end, equality-enhancing. These results reflect the instruments involved in the consolidation strategy: productive and unproductive expenditure cuts combined with a slight increase in social transfers. Furthermore, the simulation predicts a positive impact on the Portuguese net foreign asset (NFA) position. Assuming this prediction is correct, this strongly supports the motivation for the adoption of the Economic Adjustment Program which considers the large external indebtedness of Portugal as a central issue in the economic diagnosis.

Nontradable sector reform and external rebalancing in monetary union: A model-based analysis

The paper uses the QUEST III model to analyse the question of whether nontradable (service) sector reform would reduce external imbalances in monetary union, notably from the side of surplus countries. It considers an open economy with a positive net foreign asset (net creditor) position and shows that tradable and nontradable sector reforms, understood as reforms that shift the supply curve in the respective sector outward, tend to have similar external balance effects. Namely, supply-side reforms improve the price competitiveness of domestic output and tend to increase the trade and current account balance on impact. In the longer term, competitiveness gains are compensated by additional imports associated with domestic income growth. Starting from a non-zero NFA position, the denominator effect does also contribute significantly to changes in external accounts relative to GDP. The results are robust across modifications of the model.

Net foreign assets and real exchange rates revisited

Theory suggests a significant positive relationship in long-run equilibrium between the net foreign assets (NFA) of a country and its real exchange rate. Empirical tests have ignored two issues: the large variation in cross-country trade/GDP ratios, which is likely to induce substantial cross-country differences in coefficients when net foreign assets are scaled by GDP, and the reverse causality associated with valuation effects. A real exchange rate appreciation reduces the absolute value of NFA denominated in foreign currency relative to domestic GDP, because of the sizeable component of non-tradable goods in domestic GDP. This endogeneity biases the test results. New tests are implemented that address these issues. The valuation effect bias is found to be significant. The new tests nevertheless still support the existence of a long-run positive relationship between NFA and real exchange rates.