Net Foreign Assets Research Articles

The Evolutionary Pattern of Global Imbalance: Evidence from Cross Country Data from 1970 to 2010

In this article, we emphasize that net foreign asset (NFA) is an important indicator that can nicely reflect global imbalance and has not received enough attention. We use a representative data-set to examine how the NFA varies with the development stages of different countries. We also investigate the determinants of NFA and the composition of external asset and liability. We have obtained some important findings. First, the change of NFA follows an inverse U-shaped curve with the increase of gross domestic product (GDP) per capita. This means that the most-watched global imbalance may decrease with economic development in the future. Second, industrial structure, openness to international market, inflation, development of domestic financial market and public debt are important factors that affect the ratio of NFA/GDP and compositions of external asset and liability. Third, the NFA/GDP ratio in China is currently at the early stage of the inverse U-shaped curve and is expected to decrease in the future. As for the compositions of external asset and liability, China is holding too much asset in the form of foreign exchange reserves (FER) and too much liability in the form of foreign direct investment (FDI). In contrast to some existing views, we believe that the restrictions on capital mobility, rather than NFA, affect the composition of external asset and liability. This study sheds some light on the imbalance issue and the corresponding policy-making.

How would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?

AbstractIn this paper we study the determinants of gross capital flows, project the size of China's international investment position in 2020, and analyze the implications for the renminbi real exchange rate if China liberalizes the capital account. We assume in this exercise that the renminbi will have largely achieved capital account convertibility by the end of the current decade, a timetable consistent with recent proposals by the People's Bank of China. Our analysis shows that if the capital account were liberalized, China's gross international investment position would grow significantly, and inflows and outflows would become much more balanced. The private sector would turn its net liability position into a balanced position, and the official sector would reduce its net asset position significantly, relative to the country's GDP. Because of the increasing importance of private sector foreign claims and the decreasing importance of official foreign reserves, China would be able to earn higher net investment income from abroad. Overall, China would continue to be a net creditor, with the net foreign asset position as a share of GDP remaining largely stable through this decade. These findings suggest that the renminbi real exchange rate would not be particularly sensitive to capital account liberalization as capital flows are expected to be two‐sided. The renminbi real exchange rate would likely be on a path of moderate appreciation as China is expected to maintain a sizeable growth differential with its trading partners.

Equilibrium stability in open economy models

This paper derives analytical results for the relationship between the slope of the excess demand function and the dynamic properties around a deterministic steady state in a two country model. In models that admit multiple steady states, the sign of the slope of the excess demand function is positive for some steady states and negative for others. To obtain stationarity of the net foreign asset position under incomplete financial markets I introduce the stationary inducing devices analyzed in Schmitt-Grohé and Uribe (2003) and Ghironi (2006). For portfolio costs, a debt-elastic interest rate, or an overlapping generations framework the equilibrium dynamics around a steady state are unbounded if the excess demand function for the foreign traded good is increasing in the good’s own price. Otherwise the dynamics are bounded and locally unique. By contrast, with Uzawa-type preferences, the equilibrium dynamics around a steady state are shown to be bounded and locally unique irrespective of the sign of the slope of the excess demand function.

Productivity shocks, stabilization policies and the dynamics of net foreign assets

In this paper we investigate the role of macroeconomic stabilization policies for the international transmission of productivity shocks and their effects on the external sector. We develop a two-country stochastic Dynamic New-Keynesian “perpetual youth” model of the business cycle with incomplete international financial markets. Our OLG structure implies stationary net foreign asset dynamics and allows for a thorough analysis of the interaction of monetary policy with non-balanced budget fiscal policy. We derive the dynamic and cyclical properties of fiscal deficit feedback rules and their implications for net foreign assets dynamics. Our results imply that the degree of “fiscal discipline”, i.e. the extent to which the fiscal rule responds to debt dynamics, is crucial for the dynamics of net foreign assets. We show that under a counter-cyclical fiscal rule with low fiscal discipline temporary positive productivity shocks may result in substantial deteriorations of the Net Foreign Asset position in the medium run. This result crucially hinges on the interplay among nominal rigidities, non-balanced budget fiscal policy, and the wealth effects on consumption that are implied by our OLG structure.

Introducing Valuation Effects-Based External Balance Analysis into the Undergraduate Macroeconomics Curricula: A Simple Framework with Applications

Global imbalances and the sustainability of large U.S. current account deficits have dominated international macroeconomics of late. Pedagogically, a clear disconnect exists between graduate-level open-economy macroeconomics that emphasizes intertemporal current account models and net foreign asset adjustment featuring valuation effects, and, undergraduate macroeconomics that is still driven by static analysis of U.S. current account deficits and cursory coverage of valuation-effects-driven external balance adjustment. The authors of this article discuss a simple intertemporal framework, based on modern open-economy macroeconomic models, that emphasizes the significance of valuation effects arising from changes in asset prices and exchange rates. The authors also highlight the relevance of the framework by examining a few topical applications related to prominent puzzles and debates in open-economy macroeconomics.

Measuring misalignments in the Korean exchange rate

This paper measures to what extent the real effective exchange rate of the Korean won is misaligned from its equilibrium value by estimating the equilibrium value using the behavioral equilibrium exchange rate (BEER) approach. The economic fundamentals such as the terms of trade, the relative price of non-traded to traded goods, net foreign assets and real interest rate differentials are employed to assess the equilibrium exchange rate. Considering the drastic changes in Korea's trade pattern, the trade partner weights, which are used to compute the real effective exchange rate, are not fixed, but variable. The estimation results using the quarterly data from 1982Q1 to 2009Q4 indicate that the actual exchange rate of the Korean won was substantially overvalued for the period from 2005Q1 to 2007Q4, and substantially undervalued for the period from 2008Q2 to 2009Q3. The actual exchange rate deviates from the BEER and from the long-run equilibrium (or sustainable value) of the BEER by 32% and by 24% respectively in 2008Q4.

Trend Shocks, Risk Sharing and Cross-Country Portfolio Holdings

This paper analyzes the dynamics of risk premia, real exchange rates and portfolio movements in a two-country, two-good, two-bond model. We use an asymmetric set-up in the model, where one of the countries is emerging and the other one is developed and both countries issue bonds in domestic currency. The emerging country differs from the developed country in that it is subject to trend shocks and it is more risk averse. We find that the trend shocks produce strong wealth effects for the emerging country, and as a result, the terms of trade and the real exchange rate appreciate. Appreciation of the terms of trade breaks the hedging opportunities coming from international trade in goods. In contrast, the appreciation of the real exchange rate generates new hedging opportunities in international financial markets for both countries. Therefore, our model can endogenously generate large portfolio holdings. And differences in the risk aversion across countries lead to net positive foreign asset positions and significant risk premia in the emerging country. Moreover, the relative volatilities and cyclicalities of risk premia and real exchange rates improve significantly and move closer to the observed values in the data and our model can account for the lack of international risk sharing.

On the solvency of nations: Cross-country evidence on the dynamics of external adjustment

We test the hypothesis that net foreign asset positions are consistent with external solvency and examine the dynamics of external adjustment using data for 50 countries over the 1970–2006 period. Our analysis adapts Bohn's (2007) error-correction reaction function approach – which tests for a negative long-run relationship between net exports (NX) and net foreign assets (NFA) as a sufficiency condition for the intertemporal budget constraint to hold – to a dynamic panel framework. Pooled Mean Group (PMG) and Mean Group error-correction estimation yield evidence of a statistically significant, negative response of NX to NFA. Moreover, we cannot reject the hypothesis that the response is largely homogeneous across countries. Our sensitivity analysis shows that the countries with relatively weaker fundamentals need to respond more strongly to the changes in NFA to keep their NFAs on a sustainable path.

Banking system liquidity absorption and monetary base backing in the context of exchange rate policy in the Czech Republic, Poland and Hungary

This article deals with the choice of exchange rate regime in transition economies, accumulation of foreign exchange (FX) reserves in balance sheets of central banks and its consequences in overall excess banking system liquidity. The case of banking system liquidity surplus is analysed focusing on creation of liquidity through FX intervention in a regime of fixed or managed exchange rates. In addition the article focuses on the main sources of liquidity absorption in the long run and on stability of monetary base backing by net foreign assets of the central bank in the context of trend appreciation of the domestic currency typical for transition economies. Last but not least, the article examines the speed of FX reserves decline in emerging FX markets and the implications of the exchange rate regime for both exchange rate volatility and foreign exchange market structure. The problems are analysed and compared using the examples of the Czech Republic (CR), Poland and Hungary in 1999–2009. The analysis focuses on the main differences in exchange rate policies, the level of liquidity surplus, cost of sterilisation, main sources of liquidity absorption and volatility of exchange rates. We find that absorption is influenced by the volume of excess liquidity and cost of sterilisation, which reflect the level of the main policy rate. The trend growth of currency in circulation is a key source of liquidity absorption in all central banks. Decline of FX reserves is a limited source of absorption owing to the lower liquidity of FX markets in the CR, Poland and Hungary. It is not possible to confirm a hypothesis of higher exchange rate volatility under floating regimes in CR and Poland as the Hungarian forint in a fixed rate regime suffers from higher volatility due to macroeconomic instability. Trend appreciation causes a decrease in the backing of the monetary base by net foreign assets but still both currency in circulation and banks' reserves are fully backed by net foreign assets of central banks.

Demographic change and the labour share of income

Despite similar levels of per capita income, education and technology, the development of labour income shares in OECD countries has displayed different patterns since 1960. The paper examines the role of demography in this regard. We first use a standard overlapping generations model to derive the mechanisms by which demographic change can affect the labour share. It turns out that demographic change can affect the labour share either by altering the domestic capital intensity, by causing factor-biased technological change or in a small open economy framework by creating a gap between domestic savings and investments. The latter affects the country’s investments abroad and in return its net foreign asset income which directly leads to changes in the labour share. Empirical estimations based on these insights, provide evidence that an increases in the expected retirement durations and old-age dependency ratios as well as declines in labour force growth rates have indeed been major forces behind the decline in labour shares that took place in many countries. These effects tend to be larger in open economies and pension reforms towards a funded pension system seem to have accelerated the effects.

APLIKASI PENDEKATAN KESEIMBANGAN PORTOFOLIO TERHADAP NILAI TUKAR RUPIAH/DOLLAR AMERIKA

Since the adoption of freely floating exchange rate system, the rupiah against the U.S. dollar continues to fluctuate. This has stimulated research on the instability of the rupiah and the factors that influence it. This study aims to analyze the variables that affect the exchange rate using the portfolio balance approach. The portfolio balance approach is an extension of the monetary theory by incorporating a combination of assets other than domestic currency. The results of the portfolio balance approach shows some variables that affect the exchange rate are Indonesia’s money supply (broad money), Indonesia’s net foreign assets and United States’ net foreign assets. It was also found that the speed of adjustment of the portfolio balance approach is 60,56. From this finding, it can shows that the portfolio balance model can be a good reference for explaining the movements of Indonesian Rupiah – US dollar exchange rate.

Magnitude and volatility of Taiwan's net foreign assets against Mainland China: 1981–2009

The ongoing private capital inflows from Taiwan to China is a steady concern for Taiwan's policymakers. According to the official data, Taiwan's private enterprises have cumulatively invested about US$ 150–280billion in China since 1987. However, the figures are widely perceived to be an underestimation and there exists a huge gap even between the estimations conducted by different government departments. The purpose of this paper is to re-estimate Taiwan's net foreign assets (NFA) against China, revising the so-called “dark matter” hypothesis proposed by Hausman and Sturzenegger (2006, 2007). In contrast to the current statistics being limited to registered direct investment or census investigation, the advantage of our model is that direct investment, portfolio investment, and the possible knowledge and property spillovers are included. We show that changes in Taiwan's NFA against China over GDP are negative in economic and political turmoil, such as the missile crisis in 1995, Asian financial crises in 1997–98, and global tsunami in 2007–09. From 2000, the growth rates we simulate are never lower than the official data till 2009. We also suggest some possible economic causes that lead to the huge Taiwan's NFA against China.

Structural reforms and the potential effects on the Italian economy

Since the second half of 2011, after a period of prolonged low growth, Italy has found itself at the center of a severe economic crisis. Concerns about the sustainability of its debt burden, along with gloomy growth prospects, have pushed up the cost of government borrowing, exacerbating current economic conditions. At the moment Italy is facing two mounting economic challenges: (i) achieve a rapid fiscal consolidation to restore financial market confidence; (ii) implement structural reforms to strengthen medium-term growth prospects. Using the European Commission's model QUEST III with R&D, adapted to Italy, we quantify the potential effects of a set of interventions inspired to the reform packages currently being undertaken or under discussion and consider different levels of policy effort. Results show that reforms are likely to bring about sizable gains in output, consumption, employment and net foreign assets position and that most of these gains derive from labor market reforms. However, the fiscal austerity plan is likely to severely mitigate the positive effects of the interventions, especially during the earlier phases of the reform process. Most of these losses accrue to liquidity-constraint households who would experience a drop in consumption.

Explaining the Appreciation of the Brazilian Real

ABSTRACT This article seeks to identify factors explaining the appreciation of the Brazilian real observed since 2003, which was temporarily interrupted only during episodes of financial turbulence. Net foreign assets and the productivity differential relative to Brazil's main trade partners are found to be significant determinants of the real effective exchange rate in the long run. In the short term, exchange-rate developments are mostly explained by movements in net foreign assets. The production of oil is also found to explain developments in the real effective exchange rate in the long run. These results are robust to a wide range of tests. There is evidence of an overvaluation of the real in 2010, but the extent of the misalignment is hard to gauge. Fundamental Equilibrium Exchange Rate estimations point to an overvaluation between 3%–10% in 2010. Dynamic simulations of behavioral exchange-rate equations generally suggest an overvaluation of between 10%–20%. However, these estimations remain subject to large uncertainties.

Net Foreign Asset (Com) Position: Does Financial Development Matter?

We investigate the relationship between a country’s domestic financial development and the (composition of its) net foreign asset position using a pooled mean group estimator and data for 51 countries during the period 1970-2007. The results show that financial development reduces a country’s long-run net foreign asset position. In addition, financial development leads to higher net equity and lower net debt positions. These findings confirm the theoretical predictions of Mendoza et al. (2009). The results are robust to using different indicators of financial development and inclusion of the level of development of a country in the cointegrating relationship.

Neutralization in China: evidence from the balance sheet of the People’s Bank of China

We evaluate China’s neutralization policy by monthly estimations based on the central bank balance sheet from 1999:6 to 2011:6. Our results suggest that China effectively neutralizes 66% of the change of net foreign assets under a pegged currency regime. Consequently, a purchase of one yuan of net foreign assets leads to an effective increase of 1.4 yuan in the money supply, rather than 4 yuan in the absence of neutralization. In the face of rapid growth of foreign reserves, neutralization in China is becoming increasingly difficult, consistent with Mundell’s hypothesis.

Determinants of Current Account Imbalance in the Global Economy: A Dynamic Panel Analysis

This research presents an empirical investigation of the determinants of current account imbalance for the large sample of developed, emerging and developing countries during 1980-2011. Using dynamic panel GMM techniques, this study characterizes that current account balance are positively correlated with net foreign assets, trade openness and exchange rate stability and negatively associated with commodity price, real GDP growth and real effective exchange rate for the developed countries. While, among emerging countries, commodity price, real GDP growth, trade openness and de-jure capital openness is positively and net foreign asset, exchange rate stability index is negatively related with current account balance. These findings suggest that the current account determinants explain different characteristics in terms of different country groups. The results also hold Chinn and Ito (2007) and Chinn and Prasad (2003) along with three more important determinants with significant influence on current account which have not ever considered in literature.

Structural Reforms and the Potential Effects on the Italian Economy

Since the second half of 2011, after a period of prolonged low growth, Italy has found itself at the center of a severe economic crisis. Concerns about the sustainability of its debt burden, along with gloomy growth prospects, have pushed up the cost of government borrowing, exacerbating current economic conditions. At the moment Italy is facing two mounting economic challenges: (i) achieve a rapid fiscal consolidation to restore financial market confidence; (ii) implement structural reforms to strengthen medium-term growth prospects. Using the European Commission's model QUEST III with R&D, adapted to Italy, we quantify the potential effects of a set of interventions inspired to the reform packages currently being undertaken or under discussion and consider different levels of policy effort. Results show that reforms are likely to bring about sizable gains in output, consumption, employment and net foreign assets position and that most of these gains derive from labor market reforms. However, the fiscal austerity plan is likely to severely mitigate the positive effects of the interventions, especially during the earlier phases of the reform process. Most of these losses accrue to liquidity-constraint households who would experience a drop in consumption.

How Would Capital Account Liberalisation Affect China’s Capital Flows and the Renminbi Real Exchange Rates?

In this paper we study the determinants of gross capital flows, project the size of China’s international investment positions in 2020 and analyse the implications for the renminbi real exchange rates. We assume in this exercise that the renminbi will have largely achieved capital account convertibility by the end of this decade, a timetable consistent with recent proposals by the People’s Bank of China. Our analysis shows that China’s gross international investment positions would grow significantly, and inflows and outflows would become much more balanced. The private sector would turn its net liability position into a balanced position, and the official sector would reduce its net asset position significantly, relative to the country’s GDP. Because of the increasing importance of private sector foreign claims and the decreasing importance of official foreign reserves, China would be able to earn higher net investment incomes from abroad. Overall, China would continue to be a net creditor, with the net foreign asset position as a share of GDP remaining largely stable through this decade. These findings suggest that the renminbi real exchange rate would not be particularly sensitive to capital account liberalisation as capital flows are expected to be two-sided. The renminbi real exchange rate would likely be on a path of moderate appreciation as China is expected to maintain a sizeable growth differential with its trading partners.

Aggregate Savings and External Imbalances in China

Over the last decade, the internal and external macroeconomic imbalances in China have risen to unprecedented levels. In 2008, China's national savings rate soared to over 53 percent of its GDP, whereas its current account surplus exceeded 9 percent of GDP. The current paper presents a unified framework for understanding the structural causes of these imbalances. I argue that the imbalances are attributable to a set of policies and institutions embedded in the economy. Moreover, the accession of China to the World Trade Organization has dramatically amplified the effects of these structural distortions. I document major trends in aggregate savings, investment, trade, and net foreign asset positions in China, and explore options for policy reforms aimed at rebalancing the Chinese economy.