IFDP 2020-1306
Common Trade Exposure and Business Cycle Comovement

Oscar Avila-Montealegre and Carter Mix


A large empirical literature has shown that countries that trade more with each other have more correlated business cycles. We show that previous estimates of this relationship are biased upward because they ignore common trade exposure to other countries. When we account for common trade exposure to foreign business cycles, we find that (1) the effect of bilateral trade on business cycle comovement falls by roughly 25 percent and (2) common exposure is a significant driver of business cycle comovement. A standard international real business cycle model is qualitatively consistent with these facts but fails to reproduce their magnitudes. Past studies have used models that allow for productivity shock transmission through trade to strengthen the relationship between trade and comovement. We find that productivity shock transmission increases business cycle comovement largely because of a country-pair's common trade exposure to other countries rather than because of bilateral trade. When we allow for stronger transmission between small open economies than other country-pairs, comovement increases both from bilateral trade and common exposure, similar to the data.

DOI: https://doi.org/10.17016/IFDP.2020.1306

IFDP 2020-1305
Financial Integration and the Co-Movement of Economic Activity: Evidence from U.S. States

Martin R. Goetz and Juan Carlos Gozzi


We analyze the effect of the geographic expansion of banks across U.S. states on the comovement of economic activity between states. Exploiting the removal of interstate banking restrictions to construct time-varying instrumental variables at the state-pair level, we find that bilateral banking integration increases output co-movement between states. The effect of financial integration depends on the nature of the idiosyncratic shocks faced by states and is stronger for more financially dependent industries. Finally, we show that integration (1) increases the similarity of bank lending fluctuations between states and (2) contributes to the transmission of deposit shocks across states.

Keywords: Banking integration; synchronization; financial deregulation; business cycles

DOI: https://doi.org/10.17016/IFDP.2020.1305

IFDP 2020-1304
Technology, Geography, and Trade over Time: The Dynamic Effects of Changing Trade Policy


I study the dynamic effects of changes in trade policy in a multi-country model with firms that make durable and destination-specific investments in exporting capacity. Using Mexican exporter-level data, I show that incumbent exporters to minor trade partners account for a smaller share of bilateral exports than do incumbent exporters to major trade partners, indicating a systematic difference in the persistence of the export decision across destinations. The model is calibrated to capture the positive relationship between exporting persistence and export volume, and predicts that trade liberalizations with minor export destinations deliver higher bilateral export growth than liberalizations with major export destinations. Panel analysis on bilateral exports after free trade agreements is consistent with these predictions, confirming that the model is a useful tool for explaining export behavior. Furthermore, I find that heterogeneity in export churning across destinations is a key driver of aggregate dynamics and welfare gains from changes in trade policy.

Keywords: trade policy, heterogeneous firms, export participation

DOI: https://doi.org/10.17016/IFDP.2020.1304

IFDP 2020-1303
Trade Credit, Markups, and Relationships

Alvaro Garcia-Marin, Santiago Justel, and Tim Schmidt-Eisenlohr


Trade credit is the most important form of short-term finance for firms. In 2019, U.S. non-financial firms had about $4.5 trillion in trade credit outstanding equaling 21 percent of U.S. GDP. This paper documents two striking facts about trade credit use. First, firms with higher markups supply more trade credit. Second, trade credit use increases in relationship length, as firms often switch from cash in advance to trade credit but rarely away from trade credit. These two facts can be rationalized in a model where firms learn about their trading partners, sellers charge markups over production costs, and financial intermediation is costly. The model also shows that saving on financial intermediation costs provides a strong rationale for the dominance of trade credit. Using Chilean data at the firm-product-level and the trade-transaction level, we find support for all predictions of the model.

Keywords: Trade credit, markups, financial intermediation, learning

DOI: https://doi.org/10.17016/IFDP.2020.1303

IFDP 2020-1302
Intermediary Asset Pricing during the National Banking Era


Financial intermediary balance sheets matter for asset returns even when these intermediaries do not directly participate in the relevant asset markets. During the National Banking Era, liquidity conditions for the New York Clearinghouse (NYCH) banks forecast excess returns for stocks, bonds, and currencies. The NYCH banks had little to no direct participation in these markets; their main link to these markets was through securities financing. Liquidity conditions affect asset prices through the credit growth of the NYCH banks, which shapes marginal investors' discount rates. I use institutional features of this era to provide evidence in favor of this mechanism.

Keywords: Liquidity management, Margin loans, Intermediary asset pricing, National banks

DOI: https://doi.org/10.17016/IFDP.2020.1302

IFDP 2020-1301
Exchange Rates and Endogenous Productivity

Nils Gornemann, Pablo Guerron-Quintana, and Felipe Saffie


Real exchange rates (RERs) display sizable uctuations not only over the business cycle, but also at lower frequencies, resulting in large and persistent swings over decades|facts that many business cycle models struggle to match. We propose an international macroeconomics model with endogenous productivity to rationalize these facts. In the model, endogenous growth amplifies stationary uctuations generating persistent productivity differences between countries that trigger low-frequency cycles in the RER. The estimated model effortlessly replicates the empirical spectrum, autocorrelation, and half-life of the RER. In addition, we document that low frequency movements in aggregate trade ows are crucial to discipline the RER cycles. Finally, we validate the model-implied co-movement between relative prices and technology differentials using a panel of cross industry-country data on patent and industry prices.

Keywords: Real Exchange Rate, Endogenous Growth, RBC

DOI: https://doi.org/10.17016/IFDP.2020.1301

IFDP 2020-1300
Investor Sentiment and the (Discretionary) Accrual-return Relation

Jiajun Jiang, Qi Liu, and Bo Sun


Discretionary accruals are positively associated with stock returns at the aggregate level but negatively so in the cross section. Using Baker-Wurgler investor sentiment index, we find that a significant presence of sentiment-driven investors is important in accounting for both patterns. We document that the aggregate relation is only prominent during periods of high investor sentiment. Similarly, the cross-section relation is considerably stronger in high-sentiment periods in both economic magnitude and statistical significance. We then embed investor sentiment into a stylized model of earnings management, and illustrate that a positive (negative) relationship between stock returns and earnings management can endogenously emerge in the aggregate (cross section). Our analysis suggests that the (discretionary) accrual-return relation at both the aggregate and firm levels at least partially reflects mispricing that is related to market-wide investor sentiment.

Keywords: Investor sentiment, Uncertainty, Earnings management, Accrual anomaly

DOI: https://doi.org/10.17016/IFDP.2020.1300

IFDP 2020-1299
The Stock Market Response to a "Regulatory Sine Curve"

Bo Sun, Xuan Tam, and Eric Young


We construct new indicators of financial regulatory intensity and find evidence that a "regulatory sine curve" generally exists: regulatory oversight increases following a recession and wanes as the economy returns to normalcy. We then build an asset pricing model, based on the idea that regulatory oversight both deters incentives to commit fraud ex ante and reveals hidden negative information ex post. Our calibration suggests that these mechanisms can be quantitatively important for stock price dynamics.

Keywords: Cyclical financial regulation, Stock crash risk, Gradual boom and sudden crash

DOI: https://doi.org/10.17016/IFDP.2020.1299

IFDP 2020-1298
Does Unemployment Risk Affect Business Cycle Dynamics?


In this paper, I show that the decline in household consumption during unemployment spells depends on both liquid and illiquid asset positions. I also provide evidence that unemployment spells predict the withdrawal of illiquid assets, particularly when households have few liquid assets. Motivated by these findings, I embed endogenous unemployment risk in a two-asset heterogeneous-agent New Keynesian model. The model is consistent with the above evidence and provides a new propagation mechanism for aggregate shocks due to a flight-to-liquidity that occurs when unemployment risk rises. This mechanism implies that unemployment insurance plays an important role as an automatic stabilizer, particularly when monetary policy is constrained

DOI: https://doi.org/10.17016/IFDP.2020.1298

IFDP 2020-1297
Optimal Taxation with Endogenous Default under Incomplete Markets

Demian Pouzo and Ignacio Presno


How are the optimal tax and debt policies affected if the government has the option to default on its debt? We address this question from a normative perspective in an economy with noncontingent government debt, domestic default and labor taxes. On one hand, default prevents the government from incurring future tax distortions that would come along with the service of the debt. On the other hand, default risk gives rise to endogenous credit limits that hinder the government's ability to smooth taxes. We characterize the fiscal policy and show how the option to default alters the near-unit root component of taxes in the economy with risk-free borrowing. When we allow the government to default and calibrate the model to Spain, fiscal policies are more volatile, borrowing costs are higher, indebtness and welfare are both lower than in two alternatives economies, one with only risk-free debt available and the other with government's commitment to the default strategy.

Keywords: Optimal Taxation, Government Debt, Incomplete Markets, Default

DOI: https://doi.org/10.17016/IFDP.2020.1297

IFDP 2020-1296
Artificial Intelligence Methods for Evaluating Global Trade Flows

Feras A. Batarseh, Munisamy Gopinath, and Anderson Monken


International trade policies remain in the spotlight given the recent rethink on the benefits of globalization by major economies. Since trade critically affects employment, production, prices and wages, understanding and predicting future patterns of trade is a high-priority for decision making within and across countries. While traditional economic models aim to be reliable predictors, we consider the possibility that Artificial Intelligence (AI) techniques allow for better predictions and associations to inform policy decisions. Moreover, we outline contextual AI methods to decipher trade patterns affected by outlier events such as trade wars and pandemics. Open-government data are essential to providing the fuel to the algorithms that can forecast, recommend, and classify policies. Data collected for this study describe international trade transactions and commonly associated economic factors. Models deployed include Association Rules for grouping commodity pairs; and ARIMA, GBoosting, XGBoosting, and LightGBM for predicting future trade patterns. Models and their results are introduced and evaluated for prediction and association quality with example policy implications.

Keywords: AI, international trade, boosting, prediction, data mining, imports and exports, outlier events

DOI: https://doi.org/10.17016/IFDP.2020.1296

IFDP 2020-1295
Modern Pandemics: Recession and Recovery

Chang Ma, John Rogers, and Sili Zhou


We examine the immediate effects and bounce-back from six modern health crises: 1968 Flu, SARS (2003), H1N1 (2009), MERS (2012), Ebola (2014), and Zika (2016). Time-series models for a large cross-section of countries indicate that real GDP growth falls by around three percentage points in affected countries relative to unaffected countries in the year of the outbreak. Bounce-back in GDP growth is rapid, but output is still below pre-shock level five years later. Unemployment for less educated workers is higher and exhibits more persistence, and there is significantly greater persistence in female unemployment than male. The negative effects on GDP and unemployment are felt less in countries with larger first-year responses in government spending, especially on health care. Affected countries' consumption declines, investment drops sharply, and international trade plummets. Bounce-back in these expenditure categories is also rapid but not by enough to restore pre-shock trends. Furthermore, indirect effects on own-country GDP from affected trading partners are significant for both the initial GDP decline and the positive bounce back. We discuss why our estimates are a lower bound for the global economic effects of COVID-19 and compare contours of the current pandemic to the historical episodes.

DOI: https://doi.org/10.17016/IFDP.2020.1295

IFDP 2020-1294
What is Certain about Uncertainty?


Researchers, policymakers, and market participants have become increasingly focused on the effects of uncertainty and risk on financial market and economic outcomes. This paper provides a comprehensive survey of the many existing measures of risk, uncertainty, and volatility. It summarizes what these measures capture, how they are constructed, and their effects, paying particular attention to large uncertainty spikes, such as those appearing concurrently with the outbreak of COVID-19. The measures are divided into three types: (1) news-based, survey- based, and econometric; (2) asset market based; and (3) Knightian uncertainty. While uncertainty has significant real and financial effects and spills over across countries, the size and persistence of these effects depend crucially on the source of uncertainty.

DOI: https://doi.org/10.17016/IFDP.2020.1294

IFDP 2020-1293
Scarcity of Safe Assets and Global Neutral Interest Rates

Thiago Ferreira and Samer Shousha


We quantitatively evaluate the role of supply and demand of safe assets in determining neutral interest rates. Using an empirical cross-country state-space model, we find that the net supply of sovereign safe assets available to the private sector in secondary markets is an important driver of neutral rates for 11 advanced economies in the period 1970–2018. We also find that the global accumulation of international reserves in sovereign safe assets since the 1990s (the global savings glut) lowered the net supply of these assets and, thus reduced neutral rates by up to 50 basis points in our sample.

DOI: https://doi.org/10.17016/IFDP.2020.1293

IFDP 2020-1292
Computerizing Households and the Role of Investment-Specific Productivity in Business Cycles

Seunghoon Na and Hyunseung Oh


Advancements in computer technology have reshaped not only business operations but also household consumption. We estimate a business-cycle model disaggregating consumer IT and non-IT durable goods from the capital stock. We find that shocks to the supply of IT durables account for more than half of the variation in house- holds' real expenditure on IT durables. Furthermore, investment-specific productivity shocks drove nearly half of the rapid growth in household durable expenditures during the 2000s. Nonetheless, they have small influence over output dynamics, because unlike business investment goods, consumer durables do not add to the productive capital of the economy. The shocks become important when household IT goods are complementary to firms' capital, such as when online services are provided through consumers' smartphones.

Keywords: Investment; Durables; Investment-specific productivity.

DOI: https://doi.org/10.17016/IFDP.2020.1292

IFDP 2020-1291
Natural Disasters, Climate Change, and Sovereign Risk


I investigate how natural disasters can exacerbate fiscal vulnerabilities and trigger sovereign defaults. I extend a standard sovereign default model to include disaster risk and calibrate it to a sample of seven Caribbean countries that are frequently hit by hurricanes. I find that disaster risk reduces government's ability to issue debt and that climate change further restricts government's access to financial markets. Next, I show that "disaster clauses", that provide debt-servicing relief, allow governments to borrow more and preserve government's access to financial markets, amid rising risk of disasters. Yet, debt limits may need to be adopted to avoid overborrowing and a decline of welfare.

Original paper: PDF

Keywords: Sovereign risk, climate change, natural disasters.

DOI: https://doi.org/10.17016/IFDP.2020.1291r1

IFDP 2020-1290
The State Dependent Effectiveness of Hiring Subsidies


The responsiveness of job creation to shocks is procyclical, while the responsiveness of job destruction is countercyclical. This new finding can be explained by a heterogeneous-firm model in which hiring costs lead to lumpy employment adjustment. The model predicts that policies that aim to stimulate employment by encouraging job creation, such as hiring subsidies, are significantly less effective in recessions: These are times when few firms are near their hiring threshold and many firms are near their firing threshold. Policies that target the job destruction margin, such as employment protection subsidies, are particularly effective at such times.

Keywords: Labor market frictions, hiring costs, hiring subsidies, employment stabilization policies, time-varying volatility

DOI: https://doi.org/10.17016/IFDP.2020.1290

IFDP 2020-1289
U.S. Banks and Global Liquidity

Ricardo Correa, Wenxin Du, and Gordon Liao


We characterize how U.S. global systemically important banks (GSIBs) supply short-term dollar liquidity in repo and foreign exchange swap markets in the post-Global Financial Crisis regulatory environment and serve as the "lenders-of-second-to-last-resort". Using daily supervisory bank balance sheet information, we find that U.S. GSIBs modestly increase their dollar liquidity provision in response to dollar funding shortages, particularly at period-ends, when the U.S. Treasury General Account balance increases, and during the balance sheet taper of the Federal Reserve. The increase in the dollar liquidity provision is mainly financed by reducing excess reserve balances at the Federal Reserve. Intra-firm transfers between depository institutions and broker-dealer subsidiaries within the same bank holding company are crucial to this type of "reserve-draining" intermediation. Finally, we discuss factors that contributed to the repo spike in September 2019 and the subseque nt response of U.S. GSIBs to recent policy interventions by the Federal Reserve.

DOI: https://doi.org/10.17016/IFDP.2020.1289

IFDP 2020-1288
Owe a Bank Millions, the Bank Has a Problem: Credit Concentration in Bad Times

Sumit Agarwal, Ricardo Correa, Bernardo Morais, Jessica Roldán and Claudia Ruiz-Ortega


How does a bank react when a substantial share of its borrowers suffer a large negative shock? To answer this question we exploit the 2014 collapse of energy prices using the universe of Mexican commercial bank loans. We show that, after the drop in energy prices, banks exposed to the energy sector increased their exposure to these borrowers even more, relaxing credit margins to their larger debtors in the sector. An increase of one standard deviation in a bank's ex-ante exposure to the energy sector increased the loan volume to borrowers in the sector by 18 percent and reduced interest rates by 6 percent, even though borrower's credit default swap spreads were widening. Highly exposed banks amplified this sector-specific shock to the rest of the economy by contracting lending to other sectors, with important real effects, as the borrowers could not switch credit suppliers. Finally, the energy price shock had a large negative impact on macro outcomes, especially in the capital-intensive secondary sector. Quantitatively, a one standard deviation increase in the exposure of a state's banks to the energy sector reduced its GDP by 1.8 percent.

Keywords: Credit exposure, bank lending, financial stability, commodity prices, emerging markets

DOI: https://doi.org/10.17016/IFDP.2020.1288

IFDP 2020-1287
Bank Complexity, Governance, and Risk

Ricardo Correa and Linda S. Goldberg


Bank holding companies (BHCs) can be complex organizations, conducting multiple lines of business through many distinct legal entities and across a range of geographies. While such complexity raises the the costs of bank resolution when organizations fail, the effect of complexity on BHCs' broader risk profiles is less well understood. Business, organizational, and geographic complexity can engender explicit trade-offs between the agency problems that increase risk and the diversification, liquidity management, and synergy improvements that reduce risk. The outcomes of such trade-offs may depend on bank governance arrangements. We test these conjectures using data on large U.S. BHCs for the 1996-2018 period. Organizational complexity and geographic scope tend to provide diversification gains and reduce idiosyncratic and liquidity risks while also increasing BHCs' exposure to systematic and systemic risks. Regulatory changes focused on organizational complexity have significantly reduced this type of complexity, leading to a decrease in systemic risk and an increase in liquidity risk among BHCs. While bank governance structures have, in some cases, significantly affected the buildup of BHC complexity, better governance arrangements have not moderated the effects of complexity on risk outcomes.

Keywords: Bank complexity, risk taking, regulation, too big to fail, liquidity, corporate governance, agency problem, global banks, diversification

DOI: https://doi.org/10.17016/IFDP.2020.1287

IFDP 2020-1286
Capital Flows, Asset Prices, and the Real Economy: A "China Shock" in the U.S. Real Estate Market

Zhimin Li, Leslie Sheng Shen, Calvin Zhang


We study the effects of foreign real estate capital flows on local asset prices and employment using detailed housing transactions data. We document (i) a "China shock" in the U.S. real estate market after 2007 driven by the Chinese government's house purchase restrictions and (ii) "home bias" in foreign Chinese housing purchases in the United States as they are concentrated in ZIP codes historically populated by ethnic Chinese. Exploiting the quasi-random temporal and spatial variation of real estate capital inows from China, we find that foreign Chinese housing purchases have a positive and significant effect on local housing and labor markets. A one standard deviation increase in exposure to these purchases explains 24% and 18% of the cross-ZIP-code variation in local house prices and employment, respectively, with the employment effect transmitted through a housing net worth channel. We also show that these purchases drive out lower-income residents. Our results highlight the role of foreign real estate capital ows in both stimulating the real economy and inducing gentrification in local economies.

Keywords: Keywords: Capital flows, house price, employment, China shock

DOI: https://doi.org/10.17016/IFDP.2020.1286

IFDP 2020-1285
Monetary Policy Expectations, Fund Managers, and Fund Returns: Evidence from China

John Ammer, John Rogers, Gang Wang, and Yang Yu


Although many central banks in the 21st century have become more transparent, Chinese monetary policy communications have been relatively opaque, making it more difficult for financial market participants to make decisions that depend on the future path of interest rates. We conduct a novel systematic textual analysis of the discussion in the quarterly reports of China fund managers, from which we infer their near-term expectations for monetary policy. We construct an aggregate index of manager expectations and show that, as a forecast of Chinese monetary policy, it compares favorably with both market-based and model-based alternative projections. We find that expectations are more accurate for funds that commit more analytical resources, have higher management fees, and with stronger managerial educational background. We also show that fund managers act on these expectations, and that correctly anticipating shifts in Chinese monetary policy improves fund performance. Our results imply that manager skill is an important determinant of fund returns, providing the first evidence from China on a question for which studies of asset
management in other countries have reached conflicting conclusions. economy.

Keywords: Chinese monetary policy, fund managers, textual analysis

DOI: https://doi.org/10.17016/IFDP.2020.1285

IFDP 2020-1284
Taxation, Social Welfare, and Labor Market Frictions

Brendan Epstein, Ryan Nunn, Musa Orak, and Elena Patel


Taking inefficiencies from taxation as given, a well-known public finance literature shows that the elasticity of taxable income (ETI) is a sufficient statistic for assessing the deadweight loss (DWL) from taxing labor income in a static neoclassical framework. Using a theoretical approach, we revisit this result from the vantage point of a general equilibrium macroeconomic model with labor search frictions. We show that, in this context, and against the backdrop of inefficient taxation, DWL can be up to 38 percent higher than the ETI under a range of reasonable parametric assumptions. Externalities arising from market participants not taking into account the impact of changes in their search- and vacancy-posting activities on other market participants can amplify this divergence substantially. However, with theoretical precision, we show how the wedge between the ETI and DWL can be controlled for, using readily observable variables.

Keywords: Elasticity of taxable income, deadweight loss from taxation, endogenous amenities, search frictions, social welfare

DOI: https://doi.org/10.17016/IFDP.2020.1284

IFDP 2020-1283
The Hedging Channel of Exchange Rate Determination

Gordon Liao and Tony Zhang


We document the exchange rate hedging channel that connects country-level measures of net external financial imbalances with exchange rates. In times of market distress, countries with large positive external imbalances (e.g. Japan) experience domestic currency appreciation, and crucially, forward exchange rates appreciate relatively more than the spot after adjusting for interest rate differentials. Countries with large negative foreign asset positions experience the opposite currency movements. We present a model demonstrating that exchange rate hedging coupled with intermediary constraints can explain these observed relationships between net external imbalances and spot and forward exchange rates. We find empirical support for this currency hedging channel of exchange rate determination in both the conditional and unconditional moments of exchange rates, option prices, large institutional investors' disclosure of hedging activities, and central bank swap line usage during the COVID-19 market turmoil.

Keywords: Global imbalance, exchange rate, forward, hedging, covered interest rate parity, currency options, COVID19

DOI: https://doi.org/10.17016/IFDP.2020.1283

IFDP 2020-1282
Global Trade and GDP Co-Movement

François de Soyres and Alexandre Gaillard


We revisit the association between trade and GDP comovement for 135 countries from 1970 to 2009. Guided by a simple theory, we introduce two notions of trade linkages: (i) the usual direct bilateral trade index and (ii) new indexes of common exposure to third countries capturing the role of similarity in trade networks. Both measures are economically and statistically associated with GDP correlation, suggesting an additional channel through which GDP fluctuations propagate through trade linkages. Moreover, high income countries become more synchronized when the content of their trade is tilted toward inputs while trade in final goods is key for low income countries. Finally, we present evidence that the density of the international trade network is associated with an amplification of the association between global trade flows and bilateral GDP comovement, leading to a significant evolution of the trade comovement slope over the last two decades.

Keywords: International trade, international business cycle comovement, networks, input-output linkages

DOI: https://doi.org/10.17016/IFDP.2020.1282

IFDP 2020-1281
The Impact of Financial Sanctions: The Case of Iran 2011-2016

Saeed Ghasseminejad and Mohammad R. Jahan-Parvar


This study provides a detailed analysis of the impact of financial sanctions on publicly traded companies. We consider the effect of imposing and lifting sanctions on the target country's traded equities and examine the differences in the reaction of politically connected firms and those without such connections. The paper focuses on Iran due to (1) its sizable financial markets, (2) imposition of sanctions of varying severity and duration on private and state-owned companies, (3) the significant presence of politically connected firms in the stock market, and (4) the unique event of the 2015 nuclear deal, resulting in fairly rapid lifting of a sizable portion of imposed sanctions. We find that sanctions affect politically connected firms more than ordinary firms, have lasting negative effects on profitability ratios, and that politically connected firms stock prices bounce back more slowly after removal of sanctions. Firms targeted by financial sanctions decrease their leverage and increase their cash holding to manage their perceived increase in risk profile.

Keywords: Financial Sanctions; capital structure; event study; political connections; Iran; national security

DOI: https://doi.org/10.17016/IFDP.2020.1281

IFDP 2020-1280
The Economics of Platforms in a Walrasian Framework

Anil K. Jain and Robert M. Townsend


We present a tractable model of platform competition in a general equilibrium setting. We endogenize the size, number, and type of each platform, while allowing for different user types in utility and impact on platform costs. The economy is Pareto efficient because platforms internalize the network effects of adding more or different types of users by offering type-specific contracts that state both the number and composition of platform users. Using the Walrasian equilibrium concept, the sum of type-specific fees paid cover platform costs. Given the Pareto effciency of our environment, we argue against the presumption that platforms with externalities need be regulated.

Keywords: Two-sided markets, first and second welfare theorems, externalities

DOI: https://doi.org/10.17016/IFDP.2020.1280

IFDP 2020-1279
Uncertainty and Growth Disasters

Boyan Jovanovic and Sai Ma


This paper documents several stylized facts on the real effects of economic uncertainty. First, higher uncertainty is associated with a more dispersed and negatively skewed distribution of output growth. Second, the response of economic growth to an increase in uncertainty is highly nonlinear and asymmetric. Third, higher asset volatility magni…es the negative impact of uncertainty on growth. We develop and estimate an analytically tractable model in which rapid adoption of new technology may raise economic uncertainty which causes measured productivity to decline. The equilibrium growth distribution is negatively skewed and higher uncertainty leads to a thicker left tail.

Keywords: Uncertainty and growth, volatility, downside risk, growth at risk

DOI: https://doi.org/10.17016/IFDP.2020.1279

IFDP 2020-1278
Emerging Markets and the New Geography of Trade: The Effects of Rising Trade Barriers

Ricardo Reyes-Heroles, Sharon Traiberman, and Eva Van Leemput


Protectionist sentiments have been rising globally in recent years. The consequences of a surge in protectionist measures present policy challenges for emerging markets (EMs), which have become increasingly exposed to global trade. This paper serves two main purposes. First, we collect several stylized facts that characterize EMs' role in the new geography of trade. We focus on differences between advanced economies (AEs) and EMs in trade linkages, production structures, and factor supplies. Second, we build a dynamic, general equilibrium, quantitative trade model featuring multiple countries, sectors and factors of production. The model is motivated by and geared to jointly match the facts we present. We use the model to estimate the long-run global impacts of rising trade barriers on EMs|both direct impacts and spillovers through third-country effects. Heterogeneity in openness, production structure, trade linkages, and factor supplies leads to large di erences between the impacts on AEs versus EMs. We find that variations in both technological comparative advantage and factor supplies play key roles in shaping these differences.

Keywords: Emerging market economies, trade barriers, comparative advantage, dynamics

DOI: https://doi.org/10.17016/IFDP.2020.1278

IFDP 2020-1277
Patent-Based News Shocks

Danilo Cascaldi-Garcia and Marija Vukotić


We exploit firm-level data on patent grants and subsequent reactions of stocks to identify technological news shocks. Changes in stock market valuations due to announcements of individual patent grants represent expected future increases in the technology level, which we refer to as patent-based news shocks. Our patentbased news shocks resemble diffusion news, in that they do not affect total factor productivity in the short run but induce a strong permanent effect after five years. These shocks produce positive comovement between consumption, output, investment, and hours. Unlike the existing empirical evidence, patent-based news shocks generate a positive response in inflation and the federal funds rate, in line with a standard New Keynesian model. Patenting activity in electronic and electrical equipment industries, within the manufacturing sector, and computer programming and data processing services, within the services sector, play crucial roles in driving our results.

Keywords: News Shocks, Patents, Patent-based news shocks

DOI: https://doi.org/10.17016/IFDP.2020.1277

IFDP 2020-1276
Sovereign Risk Matters: The Effects of Endogenous Default Risk on the Time-Varying Volatility of Interest Rate Spreads

Sergio de Ferra and Enrico Mallucci


Emerging market interest rate spreads display substantial time-varying volatility. We show that a baseline model with endogenous sovereign default risk can account for such volatility, even in the absence of shocks to the second moments of the exogenous stochastic variables. In particular, the model features a key non-linearity that allows it to replicate the volatility of interest rate spreads and its comovement with other economic variables. Volatility correlates positively with the level of the spreads and the trade balance and negatively with output and consumption.

Keywords: Sovereign risk, time-varying volatility, interest rates

DOI: https://doi.org/10.17016/IFDP.2020.1276

IFDP 2020-1275
Avoiding Sovereign Default Contagion: A Normative Analysis

Sergio de Ferra and Enrico Mallucci


Should debtor countries support each other during sovereign debt crises? We answer this question through the lens of a two-country sovereign-default model that we calibrate to the euro-area periphery. First, we look at cross-country bailouts. We find that whenever agents anticipate their existence, bailouts induce moral hazard an reduce welfare. Second, we look at the borrowing choices of a global central borrower. We find that it borrows less than individual governments and, as such, defaults become less frequent and welfare increases. Finally, we show that central borrower's policies can be replicated in a decentralized setting with Pigouvian taxes on debt.

Keywords: Sovereign default, sovereign contagion, bailouts, Pigouvian taxes

DOI: https://doi.org/10.17016/IFDP.2020.1275

IFDP 2020-1274
How Much Will the Belt and Road Initiative Reduce Trade Costs?

François de Soyres, Alen Mulabdic, Siobhan Murray, Nadia Rocha, and Michele Ruta


This paper studies the impact of transport infrastructure projects of the Belt and Road Initiative on shipment times and trade costs. Based on a new data on completed and planned Belt and Road transport projects, Geographic Information System analysis is used to estimate shipment times before and after the Belt and Road Initiative. Two sets of data are computed to address different research questions: a global database based on an analysis of 1,000 cities in 191 countries and 47 sectors and a regional database that focuses on more granular information (1,818 cities) for Belt and Road economies only. The paper uses sectoral estimates of “value of time” to transform changes in shipment times into changes in ad valorem trade costs at the country‐sector level. The findings show that the Belt and Road Initiative will significantly reduce shipment times and trade costs. For the world, the average reduction in shipment time will range between 1.2 and 2.5 percent, leading to reduction of aggregate trade costs between 1.1 and 2.2 percent. For Belt and Road economies, the change in shipment times and trade costs will range between 1.7 and 3.2 percent and 1.5 and 2.8 percent, respectively. Belt and Road economies located along the corridors where projects are built experience the largest gains. Shipment times along these corridors decline by up to 11.9 percent and trade costs by up to 10.2 percent.

Keywords: Transport infrastructure, GIS analysis, shipment times, trade costs

DOI: https://doi.org/10.17016/IFDP.2020.1274

IFDP 2020-1273
Common Transport Infrastructure: A Quantitative Model and Estimates from the Belt and Road Initiative

François de Soyres, Alen Mulabdic, and Michele Ruta


This paper presents a structural general equilibrium model to analyze the effects on trade, welfare, and gross domestic product of common transport infrastructure. The model builds on Caliendo and Parro (2015) to allow for changes in trade costs due to improvements in transportation infrastructure, financed through domestic taxation, connecting multiple countries. The model highlights the trade impact of infrastructure investments through cross-border input-output linkages. This framework is then used to quantify the impact of the Belt and Road Initiative. Using new estimates on the effects on trade costs of transport infrastructure related to the initiative, the model shows that gross domestic product will increase by up to 3.4 percent for participating countries and by up to 2.9 percent for the world. Because trade gains are not commensurate with projected investments, some countries may experience a negative welfare effect due to the high cost of the infrastructure.

Keywords: Transportation infrastructure, trade, structural general equilibrium, belt and road

DOI: https://doi.org/10.17016/IFDP.2020.1273

IFDP 2020-1272
Piecewise-Linear Approximations and Filtering for DSGE Models with Occasionally Binding Constraints

S. Boragan Aruoba, Pablo Cuba-Borda, Kenji Higa-Flores, Frank Schorfheide, and Sergio Villalvazo


We develop an algorithm to construct approximate decision rules that are piecewise-linear and continuous for DSGE models with an occasionally binding constraint. The functional form of the decision rules allows us to derive a conditionally optimal particle filter (COPF) for the evaluation of the likelihood function that exploits the structure of the solution. We document the accuracy of the likelihood approximation and embed it into a particle Markov chain Monte Carlo algorithm to conduct Bayesian estimation. Compared with a standard bootstrap particle filter, the COPF significantly reduces the persistence of the Markov chain, improves the accuracy of Monte Carlo approximations of posterior moments, and drastically speeds up computations. We use the techniques to estimate a small-scale DSGE model to assess the effects of the government spending portion of the American Recovery and Reinvestment Act in 2009 when interest rates reached the zero lower bound.

Keywords: Bayesian Estimation, Nonlinear Filtering, Nonlinear Solution Methods, Particle MCMC, ZLB

DOI: https://doi.org/10.17016/IFDP.2020.1272

IFDP 2020-1271
The Elusive Gains from Nationally-Oriented Monetary Policy

Martin Bodenstein, Giancarlo Corsetti, and Luca Guerrieri


The consensus in the recent literature is that the gains from international monetary cooperation are negligible, and so are the costs of a breakdown in cooperation. However, when assessed conditionally on empirically-relevant dynamic developments of the economy, the welfare cost of moving away from regimes of explicit or implicit cooperation may rise to multiple times the cost of economic fluctuations. In economies with incomplete markets, the incentives to act non-cooperatively are driven by the emergence of global imbalances, i.e., large net-foreign-asset positions; and, in economies with complete markets, by divergent real wages.

Keywords: Monetary policy cooperation, global imbalances, open-loop Nash games

DOI: https://doi.org/10.17016/IFDP.2020.1271

IFDP 2020-1270
Rising Import Tariffs, Falling Export Growth: When Modern Supply Chains Meet Old-Style Protectionism

Kyle Handley, Fariha Kamal, and Ryan Monarch


We examine the impacts of the 2018-2019 U.S. import tariff increases on U.S. export growth through the lens of supply chain linkages. Using 2016 confidentia firm-trade linked data, we document the implied incidence and scope of new import tariffs. Firms that eventually faced tariff increases on their imports accounted for 84% of all exports and they represent 65% of manufacturing employment. For all affected firms, the implied cost is $900 per worker in new duties. To estimate the effect on U.S. export growth, we construct product-level measures of import tariff exposure of U.S. exports from the underlying firm micro data. More exposed products experienced 2 percentage point lower growth relative to products with no exposure. The decline in exports is equivalent to an ad valorem tariff on U.S. exports of almost 2% for the typical product and almost 4% for products with higher than average exposure.

Keywords: Global supply chains; tariffs; trade war; U.S. exports

DOI: https://doi.org/10.17016/IFDP.2020.1270

IFDP 2020-1269
When is Bad News Good News? U.S. Monetary Policy, Macroeconomic News, and Financial Conditions in Emerging Markets

Jasper Hoek, Steve Kamin, and Emre Yoldas


Rises in U.S. interest rates are often thought to generate adverse spillovers to emerging market economies (EMEs). We show that what appears to be bad news for EMEs might actually be good news, or at least not-so-bad news, depending on the source of the rise in U.S. interest rates. We present evidence that higher U.S. interest rates stemming from stronger U.S. growth generate only modest spillovers, while those stemming from a more hawkish Fed policy stance or inflationary pressures can lead to significant tightening of EME financial conditions. Our identification of the sources of U.S. rate changes is based on high-frequency moves in U.S. Treasury yields and stock prices around FOMC announcements and U.S. employment report releases. We interpret positive comovements of stocks and interest rates around these events as growth shocks and negative comovements as monetary shocks, and estimate the effect of these shocks on emerging market asset prices. For economies with greater macroeconomic vulnerabilities, the difference between the impact of monetary and growth shocks is magnified. In fact, for EMEs with very low levels of vulnerability, a growth-driven rise in U.S. interest rates may even ease financial conditions in some markets.

Note: On February 13, 2020, this paper was updated to remove a figure titled “Federal Reserve Policy and Growth in Latin America”, which was inadvertently included in the original file.

DOI: https://doi.org/10.17016/IFDP.2020.1269

IFDP 2020-1268
How ETFs Amplify the Global Financial Cycle in Emerging Markets

Nathan Converse, Eduardo Levy-Yeyati, and Tomas Williams


This paper examines how the growth of exchange-traded funds (ETFs) has affected the sensitivity of international capital flows to global financial conditions. Using data on individual emerging market funds worldwide, we employ a novel identification strategy that controls for unobservable time-varying economic conditions at the investment destination. We find that the sensitivity of flows to global financial conditions for equity (bond) ETFs is 2.5 (2.25) times higher than for equity (bond) mutual funds. We then show that our findings have macroeconomic implications. In countries where ETFs hold a larger share of the equity market, total cross-border equity flows and returns are significantly more sensitive to global financial conditions. Our results imply that the increasing role of ETFs as a channel for international capital flows has amplified the global financial cycle in emerging markets.

Keywords: exchange-traded funds; mutual funds; global financial cycle; global risk; push and pull factors; capital flows; emerging markets

DOI: https://doi.org/10.17016/IFDP.2020.1268

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

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Last Update: January 17, 2020