Staff working papers in the International Finance and Discussion Papers (IFDP) series are primarily materials produced by staff in the Division of International Finance. These topics are focused on, though by no means limited to, international macroeconomics, international trade, global finance, financial institutions, and markets, as well as international capital flows

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

Sergio de Ferra and Enrico Mallucci

Abstract: 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

Abstract: 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

Abstract: 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

Abstract: 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

Abstract: 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

Abstract: 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

Abstract: 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.

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

Abstract: 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

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Last Update: January 17, 2018