Stylized facts about globalization

Question 1

Why did inflation rise post-Covid?

Answer 1

1. Bottlenecks for supply chains (supply-side)

2. For the US, part of the inflation is due to the big fiscal stimulus

Question 2

How did Biden’s fiscal stimulus affect inflation?

Answer 2

11% of GDP stimulus -> demand surge -> consumption surge (+ supply side problems) = inflationary pressure

there was a shift in the goods demanded - from services to manufactured goods

not a surprise that US inflation > EU area inflation

Question 3

Post-covid OECD inflation

Answer 3

• 5% on average, with around 1/2 coming from the energy crisis (HICP inflation)
• HICP (Harmonized Index of Consumer Prices) is an indicator of inflation and price stability in the EU
• EU area is more responsive to the energy prices

Question 4

What is happening to oil production amidst rising oil prices?

Answer 4

Contrary to past historical observations, oil production is responding slower than usual

In the US oil production has stopped? We are in the transition period where oil prices are not driving production

Question 5

How do Labor and Wage dynamics differ in the US and other AE post-Covid?

Answer 5

The “Big Resignation”: in the US, 2-3% of the population did not come back to the labor market

In other AE, the LF participation rate has bounced back

In the US, unit labor costs (wages/productivity) are rising fast, while in other AEs - not. They are not rising as fast as the consumer prices - inflationary pressures

Question 6

What inflation dynamics are similar for the US and EMs?

Answer 6

A big part of the inflation is not energy-driven, meaning that there are endogenous inflationary pressures with respect to goods and services prices; this is important for the temporary vs persistent inflation debate

Question 7

Why is there more correlation between inflation across countries? (more headline than core) in low inflation times?

Answer 7

1. More common synchronized shocks (commodity prices)
2. Structural change propagate shocks: international input-output linkages account for 1/2 of the global component of producer price inflation
   - a shock in the US will propagate on other countries (US demand shock -> demand everywhere)
3. Exchange rate pass-through
   - how responsive countries’ imports, producer or consumer prices change in response to a change in its exchange
   - % change in response to a 1% change in the exchange rate
   - much more prevalent for the EMs
4. Convergence in monetary policy regimes across countries
   - still unclear if it is a strong effect or no

Question 8

How are US and EU area (planned) responses to high inflation differ?

Answer 8

AEs will be conducting Quantitative Tightenings but to varying degrees. The EU considered inflation to be temporary -> not too drastic or too fast QT

the US, though, is in panic mode: the FED is putting breaks on demand and the market expects 4-5 FED hikes in 2022

Monetary policy is effective when the shock is demand driven (increase in interest rates -> dampening consumption by increasing the prices on durable goods

Question 9

What are the 2 channels through which US Monetary Policy affects EMs?

Answer 9

1. US monetary policy affects global investors’ risk perceptions. Credit costs all over the world increase (higher US interest rates propagate worldwide)
2. MP is endogenous to the US MP -> “fear of floating” leads some EMs to tighten their MP after FED but not all.
   example: higher return to capital in the US than in Brazil may force the Brazilian CB to increase interest rates to avoid currency depreciation

Question 10

What are risk-on/risk-off phases?

Answer 10

In risk-on situations, investors have a high risk appetite and bid up the prices of assets in the market. In risk-off situations, investors become more risk-averse and sell assets, sending their prices lower.

Question 11

Explain the foreign currency-denominated debt mechanism through which EMs will be affected

Answer 11

the magnitude of the effect depends on (1) how much debt do you have + (2) how much of it is in usd + (3) how much of your trade is in usd (exports)

FED QT -> appreciation of the dollar (higher return on assets) -> debt levels in local terms are increasing

could be good for trade (depending on how much of exports is denominated in usd) but bad for debt

Question 12

What happened to foreign-currency denominated debt recently?

Answer 12

2006-2014 period has seen a decrease in debt (in usd) - still there but to a smaller degree

Question 13

What happens when FED interest rate increases by 1 percentage point (Aggripino and Rey)?

Answer 13

Following a US MP tightening, global financial conditions deteriorate materially.

• World Trade contracts.
• Financial conditions tighten (riskier assets will see less financial resources)
• Negative impact on capital flows
• the usd appreciates

Question 14

What are the measures of trade openness?

Answer 14

1) Restrictions to free trade

2) (Exports + Imports)/ GDP

Question 15

How do you measure financial globalization?

Answer 15

Extent of the openness in cross-border financial transactions.
De Jure: what are the restrictions on international capital movements? (IMF’s report)
De Facto: how much international trade in financial assets?

Question 16

Name financial assets

Answer 16

• Portfolio investment (equity or debt)
• FDI: >10% ownership
• other investments: loans, trade credit
• derivatives (futures, options)
• reserves (central banks)

Question 17

Describe capital movement restrictions over the years across income groups

Answer 17

KAOPEN index measures a country’s degree of capital account openness. 0 - no capital flows, 1 - no restrictions

Industrialized economies: have been becoming more and more open to intr; capital movements

EMs and developing countries have more restrictions

LDCs were more open than EMS in 70s to 2005, now around the same level

Question 18

What is the difference between flows and stocks?

Answer 18

Flows: the value of assets traded for a given year - a_t
Stocks: the value of assets held in a given year (stocks are the cumulative flows) - A_t = A_(t-1) + a_t

Question 19

How to measure financial flows and stocks de facto?

Answer 19

For stocks: IFI (International Financial Integration) measure

(Foreign assets held domestically + Domestic assets held by foreign agents)/ GDP

For flows: inflows/gdp (net purchases of domestic assets by foreign investors) and outflows/gdp ( purchases of foreign assets by domestic investors)

Question 20

Describe the international capital flows over the last 20 years

Answer 20

Euro area and other AEs spearheaded the increase in capital flows up until the GFC. After GFC, we bounced back but not to the the-crisis level (in some sense, global financial deglobalization)

Graph: Foreign asset stocks on global GDP

Question 21

What is “fly to safety”?

Answer 21

a financial market phenomenon occurring when investors sell what they perceive to be higher-risk investments and purchase safer investments, such as gold and other precious metals.

Question 22

The Global Financial Cycle

Answer 22

Rey and coauthors: time series analysis on “common factors” cross-section of data x_t (asset prices, capital flows or private credit)

x_t = lambda*f_t + some other greek letter (f_t - common factor and the other greek letter - idiosyncratic term)

One global factor accounts for around a quarter of fluctuations in
risky asset prices: highly correlated with measures of risk appetite
(VIX or expected volatility)

Question 23

What is the anomaly in data: missing wealth that Zucman (2013) talks about?

Answer 23

Zucman (2013) finds that official statistics fail to capture most of the assets held by households in offshore tax havens.

At the global level, liabilities tend to exceed assets - the world is a net debtor.

Question 24

When are countries net debtors or net creditors?

Answer 24

NFA_t = Foreign Assets held by domestic agents - domestic assets by foreigners

if NFA_t is negative -> net debtor
if NFA_t is positive -> net creditor

Question 25

What is phantom FDI? How has it been developing?

Answer 25

Phantom FDI - investment in special purpose entities with no production or employees; when investments being exchanged through MNCs is essentially empty. Share of phantom FDI in total FDi is growing steadily (from 30% in 2009 to almost 40% in 2017).

Question 26

Is financial globalization linked to tax avoidance?

Answer 26

Yes, the biggest receivers of FDI in the world are tax havens (Netherlands, Luxembourg, Hong Kong, Switzerland, Ireland etc) Also, FDI has changed in nature: from building a factory in a foreign country to financial flows

Question 27

Why should we worry about base erosion and profit shifting (BEPS)?

Answer 27

BEPS refers to tax planning strategies used by MNCs that exploit gaps and mismatches in tax rules to avoid paying tax. Disproportionally affects developing countries. -Tax avoidance is sizeable globally and visible on global statistics - BEPS leads to signicant loss in tax receipts and undermines public good provision and redistribution -Tax avoidance undermines fairness and equality before tax - Second order effects: increases concentration (MNCs pay fewer taxes than purely national firms -> can buy out domestic competitors -> grow even larger)

Question 28

What are the main tax avoidance schemes?

Answer 28

- Transfer pricing (corporations located in high-tax jurisdictions can “transfer the prices” of income and expenses and shift their income to a low-tax jurisdiction in order to avoid or reduce taxation. They do it by selling an intermediate good to another branch at an artificially high price. Ex: Ireland's Intel sells it at $90 to France, who then sells it at $100. The tax is paid in Ireland) - Debt shifting (company A in a high tax environment (australia) borrows money from company B in a low tax environment (Bermuda) and pays interest.) - Strategic localization of intangible capital (the multinational transfers its intangible assets (such as trademarks or copyright) to company B, and company A then pays royalties to company B to use these assets.)

Question 29

What is the Lucas Paradox?

Answer 29

Foreign capital used to flow to poor and rich countries, but now flows mostly to rich countries. Rich countries have current account deficits (they import capital) and poorer countries have current account surpluses (they export capital)

Question 30

Why economists are less positive on the effects of financial globalization that trade integration?

Answer 30

Furceri (2019) finds new evidence on a panel of 149 advanced and developing economies. Capital account liberalization (de jure: KAOPEN) has no/little effect on GDP but positive effect on in inequality

Question 31

Current account formula

Answer 31

CA = EX - IM CA = TB + investment income from abroad - investment income from FDI in your country the gap between national savings and investment = current account in a closed economy, CA = 0

Question 32

CA in an open economy

Answer 32

S - I = EX - IM => I = S - CA A country can finance its investment through domestic saving or through borrowing abroad if CA<0 (net external debt increases: sale to ROW) - if I export less than I import, I have to export some financial services to ROW (export debt in change for imports) Savings can be invested nationally (I) or abroad (if CA>0; purchase of assets of ROW)

Question 33

How have CAs evolved from 1990 to 2018?

Answer 33

the world as a whole is closed economy, so global balances should equal to 0 but due to statistical discrepancies - not true during 2008, the deficit and surplus widened USA is one of the biggest CA deficits

Question 34

CA and financial crisis

Answer 34

Large current account deficits (CA<0) often predict financial crisis: the crisis comes with large current account reversal (foreigners stop lending) ex: Turkey, Argentina, Greece's crises were preceded by large CA deficits ex 2: Greece. in 2010, CA increased because investors stopped investing (CA reversal)-> Savings had to increase

Question 35

What is the relationship between trade imbalances and trade wars?

Answer 35

Bilateral as well as multilateral trade imbalances are robust predictors of protectionist attacks. Anything that generates trade balance deficit (decrease in taxes or increase in G) -> more attacks #att_hit =a+ B*TB_hit +delta*X_hit X_hit = lagged attacks, bilateral real exchange rate, gravity Various fixed effects (time, country, country-pair, country-time) there is a strong correlation between TB and #attacks there is a question of Reverse causality: in particular, do trabe imbalances cause attacks or vice versa? (in anticipation of higher tariffs, you increase exports from elsewhere?) they use an IV: cyclically adjusted budget balance (CABB) - (difference between G and T) - fiscal policy of the country countries that have more surplus in the budget balance (fiscal balance) have a larger CA surplus fiscal stimuli will see TB deteriorate -> benefit trade partners -> you accompany fiscal stimulus with protectionist measures to decrease the leakages The fact that multilateral trade imbalances cause protectionist attacks suggests that global imbalances is not only a concern because of macroeconomic reasons but also because of the trade tensions they can generate

Question 36

Current account and net foreign asset position

Answer 36

Accumulating of CA deficits leads to a negative NFA (net foreign assets) with the ROW (also known as Net international investment position) NFA = Foreign assets held by domestic actors - domestic assets held by foreign agents If a country has a CA deficit in year t, its net external position (NFA) deteriorates B_t - B_t-1 = CAt NFA today = NFA yesterday +CA => the only way NFA can improve is through CA (you need CA surplus to reimburse the debt in the future) Net external position (NFA) stock (wealth) B_t = B_t-1+CA_t = B_t-2 + CA_t-1+ CA_t B_t <0 if debtor country: value of the foreign assets it holds < value of domestic assets held by foreigners (forgetting that the value of assets is volatile)

Question 37

Debtor and creditor countries graph (in % of domestic GDP)

Answer 37

Countries with higher GDP per capita are net creditors and poorer countries are net debtors. one issue with counting this debt is that some countries will never repay the debt to the IMF

Question 38

What is Balance of Payment (BOP)

Answer 38

BOP registers all transactions with foreign economic agents. Current account: exports and imports of goods and services Financial account: sale and purchase of financial assets (money, equity, public or private debt) Capital account: transfers of wealth Fundamental BOP identity = Current account + Capital account + Financial account = 0 Sum of current account (CA) + capital account (KA) is the change in NFA: opposite of financial account

Question 39

What does CA+KA<0 mean for NFA? CA+KA>0 (S>I)

Answer 39

When CA+KA<0, country has to sell (export) assets abroad. Financial account is in surplus. NFA deteriorates When CA+KA>0 (S>I), country buys/imports assets abroad. Financial account in deficit. NFA improves.

Question 40

Good imbalances vs bad imbalances

Answer 40

Good imbalances: S>I: aging countries (anticipation of later dissaving) - ex: Germany, Japan I>S: high return to investment (finance part of I through foreign saving) Bad imbalances CA surplus driven by high private saving as a result of lacking social insurance In China Low private saving in the us

Question 41

Fiscal policy and current accounts

Answer 41

Private Saving S^P = Y - T - C Public dissaving S^G = T- G Accounting identity CA = S^G + S^P - I = T-G+S^P - I

Question 42

What is a twin deficit?

Answer 42

A twin deficit occurs when a nation has both Current Account deficit and budget (fiscal) deficit. A country's is importing more than it is exporting and the government is spending more than it is earning. In this instance, the country is a debtor to the ROW Current account deficit: imports>exports Fiscal account deficit: government spending> government revenues

Question 43

What does Ricardian equivalence refer to?

Answer 43

Increasing government deficit (G-T) leads private saving to increase because taxpayers understand that even if their current taxes are not raised, their future taxes will be. Since this saving implies foregone consumption, the tax burden is shifted to the present.

Question 44

the intertemporal approach to current account dynamics

Answer 44

a_t = (1+r)a_t-1 + y_t - c_t y_t - exogenous endowment at date t a_t - net asset position, lending minus borrowing at date t r = constant interest rate y_t - c_t = net saving or dissaving (forget about G for now) ca_t = y_t - c_t +r*(a_t-1) = a_t - a_t-1 ca today is the expected discounted sum of all of the future income variations BECAUSE agents want to smooth consumption => borrow/lend to be indifferent between consuming one more unit today and consuming it tomorrow implication for CA: CA deficit when future income is expected to grow CA surplus when future income is expected to decline ex: aging countries are expecting their future income to be lower -> save now -> CA surplus

Question 45

Implications for CA dynamics in developed and EMs

Answer 45

If high GDP today (boom), countries are expected to save today (CA>0 - CA surplus). This would imply a positive correlation between GDP and CA (pro-cyclicality). Not true (especially for EMs) For EMs, booms and busts are longer and more persistent. EMs are hit by growth shocks: a bad growth rate today means persistent bad growth. In other words, agents in EMs expect the shocks to persist, which makes their expectations more negative -> Save! -> CA>0 (hence CAs become countercyclical)

Question 46

Valuation effects and the exorbitant privilege of the US

Answer 46

Valuation effects have become very large due to financial globalization and the increase in gross positions (assets and liabilities) B_t - B_t-1 = CA_t + change in capital gains a country can suffer/gain from the changes in capital valuation (change in the exchange rate or movements on the equity markets) Exorbitant privilege: the US borrows every year (accumulate CA deficits) but is not getting into more debt vis-a-vis the ROW (NFA position barely changed). How can that be? Foreign assets held by Americans (mostly denominated in foreign currency) increased in value much more that foreign-held assets in the US. Dollar depreciation of the US -> the US current account deficit is good for the ROW (consumer of last resort)

Question 47

Two channels for adjustment to external imbalance:

Answer 47

Trade channel (depreciation increases net exports): medium-long term (future trade surpluses reduce imbalance) Valuation channel: short-medium term (change in the return on US assets held by foreigners relative to return on foreign assets held by US residents). Makes it harder to adjust in the EM,

Question 48

Exorbitant privilege: Why returns are not equated even within classes?

Answer 48

1. Role of dollar as a reserve currency+liquidity of US financial markets: foreigners are willing to hold underperforming US assets because more liquid 2. composition effect: "long risky" and "short safe" 3. recent explanation: US MNCs use tax havens more than MNCs from other countries -> get high returns on investment abroad

Question 49

USD role in the monetary system

Answer 49

``` international trade invoicing (US role as an exporter&importer of traded goods) bank funding: non-US banks raise very large amounts of usd-denominated deposits corporate borrowing (non-us firms often borrow in usd) CB reserve holdings (64% of worldwide official reserves today is in usd) ```

Question 50

Exchange rate as a relative price

Answer 50

1. E is the exchange rate of the euro/dollar: price of the foreign currency (dollar) in units of the domestic currency (euro) $1 = E euros E increase means euro deprecitates (takes more euro to buy one dollar) 2. E is the price of domestic currency (euro) in units of foreign currency (usd) 1euro = E usd

Question 51

Floating VS Fixed exchange rate

Answer 51

Floating: The exchange rate is determined on exchange rate markets without interventions of central banks Fixed: central banks intervene on markets to maintain the exchange rate at announced level or around such level Dirty floating - intermediate situation

Question 52

What is a FX swap?

Answer 52

FX swap: an agreement to exchange currency between two foreign parties. sell 1 mln euro and buy usd on spot and simultaneously buy euro and sell dollar on a 1m forward.

Question 53

the dollar as a vehicle currency + hysteresis phenomenon

Answer 53

to exchange australian usd into mexican peso, less expensive to transact through usd because of high liquidity (low transaction) hysteresis phenomenon: once the liquidity is established on the market, problem of coordination for market participants to coordinate to another vehicle currency

Question 54

the declining volatility of exchange rates

Answer 54

in the LR, EX volatility decreases low levels of inflation (from convergence in monetary policy) reduce volatility in the exchange rates the more similar monetary policy is across the world, the less EX decrease in inflation -> low interest rates

Question 55

What is uncovered interest parity condition (UIP)?

Answer 55

The link between the exchange rate E euro/dollar today, the expected exchange rate E^e (one year) and the interest rate differential The choice between an investment into a riskless bond (treasury bond) or euro interbank interest rate: 1 + r_euro Buy dollars with this euro at rate E, invest it in US treasury bonds or dollar or dollar interbank markets at rate 1+ r_us In one year, she can sell her dollars at rate E^e

Question 56

What is arbitrage condition?

Answer 56

Arbitrage condition: an equilibrium situation when there is no profit from moving your money from 1 currency to another Uncovered interest parity implies that you should be indifferent between the two returns 1+r_euro = (E^e*(1+r_usd))/E r_euro = r_usd + (E^e - E)/ E return on euro asset = return on usd asset + expected return on usd asset

Question 57

what happens if E increases (today)?

Answer 57

If E increases, euro depreciates, return on USD assets E^e(1+r_usd)/E decreases or r_usd - (E^-E)/E decreases) relatively, euro assets return increases why? as euro becomes cheaper, it is relatively more expensive to buy and invest into usd assets today

Question 58

empirical validity of UIP

Answer 58

plausible assumption for OECD countries because they have perfect capital mobility (zero transaction costs) less plausible assumptions: 1. no risk aversion: only expected returns matter for the choice of investors 2. assets are perfectly substitutable 3. rational expectations: agents do not make systematic errors in forecasting and use all information

Question 59

Global risk premium in exchange rates

Answer 59

If agents are risk averse, they want to diversify assets and do not want to hold too many assets in one currency (for example euro) If share of euro increases in portfolio then must be compensated by a risk premium r_euro = r_usd + (E^e - E)/ E +p when proxies for global risk premia increase (i.e. prices of risky assets decline), the dollar appreciates

Question 60

can the UIP be validated empirically?

Answer 60

increase in diferential of interest rate (r_euro - r_usd) -> euro appreciation today if rational expectations, E^e on average = future realized exchange rate E_t+1 this can be tested empirically: 1. A random walk does better than an interest differential. The best predictor of future E is today's E: E(Et+1) = E^e = Et better for sr horizons, UIP for lr. 2. UIP puzzle: an increase in the interest rate differential (r_euro - r_usd) correlates with a future appreciation of euro cov(E_t+1 - E_t, r_euro - r_usd)<0 in data not>0

Question 61

three factors on the demand for liquidity (firms and households)"

Answer 61

interest rate (on a riskless asset such as treasury bond, TB) : r_euro Price level: P_euro Transactions (GDP): Y_euro

Question 62

How does interest rate affect demand for liquidity

Answer 62

Increase of interest rate r_euro -> decrease of demand of money: firms and households buy assets less liquid (TBs, saving accounts) that pay r_euro Demand for money increases with economic activity (GDP): firms and households transactions increase Demand for money increases with GDP Y_euro

Question 63

What is the effect of a permanent increase in money supply MS_euro on exchange rate?

Answer 63

Exchange rate will overshoot - it will depreciate by more than in the long run as a result of slow adjustment of goods prices and immediate adjustment of the exchange rate -> sr volatility of exchange rate even with forward looking rational agents

Question 64

Closed economy Monetary policy channels on AD

Answer 64

Interest rate: affects money market interest rates, lending and deposit rates Expectations: future LT interest rates Asset prices: stock market and reals estate Credit channel; loans to banks by CB

Question 65

How has globalization changed macro policy

Answer 65

Trade opennes makes mp more efficient: exchange rate channel more potent in more open economies Financial openness makes domestic mp more efficient: UIP AT THE BASE OF DEPRECIATION

Question 66

How does output affect exchange rate on financial markets

Answer 66

2 versions 1) financial expansion or boom -> Y rises -> more transactions -> money demand rises -> interest rate rises 2) boom -> infl pressure-> cb through MP rule increases i

Question 67

When does dd shift right?

Answer 67

When G, I, TR or foreign prices increase, when T decrease

Question 68

When does aa shift right?

Answer 68

When MS, foreign interest rates or expected exchange rate increase or domestic prices decrease