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Globalization and Monetary Policy Institute 2009 Annual Report Federal Reserve Bank of Dallas Contents Letter from the President 2 The Financial Crisis, Trade Finance and the Collapse of World Trade 4 Summary of Activities 16 Conference on Globalization, Political Economy and Trade Policy 18 Conference on Capital Flows, International Financial Markets and Financial Crises 24 Abstracts of Globalization and Monetary Policy Institute Working Papers Issued from October 2008 through October 2009 30 Facing Troubles in an Era of Globalization A Conversation with Nathan Sheets 38 Who’s Who at the Institute 41 Published by the Federal Reserve Bank of Dallas, March 2010. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Globalization and Monetary Policy Institute, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906. This publication is available on the Internet at www. dallasfed.org. 2 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Letter from the President As this publication goes to print, we are slowly closing the books on one of the most tumultuous economic periods since the Great Depression. An infection in the American housing sector spread like an epidemic through financial markets to countries around the world. In a matter of months, economic growth in developing and developed countries alike shifted abruptly into reverse. International trade collapsed. Manufacturing activity plummeted. Employment growth hit a wall before beginning a painful decline. No nation was spared the contagion’s effects as the global economy was dragged forcefully to the edge of a precipice. A global crisis of historic magnitude necessitated a commensurate global response. Monetary policy makers around the world quickly began to work together—announcing coordinated policy movements and establishing swap lines for foreign exchange. The events of this crisis underscore an important fact: We live in a truly interconnected world. What happens beyond our borders can have a significant impact on our domestic economy and, as a result, on U.S. monetary policy. It was that fact that motivated my decision in 2005 to make the study of globalization and its implications for the conduct of monetary policy the Dallas Fed’s signature research issue. That directive Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 3 culminated in the fall of 2007 with the formation of the Federal Open Market Committee—the Federal Reserve’s principal policymaking group—to presour Globalization and Monetary Policy Institute. Under its auspices, top minds from around ent their work on inflation dynamics. These indi- the globe have come together to explore the viduals provided analytical support for the notion linkages between an increasingly interconnected that price pressures at home can be affected by global economy and monetary policy. In the economic slack abroad. While empirical evidence two years since the institute’s establishment, its remains fragile, one thing is clear: The Fed must research team—under the advisement of profes- remain abreast of international developments if it sional and academic experts, including two central is to deliver on its mandate for price stability. In the 2009 Annual Report of the Dallas Fed’s bank governors and one Nobel laureate—has garnered considerable attention. Staff members have Globalization and Monetary Policy Institute, read- presented their findings at conferences across the ers will learn more about these research efforts country and published their research in some of and activities over the past year. Members of this the profession’s leading journals. elite team are at the leading edge of economic These individuals have also contributed research and continue to build on the institute’s significantly to the Federal Reserve’s understand- reputation for excellence in the study of globaliza- ing of our most recent crisis. For instance, in his tion and its impact on monetary policy. While they essay entitled “The Financial Crisis, Trade Finance have not yet found all the answers, I am confident and the Collapse of World Trade,” Director Mark that they continue to ask the right questions. My Wynne cuts through headlines lamenting the end colleagues and I are most grateful for their efforts of globalization to identify potential factors behind and look forward to the insights we will derive the recent collapse in world trade. Wynne argues from their important work. that the trade declines of the Great Recession were likely a result of deteriorating global economic activity and a drying up of trade finance. His analysis provides evidence that protectionist policies—while always dangerous enough to warrant a watchful eye—are not yet on a significant rise. Members of institute staff were called upon by Richard W. Fisher President and CEO Federal Reserve Bank of Dallas The Fed must remain abreast of international developments if it is to deliver on its mandate for price stability. 4 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report The Financial Crisis, Trade Finance and the Collapse of World Trade As economic activity in The financial crisis that began in August 2007 holds that the financial crisis had an independent many parts of the world and intensified in the fall of 2008 pushed the global effect on trade flows, over and above the effect it had on global economic activity, by limiting or economy into its most severe recession since started to recover in the World War II. As 2009 drew to a close, there were latter half of 2009, trade volumes picked up. severing access to trade finance. We will see that signs that economic activity in many countries was the decline in trade was excessive, even given the rebounding, but the fragile state of many countries’ severity of the recession. And there is evidence financial systems and concerns about how govern- that reduced access to trade finance is an important part of the overall explanation. ments and central banks will manage the exit strategies from the extraordinary measures taken to mitigate the worst effects of the crisis leave What Has Happened to Global Trade? many open questions about the ultimate course of Despite the recent increase in the importance the recovery. World trade collapsed in 2008–09 at of international trade in services—long considered a pace not seen since the Great Depression, raising the quintessential nontradable—the bulk of international trade still consists of trade in goods and concerns that the financial crisis would lead to deglobalization—a reversal of the globalization commodities. Each month the CPB Netherlands that has characterized the past three decades. As Bureau for Economic Policy Analysis produces global economic activity has rebounded, trade a report on global trade in goods, along with a flows have picked up as well, allaying some of breakdown for the major groupings. Chart 1 shows these fears. But the scale and the speed of the the time series of global exports of goods since collapse of global trade warrants investigation and January 1991, when the series began. Following poses a challenge for some standard models of steady growth over most of the past decade, global international economics. exports peaked in the first half of 2008 (specifical- In this essay I will discuss the impact that the ly, in April 2008) and then posted a precipitous 20 crisis had on world trade. I will then review two ex- percent decline through the early months of 2009. planations for the severity of the collapse. One line (The trough month was January 2009, but exports of argument holds that given the normal behavior hovered at close to their January level through of trade flows over the course of the business May 2009.)1 As economic activity in many parts cycle and given the severity of this most recent of the world started to recover in the latter half of cyclical downturn, a major contraction of world 2009, trade volumes picked up, and at the time of trade should have been expected. A second line of writing, the volume of trade had increased 15.5 argument, which is not incompatible with the first, percent from May through December 2009. Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 5 What was extraordinary about this trade Japan’s exports peaked earlier and saw by far the collapse was its scale and breadth. The 20 per- largest decline, while U.S. exports peaked a bit later. cent decline from peak to trough in the series in Exports of the emerging economies also peaked Chart 1 is the biggest in the history of that specific in April 2008, with central and eastern Europe and measure. Global trade declined during the 2001 re- Latin America peaking in January 2008, whereas cession, but only by 7 percent. Other measures of Asian exports did not peak until July. By early 2009, global trade with a longer time series show that the exports had turned around in most regions of the decline was the largest since World War II, indeed world, with Latin America being the last to experi- the largest since the Great Depression. ence recovery. Just as Japan experienced the most 2 Furthermore, the trade collapse was wide- severe downturn, so too has it experienced the spread. As Table 1 shows, the collapse was not sharpest rebound. But the advanced economies as confined to the advanced economies that were a whole seem to be lagging, held back in particular at the epicenter of the financial crisis, but encom- by the weak recovery of euro-area exports. passed the emerging economies as well. Exports Why Did Trade Collapse? of the advanced economies—defined here as the Organization for Economic Cooperation and Many explanations have been proposed for Development (OECD) excluding Turkey, South the scale of the collapse in trade. One immediate Korea and Mexico—peaked in April 2008 and concern was that countries were raising tariff and then declined 23.3 percent through January 2009. nontariff barriers to trade flows to protect domes- Chart 1 Global Trade Posts Historic Drop Index, 2000 = 100 180 160 Global merchandise trade volume 140 120 100 80 60 40 20 0 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 SOURCE: CPB Netherlands Bureau for Economic Policy Analysis World Trade Database. 6 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Table 1 Financial Crisis Takes Widespread Toll on World Exports Peak month Trough month Advanced economies U.S. Euro area Japan Emerging economies Asia Latin America Central and eastern Europe Africa and Middle East April 2008 July 2008 April 2008 January 2008 April 2008 July 2008 January 2008 January 2008 April 2008 January 2009 April 2009 February 2009 March 2009 January 2009 January 2009 August 2009 May 2009 April 2009 Peak to trough (percent change) –23.3 –24.7 –23.1 –41.4 –21.5 –24.7 –21.1 –30.8 –12.8 Trough to December 2009 (percent change) 12.6 20.2 8.4 40.3 22.0 29.5 20.9 12.9 8.5 SOURCE: CPB Netherlands Bureau for Economic Policy Analysis World Trade Monitor, December 2009. There is very little evidence to date that this protectionist rhetoric translated into more restrictive trade policy. tic industries from the worst of the downturn. Development and the World Trade Organiza- While there was a very real increase in protection- tion on trade and investment policy responses to ist rhetoric over the course of 2008 and 2009, there the downturn in the G-20, it was noted that the is very little evidence to date that this rhetoric responses so far have been “relatively muted” translated into more restrictive trade policy. Even- (OECD, UNCTAD, WTO 2010). In the period Octo- ett (2009) is less sanguine on this topic, noting ber 2008 to October 2009, new import-restricting a steady increase in the number of protectionist measures introduced by the members of the G-20 measures implemented during 2009. He finds that covered about 1.3 percent of G-20 imports (0.8 for several advanced economies the share of goods percent of global imports). In the more recent affected by beggar-thy-neighbor policies exceeds period from September 2009 through February precrisis levels. However, given the short history 2010, new import-restricting measures covered and nature of the data upon which this assess- 0.7 percent of G-20 imports. The report also noted ment rests, it is difficult to know how important that no major measures had been identified as the effects are at the aggregate level. Importantly, reducing market access among the G-20 members Evenett also notes that “… few governments have in the service sector, although it did draw attention introduced anything like across-the-board dis- to the potentially distortionary effects of govern- crimination against foreign commercial interests; ment support for the transportation and financial in this respect, the world economy is still far from a sectors in a number of countries. 1930s-style protectionist outcome.” To get a sense of what constitutes the normal Policymakers seem to have absorbed the behavior of trade over the course of the business lesson of the Great Depression, when protectionist cycle, it is useful to look at the time series behavior trade policy exacerbated the downturn.3 Meeting of trade and economic activity in tandem. Chart 2 in London in April 2009, the leaders of the Group plots the growth rate of global real gross domestic of Twenty publicly declared that they would “… product (GDP) and the growth rate of global ex- not repeat the historic mistakes of protectionism ports of goods and services over the past 25 years. of previous eras.” In the most recent report from Two points are worthy of note. First, global exports the OECD, the U.N. Conference on Trade and tend to move in tandem with global GDP: The cor- Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 7 relation between the growth rates of the two series the OECD countries, while exports are 2.7 times over the sample period is 0.84. That is, exports more volatile than GDP.4 Why is that? Part of the reason appears to are procyclical: They tend to boom when real economic activity is booming and to slump when be that despite recent innovations the composi- real economic activity is slumping. Second, global tion of international trade is still heavily skewed exports are a lot more volatile than global GDP. toward goods rather than services. Approximately The standard deviation of the growth rate of global 80 percent of all global trade consists of trade in GDP from 1986 to 2009 was 1.3 percent, while goods, and this share has remained remarkably the standard deviation of the growth rate of global stable over time. By contrast, the share of goods exports over the same period was 4.6 percent. in global GDP has declined by about 10 percent- We see the same pattern at the level of individual age points over the past four decades, from about countries. Engel and Wang (2007) report a series a half in 1970 to slightly more than one-third in of statistics on trade patterns in the OECD coun- recent years. Close to 70 percent of U.S. exports tries and show that the median (across countries) by value are exports of goods, while goods make correlation between the cyclical components of up about 84 percent of U.S. imports (by value). By imports and GDP is 0.61, while the median corre- comparison, goods production accounts for only The world economy is lation between the cyclical components of exports about one-fifth of overall production in the United and GDP is 0.45. Likewise, they show that imports States (measured as a share of value added).5 Fur- still far from a 1930s-style are about three times more volatile than GDP in thermore, the goods traded across international Chart 2 International Trade Moves with the Business Cycle Annual growth rate (percent) 15 Global exports of goods and services 10 5 Global GDP 0 –5 –10 –15 ’80 ’85 ’90 ’95 SOURCE: International Monetary Fund World Economic Outlook, January 2010 Update. ’00 ’05 ’10 protectionist outcome. 8 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report borders tend to be durable rather than nondu- in their study of the Great Depression and Chari, rable. Table 4 of Engel and Wang (2007) reports Kehoe and McGrattan (2007) in their study of the share of durable goods in the imports and postwar U.S. business cycles.7 Levchenko, Lewis exports of the OECD countries and shows that the and Tesar start with demand relationships that median share in recent decades has been around express domestic consumption of foreign output 60 percent. (or imports) as a function of the price of foreign So, international trade flows tend to move goods relative to domestic goods (with a constant with the business cycle; indeed, they tend to elasticity) and the scale of domestic economic increase by more in good times and decline by activity (with a constant elasticity of unity). They more in bad times than the rest of the economy. It then calculate for each quarter since 1968 how far should not then come as a great surprise that inter- actual trade flows are from the levels predicted Some of the decline in national trade flows have dried up in the midst of by these demand relationships. They report that the most severe global recession since World War in second quarter 2009, U.S. imports were a lot trade was a natural II. Far from telling us about incipient deglobaliza- lower than would have been predicted based on cyclical phenomenon. tion, as some feared at the time, some of the de- this simple relationship. In Chart 3 I show my own cline in trade was a natural cyclical phenomenon. estimates of the trade wedge over the same period. The collapse in 2009 stands out. The trade wedge, The Excess Trade Collapse the deviation of trade from levels predicted by It appears that the decline in trade was greater relative prices and the level of economic activity, than one might have expected, given what hap- was –33 percent in the first quarter of 2009 and pened over the same period to the usual determi- –40 percent in the second. This suggests that the nants of trade flows, specifically the relative price financial crisis had a more direct impact on trade of the traded goods and the level of economic flows, over and above the effect it had through the activity. For example, following Chinn (2009), decline in economic activity. Why? One possibil- Wynne and Kersting (2009) estimate a simple ity is that stress in the financial system caused model of U.S. import demand that relates real im- financial institutions to cut back on trade finance ports of goods and services into the United States to exporting firms. to U.S. real GDP and the real value of the dollar. A priori one would expect imports to be positively Access to Trade Finance as an related to real GDP and negatively related to the Explanation real value of the dollar, and a simple model along Before proceeding, we might pause to ask these lines does a reasonably good job at captur- exactly what trade finance is.8 The broadest defini- ing the quarter-to-quarter changes in the growth of tion of trade finance includes every kind of loan, U.S. imports over the past three decades. However, insurance policy or guarantee that is directly tied the model predicted a decline in U.S. imports of 3.7 to an international sale of a good or service. This percent in first quarter 2009, but the actual decline definition captures anything from direct trade (in the vintage of data used in the Wynne and credit extended by an exporter to an overseas cus- Kersting study) was 11.3 percent. tomer to government-backed guarantees issued by 6 A similar exercise is reported in Levchenko, a country’s official export credit agency. The other Lewis and Tesar (2009). However, rather than es- key institutions involved in trade finance are com- timate an import demand equation for the United mercial banks, multilateral development banks States, they perform a “wedge accounting” exercise and private insurers. In addition, various trade fiof the sort pioneered by Cole and Ohanian (2002) nance instruments are used to insure against risks Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 9 Chart 3 The Trade Wedge Illustrates 2009 Collapse Percent 40 30 20 10 0 The form that trade finance –10 takes will typically depend –20 on the degree of trust –30 between the two parties –40 –50 engaged in trade and the ’80 ’85 ’90 ’95 ’00 ’05 degree to which one or both parties is dependent on SOURCES: Bureau of Economic Analysis; author's calculations. bank financing. arising from international transactions, such as country with high political risk. Cash in advance is commercial risk, transportation risk and political least risky from the perspective of the exporter and risk. According to some estimates, about 80 to 90 most risky from the perspective of the importer. percent of global trade relies on trade finance, and The allocation of risks is reversed when the trans- most of this finance is short-term in nature. action takes place on open account. 9 The form that trade finance takes will typically Between these two extremes, banks offer a va- depend on the degree of trust between the two riety of products to offset the risk of nonpayment parties engaged in trade and the degree to which or nondelivery. A letter of credit is a commitment one or both parties is dependent on bank financ- by a bank on behalf of the importer that payment ing. Transactions that involve only the exporter will be made as soon as the terms and conditions and importer can be done on a cash-in-advance in the letter are satisfied. With a letter of credit, the basis (where the importer pays the exporter before exporter need no longer be concerned about the the goods are shipped) or on an open-account creditworthiness of the importer, but only with the basis (where the exporter is paid after the goods creditworthiness of the issuing bank. However, are shipped to the importer). The latter arrange- letters of credit are typically the most expensive ment constitutes an extension of trade credit in form of trade finance. A less expensive option is the usual sense by the exporter to the importer. documentary collection, where the exporter uses Cash in advance is used mainly when the importer a bank as its agent to collect payment from the has particularly high credit risk or is located in a importer once it presents the shipping documents 10 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report to the bank. While the bank facilitates payment demand shocks) and find that the exports of of the exporter, it does not offer any guarantee, so manufacturing sectors that are more dependent documentary collection is typically cheaper than a on external finance tend to grow significantly more letter of credit. Banks also offer export credit insur- slowly than other sectors during a banking crisis. ance when goods are sold on open account and However, what appears to be key is dependence also finance exports through working capital loans. on bank finance as opposed to other forms of What can we say quantitatively about the external finance (for example, trade credit), which impact of the financial crisis on the availability of would be consistent with the idea that the avail- trade finance? Surprisingly little, it turns out. There ability of trade finance declines during banking are no comprehensive measures of the volume of crises. Iacovone and Zavacka also find that sectors trade finance outstanding or indicators of its cost with more tangible assets that can be used as col- While exporters everywhere or availability. Such measures as do exist provide lateral also tend to do better in terms of maintain- at best a partial picture of what is happening. As ing exports during a banking crisis.11 were confronted with higher Auboin (2009) notes, at present the only source of trade finance costs, the reliable data on trade finance is the Berne Union trade finance has important implications for firms’ database, which covers trade credit insurance. exports is provided by Amiti and Weinstein (2009). decline in trade finance When concerns about the availability of trade They use a unique Japanese data set that allows availability occurred credit were at their peak in the fall of 2008, the them to match banks to individual firms to exam- International Monetary Fund conducted a survey ine the consequences of the Japanese financial primarily in the emerging of major banks in emerging markets and advanced crises of the 1990s for Japanese manufacturing ex- markets. economies in conjunction with the Bankers’ Asso- ports over that decade. Japanese exports declined ciation for Finance and Trade to get a more com- 6.7 percent in 1993 and 7.1 percent in 1999.12 The plete picture of the state of trade finance.10 More first decline came on the heels of the first round than 70 percent of the banks surveyed noted that of bank problems following the bursting of the the prices of letters of credit had risen relative to stock price and real estate bubbles in 1989 and 2007, while more than 90 percent reported higher 1991, respectively. The second decline in exports rates for short- and medium-term lending facilities was preceded by an intensification of the financial where the goods exported served as collateral. crisis in late 1997 that culminated in the national- Unsurprisingly, most of the survey respondents at- ization of the Long-Term Credit Bank (at the time tributed the higher prices to their increased cost of the eighth-largest bank in the world) at the end of funds. While exporters everywhere were confront- 1998. For each firm in their sample, which covers ed with higher trade finance costs, the decline in the period 1986 to 1999, they are able to identify trade finance availability occurred primarily in the its main “reference bank,” which is the bank that emerging markets. Trade among advanced econo- would typically handle the firms’ payment settle- mies seemed largely unaffected by the availability ment and foreign exchange dealings, that is, trade (or otherwise) of trade finance, while the availabil- finance needs. Amiti and Weinstein find a statisti- ity of financing for imports from South Asia, South cally significant relationship between the health Korea and China had decreased sharply. of these banks (as measured by changes in their Research by Iacovone and Zavacka (2009) Additional historical evidence that access to market-to-book ratios) and firms’ export growth. shows that banking crises generally do have an Specifically, a deterioration in the health of a firm’s impact on exports. They disentangle the effects main reference bank is usually followed within a of banking crises from the effects of other types year by a decline in its exports. They also find that of shocks that might affect exports (specifically, while a deterioration in bank health also has a det- Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 11 Trade and Shipping With the collapse of global trade, there was a simultaneous collapse in the demand for shipping services to transport goods internationally. According to media reports, by the summer of 2009 almost 10 percent of the global merchant shipping fleet (container ships, bulk carriers, tankers, car carriers and so on) had been laid up due to the collapse in trade. Naturally this manifested itself in shipping costs. While we do not have a good comprehensive measure of what it costs to ship goods around the world, the chart shows the recent behavior of two closely watched indexes. The Baltic Dry Index tells us what is going on in one segment of the shipping market, namely that for dry bulk commodities such as coal, iron ore and grain. After peaking at 11,793 on May 20, 2008, the index collapsed to 663 on Dec. 5, 2008 (a decline of just over 94 percent), before posting gradual improvements over the course of 2009 and into 2010. The HARPEX index, produced on a weekly basis by the shipbroking firm Harper Petersen, is a measure of the cost of shipping containers. Unlike the Baltic Dry Index, it has yet to show signs of a recovery. As of Jan. 1, 2010, the HARPEX index stood at 317.44, down from a precrisis peak of 1,444.62. The differential behavior of the two cost indexes over the past year as trade volume picked up is interesting and probably reflects capacity problems in the container liner services. This segment of the shipping market, which accounts for close to two-thirds of the market for seaborne trade, expanded dramatically as supply chains became more globalized. Movements in shipping costs reflect a number of factors. The capacity of the global merchant shipping fleet adjusts only slowly in response to increased demand due to greater trade volumes. Rapid growth in the demand for shipping capacity to move raw materials to China and other emerging markets is believed to have been instrumental in the run-up in the Baltic Dry Index in 2007 and 2008. However, higher energy prices probably also played a role. Oil prices, as measured by the price of West Texas Intermediate, peaked at $145.66 a barrel on July 11, 2008. (Prices of fuel oil—No. 2 New York—peaked the same day at $4.0425 a gallon.) The peak in oil prices came just two months after the peak in the Baltic Dry Index, and then the two series declined dramatically over the remainder of 2008. Both series have since shown a steady improvement. The tight correlation between the two series suggests that oil prices are an important component of overall shipping costs. But it is also consistent with both series being driven by a common third factor—global economic activity. Shipping Costs Reflect Global Economic Activity Index Index 14,000 1,600 1,400 HARPEX 12,000 HARPEX 78 percent decline 10,000 1,200 1,000 8,000 800 6,000 Baltic Dry Index 600 Baltic Dry 94 percent decline 4,000 400 2,000 200 0 2006 SOURCES: Harper Petersen and Co.; Bloomberg. 2007 2008 2009 0 2010 12 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report rimental effect on domestic sales, the effect is a lot understood as the entire array of financial prod- smaller than the effect on exports, consistent with ucts that serve to facilitate international trade. This the view that exporting is a particularly finance- includes—in addition to that portion of trade credit dependent activity due to its greater riskiness. extended to or received from foreign customers or But is there any evidence that the drying up of vendors—bank loans to finance working capital trade finance contributed to the excessive decline to produce for export; letters of credit; insurance; in global trade during the recent crisis? Levchenko, and the host of other financial products that exist Lewis and Tesar (2009) investigate the possibility to mitigate the risks associated with international that a collapse of trade credit was a key determi- trade. nant of the collapse of U.S. imports and exports Some indirect evidence that access to trade over the period June 2008 through June 2009 by finance was indeed a critical factor contributing to The availability of trade examining import and export performance over a the 2008–09 decline in global trade is presented large number of sectors and asking whether those by Chor and Manova (2009). Their idea is to use finance declines during sectors that are most dependent on trade credit or interbank lending rates in different countries as banking crises. most willing to extend it saw larger declines. They a measure of the cost of external capital (includ- are unable to find any statistically significant rela- ing trade finance) to firms. They interpret higher tionship, and they conclude that a collapse of trade interbank rates as being indicative of tighter credit credit is not a plausible candidate for explaining markets, and they document that countries with the excess decline. higher rates tend to export less to the United However, this finding needs to be interpreted States. Of course, the need to access external with caution. The terms trade credit and trade finance varies across sectors, as does the ability finance are often used interchangeably, but as we to post collateral for loans or the ability to obtain have noted above, there are important differ- trade credit. Chor and Manova show that coun- ences. The term trade credit is best defined as tries with tighter credit conditions suffered a larger credit created or extended by a nonfinancial firm decline in exports to the United States during the to one of its customers when there is a mismatch crisis, and these effects were most apparent in the in time between when goods are ordered and sectors that were most dependent on external fi- delivered and when they are paid for. Trade credit nance, had the fewest collateralizable assets or had in this sense is reflected in the accounts receiv- the least access to trade credit from trade partners. able on a firm’s balance sheet (with a matching Based on reduced-form estimates, they conclude amount showing up in the accounts payable on that “… U.S. imports would have fallen by 25.6% the customer’s balance sheet.) Levchenko, Lewis more if interbank rates had remained at their 13 and Tesar (2009) employ exactly such measures of peak September 2008 level through April 2009, estrade credit (either accounts payable relative to the sentially doubling the actual percentage decline in cost of goods sold or accounts receivable relative trade volumes observed after September 2009.” to total sales) to assess whether a contraction in The findings of Chor and Manova are consis- trade credit played an important role in the con- tent with the findings of Bricongne et al. (2009) for traction of global trade. Of course, such measures French exporters. They look at the performance do not distinguish between trade credit extended of about 100,000 individual French exporters to domestic customers (or received from domestic through April 2009 and find that firms in sectors vendors) and trade credit extended to foreign cus- more structurally dependent on external finance tomers (or received from foreign vendors). Trade experienced the biggest declines in exports. finance, as it pertains to international trade, is best However, their data do not allow them to distin- Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 13 guish between finance for international trade and finance, had the fewest collateralizable assets and finance for generic working capital. had the least access to trade credit. So, evidence in support of the trade finance Finance is often viewed as a veil on the engine story is, at best, suggestive. A more conclusive of the real economy, but as has been observed, evaluation of the idea will depend on better “when the veil flutters, the engine sputters.” The measures of trade finance becoming available. collapse of global trade in 2008–09 has drawn But the evidence does highlight the need for a attention to the little-studied area of trade finance better understanding of finance’s role in facilitating and the important role it plays in facilitating global international trade and points to the existence of a commerce. financial accelerator for exports similar to that gen—Mark Wynne erally believed to exist for real economic activity. Conclusions In 2008–09, global trade collapsed at a pace not seen since the Great Depression, raising concerns in some quarters that the globalization of the past three decades was going to be reversed. Global trade has since recovered (although it has yet to attain its precrisis level), and to date there seems to have been limited use of protectionist measures. However, given the prospect of elevated unemployment levels in many countries for some time to come, the pressures to engage in some form of protectionism will remain and will continue to pose a threat to free trade. Much of the decline in trade can be explained by the severity of the downturn in economic activity. But some of the decline was excessive, over and above what would have been warranted by the collapse in activity. In this essay, I have focused on limited access to trade finance as a possible explanation for the excessive decline. Existing models of international trade do not assign a prominent role to access to trade finance as an important determinant of trade. And data limitations make it very difficult to determine just how important a role trade finance plays empirically. But the limited evidence available suggests that access to trade finance is an important determinant of a firm’s ability to export and that the declines in exports to the United States were greatest among firms in countries where access to finance was already limited and for firms that were most dependent on external Notes An alternative measure of global trade from the OECD’s Main Economic Indicators tells a similar story. After peaking at $2.606 trillion (measured in year 2000 dollars) in first quarter 2008, global imports of goods and services declined to a low of $2.164 trillion in second quarter 2009 (a decline of just under 17 percent), before rebounding in the third quarter. The OECD’s measure of global exports of goods and services peaked at $2.572 trillion (2000 dollars) in second quarter 2008. This was not all that different from the first quarter figure of $2.271 trillion. The exports measure bottomed out at $2.160 trillion in second quarter 2009 (a decline of 16 percent) and subsequently rebounded. The OECD measure has the advantage of including trade in services as well as having a longer time series than the CPB measure. However, it tends to lag the CPB series in terms of availability and also relies more heavily on projections for a number of countries rather than actual published data. 2 For example, the measure of global exports reported as part of the International Monetary Fund’s International Financial Statistics database, which starts with April 1949, showed exports declining by 25 to 30 percent (on a 12-month basis) each month from January through August 2009. The only declines of comparable magnitude in this measure occurred in 1956, when exports fell about 20 percent each month from June through December. However, these statistics measure nominal rather than real trade volumes. The measure of global exports of goods and services that the OECD reports as part of its Main Economic Indicators is a real series (measured in constant 2005 dollars). This series starts in first quarter 1970. In the first and second quarters of 2009, global exports as measured by this series posted declines in excess of 14 percent (on a four-quarter basis) in both quarters, the largest declines in the series’ history. 3 The extent to which the resort to protectionism during the Great Depression contributed to the severity of the Depression is the subject of some controversy. Mario Crucini and James Kahn (1996) were the first to conduct a quantitative analysis of tariffs’ contribution to the decline in economic 1 Much of the decline in trade can be explained by the severity of the downturn in economic activity. But some of the decline was excessive, over and above what would have been warranted by the collapse in activity. 14 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report activity during the Great Depression. They showed that even when international trade constitutes a small share of aggregate output, tariffs and other trade barriers can have a significant negative effect on GDP if the goods that are traded are used as intermediate inputs in production. They conclude that the tariff war during the 1930s could have reduced U.S. gross national product by as much as 2 percent. 4 The statistics that Engel and Wang (2007) report are based on Hodrick–Prescott filtered data with smoothing parameter of 1600. 5 Goods production (defined as the sum of agriculture, mining, construction and manufacturing) accounts for a slightly higher share of gross output, closer to 30 percent. 6 The most recent vintage of the National Income and Product Accounts puts the decline of first quarter 2009 at 10.7 percent. 7 See also Ahearne, Kydland and Wynne (2005) and Cociuba and Ueberfeldt (2008) for examples of wedge accounting exercises, albeit in closed-economy frameworks. 8 See chapter 18 of Bekaert and Hodrick (2009) for a lengthy exposition of various options for financing international trade, or see U.S. Department of Commerce (2008). 9 See, for example, Auboin (2009). 10 See Dorsey (2009) and International Monetary Fund (2009). 11 According to Table 2 of Iacovone and Zavacka, tangible assets are 62 percent of the total assets of firms in the petroleum refining sector but a mere 14 percent of assets in the office and computing sector. 12 Exports also declined 1.8 percent in 1998 but posted increases in every other year of the decade. 13 See also the discussion in footnote 2 of Amiti and Weinstein (2009) on the differences between the accounting and finance uses of these terms. References Ahearne, Alan, Finn Kydland and Mark A. Wynne (2005), “Ireland’s Great Depression,” Economic and Social Review 37 (2): 215–43. Amiti, Mary, and David E. Weinstein (2009), “Exports and Financial Shocks,” NBER Working Paper Series, no. 15556 (Cambridge, Mass., National Bureau of Economic Research, December). Auboin, Marc (2009), “Boosting the Availability of Trade Finance in the Current Crisis: Background Analysis for a Substantial G20 Package,” CEPR Policy Insight no. 35 (London, Centre for Economic Policy Research, June). Bekaert, Geert, and Robert J. Hodrick (2009), International Financial Management (Upper Saddle River, N.J.: Pearson Prentice Hall). Bricongne, Jean-Charles, Lionel Fontagné, Guillaume Gaulier, Daria Taglioni and Vincent Vicard (2009), “Firms and the Global Crisis: French Exports in the Turmoil,” Banque de France Document de Travail no. 265 (Paris, Banque de France, December). Chari, V.V., Patrick J. Kehoe and Ellen R. McGrattan (2007), “Business Cycle Accounting,” Econometrica 75 (3): 781–836. Chinn, Menzie (2009), “Update on U.S. Exports and Imports: The Collapse Continues,” Econbrowser blog, June 23, 2009, www.econbrowser.com/archives/2009/06/update_ on_us_ex.html#more. Chor, Davin, and Kalina Manova (2009), “Off the Cliff and Back? Credit Conditions and International Trade During the Global Financial Crisis” (Rochester, N.Y., Social Science Research Network, Dec. 15), http://ssrn.com/ abstract=1502911. Cociuba, Simona E., and Alexander Ueberfeldt (2008), “Driving Forces of the Canadian Economy: An Accounting Exercise,” Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper no. 6 (March). Cole, Harold L., and Lee Ohanian (2002), “The U.S. and the U.K. Great Depressions Through the Lens of Neoclassical Growth Theory,” American Economic Review Papers and Proceedings 92 (2): 28–32. Crucini, Mario J., and James Kahn (1996), “Tariffs and Aggregate Economic Activity: Lessons from the Great Depression,” Journal of Monetary Economics 38 (3): 427–67. Dorsey, Thomas (2009), “Trade Finance Stumbles,” Finance and Development 46 (1): 18–19. Engel, Charles, and Jian Wang (2007), “International Trade in Durable Goods: Understanding Volatility, Cyclicality and Elasticities,” Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper no. 3 (November). Evenett, Simon J. (2009), The Unrelenting Pressure of Protectionism: The 3rd GTA Report—A Focus on the Asia-Pacific Region (London: Centre for Economic Policy Research). Iacovone, Leonardo, and Veronika Zavacka (2009), “Banking Crises and Exports: Lessons from the Past,” Policy Research Working Paper Series, no. 5016 (Washington, D.C., World Bank, August). Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 15 International Monetary Fund (2009), “Survey of Private Sector Trade Credit Developments” (Washington, D.C., International Monetary Fund, February), www.imf.org/ external/np/pp/eng/2009/022709.pdf. Levchenko, Andrei A., Logan Lewis and Linda L. Tesar (2009), “The Collapse of International Trade During the 2008–2009 Crisis: In Search of the Smoking Gun,” Gerald R. Ford School of Public Policy Research Seminar in International Economics Discussion Paper no. 592 (Ann Arbor, Mich., University of Michigan, August). OECD, UNCTAD and WTO (2010), “Report on G20 Trade and Investment Measures” (Organization for Economic Cooperation and Development, U.N. Conference on Trade and Development, and the World Trade Organization, March), www.wto.org/english/news_e/news10_e/trim_ report_08mar10_e.doc. U.S. Department of Commerce: International Trade Administration (2008), Trade Finance Guide: A Quick Reference for U.S. Exporters (Washington, D.C.: U.S. Department of Commerce). Wynne, Mark A., and Erasmus K. Kersting (2009), “Trade, Globalization and the Financial Crisis,” Federal Reserve Bank of Dallas Economic Letter, no. 8. 16 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Summary of Activities For 2009, the Dallas Fed had two high- was accepted for publication at the Journal of priority objectives that pertained to research: International Money and Finance in December “Produce high-quality current analysis and 2008 (too late for inclusion in last year’s annual long-term research that enable the Dallas Fed to report). Anthony Landry’s paper “Expectations be an active player and intellectual leader in the and Exchange Rate Dynamics: A State-Depen- Federal Open Market Committee’s monetary dent Pricing Approach,” which was circulated as policy deliberations” and “Promote research Research Department Working Paper No. 0604, that deepens our understanding of the implica- was accepted for publication at the Journal of tions of globalization for U.S. monetary policy International Economics in December 2008. through the Globalization and Monetary Policy Ananth Ramanarayanan’s paper “Vertical Institute.” Contributing to these two high-pri- Specialization and International Business Cycle ority objectives, Enrique Martínez-García and Synchronization” (joint with Costas Arkolakis Mark Wynne gave a presentation on the global of Yale University), which appeared as Institute slack hypothesis to the full FOMC at its Decem- Working Paper No. 21, was accepted for publica- ber 2009 meeting. This presentation was part tion in the Scandinavian Journal of Economics of a broader set of presentations on inflation in a December 2009 special issue of that journal dynamics. The paper underlying the presenta- on “Heterogeneous Firms and International tion is forthcoming as a Staff Paper in 2010. Trade.” Enrique Martínez-García’s paper “Investment and Trade Patterns in a Sticky-Price, Academic Research The core business product of the institute Open-Economy Model” (coauthored with Globalization and Monetary Policy Institute is its Working Paper series. By year end, we had research associate Jens Søndergaard of the Bank circulated 40 papers in the series. One of the of England) was accepted for publication in a working papers contributed by our advisory book of conference proceedings. (For recent board member William White on “Should Mon- working paper abstracts, see page 30.) etary Policy ‘Lean or Clean’?” received some high-profile press coverage and was one of the most downloaded publications on our website in 2009. However, working papers are just an Bank Publications The institute published eight international updates on the web and five Economic Letters on “Seeking Stability: What’s Next for Banking intermediate step—the ultimate objective is Regulation?” (by Simona Cociuba), “Trade, to have the research meet the standards of the Globalization and the Financial Crisis” (by peer-reviewed literature and be published in Mark Wynne and research associate Erasmus academic journals. Jian Wang’s paper “Home Kersting), “Ties that Bind: Bilateral Trade’s Role Bias, Exchange Rate Disconnect, and Optimal in Synchronizing Business Cycles” (by Ananth Exchange Rate Policy,” which was circulated as Ramanarayanan), “Has Greater Globalization Research Department Working Paper No. 0701, Made Forecasting Inflation More Difficult?” Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 17 (by Mark Wynne and Patrick Roy) and “Labor of England and the Bank for International Market Globalization in the Recession and Settlements), as well as several high-profile Beyond” (by W. Michael Cox, Richard Alm and conferences (most notably the Econometric Justyna Dymerska). The institute also published Society North American summer meeting and one Staff Paper on “Exchange Rate Policies” the Canadian Economics Association annual by senior fellow Charles Engel. The staff also meeting). Mark Wynne gave a series of lectures received some external recognition for their on “Globalization and Financial Services” at the contributions to Bank publications. The Winter American Bankers Association Stonier National 2009 issue of the Journal of Economic Perspec- Graduate School of Banking at the University of tives, a publication of the American Economic Pennsylvania in June. Association, highlighted Anthony Landry’s 2008 The institute hosted a number of external Economic Letter on “The Big Mac: A Global-to- seminar speakers over the course of the year, and Local Look at Pricing” in its Recommendations we added 11 research associates to our network. for Further Reading listing. Simona Cociuba’s (A list of all the research associates is on page 44.) Economic Letter on bank regulation is featured on the St. Louis Fed’s website dedicated to the financial crisis. Other Activity Governor Masaaki Shirakawa of the Bank of Japan formally joined the advisory board of the Conferences and Seminars Institute economists have been active over institute effective July 3, and Heng Swee Keat, managing director of the Monetary Authority of the past year presenting their work at conferenc- Singapore, joined the advisory board in August. es and seminars. Staff gave several presentations A key component of the institute’s strategy at the January 2009 meeting of the American to promote research and raise the visibility of Economic Association and organized sessions the Dallas Fed in the broader research commu- at the meeting. In April, the institute organized a nity is to run a very active visitor and seminar conference on “Globalization, Political Economy program. We hosted a number of visitors over and Trade Policy” jointly with the Department the summer, including Ina Simonovska of the of Economics at Southern Methodist University. University of California at Davis, Karen Lewis of (More details are provided in the conference the University of Pennsylvania, Pengfei Wang of summary on page 18.) On Oct. 1–2, we hosted Hong Kong University of Science and Tech- the annual meeting of the Federal Reserve nology and Chikako Baba of the University of System Committee on International Economic Wisconsin and IMF. Erasmus Kersting, a recent Analysis at the San Antonio Branch. On Nov. Texas A&M Ph.D. and currently a visiting as- 13–14, we hosted a joint conference with the sistant professor at SMU, spent the summer Bank of Canada on international capital flows working with Mark Wynne on a project on at the Dallas office. (More details are provided international trade finance and its role in the in the conference summary on page 24.) The contraction of global trade over the last year. institute also cosponsored a conference with the Tatsuma Wada from Wayne State University be- O’Neil Center for Global Markets and Freedom gan an extended visit to the institute in Septem- at SMU on Oct. 16 on “What Do Businesses Need ber. Several of these visitors have subsequently to Succeed in Today’s Global Economy?” joined our network of research associates. Staff presented their research at a number of prestigious venues (such as the Bank —Mark Wynne 18 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Conference on Globalization, Political Economy and Trade Policy On April 24 and 25, 2009, the Globalization final goods are produced by combining the and Monetary Policy Institute joined with South- outputs of the tasks, which might be regarded as ern Methodist University to cosponsor a confer- similar to intermediate goods. This final step has to ence on Globalization, Political Economy and be done in the headquarters country. In a previ- Trade Policy at SMU’s Collins Executive Education ous paper, the authors proposed a theory of task Center. Nine scholarly papers were presented and trade between countries with dissimilar relative discussed in three sessions. The first session consisted of two papers describing offshoring’s impact on the distribution of work and the relative unemployment and wages factor endowments, generating interesting results that differ from the traditional factor endowmentbased Heckscher–Ohlin model. In the present paper, Grossman and Rossi- of unskilled labor. A third offering focused on how Hansberg propose a theory of task trade between foreign direct investment (FDI) flows from more- countries that have similar relative factor endow- to less-developed countries influence innovation. ments but differ in size. Firms produce differenti- The second session started with a paper ated goods by performing a continuum of tasks, focusing on the rationale for multilateral trade each of which generates local spillovers. Tasks can agreements, followed by two presentations on in- be performed at home or abroad, but offshoring ternational protection of intellectual property. The costs vary. A crucial assumption is that the tasks first two papers in the last session concern export are characterized by external economies of scale dynamics, and the third discusses the relationship at the national level. between bilateral trade agreements and multilateral trade liberalization. In equilibrium, tasks with the highest offshoring costs may not be traded at all. Among the remainder, those with higher offshoring costs are Offshoring and FDI Princeton University professor Gene Gross- performed in the country that has higher wages and aggregate output. When offshoring costs man presented the conference’s first paper, titled aren’t too high, firms concentrate certain tasks in “Task Trade Between Similar Countries” and particular locations to realize external economies coauthored with his Princeton colleague Esteban of scale. Grossman and Rossi-Hansberg discuss Rossi-Hansberg. the relationship between equilibrium wages, equi- Most models treat the objects of international trade as final goods, not abstract tasks. However, librium outputs and relative country size, examining how the pattern of specialization reflects the Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 19 model’s key parameters. workers’ wages. The unskilled wage can increase or The theory predicts the pattern of task special- decrease as a result of offshoring. ization for countries that differ only in size. The The opening session’s final paper, titled authors find an equilibrium always exists in which “Southern Innovation and Backward Knowledge the larger country has higher wages and greater Spillovers: A Dynamic FDI Model,” was presented aggregate output of final goods. by professor Keith E. Maskus of University of If offshoring costs are low enough and the countries aren’t too different in size, another equilibrium may exist in which the smaller country Colorado at Boulder and coauthored with his colleague Yin He. The focus is a theory concerning the trade and has higher wages and greater aggregate output. In FDI relationships between the more-advanced either case, the country with the higher wages and countries of the North and the less-developed output performs tasks that are more difficult and countries of the South. costly to offshore. Syracuse University professor Devashish The authors develop a model in which the portion of Northern firms choosing to become Mitra presented the second paper, titled “Search multinationals is endogenous. In the benchmark and Offshoring in the Presence of ‘Animal Spirits,’” model, Northern firms engage in innovation coauthored with Priya Ranjan of the University of based on the local knowledge stock and learning- California at Irvine. by-doing (LBD), and a share of these products is The authors introduce two sources of unem- transferred to Southern production via FDI. An ployment in a two-factor, closed-economy general increase in Southern imitation limits the rate at equilibrium model—search frictions and fairness which countries become multinational. considerations. Models with search friction are the Up to this point, the model is pretty standard. most widely used for analyzing unemployment The Maskus and He innovation involves extending in a general equilibrium setting. Recently, mod- the model to permit Southern innovation based on els with fairness considerations have generated the amount of local knowledge and LBD. Because increasing interest. Southern firms have higher innovation costs, this Basically, this kind of model assumes un- generates inefficient specialization in both regions skilled workers demand wages that aren’t too far and reduces global growth. The authors also allow below those of skilled workers. This normally leads for “backward spillovers” to Northern innovation, to unemployment of unskilled workers but not which partially restores global efficiency and necessarily skilled workers. growth. In the present paper, the authors find that Backward spillovers from the South to the a binding fair-wage constraint increases the North do occur. In his presentation, Mascus point- unskilled unemployment rate and can at the same ed out that the video compact disk was invented time lead to a higher jobless rate for skilled work- in China, but the technology wasn’t patented. A ers. The wages of unskilled workers increase and Japanese firm learned and patented the technol- the wages of skilled workers decrease. ogy, which eventually evolved into the DVD. Next they introduce offshoring of unskilled The model’s results highlight a possibility not jobs into the model, which makes it more likely widely recognized. Specifically, technology trans- that the fair-wage constraint becomes bind- fer through multinational investment tends to rise ing. Offshoring of unskilled jobs always leads to with a decline in imitation risk, perhaps achieved increases in unskilled unemployment, decreases through strengthening intellectual property pro- in skilled unemployment and increases in skilled tection. Thus, multinationals may kick off a process 20 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report in the South in which local imitation and LBD competitive markets. In all the models, address- establish the possibility of domestic innovation as ing inefficient terms-of-trade restrictions in trade R&D costs fall. volume is the only rationale for trade agree- In equilibrium, however, all Southern firms that innovate and invest in multinational subsidiaries must obtain the same economic return ments—whether or not governments have political or economic objectives. Having identified the problem trade agree- and cover both the innovation costs and the FDI ments might solve, Bagwell and Staiger proceed to setup cost. This implies that costs of innovation the next step and evaluate the form that efficiency- will remain higher in the South than the North. As enhancing pacts might take. Once again, their a result, inefficient specialization can reduce FDI results parallel the established results for models and global knowledge accumulation. with perfectly competitive markets. To counter this, a Southern policy of strength- In particular, Bagwell and Staiger show that ening intellectual property protection and reduc- the principles of reciprocity and non-discrimi- ing the costs of inward investment can expand nation (i.e., most-favored-nation provisions) are multinational contacts and growth, an effect efficiency-enhancing because they undo the enhanced by backward spillovers to the advanced terms-of-trade restrictions in trade volume that countries. occur when governments pursue unilateral trade policies. Trade and Intellectual Property Stanford University professor Kyle Bagwell kicked off the second session with “Profit Shifting The analysis suggests that the important implications of the terms-of-trade approach are quite general, applying not just to perfectly competitive and Trade Agreements in Imperfectly Competitive but also to a wide range of imperfectly competitive Markets,” coauthored with his Stanford colleague markets. However, they emphasize that this paper Robert W. Staiger. considers only markets for which the number of The authors have been leaders in the analysis of multilateral trade agreements. They argue that firms is fixed. In a companion paper in 2008, they consid- countries constrained by such agreements are less ered imperfectly competitive models in which the likely to alter the terms of trade in their favor and number of firms is endogenous. They concluded impose negative externalities on other countries. that the inefficiencies associated with terms-of- Their previous work has mainly concentrated on trade motivations provide the only rationale for perfectly competitive markets. trade agreements in this setting as well. Under imperfect competition, trade policies Edwin Lai of the Federal Reserve Bank of can alter the terms of trade, shift profits from one Dallas presented the next paper, “Innovation, country to another and moderate or exacerbate Intellectual Property Protection and Globaliza- existing distortions associated with monopoly tion,” coauthored with Davin Chor of Singapore power. In light of the various ways trade policies Management University. may influence welfare, we might expect that new Patent protection often takes the form of rationales for trade agreements would arise under restrictions on how easily innovators are allowed imperfectly competitive markets. to invent around existing patents, which the au- In their paper, the authors consider a se- thors term “patent breadth.” Lai and Chor explore quence of trade models that feature imperfectly the implications of a patenting regime based on competitive markets, finding the same basic patent breadth by incorporating such intellectual rationale for trade agreements as under perfectly property protection considerations in a quality-im- Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 21 provement model of technology, trade and growth. SMU’s Kamal Saggi. The authors first study how changes in pat- The paper analyzes the effects of strengthen- ent breadth affect innovation rates and welfare ing intellectual property rights in developing coun- in a closed-economy benchmark. In considering tries on the level and composition of industrial whether to increase patent breadth, policymakers development. The authors first develop the theory face a tradeoff between the benefits of higher in- of a North–South product cycle in which Northern novation rates and the costs of higher prices from innovation, Southern imitation and FDI are all granting patent-holders monopoly pricing power endogenous. for a longer duration. They find an optimal breadth The theory predicts that intellectual property under certain reasonable conditions, suggesting rights reform in the South leads to increased FDI government intervention to protect intellectual from the North as developed country firms shift property will improve welfare. production to less-developed country affiliates. The paper goes on to formulate an open- This FDI accelerates Southern industrial develop- economy model in which countries interact ment, bringing increases in both the South’s share through trade and firms patent internationally. of global manufacturing and the pace at which They find a stable equilibrium for patent breadth production of recently invented goods shifts to in which national governments underprotect intel- the South. In addition, the model predicts that lectual property from a global perspective. This result is similar to findings in a 2004 paper by Lai and Grossman, which analyzed international patent protection based on duration Northern resources will be reallocated to R&D as production shifts to the South, driving an increase in the global rate of innovation. The authors go on to test the model’s predic- rather than breadth. Interestingly, home and for- tions by analyzing the responses of U.S.-based eign patent-breadth policies are strategic comple- multinationals and domestic industrial production ments—at least in the symmetric equilibrium. to intellectual property rights reforms in the 1980s This contrasts with Grossman and Lai’s finding and 1990s. that home and foreign patent-length policies are strategic substitutes. In the present paper, Lai and Chor also find First, they find that multinational companies expand the scale of their activities in countries that reform intellectual property rights. Multinationals that countries with larger domestic markets or that make extensive use of intellectual property lower innovative capabilities would tend to set disproportionately increase their use of these larger patent breadths. In addition, globalization’s inputs. reduced trade frictions lead countries to lower Second, there is an overall expansion of patent breadths. As a result, globalization actually industrial activity after intellectual property rights leads to lower equilibrium research intensities in reform, and highly disaggregated trade data indi- all countries. Other studies have found that global- cate an increase in the number of initial exports ization has no general impact on research intensi- in response to reform. These results suggest that ties, making this result even more surprising. the expansion of multinational activity more than Next on the program was professor Lee Branstetter of Carnegie Mellon University, who offsets any decline in indigenous firms’ acquiring intellectual property through imitation. presented a paper titled “Intellectual Property Rights, Imitation and Foreign Direct Investment: Theory and Evidence,” coauthored with Columbia’s Raymond Fisman, Harvard’s C. Fritz Foley and Export Dynamics and Trade Pacts The third session’s first paper, titled “A Search and Learning Model of Export Dynamics,” was 22 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report presented by New York University professor Jonathan Eaton and coauthored with Marcela Eslava, C. J. Krizan, Maurice Kugler and James Tybout. A goal of policy in many developing countries several products and export to many markets. To understand this type of export entrepreneurship, Freund and Pierola examine data on Peru’s nontraditional agriculture exports from is establishing new markets for nontraditional 1994 to 2007. This sector grew sixfold over the exports. Well-known success stories from Latin period, driven in large part by firm entry and new America include Brazilian regional jets, Chilean product and market discoveries. wines and Colombian cut flowers. By finding new The authors identify a pattern of trial and er- buyers abroad, governments hope to create jobs, ror: Firms frequently enter and exit both products bolster demand for their currencies and further and markets. Exits are more likely after one year industrial development. and among firms that start small. Large exporters The paper presents a preliminary theoretical tend to be the first to discover products and mar- framework for analyzing export dynamics at the kets new to their country, and they export more firm level. Specifically, the authors assume that products to more markets. export success reflects a process of search and learning in foreign markets. Producers interested Freund and Pierola develop a model that explains how entrepreneurs decide to develop in a particular overseas market devote resources to new export products and markets in a business identifying potential buyers. When they find one, environment characterized by sunk costs of they learn something about their products’ appeal discovery and uncertainty about costs and foreign in this market. They also learn about the potential demand. The model explains many features of the for profits by observing the experiences of rivals Peruvian data. selling similar products in the foreign market. The authors’ theoretical framework assumes Taking stock of the available information, uncertainty about exporting and sunk costs—this firms initially not selling in the foreign market leads to a process of trial and error, with a high update their beliefs about potential export profits, share of exits after one year. Good entrepreneurs and they adjust the intensity of their search efforts develop large firms that tend to export more to a accordingly, attempting to maximize their net given product and market, enter more markets expected profit streams. Export gains take place and more products, and enter new markets and when firms receive positive early signals about products earlier. Firms also start small and grow potential profits, both from their own experiences exports over time to avoid large losses from un- and from rivals’ experiences, and they intensify competitive products. The data seem to confirm their search and marketing efforts, adding quickly these predictions. to their foreign client base. World Bank economist Caroline Freund The conference’s last paper was “Bilateralism, Multilateralism and the Quest for Global Free presented the next paper, “Export Entrepreneurs: Trade,” presented by Ryerson University professor Evidence from Peru,” coauthored with her World Halis Murat Yildiz and coauthored with Kamal Bank colleague Marta Denisse Pierola. Saggi of SMU. Like the previous paper, this one considers Whether bilateralism is a stepping stone or the dynamics of exporting firms’ entry and exit. stumbling block to multilateral trade liberalization In developing countries, many exporters produce has long been a topic of intense debate. This paper only for foreign markets. These firms tend to be develops an equilibrium theory of trade agree- larger and more productive than firms focused ments and evaluates the relative merits of bilateral- on the domestic market, and they often produce ism and multilateralism. Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 23 The authors envision a three-country game in which each nation faces a range of policy options in negotiating trade agreements—join with both trading partners (i.e., practice free trade), select just one of them for a bilateral pact, or don’t deal with either of them (i.e., opt for the status quo under which all countries impose their optimal tariffs on each other). To determine whether bilateralism matters, they also analyze this game under the assumption that countries follow a purely multilateral approach to trade liberalization. Thus, both the degree and nature of trade liberalization are endogenously determined. First, Yildiz and Saggi find that global free trade is the only stable equilibrium, regardless of whether countries can pursue bilateral agreements. This lends support to the view that bilateral trade agreements aren’t stumbling blocks to multilateral trade liberalization. The second finding focuses on countries with asymmetric endowment levels. For them, there exist circumstances under which free trade is a stable equilibrium only if countries are free to pursue bilateral trade agreements. This supports the view that bilateral trade agreements are stepping stones to multilateralism. These results hold even when governments are politically motivated—that is, they value producer interests and tariff revenue more than consumer benefits that come from freer trade. —Edwin Lai 24 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Conference on Capital Flows, International Financial Markets and Financial Crises Financial markets throughout the world have become increasingly more developed in recent markets—and their regulation—impact the rest of the economy? Specifically, do they result in decades. At the same time, global financial integra- stabilization or amplification of macroeconomic tion has risen: Cross-border financial flows and as- fluctuations in response to shocks? The remainder set holdings have increased significantly over time, of this summary explains why this research is fruitshowing deepening financial-market linkages ful in the context of the current financial turmoil between countries. Economists in various fields and summarizes the researchers’ contributions. have been addressing the effects of more sophisticated financial markets and international financial Why We Need Better Models integration, but many open issues remain. These Two of the conference papers nicely illustrate include evaluating the degree and the macroeco- how the global dimension of the current financial nomic effects of financial integration, assessing crisis underscores the need to develop and apply the role of regulating financial intermediaries and new theoretical models to address these questions. understanding the emergence and transmission of Steve Kamin from the Federal Reserve Board financial crises. The current global financial crisis has brought presented evidence (in a paper coauthored with Laurie Pounder from the Federal Reserve Board) to light the need to develop a better understand- on the degree to which direct financial links ing of these issues and their implications for with the U.S. help explain the different effects on policymaking. To this end, on Nov. 13–14, 2009, foreign countries’ financial markets. Specifically, the Federal Reserve Bank of Dallas and the Bank Kamin and Pounder ask whether the exposure of a of Canada cosponsored a conference on capital country’s financial sector to U.S. mortgage-backed flows, international financial markets and financial securities (MBS) or its dependence on U.S. dollar crises.1 The purpose of the conference was to bring funding can explain how the financial sector in together researchers working on various aspects of that country fared early in the crisis. This question financial markets and financial crises. Many of the is motivated by the fact that, up until late 2008, the papers presented at the conference addressed one crisis had very different effects on many foreign of two broad questions. The first is, how integrated are international financial markets and how effective are they at sharing resources and risk? Second, what are the channels through which financial The papers presented can be found online at dallasfed.org/ institute/events/09capital.cfm. The names mentioned in bold throughout this summary are those of the presenters at the conference. 1 Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 25 countries. If these differences depend closely on crises in one market affect others, it is important to how much those countries were linked to the understand financial integration in the first place— markets for U.S. MBS or short-term U.S. dollar the degree to which it has progressed and the funding—arguably the markets where the financial reasons it has done so. Moreover, the various chancrisis originated—then the way the financial crisis nels of international financial transmission are not was transmitted abroad would be fairly clear. For- obvious, so it is also important to understand what eign financial institutions that directly held a lot of they are and how they work. U.S. MBS would have sustained tremendous losses when the market for these assets turned sour, and How Integrated Are Financial Markets? foreign institutions dependent on dollar funding It is common to point to the rise of cross- would have run into trouble when funding in these border asset holdings as evidence of international markets dried up. However, interestingly, Kamin financial integration. While such observations and Pounder find that these direct financial links tell us a lot about how integrated economies are, explain very little of the decline in financial sector they leave open the questions of why this trade in indicators in foreign countries; some with very financial assets matters, and what exactly are the little exposure to U.S. MBS had quite negative ef- frictions or conditions that make financial markets fects on their financial institutions, and vice versa. more or less imperfect. For these reasons, a long In a paper coauthored with Shang-Jin Wei line of research has used theoretical models to from Columbia University, Hui Tong from the understand the role of financial market integration IMF also addressed the issue of how the effects and the degree to which certain market frictions of the current crisis were transmitted abroad. can rationalize the observed data. In the context Tong and Wei’s paper, in contrast to Kamin and of short-run economic fluctuations, standard Pounder’s, looks at how nonfinancial firms fared in theory provides a role for international financial countries with different levels of dependence on markets to move resources to their most produc- foreign capital flows. The paper asks whether firms tive location, as well as to share risk. International operating in sectors that tend to depend heavily trade in financial assets allows a country with a on outside financing experienced more severe boom to receive investment from abroad, tempo- liquidity problems in countries more dependent rarily importing more than it exports. In addition, on foreign capital inflows. Tong and Wei find that domestic and foreign households trade financial while higher overall inflows of foreign capital assets to smooth out fluctuations in their income were associated with more severe effects on firms, stream and consumption. The level of financial the composition of capital flows matters as well. market integration can in part be understood from Foreign capital in the form of foreign direct invest- measuring how effective these mechanisms are, ment (FDI) was less a culprit than non-FDI capital. and four of the conference papers approach this The reasoning behind this may be that FDI, in the form of foreign multinationals buying out exist- task from different angles. The basic idea of shifting resources to where ing firms or creating subsidiaries, is a more stable they can be most productively used implies that source of foreign financing than non-FDI capital, country pairs with highly integrated financial including debt or portfolio equity investment. markets should have less synchronized output These two papers show how thinking about fluctuations than country pairs with less financial the current financial crisis brings one back to the integration. However, the rise of global financial two main questions raised above. If financial mar- integration has coincided with more interna- kets in different countries are so integrated that tional business cycle synchronization, not less. 26 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Sebnem Kalemli-Ozcan from the University of frame and set of countries that do not include ma- Houston, in a paper with Elias Papaioannou from jor financial disruptions, so it aims to understand Dartmouth College and José Luis Peydró from the functioning of financial markets in “normal” the European Central Bank, sheds some light on times. Whether this is different from the transmis- this apparent contradiction. Their paper consid- sion effects of financial markets during periods of ers data on cross-border banking—the amounts financial stress is a topic that comes up in several of foreign assets and liabilities banks in a country other conference papers. have—to reevaluate the relationship between Looking at implications for consumption rath- financial integration and output synchronization. er than output, Robert Kollmann from Université Kalemli-Ozcan, Papaioannou and Peydró find that Libre de Bruxelles presented a paper addressing when financial integration is measured at the level the risk-sharing role of international financial mar- of individual banks, country pairs that are more kets. Models with perfect financial markets predict integrated do have less synchronized business that relative consumption between two countries cycles; that is, there is evidence of the standard should be tightly linked with the real exchange resource shifting mechanism. The main difference rate—the relative price of national consumption with previous work is the authors’ ability to use the baskets, expressed in a common currency. This Steve Kamin from the Federal microlevel bank data to control for common global means that the functioning of financial markets Reserve Board and Alessandro factors that have increased both financial integra- Rebucci from Inter-American tion and business cycle synchronization over time. consumption basket is relatively inexpensive Development Bank Importantly, however, the paper considers a time ensures that households in a country whose compared with that of a trading partner temporarily consume relatively more. Again, this is another prediction that is not borne out in the data, where there is a very weak relationship between relative consumption and real exchange rates. Kollmann presented a model in which some households do not have access to financial markets, a feature motivated by a widely noted observation that a large fraction of households in the U.S. actually hold no financial assets and therefore just consume their income. In Kollmann’s model, the presence of these “hand-to-mouth” consumers can break the link between aggregate consumption and real exchange rates. The lesson of the paper is that, from the perspective of sharing consumption risk, international financial integration is far from complete, but this has more to do with households’ access to financial assets than with the development of financial markets. In another paper highlighting the difference between international and domestic financial markets, Diego Valderrama from the Federal Reserve Bank of San Francisco (in joint work with Katherine Smith from the U.S. Naval Academy) considers Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 27 why the composition of capital flows in developing ciation and expenditure on imports would decline, economies is so different from that in industrial- closing the deficit. Since the early ’90s, however, ized economies. Specifically, developing countries the U.S. has run a sustained trade deficit, despite have large inflows of FDI and outflows—or smaller a persistent depreciation of the U.S. dollar. Dong’s inflows—of debt, while developed economies tend paper attributes this largely to the fact that imports to have the opposite pattern. Smith and Valder- and exports have become less sensitive to changes rama build on the observation that it is costlier in in their relative prices. She points to higher costs developing countries for firms to issue debt than it for domestic distribution and increased rigidity in is in developed economies. This provides multina- prices as possible explanations for why changes in tional firms the incentive to purchase firms in de- import and export prices do not pass through as veloping countries and use their more developed strongly to the quantities of goods imported and financial markets to finance debt; FDI provides exported. The paper addresses the need to think the channel for this. At the same time, households about international financial markets in the con- would like to save some of their income to smooth text of a broader environment, including interna- out fluctuations; they do this by lending abroad tional trade in goods. because of the higher costs domestic firms face to borrow. The message in this paper is again that Channels of Financial Transmission seemingly incompatible observations can be ratio- The second broad set of questions addressed nalized as the product of individuals’ participation in the conference papers covers the mechanisms in financial markets, as imperfections in these by which shocks are transmitted through the markets affect their decisions and therefore also financial system to the rest of the economy. These affect macroeconomic aggregates. questions are of direct relevance when thinking While international trade in financial assets about the current financial crisis, and the papers certainly has effects on consumption, output covered various ways in which frictions in finan- and the composition of capital flows, its most cial markets can propagate or amplify shocks to direct mechanical manifestation is simply in the generate severe recessions. balance of trade in goods. A country that imports Three papers addressed in detail the effects more than it exports is borrowing from its trading of collateral and leverage in the financial system: partners, and a country whose exports outstrip those by Anton Korinek from the University of imports is lending to its trading partners. Indeed, Maryland (coauthored with Olivier Jeanne from without cross-country trade in financial assets, Johns Hopkins University), Michael Devereux there can be no gap between a country’s exports from the University of British Columbia (coau- and imports. In reality, trade imbalances are signif- thored with James Yetman from the Bank for Inicant—most clearly illustrated by the large and per- ternational Settlements, Hong Kong) and Enrique sistent trade deficit of the U.S. with the rest of the Mendoza from the University of Maryland. These world. In her paper at the conference, Wei Dong papers all study a basic mechanism by which from the Bank of Canada asks what can account small shocks can trigger large real macroeconomic for the behavior of the U.S. trade balance in recent effects through asset prices. In the presence of decades. The question is motivated by the obser- a collateral constraint (alternatively a leverage con- vation that, prior to the early 1990s, a standard straint), individuals—such as banks, households or mechanism naturally stabilizing the trade balance firms—cannot borrow more than a certain fraction seemed to be working: A country with a large trade of the value of their assets. When this constraint is deficit would experience an exchange rate depre- binding, a small negative shock to asset prices can 28 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report generate large effects: The value of collateral falls, argue that moderate taxes on foreign borrowing in- causing borrowing and consumption to decline, hibit excessively large credit booms and therefore which can reduce the value of assets further, caus- reduce or eliminate the chances of an economy ing a cycle of asset price declines and reduced bor- experiencing severe credit busts. rowing and consumption. The three papers apply this basic mechanism in various ways. Jeanne and Korinek explain how an economy Devereux and Yetman consider the effects of collateral constraints on the international transmission of shocks. The motivation for this borrowing from abroad can experience credit question is the widely noted observation that booms and busts that are inefficiently large from a the current financial crisis spread very quickly to social perspective. Rising asset prices increase the many countries, even between those that did not value of collateral and so allow further borrowing, have close links through international trade. The making it more likely that the collateral constraint more important links between these countries is eventually hit, triggering the decline described may be through financial markets, but the channel above. This is socially inefficient because of an of transmission through international financial externality: An individual who takes on more debt linkages is not clearly understood. (In fact, the does not take into account the effect this action general intuition described in the previous sec- Igor Livshits from the University has on asset prices and therefore on others’ bor- tion, and one of the paper’s results, indicate that in of Western Ontario and Robert rowing constraints. As such, Jeanne and Korinek normal times financial links should in fact dampen Kollmann from the Université propose the classic solution to dealing with an transmission of shocks.) Devereux and Yetman Libre de Bruxelles externality: a tax on individuals’ borrowing. They argue that the basic mechanism working through collateral constraints can explain international transmission of shocks through financial linkages. Since investors in a country diversify their asset holdings between domestic and foreign assets, shocks to the foreign country that decrease foreign asset prices can lower the value of the domestic investor’s collateral and therefore lower domestic borrowing and consumption because of a tighter collateral constraint. Mendoza’s paper is a contribution toward understanding if the effects of collateral constraints matter quantitatively for macroeconomic aggregates. Specifically, under standard assumptions on economic behavior, would we ever expect these constraints to have large macroeconomic effects? If so, what are the conditions for that to happen? Mendoza shows that, in fact, introducing collateral constraints into a standard quantitative theoretical framework can result in financial crises as infrequent, but recurrent, events. Importantly, a shock does not need to be exceptionally large or of unusual nature for a financial crisis to occur. The buildup of debt can bring the economy close Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 29 to its collateral constraint, when a small shock can are silent on the effects of financial frictions and trigger the declining asset price–collateral–bor- the transmission of shocks through financial inter- rowing cycle described above. This type of event mediaries, but Dib’s work presents a framework in would be infrequent because households typically which these effects can be studied. He finds that accumulate precautionary savings, which keeps the presence of an active banking sector with a them out of the region of debt where constraints frictional interbank market can amplify the effects threaten to bind. of supply-side shocks but dampen the effects Two other papers in the conference, by Igor of financial shocks. In addition, his framework Livshits from the University of Western Ontario provides a role for the sorts of unconventional (coauthored with Koen Schoors from the Uni- monetary policies pursued by the Fed and many versity of Ghent) and Ali Dib from the Bank of central banks over the past year, including liquidity Canada, illustrate the role of the banking sector in injections and asset swaps. the transmission of shocks. Regulation on banks’ The overall lessons from the papers at this capital adequacy and leverage has been at the conference reflect the progress that comes with center of the discussion on reforming the financial sharing insights among researchers working in system, so it is important to understand the bank- various fields. Indeed, some of the clearest implica- ing system and how bank regulation affects the tions for understanding the current crisis in the economy. U.S. may come from the work on emerging-market Livshits’ paper addresses questions on how debt crises, as in the papers presented by Mendoza banking regulation should respond to changes in and Korinek. Another theme of the conference the riskiness of assets. Prudential banking regula- papers, aside from the topics each one addressed, tion aims to curtail excessive risk taking, and it is was the integration of the analysis of “normal” eco- standard practice to do this by providing incen- nomic conditions with the study of crisis periods. tives for banks to hold safe assets. However, when From the perspective of understanding why crises the risk of safe assets rises, the failure of banking happen and what the policy implications are, this regulation to recognize this change can make the is an extremely important step. The policy implica- banking system vulnerable. Livshits illustrates this tions of some of the work presented at the confer- with a stark example: In 1998, bank regulation in ence reflect the importance of this integration. Russia considered the government’s debt to be For example, both Korinek and Jeanne’s results safe, even as the risk of default on this debt was and Mendoza’s paper show that it is important to rising. This policy encouraged banks to gamble on consider how policies affect the incentives to accu- risky currency securities to the point that when the mulate debt before a crisis. More generally, many government did finally default, the banking system of the other papers presented illustrate the need to crashed. This paper, therefore, carries important understand the degree of integration of financial lessons on the effects of bank regulation and raises markets and the channels of financial transmisquestions about the best way to induce efficient sion in order to form policy that works through investment by banks. their operation. The overall picture is encouraging Dib’s paper makes progress on understanding for future research developing these ideas further. the macroeconomic effects of banking by introducing a banking sector that intermediates credit into a variant of the models used by many central banks for policy analysis. Typically, these models —Ananth Ramanarayanan 30 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Globalization and Monetary Policy Institute Publications Abstracts of Working Papers Issued from October 2008 through October 2009 No. 21 No. 22 Vertical Specialization and Interna- The Taylor Rule and Forecast Intervals tional Business Cycle Synchronization for Exchange Rates Costas Arkolakis and Ananth Ramanarayanan Jian Wang and Jason J. Wu Abstract: We explore the impact of vertical spe- Abstract: This paper attacks the Meese–Rogoff cialization—trade in goods across multiple stages (exchange rate disconnect) puzzle from a dif- of production—on the relationship between trade ferent perspective: out-of-sample interval fore- and international business cycle synchroniza- casting. Most studies in the literature focus on tion. We develop a model in which the degree of point forecasts. In this paper, we apply Robust vertical specialization is endogenously determined Semi-parametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for by comparative advantage across heterogeneous goods and varies with trade barriers between twelve OECD exchange rates are generated, and countries. We show analytically that fluctuations modified tests of Giacomini and White (2006) are in measured productivity in our model are not conducted to compare the performance of Taylor linked across countries through trade, despite the rule models and the random walk. Our contribu- greater transmission of technology shocks implied tion is twofold. First, we find that in general, Taylor by higher degrees of vertical specialization. In rule models generate tighter forecast intervals than numerical simulations, we find this transmission the random walk, given that their intervals cover is insufficient in generating substantial depen- out-of-sample exchange rate realizations equally dence of business cycle synchronization on trade well. This result is more pronounced at longer hori- intensity. zons. Our results suggest a connection between exchange rates and economic fundamentals: Published as “Vertical Specialization and Inter- economic variables contain information useful national Business Cycle Synchronization” in in forecasting the distributions of exchange rates. Scandinavian Journal of Economics, vol. 111, no. 4, The benchmark Taylor rule model is also found to 2009, pp. 655–80. perform better than the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper. Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 31 No. 23 after G7 meetings, but not at longer horizons. Exchange Rate Pass-Through in a While the success of the G7 is partly dependent on Competitive Model of Pricing-to-Market the market environment, it is also to a significant Raphael Auer and Thomas Chaney degree endogenous to the policy process itself. The Abstract: This paper extends the Mussa and Rosen findings indicate that the reputation and cred- (1978) model of quality-pricing under perfect ibility of the G7, as well as its ability to form and competition. Exporters sell goods of different communicate a consensus among individual G7 qualities to consumers who have heterogeneous members, are important determinants for the G7’s preferences for quality. Production is subject to de- ability to manage major currencies. The paper concreasing returns to scale and, therefore, supply and cludes by analyzing the factors that help the G7 the toughness of competition react to cost changes build reputation and consensus and by discussing brought about by exchange rate fluctuations. First, the implications for global economic governance. we predict that exchange rate shocks are imperfectly passed through into prices. Second, prices of Published as “How Successful Is the G7 in Manag- low quality goods are more sensitive to exchange ing Exchange Rates?” in the Journal of Internation- rate shocks than prices of high quality goods. al Economics, vol. 79, no. 1, 2009, pp. 78–88. Third, in response to an exchange rate appreciation, the composition of exports shifts towards No. 25 higher quality and more expensive goods. We test Do China and Oil Exporters Influence these predictions using highly disaggregated price Major Currency Configurations? and quantity U.S. import data. We find evidence Marcel Fratzscher and Arnaud Mehl that in response to an exchange rate appreciation, Abstract: This paper analyses the impact of the the composition of exports shifts towards high unit shift away from a U.S. dollar focus of systemically price goods. Therefore, exchange rate pass-through important emerging market economies (EMEs) rates that are measured using aggregate data will on configurations between the U.S. dollar, the tend to overstate the actual extent of pass-through. euro and the yen. Given the difficulty that fixed or managed U.S. dollar exchange rate regimes remain Published as “Exchange Rate Pass-Through in a pervasive and reserve compositions mostly kept Competitive Model of Pricing-to-Market” in Jour- secret, the identification strategy of the paper is nal of Money, Credit and Banking, Supplement to to analyse the market impact on major currency vol. 41, no. 1, 2009, pp. 151–75. pairs of official statements made by EME poli- No. 24 cymakers about their exchange rate regime and reserve composition. Developing a novel database How Successful Is the G7 in Managing for 18 EMEs, we find that such statements not only Exchange Rates? have a statistically but also an economically sigMarcel Fratzscher nificant impact on the euro, and to a lesser extent Abstract: The paper assesses the extent to which the yen against the U.S. dollar. The findings suggest the Group of Seven (G7) has been successful in its that communication hinting at a weakening of management of major currencies since the 1970s. EMEs’ U.S. dollar focus contributed substantially to Using an event-study approach, the paper finds the appreciation of the euro against the U.S. dollar evidence that the G7 has been overall effective in recent years. Interestingly, EME policymakers in moving the U.S. dollar, yen and euro in the in- appear to have become more cautious in their tended direction at horizons of up to three months communication more recently. Overall, the results 32 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report underscore the growing systemic importance of to hold diversified portfolios. We show that the EMEs for global exchange rate configurations. interaction of the following ingredients generates a realistic equity home bias: capital accumulation, Published as “Do China and Oil Exporters Influ- shocks to the efficiency of physical investment, as ence Major Currency Configurations?” in Journal well as international trade in stocks and bonds. of Comparative Economics, vol. 37, no. 3, 2009, pp. In our model, domestic stocks are used to hedge 335–58. fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local No. 26 goods and in foreign goods. In contrast to related Monthly Pass-Through Ratios models, the low level of international diversifica- Marlene Amstad and Andreas M. Fischer tion does not depend on strongly countercyclical Abstract: This paper estimates monthly pass- terms of trade. The model also reproduces the through ratios from import prices to consumer cyclical dynamics of foreign asset positions and of prices in real time. Conventional time series meth- international capital flows. ods impose restrictions to generate exogenous shocks on exchange rates or import prices when Published as “International Portfolios, Capital estimating pass-through coefficients. Instead, Accumulation and Foreign Assets Dynamics” in a natural experiment based on data releases Journal of International Economics, vol. 80, no. 1, defines our shock to foreign prices. Our estimation 2010, pp. 100–12. strategy follows an event-study approach based on monthly releases in import prices. Projections No. 28 from a dynamic common factor model with daily Investment and Trade Patterns in a panels before and after monthly releases of import Sticky-Price, Open-Economy Model prices define the shock. This information shock Enrique Martínez-García and Jens Søndergaard allows us to recover a monthly pass-through ratio. Abstract: This paper develops a tractable two- We apply our identification procedure to Swiss country DSGE model with sticky prices à la Calvo prices and find strong evidence that the monthly (1983) and local-currency pricing. We analyze pass-through ratio is around 0.3. Our real-time the capital investment decision in the presence of estimates yield higher pass-through ratios than adjustment costs of two types, the capital adjust- time series estimates. ment cost (CAC) specification and the investment adjustment cost (IAC) specification. We No. 27 compare the investment and trade patterns with International Portfolios, Capital Accu- adjustment costs against those of a model without mulation and Foreign Assets Dynamics adjustment costs and with (quasi-) flexible prices. Nicolas Coeurdacier, Robert Kollmann and We show that having adjustment costs results Philippe Martin into more volatile consumption and net exports, Abstract: Despite the liberalization of capital and less volatile investment. We document three flows among OECD countries, equity home bias important facts on U.S. trade: a) the S-shaped remains sizable. We depart from the two familiar cross-correlation function between real GDP and explanations of equity home bias: transaction the real net exports share, b) the J-curve between costs that impede international diversification, terms of trade and net exports, and c) the weak and terms of trade responses to supply shocks that and S-shaped cross-correlation between real GDP provide risk sharing, so that there is little incentive and terms of trade. We find that adding adjustment Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 33 costs tends to reduce the model’s ability to match tral monetary authority. When capital markets are these stylized facts. Nominal rigidities cannot ac- integrated, the fiscal policy of one country will in- count for these features either. fluence equilibrium wages and interest rates. Thus, there are fiscal spillovers within a federation. The Published as “Investment and Trade Patterns in a magnitude and direction of these spillovers, in par- Sticky-Price, Open-Economy Model” in The Eco- ticular the presence of a crowding out effect, can nomics of Imperfect Markets: The Effect of Market be influenced by the choice of monetary policy Imperfections on Economic Decision-Making, rules. We find that there does not exist a monetary Giorgio Calcagnini and Enrico Saltari, ed., New policy rule that completely insulates agents in one York: Springer, 2009 region from fiscal policy in another. Some familiar policy rules, such as pegging an interest rate, can No. 29 provide partial insulation. Monetary Policy Strategy in a Global Environment No. 31 Philippe Moutot and Giovanni Vitale Fiscal Stabilization with Partial Abstract: Since the mid-1980s the world economy Exchange Rate Pass-Through has gone through profound transformations of Erasmus K. Kersting which the sources and effects are probably not yet Abstract: This paper examines the role of fiscal sta- completely understood. The process of continu- bilization policy in a two-country framework that ous integration in trade, production and financial allows for a general degree of exchange rate pass- markets across countries and economic regions— through. I derive analytical solutions for optimal which is what is generally defined as “globaliza- monetary and fiscal policy which are shown to tion”—affects directly the conduct of monetary depend on the degree of pass-through. In the case policy in a variety of respects. The aim of this paper of partial pass-through, an optimizing policymaker is to present an overview of the structural implica- uses countercyclical fiscal stabilization in addition tions of globalization for the domestic economies to monetary stabilization. However, in the extreme of developed countries and to deduct from these cases of complete or zero pass-through, the fiscal implications lessons for the conduct of monetary stabilization instrument is not employed. There policy, and in particular the assessment of risks to is also no additional gain from the fiscal instru- price stability. ment in the case of coordination between the two countries. These results are due to the specific Published as “Monetary Policy Strategy in a Global way the optimal fiscal policy rule affects marginal Environment, “ European Central Bank, Occasion- costs: Rather than being a substitute for monetary al Paper, no. 106, August 2009. policy, fiscal policy complements it by increasing the correlation of the marginal cost terms within No. 30 and across countries. This in turn makes monetary Insulation Impossible: Fiscal policy more effective at stabilizing them. Spillovers in a Monetary Union Russell Cooper, Hubert Kempf and Dan Peled Abstract: This paper studies the effects of monetary policy rules in a monetary union. The focus of the analysis is on the interaction between the fiscal policy of member countries (regions) and the cen- 34 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report No. 32 domestic inflation rates by estimating a structural Has Globalization Transformed U.S. model for a sample of G-7 economies. The model Macroeconomic Dynamics? can capture the potential effects of global output Fabio Milani fluctuations on both the aggregate supply and the Abstract: This paper estimates a structural New aggregate demand relations in the economy, and it Keynesian model to test whether globalization is estimated using full-information Bayesian meth- has changed the behavior of U.S. macroeconomic ods. The empirical results reveal a significant effect variables. Several key coefficients in the model— of global output on aggregate demand in most such as the slopes of the Phillips and IS curves, countries. Through this channel, global economic the sensitivities of domestic inflation and output conditions can indirectly affect inflation. The to “global” output, and so forth—are allowed in the results, instead, do not seem to provide evidence estimation to depend on the extent of globalization in favor of altering domestic Phillips curves to in(modeled as the changing degree of openness to clude global slack as an additional driving variable trade of the economy), and, therefore, they be- for inflation. come time-varying. The empirical results indicate that globalization can explain only a small part of No. 34 the reduction in the slope of the Phillips curve. The Should Monetary Policy sensitivity of U.S. inflation to global measures of “Lean or Clean”? output may have increased over the sample, but William R. White it remains very small. The changes in the IS curve Abstract: It has been contended by many in the caused by globalization are similarly modest. Glo- central banking community that monetary policy balization does not seem to have led to an attenu- would not be effective in “leaning” against the ation in the effects of monetary policy shocks. The upswing of a credit cycle (the boom) but that nested closed economy specification still appears lower interest rates would be effective in “cleaning” to provide a substantially better fit of U.S. data than up (the bust) afterwards. In this paper, these two various open economy specifications with time- propositions (can’t lean, but can clean) are exam- varying degrees of openness. Some time variation ined and found seriously deficient. In particular, it in the model coefficients over the postwar sample is contended in this paper that monetary policies exists, particularly in the volatilities of the shocks, designed solely to deal with short-term problems but it is unlikely to be related to globalization. of insufficient demand could make medium-term problems worse by encouraging a buildup of debt No. 33 that cannot be sustained over time. The conclusion Global Slack and Domestic Inflation reached is that monetary policy should be more Rates: A Structural Investigation for focused on “preemptive tightening” to moderate G-7 Countries credit bubbles than on “preemptive easing” to Fabio Milani deal with the aftereffects. There is a need for a new Abstract: Recent papers have argued that one im- macrofinancial stability framework that would plication of globalization is that domestic inflation use both regulatory and monetary instruments to rates may have now become more a function of resist credit bubbles and thus promote sustainable “global,” rather than domestic, economic condi- economic growth over time. tions, as postulated by closed-economy Phillips curves. This paper aims to assess the empirical importance of global output in determining Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 35 No. 35 if the power of the corresponding short-horizon European Hoarding: Currency Use regression is low. We simulate population R- Among Immigrants in Switzerland squared for long-horizon regressions in the latter Andreas M. Fischer setting, using Monetary and Taylor rule models of Abstract: Do immigrants have a higher demand exchange rates calibrated to the data. Simulations for large-denominated banknotes than natives? show that long-horizon regression can have sub- This study examines whether cash orders for CHF stantial forecasting power for exchange rates. 1000 notes, a banknote not used for daily transactions, is concentrated in Swiss cities with a high No. 37 foreign-to-native ratio. Controlling for a range of Global, Local, and Contagious Inves- socio-economic indicators across 250 Swiss cities, tor Sentiment European immigrants in Switzerland are found to Malcolm Baker, Jeffrey Wurgler and Yu Yuan hoard fewer CHF 1000 banknotes than natives. A Abstract: We construct indexes of investor senti- 1 percent increase in the immigrant-to-native ratio ment for six major stock markets and decompose leads to a reduction in currency orders by CHF them into one global and six local indexes. Relative 4000. This negative correlation between immi- market sentiment is correlated with the relative grant-to-native ratio and currency orders for CHF prices of dual-listed companies, validating the in- 1000 notes holds irrespective of the European dexes. Both global and local sentiment are contrar- immigrants’ country of origin. Hoarding of large- ian predictors of the time series of major markets’ denominated banknotes by natives is attributed to returns. They are also contrarian predictors of the tax avoidance. time series of cross-sectional returns within major markets: When sentiment from either global or No. 36 local sources is high, future returns are low on Can Long-Horizon Forecasts Beat the various categories of difficult-to-arbitrage and Random Walk Under the Engel–West difficult-to-value stocks. Sentiment appears to be Explanation? contagious across markets based on tests involv- Charles Engel, Jian Wang and Jason Wu ing capital flows, and this presumably contributes Abstract: Engel and West (EW, 2005) argue that to the global component of sentiment. as the discount factor gets closer to one, presentvalue asset pricing models place greater weight No. 38 on future fundamentals. Consequently, current A Model of International Cities: Impli- fundamentals have very weak forecasting power cations for Real Exchange Rates and exchange rates appear to follow approxi- Mario J. Crucini and Hakan Yilmazkuday mately a random walk. We connect the Engel– Abstract: We develop a model of cities each inhab- West explanation to the studies of exchange rates ited by two agents, one specializing in manufactur- with long-horizon regressions. We find that under ing, the other in retail distribution. The distribution EW’s assumption that fundamentals are I(1) and sector represents the physical transformation of all observable to the econometrician, long-horizon internationally traded goods from the factory gate regressions generally do not have significant to the final consumer. Using a panel of micro-pric- forecasting power. However, when EW’s assump- es at the city level, we decompose the cross-sec- tions are violated in a particular way, our analytical tional variance of long-run LOP deviations into the results show that there can be substantial power fraction due to distribution costs, trade costs and a improvements for long-horizon regressions, even residual. For the median good, trade costs account 36 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report for 50 percent of the variance, distribution costs components to estimate co-movements between account for 10 percent with 40 percent of the vari- remittances and output series. Empirical results ance unexplained. Since the sample of items in the indicate that remittances are countercyclical with data are heavily skewed toward traded goods, we all the home countries: Mexico, El Salvador and also decompose the variance based on the median Turkey. With respect to source countries, remitgood on an expenditure-weighted basis. Now the tances to Mexico are countercyclical with the tables turn, with distribution costs accounting for United States business cycle, while remittances 43 percent, trade costs 36 percent and 21 percent from the United States to El Salvador and remit- of the variance unexplained. tances from Germany to Turkey are strongly procyclical with output fluctuations in the source No. 39 country. The contribution of this paper to the State-Dependent Pricing, Local- literature is twofold: (1) I use high-frequency data Currency Pricing, and Exchange Rate (quarterly) for a relatively long period of time; Pass-Through and (2) I employ more recent and sophisticated Anthony Landry econometric techniques in the decomposition of Abstract: This paper presents a two-country DSGE the series into stochastic permanent and cyclical model with state-dependent pricing as in Dotsey, components. The existing literature lacks both of King, and Wolman (1999) in which firms price- these important aspects of my analysis. I show that discriminate across countries by setting prices in once both of these factors are incorporated into local currency. In this model, a domestic monetary the analysis, empirical results are more aligned to expansion has greater spillover effects to foreign prices and foreign economic activity than an otherwise identical model with time-dependent pricing. In addition, the predictions of the statedependent pricing model match the business- those predicted by economic theory. Working Papers Issued from October 2007 through September 2008 time-dependent pricing model when driven by No. 1 Is Openness Inflationary? Imperfect Competition and Monetary Market Power monetary policy shocks. Richard W. Evans No. 40 No. 2 A Monetary Model of the Exchange Rate with Informational Frictions cycle moments better than the predictions of the Business Cycles and Remittances: Can the Beveridge–Nelson Decomposition Provide New Evidence? Roberto Coronado Enrique Martínez-García Published as “A Model of the Exchange Rate with Informational Frictions,” in B.E. Journal of Macroeconomics, vol. 10, no. 1, 2010, Contributions, Article 2. Abstract: In this paper, I analyze the business cycle No. 3 International Trade in Durable Goods: Underproperties of remittances and output series for three pairs of countries: United States–Mexico, United States–El Salvador, and Germany–Turkey. Using an unobserved components state-space model (via the Beveridge–Nelson decomposition), I decompose the remittances and output series into stochastic permanent and cyclical components. I then use the resulting stationary cyclical standing Volatility, Cyclicality, and Elasticities Charles Engel and Jian Wang Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 37 No. 4 Cross-Border Returns Differentials Stephanie E. Curcuru, Tomas Dvorak and Francis E. Warnock Published as “Cross Border Returns Differentials” in Quarterly Journal of Economics, vol. 123, no. 4, 2008, pp. 1495–1530. No. 5 Production Sharing and Real Business Cycles in a Small Open Economy José Joaquín López No. 6 Driving Forces of the Canadian Economy: An Accounting Exercise Simona E. Cociuba and Alexander Ueberfeldt No. 7 Accounting for Persistence and Volatility of Good-Level Real Exchange Rates: The Role of Sticky Information Mario J. Crucini, Mototsugu Shintani and Takayuki Tsuruga No. 13 Globalization, Domestic Inflation and Global Output Gaps: Evidence from the Euro Area Alessandro Calza No. 14 The Effect of Trade with Low-Income Countries on U.S. Industry Raphael Auer and Andreas M. Fischer No. 15 Variety, Globalization, and Social Efficiency W. Michael Cox and Roy J. Ruffin No. 16 Technical Note on ‘The Real Exchange Rate in Sticky Price Models: Does Investment Matter?’ Enrique Martínez-García and Jens Søndergaard No. 17 The Real Exchange Rate in Sticky Price Models: Does Investment Matter? Published as “Accounting for Persistence and Volatility of Good-Level Real Exchange Rates: The Role of Sticky Information” in Journal of International Economics, In press accepted manuscript, 2010, doi:10.1016/j.jinteco.2010.01.003. Enrique Martínez-García and Jens Søndergaard No. 8 How Should Central Banks Define Price Stability? Sophie Guilloux and Enisse Kharroubi Mark A. Wynne No. 9 Country Portfolios in Open Economy Macro Models Michael B. Devereux and Alan Sutherland No. 10 Vehicle Currency Michael B. Devereux and Shouyong Shi No. 11 Globalization and Monetary Policy: An Introduction Enrique Martínez-García No. 12 Financial Globalization, Governance, and the Evolution of the Home Bias Bong-Chan Kho, René M. Stulz and Francis E. Warnock Published as “Financial Globalization, Governance, and the Evolution of the Home Bias” in Journal of Accounting Research, vol. 47, no. 2, 2009, pp. 597–635. No. 18 Some Preliminary Evidence on the Globalization–Inflation Nexus No. 19 Default and the Maturity Structure in Sovereign Bonds Cristina Arellano and Ananth Ramanarayanan No. 20 An International Perspective on Oil Price Shocks and U.S. Economic Activity Nathan S. Balke, Stephen P. A. Brown and Mine K. Yücel 38 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Facing Troubles in an Era of Globalization A Conversation with Nathan Sheets Reprinted from Southwest Q. For more than a year, we’ve been Economy, First Quarter 2009, trying to contain a global financial Federal Reserve Bank of Dallas crisis. What went wrong? A. The global economy has sustained the most Economist Nathan Sheets, intense and far-reaching financial shock in at least director of the Federal number of factors have contributed to it. Most Reserve Board’s Division of important, our major financial institutions weren’t International Finance, puts There’s plenty of blame to go around. We should a global perspective on the also include credit rating agencies, the regulators, current economic crisis and down in the capacity to analyze and understand the Fed’s response to it. the risk in the system. 50 years, a truly phenomenal financial shock. A managing risk in a careful and prudent way. corporate boards and investors. There was a break- A lot of folks see this crisis as first and foremost about housing. I see housing being more of a trigger that brought this failure of risk management to light. We’re now seeing those financial shocks having a real impact on spending, production and Q. What does all this mean for your GDP across the globe. I see this occurring through bailiwick—international finance? three important channels. A. The implications for the financial system are First, banks’ willingness to lend has signifi- profound. We’ve seen a huge increase in risk aver- cantly deteriorated, so firms and individuals aren’t sion among investors. We’ve seen marked stresses getting the credit they need. in various kinds of financial markets, ranging from very short-term interbank markets all the way to Second, we’ve seen a huge adverse wealth shock. With stock markets down as much as 50 longer-term debt markets. Equity prices have fallen percent and housing prices falling in a number of significantly. There aren’t many markets that have countries, people don’t have the balance sheets to escaped the blow. sustain spending. Third, the financial developments have hit consumer and business confidence. It’s true in the Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 39 U.S., U.K. and euro area, where the financial shock Q. How does the international dimen- has been intense, but it’s also true in emerging- sion affect the Fed’s analysis and market economies, where they didn’t have the actions? financial exposure. A. Let me give you a concrete example. Many financial institutions outside the U.S. have had Q. How has the accelerating global- significant demand for short-term dollar fund- ization of recent decades shaped this ing. They made loans to corporations in dollars or crisis? bought U.S.-denominated assets, and they needed A. The fact that we’re more globalized now has dollars to fund those assets. I can’t think of a previ- been one of the extraordinary features of this crisis. ous instance of financial stress associated with You look at trends in many financial markets—the such pronounced demand for dollars outside our U.S. line, the U.K. line, the euro-area line, the Japan borders. line—and they’re all moving together more or less The interbank markets these institutions in lockstep. The degree of integration has been depended on for funding essentially froze up last phenomenal. fall, and it created huge excess demand for short- Part of that is a reflection of the fact that term dollar liquidity abroad. Many of these foreign our financial markets were highly integrated, so institutions would come to New York or other U.S. subprime loans issued here ended up on foreign markets in search of dollars, so it would at times balance sheets. We’re also very integrated through spill over into our markets and create stresses. trade channels, meaning that the slowdown that’s In response, the Fed joined with other major occurred as a result of this financial shock has hit central banks to create a network of swap facili- other economies and fed back into ours. ties, where we provide foreign central banks dollar One way of framing this is the debate about liquidity and they give us an equivalent amount decoupling. If the U.S. economy slows or U.S. of their currencies. They then lend these dollars to financial markets encounter problems, what does financial institutions in their economies that need that mean for the rest of the world? There really them. There’s very little risk for the Fed. We have was quite an argument about decoupling until claims on the foreign central banks as well as hold- about six months ago, centered on the question of ings of their currencies to protect us. whether other countries could avoid the troubles We have had to extend the scope and influ- brewing in the United States. Now, it’s clear that we ence of our liquidity facilities beyond our national rise and fall together. borders, and that’s been a new challenge. Given the degree of integration and similar failures of risk management across the world, I Q. Has globalization put greater think this episode is in some sense deeper than it emphasis on cooperation with other would have been otherwise. central banks? That doesn’t mean that there aren’t many A. Absolutely. Central banks regularly commu- positive factors from globalization. There are nicated through mechanisms that were already important efficiency gains, for example, but we’re in place, but the global stresses we’ve been facing seeing that we’re tied together and that we have have made it all the more important that central many common vulnerabilities and shortcomings. banks interact to keep each other informed and, We need to work together to manage these chal- where possible, even coordinate policy. lenges and the responses to them. The swap agreements are an important example of this. Another is the coordinated inter- 40 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report est rate cuts by the Fed and other central banks the moment is the so-called financial accelerator in early October. Easing monetary policy was in effect, where sharp declines in asset prices hit the the interest of each of these economies, but there’s balance sheets of firms and individuals and make a strong additional statement that’s made when them less creditworthy. This can be a mechanism central banks show they’re cooperating to address through which these kinds of financial shocks eat global problems. into the economy and become quite intense. Another current issue is the zero lower Q. What else will help us deal with bound. What are the implications for policy and global financial threats? the economy once short-term interest rates, the A. These aren’t just Fed issues but matters of the traditional tool for monetary policy, have been cut broader financial architecture. We need better to nearly zero. What’s the next step? mechanisms to address problems faced by very large institutions that can be seen as too big to fail. Q. How will this financial crisis affect We also need a well-articulated resolution process the pace of globalization? for a wider range of financial institutions. We have A. If anything, it may accelerate globalization in a good mechanism for addressing commercial the sense that we’re now very aware that we need banks under stress, but there’s nothing comparable to work closely together with other countries on for some other types of institutions. such things as financial-sector supervision and rating assets. Major financial institutions are truly Q. More broadly, has globalization global in scope, and if we’re approaching things affected the way the Federal Reserve one way and the French another and the Germans does its job? another and the British another, it creates disso- A. It’s certainly different. These dollar-funding nance in the global economy. pressures I mentioned earlier are a manifestation The leaders of the G-20 economies met in No- of just how much things have changed. We see this vember in Washington, and they’re going to meet increased interdependence among economies again in early April in London. They’re in the midst and the need for collaboration among central of addressing many of these issues in a global way, banks and regulators in various countries. and I think we’ll find that process has some staying Some people have argued that the effective- power. We’ll end up more integrated, more coher- ness of monetary policy is being diminished, ent and more consistent across countries than we and I don’t see that. Globalization has shifted were before this crisis erupted. the range of variables and the things you need to Along the way, there’s risk of protectionism think about. You need to focus not only on what’s emerging. History teaches that we’re more pros- going on within your own borders and your own fi- perous if we’re open rather than closed—especially nancial markets but also on what’s going on in the at times like this. Think about what happened rest of the world and in global financial markets. in the Great Depression, when countries put up There are feedback effects that are significant for sizable tariffs and global trade collapsed. That can assessing economic conditions and making policy start a downward spiral for the global economy, so decisions. we have to guard very forcefully against protec- We’re constantly trying to expand our analytical tool kit and improve our understanding of how economies and policies work. It’s not explicitly global, but one issue we’re thinking hard about at tionism. Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 41 Who’s Who at the Institute Director of the Institute Senior Fellows Mark A. Wynne joined the Federal Reserve Bank Marianne Baxter is a professor of economics at of Dallas in 1989 and is currently a senior econo- Boston University. Her research interests include mist and vice president. He is widely published macroeconomics, international economics and in many leading professional journals. During finance. Baxter’s current work studies the effect 1997–98, Wynne worked on issues related to of alternative monetary policy rules in highly monetary policy strategy under economic and integrated, globalized industrial economies. She monetary union for the European Monetary previously taught at the Universities of Virginia, Institute and, later, the European Central Bank. Rochester and California, Santa Barbara. She also He holds first-class honors B.A. and M.A. degrees served on the president’s advisory committee at from the National University of Ireland (University the Federal Reserve Bank of New York and has College, Dublin) and an M.A. and a Ph.D. from the been a visiting scholar at the Federal Reserve University of Rochester. Banks of Richmond, New York, Chicago and Minneapolis. Baxter received a B.A. in economics and Advisory Board Chairman statistics from the University of Rochester and her John B. Taylor is Mary and Robert Raymond Ph.D. in economics from the University of Chicago. Professor of Economics at Stanford University. He is a globally recognized expert on international W. Michael Cox is director of the O'Neil Center for monetary and financial issues and has produced Global Markets and Freedom at Southern Method- extensive research on monetary policy, fiscal ist University's Cox School of Business and former policy and international economic policy. Taylor senior vice president and chief economist at the is recognized throughout the economics profes- Dallas Fed. He is author of a host of essays and sion and within monetary policy circles as the reports that have received extensive attention from originator of the Taylor rule, a guiding principle for leading publications including the Wall Street Jour- macroeconomic stabilization followed by many nal, New York Times and USA Today. He is also central banks. He also serves as senior fellow at widely published in the nation's leading economic the Hoover Institution and Stanford Institute for journals. Cox received an undergraduate degree Economic Policy Research, was founding director in business and economics from Hendrix College of the Stanford Introductory Economics Center and a Ph.D in economics from Tulane University. and is a research associate at the National Bureau of Economic Research. Taylor has many years of Mario Crucini is an associate professor of eco- distinguished service with the U.S. government, nomics at Vanderbilt University. He is currently most recently as undersecretary of Treasury for an associate editor of the Journal of International international affairs from 2001 to 2005. He was a Economics and the Journal of Money, Credit and member of the president’s Council of Economic Banking. He is also a member of the board of Advisers from 1989 to 1991. He received a B.A. in editors of the Review of International Economics. economics from Princeton University and a Ph.D. Crucini has written widely on international busi- in economics from Stanford University. ness cycles, the contribution of trade policy to the 42 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Great Depression and, most recently, international Francis E. Warnock is associate professor of pricing. He received a B.A. from the University of business administration at the Darden Graduate Western Ontario and an M.A. and Ph.D. from the School of Business at the University of Virginia. University of Rochester. He is currently a faculty research fellow at the National Bureau of Economic Research and a Michael B. Devereux is professor of economics research associate at the Institute for International at the University of British Columbia and a visiting Integration Studies at Trinity College Dublin. He scholar at the International Monetary Fund in was recently a consultant at the International Washington, D.C. He is widely published in leading Monetary Fund and a research fellow at the Hong economic journals and is associate editor of the In- Kong Monetary Authority. In addition, he served ternational Journal of Central Banking. He received for several years as senior economist in the Intera B.A. in economics and politics and an M.A. in national Finance Division at the Federal Reserve economics from University College, Dublin, and a Board. Warnock received a B.A. from Johns Hop- Ph.D. from Queen’s University, Kingston, Ontario. kins University and Ph.D. from the University of North Carolina at Chapel Hill. Charles Engel is professor of economics at the University of Wisconsin–Madison and a research Institute Staff Economists associate of the National Bureau of Economic Simona E. Cociuba joined the Dallas Fed in 2007. Research. He has written extensively on exchange Her major fields of concentration are macroeco- rate determination. He is currently coeditor of the nomics, growth and development. She received Journal of International Economics and has been a a Ph.D. in economics from the University of Min- visitor or consultant to many central banks, includ- nesota. ing the Board of Governors of the Federal Reserve, De Nederlandsche Bank, Reserve Bank of Austra- Anthony Landry joined the Federal Reserve Bank lia, Bank of England and several Federal Reserve of Dallas in 2006. Previously, he worked at the Banks. He received a B.A. from the University of Bank of Canada. Landry’s recent research focuses North Carolina at Chapel Hill and a Ph.D. from the on the effects of nominal rigidities in the context of University of California–Berkeley. open-economy macroeconomic models. He holds an M.A. in economics from McGill University and Karen Lewis is the Joseph and Ida Sondheim Pro- a Ph.D. in economics from Boston University. fessor in International Economics and Finance at the University of Pennsylvania’s Wharton School. Enrique Martínez-García’s main research In that position, she also serves as codirector of the interests are in the fields of international macroWeiss Center for International Financial Research. economics and finance, monetary economics and She has served as associate editor for a host of applied econometrics. Previously, Martínez-García publications and is regularly cited for her work in was a teaching and research assistant at the Univer- international financial markets and monetary eco- sity of Wisconsin–Madison and at the university’s nomics. Lewis received a B.A. from the University Center for World Affairs and the Global Economy. of Oklahoma and an M.A. and a Ph.D. from the He also worked at the Bank of England. He holds University of Chicago. a B.A. from the University of Alicante in Spain, an M.A. from the University of Pennsylvania and a Ph.D. from UW–Madison, all in economics. Globalization and Monetary Policy Institute 2009 Annual Report • FEDERAL RESERVE BANK OF DALLAS 43 Ananth Ramanarayanan joined the Dallas Fed Advisory Board Members in 2007, after receiving a Ph.D. in economics from Charles Bean the University of Minnesota. His research interests Deputy Governor are in the fields of international trade and macro- Bank of England economics. Martin Feldstein Jian Wang is a senior economist with primary George F. Baker Professor of Economics research interests in open-economy macroeco- Harvard University nomics, international finance and monetary and President Emeritus economics. Prior to joining the Bank, he taught at National Bureau of Economic Research the University of Wisconsin–Madison. He holds an M.A. from the University of Arkansas and a Ph.D. Heng Swee Keat in economics from UW–Madison. Managing Director Monetary Authority of Singapore Support Staff Janet Koech has been an economic analyst for the R. Glenn Hubbard Globalization and Monetary Policy Institute since Dean, Graduate School of Business October 2007. Koech holds B.A. and M.A. degrees Columbia University in economics from the University of Kansas. She is from Kenya. Otmar Issing President, Center for Financial Studies Hector Mendoza has been a research analyst for Frankfurt am Main, Germany the Globalization and Monetary Policy Institute since November 2009. He graduated from Finn Kydland Northwestern University with a B.S. in industrial Henley Professor of Economics engineering and received an M.S. in financial University of California, Santa Barbara and industrial economics from the University of Nobel Laureate (2004) London Royal Holloway College. He is a native of Mexico. Guillermo Ortiz Governor Patrick Roy began working at the Dallas Fed as a Banco de México research assistant in November 2007. He graduated from Bentley College in 2005 with a B.S. in Kenneth Rogoff economics. Roy was deployed to Iraq as a platoon Thomas D. Cabot Professor of Public Policy leader in 2006–07 and still serves as an officer in Harvard University the Texas Army National Guard. Masaaki Shirakawa Governor Bank of Japan William White Former Economic Adviser and Head Monetary and Economic Department Bank for International Settlements 44 Federal Reserve Bank of Dallas • Globalization and Monetary Policy Institute 2009 Annual Report Research Associates Erasmus Kersting Raphael Auer Southern Methodist University Swiss National Bank Enisse Kharroubi Chikako Baba Bank of France International Monetary Fund Robert Kollmann Claudio Borio European Centre for Advanced Research in Bank for International Settlements Economics and Statistics Alessandro Calza Fabio Milani European Central Bank University of California, Irvine Andrew Filardo Philippe Moutot Bank for International Settlements European Central Bank Andreas Fischer Shigenori Shiratsuka Swiss National Bank Bank of Japan Marcel Fratzscher Jens Søndergaard European Central Bank Bank of England Bill Gruben Giovanni Vitale Texas A&M International University European Central Bank Sophie Guilloux Yu Yuan Bank of France University of Iowa Ping He Tsinghua University